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Foreign Tax Credit Tx 8300. Learning Objectives. 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, and

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Learning objectives l.jpg
Learning Objectives

  • 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, and

  • Explain tax _______.

You should be able to:


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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 > ____ 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


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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 Domco’s 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 tax’s 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

    • 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


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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. corporation’s German subsidiary pays German income tax

U.S. family’s 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 FC2’s foreign income taxes?

DC

40%

FC1

10%

FC2


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DC with Foreign Branch

Remit $75

DC

FB

Profit $100

U.S. rate

FTC

U.S. tax

Profit $100

FIT

Remit


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DC with Foreign Subsidiary

Dividend $75

DC

FC

Dividend + gross up $100

U.S. tax rate

Tax before DPC

Deemed paid credit

U.S. tax

Profit $100

FIT

E&P



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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 Domco’s deemed paid tax? By how much do the dividends increase Domco’s gross income?

Domco

Dividend

40%

Profit $1,000

FIT 300

E&P $ 700

Forco


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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?

Domco

Branch

Gross $500

FIT 50

Dividend

100%

Profit $100

FIT 36

E&P $ 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 Domco’s deemed paid tax? By how much do the dividends increase Domco’s gross income?

Domco

Dividend

100%

Profit $1,000

FIT 400

$ 600

Forco1

100%

Dividend $30

Profit $100

FIT 25

E&P $ 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 Domco’s deemed paid tax? By how much do the dividends increase Domco’s gross income?

Domco

Dividend

90%

Profit $2,000

FIT 500

$1,500

Forco1

80%

Dividend $200

Profit $1,000

FIT 400

E&P $ 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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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 limitation

  • Foreign tax credit

  • U.S. tax liability

  • Excess credit or excess limit

  • Worldwide ETR

  • MTR on foreign profit


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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 limitation

  • Foreign tax credit

  • U.S. tax liability

  • Excess credit or excess limit

  • Worldwide ETR

  • MTR on foreign profit


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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%.


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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%.


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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

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?


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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?


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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

FSC

Dividends

Passive

Income

FSC Foreign

Trade Income

High Withholding

Tax Interest

DISC

Dividends

Noncontrolled §902

Corporation Dividends

Shipping

Income

Financial Services

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:

What is Domco’s foreign tax credit if it ignores separate baskets?


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Example: FTC Baskets

Domco earns income and pays taxes as follows:

What is Domco’s 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 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?


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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 year’s ____


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Example: OFL Recapture

Domco earns income and pays taxes as follows:

What is Domco’s 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 without Sparing

Tax Holiday with Sparing

Host Country

Tax liability

HomeCountry

Initial tax

Tax credit

Tax liability


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