A 2002 law still governs income tax rates paid to non-U.S. citizens and corporations

By Edmund E. Brobesong

Brobesong

On Aug. 21, 2002, Public Law No. 107-212 incorporated the U.S. income tax treaty rates into the Organic Act of Guam. Therefore, Guam taxpayers apply U.S. income tax treaty rates with respect to payments made to foreign persons (effective for payments made after Aug. 21, 2002).

For example, dividends paid by a U.S. corporation to a Japan corporation are not subject to U.S. 30% withholding tax when the Japan corporation owns at least 50% of the stock of the U.S. corporation. Similarly, interest paid by a U.S. corporation to a Japan corporation is generally not subject to U.S. 30% withholding tax. For any payments made after Aug. 21, 2002, any dividends or interest paid by a Guam corporation to a Japan corporation would not be subject to Guam 30% withholding tax (where the payor otherwise satisfies the requirements of the Japan-United States income tax treaty).

Because the Guam Foreign Investment Equity Act of 2002 did not include the Northern Mariana Islands, NMI taxpayers cannot apply U.S. income tax treaty rates with respect to payments made to foreign persons. But NMI taxpayers can route their payments through Guam in an effort to benefit from the U.S. income tax treaty rates applicable in Guam.

A Japan corporation with an NMI subsidiary corporation operating a business in Saipan (or other island in the NMI) can establish a Guam corporation as a holding company to own the CNMI corporation.  Assuming that the NMI corporation is profitable, any dividends paid by the NMI corporation to the Guam holding company will be included in gross income (dividend income) of the Guam holding company.  However, the Guam holding company will be allowed the dividends received deduction if it owns at least 10% of the NMI corporation.  Thus, the NMI profits can be shifted from the NMI to Guam without any Guam income tax.  Thereafter, the Guam corporation can pay dividends to the Japan corporation without any Guam 30% withholding tax.

Similarly, the Japan corporation could loan money to the Guam holding company and the Guam holding company could loan money to the NMI corporation.  In this case, interest paid by the NMI corporation would be deducted by the NMI corporation and included in the gross income of the Guam holding company. Thus, the Guam corporation may have to pay Guam income tax of 21% on the interest income (which could be reduced by any available foreign tax credits).  A 21% Guam income tax is better than 30% withholding tax.

In turn, the Guam holding company could pay interest to the Japan corporation without any Guam 30% withholding tax.  In order to avoid the anti-conduit rules, the interest charged by the Guam holding company to the NMI corporation should be at least 1% more than the interest charged by the Japan corporation to the Guam holding company.

Rather than establishing a Guam corporation as the holding company, a Guam limited liability company could be established as the holding company. By making use of the limited liability company laws of Guam and the NMI, foreign investors may be able to use the provisions of the Guam and NMI mirror codes (as well as the Guam Foreign Investment Equity Act) to take earnings out of Guam and NMI without any liability for Guam or NMI 30% withholding tax.

— Edmund E. Brobesong is the senior manager of the tax group at Ernst & Young, Guam. He can be reached at [email protected].