Category: Compensation & Employee Benefits;
International Copyright 1998, The Tax Resource Group. All rights reserved. Telephone 800-578-3498. Internet: www.taxresourcegroup.com For purposes of this memo, I will assume that the taxpayer's surrender of his "green card" in 1995 is legitimate and will be respected for tax purposes. I will also assume that the taxpayer does not meet the substantial presence test for U.S. resident status. Employee vs. Independent Contractor Issue Regarding the taxpayer's status as an independent contractor, I offer an excerpt from the IRS Worker Classification Training Manual which I believe fairly states the law in this area. Officers are specifically included within the definition of employee for purposes of FICA, FUTA, and federal income tax withholding. See IRC sections 3121(d)(1), 3306(i), and 3401(c). The common law standard is not applicable. The regulations provide that generally an officer of a corporation is an employee of the corporation. However, an officer is not considered to be an employee of the corporation if two requirements are met: (1) the officer does not perform any services or performs only minor services; and (2) the officer is not entitled to receive, directly or indirectly, any remuneration. Treas. Reg. section 31.3121(d)-1(b). The officer must meet both requirements to be excepted from employee status. In determining whether services performed by a corporate officer are considered minor or nominal, examine the character of the service, the frequency and duration of performance, and the actual or potential importance or necessity of the services in relation to the conduct of the corporation's business. It seems to me that receiving compensation of $10,000 per month falls far outside the limited exception set forth at Reg. Sec. 31.3121(d)-1(b) mentioned above. Accordingly, it seems fairly clear that the taxpayer must be treated as an employee both from the standpoint of determining his own tax consequences as well as with respect to the employment tax liability of the payor corporation. Further, it seems to me that this conclusion eliminates Article 14 of the Treaty from consideration. Treaty Protection for Compensation Having established the taxpayer must be viewed as an employee, the issue is whether there is any protection afforded by Article 15 of the U.S.-Mexico Tax Treaty. You are concerned that the employer's deduction of these amounts, which employer clearly has a permanent establishment in the source country, prevents the benefits conferred by Article 15. I think you are absolutely right: there is no Article 15 benefit to be had in this case. There are three prerequisites to the benefits of Article 15, and your client seems to meet only one of them. · The employee is present in the source state (in this case, the U.S.) for less than 184 days within a 12-month period; · the compensation is paid by or on behalf of an employer who is not a resident of the source state (the U.S. in this case); · the compensation is not deducted by a permanent establishment or fixed base the employer has in the source state (i.e., the U.S.). I think the taxpayer meets the first requirement only, and thus the compensation is taxable in the U.S. at regular graduated income tax rates. You know, of course, that as a nonresident alien, the taxpayer is taxed only on his U.S. source income. IRC Section 872(a)(2). With respect to compensation for services, only services performed within the U.S. are considered U.S. source income. See Section 862(a)(3). Accordingly, to the extent the taxpayer is compensated for work done outside the U.S., the income is not taxable in the U.S. Similarly, the U.S. corporation's liability for withholding taxes is relieved to the extent the employee in question is a nonresident alien and the services in question were performed outside the U.S. I have attached a memo I prepared recently for another client. Dividend Withholding Issue The availability of reduced dividend withholding rates under the treaty turns on whether the U.S. office is a permanent establishment with respect to your client's business of being an employee/officer. Article 10(5). Clearly, under Article 5(2)(c), an office is a permanent establishment with respect to the U.S. corporation's activities. In this case, however, there are two taxpayers: the corporation and the employee. As far as dividends are concerned, it is the owner of the dividends that must have the permanent establishment in order to spoil the benefits of reduced withholding rates under the treaty. Is the U.S. office a permanent establishment with respect to the individual's business of being an employee? It seems inconceivable to me that the business of being a company president could somehow be divorced from the place where the company has its only office, even though the president may in fact spend little time there. After all, it is not as if the taxpayer is just a traveling salesman; he is the president of the company. In fact, the taxpayer retained his office at company headquarters in Houston. I think that disposes of any remaining doubt. Accordingly, I believe the dividends are subject to regular U.S. rates, presumably withholding at the rate of 30% under Section 1441.  |