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SPPTChap 011
SPPTChap 011
International
Taxation
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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
Complex calculation in U.S.
FTC is lower of
Actual taxes paid to foreign government
Taxes if the income earned in U.S.
Maximum FTC
Taxes if the income earned in U.S.
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
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
End of Chapter 11
11-31