Learning Objectives 1.Identify characteristics of a _________ tax, 2.Determine a DC’s ______ paid credit, 3.Calculate the foreign tax credit _________, 4.Explain the function of FTC _______, 5.Compute a U.S. person’s ____ from outbound investments, and 6.Explain tax _______. You should be able to:
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 generally- imposed 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 Profit (pre-royalty) Diamond tax Income tax Royalty deduction Profit Income tax rate Creditable tax
Predominant Character Not a ____-up levy Likely to reach net ____ –____________ test, –Gross _______ test, and –___ income test
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
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 Cite Code Section Identifying Each Levy as Creditable Tax
DPT Requirements 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 ________ DC FC1 FC2 FC3 FC4 FC5 FC6
Example: DPT Requirements DC FC1 FC2 40% 10% 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 FB Remit $75 DC Profit$100 FIT Remit Profit$100 U.S. rate FTC U.S. tax
DC with Foreign Subsidiary FC Dividend $75 DC Profit$100 FIT E&P Dividend + gross up$100 U.S. tax rate Tax before DPC Deemed paid credit U.S. 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 Forco 40% Profit$1,000 FIT 300 E&P$ 700 Dividend
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? 3.Assuming Domco’s FTC limit is $67, what is Domco’s FTC? 2.What is Domco’s gross income? Domco Forco 100% Profit$100 FIT 36 E&P$ 64 Branch Gross$500 FIT 50 Dividend
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 Forco1 100% Profit$1,000 FIT 400 $ 600 Dividend Forco2 100% Profit$100 FIT 25 E&P$ 75 Dividend$30
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 Forco1 90% Profit$2,000 FIT 500 $1,500 Dividend Forco2 80% Profit$1,000 FIT 400 E&P$ 600 Dividend$200
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 (§____)
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 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. In high-tax countries, _______ ___________ tax is deferred.
Example: MTR in Low-Tax Country 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 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
Pre-2007 FTC Baskets Passive Income High Withholding Tax Interest Noncontrolled §902 Corporation Dividends Financial Services Income Shipping Income DISC Dividends FSC Foreign Trade Income FSC Dividends Residual Income Cross-crediting ______ baskets is permitted Cross-crediting _____ baskets is not Each basket has its own §904 _________ formula and ________ period No segmentation by ______
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 FTCForeign Tax Foreign Operations$ 400,000$ 136,000$ 180,000 U.S. Operations500,000170,0000 Foreign Portfolio Dividends 100,000 34,000 10,000 Totals$1,000,000$ 340,000$ 190,000 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 FTCForeign Tax Foreign Operations$ 400,000$ 136,000$ 180,000 U.S. Operations500,000170,0000 Foreign Portfolio Dividends 100,000 34,000 10,000 Totals$1,000,000$ 340,000$ 190,000 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 $______ dividends from its wholly-owned foreign subsidiary, Forco. Forco pays ___% of its dividends from E&P attributable to its business operations and the rest from E&P attributable to its passive investment activities. How does Domco treat these dividends for FTC purposes?
Recapture of Foreign Loss U.S. companies pay U.S. tax on _________ income. Thus, overall losses from foreign activities are deductible against ____ source income. However, this reduces ____ tax on ____ source income. So, §904(f) contains a _________ rule.
Recapture of Foreign Loss If overall foreign loss occurs, –______ against U.S. income but –Recapture in later year Involves treating ___ as ____ Affects ___ limitation Recapture lesser of: –_______ foreign ____ account or –___% of current year’s ____
Example: OFL Recapture Domco earns income and pays taxes as follows: Irish Income Irish Taxes U.S. Income U.S. Tax Before FTC 2003$-24,0000$ 74,000$ 7,500 2004-10,000080,00012,500 200530,0003,75070,00022,500 200640,0005,00060,00022,250 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 Tax Holiday with Sparing Tax Holiday without Sparing Host Country Home Country Tax liability Initial tax Tax credit Tax liability