Chapter c16

Prentice Hall's Federal Taxation 2016: Corporations, 29e (Pope)Chapter C16: U.S. Taxation of Foreign-Related Transactions

LO1: Jurisdiction to Tax

1) U.S. citizens, resident aliens, and domestic corporations are taxed by the U.S. government on their worldwide income at regular U.S. tax rates.Answer: TRUEPage Ref.: C:16-2Objective: 1

2) Identify which of the following statements is true.A) U.S. citizens, resident aliens, and domestic corporations are taxed by the U.S. government on their worldwide income at regular U.S. tax rates.B) Nonresident aliens and foreign corporations are not subject to U.S. taxation on their non-U.S. source investment income and part or all of their non-U.S. source trade or business income.C) In a particular year, the overall foreign tax credit limitation permits a taxpayer to offset "excess" foreign taxes paid in one country against "excess" limitation amounts originating in other countries.D) All of the above are true.Answer: DPage Ref.: C:16-2Objective: 1

3) Which of the following characteristics is not used by the U.S. government to determine the tax treatment accorded foreign-related transactions?A) the taxpayer's country of citizenshipB) the taxpayer's country of residenceC) the taxpayer's type of businessD) the type of income earnedAnswer: CPage Ref.: C:16-2Objective: 1

LO2: Taxation of U.S. Citizens and Resident Aliens

1) If foreign taxes on foreign income exceed U.S. taxes on foreign income, the excess foreign taxes are credited against U.S. taxes in the current year.Answer: FALSEPage Ref.: C:16-5Objective: 2

2) Income derived from the sale of merchandise inventory (i.e., final goods purchased for resale) are sourced in the country where the sale occurs.Answer: TRUEPage Ref.: C:16-6Objective: 2

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3) Excess foreign tax credits can be carried back one year and forward five years.Answer: FALSEPage Ref.: C:16-6Objective: 2

4) Excess foreign taxes in one basket cannot offset limitation amounts in another basket.Answer: TRUEPage Ref.: C:16-7Objective: 2

5) U.S. citizens and resident aliens working abroad may qualify for the foreign-earned income exclusion of $97,600 in 2013.Answer: TRUEPage Ref.: C:16-9Objective: 2

6) A taxpayer who is physically present in a foreign country for 330 full days out of a 12-month period and maintains a tax home there has satisfied the bona fide foreign resident test.Answer: TRUEPage Ref.: C:16-9Objective: 2

7) Julia, an accrual-method taxpayer, is a U.S. citizen and a resident of a foreign country. Her tax year for both countries is a calendar year. Julia accrues 50,000 coras for the foreign country tax liability on December 31 of last year when the exchange rate is one cora = $1. Julia pays the tax to the foreign country on its due date, March 1 of the current year. The exchange rate on that date is one cora = $1.50. Julia files her U.S. tax return for last year on April 15 of the current year when the exchange rate is one cora = $2. Julia's foreign tax credit isA) $50,000.B) $75,000.C) $100,000.D) none of the aboveAnswer: BExplanation: 50,000 coras × $1.50/1 cora = $75,000Page Ref.: C:16-4; Example C:16-1Objective: 2

8) Ashley, a U.S. citizen, works in England for part of the year. She earns $40,000 in England, paying $10,000 in income taxes to the British government. Her U.S. income is $60,000 and she pays $12,000 in U.S. taxes. Her taxes on her worldwide income are $20,000. What is Ashley's foreign tax credit? Assume she does not qualify for the foreign-earned income exclusion.A) $8,000B) $10,000C) $12,000D) none of the aboveAnswer: AExplanation: Lower of foreign taxes paid ($10,000) or the limit [20,000 × (40,000/100,000) = $8,000]Page Ref.: C:16-5Objective: 2

9) Ashley, a U.S. citizen, works in England for part of the year. She earns $40,000 in England, paying $10,000 in income taxes to the British government. Her U.S. income is $60,000 and she pays $12,000 in U.S. taxes. Her U.S. taxes on her worldwide income are $20,000. What is Ashley's excess foreign tax credit? Assume she does not qualify for the


foreign-earned income exclusion.A) $0B) $2,000C) $4,000D) none of the aboveAnswer: BExplanation: Foreign taxes paid $10,000Foreign tax credit 8,000Excess $2,000

Page Ref.: C:16-5; Example C:16-2Objective: 2

10) Alan, a U.S. citizen, works in Germany and earns $70,000, paying $20,000 in German taxes. His U.S. income is $40,000 and he pays $8,000 in U.S. taxes. His U.S. taxes on his worldwide income are $22,500. What is Alan's foreign tax credit? Assume he does not qualify for the foreign-earned income exclusion.A) $12,000B) $14,318C) $20,000D) none of the aboveAnswer: BExplanation: Lower of foreign taxes paid ($20,000) or the limit [22,500 × (70,000/110,000) = 14,318]Page Ref.: C:16-5Objective: 2

11) Alan, a U.S. citizen, works in Germany and earns $70,000, paying $20,000 in German taxes. His U.S. income is $40,000 and he pays $8,000 in U.S. taxes. His U.S. taxes on his worldwide income are $22,500. What is Alan's excess foreign tax credit? Assume he does not qualify for the foreign-earned income exclusion.A) $0B) $5,682C) $8,000D) none of the aboveAnswer: BExplanation: Foreign taxes paid $20,000Foreign tax credit 14,318 Excess $5,682



12) For the foreign credit limitation calculation, income derived from the sale of inventory which is produced by the seller, is considered earnedA) where production occurs.B) where the sale occurs.C) where the seller is a resident.D) partially where produced and partially where sold.Answer: DPage Ref.: C:16-6Objective: 2

13) A U.S. citizen accrued $120,000 of creditable foreign taxes last year. The citizen's foreign tax credit limitation for last year is $90,000 (only a single limitation need be calculated). The excess foreign tax credit limitation for the year preceding the year in which the excess foreign taxes were incurred is $2,000. A similar $2,000 excess foreign tax credit limitation position is expected in each of the next 10 years. What portion of the excess foreign taxes can be expected to be noncreditable because of the foreign tax credit limitation?A) $0B) $2,000C) $8,000D) none of the aboveAnswer: CExplanation: Excess credits can be carried back one year and forward ten years, or a total of eleven years. The credits that are expected not to be used are $16,000 [$30,000 - ($2,000 × 11)].Page Ref.: C:16-6 and C:16-7; Example C:16-3Objective: 2

14) Identify which of the following statements is false.A) An accrual-basis taxpayer must make an adjustment to their foreign tax credit which reflects the change in exchange rates between the accrual date and the payment date.B) Dividend income received by a U.S. individual from a foreign corporation earning nearly all of its income from outside the United States is foreign-source income.C) Income from the sale of personal property (other than inventory) by a U.S. resident is considered earned in the country where the personal property is delivered.D) Itemized deductions are allocated between U.S. and foreign-source income.Answer: CPage Ref.: C:16-6Objective: 2

15) Identify which of the following statements is true.A) Foreign taxes paid in excess of the foreign tax credit limitation can be carried back to the previous three tax years and then carried over to the succeeding five tax years.B) When a taxpayer reports excess foreign tax credits in more than one year, the excess credits are used in a last-in-first-out (LIFO) manner.C) When computing the foreign tax credit limitation, taxable income for individual taxpayers is computed without a personal exemption deduction.D) All of the above are false.Answer: CPage Ref.: C:16-6Objective: 2

16) What are the carryback and carryforward periods for the foreign tax credit?A) back two years; forward five yearsB) back three years; forward ten yearsC) back one year; forward ten yearsD) back two years; forward twenty years


Answer: CPage Ref.: C:16-7Objective: 2

17) Karen, a U.S. citizen, earns $40,000 of taxable income from U.S. sources, $20,000 in taxable wages from Country A and $20,000 in taxable interest from Country B. The U.S. tax rate is 25%. The tax on Country A income is $8,000, and Country B charges no tax on the interest income. Assuming two baskets are needed for the two types of income because the interest is passive income, Karen's foreign tax credit that can be claimed isA) $5,000.B) $10,000.C) $20,000.D) none of the aboveAnswer: AExplanation:

Type of IncomeEarned

U.S. TaxLiability

Foreign Taxes Paid

on AccrualU.S. Foreign TaxCredit Limitation

Interest $ 5,000 $ 0 $ 0Wages 5,000 8,000 5,000

$10,000 $ 8,000 $ 5,000

Page Ref.: C:16-7 and C:16-8; Example C:16-4Objective: 2

18) Karen, a U.S. citizen, earns $40,000 of taxable income from U.S. sources, $20,000 in taxable wages from Country A and $20,000 in taxable interest from Country B. The U.S. tax rate is 25%. The tax on Country A income is $8,000, and Country B charges no tax on the interest income. Assuming only a single basket is required, Karen's foreign tax credit that can be claimed isA) $5,000.B) $8,000.C) $10,000.D) none of the aboveAnswer: BPage Ref.: C:16-7Objective: 2


19) A U.S. citizen, who uses a calendar year as his tax year, is transferred to a foreign country by his employer. The U.S. citizen arrived in the foreign country on November 3 of last year. Residency is expected to be maintained in the foreign country until August 4 of next year. None of the years are a leap year. The first year for which an earned income exclusion can be claimed isA) last year.B) the current year.C) next year.D) The earned income exclusion cannot be claimed.Answer: APage Ref.: C:16-9; Example C:16-5Objective: 2

20) The physical presence test method of qualifying for the foreign-earned income exclusion requires theA) presence in one foreign country for at least 330 full days during a 12-month period.B) presence in one or more foreign countries for at least 330 full days during a single tax year.C) presence in one or more foreign countries for at least 330 full days during a 12-month period.D) presence in one or more foreign countries for at least 330 consecutive full days during a 12-month period.Answer: CPage Ref.: C:16-9Objective: 2

21) Identify which of the following statements is false.A) The foreign-earned income exclusion is $91,400 in 2009.B) The primary purpose for the foreign-earned income exclusion is to prevent double taxation of income.C) A taxpayer who is physically present in a foreign country for 330 full days out of a 12-month period satisfies the bona fide foreign resident test.D) All of the above are false.Answer: CPage Ref.: C:16-9Objective: 2

22) Identify which of the following statements is true.A) An individual who is physically present in a foreign country for 330 full days out of a 12-month period can claim the foreign-earned income exclusion only for the days in the 12-month period he/she is physically present in a foreign country.B) An individual, who is a bona fide resident of a foreign country for at least one full tax year, can claim the foreign-earned income exclusion for all days on which he/she is a resident of the foreign country and physically present in that country.C) Fringe benefits that are excluded from gross income under a Code Section other than Sec. 911 reduce the annual dollar ceiling for the foreign income exclusion.D) All of the above are false.Answer: DPage Ref.: C:16-9Objective: 2


23) Identify which of the following statements is false.A) Earned income is excludable from gross income only if it is foreign-source income.B) Taxable pensions and annuities are excluded from the definition of earned income when computing the foreign-earned income exclusion.C) An individual meets the bona fide resident test by establishing a home in a foreign country for 330 days.D) All of the above are false.Answer: CPage Ref.: C:16-9Objective: 2

24) Perry, a U.S. citizen, is transferred by his employer to Japan for a three-year assignment. Which one of the following items is not excluded under Sec. 911?A) base salaryB) cost-of-living allowanceC) housing costsD) premiums paid on first $50,000 of group term life insuranceAnswer: DPage Ref.: C:16-10Objective: 2

25) U.S. citizen who has a calendar tax year establishes a tax home and residence in a foreign country and qualifies for the foreign-earned income exclusion for 60 days in 2010; 365 days in 2011; and 60 days this year, 2012. The maximum earned income exclusion for this year is?A) $13,733B) $16,044C) $13,151D) none of the aboveAnswer: BExplanation: $267.4 × 60 = $16,044Page Ref.: C:16-10Objective: 2

26) U.S. citizen Barry is a bona fide resident of a foreign country for all of 2013. Barry uses a calendar year as his tax year and receives $158,000 in salary and allowances from his employer. Included in the $158,000 is a $25,000 housing allowance. Barry's housing costs are $30,000. The base housing amount for the current year is $15,616. What amount related to his housing can Barry exclude on his Form 2555?A) $14,384B) $25,000C) $30,000D) $13,545Answer: AExplanation: Housing costs incurred $30,000 Minus: base housing amount ( 15,616)Housing cost amount exclusion $14,384


27) U.S. citizen Patrick is a bona fide resident of a foreign country for all of the current year. Patrick uses a calendar year as his tax year. He has $100,000 of self-employment income and incurs $20,000 in housing expenses. The base housing cost amount is $15,616. The deduction for housing expenses isA) $13,184 for AGI.


B) $13,184 from AGI.C) $4,384 for AGI.D) $6,816 from AGI.Answer: CExplanation: $20,000 - $15,616 = $4,384 deductible for AGIPage Ref.: C:16-11; Example C:16-8Objective: 2

28) Jose, a U.S. citizen, has taxable income from U.S. sources of $15,000 and taxable income from a foreign country of $35,000. Assume the U.S. tax rate is 25% and Jose paid $12,000 in taxes to the foreign country. What foreign tax credit can be claimed by Jose?Answer:

Source Taxable Income U.S. Tax Liability(25%)

U.S.ForeignTotal

$ 15,000 35,000$ 50,000

$ 3,750 8,750a

$ 12,500

a$12,500 × ($35,000/$50,000) = $8,750Page Ref.: C:16-5; Example C:16-2Objective: 2

29) Michael, a U.S. citizen, earned $100,000 of foreign-earned income and no other U.S. or foreign income in 2013. He also incurred $10,000 of employment-related expenses, none of which were reimbursed. If the full foreign-earned income exclusion is utilized, calculate the deductible employment-related expense (before the 2% nondeductible floor).Answer: $10,000 × ($97,600/$100,000) = $9,760 nondeductible$10,000 - $9,760 = $240 deductible (before the 2% nondeductible floor*)Page Ref.: C:16-10Objective: 2

30) Darlene, a U.S. citizen, has foreign-earned income of $150,000 and employment-related expenses of $15,000. Darlene earns no other income. Darlene also has $12,000 of itemized deductions not directly related to the foreign-earned income. She can exclude $97,600 of foreign-earned income. Darlene incurs $33,750 of Country C income taxes on $150,000 of Country C taxable income. How much of Darlene's foreign income taxes are noncreditable?Answer: [1 - ($97,600 - $9,760) / ($150,000 - $15,000) ] × $33,750 = $11,812.5.Page Ref.: C:16-13; Example C:16-11Objective: 2


31) Marcella, an alien individual, is present in the United States for 122 days this year and 122 days each in the past two years. Does she satisfy both the 31-day and 183-day requirements for U. S. Residency status?Answer: Yes, 31-day test: 122 days this year >31 day test183 day test: this year: 122 days × 1 =122.00 dayslast year: 122 days × 1/3 =40.67previous year: 122 days × 1/6 =20 .33

183 daysPage Ref.: C:16-9; Example C:16-5Objective: 2

32) In January of the current year, Stan Signowski's U.S. employer assigned him to their Paris office. This year, he earned salary, a cost-of-living allowance, a housing allowance, a home leave allowance that permits him to return home once each year, and an education allowance to pay for U. S. schooling for his son. Stan and his wife, Jennifer, have rented an apartment in Paris and paid French income taxes. What tax issues does Stan need to consider when preparing his tax return?Answer: • Is Stan Signowski eligible to claim the foreign-earned income exclusion?• Does Stan Signowski qualify for the Sec. 911 foreign-earned income exclusion under the physical presence test for his year of arrival?• Is Stan Signowski a bona fide resident of France? Will he qualify for the Sec. 911 foreign-earned income exclusion under the bona fide foreign resident test for his entire second year in France? Will this alternative increase his foreign-earned income exclusion for his year of arrival? For his second year in France?• What foreign income items are eligible for the foreign-earned income exclusion? What is the dollar ceiling for his foreign-earned income exclusion?• Is Stan Signowski eligible to exclude a portion of his housing cost amount in addition to his basic foreign-earned income exclusion? If so, what is the amount of his exclusion?• What portion of Stan Signowski's employment-related expenses is nondeductible?• What portion of Stan Signowski's foreign tax payments is noncreditable?• How does Stan Signowski translate his foreign income, expenses, and taxes?• How does Stan Signowski make the basic Sec. 911 exclusion? How does Stan Signowski make the housing cost amount exclusion?• How does Stan Signowski report the Sec. 911 foreign earned-income exclusion?• Will Stan Signowski be better off by electing out of the Sec. 911 foreign-earned income exclusion?


Stan appears to satisfy the basic Sec. 911 exclusion requirements for his year of arrival since he will be physically present in France for at least 330 days during his year of arrival. The actual number days for which the exclusion can be claimed depends on the length of time he spent in the United States. The salary, cost-of-living allowance, housing allowance, home leave allowance, and education allowance all are excludable up to the Sec. 911 limitation (calculated on a daily basis). In addition, Stan can claim an exclusion for the housing cost amount minus the base amount (calculated on a daily basis). Both exclusions are denied for the portion of Stan's salary and allowances attributable to his time in the United States. The portion of his employment-related expenses and foreign taxes attributable to the excluded income are unable to be deducted or credited. The foreign-earned income exclusion and housing cost amount exclusion are both elected by claiming such amounts on Form 2555.

Not knowing the amount of the foreign income taxes, and other components of Stan's tax return, it is impossible to know whether Stan should elect out of the Sec. 911 exclusion. Stan may have spent sufficient number of days in the United States on his trip home to need to qualify for the foreign-earned income exclusion under the bona fide foreign resident rules. In such case, he will not qualify for the exclusion until the end of this second calendar year in France. The exclusion would then be available retroactively back to the date on which he established foreign residency status.Page Ref.: C:16-3 through C:16-8 and C:16-19 through C:16-30Objective: 2

LO3: Taxation of Nonresident Aliens

1) Nonresident aliens are not allowed to claim the standard deduction.Answer: TRUEPage Ref.: C:16-17Objective: 3

2) Identify which of the following statements is true.A) If a foreign national has a closer connection with his home country, the individual is taxed as a resident alien.B) To obtain resident status, an alien must meet both the lawful permanent resident test and the substantial presence test.C) An individual who is a resident alien of the United States is taxed on his or her worldwide income at the same tax rates that would apply to a U.S. citizen.D) All of the above are false.Answer: CPage Ref.: C:16-14Objective: 3


3) Identify which of the following statements is true.A) Capital gains earned in the United States, other than in the conduct of a U.S. trade or business, are taxed to a nonresident alien only if the alien is physically present in the United States for at least 183 days during the tax year.B) Aliens, who are U.S. residents, are taxed only on their U. S. income.C) A nonresident alien from a nontreaty country is taxed at a 35% rate on U.S. source investment income without the benefit of any deductions.D) All of the above are true.Answer: APage Ref.: C:16-15Objective: 3

4) Pedro, a nonresident alien, licenses a patent to a U.S. company for an $11 per unit fee for each unit produced. As a result of receiving the fee, Pedro must recognize the fee asA) ordinary income taxable in the United States.B) capital gain taxable in the United States.C) no gain or income taxed in the United States.D) a portion of the gain, depending on the number of days Pedro is physically present in the United States during the current year.Answer: APage Ref.: C:16-15Objective: 3

5) A nonresident alien earns $10,000 of dividends from a domestic corporation, which is the alien's only U.S. source income. Which one of the following statements is incorrect?A) The nonresident alien's U.S. tax rate is 30% unless reduced by a tax treaty.B) The domestic corporation must withhold the U.S. taxes from the alien's dividend payment.C) The 30% tax rate is applied against gross income.D) The nonresident alien must pay estimated taxes on the dividend income at a 30% rate.Answer: DPage Ref.: C:16-16Objective: 3

6) Income is "effectively connected" with the conduct of a U.S. business only ifA) the asset-use test is met.B) the business activities test is met.C) activities of the U.S. business are a material factor in the realization of the income.D) Either A, B, or C can be correct.Answer: DPage Ref.: C:16-17Objective: 3


7) Identify which of the following statements is false.A) A nonresident alien can elect to have income earned on a passive real estate investment treated as trade or business income.B) Nonresident aliens may use either the standard deduction or claim itemized deductions.C) Nonresident aliens are generally allowed to claim only a single personal exemption.D) All of the above are false.Answer: BPage Ref.: C:16-17Objective: 3

8) Jacque, a single nonresident alien, is in the United States for 80 days in the current year engaging in the conduct of a U. S. trade or business. Jacque has $3,000 of interest income earned on a bank account in his home county and $1,800 of interest income earned on a bank account located in Addison, Illinois. How will the dividend be taxed and how will the tax be collected?Answer: The United States does not tax the interest income.Page Ref.: C:16-15Objective: 3

9) Jacque, a single nonresident alien, is in the United States for 80 days in the current year engaging in the conduct of a U. S. trade or business. Jacque has $30,000 of dividend income paid by a U. S. corporation on a stock investment portfolio unrelated to his trade or business. How will the dividend be taxed and how will the tax be collected?Answer: The United States taxes the dividend income as investment income at a 30% rate. The tax owed is $9,000 (0.30 × $30,000). A lower tax rate is not available to Jacque unless a tax treaty to which the United States is a party applies. The tax is collected through withholding.Page Ref.: C:16-16Objective: 3

10) Jacque, a single nonresident alien, is in the United States for 80 days in the current year engaging in the conduct of a U. S. trade or business. Jacque has a $15,000 capital gain on the sale of stock in a U. S. corporation while he was in the United States. The capital gain is not connected to his trade or business. How will the capital gain be taxed and how will the tax be collected?Answer: The capital gain is exempt from U.S. taxation since Jacque was present in the United States for fewer than 183 days in the current year and because the gain is not effectively connected with the conduct of a U.S. trade or business.Page Ref.: C:16-16Objective: 3

11) Jacque, a single nonresident alien, is in the United States for 80 days in the current year engaging in the conduct of a U. S. trade or business. Jacque has $75,000 of sales income earned while in the United States and $30,000 of non-U. S. sales income earned while he was outside the United States. How will the income be taxed and how will the tax be collected?Answer: The $30,000 of non-U.S. sales commissions are exempt from U.S. taxation. The $75,000 of U.S. sales commissions are taxed as being effectively connected with the conduct of a U.S. trade or business. This amount can be reduced by any business expenses and itemized deductions incurred and by a single personal exemption. The taxable income is taxed at the rates applicable to a single taxpayer and collected through estimated tax payments.Page Ref.: C:16-17Objective: 3

12) Define the term "nonresident alien" and discuss the special tax consequences of U.S. taxation on various types of income of a nonresident alien.


Answer: A nonresident alien is an alien who does not have permanent residence status, (i.e., does not have a "green card" or does not meet the substantial presence test). Investment income is taxed to a nonresident alien only when it is U.S.-source income. Investment income is taxed at a 30% rate, or a reduced rate permitted by treaty. The rate is applied to the gross income amount. The U.S. payer is required to withhold from the income the amount of U.S. taxes due. A nonresident alien who owns or operates a business in the United States is taxed on his U.S. trade or business income. Income is "effectively connected" with the conduct of a U.S. trade or business if either an asset-use or business activities test is satisfied.

An alien who conducts a U.S. trade or business may have to make two separate tax calculations. Investment income that is unrelated to the U.S. trade or business is taxed at a 30% rate or at a lower rate specified in a tax treaty. The tax is collected by withholding. Business income is reduced by all related expenses and losses and taxed at the regular U.S. tax rates. Nonresident aliens cannot use the standard deduction otherwise available for individual taxpayers. They must itemize their deductions. Nonresident aliens are limited to a single personal exemption. The business income for an unmarried nonresident alien is taxed using the tax rate schedules for a single taxpayer. A married nonresident alien uses the tax rate schedule for married filing separately, unless an election to file a joint return with a U.S. resident or citizen is made. The taxes that are owed on the U.S. trade or business income can be offset by available tax credits. Business taxes are collected via estimated tax payments or when the return is filed.Page Ref.: C:16-14 through C:16-18Objective: 3

13) Compare the U. S. tax treatment of a nonresident alien and a resident alien, both of whom earn U. S. trade or business and U. S. investment income.Answer: A nonresident alien who earns investment income is taxed only to the extent that such amounts are U.S.-source income. U.S.-source investment income is taxed at a 30% rate without any reduction for deductions, losses, etc. U.S-source income that is effectively connected with the conduct of a U.S. trade or business is taxed at the regular individual tax rates. Such amounts can be reduced by deductions, losses, etc. Only limited amounts of foreign-source income that is effectively connected with the conduct of a U.S. trade or business is taxed by the United States. A resident alien is taxed on his or her worldwide income without any different tax treatment for trade or business income or investment income. A resident alien is permitted to reduce both income forms by any deductions, losses, etc. that are related to the income. The resulting amount is then taxed at the progressive individual tax rates.Page Ref.: C:16-14 through C:16-18Objective: 3


LO4: Taxation of U.S. Businesses Operating Abroad

1) U.S. shareholders are not taxed on dividends paid by a foreign subsidiary as long as the earnings are not remitted to them as dividends.Answer: TRUEPage Ref.: C:16-18Objective: 4

2) A U.S. corporation can claim a credit for foreign taxes withheld from dividends paid by a foreign corporation in which it owns at least 10% of the stock.Answer: TRUEPage Ref.: C:16-19Objective: 4

3) Under the Subpart F rules, controlled foreign corporations (CFCs) are required to distribute a certain portion of their income as dividends to their U.S. shareholders.Answer: FALSEPage Ref.: C:16-25 and C:16-26Objective: 4

4) Overseas business activities conducted by U.S. corporations receive which one of the following favorable tax breaks?A) Foreign subsidiaries of U.S. corporations are exempt from the U.S. corporate income tax unless they earn U.S.-source investment or trade or business income.B) Foreign subsidiaries of U.S. corporations are always exempt from the U.S. corporate income tax even if they earn U.S.-source investment or trade or business income.C) Domestic corporations conducting business in a foreign country through a branch office or facility can exempt non-U.S. income from the U.S. corporate income tax.D) All of the above are correct.Answer: APage Ref.: C:16-18Objective: 4

5) Which of the following is an advantage of conducting foreign operations through a branch?A) Foreign branch losses can offset domestic income.B) Foreign branch income is taxed at a lower rate than domestic income.C) The parent's assets are protected from foreign branch creditors.D) Foreign branch income is taxed by both the United States and the host country.Answer: APage Ref.: C:16-19Objective: 4


6) U.S. Corporation, a domestic corporation, owns all of Foreign Corporation's stock. Foreign Corporation is incorporated in France. This year, Foreign Corporation reports $100,000 in aftertax profits in France, none of which is Subpart F income. U.S. CorporationA) must include the $100,000 profit in its current-year U.S. tax return.B) never has to include Foreign Corporation's profits in its U.S. tax return.C) reports Foreign Corporation's profits in its U.S. tax return in the same manner it would if Foreign Corporation were instead a foreign branch.D) must include Foreign Corporation's profits in its U.S. tax return when they are paid to U.S. Corporation in the form of a dividend.Answer: DPage Ref.: C:16-20Objective: 4

7) U.S. Corporation, a domestic corporation, owns all of Foreign Corporation's stock. Foreign Corporation is incorporated in France. This year, Foreign Corporation suffers a $100,000 net operating loss (NOL) in France. What amount of the $100,000 NOL can U.S. Corporation use to reduce its current-year U.S. taxable income?A) $100,000B) $50,000C) $0D) none of the aboveAnswer: CPage Ref.: C:16-21; Example C:16-18Objective: 4

8) U.S. Corporation owns 45% of the stock of Foreign Corporation. Foreign Corporation is incorporated in France. During the current year, Foreign Corporation reports $100,000 of E&P, pays $30,000 in foreign income taxes, and remits $40,000 of dividends ratably to its shareholders. In prior post-1986 tax years, Foreign Corporation reported $60,000 of E&P, paid foreign income taxes of $20,000, and paid no dividends. What is U.S. Corporation's deemed paid foreign tax credit for the current-year dividend?A) $5,000B) $5,625C) $18,000D) $22,000Answer: BExplanation: 0.45 × {[$40,000/ ($100,000 + $60,000)] × [$30,000 + $20,000]} = $5,625Page Ref.: C:16-21; Example C:16-18Objective: 4


9) Cane Corporation owns 45% of the stock of Edmonton Airline Corporation. In its first year of operations, Edmonton Airline, a Canadian corporation, earns $400,000 of E&P and pays a $100,000 dividend to Cane Corporation. Edmonton Airline pays $50,000 in Canadian income taxes. All amounts are expressed in U.S. dollars. What is Cane Corporation's deemed paid foreign tax credit for the dividend?A) $ 0B) $12,500C) $50,000D) none of the aboveAnswer: BExplanation: $50,000 × ($100,000/$400,000) = $12,500Page Ref.: C:16-20Objective: 4

10) U.S. Corporation owns 45% of the stock of Foreign Corporation. Foreign Corporation is incorporated in Country T. In its first year of operations, Foreign Corporation earns 60,000 frugs of E&P, pays a 40,000- frug dividend, and pays 5,000 frugs in income taxes. The exchange rate between the dollar and the frug is: first year average, 1 frug = $0.20; yearend, 1 frug = $0.25; tax payment date, 1 frug = $0.30; and dividend payment date, 1 frug = $0.28. What is the translated dividend amount?A) $5,400B) $4,500C) $5,040D) $3,600Answer: CExplanation: 40,000 frugs × .45 × $0.28 /frug = $5,040Page Ref.: C:16-21; Example C:16-19Objective: 4

11) U.S. Corporation owns 45% of the stock of Foreign Corporation. Foreign Corporation is incorporated in Country T. In its first year of operations, Foreign Corporation earns 100,000 frugs of E&P, pays a 20,000- frug dividend to U. S. Corporation, and pays 5,000 frugs in income taxes. The exchange rate between the dollar and the frug is: first year average, 1 frug = $0.20; yearend, 1 frug = $0.25); tax payment date, 1 frug = $0.30; and dividend payment date, 1 frug = $0.28. What is the translated foreign tax amount attributable to the dividend for deemed paid foreign tax credit purposes?A) $200.00B) $250.00C) $300.00D) $280.00Answer: CExplanation: 5,000 frugs × $0.30/frug × (20,000 dividend/100,000 E&P) = $300Page Ref.: C:16-21; Example C:16-19Objective: 4


12) Identify which of the following statements is true.A) The losses of a foreign corporation that is 100% owned by a domestic corporation can be deducted by the domestic corporation to offset its gross income in the year incurred.B) The deemed paid foreign tax credit was enacted so as not to discourage foreign direct investment through foreign branches.C) A dividend remittance made by a noncontrolled foreign corporation is translated into U.S. dollars at the current exchange rate for the date the dividend is paid.D) All of the above are false.Answer: CPage Ref.: C:16-21Objective: 4

13) Identify which of the following statements is true.A) The foreign income taxes withheld from a dividend remittance made by a foreign corporation are translated into U.S. dollars at the current exchange rate in effect for the date the dividend is paid.B) A U.S. subsidiary that is used by a foreign parent corporation to conduct its U.S. business activities is required to withhold 30% of dividends paid to the foreign corporation unless a treaty provides for a lower withholding rate.C) A foreign corporation that conducts a U.S. trade or business may be required to pay the corporate income tax, the corporate alternative minimum tax, and the branch profits in a single year.D) All of the above are false.Answer: BPage Ref.: C:16-22Objective: 4

14) A foreign corporation is owned by five unrelated individuals. John, Sam, and David are U.S. citizens who own 30%, 18% and 9%, respectively, of the foreign corporation's single class of stock. Alberto and Manuel are nonresident aliens who own 37% and 6%, respectively, of the foreign corporation's stock. Which of the following statements is true?A) There are three "U.S. shareholders" and the foreign corporation is a controlled foreign corporation (CFC).B) There are three "U.S. shareholders" and the foreign corporation is not a controlled foreign corporation (CFC).C) There are two "U.S. shareholders" and the foreign corporation is not a controlled foreign corporation (CFC).D) There are two "U.S. shareholders" and the foreign corporation is a controlled foreign corporation (CFC).Answer: CPage Ref.: C:16-24 through C:16-27Objective: 4


15) Identify which of the following statements is true.A) For a foreign corporation to be a controlled foreign corporation (CFC), more than 40% of its voting stock, or more than 40% of the value of its outstanding stock, must be owned by U.S. shareholders on any day of the corporation's tax year.B) Under the Subpart F rules, controlled foreign corporations (CFCs) are required to distribute a certain portion of their income as dividends to their U.S. shareholders.C) When a controlled foreign corporation (CFC) earns Subpart F income, such income is considered to be a constructive distribution to the CFC's U.S. shareholders on the last day of the CFC's tax year, or the last day on which CFC status is retained.D) All of the above are true.Answer: CPage Ref.: C:16-25 and C:16-26Objective: 4

16) A controlled foreign corporation (CFC) is incorporated in Country B, and is 100% owned by American Manufacturing Corporation. It purchases raw materials from its U.S. parent corporation, manufactures widgets, and sells 70% of the widgets to unrelated purchasers in Country A and 30% to unrelated purchasers in Country B. All widgets will be used in the countries in which they are purchased. The sales produce $100,000 of taxable income. The foreign-base company sales income reportable by American Manufacturing Corporation under the Subpart F rules isA) $0.B) $30,000.C) $70,000.D) $100,000.Answer: APage Ref.: C:16-24 through C:16-27Objective: 4

17) Phoenix Corporation is a controlled foreign corporation (CFC) incorporated in Country X. It is 100% owned by its U.S. parent corporation. Phoenix has $80,000 of taxable income from the sale of widgets that were purchased from their U.S. parent corporation. All widgets are intended for use or consumption within Country X and have the same gross profit. Sixty percent of the widgets were sold through a Country X wholesaler that is 100% owned by Phoenix, and 40% are sold through unrelated Country X wholesalers. What amount of profits will be constructively distributed as foreign-base company sales income to the U.S. parent company?A) $0B) $32,000C) $48,000D) $80,000Answer: APage Ref.: C:16-24 through C:16-27Objective: 4


18) Phoenix Corporation is a controlled foreign corporation (CFC) incorporated in Country X. It is 100% owned by its U.S parent corporation. Phoenix has $80,000 of taxable income from the sale of widgets that were purchased from their U.S. parent corporation. All widgets have the same gross profit. Sixty percent of the widgets were sold through a Country Y wholesaler that is 100% owned by Phoenix, and are destined for use in Country Y. The remaining 40% are sold through unrelated Country X wholesalers and are destined for use in Country X. What amount of profits will be constructively distributed as foreign- base company sales income to the U.S. parent company?A) $0B) $32,000C) $48,000D) $80,000Answer: CPage Ref.: C:16-24 through C:16-27Objective: 4

19) Identify which of the following statements is true.A) When a controlled foreign corporation (CFC) uses Subpart F income to invest in U.S. property, the investments are characterized as constructive distributions.B) A controlled foreign corporation (CFC) can avoid the constructive dividend distribution resulting from investments in U.S. property if it invests in U.S. government obligations.C) Distributions made by a controlled foreign corporation (CFC) are deemed to be paid first from tax-deferred earnings.D) All of the above are false.Answer: BPage Ref.: C:16-28 and C:16-29Objective: 4

20) Domestic corporation X owns all the stock of controlled foreign corporation (CFC) T. X's acquisition cost for the CFC investment is $150,000. The CFC reports E&P of $200,000 since the domestic corporation acquired its interest, of which $120,000 was Subpart F income. The CFC makes a cash distribution of $90,000 to the domestic corporation. What is the domestic corporation's basis for its investment in T immediately after the cash distribution?A) $150,000B) $180,000C) $230,000D) none of the aboveAnswer: BExplanation: $150,000 + $120,000 - $90,000 = $180,000Page Ref.: C:16-29; Example C:16-27Objective: 4


21) Identify which of the following statements is true.A) Foreign-base company sales income is earned when personal property is purchased by a Country X controlled foreign corporation (CFC) from its U.S. parent corporation and is sold to unrelated persons in Country Z.B) Section 482 permits the IRS to restructure transactions between related parties as if the transactions were conducted at arm's length.C) One tax avoidance practice which Sec. 482 attempts to prevent is the transfer of tangible property to a foreign subsidiary at a price which is below the arm's-length price that would be used by unrelated parties.D) All of the above are true.Answer: DPage Ref.: C:16-30Objective: 4

22) Which of the following statements regarding inversions is incorrect?A) The objective of an inversion is to avoid U.S. tax on worldwide income.B) In an inversion, a U.S. corporation reorganizes as a foreign corporation.C) The IRS will disregard the inversion if the former shareholders of the U.S. corporation continue to own 60% of the foreign corporation's stock.D) The IRS will examine whether the foreign corporation conducts substantial business in the foreign country of incorporation to determine if the inversion is valid.Answer: CPage Ref.: C:16-31 and C:16-32Objective: 4

23) Which of the following is required in order for a transaction to be considered a corporate inversion?A) A foreign corporation acquires substantially all of the assets of a U.S. corporation.B) Former shareholders of the U.S. corporation own 80% or more of the stock in the foreign corporation by reason of their U.S. stock ownership.C) The former U.S. company and its affiliates do not conduct substantial business in the foreign country of incorporation.D) All of the above are required.Answer: DPage Ref.: C:16-31 and C:16-32Objective: 4

24) What are the consequences of classification as a corporate inversion?A) The foreign corporation will be treated as if it is a U.S. corporation.B) Foreign tax credits will be disallowed on all future earnings.C) The corporation will be subject to a flat 35% tax rate.D) If more than half of the shareholders of the new company are the same as the former company, the corporation is considered a U.S. corporation.Answer: APage Ref.: C:16-31 and C:16-32Objective: 4


25) Which of the following statements is incorrect?A) A domestic subsidiary's earnings are taxed in the year earned.B) A foreign corporation's (less than 50% ownership) are not taxed until repatriated.C) All of a controlled foreign corporation's earnings are taxed as earned.D) U.S. taxpayers with a foreign branch can reduce part or all of their U.S. taxes by the foreign tax credit.Answer: CPage Ref.: C:16-22 and C:16-23Objective: 4

26) Cane Corporation owns 45% of the stock of Edmonton Airline Corporation. In its first year of operations, Edmonton Airline, a Canadian corporation, reports $400,000 of E&P and pays a $100,000 dividend to Cane Corporation. Edmonton Airline pays $50,000 in Canadian income taxes. All amounts are expressed in U.S. dollars. What is Cane Corporation's U.S. tax liability as a result of receiving the dividend? (Assume a 34% U.S. corporate tax rate.)Answer: Dividend $100,000Plus: deemed paid credit "gross up" 12,500Gross income $112,500Times: tax rate × 0 .34 Gross tax liability $ 38,250Minus: indirect credit ( 12,500)Net U.S. tax liability $ 25,750Page Ref.: C:16-21; Example C:16-18Objective: 4

27) A foreign corporation with a single class of stock is owned equally by Jericho Corporation, a U. S. corporation, and Joshua, a U. S. citizen. Joshua owns no Alpha Corporation stock. Is the foreign corporation a controlled foreign corporation (CFC)?Answer: Yes, the foreign corporation is a CFC (100% owned by U.S. shareholders Jericho Corporation and Joshua).Page Ref.: C:16-24 through C:16-27Objective: 4

28) A foreign corporation with a single class of stock is owned equally by Jericho Corporation, a U. S. corporation, and Joshua, a nonresident alien. Joshua owns no Alpha Corporation stock. Is the foreign corporation a controlled foreign corporation (CFC)?Answer: Non-CFC (only 50% owned by U.S. shareholder Jericho Corporation).Page Ref.: C:16-24 through C:16-27Objective: 4

29) A foreign corporation with a single class of stock is owned 8% by Bert, 49% by Xi Yong, 30% by Ernie, and 13% by Mark. Bert, Ernie, and Mark are U. S. citizens, and Xi Yong is a nonresident alien. The shareholders are not related. Is the foreign corporation a controlled foreign corporation (CFC)?Answer: It is not a CFC (only 43% owned by U.S. shareholders Mark and Ernie). Bert's ownership is not counted as he owns less than 10%.Page Ref.: C:16-24 through C:16-27Objective: 4


30) A foreign corporation with a single class of stock is owned 8% by Bert, 49% by Xi Yong, 30% by Ernie, and 13% by Mark. Bert, Ernie, and Mark are U. S. citizens, and Xi Yong is a nonresident alien. Bert is Ernie's son. Is the foreign corporation a controlled foreign corporation (CFC)?Answer: It is a CFC. (Bert is now a U.S. shareholder. )U.S. shareholders Bert, Ernie, and Mark now own 51% of the foreign corporation's stock.Page Ref.: C:16-25; Example C:16-22Objective: 4

31) Music Corporation is a CFC incorporated in Country M. Music receives interest and dividends from its two foreign subsidiary corporations, Sharp Corporation and Flat Corporation. Sharp is incorporated in Country S and conducts all of its activities in that country. Flat is incorporated in Country M and conducts all of its activities in that country. Are the interest and dividends received by Music Corporation FPHCI?Answer: Only the dividends and interest received from Sharp Corporation represent FPHCI since it is not incorporated in Country M.Page Ref.: C:16-26; Example C:16-23Objective: 4

32) Zeta Corporation, incorporated in Country Z, is 100% owned by Zelda Corporation, a U. S. corporation. Zelda purchases some machines from an unrelated corporation, for use in Country A. The portion of the sales contract covering installation and maintenance of the machines is assigned by Zelda to Zeta. Zeta is to be paid for these services by Zelda. Does this qualify as foreign base company services income?Answer: Yes, because it is performed for a related party (Zelda) outside of its country of incorporation (Country A).Page Ref.: C:16-27; Example C:16-25Objective: 4

33) Domestic corporation B owns 200 of the 400 outstanding shares of foreign corporation K's stock. U.S. citizen R owns the remaining K stock. The domestic corporation held the stock for 40 days two years ago, 365 days last year, and 80 days this year. None of K's income is Subpart F income. The foreign corporation has E&P of $50,000 for each of the three years in question. None of the years is a leap year. On the 80th day of the current year, the stock is sold by B to R in a transaction in which a $100,000 gain is recognized by B. What part of B's gain is capital gain?Answer: Recognized gain $100,000Dividend income:Two years ago: $50,000 × (200/400) × (40/365) = $ 2,740Last year: $50,000 × (200/400) × (365/365) = 25,000Current year: $50,000 × (200/400) × (80/365) = 5,479Minus: dividend income ( 33,219)Capital gain $ 66,781

Page Ref.: C:16-29 Example C:16-28Objective: 4


34) A foreign corporation is a CFC that is in its initial year of operation. For the current year, it reports $1 million of earnings and has an aggregate U. S. Property investment of $400,000. If none of the earnings qualified as Subpart F income, explain how the earnings are taxed.Answer: By making the $400,000 investment in U. S. Property, the foreign corporation loses its tax deferral for these earnings and causes the $400,000 to be taxed ratably to its U. S. Shareholders.Page Ref.: C:16-28 and C:16-29Objective: 4

35) Bell Corporation, a domestic corporation, sells jars to its wholly owned foreign subsidiary, Jam. Jam Corporation is incorporated in and pays taxes to Country J. Bell Corporation normally sells jars to a U.S. wholesaler providing services similar to those provided by Jam at a price of $4 per unit. Both wholesalers incur similar costs. If Bell Corporation sells jars to Jam for $3 per unit, what are the tax effects?Answer: Bell Corporation's profits increase by $1 and Jam's profits decrease $1 for every unit sold to Jam. Unless the additional profit is Subpart F income, it is not taxed by the United States until Jam remits it to Bell as a dividend.Page Ref.: C:16-30; Example C:16-29Objective: 4

36) Discuss the advantages of conducting overseas business activities through a foreign corporation.Answer: 1) The foreign corporation's liabilities are separated from those of the parent corporation, thus limiting the domestic corporation's losses to its capital investment.

2) The U.S. income tax levy on the domestic corporation's ratable share of the foreign corporation's earnings is postponed until the earnings are remitted to the U.S. corporation. The postponement of the U.S. tax liability can be lost if the foreign corporation is classified as a controlled foreign corporation (CFC), foreign personal holding company (FPHC), or passive foreign investment company (PFIC). These special corporations characteristically have majority U.S. ownership and earn in many cases primarily passive or holding company income.

3) A domestic corporation receiving a dividend from a foreign corporation can claim a special deemed paid foreign tax credit for a ratable share of the foreign income taxes paid by the foreign corporation. The deemed paid tax credit is available only if the foreign corporation makes dividend payments out of E&P and if the domestic corporation owns at least 10% of the foreign corporation's stock on the distribution date.Page Ref.: C:16-18Objective: 4


37) What is the branch profits tax? Explain the Congressional intent behind its enactment.Answer: The branch profits tax is imposed on the U.S. branch of a foreign corporation. It is equivalent to the tax that would be imposed on distributions made by the U.S. subsidiary of a foreign parent corporation. The branch tax is levied on either the branch's dividend-equivalent amount or its allocable interest. The dividend-equivalent amount tax base equals the foreign corporation's E&P for the tax year that is effectively connected with the conduct of its U.S. trade or business increased by earnings remitted by the branch to the foreign corporation and decreased by earnings reinvested in assets related to the branch's conduct of a U.S. trade of business. The allocable interest portion of the tax provides that certain interest paid by a U.S. trade or business of a foreign corporation is treated as U.S.-source interest and as such is possibly subject to withholding as if paid by a U.S. corporation. The branch profits tax is imposed in an attempt to equate the tax treatment of U.S. branch activities and U.S. subsidiary corporations owned and/or operated by foreign parent corporations. Were the branch profits tax not in place, no tax would be imposed on remittances made by a branch activity to its foreign parent corporation. A 30% rate (or a lower rate specified in a tax treaty), however, would be imposed on remittances made by a U.S. subsidiary corporation to its foreign parent corporation. The branch profits tax attempts to reduce these differences.Page Ref.: C:16-18Objective: 4

38) Discuss the use of a "tax haven" nation to reduce taxes and the effect of Subpart F rules on such planning.Answer: A domestic manufacturing corporation forms a sales subsidiary in a foreign country that imposes either no corporate income tax or taxes at a low corporate tax rate. The goods and services are delivered directly by the U.S. corporation to the foreign purchasers. The sales subsidiary is billed for the goods by the domestic corporation. The sales subsidiary, in turn, bills the foreign purchasers at a higher price. The sales subsidiary's profits largely escape U.S. and local taxation.

Under Subpart F, U.S. shareholders must report their ratable shares of a controlled foreign corporation's Subpart F income and its increased investments in U.S. property. A U.S. shareholder is taxed on these income items only when the foreign corporation is a controlled foreign corporation (CFC) for at least 30 days during its tax year. If this requirement is met, each U.S. shareholder's ratable share of these income items must be reported as a deemed dividend that is distributed on either the last day of the CFC's tax year or the last day on which the CFC status is retained.Page Ref.: C:16-30Objective: 4


39) What are the five major income categories that are taxed under the Subpart F rules? Explain the concept of Subpart F income.Answer: 1) Income from the insurance of U.S. and foreign risks.2) Foreign-base company income.3) Boycott-related income.4) Income equal to the amount of any bribes, kickbacks, or other illegal payments made by or for the CFC.5) Income from countries where, for political or other reasons, the deferral privilege is denied.

Subpart F income is one of the two categories of income (the other being increases in investments in U.S. property) that must be constructively distributed by the CFC to its U.S. shareholders on the last day of its tax year or on the last day of its tax year on which CFC status is retained. Subpart F income includes five major categories of "tainted" income that the U.S. government feels should be taxed to the CFC's U.S. shareholders in the year in which it is earned.Page Ref.: C:16-28 and C:16-29Objective: 4

40) Discuss the Sec. 482 rules concerning the sale of goods and services between a domestic parent corporation and a foreign subsidiary at a lower-than-normal price.Answer: Section 482 is designed to prevent tax avoidance when the domestic corporation sells goods and services to the subsidiary at a price that is less than the price that would be arrived at in arm's-length dealings. Another method is having the foreign subsidiary pay a less-than- arm's-length charge for the use of intangibles. Both situations cause an increased amount of profits to be earned by the foreign subsidiary that are exempt from U.S. taxation.

Section 482 authorizes the IRS to distribute, apportion, or allocate gross income, deductions, credits, allowances, or any items affecting taxable income between or among controlled entities to prevent tax evasion and to clearly reflect the income of the entities. The Sec. 482 regulations detail rules for transfers of tangible and intangible properties.Page Ref.: C:16-30Objective: 4


41) What is a corporate inversion and why was this provision enacted?Answer: In a corporate inversion, a U.S. corporation with substantial foreign-source income reorganizes as a foreign corporation in order to avoid U.S. tax on foreign income. The U.S. corporation merges into a foreign-owned entity or transfers substantially all of its assets into the foreign corporation.

Congress enacted two provisions to prevent the erosion of the U.S. corporate tax base. Under the first provision, a foreign corporation will be deemed to be a U.S. corporation for U.S. tax purposes if (1) the foreign corporation acquired substantially all the assets of the U.S. corporation, (2) former shareholders of the U.S. corporation own 80% or more (by vote or value) of stock in the foreign corporation by reason of their U.S. stock ownership, and (3) the foreign corporation and its affiliates do not conduct substantial business in the foreign country of incorporation. If these requirements are met, the IRS will disregard the inversion and continue to treat the corporation as a U.S. corporation.

The second provision prevents taxpayers from using a U.S. corporation's otherwise available tax attributes to offset income recognized in an inversion transaction for a ten-year period. A corporation is subject to this provision if (1) the foreign corporation acquired substantially all the assets of the U.S. corporation, (2) former shareholders of the U.S. corporation own between 60 and 80% (by vote or value) of stock in the foreign corporation by reason of their U.S. stock ownership, and (3) the foreign corporation and its affiliates do not conduct substantial business in the foreign country of incorporation. This provision prohibits a U.S. corporation from using a net operating loss and/or foreign tax credit to reduce its tax on the inversion transaction.Page Ref.: C:16-31 and C:16-32Objective: 4

42) Guinness Corporation, a U. S. corporation, began operating overseas in the current year. This year, Guinness sold machine tools that it manufactured in the United States to Canadian companies from a branch office located in Toronto, purchased a 40% investment in a Brazilian corporation from which it received a dividend, and received royalties from an English firm that is the licensee of machine tool patents held by Guinness. The English firm uses the patents to manufacturer machine tools it sells in England. What international tax issues should Guinness's Director of Taxes consider with respect to these activities?Answer: • Does Guinness Corporation have to recognize its profit from the machine tool sales in Canada in its current year tax return?• Did Guinness Corporation pay any Canadian income taxes on the machine tool sales?• Are the foreign taxes creditable? If so, what exchange rate is used to translate the taxes? What foreign tax credit limitation applies to the foreign taxes? Is a foreign tax credit carryback or carryover created?• How is the foreign tax credit election made? Does the credit have to be claimed with respect to all foreign taxes? Is it advisable to deduct the foreign taxes (instead of crediting them)?• Does Guinness Corporation have to report the dividend received from the Brazilian corporation in its current year tax return?• Do the Subpart F rules apply to the investment in the Brazilian corporation?• What exchange rate is used to translate the dividend?• Were any income taxes withheld by the Brazilian government on the dividend payment? Was the appropriate amount of taxes withheld in accordance with the U.S.-Brazil tax treaty? Are such taxes creditable? What exchange rate is used to translate such taxes?


• Is Guinness Corporation eligible to claim a deemed paid foreign tax credit with respect to the dividend? If so, what is the amount of the deemed paid credit?

What foreign tax credit limitation applies to the foreign taxes?• Does Guinness Corporation have to report the royalties received from the U.K. company in its current year tax return? What exchange rate is used to translate the royalty payment?• Were any U.K. taxes withheld from the royalty payment? Was the appropriate amount of taxes withheld in accordance with the U.S.-U.K. tax treaty? What exchange rate is used to translate the taxes? Are the U.K. taxes creditable? What foreign tax credit limitation applies to the foreign taxes?• Are any Guinness Corporation expenses allocable to the foreign-source income that is received? What effect do such expenses have on the foreign tax credit limitation(s)?Guinness Corporation reports the machine tool profits, dividends, and royalties in its current-year tax return. Any expenses allocable to the income items under Reg. Sec. 1.861-8 are deductible in determining foreign-source taxable income.

The machine tool profits and foreign taxes are translated under different rules depending on the functional currency for the operation (i.e., the U.S. dollar or Canadian dollar). The dividend and royalties are translated using the exchange rate for the date on which the payment was made. Foreign taxes withheld on the payment also are translated using the same exchange rate. The U.S.-Canada and U.S.-U.K. tax treaties will apply to the branch profits and dividend payments. The Brazilian corporation is not a CFC. Therefore, Subpart F does not apply. A deemed paid foreign tax credit can be claimed for a portion of the Brazilian corporation's foreign income taxes. The U.S.-Brazil tax treaty needs to be checked regarding the appropriate withholding rate. The credit is translated using the historical exchange rate at which the taxes were paid. For foreign tax credit purposes, the machine tool profits are in the other income basket, the dividend is in a separate basket for noncontrolled Sec. 902 corporation dividends, and the royalties are likely passive income, although they could be in the other income basket depending on the facts and circumstances. The credit is claimed on Form 1118, with separate forms being filed for each foreign tax credit limitation basket.Page Ref.: C:16-24 through C:16-27Objective: 4


43) Quality Corporation created a foreign subsidiary in Country C this year. The subsidiary receives components from Quality, assembles the components into a finished product using local labor, and sells them to unrelated wholesalers in Countries A, B, and C using its own sales force. The foreign subsidiary has paid no dividends to the parent this year. What tax issues should Quality's Director of Taxes consider with respect to these activities?Answer: • Is the Country C corporation a controlled foreign corporation?• Do the Country A, B, and C sales constitute foreign-base company sales income?• Do the Country C assembly activities constitute manufacturing or a substantial transformation so as to be an exception to the foreign-base company sales income definition?• If the Country A and B sales constitute foreign-base company sales income, what is the amount of the constructive dividend deemed paid at the year-end?• What portion of the sales are foreign-base company income? Do any of the subsidiary's expenses offset the Subpart F income? Does the Subpart F income de minimis rule permit exclusion of the Subpart F income?• What exchange rate is used to translate the foreign income? The foreign taxes? Are the Country A income taxes creditable against the foreign-base company income under the deemed paid credit rules? What foreign tax credit limitation basket applies to the Subpart F income? How is the foreign tax credit reported?• What effect does the Subpart F income constructive distribution have on the CFC's E&P? Can the constructive dividend be distributed to Quality Corporation tax-free?• Did the Country A subsidiary invest any money in U.S. property that may be an investment in U.S. property? Is such an investment taxable in the United States?• What effect does the constructive dividend have on Quality Corporation's basis for the Country C subsidiary corporation's stock?• Do the Sec. 482 rules apply to the transfer of the components to the Country C subsidiary?

It appears that the subsidiary corporation is majority U.S. controlled and therefore is a CFC. The assembly operation may qualify as Country Z manufacturing and permit all the sales to be exempt from Subpart F. Since direct labor costs and overhead exceed 20% of the total cost of goods sold, it is highly likely the assembly operation is manufacturing and excluded from the Subpart F income category. If it is not manufacturing, the Country A and B sales will be foreign-base company sales income and taxed to the U.S. shareholders currently. If Subpart F income, the sales income is taxed to Quality in the current year, and the dividend is eligible for the deemed paid credit. Special translation rules found in Subpart F will govern translation of the dividend and any related taxes. The look-through rules for the foreign tax credit will place the income in the other basket. The credit election will be made on Form 1118. Quality stock basis is increased by the constructive dividend that can be distributed tax-free from the CFC's previously taxed Subpart F income E&P pool. Since Quality and the foreign subsidiary are related parties, the Sec. 482 transfer pricing rules will apply to the transfer of the components.Page Ref.: C:16-25 and C:16-26Objective: 4


LO5: Tax Planning Considerations

1) A nonresident alien can elect to be considered a resident alien if the nonresident alien is married to a U.S. citizen or a resident alien on the last day of the tax year and both spouses consent.Answer: TRUEPage Ref.: C:16-36Objective: 5

2) A taxpayer may make the election to either deduct or take a credit for foreign income taxesA) annually.B) once every five years.C) only once, and the election applies to all future tax years.D) No election is available.Answer: APage Ref.: C:16-32Objective: 5

3) Identify which of the following statements is true.A) When a cash-basis taxpayer elects to take a credit for accrued foreign income taxes, certain other income and expense items must likewise be accrued.B) The taxpayer may revoke an election to exclude foreign-source earned income if a loss is incurred from foreign employment.C) A nonresident alien can elect to be considered a resident alien if the nonresident alien is married to a U.S. citizen or a resident alien sometime during the tax year and both spouses consent.D) All of the above are true.Answer: BPage Ref.: C:16-34Objective: 5

4) A nonresident alien cannotA) elect to be treated as a resident alien.B) elect to be treated as a resident alien before satisfying the substantial presence test for the calendar year following the election year if unmarried.C) make an irrevocable election to be treated as a resident alien after satisfying the substantial presence test.D) make an election to be treated as a resident alien if married to a resident alien.Answer: BPage Ref.: C:16-35Objective: 5

5) Explain the alternatives available to individual taxpayers for reporting foreign income taxes that have been paid or accrued.Answer: An annual election is available to individual taxpayers, allowing them to choose to deduct or credit any foreign income taxes that have been paid or accrued. Simplified reporting rules apply to taxpayers with small foreign tax credit amounts from passive income sources. However, almost all taxpayers elect to claim the foreign tax credit.Page Ref.: C:16-32 and C:16-33Objective: 5

6) Compare the foreign tax payment claimed as a deduction versus a similar payment claimed as a credit. Create an example to demonstrate the tax effect. Use 28% as the marginal tax rate in your example.Answer: Deduction CreditGross income $ 100 $ 100


Minus: foreign income taxes ( 30) (0)Taxable income $ 70 $ 100Times: marginal tax rate × 0.28 × 0.28Gross U.S. tax liability $19.60 $ 28Minus: foreign tax credit ( 0) ( 30)Net U.S. tax liability $19.60 $ 0

The credit is usually the most advantageous. However, the deduction may be desirable when there is no U.S. tax liability against which to use the credit. In that instance, the deduction would increase the net operating loss claimed as a carryback or carryforward.Page Ref.: C:16-33Objective: 5

LO6: Compliance and Procedural Considerations

1) There are no questions for this section.

LO7: Financial Statement Implications

1) In accounting for multinational corporations,A) SFAS 109 requires companies to include taxes on repatriation of foreign earnings as a deferred tax asset.B) the deferral of foreign earnings is a temporary difference.C) SFAS 109 allows the parent to exclude taxes on repatriated foreign earnings if they will not be repatriated in the foreseeable future.D) a corporation with excess foreign tax credits will record a deferred tax liability.Answer: CPage Ref.: C:16-39Objective: 7


2) Describe the financial statement implications of the foreign tax credit and a foreign subsidiary.Answer: A corporation having excess foreign taxes because of the FTC limitation will record a deferred tax asset, possibly subject to a valuation allowance. The valuation allowance will increase the corporation's effective tax rate. Full use of the foreign tax credit without limitation will not affect the corporation's effective tax rate.

A U.S. parent does not include a foreign subsidiary's earnings in its gross income until the subsidiary repatriates the earnings as a dividend, assuming the subsidiary is not a controlled foreign corporation. ASC 740 states that a reporting entity does not recognize a deferred tax asset for the excess of financial reporting basis over tax basis of an investment in a foreign subsidiary unless that temporary difference will reverse in the foreseeable future. Such a basis difference will occur if the consolidated financial statements recognize the foreign earnings but the U.S. parent's tax return does not. If the group does not invoke the ASC 740-30-25-17 exception because it expects to repatriate the earnings in the future, the deferral and subsequent repatriation will not affect the effective tax rate. If the group does invoke the exception, the deferral is treated as a permanent difference that reduces the effective tax rate. However, if the subsidiary repatriates the earnings in a future year, the repatriation will increase the effective tax rate. Using the exception could cause wide swings in the effective tax rate. These potential swings might induce management to forgo the exception, or, if using the exception, inhibit management from repatriating the foreign earnings.Page Ref.: C:16-38 and C:16-42Objective: 7


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