Foreign Tax Credit
Tx 8300
Learning Objectives
You should be able to:
1.
2.
3.
4.
5.
6.
Identify characteristics of a _________ tax,
Determine a DC’s ______ paid credit,
Calculate the foreign tax credit _________,
Explain the function of FTC _______,
Compute a U.S. person’s ____ from
outbound investments, and
Explain tax _______.
Dealing with Double Tax
• ___________ systems exempt FSI.
• ______ systems allow FTC.
• ______ systems exempt some income and
otherwise allow the FTC.
• ________ often modify how these systems
address double tax problems.
Basic Choices in U.S.
• Deduct:
– Foreign ______ tax, §164(a)(3)
– Any foreign ___ of trade or business, §162(a)
– Any foreign ___ of investment activity, §212(1)
• Credit foreign income tax, §901(a)
– Annual _________
– _____ return to change election
Creditable Foreign Levies
• Must be a ___ and
• Either:
– Its ___________ character is
that of income tax in ____
sense or
– It ___________ for generallyimposed income tax
What Is a Tax?
• __________ transfer
– Excludes payments > ____ foreign tax liability
– Must exhaust all practical ________
• Pursuant to government’s ______ authority
– Excludes _____, penalties, interest, custom
duties, and compulsory _____
– Excludes levies for specific _________
________ not otherwise available
Example: Dual Capacity
Domco earns $4.2 million before-tax profit mining diamonds in Hostia.
Hostia imposes a “diamond tax” at ___% of the profit. Since Domco pays
the diamond tax, it does not pay the general income tax of 25%. What is
Domco’s creditable tax?
CHECK
(A - B - C) x
D
1 - D
where A = gross receipts
B = cost and expenses
C = diamond tax
D = general income tax rate
Profit (pre-royalty)
Diamond tax
Income tax
Royalty deduction
Profit
Income tax rate
Creditable tax
Predominant Character
• Likely to reach net ____
– ____________ test,
– Gross _______ test, and
– ___ income test
• Not a ____-up levy
Realization Test
• Focuses on ______ of tax’s
assessment
• Satisfied if assessment follows:
– ___________ event
– Pre-___________ event in some
cases
Gross Receipts Test
• Foreign tax base must begin with:
– Actual _____ ________ or
– Estimated gross receipts if result does not
______ actual gross receipts
• Gross receipts may be estimated when
transactions occur between _______
persons
• _____estimating gross receipts is okay
Net Income Test
• Foreign tax must allow _________ of costs
and expenses to determine tax base
• ____estimating costs and expenses okay
Soak-Up Tax
• Applies only to extent ___ is permitted
• Since U.S. law does not allow, foreign
government does not ______ soak-up tax
Substitute for Income Tax
• Requirements:
– Must apply __ ____ __ income tax
– Cannot be a _______ tax
• Examples:
– ___________ taxes on nonresidents
– Special ________ taxes
Summary: Creditable Taxes
Must Be a Tax
1. Compulsory
2. Per tax authority
Predominant Character
1. Realization test
2. Gross receipts test
3. Net income test
4. Not a soak-up
Substitute for Income Tax
1. In lieu of
2. Not a soak-up
Creditable Taxes Include
• Foreign income tax paid ________, §901
– Partnership’s tax _____ through to U.S. partners
– Foreign branch’s tax __________ to U.S.
corporation
• Foreign tax in lieu of income tax, §___
– Withholding tax on foreign investment income
– Special industry tax
• ______ paid tax, §902
Cite Code Section Identifying
Each Levy as Creditable Tax
U.S. “green card holder” pays Belgian income tax on foreign profits
U.S. citizen has Dutch tax withheld on her Dutch dividends
U.S. individual is partner in U.K. partnership that pays U.K. income tax
U.S. corporation has Cyprian sales office that pays Cyprian income tax
U.S. corporation pays Polish income tax on profit dependent agent generates
U.S. corporation’s German subsidiary pays German income tax
U.S. family’s closely-held Mexican corporation pays Mexican income tax
DPT Requirements
DC
• DC owns foreign sub
–
–
–
–
Direct ownership of ___% at each link
Indirect ownership of __% in each sub
For tiers ___, foreign subs are CFCs
For tiers ___, DC is U.S. “shareholder”
• DC receives ________
FC1
FC2
FC3
FC4
FC5
FC6
Example: DPT Requirements
DC
40%
FC1
10%
FC2
When FC2 remits dividends to FC1 and
FC1 remits dividends to DC, can DC claim
a foreign tax credit for FC2’s foreign
income taxes?
DC with Foreign Branch
DC
Remit $75
FB
Profit
$100
U.S. rate
FTC
U.S. tax
Profit
FIT
Remit
$100
DC with Foreign Subsidiary
DC
Dividend + gross up $100
U.S. tax rate
Tax before DPC
Deemed paid credit
U.S. tax
Dividend $75
FC
Profit
FIT
E&P
$100
Calculating Deemed Paid Tax
DPT =
Dividends from foreign sub
Post -1986 E & P of foreign sub
x Post -1986 foreign income tax
Example: DPT for Single Tier
Domco owns 40% of Forco. Forco earns $1,000 profit, pays $300 in
foreign income tax, and remits $____ to Domco as dividends. What is
Domco’s deemed paid tax? By how much do the dividends increase
Domco’s gross income?
Domco
Dividend
40%
Forco
Profit $1,000
FIT
300
E&P $ 700
Example: DPT for Single Tier
Forco is Domco’s newly-organized, 100%-owned foreign subsidiary.
Forco earns $100 profit, pays $36 in foreign income tax, and remits $___
to Domco as dividends. Domco’s foreign branch makes $500 gross profit
from sales and pays $50 foreign income tax.
1. What is Domco’s deemed paid tax?
2. What is Domco’s gross income?
3. Assuming Domco’s FTC limit is
$67, what is Domco’s FTC?
Domco
Dividend
Branch
100%
Forco
Profit
FIT
E&P
$100
36
$ 64
Gross
FIT
$500
50
Example: DPT for Two Tiers
Domco owns 100% of Forco1, and Forco1 owns 100% of Forco2. Forco1
earns $1,000 profit, pays $400 in foreign income tax, and remits $____ to
Domco as dividends. Forco2 earns $100 profit, pays $25 in foreign
income tax, and remits $30 to Domco as dividends. What is Domco’s
deemed paid tax? By how much do the dividends increase Domco’s gross
income?
Domco
Dividend
100%
Forco1
Dividend $30
Profit $1,000
FIT
400
$ 600
100%
Forco2
Profit
FIT
E&P
$100
25
$ 75
Example: DPT for Two Tiers
Domco owns 90% of Forco1, and Forco1 owns 80% of Forco2. Forco1
earns $2,000 profit, pays $500 in foreign income tax, and remits $____ to
Domco as dividends. Forco2 earns $1,000 profit, pays $400 in foreign
income tax, and remits $200 to Forco1 as dividends. What is Domco’s
deemed paid tax? By how much do the dividends increase Domco’s gross
income?
Domco
Dividend
90%
Forco1
Dividend $200
Profit $2,000
FIT
500
$1,500
80%
Forco2
Profit $1,000
FIT
400
E&P $ 600
Foreign Tax Credit Basics
Foreign tax credit is lesser of:
Creditable tax or
FTC limitation
FTC Limit
= FSTI x U.S. ETR
Creditable tax is sum of:
Foreign income tax (§____)
Tax in lieu of FIT (§____)
Deemed paid tax (§____)
Tax Rate Basics
U.S. effective tax rate
=
U.S. tax
U.S. profit
Foreign effective tax rate
=
Foreign tax
Foreign profit
Worldwide effective tax rate
MTR from foreign investment
=
U.S. tax + Foreign tax
Worldwide profit
=
Incremental foreign tax
Incremental foreign profit
Example: Foreign Tax Credit
Domco’s U.S. ETR is 34%. Domco earns $____ foreign profit and $300 U.S.
profit. Its creditable taxes are $60. Compute the following for Domco:
1. Foreign ETR
2. §904 limitation
3. Foreign tax credit
4. U.S. tax liability
5. Excess credit or excess limit
6. Worldwide ETR
7. MTR on foreign profit
Example: Foreign Tax Credit
Domco’s U.S. ETR is 34%. Domco earns $200 foreign profit and $300 U.S.
profit. Its creditable taxes are $___. Compute the following for Domco:
1. Foreign ETR
2. §904 limitation
3. Foreign tax credit
4. U.S. tax liability
5. Excess credit or excess limit
6. Worldwide ETR
7. MTR on foreign profit
Examples: Marginal Tax Rates
What is Domco’s MTR on its foreign profit in each of the following situations?
1.
U.S. ETR is 34%, and foreign ETR is 30%.
2.
U.S. ETR is 34%, and foreign ETR is 36%.
3.
U.S. ETR is 34%, and foreign ETR is 42%.
4.
U.S. ETR is 34%, and foreign ETR is 25%.
Examples: U.S. Residual Tax
Assume the U.S. effective tax rate is 35%. In the following situations, what is
Domco’s U.S. residual tax rate on its foreign profits?
1.
Foreign ETR is 30%.
2.
Foreign ETR is 36%.
3.
Foreign ETR is 42%.
4.
Foreign ETR is 25%.
Business in Low-Tax Countries
• Capital ______ neutral
• Residual U.S. tax due when
______ ________
• MTR equals ____ ___ if
profits remitted currently
• Creates incentive for ____taxed _______ income
Business in High-Tax Countries
•
•
•
•
Capital ______ neutral
No ____ ________ tax due
MTR equals _______ ___
Creates incentive for ___taxed _______ income
Excess Credit Planning
FTC = Lesser of : Creditable taxes or
FSTI
x (WWTI x U.S. ETR)
WWTI
• Decrease foreign ETR
– Remit foreign profits in __________ form
– ______ offshore in high-tax countries
– Use _______ _______ to shift income from
high-to low-tax countries
• Increase low-taxed FSTI
– Export, passing title ______
– Lease ______ assets and buy ____ assets
– License technology for use abroad in country
with ___ royalty ___________ tax
Deferral Effect on MTR
• When DCs conduct business abroad through
foreign subsidiaries, deferring dividends
______ the MTR on foreign profits.
• In low-tax countries, ____ ________ tax is
deferred.
t us - t f
MTR = t f +
(1 + d)
y
• In high-tax countries, _______ ___________
tax is deferred.
t div (1 - t f )
MTR = t f +
y
(1 + d)
Example: MTR in Low-Tax Country
MTR = t f +
t us - t f
y
(1 + d)
Domco’s wholly-owned foreign subsidiary, Forco, operates in a country with a
___% ETR. Assume the U.S. ETR is 34%, and Forco distributes all its E&P as
dividends in the current year. What is Domco’s MTR on Forco’s foreign profits?
Assume the same facts except that Forco does not plan to distribute current profits
for 4 years and the applicable discount rate is 12%. What is Domco’s MTR on
Forco’s foreign profits?
Example: MTR in High-Tax Country
MTR = t f +
t div (1 - t f )
y
(1 + d)
Domco’s wholly-owned foreign subsidiary, Forco, operates in a country with a
___% ETR and a ___% dividend withholding tax. Assume the U.S. ETR is 34%,
and Forco distributes all its E&P as dividends in the current year. What is Domco’s
MTR on Forco’s foreign profits?
Assume the same facts except that Forco does not plan to distribute current profits
for 4 years and the applicable discount rate is 12%. What is Domco’s MTR on
Forco’s foreign profits?
FTC Baskets
•
•
•
•
Cross-crediting decreases U.S. ________ ___
Investment income is highly ______
Congress decided to limit _______________
Nine baskets, each containing
– __________ taxes
– FTC __________
– _________ periods
FSTI
FTC = Lesser of : Creditable taxes or
x U.S. tax before FTC
WWTI
Pre-2007 FTC Baskets
• Cross-crediting ______
baskets is permitted
Residual
Income
FSC
Dividends
Passive
Income
• Cross-crediting _____
baskets is not
FSC Foreign
Trade Income
• Each basket has its own
§904 _________
formula and ________
period
• No segmentation by
______
High Withholding
Tax Interest
DISC
Dividends
Noncontrolled §902
Corporation Dividends
Shipping
Income
Financial Services
Income
Passive Income Basket
• Portfolio dividends, some interest,
non-business _____ and royalties,
annuities, some net _____
• High-taxed income is “_________”
• ___-tax basket
Residual Basket
• ____________, marketing, and service
income
• _______ profit (other than FSC or DISC)
• Business rent and _______ income
• “______ ___” passive income
Example: FTC Baskets
Domco earns income and pays taxes as follows:
Taxable
Income
U.S. Tax
Before FTC
Foreign Tax
$ 400,000
$ 136,000
$ 180,000
U.S. Operations
500,000
170,000
0
Foreign Portfolio Dividends
100,000
34,000
10,000
$1,000,000
$ 340,000
$ 190,000
Foreign Operations
Totals
What is Domco’s foreign tax credit if it ignores separate baskets?
Example: FTC Baskets
Domco earns income and pays taxes as follows:
Taxable
Income
U.S. Tax
Before FTC
Foreign Tax
$ 400,000
$ 136,000
$ 180,000
U.S. Operations
500,000
170,000
0
Foreign Portfolio Dividends
100,000
34,000
10,000
$1,000,000
$ 340,000
$ 190,000
Foreign Operations
Totals
What is Domco’s foreign tax credit if it considers separate baskets?
CFC Look-Through
• CFCs are foreign corporations that
U.S. shareholders _______.
• Look through rules allocate foreign
_______ income U.S. companies
receive from ____ among baskets.
Example: Look-Through
Domco receives $______ dividends from its wholly-owned foreign
subsidiary, Forco. Forco pays ___% of its dividends from E&P
attributable to its business operations and the rest from E&P attributable to
its passive investment activities. How does Domco treat these dividends
for FTC purposes?
Recapture of Foreign Loss
• U.S. companies pay U.S. tax on
_________ income.
• Thus, overall losses from foreign
activities are deductible against ____
source income.
• However, this reduces ____ tax on
____ source income.
• So, §904(f) contains a _________
rule.
Recapture of Foreign Loss
• If overall foreign loss occurs,
– ______ against U.S. income but
– Recapture in later year
• Involves treating ___ as ____
• Affects ___ limitation
• Recapture lesser of:
– _______ foreign ____ account or
– ___% of current year’s ____
Example: OFL Recapture
Domco earns income and pays taxes as follows:
Irish
Income
Irish
Taxes
U.S.
U.S. Tax
Income Before FTC
2003
$-24,000
0
$ 74,000
$ 7,500
2004
-10,000
0
80,000
12,500
2005
30,000
3,750
70,000
22,500
2006
40,000
5,000
60,000
22,250
What is Domco’s foreign tax credit in 2005 and 2006?
Tax Sparing
• Host countries may allow “tax ________”
• Holiday creates incentive to invest when
____ country has:
– ___________ system or
– Tax _______
• Sparing allows residents to ______ foreign
taxes the host country ______
Tax Sparing
• “Tax sparing credits” are
the same as foreign tax
credits except investors
___ __ foreign income tax
• __ U.S. treaties allow tax
sparing
A company invests abroad and earns $100. Assuming
home and host country tax rates of 50% and ___%,
respectively, determine the total tax liability with:
• No tax holiday
• Tax holiday without tax sparing
• Tax holiday with tax sparing
Tax Sparing Example
No Tax
Holiday
Host Country
Tax liability
Home Country
Initial tax
Tax credit
Tax liability
Tax Holiday
without Sparing
Tax Holiday
with Sparing