U.S. International Tax Law – 8
U.S. Foreign Tax Credit
Choices for outbound arrangements:
1) U.S. sales office/export subsidiary
2) Foreign country subsidiary
3) Independent local agent
4) Dependent local agent
5) Internet – websites
Cf, discussion of inbound U.S. investment.
5/4/2009
(c) William P. Streng
1
Foreign Branch Options
Use (i) U.S. parent corporation or (ii) a
special purpose U.S. (or foreign) subsidiary.
Branch of U.S. corporation will enable U.S.
tax deductions, e.g., (i) minerals and oil and
gas exploration and (ii) consolidated return
treatment (loss utilization, but “recapture”) .
No limitation of liability for foreign branch
assets – but, use a special purpose U.S.
subsidiary for only
holding this investment.2
5/4/2009
(c) William P. Streng
Use of a Foreign Business
Corporate Organization
If a corporation, deferral of U.S. income tax
is available, assuming inapplicability of
Subpart F (e.g., if active business operations
& tax holidays in the foreign country).
Organization of a foreign corporation may
accommodate joint foreign investors.
What form of foreign business entity should
be used to enable corporate status? LLC?
Use a “hybrid entity” or a corp. in the
foreign country?
5/4/2009
(c) William P. Streng
3
1
Income Tax Exposure in
the Foreign Jurisdiction
1) No tax if no representative office in the
jurisdiction – dependent upon local law.
2) Tax liability if a local agent, unless that
agent is “independent” of U.S. principal.
3) Foreign country tax liability if a local
country subsidiary (but possible exception
if the corporate “place of mind and
management” is elsewhere).
5/4/2009
(c) William P. Streng
4
U.S. Foreign Tax Credit
Planning
Assuming foreign country income tax
jurisdiction exists - U.S. tax planning
objective is to limit foreign taxes to assure
no excess foreign tax credits arise.
U.S. tax objectives: generate income as:
(i) foreign source, (ii) low taxed & (iii)
FTC general limitation category.
5/4/2009
(c) William P. Streng
5
Possible Impact of an
Income Tax Treaty
The foreign country income tax result
may be moderated by a bilateral income
tax treaty between the foreign
destination country and the United States
(or, perhaps, between a third jurisdiction
and the destination country).
A foreign country may impose less
extensive tax jurisdiction than under that
tax treaty (e.g.,(c)participation
exemption).6
5/4/2009
William P. Streng
2
Application of a Bilateral
U.S. Income Tax Treaty
1) Business profits allocation – Art. 7(1) determination of the amount of business
profits subject to foreign country tax.
2) Amount of income subject to tax choices are (a) only income attributable to
the P.E. or (b) a “limited force of
attraction” rule, similar to U.S. rules.
3) Tax deduction treatment of expenses??
5/4/2009
(c) William P. Streng
7
Tax Treaty Concept of
“Permanent Establishment”
Fixed place of business for engaging in
industrial or commercial activity.
U.S. Model Treaty, Article 5(1).
How distinguish between “dependent”
and “independent” agent? Art. 5(5) & (6).
Remember the Taisei Fire case (U.S. Tax
Court) in the inbound context.
5/4/2009
(c) William P. Streng
8
Income Tax Treaty
Interpretation Tools
1) OECD Commentary - under
continual revision
2) U.S. Treasury (unilateral?)
“Technical Explanation” of a
particular bilateral U.S. income
tax treaty (& 2006 Model).
3) Court decisions in the U.S. and
other jurisdictions (e.g., Taisei).
5/4/2009
(c) William P. Streng
9
3
Mitigating Possible Double
National Level Taxation
Possible double taxation exposure exists since
the U.S. income tax is imposed on a
worldwide basis (assuming a foreign
country income tax liability).
Options for unilateral relief include:
1) a deduction for the foreign tax paid
2) a (limited) credit for the foreign tax paid
3) exemption under a territorial system.
5/4/2009
(c) William P. Streng
10
Bilateral (i.e., Income Tax
Treaty) Relief
Accomplished under a U.S. bilateral
income tax treaty. Article 23 (2006).
- possible shifting of tax liability from
source to residence jurisdiction.
- a U.S. income tax treaty does include a
“savings clause” - enabling the
continuing worldwide tax jurisdiction
of U.S. citizens/residents/corporations.
5/4/2009
(c) William P. Streng
11
Tax Characterization of the
Foreign Business Entity
Necessary to have limitation of liability?
Use a corporation or a LLC?
Necessary to have two or more owners?
Use two special purpose subs in the U.S.
to hold 50% (or 90 & 10%?) interests.
Deferral is not important if the foreign
tax rate is high as or higher than the
U.S. income tax rate.
5/4/2009
(c) William P. Streng
12
4
Entity Choices Outside the
U.S.
Foreign corporation in host country
(and similar foreign counterparts).
Third country corporation.
Limited liability company (LLC).
Limited partnership (LP).
General partnership (GP).
Contractual joint venture (JV).
5/4/2009
(c) William P. Streng
13
Entity Choices Outside U.S.
- Business Law Aspects
1.
2.
3.
4.
5.
Limitation of liability.
Control arrangements.
Profit sharing split.
Foreign country tax burden.
Foreign tax credit (i) availability and
(ii) excess FTC position.
5/4/2009
(c) William P. Streng
14
Former §7701 Entity/Corp.
Characterization Regs.
1) Associates (both corp. or partnership).
2) Objective to carry on business and divide
the profits (both corp or ptnship, not trust).
3) Continuity of life - death, insanity or
bankruptcy not causing dissolution.
4) Centralized management - non-owner may
have continuing authority to make
management decisions.
continued
5/4/2009
(c) William P. Streng
15
5
Former Code §7701
Regulations,
continued
5) Free transferability of ownership interests
- owners have power, without the consent of
other owners, to substitute others (not
previously equity owners) for themselves in
the organization;
6) Limited Liability - no equity owner is
personally liable for the debts of or claims
against the organization.
5/4/2009
(c) William P. Streng
16
Rev Rul. 88-8
Foreign Law Criteria Applied
The factual criteria specified in (former)
§7701 regulations must be applied in
determining the status of an entity (including
foreign entity) as a corporation for U.S. tax.
Inconsistent classification possible: Use of a
hybrid entity - a corporation for foreign law
purposes but a partnership for U.S. income
tax purposes. Cf., a reverse hybrid (U.S.
corp. status; foreign
flow-through).
5/4/2009
(c) William P. Streng
17
“Check-the-box” Entity Characterization Regs.
Elective approach of structuring entities to
be a (i) corporation or (ii) partnership for
U.S. tax purposes. Permits the use of “hybrid
entities.”
Certain business entities are automatically
classified as corporations for U.S. tax
purposes, including a list of specific foreign
entities. Reg. §301.7701-2(b)(8).
5/4/2009
(c) William P. Streng
18
6
Hybrid Entity Issues
(Corp. in Foreign Country)
U.S. Corporate Parent
Foreign Corp Sub FCountry-1
(As a Holding Co. – Corp. for US Tax)
Royalty/
Operating Co. 3 (LLC?)
Finance Co. 2
pays royalty &
interest to Finance Co. 2
(LLC?)
(Foreign Country 2)
(Foreign Country 3)
Co. 2 & 3 are conduits for U.S. income tax
5/4/2009
(c) William P. Streng
19
Hybrid Branch & Possible
Limitations
Notice 98-11 - separate status for hybrids?
Temporary Regs. - T.D. 8767
Notice 98-35 - withdrawing these items
Proposed Regs. 1.954-9, pending (next slide)
Proposed “Extraordinary Transaction” Rule
Withdrawal of this Rule - Notice 2003-46
Issue: Should IRS be able to promulgate a
“branch rule” for FPHC income?
5/4/2009
(c) William P. Streng
20
Hybrid Branch
Prop. Regs. §1.954-9 (1999)
1. Hybrid payments to related entity
reducing foreign country tax and having a
FPHC classification.
2. Hybrid status: fiscally transparent in the
US but not fiscally transparent in the
country of the payor entity.
3. “Tax disparity” test satisfied (less than
90% rate of the payor’s tax)?
5/4/2009
(c) William P. Streng
21
7
Capitalization of the
Foreign Corporation
Use debt or special class(es) of stock?
Is the interest on the debt deductible for
foreign country income tax purposes?
And, FTC “look-through” rule. §904(d)(3).
Debt arrangement enables the tax-free
repayment of principal (not treated as
dividend) and is free of the applicability of
the withholding at source rules (if treaty).
5/4/2009
(c) William P.treatment
Streng
22
Cf., stock redemption
under §302.
Capitalization of the
Foreign Corporation, cont.
Transfer of tangible property and
intangibles as:
1. Contribution to capital (consider §§351
& 367(d)) (foreign source ordinary
income), or
2. Sale, lease or license (consider §482).
Consider (a) applicability of sourcing rules
& (b) tax characterization rules ordinary income or capital gain.
5/4/2009
(c) William P. Streng
23
Fundamental Foreign Tax
Credit Issues
1) Who is eligible for FTC?
2) Which foreign taxes are creditable?
3) The “direct credit” regime.
4) The indirect or "deemed paid" credit
(paid by foreign subsidiaries) regime.
5) Possible limitations on foreign tax
credit availability.
6) Foreign currency translation.
5/4/2009
(c) William P. Streng
24
8
Eligible Taxpayers for the
Direct FTC
1) Foreign branch of a U.S. corporation.
2) Individuals - U.S. citizens and
resident aliens.
3) Individuals and corporations through
partnerships & S corporations.
Credit is available for direct taxes,
including withholding at source, if
the tax is an income tax & imposed
on the recipient of the income.
5/4/2009
(c) William P. Streng
25
“Hybrid Entities”
Who is the taxpayer? Reg. §1.901-2(f)(1)
prescribes the “technical taxpayer rule.”
Inquiry: Who has the legal liability for the
foreign income tax under applicable
foreign law when flow-through for foreign
tax purposes?
Guardian Industries case –
U.S. corp. has §901 credit for tax paid by
“subsidiary” - a disregarded entity for
U.S. tax but a corp. for foreign tax. The
disregarded entity had the tax obligation
for foreign tax purposes.
5/4/2009
(c) William P. Streng
26
“Creditable” Taxes
Code §§901 and 903
§901(a) identifies income, war profits
and excess profits taxes as creditable.
Must be a tax on income; cannot be an
excise tax, sales tax, VAT, capital or
net worth taxes (deductible taxes).
Reg. §1.901-2(a)(1) - the tax must be an
income tax in the U.S. sense, but exact
parallelism to U.S. system not required.
5/4/2009
(c) William P. Streng
27
9
Subnational Taxes
Foreign subnational taxes are creditable.
U.S. subnational taxes are not creditable but
only deductible.
Does this create an incentive to base
investment in foreign jurisdiction; i.e., what
is impact on net after-tax return?
Policy issue: Provide a deduction only for
foreign subnational taxes? Provide a credit
for U.S. state & local taxes?
5/4/2009
(c) William P. Streng
28
Is the Foreign Levy a “Tax”
(or a Benefit)?
Reg. §1.901-2(a)(2)(i) specifies that
penalties, fines, interest, customs
duties and similar obligations are not
taxes.
Tax vs. Royalty: Cf., Rev. Rul. 55-296
& IR-1638. No FTC is available unless
the foreign government also obtains an
appropriate royalty amount for the
production of oil it owns.
5/4/2009
(c) William P. Streng
29
“Dual Capacity”
FTC Regulations
Not determining on “all or nothing” basis.
Divide amount paid between (i) the
creditable tax portion and (ii) the
noncreditable (but deductible) royalty.
How demonstrate that portion which is the
payment for the creditable tax?
Two methods: (1) facts & circumstances Reg. §1.901-2A(c)(2), and (2) safe harbor
- Reg. §1.901-2A(c)(3) & (d) & (e).
5/4/2009
(c) William P. Streng
30
10
Example re Dual Capacity
Taxpayer
$1,000 gross receipts and $500 of mining
costs; no royalty paid to the government.
Levy of $300 to the foreign government;
General tax rate is 33 1/3 percent.
Computation: gross receipts (1000) less
mining costs (500) less the levy (300)
times tax rate (33 1/3 percent)
66 2/3 percent (or 1.0 less tax rate)
Therefore, 100 is the
creditable tax amount.
5/4/2009
(c) William P. Streng
31
“Income Tax in the U.S.
Sense”?
Tax must reach "net gain” to be
creditable. Reg. §1.901-2(a)(3)(i).
“Net gain” test is satisfied if tax meets:
1) the “realization” requirement
2) the “gross receipts” requirement
3) the “net income” requirement
5/4/2009
(c) William P. Streng
32
Bank of America case
Tax on gross receipts from banking
business re interest, etc. and gross
profits re sale of currency and notes.
Held: not equivalent to a net income tax.
Issue of whether the other country is
attempting to reach some net gain.
Direct tax on gross income is creditable
if intended to reach some net gain.
5/4/2009
(c) William P. Streng
33
11
Texasgulf, Inc. case
Ontario Minerals Tax is creditable.
Approximation method applied to
determine profit.
“Processing allowance” held to
compensate for disallowed deductions.
This allowance is approximate to or
greater than the amount of
nonrecoverable expenses.
5/4/2009
(c) William P. Streng
34
Code §903 “In Lieu of”
Foreign Tax Credit
Special foreign tax as a substitute for
and not in addition to a generally
applicable income tax.
Tax base need not be income tax base.
Why permitted as a creditable tax?
Must satisfy the dual capacity rules and
not be a “soak-up tax”.
5/4/2009
(c) William P. Streng
35
“Soak-up” Taxes
Reg. §1.901-2(c) specifies that a “soakup” tax is not creditable – i.e., a tax
conditioned on the availability to the
taxpayer to claim a foreign tax credit
in its home jurisdiction.
Rev. Ruls. 87-39 & 2003-8
What is the statutory authority for this
soak-up tax/no FTC tax regulation?
5/4/2009
(c) William P. Streng
36
12
Gross Income Taxes &
Withholding Tax
Should gross income taxes be creditable?
Foreign gross basis withholding taxes on
income such as interest, dividends,
rents and royalties – treated as "in lieu
of" taxes under Code §903?
Will the withholding tax apply to net
gain (e.g., where limited expenses are
being incurred)?
5/4/2009
(c) William P. Streng
37
Rev. Rul. 78-234
Withholding Tax at Source
Withholding tax on dividends, interest,
royalties and management fees.
Gross tax on management or professional
fees is not the equivalent of a U.S. income
tax & is not creditable.
Separate taxes on dividends, interest and
royalties not allowing for deductions.
Equivalent to gross withholding taxes in
U.S.? Here, creditability under §901.
5/4/2009
(c) William P. Streng
38
Actual foreign tax payment
required
Taxpayer must submit receipts showing
actual payment of the foreign tax.
Reg. §1.905-2(a)(2).
Must be a compulsory payment, i.e.,
must exhaust all effective and practical
remedies to reduce the foreign tax.
Reg. §1.901-2(e)(5).
5/4/2009
(c) William P. Streng
39
13
Refunds, Rebates &
Subsidies
Code §901(i).
Not a creditable tax if an amount will be
credited, refunded, rebated, etc.
See Nissho Iwai American Corp. v.
Commissioner - A net loan arrangement;
but, a credit was received by the borrower
for a portion of the tax paid.
Treated as a subsidy when the transactions
are integrated; then, no FTC is available.
5/4/2009
(c) William P. Streng
40
Amoco case
Was a Tax Subsidy Available?
U.S. oil company and an instrumentality of
Egypt government (i.e., a wholly owned
government corporation; cf., Pemex).
How structure the payment of taxes under a
production sharing agreement so taxes are
treated as paid by AMOCO (for FTC
purposes)? Credit claimed by both parties.
Tax Court says Amoco paid the taxes & no
indirect subsidy. Egypt Govt. cannot
subsidize itself. Tax
burden was on Amoco.41
5/4/2009
(c) William P. Streng
Denial of FTC for Political
Purposes
Code §901(j).
FTC denial re: Cuba, Iran, Iraq (not
from 1982 to 1990 & not after 2004),
North Korea, Sudan & Syria.
(i.e., all members of the “Axis of Evil,”
plus some others). Where is Libya?
Previously on the list: South Africa and
Vietnam.
Cuba: including Guantanamo?
5/4/2009
(c) William P. Streng
42
14
Election and Accounting
Rules
§905(a) - permits a cash method taxpayer
to elect the accrual method for FTC
purposes. What potential problem does
this accrual method option remedy?
§905(c) – an accrual basis taxpayer must
make adjustments when the accrued tax
amount changes or where taxes are not
actually paid within two years.
What if the foreign tax is contested?
Accrual of tax when the issue is resolved.
5/4/2009
(c) William P. Streng
43
Indirect “Deemed Paid”
Credit Availability
§902
Objective: A branch of a U.S. corporation
and a foreign subsidiary of a U.S. corp. are
to be treated similarly with respect to the
availability of the foreign tax credit.
U.S. tax treatment: A 10% or greater
corporate shareholder is deemed to have
paid a proportionate share of the foreign
corporation's post-1986 foreign income
taxes. Cf., §243(a) DRD. Why 10%?
5/4/2009
(c) William P. Streng
44
Indirect Credit –
Calculating the Amount
1) Determine the amount of foreign taxes
deemed paid: (a) all or only a partial E&P
distribution? (b) allocations to multiple
shareholders?
2) Determine the dividend amount: the
dividend as grossed-up is to include the
allocated income tax amount (Code §78).
3) Determine the U.S. income tax on the
grossed-up amount before & after FTC.
5/4/2009
(c) William P. Streng
45
15
Indirect Credit –
Determining Ownership
1) No attribution of indirect ownership to
obtain the 10% minimum ownership.
2) Determining indirect ownership when
foreign corporate ownership by:
a) general partnership (US)
b) limited partnership (US)
c) foreign partnership
d) S corporation
e) LLC
See § 902(c)(7).
5/4/2009
(c) William P. Streng
46
Example:
Interest Held Through an LLC
U.S. corp. & U.S. individual own 50%
interests in a U.S. limited liability
company (treated as a partnership for
U.S. tax). The LLC owns a 20% interest
in a foreign corporation.
Should indirect credits be available here?
Concern re complicated allocation
provisions and structures? Note:
§902(c)(7) - as enacted in 2004 Jobs Act.
5/4/2009
(c) William P. Streng
47
Indirect credit through
multiple tiers
§902(b). Six tiers eligibility for credit.
Ten percent direct ownership (by owner sub)
and 5 percent indirect ownership (by U.S.
parent) for each lower tier required.
What if needing more tiers?
Why need even more than one tier after the
“choice of entity” rules (i.e., disregarded
entities)? Hi-tax/low-tax companies?
Subpart F planning to come.
5/4/2009
(c) William P. Streng
48
16
Determination of Earnings,
Foreign Taxes and Dividends
Distribution of the proportionate amount
of post-1986 (1) earnings and (2) foreign
taxes to be determined.
See the §902 computation formula.
What is a “dividend?” The Code §316
definition applies, either (i) current e&p
or (ii) accumulated e&p.
What is “accumulated e&p”?
5/4/2009
(c) William P. Streng
49
The Perpetual Pool System
(i.e., not year-by-year)
§ 902(c)(1) perpetual pool of post-1986
earnings starting in 1987.
§ 902(c)(2) continuing pool of foreign taxes
starting in 1987.
Cf., the prior single year approach,
resulting in the “rhythm method” of FTC
planning (e.g., fluctuations of income and
tax paid: repatriate dividends for only
the high foreign tax paid years).
5/4/2009
(c) William P. Streng
50
Goodyear Tire & Rubber
U.S. Rules Are Applicable
Goodyear G.B. had a net operating loss
carryback and received a substantial
refund of U.K. income tax payments.
Code §905(c) requires a redetermination of
FTC when foreign tax is refunded.
U.S. earnings and profits rules are used,
however, to measure the distribution of
“accumulated profits” (pre-1987) as a
“dividend” for U.S. income tax purposes.
5/4/2009
(c) William P. Streng
51
17
Vulcan Materials
“Mixed Corporation”
Vulcan, a U.S. corporation, was a shareholder
of a Saudi corporation.
Saudi income tax on a "mixed corporation" is
imposed on only that portion of the profits
attributable to the foreign ownership
interest. Domestic owner subject to zakat.
Dividends not subject to Saudi tax at source.
What was the “accumulated profits” amount
allocable to the U.S. shareholder? Is a
“special allocation” permitted?
5/4/2009
(c) William P. Streng
52
Foreign currency
conversion
Issue: Conversion of (1) foreign
earnings and (2) foreign taxes paid into
U.S. dollars for determining FTC.
Code §986(a)(1)(A) - accrual basis
taxpayers - use average exchange rate.
Code §986(a)(2)(A) - cash method
taxpayers - use the exchange rate when
the taxes are paid.
5/4/2009
(c) William P. Streng
53
Impact of Deficits on the
FTC Computation
Interrelated complications:
1) Nimble dividend rule, although deficit
E&P.
2) Foreign country does not have NOL
carryback or carryforward system.
3) Carryback of post-1986 or
carryforward of pre-1987 deficits.
5/4/2009
(c) William P. Streng
54
18
Possible Reforms
Problem with Eternal Pools
Issue: Dealing with the complexity of the
present structure for calculating indirect
foreign tax credits.
Options:
1) Moving pools, rather than “eternal pools”
2) Limit on years in the eternal pools
3) Year by year method but a general antiabuse rule.
5/4/2009
(c) William P. Streng
55
Tax Sparing Credits
U.S. Position - “No”
Re: Foreign country tax holiday programs.
Under "tax sparing" concept a tax credit is
provided in home country even though
foreign country taxes not actually paid.
U.S. rule: Uncollected foreign taxes are not
creditable for U.S. income tax purposes.
For U.S. tax planning: use a foreign
country subsidiary and achieve deferral
of the current U.S. income taxation.
5/4/2009
(c) William P. Streng
56
Foreign Tax Credit &
Possible Limitations
Code §904 - fundamental concepts:
(1) no credit for foreign tax paid against
U.S. tax on U.S. sourced income; and,
(2) no averaging of tax rates between
different types of income (§904(d)).
Basic FTC limitation formula:
Applicable fraction times U.S. income
tax on worldwide income.
5/4/2009
(c) William P. Streng
57
19
FTC Limitation Example
Two Income Items Only
100 U.S. source income taxed at 40%
= 40
100 foreign source income taxed at 70% = 70
200 total income - U.S. tax imposed at 40%
= 80 U.S. tax (before FTC applicability)
Is the available foreign tax credit amount:
a) 80 less 70 (i.e., net 10 U.S. income tax)? or
b) 80 less 40 (i.e., net 40 U.S. income tax &
total 110 tax – 40US + 70 foreign)?
5/4/2009
(c) William P. Streng
58
Foreign Tax Credit
Excess Credit Carryover
Code §904(c) – Excess foreign tax credits
– carryback one year and carryforward
for ten years.
Pre-2004 rule: Carryback two years and
carryforward five years.
5/4/2009
(c) William P. Streng
59
Foreign Tax Credit
Limitations
“Baskets”, Losses and Look-Through
Rules:
Separate Limitation
Categories/Baskets under Code §904(d).
Objective: Reduce cross-crediting of
excess foreign tax credits against income
subject to lesser tax rates.
E.g., manufacturing income taxed at high
rate vs. low taxed interest income.
5/4/2009
(c) William P. Streng
60
20
Possible Types of FTC
Limitation Formulas
1. Worldwide - only one limitation fraction.
2. Separate country limitation.
3. Different “types of income” limitationCode §904(d).
4. Each item of income limitation.
Fundamental issue: how much “crosscrediting” to allow?
What about losses in some countries or
activities?
5/4/2009
(c) William P. Streng
61
FTC Limitation Baskets –
Prior §904(d)(1)
1) Passive income (FPCI income)
2) High withholding tax interest-5%+
3) Financial services income
4) 10-50 corporation dividends
5) Overall/residual basket (I basket).
Must determine for each basket:
(a) gross income, (b) deductions, and
(c) the foreign tax amount.
5/4/2009
(c) William P. Streng
62
10-50 Corp. Dividends Limitation Choices
1) Limitation formula applied on a
corporation by corporation basis
(i.e., separate calculations).
2) Combination: Treat all as one §902
corporation (the rule for post 2002
distributions from pre-2003 E&P).
3) Look-through rule applicable (for
distributions of post-2002 income).
5/4/2009
(c) William P. Streng
63
21
Post 2006 Tax Years
2004 Jobs Act
Code §904(d)(1): Two basket
limitation system:
1) General category income
(including shipping income &
owner occupied imputed income)
2) Passive category income – FPHC
Income (not export financing
interest & high-taxed income)
5/4/2009
(c) William P. Streng
64
Income & Deduction
Sourcing Rules
Must use U.S. rules concerning sourcing of
both income and deductions.
Numerator and denominator of the FTC
limitation formula are based on amounts
determined under U.S. sourcing rules.
This may produce a conflict with the foreign
country imposing the tax & asserting it
has primary income tax jurisdiction.
5/4/2009
(c) William P. Streng
65
Example
Divergent Income Sourcing
Legal services are performed in U.S.
for a foreign client. U.S. source for
U.S. income tax purposes, but foreign
source for foreign tax purposes.
No foreign tax credit since, for U.S.
income tax purposes, income is U.S.
The numerator of the FTC limitation
fraction will be zero.
5/4/2009
(c) William P. Streng
66
22
Capital Gains
p. 388
§904(b)(2)
§904(b) has special rules for capital gains –
netting with foreign cap losses.
Further objective: to adjust for capital gain
tax rate differentials. §1(h)(11) expiring
after 2010?
Also, for “dividend rate differentials”.
Relevant for individuals; not relevant for
corporations (since no income tax rate
differentials).
5/4/2009
(c) William P. Streng
67
De Minimis Exemption
§904(k) – exemption from foreign tax
credit limitation:
1) Limit of $300 ($600 if married)
2) Only qualified passive income
(e.g., thru a mutual fund or ETF)
3) Elect de minimis rule applicability
5/4/2009
(c) William P. Streng
68
Anti-Abuse Rules
Cross border tax arbitrage
IRS Notice 98-5 - possible economic profit
test (withdrawn in Notice 2004-19) –
IRS Notice 2004-19 - no regs. released
Existing law to be applied: Substance over
form; step transaction; etc.
§704(b) regs. (p.402) - no special allocations
of creditable taxes – any allocation will
not have substantial economic effect.
See §911(k) & (l) – holding periods.
5/4/2009
(c) William P. Streng
69
23
Compaq case & its sequel
Compaq case (reversed by Fifth
Circuit) & IES case (reversed by 8th
Circuit). Transaction does have
economic substance.
ADR transaction with foreign dividend
and withholding tax stripped.
Capital loss can offset prior realized
capital gain.
5/4/2009
(c) William P. Streng
70
Statutory Anti-Abuse
Provisions
Code §901(k) – Limitation on the FTC
stripping transaction.
Code §901(l) – 2004 Jobs Act
holding period requirement imposed for
various income types to enable FTC
For FTC eligibility purposes, must hold 15
days during a 31 day period.
5/4/2009
(c) William P. Streng
71
Code §904 FTC Limitation
Planning Options
Structuring of arrangements to enable
reduction of overall effective foreign tax rate:
1) Lending money and generating interest
expense deduction and lower withholding
rate of the outbound interest payment.
2) Export of goods - pass title to (i) generate
foreign source income and (ii) avoid any
income tax in the foreign jurisdiction. cont.
5/4/2009
(c) William P. Streng
72
24
Code § FTC Limitation
Planning Problems, cont.
3) Technology licensing arrangement with
the foreign subsidiary and extraction of
low/no taxed, deductible royalty, to which the
look-through rules are applicable for FTC.
4) Managerial and technical services in
foreign country - same planning objective,
i.e., deductibility of payment for local
country income tax and low/no withholding
tax at source. (c) William P. Streng
5/4/2009
73
25