Outbound Taxation
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Recall definition
Two important planning areas:
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Use of foreign tax credit to minimize double
taxation
Use of foreign corporations to shift income
out of US taxing jurisdiction
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Foreign Tax Credit - Overview
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Three big questions:
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Who gets a FTC?
What are creditable foreign taxes?
How much FTC is available each year?
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Example 1: Taxpayers Eligible
for the FTC
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Which of the following taxpayers is
allowed a US foreign tax credit?
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US citizen earning income in France and
paying French income tax
US corporation with a branch office in Japan
paying Japanese income tax
Foreign corporation earning US income on
which it pays both US and foreign taxes
Nonresident foreign individual earning US
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income subject to US and foreign taxes
Creditable Foreign Taxes
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Must be a ‘tax’ or ‘in lieu of’ a tax
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Not a payment for any specific benefit, not
related to transactions between the taxpayer
and the government
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Special rules for splitting ‘dual-capacity’ payments
Must be an ‘income’ tax
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Imposed on realized net gain derived from
actual gross receipts
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Figure 13-1 Types of Tax Collected as a Percentage of
Total Tax Revenues for OECD Member Countries, 1997
Other Taxes
14%
Personal Income Tax
27%
Consumption Taxes
18%
Corporate Income Tax
9%
Property Tax
6%
Social Security and
Payroll Tax
26%
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Foreign Income Tax Systems
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Rates range from zero to 42 percent (Canada
and Japan)
Imputation system for alleviating doubletaxation of corporate earnings
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Shareholders receive a tax credit for portion of
corporate tax paid and report dividend income equal
to dividend received plus credit amount
Many other differences in computation of
taxable income and tax liability
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Value-Added Tax Systems
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Common in Europe and many other developed
countries
Consumption tax
Assessed on producers and distributors of goods
and services based on ‘value added’ at each
stage of production and distribution
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Value-added generally equal to difference between
sales price and non-labor costs of production or
acquisition
Rates can be as high as 20+ percent
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Example 2: Creditable Foreign
Taxes
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Which of the following foreign taxes are
likely to be creditable?
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Value-added tax
Excise tax
Tax on gross receipts, with no allowance for
deductions
Customs taxes imposed on imports of raw
materials
Tax on net income computed under
International Accounting Standards
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Example 3: Splitting DualCapacity Payments
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BigOil Co. extracts oil with a gross value
of $10 million from oil deposits owned by
a foreign government. It incurs $2 million
of operating expenses, and pays a 60% oil
tax on its net profit. The foreign
government’s normal income tax rate is
35%.
How much of BigOil’s payment is
considered a tax, and how much is a
royalty?
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Limits on Allowable FTC
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Concept: FTC is allowed only up to the
amount of US taxes paid on foreign
source income
Mechanics:
Credit = US Income X Foreign Source Income
Limit Tax
Worldwide Income
Unused credits may be carried back 2 years
and forward 5, subject to the limit in those
years
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Example 4: Applying the
Overall FTC Limitation
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Global Inc., a US corporation, earned $4
million of worldwide taxable income, of
which $1 million is foreign source.
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If Global paid $300,000 of foreign taxes,
compute its US tax liability after allowable
FTC and total tax burden
What if Global paid $500,000 of foreign
taxes?
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FTC Limits – Separate Baskets
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FTC limit is applied separately for foreign taxes
paid on income in separate baskets:
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Passive income
High interest withholding income
Financial services income
Shipping income
Dividends received by a corporation from each noncontrolled Sec. 902 corporation
Dividends from a DISC or former DISC
Foreign trade taxable income
Distributions from a FSC
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All other income
Separate Basket Limits
continued
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What is the goal of the separate basket
limitations on the FTC?
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Do these limits increase or decrease
taxpayers’ ability to use FTCs?
What do many of the separate baskets
have in common?
Note: Overall limit applies after the
separate basket limitations
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Example 5: Applying the FTC
Basket Limitations
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Refer to example 3. Suppose that Global’s
foreign source income is composed of
$600,000 of passive income and $400,000
of shipping income. All $300,000 of its
foreign taxes paid relate to the passive
income. Compute Global’s separate
basket FTC limitations, its US tax liability
after FTC, and its total tax burden.
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Cross-Crediting Opportunities
and Limits
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Cross-crediting is advantageous when
some foreign income is taxed at a low
foreign tax rate while other foreign
income is taxed at a high foreign tax rate
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Cross-crediting is possible only when both
sources of income are in the same basket, or
when both sources of income are in the
general basket
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Example 6: Cross-Crediting
and the FTC
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Nova Corporation earned $1 million of foreign
income in country A, on which it paid foreign
income tax of $100,000, and $1.5 million in
country B on which it paid tax of $600,000. Its
US source income is $3 million.
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If all of Nova’s foreign income is in the general
basket, calculate its allowable FTC and net US tax
liability.
What if Nova’s two foreign income sources are in
separate baskets (or if per-country FTC limits
applied)?
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Conclusions
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What are the burdens imposed by the FTC
rules?
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Information gathering and compliance
burdens?
Impact on after-tax return from investment in
foreign jurisdictions?
What planning opportunities can you
identify related to the FTC?
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