Outbound Taxation

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Outbound Taxation

• Recall definition
• Two important planning areas
• 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

• Three big questions
• 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

• Which of the following taxpayers is allowed a US
  foreign tax credit?
• 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 income
  subject to US and foreign taxes

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Creditable Foreign Taxes

• Must be a tax or in lieu of a tax
• Not a payment for any specific benefit, not
  related to transactions between the taxpayer and
  the government
• Special rules for splitting dual-capacity
  payments
• Must be an income tax
• Imposed on realized net gain derived from actual
  gross receipts

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Foreign Income Tax Systems

• Rates range from zero to 42 percent (Canada and
  Japan)
• Imputation system for alleviating double-taxation
  of corporate earnings
• 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

• 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
• 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

• Which of the following foreign taxes are likely
  to be creditable?
• 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 Dual-Capacity Payments

• 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 governments normal income
  tax rate is 35.
• How much of BigOils payment is considered a tax,
  and how much is a royalty?

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Limits on Allowable FTC

• Concept FTC is allowed only up to the amount of
  US taxes paid on foreign source income
• Mechanics
• Credit US Income X Foreign Source
  IncomeLimit 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

• Global Inc., a US corporation, earned 4 million
  of worldwide taxable income, of which 1 million
  is foreign source.
• 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

• FTC limit is applied separately for foreign taxes
  paid on income in separate baskets
• Passive income
• High interest withholding income
• Financial services income
• Shipping income
• Dividends received by a corporation from each
  non-controlled Sec. 902 corporation
• Dividends from a DISC or former DISC
• Foreign trade taxable income
• Distributions from a FSC
• All other income

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Separate Basket Limits continued

• What is the goal of the separate basket
  limitations on the FTC?
• 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

• Refer to example 3. Suppose that Globals
  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 Globals separate
  basket FTC limitations, its US tax liability
  after FTC, and its total tax burden.

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Cross-Crediting Opportunities and Limits

• 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
• 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

• 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.
• If all of Novas foreign income is in the general
  basket, calculate its allowable FTC and net US
  tax liability.
• What if Novas two foreign income sources are in
  separate baskets (or if per-country FTC limits
  applied)?

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Conclusions

• What are the burdens imposed by the FTC rules?
• 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?