A foreign person (including a corporation) that is engaged in a U.S. trade or business generally is subject to tax on a net basis on its effectively connected income at a rate of 35%.
U.S. federal income tax law provides a safe harbor by exempting from U.S. trade or business status trading for one’s own account in stocks, securities (including debt instruments), commodities, and derivatives thereof. Most offshore funds rely on this exemption. The safe harbor does not apply to persons that are characterized as dealers for U.S. federal income tax purposes or for activities outside the scope of the exemption.
Many offshore corporations file a protective tax return to ensure both the ability to claim deductions as well as the running of a statute of limitations even though the safe harbor exemption should be available.
In general, the Internal Revenue Code provides that a foreign corporation will receive the benefit of deductions and credits only by “filing or causing to be filed with the Secretary a true and accurate return.” Treasury regulations generally provide that such a return is timely only if it is filed within 18 months of the ordinary due date for the return.
In Swallows Holding, Ltd. v. Commissioner, 126 T.C. No. 6 (Jan. 26, 2006), the Tax Court has ruled that the timely filing requirement in the regulations is invalid.