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agrees to pay B a certain amount of interest net of any
tax that country X may impose on B with respect to its
interest income. Country X imposes a 10 percent tax on
the gross amount of interest income received by
nonresidents of country X from sources in country X,
and it is established that this tax is a tax in lieu of
an income tax within the meaning of � 1.903-1(a).
Under the law of country X this tax is imposed on the
nonresident recipient, and any resident of country X
that pays such interest to a nonresident is required to
withhold and pay over to country X 10 percent of the
amount of such interest, which is applied to offset the
recipient’s liability for the tax. Because legal
liability for the tax is imposed on the recipient of
such interest income, B is the taxpayer with respect to
the country X tax imposed on B’s interest income from
B’s loan to A. Accordingly, B’s interest income for
federal income tax purposes includes the amount of
country X tax that is imposed on B with respect to such
interest income and that is paid on B’s behalf by A
pursuant to the loan agreement, and, under paragraph
(f)(2)(i) of this section, such tax is considered for
purposes of section 903 to be paid by B.
Example (2). The facts are the same as in example
(1), except that in collecting and receiving the
interest B is acting as a nominee for, or agent of, C,
who is a United States person. Because C (not B) is
the beneficial owner of the interest, legal liability
for the tax is imposed on C, not B (C’s nominee or
agent). Thus, C is the taxpayer with respect to the
country X tax imposed on C’s interest income from C’s
loan to A. Accordingly, C’s interest income for
federal income tax purposes includes the amount of
country X tax that is imposed on C with respect to such
interest income and that is paid on C’s behalf by A
pursuant to the loan agreement. Under paragraph
(f)(2)(i) of this section, such tax is considered for
purposes of section 903 to be paid by C. No such tax
is considered paid by B.
Example (3). Country X imposes a tax called the
“country X income tax.” A, a United States person
engaged in construction activities in country X, is
subject to that tax. Country X has contracted with A
for A to construct a naval base. A is a dual capacity
taxpayer (as defined in paragraph (a)(2)(ii)(A) of this
section) and, in accordance with paragraphs (a)(1) and
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