August 15, 2011 The Tax Lawyer

The Submerged Logic of “Doing Business” and Attribution: Diving Below the Surface of the Offshore Lending “GLAM”

Vol. 64, No. 2 - Winter 2011

Andrew Walker


    In a recent, widely publicized general legal advice memorandum (the GLAM), the Service raised questions about the standards that determine when a foreign person is engaged in the conduct of a trade or business within the United States under section 864 (a USTB) based on the attribution to the foreign person of activities conducted in the United States by agents or contractors. The GLAM focuses specifically on whether an active lending business is conducted by a foreign corporation in the United States if loan origination activity is carried out by U.S. agents or contractors. The GLAM concludes that, even if loans to U.S. borrowers are originated by an independent company that lacks express authority to contractually bind a foreign lender to make loans, interest on the loans is effectively connected with the active conduct of a lending, financing, or similar business in the United States, and subject to net income tax.

    The GLAM invites scrutiny, not just for the specific result it reaches with regard to lending by foreigners, but for its general reasoning. This reasoning has implications for nexus standards under section 864 more broadly. The GLAM appears to conclude that the loan originator’s U.S. activities are attributable to the foreign corporation merely because they are a “component” of a unitary lending business. The GLAM specifically disavows the relevance of the distinction between “dependent” agents and “independent” agents in determining whether a third party’s activities may be attributed to a foreign person. Indeed, the GLAM suggests that even the activities of an independent contractor (who is not an agent in a common law sense) may be attributed to a foreign person. The GLAM further treats as irrelevant whether the U.S. service provider has authority to bind the foreign person contractually. Accordingly, the GLAM adopts positions with broad implications on when it is appropriate to attribute third-party activity of U.S. actors to a foreign person as a matter of the “tax common law.”

    This is very different from the approach that applies to a foreign person entitled to the benefits of an income tax treaty. Treaty business nexus standards require that the foreign person have a permanent establishment in the host country to which income is attributable. Treaties generally attribute the activities of third parties to a foreign person only if the third party is a “dependent agent” with authority to conclude contracts in the principal’s name. This is not the first time the Service has suggested that regular activities of an independent agent give rise to a USTB. However, imputing activities of independent agents with express contracting authority is still a far narrower conception of “agency attribution” than the GLAM adopts.

    Indeed, the GLAM approach to attribution is closer to the approach asserted by some states in the domestic multistate context. In the multistate context, a number of states take the position that nexus arises merely from a substantial economic presence in a host state and purposive access to its markets (economic nexus). Similarly, the presence of an independent contractor or “unitary” affiliate within the host state may create nexus with that state. Accordingly, the suggestion in the GLAM that activities of an independent contractor (i.e., nonagent) may be attributed to a foreign recipient of its services is akin to this multistate approach to attributive nexus. Similarly, the GLAM suggestion that conduct of a “component” of the foreign corporation’s lending business by a U.S. service provider creates nexus echoes the multistate theory of “affiliate nexus.”

    Because the statutory concept “conduct of a trade or business within the United States” is amorphous, section 864 invites competing views of nexus and attribution under section 864 dependant on what one considers the general intent of the “U.S. trade or business” and “effectively connected income” concepts. Read literally, for example, the statutory language could be interpreted to require that a unified group of activities that constitute an independent economic enterprise conducted for profit be conducted entirely within the United States. The statute does not say “conduct of a trade or business, or any portion thereof, within the United States.” On the other hand, case law has understood the language to require that the foreign person conduct such an active business, but that only some portion of the business activity need be in the United States. One could even interpret section 864 to encompass a foreign corporation that merely avails itself of U.S. markets. The latter understanding conflates conducting business “within the United States” and business “with” the United States, but is not so clearly implausible that it would violate the “plain meaning” rule. Because the GLAM suggests a Service view of the general intent of section 864 closer to this interpretation, the GLAM poses, perhaps inadvertently, questions about the relationship of the business nexus and attribution standards under section 864 to those that apply in the treaty context and multistate context.

    As there are already a number of excellent discussions focused on the distinction between lending activities that constitute an active financing business and activities that merely constitute investing or trading in debt, that is not the focus of this Article. Nor does this Article focus narrowly on the question of attribution in the context of financing businesses. Instead, this Article focuses on the GLAM’s approach to agency attribution, both in the narrow context of the “effectively connected income” regulations addressed by the GLAM and more generally. There are already a number of excellent discussions of agency attribution—although these have generally been intended to identify the differences between treaty and “tax common law” attribution standards, and determine what the applicable standard of attribution is under section 864. This Article addresses those questions as well, but also examines the multistate approach to attribution as a benchmark and explores in greater detail why the standards may differ and whether, as a policy matter, these differing approaches to attribution make sense.

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