Private Letter Ruling 9413005, 01/06/1994, IRC Sec(s). 641

UIL No. 9114.03-13; 0641.02-00; 0662.00-00; 0661.01-02

Date: January 6, 1994

District Director: ***

Taxpayer's Name: ***

Taxpayer's Address: ***

Taxpayer's EIN: ***

Year(s) Involved: ***

LEGEND:

D = ***

A = ***

State Y = ***

Dear ***

This is in reply to your request for Technical Advice which was dated October 4, 1993 and was received in the Office of Associate Chief Counsel (Technical).

Issue

1. Whether the estate of D, a U.S. citizen domiciled in Germany on the date of death1 is a domestic estate?

2. Whether U.S. source income of the estate was properly taxed in the U.S. to the estate as a separate entity during the taxable years at issue?

Facts

In 1982, D, a U.S. citizen, was a resident and domiciliary of the United States. On November 15, 1982, D established an irrevocable trust, naming Bank A as the Trustee. The Trust was governed by the laws of State Y. The Trust corpus was comprised of U.S. securities, administered in the U.S. by a U.S. trustee, Bank A. The terms of the trust stated that upon the death of D, the assets of the Trust were to pass to the executor of her estate, absent the exercise of her general power of appointment. D did not exercise her power.

D moved to Germany in 1983 and executed a German will on May 21, 1984, appointing Bank A as the executor of her estate in the United States, and her nephew as the executor of her estate for her German holdings. All beneficiaries of the estate are citizens and residents of Germany. D died August 15, 1989, a domiciliary of Germany for U.S. estate tax purposes and for purposes of the Estate Tax Treaty. Section 2001(a) of the Code, section 20.0-1(b)(1) of the regulations and Article 4 of the Estate Tax Treaty.

Bank A, as executor, established a fiscal year for the estate, ending on the last day in July. During the two fiscal years ended July 31, 1990 and July 31, 1991, Bank A made no distributions to the beneficiaries. Bank A filed a Form 1041 for each fiscal year, reflecting all income earned by the estate and the fact that no distributions were made to beneficiaries. During fiscal years 1990 and 1991, the estate paid U.S. income tax on all income earned by the estate. In 1992, the estate filed an amended Form 1041, claiming a refund of all taxes paid because the income was also subject to tax in Germany.

Germany does not recognize an estate as a separate taxable entity. Under German law, any income is attributable directly to the beneficiaries. Thus, the German tax authorities have assessed income tax on the beneficiaries on the income paid to the U.S. estate of D that was also subject to tax in the United States in the hands of the estate. According to Bank A, the German tax administrators reportedly are advising the beneficiaries that the executor erroneously made tax payments to the United States and that they should take legal action against the executor. It has been suggested that the income should have been attributable to the beneficiaries and entitled to a reduction or elimination of U.S. tax under the income tax treaty with Germany.

When notified of the conclusions of this memorandum, Bank A declined an adverse conference.

Law AND ANALYSIS

A U.S. person as defined under section 7701(a)(30)(D) of the Code includes any estate or trust other than a foreign estate or trust as defined under section 7701(a)(31). Under section 7701(a) (31), a foreign estate is one "the income of which, from sources without the United States which is not effectively connected with the conduct of a trade or business within the United States, is not includible in gross income under subtitle A." Whether an estate of a U.S. citizen is foreign or domestic depends on the facts and circumstances. The criteria for determination of the situs of an estate or trust are found in a number of rulings and in case law, principally, Rev. Rul. 60-181, 1960-1 C.B. 257, Rev. Rul. 62-154, 1962 C.B. 1480, Rev. Rul. 81-112, 1981-1 C.B. 598, and B. W. Jones Trust v. Comm'r., 46 B.T.A. 531 (1942) , aff'd 132 F2d 914 (4th Cir. Ct. of Appeals 1943).

In B. W. Jones, the trust in question was held to be a U. S. resident for income tax purposes. In making this determination the following facts were considered: 1) the country under whose law the trust was created, 2) the residence or citizenship of the settlor, 3) the residence or citizenship of the beneficiaries 4) the location of the trust assets, 5) the residence of the trustee, and 6) the location of the administration of the assets. In the instant case, D, a U.S. citizen, appointed Bank A, a U.S. person, as executor of her U.S. estate. All of the assets of the estate were located and administered in the United States. The beneficiaries were all citizens and residents of Germany. Considering all of these facts and circumstances, D's estate is a domestic estate, resident in the United States for income tax purposes. The executor does not dispute this determination.

For federal estate tax purposes, U.S. estate tax is imposed on the domestic estate of D. Sections 2001, 2031, and 2033. For U.S. income tax purposes, D's domestic estate is a separate legal entity under U.S. law and subject to U.S. income tax. Section 641(a)(3). Under U.S. law, estate income is taxed once, either to the fiduciary or to the beneficiaries. If the income is retained and accumulated by the fiduciary until the estate settlement is completed, it is taxable to the fiduciary, as fiduciary, employing a separate tax rate schedule applicable to estates and trusts. Section 1.641(a)-2 of the regulations. This is also the result in a variety of revenue rulings published by the Service: Rev. Rul. 68-605, 1968-2 C.B. 390, Rev. Rul. 81-244, 1981-2 C.B. 151, and Rev. Rul. 86-76, 1986-1 C.B. 284, (Situation 2).

No distributions were made to any beneficiary in the fiscal years at issue and it does not appear that under the terms of the will income was required to be distributed currently. Thus, pursuant to section 661, no distribution deduction may be taken by the estate and the income is not attributable to the beneficiaries under U.S. law under section 662. Further, under U.S. law, because the domestic estate is the proper taxable entity, there is no foreign tax credit available to the estate for German income tax imposed upon the beneficiaries.

Application of the Treaties with Germany

One of the principal purposes of the tax treaty network is the avoidance of double taxation. Two treaties with Germany may apply in this area; the prior United States -- Germany Income Tax Treaty (the 1954 Treaty), 1 and the current U.S. -- Germany Income Tax Treaty (the 1990 Treaty). 2 In the instant case, the result is double taxation of the same income to different taxpayers -- the estate in the United States and the beneficiaries in Germany without the relief of a foreign tax credit. For income tax purposes of the estate, the 1954 Treaty will apply to the fiscal year beginning July 31, 1990, because the estate is on a fiscal year that began prior to January 1, 1990. 3 The subsequent fiscal year will be subject to the 1990 Treaty. The application of the 1954 Treaty and the 1990 Treaty to the income of the estate is explained below.

Fiscal Year ending 1990 under The 1954 Treaty

First, the 1954 Treaty provides a "saving clause" in Article XV(1)(a) reading in pertinent part

(a) The United States, in determining United States tax in the case of its citizens, residents or corporations, may, regardless of any other provision of this Convention, include in the basis upon which such tax is imposed all items of income taxable under the revenue laws of the United States as if this Convention had not come into effect.

With respect to the taxation of the income of the estate of D, in relevant part the 1954 Treaty limits the U.S. tax to 15% on the gross amount of dividends from a domestic corporation received BY A NATURAL PERSON resident in Germany (Article VI). 4 U.S. source interest that is derived BY A NATURAL PERSON resident in Germany is exempt from U.S. tax (Article VII). The 1954 Treaty makes no reference to entities such as trusts or estates. However, section 503.8 of the regulations to the 1954 Treaty (T.D. 6122) addresses the application of the 1954 Treaty to beneficiaries of an estate or trust that are residents of Germany. In general, that regulation provides a treaty exemption for dividend, interest and royalty income under Articles VII (Interest), VIII ( Royalties), and XIV (Certain Dividends and Interest) of the 1954 Treaty, paid to or derived by a German resident who is the beneficiary of a trust or estate to the extent that the trust or estate includes the income in its taxable income, and the income is includible in the gross income of the beneficiary.

Here, the interest was not considered paid to any natural person resident in Germany (the beneficiaries), but was paid to the domestic estate. The interest income was taxable to the estate for U.S. tax purposes, and was not includible in the gross income of the beneficiaries for the fiscal year ending July 31, 1990.

The dividends paid to the estate are governed by Article VI of the treaty, not Article XIV. Thus, no argument can be made by the estate's beneficiaries that the dividends are taxable to them pursuant to section 503.8 of the regulations. 5 No treaty exemption is available for the dividend income for the estate's fiscal year ending on July 31, 1990.

Therefore, no treaty exemption is available for either the interest or the dividend income and double taxation results. Article XV provides the mechanism for relief from double taxation in country of residence. In the instance of U.S. citizens, residents and corporations, relief from taxation is provided by the foreign tax credit system. Article 12 of the Technical Explanation of Protocol to the 1954 Treaty. 6 As explained above, no foreign tax credit is available to the estate of D, because the estate was not subject to tax in Germany. 7

Under Article XVII of the 1954 treaty, if a taxpayer can show proof of double taxation, the taxpayer may ask for assistance from the competent authority of the Contracting State of which he is a resident. The competent authorities may then enter into an agreement to avoid double taxation. The request for relief would have to be made either by the estate to the U.S. competent authority or by the beneficiaries to the German competent authority.

Subsequent Fiscal Years under the 1990 Treaty

For the fiscal year beginning August 1, 1990, the 1990 Treaty applies. In contrast to the 1954 Treaty, the 1990 Treaty specifically defines "residence" and specifically references conduit entities, such as trusts, estates and partnerships. Article 4 of the 1990 Treaty, provides general rules for deciding "residence" for treaty purposes. That article, in relevant part, states,

For purposes of this Convention, the term "resident of a Contracting State" means any person who, under the laws of that State, is liable to tax therein by reason of his domicile, residence, place of management, place of incorporation, or any other criterion of a similar nature, provided, however, that . . .

(b) in the case of income derived or paid by a partnership, estate, or trust, this term applies only to the extent that the income derived by such partnership, estate, or trust is subject to tax in that State as the income of a resident, either, in its hands or in the hands of its partners or beneficiaries.

The Technical Explanation (signed August 29, 1989) for Article 4, states that

[t]he determination of residence for treaty purposes looks first to a person's liability to tax as a resident under the respective taxation laws of the Contracting States. A person who, under those laws, is a resident of one Contracting State and not of the other need look no further. That person is a resident for purposes of the Convention of the State in which he is resident under internal law.

The Technical Explanation for Article 4 further provides that,

Under subparagraph (b), a partnership, estate or trust will be treated as a resident of a Contracting State for purposes of the Convention to the extent that the income derived by such person is subject to tax in that State as the income of a resident, either in the hands of the person deriving the income or in the hands of its partners or beneficiaries. . . . [T]he treatment under the Convention of income received by a trust or estate will be determined by the residence for taxation purposes of the person subject to tax on such income, which may be the grantor, the beneficiaries or the estate or trust itself, depending on the particular circumstances.

Further authority is found in Paragraph 10 of the 1989 Protocol, providing, in relevant part, that with reference to Articles 10 (Dividends), 11 (Interest), and 12 (Royalties), "[the United States] shall deem the recipient of dividends, interest, or royalties who is a resident of [Germany] to be the beneficial owner for the purposes of Articles 10, 11, and 12 if the recipient is the person to which the income is attributable for tax purposes under the laws of the [United States]." As explained above, under U.S. law, the income at issue is not attributable to the German beneficiaries, it is attributable to the domestic estate.

Like the 1954 Treaty, the 1990 Treaty also contains a "saving clause" preserving the United States' right to tax its residents and citizens. Paragraph 1 of the 1989 Protocol. The "saving clause" thus preserves the right of the United States to tax the estate of D, a resident of the United States for tax purposes.

The 1990 Treaty contains an article for relief from double taxation as well -- Article 23. Again, with respect to the taxation of a U.S. citizen or resident, this article is subject to the limitations of U.S. law allowing a foreign tax credit. Article 23(1). Also, Article 23(2) giving relief for German residents will not provide relief because the U.S. source income of the estate is not taxed to the beneficiaries under U.S. law.

Therefore, the analysis for the 1954 Treaty is not changed for the later year; the estate is a separate taxable entity for U.S. tax purposes, resident in the United States. Here, no distribution was made to the beneficiaries and, under U.S. law, the income is taxable to the estate, not to the beneficiaries, even though the beneficiaries may be subject to tax in Germany on the same income. Because of the resulting double taxation, this case may be appropriate for consideration for competent authority relief under Article 25 -- Mutual Agreement Procedure; again, either the estate or the beneficiaries may initiate a request with their respective Competent Authority.

If the conflict cannot be solved by Mutual Agreement arranged by the competent authorities, Paragraph 21 of The Protocol to the 1990 Treaty (signed August 29, 1989) specifically addresses the case where income may be subject to double taxation because it is attributable to different persons under each state's internal law, and provides that Germany will avoid double taxation by means of a tax credit under Article 23(2)(b).

In later fiscal years, any distributions of current income to the beneficiaries would be subject to U.S. tax in the hands of the beneficiaries. Section 871(a)(1)(A) in pertinent part provides that there is a 30% tax on interest and dividend income received by nonresident alien individuals, such as the beneficiaries in this case. This tax is collected by withholding at source under section 1441. The 30% rate may be changed by a tax treaty. In that case, the income properly taxable to the beneficiaries under section 662 will be eligible for treaty benefits under Articles 10 and 11 of the 1990 Treaty, provided the beneficiaries are not citizens of the U.S. and are residents of Germany for purposes of the 1990 Treaty. The estate would then be required to withhold taxes under section 1441 on any distributions to the beneficiaries. Section 1.1441-3(f) of the regulations.

Conclusion

Based upon the foregoing facts, it is held that the estate of D must include the U.S. dividend and interest income in its gross income as a domestic estate for the fiscal years ending on July 31, 1990 and July 31, 1991.

Because of the resulting double taxation, the parties may consider requesting competent authority assistance. No opinion is expressed as to the appropriateness of any relief under a Mutual Agreement article.

A copy of this technical advice memorandum will be given to the taxpayer. Section 6110(j)(3) of the Code provides that it may not be used or relied upon as precedent.

1  References to the 1954 Income Tax Treaty will include the Protocol, signed September 17, 1965, ratified December 27, 1965, which is effective for tax years beginning on or after January 1, 1965 (1965 Protocol).

2  References to the 1990 Treaty will include the Protocol to the Convention signed August 29, 1989.

3  See Article 32(2)(b) of the 1990 Treaty.

4  Article VI of the 1954 Treaty was changed by the 1965 Protocol. The 1954 version of Article VI only applied to U.S. source dividends paid to a German corporation that owned at least 10% of the voting stock of the U.S. corporation and that did not have a U.S. permanent establishment.

5  Article XIV cannot apply in the instant case; dividends and interest paid by a U.S. corporation are governed by Paragraph (2), which states, in general, that the income will not be subject to tax in Germany if the recipient is not a resident or company of Germany. T.D. 6122, containing the regulations, was published January 28, 1955. Those regulations were not amended to reflect the changes of the 1965 Protocol. However, IF the income had been paid currently to the beneficiaries, the beneficiaries could have claimed any benefits provided under the 1954 Treaty as amended by the 1965 Protocol. See Rev. Rul. 55-414, 1955-1 C.B 385.

6  The official title of this document is Memorandum of Treasury Department Concerning Proposed Protocol Amending the Income Tax Convention Between the United States and the Federal Republic of Germany.

7  It appears that likewise there will be no credit or exemption relief granted by Germany for the German beneficiaries under Article 12(b), because although this is U.S. source income taxed in the United States, it is not taxable here in the hands of the beneficiaries.