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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

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Foreign Tax Credit - Overview

Three big questions: Who gets a FTC? What are creditable foreign taxes? How much FTC is available each year?

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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

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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 realized net gain derived

from actual gross receipts

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Figure 13-1 Types of Tax Collected as a Percentage of Total Tax Revenues for OECD Member Countries, 1997

Personal Income Tax27%

Corporate Income Tax9%

Social Security and Payroll Tax

26%

Property Tax6%

Consumption Taxes18%

Other Taxes14%

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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

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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

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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

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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?

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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

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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?

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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

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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

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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.

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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

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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)?

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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?