The second layer of American tax on a British branch

Section 884(a) imposes a 30 per cent charge on the after-tax earnings of a foreign corporation's US trade or business. The instructions call those earnings effectively connected earnings and profits. The charge falls on earnings the business does not reinvest.

So it is a tax on money leaving, not a tax on money earned. The corporate tax already dealt with the earning.

Compare two structures. A US subsidiary pays corporate tax on its profits, and a dividend to its British parent attracts withholding on the way out.

A branch pays the corporate tax too. Without section 884 the profits would then travel home untaxed, so the branch structure would beat the subsidiary purely on tax.

The charge closes that gap. It is why the treaty caps it at the direct dividend rate rather than at some separate figure, as we set out in US dividend withholding.

Only where the company has something America can tax on a net basis. In practice that means a US trade or business, which usually means a permanent establishment under the treaty.

The treaty also reaches a company taxed on a net basis on real property income or on certain gains. So a British company holding US property can meet the condition without any branch at all.

Underneath it all sits effectively connected income, which is what makes profits taxable on a net basis in the first place. No net-basis tax, no second charge.

The charge starts from effectively connected earnings and profits, which is a narrower figure than accounting profit. It takes the branch's effectively connected income, applies the ordinary corporate tax, and then works from whatever survives that.

So two separate adjustments matter before the branch profits tax ever arrives. The corporate computation comes first, and the earnings and profits rules then shape the base the charge actually touches.

The charge applies to effectively connected earnings and profits that the business does not reinvest by the close of the year. It also catches earlier earnings later disinvested.

US net equity is the measuring stick. An increase across the year generally counts as reinvestment. A decrease generally counts as a disinvestment of earlier earnings not yet charged.

So the figure moves with the balance sheet rather than with the cash you remitted. That catches people out.

So track the opening and closing positions deliberately. A company that never recorded the opening figure cannot compute the movement, and reconstructing it after the year end runs slow and expensive.

The convention allows the additional tax, then limits it. The rate may not exceed the rate Article 10 sets for a direct dividend, meaning the rate for a company owning at least a tenth of the voting power.

That is a substantial cut from 30 per cent. The instructions confirm the mechanism plainly: where treaty benefits apply, the rate is the rate the treaty specifies for branch profits.

A company must meet the requirements of the treaty's limitation on benefits article, and nothing less will do. Our guide to that article walks through the tests a British company can actually use, from the ownership route to the active business one.

The instructions add a useful simplification. Where the treaty entered into force after 1986, meeting its limitation on benefits article is enough, and no separate qualified resident test applies.

They also close a door firmly. Treaties other than income tax treaties exempt no foreign corporation from this charge.

Qualifying also has to be evidenced rather than merely asserted. Keep the ownership analysis and the income flows for the year in question, because the question tends to arrive years afterwards.

Three groups escape the additional charge entirely rather than merely capping it. The convention lists them in the same paragraph that permits the tax.

The first is a company already carrying on the relevant activities before October 1998. The second is a company qualifying through the listed company route. The third is a company entitled to benefits under the derivative benefits or competent authority paragraphs.

The two charges stack rather than replace each other. Corporate tax applies to the branch profits first, and the additional charge applies to what remains and then leaves.

So model both together. A branch looked at through corporate tax alone always reads cheaper than it is.

Run the arithmetic in that order every time. Corporate tax reduces the pool first, and the branch profits tax then takes its percentage of whatever leaves the pool that remains.

Yes, and this surprises people. The instructions state that a foreign corporate partner in a partnership carrying on a US trade or business faces the charge on its earnings attributable to its share of effectively connected income.

So a British company can meet the test without ever opening an office. A partnership interest alone can carry it there.

The regulations allow a company with a chargeable amount to reduce its US liabilities and treat earnings as reinvested rather than remitted. The reduction cannot exceed the lesser of two figures.

Those are the amount of US liabilities, and the reduction needed to bring the chargeable amount to zero. You make the election by attaching a statement to a timely filed return.

Keep the two sides consistent. The statement must show the liabilities reduced for this purpose and the matching reduction for interest expense allocation.

No, and that is a genuine administrative relief. The regulations require no estimated tax payments in respect of a foreign corporation's liability for the branch profits tax, which is unusual among American charges of this size.

Still, the cash has to exist when the return goes in. Plan for it even though nothing falls due during the year.

Section III of Form 1120-F carries both this charge and the tax on excess interest. The same return reports the branch's income and computes the liability.

The form also transmits a treaty-based return position disclosure where you take one. Our guide to Form 8833 covers when that applies.

A neat interaction follows. Where a foreign corporation faces this charge for a year, withholding does not apply to dividends it pays out of that year's earnings.

America declines to tax the same profits a third time. Where a treaty prohibits the charge, though, dividends from those earnings can attract withholding instead.

The charge exists to make the two structures comparable, so it rarely decides the question by itself. A subsidiary brings its own filings, its own transfer pricing and its own corporate formalities.

Weigh the whole picture instead. In our practice, companies restructure around this one charge and acquire three new problems in exchange.

Compare the full cost on both sides before moving. A subsidiary's dividend withholding and the branch profits tax land at the same treaty rate, so the second layer is rarely where the real difference sits.

The rules address companies that stop. Terminating a US trade or business, or liquidating or reorganising, affects the charge and can require a waiver of the limitation period.

So treat an exit as a planned event rather than an afterthought. The paperwork runs alongside the commercial decision.

The waiver matters particularly here. Executing one keeps the assessment window open, which the rules require in the specific circumstances the regulations set out.

Take an illustrative case with round numbers. A British engineering company runs a US branch that earns one million dollars and pays corporate tax on it.

Suppose eight hundred thousand remains after that tax, and US net equity falls by three hundred thousand across the year. Roughly that much counts as leaving the business.

At the statutory 30 per cent the additional charge would run to ninety thousand dollars. Qualify under the treaty and the rate drops to the direct dividend rate, cutting the charge by most of its value.

The commonest is budgeting for corporate tax alone and meeting the second charge at filing. The second is assuming the treaty rate applies automatically because the company is British.

After those comes the net equity figure nobody tracked. The charge turns on movement across the year, so a company that never measured the opening position cannot compute the closing one.

A fourth is forgetting the partnership route entirely, which catches companies holding a US partnership interest and nothing else.

First we establish whether the charge applies at all, because a company without a US trade or business or net-basis property income never reaches it. Then we compute the effectively connected earnings and the net equity movement.

We also document the limitation on benefits position, since the cap depends on it. Start with our treaty relief service, or reach us through our contact page.