Chapter

2. Chapter 12 Jurisdictional Issues in Business Taxation

3. Jurisdictional Issues • Nexus - the right to tax • Apportionment • Permanent establishment in foreign country • Worldwide taxation and foreign tax credits • Blending high and low tax income • Branch versus subsidiary • Preventing abuse: Subpart F and transfer pricing

4. State and Local Tax • Taxation requires nexus - degree of contact between business and state • What does it mean to have legal domicile? • What consitutes physical presence? • economic nexus: regular commercial activity - law still unclear. • What is the current debate surrounding internet (and catalog) sales?

5. Apportionment of State Income • How determine State X’s share of Corporation C’s taxable income? • Under UDIPTA model, apportion based on what three factor weights? • About 1/2 of the state double-weight sales. Does this favor in-state or out of state businesses?

6. International Business Transactions - Jurisdiction • Tax treaties govern the jurisdiction to tax as well as exceptions related to tax rates. • Business activities are taxed only by country of residence (incorporation) unless the firm maintains a ___________ _____________ in another country. • fixed location, such as an office of factory, with regular commercial operations. • typically does not result from mere exporting

7. International Jurisdiction - continued • Double taxation may result from two jurisdictions claiming right to tax the same income. • Does the U.S. tax foreign income earned by U.S. corporations? • If the U.S. corporation has a branch that is doing business as a permanent establishment, both the foreign country and the U.S. will tax the branch income. • What relief exists for double taxation? • _________ or _________. Which is better?

8. The Foreign Tax Credit • In the U.S. (and other major trading partners), the relief comes from a foreign tax credit. • Applies only to INCOME taxes. • Reduce U.S. taxes by foreign income taxes paid. • These rules are extremely complex, but this chapter teaches the basics.

9. Foreign Tax Credit Limitation • The U.S. will only grant a credit up to the U.S. tax rate X foreign source taxable income. • FTC limit = __________ X _______ income / worldwide income. • If the firm has paid more foreign tax than the FTC limit, ___ year carryback, ____ year carryforward.

10. FTC Planning • Firms can cross-credit between high- and low-tax rate country income. • Without cross-crediting, here’s the problem: • Pay tax on income in Japan branch at 50% of $100, only claim $___ FTC. • Pay tax on income in Ireland branch at 10% of $100, only claim $___ FTC. • Total U.S. tax on $200 x 35% = $70 - $___ FTC = $___ U.S. tax paid + $___ foreign tax paid = $___ total worldwide tax burden.

11. FTC Planning - Cross Credit • With cross-credit, you combine all similar type foreign source income to compute limitation: • FTC limit = $70 US tax X $____ foreign income / $____ worldwide income = $___. • Total U.S. tax on $200 x 35% = $70 - $___ actual foreign taxes paid = $___ U.S. tax paid + $___ foreign tax paid = $___ total worldwide tax.

12. FTC for Alternative Minimum Tax • FTC has additional limits for AMT purposes: • AMT FTC limit = ______ x ____________ / worldwide AMTI. • FTC cannot exceed ___% of _______.

13. Organizational Forms - Direct Taxation • Foreign branch or partnership - the U.S. corporation is fully taxed on branch or (share of) partnership income. • The U.S. corporation has a direct foreign tax credit for income taxes paid by branch or partnership. • The export operation, branch or partnership may be owned by any entity in the domestic group: e.g.by a U.S. headquarters corporation or by a separate domestic subsidiary created by that purpose.

14. Organizational Forms - Foreign Subsidiary • The foreign sub is NOT part of the consolidated U.S. return. • The U.S. does not generally have the right to tax subsidiary income until what happens? • Explain dividend gross-up and deemed paid credits:

15. Deemed-paid Credit - Example • USCo pays tax at 35%. UKSub pays tax at 40%. • UKSub earns $100 pretax, pays tax of $40 and has after-tax earnings of $60. • If UKSub pays a dividend of all the after-tax earnings of $60, the dividend is “grossed-up” to the pre-tax amount of $____. • USCo has $100 of foreign source income, but may claim a FTC of $___ subject to the FTC limitation. • If this is the only foreign source income, USCo would be limited to $___ of FTC.

16. Deferral of U.S. Tax • Because foreign subsidiary income is not taxed in the U.S. until repatriated, large tax savings result from earning income in low-tax countries and delaying repatriation. • U.S. tax is deferred until repatriation. • Under U.S. GAAP (APB Opinion 23), firms can avoid recording deferred tax if they state that the earnings are “permanently reinvested.”

17. Deferral creates incentives for tax avoidance • Tax deferral creates incentives to shift income artificially into low-rate countries (“tax havens”). Examples: • Place cash in Bermuda subsidiary bank account - earn interest tax-free. • Sell goods at low prices to Cayman Islands; resell at high prices to foreign customers - earn tax-free profit. • U.S. law prevents above abuses.

18. Controlled Foreign Corporations • CFC is a foreign corp in which U.S. shareholders own > ___% voting power or stock value. • Subpart F income of CFC is taxed as constructive dividence to all U.S. shareholders >=____% stock interest. Examples (Sec 952-954): • foreign based company sales income (resale out of country with little value added) • passive income • Loans back to U.S. are treated as ________ (Sec 951, 956)

19. Transfer Pricing • Where SubpartF rules do not apply, firms can engage in some income shifting between entities through transfer prices. Examples: • IRS has broad powers under IRC Section ____ to reallocate income to correct unrealistic prices.