U.S. Export Taxation, Treaty Challenges, and Filing Leniency Bear Watching

by Michael J. Miller
Published: March 15, 2002
Source: Canadian Tax Journal

While the US Congress debates book-tax discrepancies arising in connection with the Enron affair, the US courts, the Bush administration, and the Internal Revenue Service consider more mundane but significant US federal tax matters. From the WTO ruling on the US taxation of exports and taxpayer claims that the Canadian treaty overrides the alternative minimum tax, to liberalization of election and filing requirements, the authors explore some of the important recent developments.

Response to WTO Ruling on US Export Subsidies

On January 14, 2002, the World Trade Organization ("WTO") ruled in favor of the European Union ("EU") in connection with its dispute with the United States over the US FSC Repeal and Extraterritorial Income Exclusion Act ("EIEA").(1) Rejecting the United States' appeal of an earlier WTO panel decision,(2) the WTO Appellate Body held that the EIEA violated WTO free trade rules by, among other things, allowing revenue to be forgone that would otherwise be due, in violation of the Agreement on Subsidies and Countervailing Measures ("the SCM agreement"); allowing export-contingent subsidies, also in violation of the SCM agreement; and failing to be a measure intended to avoid double taxation, as permitted under footnote 59 of the SCM agreement.(3)

The WTO's Appellate Body's decision also held that the EIEA violated WTO free trade rules by failing to completely withdraw the export subsidies found by the WTO to be illegal in a the predecessor foreign sales corporation ("FSC") regime. The EIEA was enacted in 2000 to replace the FSC rules and therefore is sometimes referred to as "the FSC-replacement legislation."(4)

The next step in the dispute is to establish (or agree upon) the annual harm caused to EU firms under the FSC regime and its successor, the EIEA. On November 17, 2000, the EU requested authorization from the WTO Dispute Settlement Body for countermeasures against US exporters, arguing that the EIEA causes US $4.043 billion in harm to EU business annually.

On February 14, 2002, the Office of the US Trade Representative ("USTR") submitted documents to a WTO arbitration panel taking the position that the annual harm to EU firms resulting from the FSC regime is not more than US $956 million. The figure was based on official US budget figures for 2000, which estimated the forgone revenue at US $3.89 billion. This amount was then adjusted downward by 8.2 percent for permissible exports of services, and the remaining amount was multiplied by 26.8 percent, the EU's proportionate share of total world production for 2000.

In a second submission, filed February 26, 2002, the USTR increased its estimate of EU damages to between US $1.05 and $1.11 billion. In the second submission, the USTR determined that the actual value of the FSC subsidy was US $4.15 billion in 2000 and US $3.91 billion in 2001. The USTR also adjusted the deduction for permissible exports of services to 0.57 percent, agreeing with the EU that a deduction should be made only for engineering and architectural services. Finally, the US agreed with the EU that the amount of the FSC subsidy should be adjusted upward by 7.2 percent to reflect new features of the EIEA that were not present under the FSC regime. The USTR arrived at the US $1.11 and $1.05 billion figures by multiplying the adjusted figures for 2000 and 2001, respectively, by 26.8 percent (the EU's proportionate share of total world production for 2000).

Notwithstanding the USTR's increased estimate, the USTR maintains that the EU's underlying methodology is flawed because it assumes that the EU is the only WTO member affected by the FSC regime and FSC-replacement legislation. The USTR has pointed out that all EU member states are affected. In the USTR's view, only a portion of the annual FSC/EIEA value should be allocated to the EU, based on the portion of global production attributable to the EU. Whatever the number, a separate issue is whether the EU will ultimately seek sanctions or compensation. An EU spokesman recently stated that the EU would prefer compensation to retaliation, but this may change if the EU grows skeptical of US efforts to resolve the longstanding FSC dispute in good faith.

Another key issue is how quickly the United States will be able to comply with the WTO ruling. The EU has emphasized that the sanctions issue should not obscure the related compliance issue. Congress and the Bush administration reportedly have made commitments to EU Trade Commissioner Pascal Lamy that the United States will comply with the WTO ruling, but the EU apparently would prefer to see some tangible evidence of that commitment. According to one EU official, "We are looking for action that goes in that direction, for a road map showing how the US will achieve compliance."(5)

House Ways and Means Committee Chair William M. Thomas has said that his tax-writing panel will schedule a series of hearings on the US response to the WTO Appellate Body's decision. Representative Thomas has also told US Trade Representative Robert B. Zoellick that the committee will shortly expect a written statement on the White House plans to end the FSC dispute. Representative Thomas has stated that it is important that the Europeans see "a serious and good-faith effort" from the United States to comply with the WTO ruling.

The most challenging issue is how the United States will achieve compliance. Senate Finance Committee Majority Trade Counsel Ted Posner has said that the dispute will not be easy to resolve. Some observers have suggested that the United States could resolve the dispute by adopting a territorial system of corporate taxation or a value-added tax ("VAT") system, and the authors of this article understand that the Treasury department is studying these matters. In any event, Posner has reportedly expressed skepticism whether either approach would bring the US corporate tax system into compliance with the WTO ruling. National Foreign Trade Counsel William A. Reinsch has confirmed that there is no obvious answer as to how the United States could achieve compliance (presumably, short of repealing the EIEA altogether).


A recent case decided by the US Tax Court arrives at an interesting interpretation of the US-Canada treaty (the "Treaty").(6)

In Tom Kappus,(7) the US Tax Court held that two US citizens residing in Canada during 1997 were properly subject to a limitation ("the AMT limit") on the use of US foreign tax credits ("FTCs") for the purposes of the US alternative minimum tax ("AMT").(8) In general, the AMT limit precludes a taxpayer from using FTCs to offset more than 90 percent of the otherwise applicable AMT.(9)

The taxpayers, who lived and worked in Canada, were Canadian residents in 1997 for the purposes of the treaty and argued that the treaty overrode the AMT limit.(10)

Paragraph 1 of article XXIV (Elimination of Double Taxation) of the treaty sets forth the general rule as follows:

1. In the case of the United States, subject to the provisions of paragraphs 4, 5 and 6, double taxation shall be avoided as follows: In accordance with the provisions and subject to the limitations of the law of the United States (as it may be amended from time to time without changing the general principle hereof), the United States shall allow to a citizen or resident of the United States, or to a company electing to be treated as a domestic corporation, as a credit against the United States tax on income the appropriate amount of income tax paid or accrued to Canada[.]

Paragraph 4 of this article provides additional guidance applicable to US citizens who are resident in Canada.

4. Where a United States citizen is a resident of Canada, the following rules shall apply:

(a) Canada shall allow a deduction from the Canadian tax in respect of income tax paid or accrued to the United States in respect of profits, income or gains which arise (within the meaning of paragraph 3) in the United States, except that such deduction need not exceed the amount of the tax that would be paid to the United States if the resident were not a United States citizen; and

(b) For the purposes of computing the United States tax, the United States shall allow as a credit against United States tax the income tax paid or accrued to Canada after the deduction referred to in subparagraph (a). The credit so allowed shall not reduce that portion of the United States tax that is deductible from Canadian tax in accordance with subparagraph (a).(11)

The original treaty was signed in 1980. Pursuant to the Tax Reform Act of 1986),(12) the US Congress amended the AMT provisions applicable to non-corporate taxpayers and introduced the AMT limit. Legislation enacted in 1988, clarifying the interaction of the Code with US tax treaties, expressly provides that certain aspects of the 1986 act, including the AMT limit, will apply notwithstanding any US treaty obligation in effect prior to the 1986 act.(13)

Protocols amending the treaty were signed in 1983, 1984, 1995, and 1997, but they did not amend article XXIV of the treaty in any relevant way or make any reference whatever to the AMT limit, however. The 1995 protocol amended article II (Taxes Covered) to provide that, in the case of the United States, the taxes to which the treaty generally applies are "the Federal income taxes imposed by the Internal Revenue Code of 1986."

The taxpayers' argument consisted of two elements: first, that the partial denial of FTCs pursuant to the AMT limit was inconsistent with the United States' obligation under article XXIV to provide FTCs for Canadian taxes; and second, that the treaty rule is "later in time" than the AMT limit and, therefore, takes precedence in the event of a conflict.(14)

With respect to the first element, the taxpayers argued that, although paragraph 1 of article XXIV generally permits future amendments of US FTC limitations, future amendments are not permitted under paragraph 4, which applies specifically to US citizens residing in Canada. They further argued that, even if the same amendments of US law permitted under paragraph 1 are also permitted under paragraph 4, the AMT limit is prohibited under article XXIV because it causes double tax and is therefore inconsistent with the general principle of eliminating double taxation. As shown in the text quoted above, paragraph 1 parenthetically permits US FTCs to be limited by US law "as it may be amended from time to time without changing the general principle hereof[.]"

With respect to the second element of their argument, the taxpayers contended that article XXIV of the treaty is later in time than the (1986) AMT limit, as a result of the 1995 and 1997 protocols.

In response, the Internal Revenue Service (the "IRS") argued that the AMT limit is not inconsistent with article XXIV of the treaty and that, in any event, the (1986) AMT limit is later in time than the treaty, which was signed in 1980 and not amended in any relevant way thereafter.

The Tax Court held for the IRS. Observing that the 1995 protocol revised article II so that the treaty would apply to "the Federal income taxes imposed by the Internal Revenue Code of 1986[,]" the Tax Court concluded that the 1995 protocol "contemplates that the US-Canada treaty accepted the changes to US revenue laws that were made by the Tax Reform Act of 1986, including the enactment of section 59(a)(2) [the AMT limit]."(15) Accordingly, the Tax Court concluded that there is no conflict between the Treaty and the AMT limit, and declined to address the later-in-time issue.

The result reached by the Tax Court appears to be correct, but its rationale is implausible. The 1995 protocol contains no express indication that Canada accepted, or was even aware of, the multitude of changes to the Code wrought by the 1986 act. It seems far more likely that the 1995 protocol's amendment to article II was intended simply to update the reference to US tax laws so that there could be no argument that the treaty no longer applied to limit US taxing jurisdiction.

Moreover, if the Tax Court's analysis were correct, it would prove too much (indeed much too much). No principled basis exists for distinguishing between the changes made by the 1986 act and the prior amendments to the Code. The amendment to article II on which the Tax Court relied heavily refers to "the Federal income taxes imposed by the Internal Revenue Code of 1986" -- not the 1986 act. Thus, following the Tax Court's logic one would be forced to conclude that the 1995 protocol evidences Canada's acquiescence in, and the implicit modification of the treaty to conform with, the entire Internal Revenue Code of 1986. Of course, this result would be overbroad since it would effectively eliminate any provision of the treaty to the extent that it conflicts with the Code as it read at that time.(16)

That the Tax Court adopted such an ill-considered rationale is especially perplexing because it was unnecessary. As noted above, paragraph 1 of article XXIV expressly provides that the availability of US FTCs is subject to the limitations of US law as it may be amended from time to time, without changing the principle of eliminating double taxation. Although there appears to be a legitimate question whether the AMT limit violates the principle of eliminating double taxation,(17) there is no apparent basis for treating the relevant provisions of article XXIV as taking precedence over the (1986) AMT limit under the later-in-time rule. As noted above, the treaty was signed in 1980; the salient features of article XXIV were included in the original treaty and, as of this writing, have not subsequently been amended. The signing of protocols in 1995 and 1997 would not appear to suggest any intention to "revitalize" treaty provisions that may conflict with post-1980 amendments to the Code.

Ideally, Kappus will be reversed on appeal before it can create too much confusion. Unfortunately, the tax liability at issue in Kappus was relatively minimal, so an appeal seems unlikely. Nevertheless, the authors are hopeful that the flaws of the court's analysis are sufficiently self-evident that Kappus will be summarily repudiated or distinguished.

More Lenient Rules on Obtaining US Deductions

As a general proposition, non-US persons engaging in a trade or business in the United States are taxed on their net income.(18) Pursuant to sections 874(a) and 882(c)(2), however, a non-US person is entitled to claim deductions (or credits) only if it files a US return. A protective return (showing no US tax liability) may be filed to preserve such entitlement, but in many cases the need to do so may not be apparent.

The Treasury regulations prescribe a filing deadline that taxpayers must comply with in order to satisfy the return requirement.(19) Until recently, this deadline could be waived only in "rare and unusual circumstances."(20) Given the harsh nature of the deduction disallowance remedy, the scope of this exception was considered by many to be unduly narrow.

In response to these concerns, temporary regulations issued on January 28, 2002 permit the IRS to waive the normal filing deadline for non-US persons who establish to the satisfaction of the IRS that they acted reasonably and in good faith in failing to file a US return (including a protective return).(21)

As a preliminary matter, the temporary regulations provide, however, that a non-US person will not be considered to have acted reasonably if it knew that it was required to file the return and chose not to do so.(22) Similarly, no waiver will be granted unless the taxpayer cooperates in the process of determining its US federal tax liability for the year at issue.(23)

Assuming that these preliminary hurdles are satisfied, the regulations set forth six factors that shall be considered in determining whether the non-US person acted reasonably in good faith. The factors for corporations (which are substantially identical to those applicable to individuals) are as follows:

(A) Whether the corporation voluntarily identifies itself to the Internal Revenue Service as having failed to file a U.S. income tax return before the Internal Revenue Service discovers the failure to file;

(B) Whether the corporation did not become aware of its ability to file a protective return . . . by the deadline for filing a protective return;

(C) Whether the corporation had not previously filed a U.S. income tax return;

(D) Whether the corporation failed to file a U.S. income tax return because, after exercising reasonable diligence (taking into account its relevant experience and level of sophistication), the corporation was unaware of the necessity for filing the return;

(E) Whether the corporation failed to file a U.S. income tax return because of intervening events beyond the corporation's control; and

(F) Whether other mitigating or exacerbating factors existed."(24)

The regulation also provides six examples illustrating certain circumstances in which a non-US (foreign) corporation ("FC") does or does not receive a waiver.(25) The waiver is granted in two examples but denied in four others.

In the first favorable example,(26) FC, which has never filed a US tax return, is a limited partner in a partnership that conducts business in the United States at a loss for four years. FC's tax director improperly concludes that US returns are not required because the partnership earns no profit; during that period, FC is aware of neither the obligation to file a return nor the ability to file a protective return. Only in year 5, when the partnership earns a profit, does FC seek US tax advice and discover that it should have filed returns for years 1 through 4. FC promptly notifies and cooperates with the IRS. FC qualifies for a waiver of the filing deadline.

In the other favorable example,(27) FC is a technology company with minimal business or tax experience internationally that opens a US office to market a software program; FC has never filed a US tax return. FC's US office earns income in the United States in years 1 and 2, but does not file a return for either year; during that period, FC is aware of neither the obligation to file a return nor the ability to file a protective return. In January of year 4, FC engages US counsel in connection with a proposed license to a US company and learns that it should have filed for years 1 and 2. FC promptly notifies and cooperates with the IRS. FC qualifies for the waiver.

The temporary regulations should provide relief to many non-US persons who will be genuinely shocked to learn that they had, and violated, an obligation to file US returns. The relief is not automatic, however, and in some situations it will be difficult indeed to convince the IRS that the failure to file was reasonable and in good faith. As illustrated by two unfavorable examples in the regulations, it is virtually certain that no waiver will be granted if the taxpayer (1) fails to cooperate with the IRS in determining its US tax liability, or (2) was aware that it could preserve the right to deductions by filing a protective return prior to the filing deadline.(28)

It is less clear whether the failure to contact the IRS or the presence of a prior US filing history will necessarily preclude a waiver. In one example of the temporary regulations, an IRS examiner initiated an inquiry into FC's failure to file, but the significance of this factor is unclear because FC also had extensive experience conducting business activities internationally, including making tax filings, and made no effort to seek US tax advice.(29) In another example, FC had previously filed US tax returns, but the significance of this factor is unclear because, prior to the filing deadline, FC was also aware that it could protect its interests by filing a protective return.(30) How lenient the IRS will be in borderline situations remains to be seen.

Extended Deadline for "Check-the-Box" Entity Classification Choices

Under the United States' current entity classification rules, certain business entities may elect to be treated as either a corporation or a partnership (or disregarded entity) for US tax purposes.(31) This election, which literally involves checking a box for the desired US tax classification, is generally referred to as a "check-the-box" election. In the absence of an affirmative election, default rules would classify an eligible non-US business entity as a corporation if none of its members has personal liability for the debts of or claims against the entity, or otherwise as a partnership (or disregarded entity).(32) An election that is effective as of the date on which an entity was formed is called an "initial classification election."

In general, a check-the-box election may be made retroactive for a period of up to 75 days prior to filing. If the election is not an initial classification election, the change in US tax classification will result in certain transactions being deemed to occur for US tax purposes.(33) If the entity has US assets or direct or perhaps even indirect US members, a change in classification could result in the imposition of US tax on the entities or the members.

An entity that elects to change its US tax status generally cannot elect to again change its US tax status for 60 months thereafter, unless the first election was an initial classification election.(34) Thus, if a non-US entity neglects to make its US check-the-box election within 75 days of formation, not only might the "untimely" election give rise to US tax, but a subsequent election to again change US tax classification generally will not be permitted for 60 months.

Revenue procedure 2002-15,(35) issued February 11, 2002, provides relief for certain non-US entities that file an untimely initial classification election within six months of the deadline -- that is, within six months and 75 days of formation. To qualify for this relief, (1) an entity must have failed to achieve the desired classification solely because its check-the-box election was untimely; (2) the due date for its tax return (excluding extensions, and based on its US tax status without regard to the election) must not have passed; and (3) the entity must have reasonable cause for having failed to make its election on a timely basis. An entity that relies on the Revenue procedure must set forth such reliance at the top of its election and attach a statement explaining the reason for the failure to timely file.(36)

Relief from Penalties for Taxpayers Disclosing Tax Shelters

On December 21, 2001, the IRS announced a disclosure initiative aimed at encouraging taxpayers to disclose tax shelters and other questionable items reported on their tax returns.(37)

If a taxpayer discloses any item in accordance with the terms of the announcement, the accuracy-related penalty otherwise imposed under Section 6662(b) will be waived for that portion of an underpayment attributable to the disclosed item and due to one or more of the following: (1) negligence or disregard of rules or regulations; (2) any substantial understatement of income tax; (3) certain valuation misstatements; and (4) any substantial overstatement of pension liabilities.(38)

To obtain such penalty relief, the taxpayer must disclose the item before April 23, 2002 and before the item (or another item arising from the same transaction) is raised by the IRS during an examination. To disclose an item within the meaning of the IRS announcement, the taxpayer must, among other things, describe the material facts of the transaction, provide the names and addresses of the promoters who solicited the taxpayer's participation, provide upon request copies of materials and documents related to the transaction or item, and sign a penalties of perjury statement regarding the accuracy of the information provided.

Penalty relief is not available, however, for items that result from certain specified transactions, including any transaction (1) that did not in fact occur but for which the taxpayer claimed tax benefits, (2) that involved the taxpayer's fraudulent concealment of income or the concealment of a foreign financial account or foreign trust, or (3) involving the treatment of personal expenses as deductible business expenses. In addition, the announcement expressly reserves the IRS's right to impose any civil penalty other than the accuracy penalty and to investigate, or recommend prosecution for, any criminal misconduct.

Pursuant to the announcement, a taxpayer's disclosure of an item creates no inference that its treatment of the item was improper or that the accuracy penalty would apply if there is an underpayment of tax. In addition, taxpayers that do not disclose under this initiative are not precluded from demonstrating that they satisfy the reasonable cause exception under Section 6664(c).(39)

US Representative Lloyd Doggett, the author of certain prior legislation to shut down abusive tax shelters, has suggested that the initiative is misguided:

The "all carrot and no stick" amnesty program is no substitute for addressing the serious problem of abusive tax shelters. Even when caught red-handed, the tax abusers and shelter promoters rarely pay penalties even when the amnesty is not in effect. Instead of working with Congress to give the IRS the tools it needs to crack down on this enormous challenge to our fiscal health, the Treasury Department continues its "benign" neglect of the corporate tax system toward its final goal of 'no corporate taxation."(40)

Representative Doggett does not appear to have fairly described the goals of the current Treasury department, but his skepticism of the disclosure initiative appears entirely justified. On the basis of the relatively minimal degree of enforcement to date, it is unclear whether the IRS's tax amnesty program will provide any meaningful incentive for aggressive taxpayers to invite an audit.


Despite pressure on the United States to resolve challenges to its regime for the taxation of exports, the Bush administration continues to provide certain relief to taxpayers -- both US and non-US -- on issues from disclosed tax shelter transactions to delayed check-the-box elections and protective returns for non-US entities. At the same time, the IRS's rejection of a recent claim for relief from the AMT under the US-Canada treaty was sensibly upheld but using at least one questionable rationale.

The authors believe that these disparate matters continue to bear watching.


1. Pub. L. no. 106-519, enacted on November 15, 2000.

2. World Trade Organization Panel Report, United States: Tax Treatment for "Foreign Sales Corporations," WT/DS108/RW, August 20, 2001.

3. World Trade Organization Appellate Body Report, United States: Tax Treatment for "Foreign Sales Corporations," WT/DS108/AB/RW, January 14, 2002. The Panel and Appellate Body decisions were adopted by the WTO Dispute Settlement Body on January 29, 2002.

4. The FSC rules themselves were introduced to replace a prior regime applicable to domestic international sales corporations ("DISC rules"). The DISC rules had been criticized as an impermissible export subsidy, violating the General Agreement on Tariffs and Trade (GATT).

5. As reported in Chuck Gnaedinger, "Set FSC Sanctions at $956 Million, U.S. Trade Rep Tells WTO" (2002) vol. 94 no. 8 Tax Notes 963-4, at 964.

6. The Convention Between the United States of America and Canada with Respect to Taxes on Income and on Capital, signed at Washington, DC on September 26, 1980, as amended by the protocols signed on June 14, 1983, March 28, 1984, March 17, 1995, and July 29, 1997 (herein referred to as "the treaty").

7. 83 TCM (2002).

8. Under the AMT, a taxpayer's ability to use deductions and credits to offset gross income is significantly limited. The AMT tax rate is lower than the normal income tax rate, however, and is actually imposed only to the extent that the minimum tax determined thereunder exceeds the regular income tax. See sections 55-59 of the Internal Revenue Code of 1986, as amended (herein referred to as "the Code"). Unless otherwise stated, statutory references in this article are to the Code.

9. Pursuant to section 59(a)(2), the FTC allowable for AMT purposes may not exceed the excess of (1) the pre-credit tentative minimum tax over (2) 10 percent of the amount that would be the pre-credit minimum tax without regard to the AMT net operating loss deduction (and another provision limiting certain benefits for independent oil producers).

10. Note that the United States taxes its citizens on their worldwide income, even if they are residents of another country. Article XXIX(2) of the Treaty generally preserves the right of the United States to tax its citizens as if the Treaty were not in effect. This "savings clause" does not apply to certain specified articles, including the article governing the elimination of double taxation.

11. Paragraph 5 of article XXIV provides additional rules for a US citizen resident in Canada with respect to dividends, interest, and royalties arising in the United States. Paragraph 6 provides that, in the case of a US citizen resident in Canada, items of income referred to in paragraphs 4 and 5 shall be considered to arise in Canada to the extent necessary to avoid double taxation (notwithstanding certain other sourcing rules set forth in paragraph 3). These additional rules did not affect the AMT Limit at issue in Kappus.

12. Pub. L. no. 99-514, enacted on October 22, 1986 (herein referred to as "the 1986 act").

13. Technical and Miscellaneous Revenue Act of 1988, Pub. L. no. 100-647, enacted November 10, 1988, section 1012(aa)(2).

14. In general, neither treaty provisions nor Code provisions has precedence over the other: section 7852(d). In the event of a conflict, the provision that is later in time takes precedence over the earlier provision. For example, Paul J. Pekar, 113 TC no. 12 (1999); S. rep. 455, 100th Cong., 2d sess., 321-322 (1988).

15. Supra note 7, at 1207.

16. For example, the Code as in existence immediately following the 1986 act would permit the business profits of a non-US corporation doing business in the US to be subject to US tax, regardless of whether the corporation has a permanent establishment (PE). The Tax Court's view, among a great many other things, would casually elide the PE requirement of article VII (Business Profits) as applied to the US.

17. In contrast to certain other limitations on the use of FTCs, for example, under section 904, which places foreign taxes paid or accrued with respect to various different categories of income in their own "baskets" for FTC purposes to prevent cross-crediting, the AMT limit does not appear to be intended to prevent any benefit other than offsetting "too much" US tax liability with FTCs. Absent the need to preclude some arguably inappropriate windfall, it may be difficult to reconcile the AMT limit with the principle of eliminating double taxation.

Note that the taxpayers' threshold contention with respect to the interpretation of article XXIV, that is, that FTCs provided for under paragraph 4 are not subject to future FTC limitations under US law, is not convincing. Had a departure from the general rules of paragraph 1 been intended, such departure presumably would have been expressly indicated.

18. Sections 871(b) and (a).

19. Treas. reg. sections 1.874-1(b)(1) and 1.882-4(a)(3)(i).

20. See former Treas. reg. sections 1.874-1(b)(2) and 1.882-4(a)(3)(ii).

21. TD 8981, 2002-7 IRB 496, adding temp. Treas. reg. sections 1.874-1T (applicable to individuals) and 1.882-4T (applicable to corporations).

22. Temp. Treas. reg. sections 1.874-1T(b)(2) and 1.882-4T(a)(3)(ii).

23. Temp. Treas. reg. sections 1.874-1T(b)(2) and 1.882-4T(a)(3)(ii).

24. Temp. Treas. reg. section 1.882-4T(a)(3)(ii).

25. The examples applicable to individuals are essentially the same as those applicable to corporations.

26. Temp. Treas. reg. section 1.882-4T(a)(3)(iii), example 1.

27. Ibid., example 4.

28. Ibid., examples 2 and 3.

29. Ibid., example 5.

30. Ibid., example 6.

31. See Treas. reg. section 301.7701-3. A single-member business entity that is not treated as a corporation would be treated as a disregarded entity, rather than a partnership, because a partnership must have at least two partners.

32. Treas. reg. section 301.7701-3(b)(2). Note that a Canadian company or corporation will be eligible to elect partnership (or disregarded entity) status for US tax purposes only if it is a Nova Scotia unlimited liability company or another company or corporation whose owners have unlimited liability pursuant to federal or provincial law. Treas reg. sections 301.7701-2(b)(8)(i) and (ii)(A)(1).

33. For example, if an entity treated as a partnership elects to be treated as a corporation, the partnership is deemed to have contributed all of its assets to a new corporation and to have distributed shares of the corporation to its partners in redemption of their partnership interests. Treas. reg. section 301.7701-3(g)(1)(i).

34. Treas. reg. section 301.7701-3(c)(1)(iv).

35. Rev. proc. 2002-15, 2002-6 IRB 490.

36. An entity not eligible for the relief provided therein may seek a private letter ruling.

37. Announcement 2002-2, 2002-2 IRB 304.

38. The accuracy penalty generally is imposed at a rate of 20 percent pursuant to section 6662(a). In the case of a "gross valuation misstatement," however, the penalty is increased to 40 percent: section 6662(h)(1).

39. Pursuant to section 6664(c), the accuracy penalty generally does not apply to any portion of an underpayment with respect to which the taxpayer shows that there was reasonable cause and that it acted in good faith. There are certain situations, however, in which the reasonable cause exception does not apply, including certain transfer-pricing adjustments. See section 6662(e)(3)(D).

40. As reported in Tax Notes Today, February 26, 2002.