2 Learning Objectives You should be able to: 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, andExplain tax _______.
3 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.
4 Basic Choices in U.S. Deduct: Credit foreign income tax, §901(a) 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
5 Creditable Foreign Levies Must be a ___ andEither:Its ___________ character is that of income tax in ____ sense orIt ___________ for generally-imposed income tax
6 What Is a Tax? __________ transfer Excludes payments > ____ foreign tax liabilityMust exhaust all practical ________Pursuant to government’s ______ authorityExcludes _____, penalties, interest, custom duties, and compulsory _____Excludes levies for specific _________ ________ not otherwise available
7 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?CHECKProfit (pre-royalty)Diamond taxIncome taxRoyalty deductionProfitIncome tax rate Creditable tax
8 Predominant Character Likely to reach net ________________ test,Gross _______ test, and___ income testNot a ____-up levy
9 Realization Test Focuses on ______ of tax’s assessment Satisfied if assessment follows:___________ eventPre-___________ event in some cases
10 Gross Receipts Test Foreign tax base must begin with: Actual _____ ________ orEstimated gross receipts if result does not ______ actual gross receiptsGross receipts may be estimated when transactions occur between _______ persons_____estimating gross receipts is okay
11 Net Income TestForeign tax must allow _________ of costs and expenses to determine tax base____estimating costs and expenses okay
12 Soak-Up Tax Applies only to extent ___ is permitted Since U.S. law does not allow, foreign government does not ______ soak-up tax
13 Substitute for Income Tax Requirements:Must apply __ ____ __ income taxCannot be a _______ taxExamples:___________ taxes on nonresidentsSpecial ________ taxes
14 Summary: Creditable Taxes Predominant CharacterRealization testGross receipts testNet income testNot a soak-upMust Be a TaxCompulsoryPer tax authoritySubstitute for Income TaxIn lieu ofNot a soak-up
15 Creditable Taxes Include Foreign income tax paid ________, §901Partnership’s tax _____ through to U.S. partnersForeign branch’s tax __________ to U.S. corporationForeign tax in lieu of income tax, §___Withholding tax on foreign investment incomeSpecial industry tax______ paid tax, §902
16 Cite Code Section Identifying Each Levy as Creditable Tax U.S. “green card holder” pays Belgian income tax on foreign profitsU.S. citizen has Dutch tax withheld on her Dutch dividendsU.S. individual is partner in U.K. partnership that pays U.K. income taxU.S. corporation has Cyprian sales office that pays Cyprian income taxU.S. corporation pays Polish income tax on profit dependent agent generatesU.S. corporation’s German subsidiary pays German income taxU.S. family’s closely-held Mexican corporation pays Mexican income tax
17 DPT Requirements DC owns foreign sub DC receives ________ Direct ownership of ___% at each linkIndirect ownership of __% in each subFor tiers ___, foreign subs are CFCsFor tiers ___, DC is U.S. “shareholder”DC receives ________FC1FC2FC3FC4FC5FC6
18 Example: DPT Requirements 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?DC40%FC110%FC2
19 DC with Foreign Branch Profit $100 U.S. rate FTC U.S. tax Profit $100 Remit $75DCFBProfit $100U.S. rateFTCU.S. taxProfit $100FITRemit
20 DC with Foreign Subsidiary Dividend $75DCFCDividend + gross up $100U.S. tax rateTax before DPCDeemed paid creditU.S. taxProfit $100FITE&P
22 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?DomcoDividend40%Profit $1,000FITE&P $ 700Forco
23 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.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?DomcoBranchGross $500FITDividend100%Profit $100FITE&P $ 64Forco
24 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?DomcoDividend100%Profit $1,000FIT$ 600Forco1100%Dividend $30Profit $100FITE&P $ 75Forco2
25 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?DomcoDividend90%Profit $2,000FIT$1,500Forco180%Dividend $200Profit $1,000FITE&P $ 600Forco2
26 Foreign Tax Credit Basics Foreign tax credit is lesser of:Creditable tax orFTC limitationCreditable tax is sum of:Foreign income tax (§____)Tax in lieu of FIT (§____)Deemed paid tax (§____)
28 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:Foreign ETR§904 limitationForeign tax creditU.S. tax liabilityExcess credit or excess limitWorldwide ETRMTR on foreign profit
29 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:Foreign ETR§904 limitationForeign tax creditU.S. tax liabilityExcess credit or excess limitWorldwide ETRMTR on foreign profit
30 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%.
31 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%.
32 Business in Low-Tax Countries Capital ______ neutralResidual U.S. tax due when ______ ________MTR equals ____ ___ if profits remitted currentlyCreates incentive for ____-taxed _______ income
33 Business in High-Tax Countries Capital ______ neutralNo ____ ________ tax dueMTR equals _______ ___Creates incentive for ___-taxed _______ income
34 Excess Credit Planning Decrease foreign ETRRemit foreign profits in __________ form______ offshore in high-tax countriesUse _______ _______ to shift income from high-to low-tax countriesIncrease low-taxed FSTIExport, passing title ______Lease ______ assets and buy ____ assetsLicense technology for use abroad in country with ___ royalty ___________ tax
35 Deferral Effect on MTRWhen 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.
36 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?
37 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?
38 FTC Baskets Cross-crediting decreases U.S. ________ ___ Investment income is highly ______Congress decided to limit _______________Nine baskets, each containing__________ taxesFTC ___________________ periods
39 Corporation Dividends Pre-2007 FTC BasketsCross-crediting ______ baskets is permittedCross-crediting _____ baskets is notEach basket has its own §904 _________ formula and ________ periodNo segmentation by ______ResidualIncomeFSCDividendsPassiveIncomeFSC ForeignTrade IncomeHigh WithholdingTax InterestDISCDividendsNoncontrolled §902Corporation DividendsShippingIncomeFinancial ServicesIncome
40 Passive Income BasketPortfolio dividends, some interest, non-business _____ and royalties, annuities, some net _____High-taxed income is “______-___”___-tax basket
41 Residual Basket ____________, marketing, and service income _______ profit (other than FSC or DISC)Business rent and _______ income“______ ___” passive income
42 Example: FTC Baskets Domco earns income and pays taxes as follows: Taxable IncomeU.S. Tax Before FTCForeign TaxForeign Operations$ 400,000$ 136,000$ 180,000U.S. Operations500,000170,000Foreign Portfolio Dividends100,00034,00010,000Totals$1,000,000$ 340,000$ 190,000What is Domco’s foreign tax credit if it ignores separate baskets?
43 Example: FTC Baskets Domco earns income and pays taxes as follows: Taxable IncomeU.S. Tax Before FTCForeign TaxForeign Operations$ 400,000$ 136,000$ 180,000U.S. Operations500,000170,000Foreign Portfolio Dividends100,00034,00010,000Totals$1,000,000$ 340,000$ 190,000What is Domco’s foreign tax credit if it considers separate baskets?
44 CFC Look-ThroughCFCs are foreign corporations that U.S. shareholders _______.Look through rules allocate foreign _______ income U.S. companies receive from ____ among baskets.
45 Example: Look-Through Domco receives $______ dividends from its wholly-owned foreign subsidiary, Forco. Forco pays ___% of its dividends from E&P attributable to its business operations and the rest from E&P attributable to its passive investment activities. How does Domco treat these dividends for FTC purposes?
46 Recapture of Foreign Loss U.S. companies pay U.S. tax on _________ income.Thus, overall losses from foreign activities are deductible against ____ source income.However, this reduces ____ tax on ____ source income.So, §904(f) contains a _________ rule.
47 Recapture of Foreign Loss If overall foreign loss occurs,______ against U.S. income butRecapture in later yearInvolves treating ___ as ____Affects ___ limitationRecapture lesser of:_______ foreign ____ account or___% of current year’s ____
48 Example: OFL Recapture Domco earns income and pays taxes as follows:Irish IncomeIrish TaxesU.S. IncomeU.S. Tax Before FTC2003$-24,000$ 74,000$ 7,5002004-10,00080,00012,500200530,0003,75070,00022,500200640,0005,00060,00022,250What is Domco’s foreign tax credit in 2005 and 2006?
49 Tax Sparing Host countries may allow “tax ________” Holiday creates incentive to invest when ____ country has:___________ system orTax _______Sparing allows residents to ______ foreign taxes the host country ______
50 Tax Sparing“Tax sparing credits” are the same as foreign tax credits except investors ___ __ foreign income tax__ U.S. treaties allow tax sparingA 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
51 Tax Sparing Example No Tax Holiday Tax Holiday without Sparing Tax Holiday with SparingHost CountryTax liabilityHome CountryInitial taxTax creditTax liability