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Non-ECI Non-FDAP – how is US sourced income that is neither ECI nor FDAP taxed in the US if derived by a non-resident?
Non-ECI Non-FDAP
This is the point of contention. In the last episode Gary Carter outlined that all US-sourced income is taxable in the US unless there is a specific exemption.
James Baker of James Baker & Associates defends a different position in this episode. He argues that US-sourced income that is neither ECI nor FDAP is not taxable in the US if derived by a non-resident.
Here is what we learned but please listen in as James explains all this much better than we ever could.
To listen while you drive, walk or work, just access the episode through a free podcast app on your mobile phone.
Non-ECI Non-FDAP Income
Let use the example of an Australian Pty Ltd selling merchandise into the US from Australia. To what extent are the profits taxable in the US, disregarding the US – Australian Double Tax Agreement (‘DTA’ or ‘treaty’).
FDAP
Selling merchandise into the US is clearly not FDAP. FDAP stands for fixed or determinable annual or periodic income. So think of interest, dividends, royalties, salaries, wages, annuities and so on – any income you pay or receive following a certain formula. That is FDAP. Not the sale of inventory.
The taxation of FDAP is straight forward. If US-sourced and not connected to a US trade or business, the payer has to withhold 30% withholding tax unless a treaty applies.
ECI
If the Australian Pty Ltd has a US Trade or Business (‘USTB’) in the US and hence effectively connected income (‘ECI’) with this USTB, things are relatively clear as well. ECI is taxable in the US. Whoever this ECI is assigned to has to prepare a tax return and then pay tax in the US on this ECI unless a treaty applies.
Non-ECI Non-FDAP
Where it gets confusing is income that is neither ECI nor FDAP. How do you treat US-Sourced Non-ECI Non-FDAP? That is the point of contention
In the last two episodes Ross Treeby and Gary Carter argued that all US-sourced income is taxable in the US (disregarding any treaties). The only difference is how. So whether US-sourced income is ECI or not only matters for how it is taxed, not whether it is taxed. That is what Gary Carter said in the last US update.
But James Baker will argue in this episode that this is not correct. That a non-resident who derives income that is neither ECI nor FDAP has no taxable income in the US. And he bases his argument for ECI on s882 (a) (1) and for FDAP on s881 IRC.
s882 (a) (1) IRC
James Baker argues that s882 does not apply to non-ECI due to s882 (a) (1). He argues that a foreign corporation only needs to include income that is ECI.
s882 (a): “(1) In general
A foreign corporation engaged in trade or business within the United States during the taxable year shall be taxable as provided in section 11 or 59A, on its taxable income which is effectively connected with the conduct of a trade or business within the United States.”
s881 (a) IRC
And then there is s881 (a) that lists various forms of FDAP income (fixed or determinable annual or periodic) such as interest, dividends, royalties, wages, salaries, annuities and so on.
s881: “(a) Imposition of tax
Except as provided in subsection (c), there is hereby imposed for each taxable year a tax of 30 percent of the amount received from sources within the United States by a foreign corporation as—…”
Conclusion
And that’s it, James Baker argues. Any income that is neither ECI nor FDAP is not taxable in the US if derived by a foreign corporation. You don’t even need the treaty to pull you out.
In US 17 we will look at this issue again.
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Last Updated on 16 December 2022
Tax Talks spoke to James Baker - Chief Operating Officer at James Baker and Associates - for more details.
