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Outbound Taxation

Outbound Taxation. Recall definition Two important planning areas: Use of foreign tax credit to minimize double taxation Use of foreign corporations to shift income out of US taxing jurisdiction. Foreign Tax Credit - Overview. Three big questions: Who gets a FTC?

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Outbound Taxation

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  1. Outbound Taxation • Recall definition • Two important planning areas: • Use of foreign tax credit to minimize double taxation • Use of foreign corporations to shift income out of US taxing jurisdiction

  2. Foreign Tax Credit - Overview • Three big questions: • Who gets a FTC? • What are creditable foreign taxes? • How much FTC is available each year?

  3. Example 1: Taxpayers Eligible for the FTC • Which of the following taxpayers is allowed a US foreign tax credit? • US citizen earning income in France and paying French income tax • US corporation with a branch office in Japan paying Japanese income tax • Foreign corporation earning US income on which it pays both US and foreign taxes • Nonresident foreign individual earning US income subject to US and foreign taxes

  4. Creditable Foreign Taxes • Must be a ‘tax’ or ‘in lieu of’ a tax • Not a payment for any specific benefit, not related to transactions between the taxpayer and the government • Special rules for splitting ‘dual-capacity’ payments • Must be an ‘income’ tax • Imposed on realizednet gain derived from actual gross receipts

  5. Foreign Income Tax Systems • Rates range from zero to 42 percent (Canada and Japan) • Imputation system for alleviating double-taxation of corporate earnings • Shareholders receive a tax credit for portion of corporate tax paid and report dividend income equal to dividend received plus credit amount • Many other differences in computation of taxable income and tax liability

  6. Value-Added Tax Systems • Common in Europe and many other developed countries • Consumption tax • Assessed on producers and distributors of goods and services based on ‘value added’ at each stage of production and distribution • Value-added generally equal to difference between sales price and non-labor costs of production or acquisition • Rates can be as high as 20+ percent

  7. Example 2: Creditable Foreign Taxes • Which of the following foreign taxes are likely to be creditable? • Value-added tax • Excise tax • Tax on gross receipts, with no allowance for deductions • Customs taxes imposed on imports of raw materials • Tax on net income computed under International Accounting Standards

  8. Example 3: Splitting Dual-Capacity Payments • BigOil Co. extracts oil with a gross value of $10 million from oil deposits owned by a foreign government. It incurs $2 million of operating expenses, and pays a 60% oil tax on its net profit. The foreign government’s normal income tax rate is 35%. • How much of BigOil’s payment is considered a tax, and how much is a royalty?

  9. Limits on Allowable FTC • Concept: FTC is allowed only up to the amount of US taxes paid on foreign source income • Mechanics: Credit = US Income X Foreign Source IncomeLimit Tax Worldwide Income Unused credits may be carried back 2 years and forward 5, subject to the limit in those years

  10. Example 4: Applying the Overall FTC Limitation • Global Inc., a US corporation, earned $4 million of worldwide taxable income, of which $1 million is foreign source. • If Global paid $300,000 of foreign taxes, compute its US tax liability after allowable FTC and total tax burden • What if Global paid $500,000 of foreign taxes?

  11. FTC Limits – Separate Baskets • FTC limit is applied separately for foreign taxes paid on income in separate baskets: • Passive income • High interest withholding income • Financial services income • Shipping income • Dividends received by a corporation from each non-controlled Sec. 902 corporation • Dividends from a DISC or former DISC • Foreign trade taxable income • Distributions from a FSC • All other income

  12. Separate Basket Limits continued • What is the goal of the separate basket limitations on the FTC? • Do these limits increase or decrease taxpayers’ ability to use FTCs? • What do many of the separate baskets have in common? • Note: Overall limit applies after the separate basket limitations

  13. Example 5: Applying the FTC Basket Limitations • Refer to example 3. Suppose that Global’s foreign source income is composed of $600,000 of passive income and $400,000 of shipping income. All $300,000 of its foreign taxes paid relate to the passive income. Compute Global’s separate basket FTC limitations, its US tax liability after FTC, and its total tax burden.

  14. Cross-Crediting Opportunities and Limits • Cross-crediting is advantageous when some foreign income is taxed at a low foreign tax rate while other foreign income is taxed at a high foreign tax rate • Cross-crediting is possible only when both sources of income are in the same basket, or when both sources of income are in the general basket

  15. Example 6: Cross-Crediting and the FTC • Nova Corporation earned $1 million of foreign income in country A, on which it paid foreign income tax of $100,000, and $1.5 million in country B on which it paid tax of $600,000. Its US source income is $3 million. • If all of Nova’s foreign income is in the general basket, calculate its allowable FTC and net US tax liability. • What if Nova’s two foreign income sources are in separate baskets (or if per-country FTC limits applied)?

  16. Conclusions • What are the burdens imposed by the FTC rules? • Information gathering and compliance burdens? • Impact on after-tax return from investment in foreign jurisdictions? • What planning opportunities can you identify related to the FTC?

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