Do US capital gains go into the re-sourced or passive category for foreign tax credits from DE tax on the US tax return?

[applepenpineapple 70]

As a resident in Germany, when claiming foreign tax credits from German taxes on capital gains that came from selling stocks of U.S. companies, do you put them into the re-sourced by treaty or the passive income category on the U.S. tax return?

 

An accountant previously told me that capital gains from stocks of U.S. companies should go into re-sourced category, along with U.S. interest. But recently I was told instead that any capital gains (which aren't from U.S. immovable property) regardless of where the paying company is established, should go into passive category, when the recipient is a resident of Germany. And that only U.S. interest would go into re-sourced category.

 

Is this correct, and why would U.S. capital gains and U.S. interest be treated as different categories?

 

I don't see a difference in their descriptions in the tax treaty. Both articles say these that are derived from a contracting state and paid to a recipient that is resident of the other contracting state may be taxed in the other contracting state (except for alienation of immovable property). No mention of sourcing.

 

The only thing I can think of is that maybe because withholding tax is taken from foreign interest and dividends, but not from foreign capital gains from sales of stocks.

[PandaMunich 16,704]

2 hours ago, applepenpineapple said:

The only thing I can think of is that maybe because withholding tax is taken from foreign interest and dividends, but not from foreign capital gains from sales of stocks.

There is no US source tax (what you call withholding tax andwhat in German is called Quellsteuer) on US interest, see article 11 of the double taxation agreement between Germany and the USA (DTA): http://www.pinkernell.de/dbausa.htm#Art11

 

Regarding re-sourcing, please read article 23 no. 5 (and especially section c) of that paragraph) of the double taxation agreement: 

http://www.pinkernell.de/dbausa.htm#Art23

 

5. Where a United States citizen is a resident of the Federal Republic of Germany:

 

a) With respect to items of income not excluded from the basis of German tax under paragraph 3 that are exempt from United States tax or that are subject to a reduced rate of United States tax when derived by a resident of the Federal Republic of Germany who is not a United States citizen,

 

(Note Panda: they mean the US income for which this DTA assigns the taxation rights to Germany and which Germany then taxes, e.g. capital income like interest, dividends, gains from selling stocks/funds/options/bonds and so on. This income - if it had been received by a non-US-citizen - would either be exempt from US tax entirely, or the US could only charge a reduced tax rate, i.e. those 15% US source tax on US dividends. The US does not get more tax than that from non-US-citizens.

They do not mean income like US rental profit, for which this DTA assigns the taxation rights to the USA, i.e. where the DTA does not assign the taxation rights to Germany, since there Germany does not get to tax that income (well, Germany does get some extra money even there, through Progressionsvorbehalt - but let's not go there, since Progressionsvorbehalt does not count as "taxation").

 

the Federal Republic of Germany shall allow as a credit against German tax, subject to the provisions of German tax law regarding credit for foreign tax, only the tax paid, if any, that the United States may impose under the provisions of this Convention

 

(Note Panda: Germany will only use the 15% US source tax on US dividends that is set by this DTA, to reduce the 25% German tax that you owe on them),

 

other than taxes that may be imposed solely by reason of citizenship under paragraph 4 of Article 1 (General Scope)

 

(Note Panda: Germany will not do a tax credit for tax that you had to pay simply because you are a "US citizen", they would only use US source tax for a tax credit that a non-US-citizeb investor would have had to pay, i.e. those 15% on dividends allowed by article 10 of the DTA);

 

 

b.) For purposes of computing United States tax, the United States shall allow as a credit against United States tax the income tax paid to the Federal Republic of Germany after the credit referred to in subparagraph a)

 

(Note Panda: on US dividends, Germany will have done a 15% tax credit because of the US source tax, which means that you only pay 10% German tax on US dividends in your German tax return --> the US will not lower your US tax by more German tax than you actually have to pay, i.e. only by 10%.

In the case of US interest, since no US source tax is allowed by this DTA, Germany would tax the US interest with 25% in your German tax return, which means that in your US tax return, you get to use the whole 25% German tax that you have to pay on interest as a tax credit);

 

the credit so allowed shall not reduce that portion of the United States tax that is creditable against the German tax in accordance with subparagraph a); and

 

 

c) For the exclusive purpose of relieving double taxation in the United States under subparagraph b), items of income referred to in subparagraph a) shall be deemed to arise in the Federal Republic of Germany to the extent necessary to avoid double taxation of such income under subparagraph b).

 

(Note Panda: if you read c) attentively, you will see that the USA have agreed to view your US capital income as German income. They do this because US tax credit rules only allow a tax credit for "foreign earned" income (just look at the US tax form 1116), so to apply the tax credit, the USA have to "relabel" (= re-source) all your capital income as "German capital income", i.e. as "foreign earned" (= not earned in the USA).)

 

 

***************************************************

And now read the instructions for "form 1116": https://www.irs.gov/pub/irs-pdf/i1116.pdf

 

f. Certain Income Re-Sourced by Treaty

If a sourcing rule in an applicable income tax treaty treats U.S. source income as foreign source, and you elect to apply the treaty, the income will be treated as foreign source.

 

Note Panda: they call the "Double Taxation Agreement" a "Treaty".

[Straightpoop 688]

On 8.10.2022, 17:57:45, applepenpineapple said:

do you put them into the re-sourced by treaty or the passive income category on the U.S. tax return?

 

Either/or is the correct short answer.

 

Here beginneth the long answer:

 

US TAX RULES:

 

The "sourcing rules" under US domestic tax law provide that capital gains from the sale of intangible personalty, e.g. shares of foreign or domestic stock, funds, bonds, etc. are sourced in the country in which the US citizen/LPR taxpayer is resident at the time the gain is realized.

 

However, if the country of residence (e.g. Germany) does not impose a tax of at least 10% on the gain thus realized, the gain will be sourced in the United States for a US Citizen or LPR.  A capital loss will be sourced similarly provided that if the transaction had produced a gain that gain woulda, coulda, shoulda been taxed by the resident country by at least 10%.

 

Germany-USA TREATY RULES:

 

If under the treaty Germany is granted the EXCLUSIVE right to tax a certain item of income earned by its resident (e.g. interest, gain from sale of intangible personalty, etc.) then if US domestic sourcing rules would consider such item of income "US sourced" the US citizen/LPR taxpayer would be unable to claim a credit for German taxes paid on that income because it is not "foreign sourced".  In other words, such item(s) of income would be subject to double taxation.

 

 Art. 23 (discussed by Panda Munich above) solves that problem by overriding US sourcing rules to the extent necessary to avoid double taxation.  Such income is considered "treaty resourced" to Germany.

 

Where things get hairy is what happens when, as a result of the application of German stock loss carryforwards (Aktienverlusttopf) the gain in a particular year is not taxed in Germany at all?  Ditto as the result of a Allgemeinverlusttopf which may even eliminate German taxes on investment income items such as dividends and interest?  And don't forget about the good ol' US short and long-term gain carryforwards which could result in no gains for US tax purposes even as Germany is hitting them with 26.375%.  (That's where the US foreign tax credit carryforwards ride to the rescue.)

 

Fun stuff, no?

 

 

 

[applepenpineapple 70]

On 10/10/2022, 9:29:16, Straightpoop said:

 

Either/or is the correct short answer.

 

Here beginneth the long answer:

 

US TAX RULES:

 

The "sourcing rules" under US domestic tax law provide that capital gains from the sale of intangible personalty, e.g. shares of foreign or domestic stock, funds, bonds, etc. are sourced in the country in which the US citizen/LPR taxpayer is resident at the time the gain is realized.

 

However, if the country of residence (e.g. Germany) does not impose a tax of at least 10% on the gain thus realized, the gain will be sourced in the United States for a US Citizen or LPR.  A capital loss will be sourced similarly provided that if the transaction had produced a gain that gain woulda, coulda, shoulda been taxed by the resident country by at least 10%.

 

Germany-USA TREATY RULES:

 

If under the treaty Germany is granted the EXCLUSIVE right to tax a certain item of income earned by its resident (e.g. interest, gain from sale of intangible personalty, etc.) then if US domestic sourcing rules would consider such item of income "US sourced" the US citizen/LPR taxpayer would be unable to claim a credit for German taxes paid on that income because it is not "foreign sourced".  In other words, such item(s) of income would be subject to double taxation.

 

Then according to Straightpoop, for a typical scenario with capital gains paid by a US company to a recipient who is resident of Germany, the capital gains would be foreign sourced to begin with and assigned to the passive category? Do you have a citation or know the relevant section of the US tax code?

 

How does the US tax code source the interest paid by US companies?

 

 

Also, qualified dividends and long term capital gains are taxed at different rate groups (capital gain excess [standard deduction], 0%, 15%, etc), and ordinary dividends are taxed at standard deduction, 10%, 12%, etc.

When calculating the amount of US tax on US dividends to claim for German credits, would you:

• calculate the pro-rated amount per tax rate group,
• or simply divide the US dividends by adjusted gross income, multiplied by the US tax before credits?

 

On 10/9/2022, 2:26:20, PandaMunich said:

There is no US source tax (what you call withholding tax andwhat in German is called Quellsteuer) on US interest, see article 11 of the double taxation agreement between Germany and the USA (DTA): http://www.pinkernell.de/dbausa.htm#Art11

 

(Note Panda: if you read c) attentively, you will see that the USA have agreed to view your US capital income as German income. They do this because US tax credit rules only allow a tax credit for "foreign earned" income (just look at the US tax form 1116), so to apply the tax credit, the USA have to "relabel" (= re-source) all your capital income as "German capital income", i.e. as "foreign earned" (= not earned in the USA).)

 

 

***************************************************

And now read the instructions for "form 1116": https://www.irs.gov/pub/irs-pdf/i1116.pdf

 

f. Certain Income Re-Sourced by Treaty

If a sourcing rule in an applicable income tax treaty treats U.S. source income as foreign source, and you elect to apply the treaty, the income will be treated as foreign source.

 

Note Panda: they call the "Double Taxation Agreement" a "Treaty".

 

Sorry, I did not complete my sentence. What I meant about the withholding tax is that on the papers that come with the 1099 forms issued by US brokerage accounts, there is a page for "foreign income and foreign withholding tax". On this page, I've only seen interest and dividends paid by non-US companies. The interest at 0% tax, and dividends typically at 15% tax. I've never seen capital gains listed on this page.

 

So I was wondering if this page could be a hint about sourcing rules, if maybe interest paid by a US company should be US-sourced and assigned to the re-sourced by treaty category, since interest from foreign companies show up on that page, and if capital gains from sales of US stocks should be sourced to the recipients country of residence and assigned to the passive category, since capital gains from non-US companies don't show up on that page.  In this case, the US brokerage and ADR administrator assumes the account holder is a US citizen and US resident and withholds the 15% foreign tax on foreign dividends.

 

But that page appears to be informational, and doesn't seem to be officially part of the 1099 form, so I wouldn't rely on such assumptions. I would prefer to find the part of the US tax code that talk about the sourcing rules.

[PandaMunich 16,704]

On 10/10/2022, 21:29:16, Straightpoop said:

Where things get hairy is what happens when, as a result of the application of German stock loss carryforwards (Aktienverlusttopf) the gain in a particular year is not taxed in Germany at all?  Ditto as the result of a Allgemeinverlusttopf which may even eliminate German taxes on investment income items such as dividends and interest?  

Don't forget about the third "pot", the new Optionensverlusttopf ;-)

 

Just for your delectation, the steps for "using" losses between these 3 pots, taken from Randziffer 118 of the BMF-Schreiben "Einzelfragen zur Abgeltungsteuer", which is always "Anhang 19 II" in the "Amtliches Einkommensteuer-Handbuch".

A new version of this book is published every year, both on paper (24€) and online (freely accessible): https://esth.bundesfinanzministerium.de/esth/2021/C-Anhaenge/Anhang-19/II/inhalt.html

 

The following sequence of steps has to be adhered to in the assessment, for offsetting losses (Verlustverrechnung bei Kapitalerträgen) in the different "loss offset groups" (Note Panda: that's what they call the "pots"):

1. Gains/losses on the sale of shares within the meaning of § 20 (6) sentence 4 EStG from the current year; Losses on the disposal of shares within the meaning of § 20 (6) sentence 4 EStG from the current year may only be offset against gains on the disposal of shares.
2. Gains/losses from forward transactions from the current year (incurred after 31 December 2020); Losses from forward transactions within the meaning of § 20 (6) sentence 5 EStG from the current year (incurred after 31 December 2020) may be offset up to the amount of €20,000 and only against gains from forward transactions and income from option writer premiums.
3. Losses within the meaning of § 20 (6) sentence 6 EStG from the current year (incurred after 31 December 2019) may be offset against income from capital assets up to an amount of €20,000.
4. other capital income/losses from the current year; other negative income from the current year within the meaning of § 20 EStG may be offset against positive income within the meaning of § 20 EStG.
5. Losses carried forward (= Verlustvorträge) within the meaning of § 20 (6) sentence 3 EStG from the sale of shares within the meaning of § 20 (6) sentence 4 EStG may only be offset against gains on the sale of shares that remain after offsetting in accordance with items 1, 3 and 4.
6. Losses carried forward within the meaning of § 20 (6) sentence 3 EStG from forward transactions within the meaning of § 20 (6) sentence 5 EStG (which arose after 31 December 2020) may only be offset against gains from forward transactions that remain after offsetting pursuant to nos. 2 to 4 and against income from option writer premiums only up to the amount of € 20,000.
7. Losses carried forward within the meaning of § 20 (6) sentence 3 EStG from losses within the meaning of § 20 (6) sentence 6 EStG (which arose after 31 December 2019) may only be offset against income from capital assets that renains after offsetting in accordance with nos. 1 to 6 and only up to an amount of €20,000.
8. other loss carryforwards within the meaning of § 20 (6) sentence 3 EStG may be offset against positive income after offsetting pursuant to nos. 1 to 7 within the meaning of § 20 EStG.

Nice, isn't it? 

Back in the 2020 version of Randziffer 118, there were only 4 steps: https://esth.bundesfinanzministerium.de/esth/2020/C-Anhaenge/Anhang-19/II/inhalt.html

1. Share capital gains/losses from the current year; share capital losses may only be offset against share capital gains.
2. other capital gains/losses from the current year; other negative income from § 20 EStG may be offset against positive income from § 20 EStG.
3. loss carryforwards from the sale of shares within the meaning of § 20 (6) sentence 3 EStG; the loss carryforwards may only be offset against gains on the disposal of shares remaining after offsetting in accordance with items 1. and 2. above.
4. other loss carryforwards within the meaning of § 20 (6) sentence 3 EStG; the loss carryforwards may be offset against positive income after offsetting in accordance with items 1. to 3. from § 20 EStG.

Our only hope of getting rid of these ever multiplying loss pots is Germany's Supreme Court, the Bundesverfassungsgericht.

Even Germany's highest financial court, the BFH, is of the opinion that the Aktientopf is against the constitution and has therefore escalated this topic to the Bundesverfassungsgericht, to rule on it: https://blogs-pwc-de.translate.goog/de/steuern-und-recht/article/228527/update-vorlage-an-das-bundesverfassungsgericht-der-bfh-haelt-die-verlustverrechnungsbeschraenkung-fuer-aktienveraeusserungsverluste-fuer-verfassungswidrig/?_x_tr_sl=de&_x_tr_tl=en&_x_tr_hl=en-US&_x_tr_pto=wapp

 

So there is hope, we may yet be rid of all these "pots": https://blog-handelsblatt-com.translate.goog/steuerboard/2021/06/07/gute-nachrichten-fuer-private-anleger-bfh-haelt-beschraenkung-der-verlustverrechnung-fuer-aktien-fuer-verfassungswidrig/?_x_tr_sl=de&_x_tr_tl=en&_x_tr_hl=en-US&_x_tr_pto=wapp

[Straightpoop 688]

On 12.10.2022, 19:44:12, applepenpineapple said:

I would prefer to find the part of the US tax code that talk about the sourcing rules.

 

26 USC §861-865 (and the regulations thereunder)

[applepenpineapple 70]

8 hours ago, Straightpoop said:

 

26 USC §861-865 (and the regulations thereunder)

 

Thanks. I wasn't clear which parts relate specifically to capital gains from sales of stocks.

Is it this very broad, unspecific text, 26 USC §865 (a)?

Are stock shares considered personal property?

https://www.law.cornell.edu/uscode/text/26/865

 

Quote

(a)General ruleExcept as otherwise provided in this section, income from the sale of personal property—

(1)

by a United States resident shall be sourced in the United States, or

(2)

by a nonresident shall be sourced outside the United States.

 

 

Regarding interest from US banks, US bonds, I guess it's 26 USC §861 (a) (1):

https://www.law.cornell.edu/uscode/text/26/861

 

Quote

(a)Gross income from sources within United StatesThe following items of gross income shall be treated as income from sources within the United States:

(1)InterestInterest from the United States or the District of Columbia, and interest on bonds, notes, or other interest-bearing obligations of noncorporate residents or domestic corporations

 

 

 

Regarding separate loss pots for German taxes, I guess losses from conventional stocks and ETFs (Aktienfonds, Anlage KAP-INV) cannot be mixed with each other.

[applepenpineapple 70]

Quote

(2)Special rules for United States citizens and resident aliens

For purposes of this section, a United States citizen or resident alien shall not be treated as a nonresident with respect to any sale of personal property unless an income tax equal to at least 10 percent of the gain derived from such sale is actually paid to a foreign country with respect to that gain.

 

I see in 865(g)(2) the rule about 10% foreign tax paid on the gain, for whether or not the sale of stocks would count as US or foreign sourced.

 

I can think of 3 cases where the German tax is less than 10%.

 

1) gains from sales of stock acquired before 2009.

As it's 0% rated in Germany, would this then go into re-sourced by treaty category?

 

 

2) gains from sales of stock with wash sale loss disallowed.

As Germany has no wash sale rule, the wash sale loss disallowed by the US would count towards German calculations, lowering the effective tax rate.

 

For example:

20,000 proceeds

15,000 cost

--------------

5,000 gross profit

-4,000 wash sale disallowed

-------------------

1,000 net profit on German tax return

5,000 net profit on US tax return

-----------------------

26.375% tax in Germany = 263.75

Effective tax rate = 263.75 / 5,000 = 5.275%

 

As less than 10% was actually paid "with respect to that gain" (which gain? The 1,000 or 5,000?), would it have to be re-sourced by treaty?

 

 

3) Then another problem happens to the calculation of the effective tax rate and the allocation of foreign taxes when you either apply this to the aggregate gain from all properties, or to each separate property.