AK0048

INTERNATIONAL ACCOUNTING

International Taxation

ACCOUNTING PROGRAM
Learning Objectives
• Describe differences in corporate income tax and withholding
tax regimes across countries
• Explain how overlapping tax jurisdictions cause double taxation
• Show how foreign tax credits reduce the incidence of double
taxation
• Demonstrate how rules related to controlled foreign
corporations, subpart F income, and foreign tax credit baskets
affect U.S. taxation of foreign source income

11-2
Learning Objectives
• Describe some of the benefits provided by tax treaties
• Explain and demonstrate procedures for translating foreign
currency amounts for tax purposes
• Describe tax incentives provided by countries to attract foreign
direct investment and stimulate exports

11-3
 Impact of Taxes—International Business
Decisions
• Impact of Taxes
• International location decisions
• Legal form of operation
• Method of financing

11-4
 Types of Taxes and Tax Rates
• Types of taxes
• Corporate income taxes
• Imposed by governments
• Tax rates vary
• Zero percent in tax havens
• Over forty percent
• Withholding taxes
• Taxes on dividends
• Other amounts paid to foreign citizens

11-5
 Corporate Income Tax
• Corporate income tax rates
• Significant variation worldwide
• Provides tax planning opportunity
• Basis of taxability
• Type of activity
• Nationality of the company owners
• Variation in
• Methods of calculating taxable income
• Differences
• Deductibility of expenses

11-6
 Corporate Income Tax
• Tax Haven
• Abnormally low corporate income tax rates
• No corporate income tax at all
• Minimum worldwide income taxes
• Bahamas and the Isle of Man No corporate income tax
• Liechtenstein Tax rates from 7.5 percent to 15 percent

11-7
 Withholding Tax Regimes
• Application to
• Dividends
• Interest
• Royalties
• Vary across countries
• Type of payment
• Recipient
• Impacts tax planning
• Tax-planning strategy
• Thin capitalization

11-8
 Value-added tax
• Substitute for sales taxes
• Added into Price of product, Price of service
• At each stage of Production, Distribution
• Used in Australia, Canada, China, Mexico, Nigeria, Turkey, and
South Africa

11-9
 Tax Jurisdiction
• Taxation approaches
• Worldwide (nationality) approach
• Tax on all income of Resident, Company of a country Regardless of place of
earning, Territorial approach
• Tax only on Income earned in that country
• Common approach
• The worldwide approach

11-10
 Tax Jurisdiction
• Basis for taxation
• Source
• Followed by most of countries
• Citizenship
• Taxes citizens regardless of
• Source
• Residence
• Residence
• Taxes residents regardless of
• Source Citizenship

11-11
 Tax Jurisdiction
• Basis for taxation – The U.S. approach
• The basis of U.S. taxes
• Source Citizenship
• Residence Green card test
• U.S. taxes
• Foreign branch Includes income in U.S. parent
• Not foreign subsidiary
• Only dividend paid taxed

11-12
 Double taxation
• Same income taxed In a foreign country and Country of residence
• Discourages
• Capital-export neutrality
• Mechanisms for elimination
• Bilateral tax treaties Foreign tax credits

11-13
 Double taxation
• Solutions
• Adoption of territorial approach Exemption of foreign source income
• Deduction of taxes By parent company Paid to foreign governments
• Tax credit To parent company For tax paid to foreign governments
• U.S. allows
• Deduction of taxes
• Credit approach

11-14
 Double taxation
• FTC – Example
• Assume : GCO, a U.S. company has a branch in Mexico where
corporate income tax rate is 33%, The U.S. corporate income
tax rate is 35%, GCO has foreign source income in Mexico of
$50,000
• GCO pays $16,500 of corporate income tax in Mexico and
$20,000 of other taxes
• GCO decides to do a calculation to choose between using taxes
paid in Mexico as a deduction or tax credit

11-15
 Double taxation
• FTC – Example

• Deduction Credit
• Foreign source income $50,000 $50,000
• Deduction for all taxes paid $36,500 $ 0
• U.S. taxable income $13,500 $50,000
• U.S tax before tax credit $4,725 $17,500
• Foreign tax credit $ 0 $16,500
• Net U.S. tax liability $ 4,725 $ 1,000

11-16
 Calculation of Foreign Tax Credit
•

11-17
 FTC baskets
• Created by Tax Reform Act of 1986
• Nine FTC baskets
• Foreign source income
• FTC calculated separately for each
• Netting FTCs across baskets—not allowed
• Excess FTC allowed to be
• Carried back
• Carried forward
• Offset additional taxes paid on income basket
• Reduction of number of baskets to two
• General income
• Passive income
• Reduced likelihood of excess FTC’s going unused
• Reduction by The American Jobs Creation Act of 2004
11-18
 Indirect FTC (for subsidiaries)

• Indirect FTC
• Allowed by U.S. On foreign taxes
• Paid by foreign subsidiary U.S. parent company
• Before-tax amount of dividend
• Qualification for indirect FTC
• U.S. company
• Minimum 10% of voting stock Foreign company

11-19
 Controlled Foreign Corporations
• Controlled Foreign Corporations
• Foreign corporation U.S. shareholder Owning at least 10 percent of the
stock
• U.S. shareholders own more than 50% of Combined voting power Or fair
value of the stock
• CFC income referred as Subpart F income Taxable currently
• There is a safe harbor for such income in jurisdictions with tax
rate > 90% of the U.S. rate

11-20
 Subpart F Income
• Income from
• Insurance of U.S. risks
• Countries engaged in international boycotts
• Certain illegal payments
• Foreign base company income
• Amount of Subpart F income taxable
• Less than 5% of total income No income taxable Between 5% to 70 % of
total income
• Proportion of Subpart F income to total is taxable Greater than 70 % of
total income 100% of the CFC’s income taxed currently

11-21
Summary of foreign source income taxation
• To determine foreign income
• Factors considered
• Legal form of the foreign operation
• Operation qualify as CFC
• Location in tax haven
• Income qualifies as Subpart F income

11-22
 Tax Treaties
• Bilateral agreements
• Tax on individuals of one country
• Income earned in other country
• Alleviate double taxation problems
• Facilitate international trade and investment
• Information sharing between governments
• Helps in domestic enforcement

11-23
 Model treaties
• OECD model treaty
• Basis for most bilateral treaties of developed countries
• Tax if permanent establishment In the country
• Recommends reduction of withholding tax rates
• Recommended withholding tax rates 5% of direct investment dividends
• 15% of portfolio dividends 10% of interest 0% of royalties

11-24
 U.S. Tax Treaties
• Zero percent withholding tax Interest and royalties
• 15 percent Dividend payments
• Treaties with over 50 countries
• One notable exception
• Brazil
• Lack of Brazilian investment in the U.S.
• Treaty shopping
• Tax reduction tactic
• Benefit of tax treaty between country

11-25
 Translation of foreign branch income
• Net income
• Translated into U.S. dollars
• Use of average exchange rate of the year
• Net income after foreign taxes paid
• Added
• Taxes paid to the foreign government
• Payment date exchange rate
• Grossing up
• Earnings are repatriated to the U.S
• Converted to U.S. dollars
• Difference due to exchange rate
• Foreign exchange gain or loss

11-26
Translation of foreign subsidiary income
• Dividends paid to U.S. parent
• Translated at the spot rate
• On the date of payment
• Added
• Taxes deemed paid on the dividend
• Payment date spot rate
• Grossed up
• Translated deemed taxes paid
• Determines foreign tax credit

11-27
 Tax Incentives
• Tax holidays
• Incentive used by a government
• Partially or completely exempts a taxpayer
• A period of time
• Offered by many Asian countries
• Encourages foreign direct investment
• MNEs enjoy significant tax reductions
• If profits are not repatriated

11-28
 U.S. export incentives
• Prevention of tax avoidance
• CFC and Subpart F income
• Domestic international sales corporation (DISC)
• Short-lived export incentive program
• For U.S. companies
• Repealed due to foreign opposition
• Foreign sales corporation (FSC)
• Short-lived export incentive program
• For U.S. companies
• Replaced by Extraterritorial Income Exclusion Act (ETI)
• Repealed due to foreign opposition

11-29
 American Jobs Creation Act of 2004 (AJCA)
• American Jobs Creation Act
• Attempt to spur job growth
• In the U.S. manufacturing sector
• Provides deduction
• Effectively reduces income tax rates
• For domestic manufacturers
• Available even to companies that don’t export
• Allows for significant tax breaks
• On repatriations of foreign source income

11-30