The privatization of the space industry has seen dramatic growth in recent years, and it appears that more significant developments are on the horizon. During 2013, SpaceX (the space exploration company founded by Elon Musk, co-founder of PayPal and Tesla Motors) successfully launched a major communications satellite into orbit for a private satellite operator, and became the first private company to transport cargo to the International Space Station. In December 2013, SpaceX beat out Blue Origin, the space company founded by Miami’s own Jeff Bezos of Amazon, in the bid for control of Launch Pad 39A at Cape Canaveral by NASA, where many historic U.S. space missions began. Virgin Galactic, a space tourism company founded by Sir Richard Branson of Virgin Atlantic, has already begun accepting reservations for commercial flights into space, and expects to launch its first commercial spaceflight during 2014.
With the industry getting ready for blast off, the sourcing rules for income from space activities will become an important consideration for U.S. companies entering the private space industry.
Impact of Sourcing Rules
The United States federal tax system subjects U.S. persons to income tax on its worldwide income, including income from both sources within the U.S. (U.S. source) and income from sources outside the U.S. (foreign source). U.S. persons are generally concerned with the source of income because they need to establish the amount of their foreign source income for foreign tax credit limitation purposes. Foreign persons, however, are subject to U.S. tax on two categories of income:
- Certain passive types of U.S. source income and
- Income that is effectively connected to a U.S. trade or business.
As a result, the source of income is significant for foreign persons because they generally are subject to U.S. federal income tax only on U.S. source income.
Space Activity Income Derived by a U.S. Person
U.S. tax laws provide that income from space activity derived by a U.S. person or a Controlled Foreign Corporation (CFC) is income from U.S. sources, except that income attributable to functions performed, resources employed or risks assumed in a foreign country is treated as foreign source income.
Because U.S. persons are taxed on both U.S. source and foreign source income, U.S. companies engaged in the private space industry, generally would be subject to U.S. tax on all of its space activity income, regardless of source.
A more tax efficient structure is available to U.S. persons in the private space industry by conducting business through certain foreign corporations. By structuring its operations so that the space activity income is attributable to functions performed, resources employed or risks assumed outside of the U.S., the CFC’s income would be foreign source income that is not subject to U.S. federal income tax. In addition, the space activity income would not be treated as Subpart F income, allowing U.S. shareholders to defer paying U.S. income tax on their share of the CFC’s space activity income until it is repatriated back into the United States.
If properly structured, the income can be repatriated to the U.S. shareholders at qualified dividend rates (currently 20%) as opposed to ordinary income rates (currently the highest rate of which is 39.6%).