Foreign Tax Credit Tx 8300

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Foreign Tax CreditTx 8300
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Learning Objectives
You should be able to

1. Identify characteristics of a _________ tax,
2. Determine a DCs ______ paid credit,
3. Calculate the foreign tax credit _________,
4. Explain the function of FTC _______,
5. Compute a U.S. persons ____ from outbound
   investments, and
6. Explain tax _______.

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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.

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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

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Creditable Foreign Levies

• Must be a ___ and
• Either
• Its ___________ character is that of income tax
  in ____ sense or
• It ___________ for generally-imposed income tax

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What Is a Tax?

• __________ transfer
• Excludes payments gt ____ foreign tax liability
• Must exhaust all practical ________
• Pursuant to governments ______ authority
• Excludes _____, penalties, interest, custom
  duties, and compulsory _____
• Excludes levies for specific _________ ________
  not otherwise available

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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 Domcos creditable tax?

CHECK Profit (pre-royalty) Diamond tax Income
tax Royalty deduction Profit Income tax
rate Creditable tax
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Predominant Character

• Likely to reach net ____
• ____________ test,
• Gross _______ test, and
• ___ income test

• Not a ____-up levy

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Realization Test

• Focuses on ______ of taxs assessment
• Satisfied if assessment follows
• ___________ event
• Pre-___________ event in some cases

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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

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Net Income Test

• Foreign tax must allow _________ of costs and
  expenses to determine tax base
• ____estimating costs and expenses okay

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Soak-Up Tax

• Applies only to extent ___ is permitted
• Since U.S. law does not allow, foreign government
  does not ______ soak-up tax

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Substitute for Income Tax

• Requirements
• Must apply __ ____ __ income tax
• Cannot be a _______ tax
• Examples
• ___________ taxes on nonresidents
• Special ________ taxes

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Summary Creditable Taxes

• Predominant Character
• Realization test
• Gross receipts test
• Net income test
• Not a soak-up

• Must Be a Tax
• Compulsory
• Per tax authority

• Substitute for Income Tax
• In lieu of
• Not a soak-up

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Creditable Taxes Include

• Foreign income tax paid ________, 901
• Partnerships tax _____ through to U.S. partners
• Foreign branchs tax __________ to U.S.
  corporation
• Foreign tax in lieu of income tax, ___
• Withholding tax on foreign investment income
• Special industry tax
• ______ paid tax, 902

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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. corporations German subsidiary pays German
income tax
U.S. familys closely-held Mexican corporation
pays Mexican income tax
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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
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Example DPT Requirements
When FC2 remits dividends to FC1 and FC1 remits
dividends to DC, can DC claim a foreign tax
credit for FC2s foreign income taxes?
DC
40
FC1
10
FC2
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DC with Foreign Branch
Remit 75
FB
DC
Profit 100 U.S. rate FTC U.S. tax
Profit 100 FIT Remit
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DC with Foreign Subsidiary
Dividend 75
FC
DC
Dividend gross up 100 U.S. tax rate Tax
before DPC Deemed paid credit U.S. tax
Profit 100 FIT EP
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Calculating Deemed Paid Tax
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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
  Domcos deemed paid tax? By how much do the
  dividends increase Domcos gross income?

Domco
40
Dividend
Profit 1,000 FIT 300 EP 700
Forco
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Example DPT for Single Tier

• Forco is Domcos newly-organized, 100-owned
  foreign subsidiary. Forco earns 100 profit, pays
  36 in foreign income tax, and remits ___ to
  Domco as dividends. Domcos foreign branch makes
  500 gross profit from sales and pays 50 foreign
  income tax.

1. What is Domcos deemed paid tax?

2. What is Domcos gross income?
3. Assuming Domcos FTC limit is 67, what is
Domcos FTC?
Domco
Branch
Gross 500 FIT 50
100
Dividend
Profit 100 FIT 36 EP 64
Forco
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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 Domcos deemed paid tax? By
  how much do the dividends increase Domcos gross
  income?

Domco
100
Dividend
Profit 1,000 FIT 400 600
Forco1
100
Dividend 30
Profit 100 FIT 25 EP 75
Forco2
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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 Domcos deemed paid tax? By
  how much do the dividends increase Domcos gross
  income?

Domco
90
Dividend
Profit 2,000 FIT 500 1,500
Forco1
80
Dividend 200
Profit 1,000 FIT 400 EP 600
Forco2
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Foreign Tax Credit Basics
Foreign tax credit is lesser of Creditable
tax or FTC limitation
Creditable tax is sum of Foreign income tax
(____) Tax in lieu of FIT (____) Deemed paid
tax (____)
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Tax Rate Basics
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Example Foreign Tax Credit

• Domcos 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

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Example Foreign Tax Credit

• Domcos 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

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Examples Marginal Tax Rates

• What is Domcos 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.
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Examples U.S. Residual Tax

• Assume the U.S. effective tax rate is 35. In the
  following situations, what is Domcos 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.
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Business in Low-Tax Countries

• Capital ______ neutral
• Residual U.S. tax due when ______ ________
• MTR equals ____ ___ if profits remitted currently
• Creates incentive for ____-taxed _______ income

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Business in High-Tax Countries

• Capital ______ neutral
• No ____ ________ tax due
• MTR equals _______ ___
• Creates incentive for ___-taxed _______ income

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Excess Credit Planning

• 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

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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.
• In high-tax countries, _______ ___________ tax is
  deferred.

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Example MTR in Low-Tax Country
Domcos wholly-owned foreign subsidiary, Forco,
operates in a country with a ___ ETR. Assume the
U.S. ETR is 34, and Forco distributes all its
EP as dividends in the current year. What is
Domcos MTR on Forcos 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
Domcos MTR on Forcos foreign profits?
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Example MTR in High-Tax Country
Domcos 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 EP as
dividends in the current year. What is Domcos
MTR on Forcos 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
Domcos MTR on Forcos foreign profits?
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FTC Baskets

• Cross-crediting decreases U.S. ________ ___
• Investment income is highly ______
• Congress decided to limit _______________
• Nine baskets, each containing
• __________ taxes
• FTC __________
• _________ periods

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Pre-2007 FTC Baskets

• Cross-crediting ______ baskets is permitted
• Cross-crediting _____ baskets is not
• Each basket has its own 904 _________ formula
  and ________ period
• No segmentation by ______

Residual Income
Passive Income
FSC Dividends
High Withholding Tax Interest
FSC Foreign Trade Income
Noncontrolled 902 Corporation Dividends
DISC Dividends
Financial Services Income
Shipping Income
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Passive Income Basket

• Portfolio dividends, some interest, non-business
  _____ and royalties, annuities, some net _____
• High-taxed income is ______-___
• ___-tax basket

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Residual Basket

• ____________, marketing, and service income
• _______ profit (other than FSC or DISC)
• Business rent and _______ income
• ______ ___ passive income

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Example FTC Baskets

• Domco earns income and pays taxes as follows

Taxable Income U.S. Tax Before FTC Foreign Tax
Foreign Operations 400,000 136,000 180,000
U.S. Operations 500,000 170,000 0
Foreign Portfolio Dividends 100,000 34,000 10,000
Totals 1,000,000 340,000 190,000
What is Domcos foreign tax credit if it ignores
separate baskets?
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Example FTC Baskets

• Domco earns income and pays taxes as follows

Taxable Income U.S. Tax Before FTC Foreign Tax
Foreign Operations 400,000 136,000 180,000
U.S. Operations 500,000 170,000 0
Foreign Portfolio Dividends 100,000 34,000 10,000
Totals 1,000,000 340,000 190,000
What is Domcos foreign tax credit if it
considers separate baskets?
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CFC Look-Through

• CFCs are foreign corporations that U.S.
  shareholders _______.
• Look through rules allocate foreign _______
  income U.S. companies receive from ____ among
  baskets.

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Example Look-Through

• Domco receives ______ dividends from its
  wholly-owned foreign subsidiary, Forco. Forco
  pays ___ of its dividends from EP attributable
  to its business operations and the rest from EP
  attributable to its passive investment
  activities. How does Domco treat these dividends
  for FTC purposes?

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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.

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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 years ____

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Example OFL Recapture

• Domco earns income and pays taxes as follows

Irish Income Irish Taxes U.S. Income U.S. Tax 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 Domcos foreign tax credit in 2005 and
2006?
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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 ______

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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
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Tax Sparing Example
No Tax Holiday
Tax Holiday with Sparing
Tax Holiday without Sparing
Host Country
Tax liability
Home Country
Initial tax Tax credit Tax liability