Slide 10-1
Principles of Taxation: Advanced
Strategies
Chapter 10
 International Business Expansion
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Copyright (c) 2002 by the McGraw-Hill Companies Inc
Slide 10-2
US Taxation of Foreign
Operations
United States taxes world wide income of
all US citizens, resident aliens and domestic
corporations
 Significant possibility of double taxation of
these entities on income earned outside
United States
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Copyright (c) 2002 by the McGraw-Hill Companies Inc
Slide 10-3
Tax Treaties
US has tax treaties with over 50 foreign
countries
 Common treaty provisions
 Restrictions on ability to tax
 Favorable rates
 Income Exclusions
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Slide 10-4
Common Foreign Taxes
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Personal income tax
Corporation income tax
Payroll taxes
Value added tax
Property tax
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Slide 10-5
Foreign Taxation of Corporations
– Common Features
Imputation of corporation income to
shareholders to relieve effects of double
taxation
 Various methods of depreciation
 Rates varying from 15% to 45%
 Various tax incentives

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Slide 10-6
Value Added Tax
Imposed on producers and distributors of
products and services at each stage of
production and distribution process
 Tax imposed on “value added”
 Value added is difference between sale
price of product or service and non-labor
costs of production
 Typical rates between 5% to 25%
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McGraw-Hill/Irwin
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Slide 10-7
Foreign Tax Credit
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Designed to minimize or eliminate double taxation
Only allowed for creditable taxes such as income
tax
FTC limitation = (foreign source income/world
wide income) x US tax on world wide income
Actual foreign tax credit is lesser of limitation or
foreign taxes paid or accrued
Unused credits may be carried back 2 years and
forward 5 years
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Slide 10-8
Foreign Tax Credit Example

J Co earns $ 300,000 of income in US and
$ 150,000 in Belgium. It pays Belgian tax
of $ 60,000. US tax liability before credits
is $ 153,000
$150,000
x$153,000  $51,000
$450,000
Foreign tax credit equal to limitation of $ 51,000
Carryover of $ 10,000
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Slide 10-9
Foreign Tax Credit – Baskets
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Foreign tax credit is computed separately for
different types of income. Limitation applies to
each separately
Baskets:
 Passive income
 High withholding tax income
 Financial services income
 Shipping income
 Certain foreign dividends
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Slide 10-10
Sourcing of Income and
Deductions
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Determines numerator of foreign tax credit
limitation fraction
 The larger the amount of income that is
foreign sourced, the larger the credit
allowable
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Slide 10-11
Sourcing of Income and
Deductions
Service income sources to where services
performed
 Rental income sourced to location of
property
 Interest income sourced to residence of
debtor
 Dividend income sourced to location of
dividend paying company
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Slide 10-12
Sourcing of Sales of Property
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General rule: income sourced to residence of seller
Exceptions:
 Depreciation recapture sourced to where property
depreciated
 Inventory
 Generally sourced to where title passes
• Exceptions:
– Manufactured inventory sourced to where
manufactured
– Inventory manufactured in US for sale
abroad sourced 50% foreign 50% US
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Slide 10-13
Deduction Sourcing
Generally sourced same way as income
 Indirect expenses apportioned between US
and foreign source
 Interest sourced on assets
 IRS has broad reallocation powers under
section 482
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Slide 10-14
Forms of Foreign Operations
Local agent
 Branch
 Partnership
 Controlled subsidiary
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Slide 10-15
Controlled US Subsidiaries
Subject to US tax on world wide income
 Can utilize foreign tax credit
 May be included in US consolidated return
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Slide 10-16
Controlled Foreign Subsidiaries
Not subject to US taxation until earnings
distributed
 Parent may get deemed foreign tax credit
on dividends for foreign subsidiary
 May not be included in US consolidated
return
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Slide 10-17
Subpart F Income – Effect
Subpart F income earned by controlled
foreign subsidiary subject to US tax when
earned by subsidiary
 Controlled foreign subsidiary – More than
50% of stock owned by US shareholders
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Slide 10-18
Subpart F Income
Sales to a related party
 Passive income
 Income from countries subject to boycott or
which the US has severed relations
 Payments of illegal bribes
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Slide 10-19
Subpart F Income
Controlled corporations must keep track of
both Subpart F income and income that is
not Subpart F income
 Distributions first made from Subpart F
earnings and profits and nontaxable
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Slide 10-20
Transfer Pricing
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Section 482 used to prohibit arbitrary shifting of
profits between controlled entities due to transfer
pricing
Goal is to get price in comparable uncontrolled
transaction
Methods:
 Resale price method
 Cost-plus method
 Comparable profits
 Profit split method
McGraw-Hill/Irwin
Copyright (c) 2002 by the McGraw-Hill Companies Inc