Mutiple choice question : Alexandra, a country X citizen, resident and domicilia

ID: 2446971 • Letter: M

Question

Mutiple choice question : Alexandra, a country X citizen, resident and domiciliary and a foreign taxpayer for all U.S tax purposes, forms and owns 100% of RealCO, a Pennsylvania corporation, in order to invest in Pennsylvania real estate projects. The U.S. and country X do not have any income tax treaty. In an effort to reduce overall U.S. income tax by generating an interest deduction, Alexandra forms RealCo with a loan of $300,000 and with an equity contribution of $350,000. Before making the loan, Alexandra had the $300,000 invested in a 5% interest rate certificate of deposit with a Pennsylvania bank. Assuming RealCo pays Alexandra 5%interest of $15,000 in interest annually and assuming RealCo is in the 35% tax bracket, the net overall annual U.S income tax savings as to Alexandra and RealCo will be: (Explain your answer)

A) $750

B) $5,250

C) $0

D) $4,500

Explanation / Answer

Taxation of Non Residents – A non-resident is subject to U.S. tax on income earned from U.S. sources.

Income from U.S. sources is put in two categories.

(‘1) Income from investment and other passive income- No deduction is allowed for income which falls in this category. Income of these sources is taxed at flat rate of 30 % unless a treaty is made for lower tax.

(‘2) Business income- This includes income which is related with U.S. trade or business and also includes compensation for services rendered in U.S. This is taxed at graduated slab rate as applicable to U.S. residents.

Overall taxability of Alexandra and Real Co is summarised as under.

Particulars

Amount

Tax Saving to Real Co on payment of interest to Alexandra (15000 x 35 %)

5,250

Tax payable by Alexandra on interest received from Real Co ( 15,000 x 30 %) ( Taxable at flat rate of 30 %)

(4500)

Overall Tax Saving

750

Answer- Option A is correct answer.