Jurisdiction to Tax Income Earned in a Foreign Country

If a U.S. company performs a contract, provides services or does some type of work directly in a foreign country or through a branch in a foreign country, foreign tax could be imposed on the revenue earned in that country. If the United States has a tax treaty with the foreign country, the business profits earned from the U.S. company’s business activities in the foreign country generally are taxable in the foreign country only if the U.S. company has a permanent establishment which is an office, branch or fixed base in the foreign country. If the United States does not have a tax treaty with the foreign country, then other standards under foreign law could apply to determine if the foreign country has jurisdiction to tax the revenue earned by the U.S. company in the foreign country.

A U.S. company which earns revenue from business activities in a foreign country is taxable on its worldwide income on its U.S. federal tax return if it does not have a foreign subsidiary corporation. If a U.S. company earns revenue from conducting business activities directly in a foreign country or through a foreign branch, the foreign source income is taxable on the U.S. company’s U.S. federal tax return. The U.S. company would be entitled to a foreign tax credit subject to the applicable limitation on its U.S. federal tax return for the foreign taxes paid on the income earned in the foreign country.

A U.S. person who owns a foreign company that elects to be a foreign partnership or foreign disregarded entity for U.S. tax purposes is taxable on the income of the foreign company on its U.S. federal tax return. Similarly, losses of the foreign company treated as a pass-through for U.S. tax purposes will be reportable on the U.S. owner’s U.S. federal tax return subject to applicable basis limitation for foreign partnerships.

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