Internal Revenue Service
Revenue Ruling

TaxLinks.com   sm

 Rev. Rul. 75-23

1975-1 C.B. 290

Sec. 864
Sec. 875
Sec. 881
Sec. 882
Sec. 1441
Sec. 1442

IRS Headnote

Withholding; Netherlands Antilles corporation member of U.S. partnership. A foreign corporation formed under the laws of the Netherlands Antilles for the purpose of investing foreign capital in major commercial real estate projects in the U.S. through a limited U.S. partnership of which it is a limited partner is considered to be engaged in the business of the partnership and the distributive share of partnership income is taxable to it under section 882 of the Code and is not subject to U.S. withholding under section 1442. Further, pursuant to Article XII of the U.S.-Netherlands convention as extended to the Netherlands Antilles, dividends and interest paid by the corporation are not subject to U.S. tax unless the recipient is a citizen, resident, or corporation of the U.S.

Full Text

Rev. Rul. 75-23

Advice has been requested whether certain amounts paid to and by the taxpayer will be subject to United States withholding under sections 1441 and 1442 of the Internal Revenue Code of 1954 under the circumstances described below.

The taxpayer, N, is a foreign corporation organized pursuant to the laws of the Netherlands Antilles and a limited partner in P, a United States limited partnership. N was incorporated primarily to invest foreign capital through P in major commercial real estate projects in the United States. No United States person holds stock or notes of N. N raised the capital that it contributed to P by the issuance of its stock and notes to nonresident alien individuals and foreign corporations, including individuals and corporations of foreign countries other than the Netherlands and the Netherlands Antilles. It is assumed for purposes of this Revenue Ruling that the notes issued by N evidence bona fide indebtedness of N.

The business reason for incorporating N and interposing it between P and the foreign investors, in part, was that a corporation was more acceptable than a limited partnership as an investment vehicle to foreign investors because many foreign investors were unfamiliar with the concept of a United States limited partnership, the corporation's stock would be more freely and readily transferable than limited partnership interests, and in the absence of the corporation, all foreign investors, as limited partners in a partnership engaged in a United States trade or business, would have had to file individual United States income tax returns.

Although N's primary investments are made through P, N also invests directly in United States real property in which P has no interest. T, a domestic corporation, is the investment advisor to N on its direct investments. N maintains offices and has agents and employees in the Netherlands Antilles and the United States. N is subject to the tax laws of the Netherlands Antilles on its income from United States sources.

P's principal activity consists of making mortgage loans to, and equity investments in, major commercial real estate projects. P forms and invests in joint ventures with United States real estate developers. P makes new mortgage loans to joint ventures in which it has an equity interest and acquires existing mortgages that have arisen with respect to projects in which it has or will acquire an equity interest. All of P's investment decisions are made in the United States by T, which is the general partner in P. T carries out the daily business operations of P in the United States under a management agreement between P and T.

P distributes all of its income, gains, losses, deductions, and credits to its partners in a ratio of 90 percent to the limited partners and 10 percent to T, the general partner. N in turn, distributes all of its income as dividends and interest on its stock and notes. N's distributive share of the items of P is derived from rents, gains from the sale of real estate and interest from mortgage loans. N also receives income from its direct investments.

Article III of the 1948 Income Tax Convention between the United States and the Netherlands, as extended to the Netherlands Antilles, T.D. 5778, 1950-1 C.B. 92 (The Convention) provides, in effect, that a Netherlands Antilles corporation shall be subject to United States tax on its industrial or commercial profits derived from sources within the United States only if it is engaged in a trade or business in the United States through a permanent establishment. Section 505.105(a) of the regulations under the Convention that are applicable to the Netherlands Antilles provides, in part, that Article III has no application to income derived from real property located in the United States, including rentals and royalties therefrom, nor to gains from the sale or disposition of such property, nor to interest, dividends, royalties, other fixed or determinable annual or periodical income and gains derived from the sale or exchange of capital assets.

Article V of the Convention, as applicable to the Netherlands Antilles, provides that income of whatever nature derived from real property and interest from mortgages secured by real property shall be taxable only in the contracting state in which the real property is situated.

Under section 875(1) of the Code, a foreign corporation will be considered to be engaged in a trade or business within the United States if the partnership of which such corporation is a member is so engaged.

Section 1442 of the Code, which deals with withholding of tax on amounts paid to foreign corporations, provides for withholding at the source in the same manner and on the same items of income as provided in section 1441. Under section 1442(a) withholding is not required as to items of income that are effectively connected with the conduct of a trade or business within the United States and that are included in the gross income of the corporation under section 882(a).

Section 881(a) of the Code imposes a tax of 30 percent on certain items of income, including interest and dividends, received from sources within the United States, but only to the extent the amounts so received are not effectively connected with the conduct of a trade or business within the United States.

Section 882(a) of the Code provides, in part, that a foreign corporation engaged in trade or business within the United States shall be taxable as provided in section 11 or 1201(a) on its taxable income that is effectively connected with the conduct of a trade or business within the United States.

Section 864(c)(2) and (3) of the Code set forth the factors that are taken into account in determining whether income, gain, or loss of a foreign corporation engaged in trade or business in the United States are effectively connected with the conduct of such trade or business. With respect to income, capital gain, or loss from sources within the United States of the type described in section 881(a), section 864(c)(2) provides, in part, that the factors taken into account shall include whether (A) the income, gain, or loss is derived from assets used in or held for use in the conduct of such trade or business, or (B) the activities of such trade or business were a material factor in the realization of the income, gain, or loss.

Section 1.864-4(c)(3) of the Income Tax Regulations provides, in part, that the business activities test shall ordinarily apply in making a determination with respect to income, gain, or loss that, even though generally of the passive type, arises directly from the active conduct of a trade or business in the United States.

Section 864(c)(3) of the Code provides that all income, gain or loss from sources within the United States (other than income, gain, or loss to which section 864(c)(2) applies) shall be treated as effectively connected with the conduct of a trade or business within the United States. Section 1.864-4(b) of the regulations provides that all income, gain, or loss derived by a foreign corporation engaged in trade or business in the United States from sources in the United States that does not consist of income, gain, or loss described in section 881(a) of the Code or of gain or loss from the sale of capital assets shall be treated as effectively connected with the conduct of a trade or business in the United States.

Article XII of the 1948 Income Tax Convention between the United States and the Netherlands, T.D. 5778, 1950-1 C.B. 92, as extended to the Netherlands Antilles, by the Protocol that became effective on September 28, 1964 (The Convention) provides, in effect, that dividends and interest paid by a Netherlands Antilles corporation shall be exempt from United States tax unless the recipient is a citizen, resident, or corporation of the United States. Article XII of the Convention is applicable to dividends or interest paid by a corporation owned by persons other than residents of the Netherlands or the Netherlands Antilles, provided that such corporation is a bona fide corporation. See "Statement of Treasury Department with Respect to the Protocol Dated October 23, 1963, Amending the United States-Netherlands Income Tax Convention", 1965-1 C.B. 667, 669.

In the instant case, P, the limited partnership of which N is a limited partner, is engaged in the active conduct of a business in the United States involving the acquisition, management and disposition of commercial real estate. Section 875(1) of the Code, which attributes the United States trade or business of a partnership to partners that are foreign corporations, is not limited to general partners. Therefore, under section 875(1) N is also considered engaged in P's business. Moreover, under sections 864(c)(2) and (3) of the Code and the regulations thereunder, N's distributive share of the partnership income of P is effectively connected with the trade or business of N in the United States.

Based upon the foregoing it is held as follows:

(1) N's distributive share of the partnership income of P is taxable to N under section 882 of the Code and is not subject to United States withholding under section 1442.

(2) Under Article XII of the Convention dividends and interest paid by N on its stock and notes are exempt from United States taxation and withholding under sections 1441 and 1442 of the Code unless the recipient of such dividends or interest is a citizen, resident, or corporation of the United States.