My U.S.-based partnership is planning to buy real estate in Europe in
Poland, which has a comprehensive no double taxation treaty with the
U.S.  We plan to sell this real estate in about 5-7 years.

In all European Union countries, Poland included, an entity selling
real estate must pay 22% of his proceeds as a type of sales tax, or in
Europe called Value Added Tax (VAT).  When the new owner later sells
the real estate, he must pay 22% of his sale proceeds, minus whatever
the original seller paid in VAT, as his own VAT payment.

My questions is this:  When the Partnership sells the property, it
will have to pay Value Added Tax on its proceeds; in regards to the
partners' U.S. tax returns, will the VAT be considered
(1) a normal transaction expense; 
or 
(2) a tax paid in a foreign jurisdiction and eligible to be
credited against any U.S. taxes due to the double taxation treaty?

For example, say I will buy property for $100 and sell in five years for $300:
I buy property from seller for $100 and seller pays 22%*$100=$22 in VAT
I sell property for $300 and owe 22%*300-$22=$44 in VAT (I subtract
out what previous seller paid)

The partnership thus gains $300-$44-100=$156 cash from the transaction.

When the partners do their taxes in the U.S., and assume they are all
in the 35% bracket, what taxes does we collectively pay?
1) $300-44-100=$156 profit; $156*35%= $54.60 in U.S. taxes?
OR
2) $300-100= $200; $200*35% = $70; but I paid $44 in taxes in Poland,
so I only owe $70-$44=$26 because the VAT is considered a tax credit
for the U.S. due to the double taxation treaty and VAT qualifying under it?


THANKS

Hello and thank you for your question.  Although the Google Answers
disclaimer regarding legal and tax advice applies, I am confident that
I have found the answer.

Under the UNITED STATES - POLAND INCOME TAX CONVENTION (the "Treaty"),
the United States will not tax the US partners' gain from the sale of
the real estate in Poland.

Take a look at Article 7 of the Treaty (page 9 of the .pdf file)
http://www.irs.gov/pub/irs-trty/poland.pdf 

The treaty provision is consistent with Internal Revenue Code Section
862(a)(5) which provides that gains, profits, and income from the sale
or exchange of real property located without the United States shall
be treated as income from sources without the United States.

Does that fact that the real property belonged to and was sold by a US
partnership change the answer?  Happily, no.
"The term 'resident of the United States means ... Any person (except
a company or entity treated as a corporation for United States tax
purposes) resident in the United States for purposes of its tax, but
in the case of a partnership ... only to the extent that the income
derived by such person in that capacity is subject to United States
tax as the income of a resident." Id. at 6.

So your partnership, despite being itself a US resident, does not
expose its US members to income tax on the income derived from the
sale of real property in Poland.

Returning to your question, the US federal tax credit is limited to
income taxes, and as the following source states, "the U.S. does not
consider the VAT to be the equivalent of an income tax. The tax is
deductible as an expense but a VAT can't be used to claim a foreign
tax credit."
http://www.rpifs.com/offshoretax/otaxcredit.htm

So if the sale of the property were taxable by the US as well as
Poland, and if there were no treaty relief, you would not be able to
take a foreign tax credit for the VAT tax paid.  But since the US does
not tax the gain in the first instance, you'll be fine.
 
Search terms used:
poland convention income tax site:irs.gov poland partnership  site:irs.gov    

Thanks again for bringing us your question.

Sincerely,
Google Answers Researcher
Richard-ga

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Request for Answer Clarification by polonia-ga on 25 Jun 2004 08:16 PDT

Richard--

I have reviewed what you wrote and would like just one clarification--
where in the code does it state that something falling under Section
862(a) is not taxable in the US?  I assume 862(b) states that somehow?
 Although I must admit that 862(b) is pretty much incomprehensible to
me!

THANKS

---

Clarification of Answer by richard-ga on 25 Jun 2004 09:16 PDT

Hello again.

Making sense of the Internal Revenue Code is always a challenge.

You make a good point in your clarification request.  U.S. persons are
taxed on their worldwide income.  If not for the Treaty, the foreign
source income of a US person would indeed be subject to US income tax
(and there would be no foreign tax credit for the VAT tax paid).
http://www.bnatax.com/tm/insights_incomewithrespecttowhich.htm

So really the dispositive provision is Article 7 of the Treaty, cited in my answer.

-R

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Clarification of Answer by richard-ga on 25 Jun 2004 09:26 PDT

Also, take a look at pages 78-82 in the EY Guide.
http://www.bnatax.com/tm/insights_incomewithrespecttowhich.htm

In some circumstances you may be able to avoid the VAT tax too!

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Clarification of Answer by richard-ga on 25 Jun 2004 09:27 PDT

I gave you the wrong link to the EY Guide
http://www.ey.com.pl/gcrdownload/RE_EY%20real%20estate%2018.03.2004.pdf

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Request for Answer Clarification by polonia-ga on 25 Jun 2004 11:08 PDT

But Richard, here is the situation:  I will pay VAT in POland of 22%. 
I understand that is not a tax credit.  But I will pay no other taxes
in Poland since Poland does not tax any legal entity based outside of
the country.  Therefore, I will have no income tax credit for taxes
paid in a foreign country on income earned in a foreign country.  If
this is the situation, will i still not get taxed on my "gain", which
I am defining as (Sale Proceeds-VAT-purchase price)?

Thanks again!

---

Clarification of Answer by richard-ga on 25 Jun 2004 11:49 PDT

Hello again:

The way I see it, you will pay the same tax in Poland that any Polish
property-owner pays.  That tax is the VAT.

Since the Treaty exempts you from US tax on your gain from the sale,
you will pay no US tax.  You will not get a tax credit for paying the
VAT.  But you're paying nothing to the US, so paying the Polish tax
and getting no US credit for it is a fair result.

Does this make sense to you?  Am I missing something?

-R

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Request for Answer Clarification by polonia-ga on 25 Jun 2004 12:08 PDT

I've been speaking to an attorney in Poland and he said to me that if
a firm in Poland were to make a profit on land, they would have to pay
VAT and afterwards they would pay taxes on the income the company (or
its partners) made after VAT.

However, since I am a US partnership I would not be charged any income
taxes.  Thus, I do not understand how the US will not charge me or the
partners income taxes if they see and realize that I wasn't charged
any income taxes in Poland.  Do you see what I'm saying?  I guess it's
possible no one will charge me income taxes in this situation but that
just seems a bit strange to me.

THANKS

---

Clarification of Answer by richard-ga on 25 Jun 2004 13:34 PDT

I'm satisfied that you won't pay US tax on the gain.
Not knowing anything about Polish tax law, I assumed that a Polish
seller paid VAT and nothing else.  If your attorney tells you that (1)
a Polish seller also pays income tax, but (2) as a foreign seller you
don't, then indeed you have a windfall.

It is likely that your Polish attorney is correct.  It used to be that
foreigners who bought and sold real property in the US got away
without paying US income tax on their gains (and they generally paid
nothing in their home country either).  That changed when the US
adopted a particular tax called FIRPTA, which imposes a tax and a
withholding requirement to make sure the tax  gets paid.
FIRPTA
http://www.irs.gov/businesses/small/international/article/0,,id=105000,00.html

So if Poland has no FIRPTA-type tax to apply to you then it makes
sense that you will pay no income tax at all.

I'm glad this has had a happy outcome for you.

Richard-ga

Thanks for all the effort!

VAT is an indirect tax and is therefore permitted under the treaties
and is not tax deductable

It would be shocked if it weren't tax deductible or a tax credit.  VAT
on real estate is essentially a gains tax-- you take what you pay,
plus all capital expenditures you make in improving the property, and
subtract that from what your proceeds.  Definietly sounds like a gains
tax to me.

AIUI any VAT paid should be treated as a normal business expense when
assessing your US tax, i.e. you should be US taxed on net profit. But
you cannot offset EU VAT against US income tax in the same way as we
cannot offset US sales tax against EU VAT.

And you are calculating your VAT wrong. If you buy something for PZL
122, the seller doesn't collect 22% VAT on PSL 122; he collects 22%
VAT on PSL 100, making the selling price incl VAT PZL 122.

Further, VAT is not taxed on land across the EU; the option to tax is
there but not all countries have taken it, I believe the UK does not
usually tax on land sales.

Owain

My calculation assumes that the amount of money collected by the
seller from me is 100.  In Poland prices presented tend to include
vat, as opposed to the US where you add sales tax at the register.  I
understand that VAT on goods is an expense as opposed to a tax credit.
 However, it makes no sense to have it not credit against US gains tax
because it is a gains tax in Europe when it comes to real estate.

Does anyone know where I can find information on this?  A website?

THANKS

Richard,

It seems to me that Article 7 of the treaty in essence permits Poland
to tax the gain but it does not appear to preclude the US from also
taxing it.