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U.S.

TAXATION OF FOREIGN-SOURCE CORPORATE INCOME

Submitted by
Kavitha M 1121542 Aishwarya 1121559 Kevin Vinay Shon 1121530 1121504 1121526

S. It is a miracle since taxes are the last topic on which one would expect sovereign States to reach a consensus upon since in international taxation. Thus the possibility of double taxation is very real 1 http://indirecttax.indlaw. on the profits of an American-owned corporation with foreign operations The Dilemma of double taxation in foreign taxation  If every nation resorts to tax and if the activities are carried on in two or more than two countries. an import of another country. Nevertheless. trade. Hence it‟s necessary to avoid double taxation  An export of one country is by its very nature. it is only a concession to the source State‟s ability to impose taxes first as the income is generated in that State and it does not reflect the optimal allocation1   Identifies several of the problems and policy choices associated with taxing foreignsource income This topic mainly focuses on income tax imposed by the U. the same income gets taxed in all the countries and it results into double taxation  Double taxation has a cascading effect on the cost of operations and effectively acts as a hindrance to cross border investments. one country's gain in revenue is another's loss. a coherent international tax regime exists that enjoys nearly universal support  The existence of the regime shows that inspite of the sovereign rights of each State to determine its own taxation policies. commerce and services. though the State which has the „source jurisdiction‟ is granted the prior right to tax all income and the State which has the „residence jurisdiction‟ has the primary obligation to prevent double taxation.com/search/articles/?406b7b7a-07de-46a2-b7c8-a68c8f8497a0 . a universally acceptable regime that will be followed by majority of the countries can be arrived at  In the international taxation regime.INTRODUCTION International Taxation  The current international tax regime is a flawed miracle.

S. If each country gets its share of tax revenues. the bilateral and multilateral trade grows and the overall tax collection also increases as a result of which both countries tend to benefit   The Tax payer has a choice of either credit or a deduction for foreign taxes The credit method cannot exceed the tax that would have been owed had the foreign income in fact been earned in the U.25 The income worldwide is taxed in United States. individual tax @15% Net After Tax $100 -40 -35 25 3.Example # 1: Atlantus corporate taxable income Atlantus tax @40% US Tax @35% on $100 Dividend to U. And general rules are applied which is the divisions( when earned) and subsidiaries ( when dividends are remitted).75 $21. Avoidance of Double Taxation  Avoidance of double taxation is to share the revenues between two countries. . shareholders U.S.S. The income is taxed in the United States depends on the firm through which one does business abroad.

If cash is needed in the United States.00 This example clearly shows that the tax affects has a big impact on the business decisions of whether to repatriate the potential dividend. If the company would have invested in U.the potential dividend of a subsidiary operating in tax haven is $100 Eg: Tax haven taxable income Tax haven tax @ 0% Potential dividend o U. Another bias that occurs is the U.S shareholders is a technical term that includes any U. and capital gains.0.S where the tax rate stands at 40%.they would be able to only give a dividend of 40$.A CFC is a foreign corporation owned more than 50% in terms of either voting power or market value by so called U. thus deferring the tax on dividends. instead of repatriating the cash as dividend have the other country subsidiary lend it to the U. interest.S Congress concluded are too frequently and abusively shifted offshore for the purpose of deffering U. even though not so in form) .Standard strategies. Controlled foreign corporations: The concept of CFC was created to thwart some of the more flagrant instances of advantage being taken of the deferral of axation until dividends are repatriated.00 .S shareholders” Disadvantages of CFC status:  Loss of the subpart F incomeand other income from acitivities the U.S Corp.S Corp $100. biases and abuses Tax haven Assume he small but climatically delightful nation of tax haven has a zero tax rate.S taxation  Loss of ax deferral on earnings and profits reinvested by CFC is US property(reinvestment in US property is deemed to be repatriated of profits in substance.S person or corporation that owns more than 10% of a foreign corporation is not a “U.S companies places their portfolio overseas and invest from abroad.00 $100.

for purposes of this discussion as it is the major category applicable to most foreign corporations. grandchildren. According to I.C.C. kickbacks. person (which could be an individual such as a spouse. (4) Illegal bribes.R. What is Subpart F Income? Tax deferral is a major motivator to work abroad.result in ordinary income rather than capital gain. section where you can find the applicable definition of the category: (1) Insurance income (I. corporation. Gain on the sale or redemption of stock. These categories are listed below along with the I. tax systems to inappropriately generate low or nontaxed income on which U.C.R.S. capital gains. interest.e. but subpart F was enacted by Congress to limit the deferral of U. including redemptions in liquidation of a CFC.C. children. royalties.C.R. Section 162 (c)). . or parents.S.R. taxation of certain income earned outside the United States by controlled foreign corporations (“CFC”).S. (3) Income from countries subject to international boycotts (I. We will focus on the second category. Section 954(c)) – this includes income from passive investments (i. Section 954). dividends.C Section 953). this includes income from selling personal property purchased or sold to a related U.R. there are several categories of subpart F income. foreign-base company income.R. tax may be permanently deferred.C. subject.R.S. Section 999). and (5) Income from countries where the United States has severed diplomatic relations (I. and certain rents).to the standard tests of dividend characterization having to do with adequate earnings and profits. Foreign-base company income includes: (1) Foreign personal holding company (investment) income (I.R. and other similar payments (I. (2) Foreign-base company sales income (I. One of the purposes of Subpart F is to prevent CFCs from structuring transactions in a way that are designed to manipulate the inconsistencies between foreign and U.C Section 954(d)) – in general. (2) Foreign-base company income (I. Section 901 (j)). Section 952. but it is also very difficult to determine.C. Subpart F income is one of the important issues to be aware of when completing Form 5471.R.

architectural.R. (3) Foreign-base company services income (I.R.R. The earnings and profits are taxed whether or not they are distributed. if a consulting company is organized in a tax haven and provides consulting services to unrelated persons. skilled. For example. engineering.C. this income would not be considered subpart F income to the U. It also includes services performed by a CFC in a case where substantial assistance contributing to the performance of such services has been furnished by a related person. Section 958(a)). this includes income derived in connection with the performance of technical. Additionally. It also excludes income received from services performed in the CFCs country of incorporation.C. but subpart F income is limited to the extent of the earnings and profits each year. industrial. 2 2 http://www. and (5) Foreign-base company oil related income (I. Services directly related to the sale or exchange by the CFC of property manufactured.partnership.C. then the earnings and profits of the corporation will be taxable each year to the shareholders owning 10% or more determined by direct ownership (or the attribution rules discussed in I. Section 954(e)) – per the IRS. or extracted by it that are performed before the time of the sale or exchange or an offer or effort to sell or exchange such property are excluded.C Section 954 ((f)). Section 954 (g)) If a foreign company is determined to have subpart F income.taxplannercpa. foreign-base company service income excludes income from services provided by a CFC to an unrelated person with no related person involvement. scientific. shareholders.com/WP/5471/what-is-subpart-f-income/ .S.R. produced. (4) Foreign-base company shipping income (I. commercial or “like services” for or on behalf of any related person outside the country under the laws of which the CFC is created or organized. managerial. grown. estate or trust that controls or is controlled by the controlled foreign corporation (defined as greater than 50% ownership).

The credit may also be granted in those systems taxing residents on income that may have been taxed in another jurisdiction.. class of income. This limitation may be computed by country.e. Illustration of deemed tax and derivative tax the terminology deemed paid or derivative credit is at first perplexing. Given is an illustration which signifies the difference the difference between deemed paid and derivative: In a hypothetical situation a 100% wholly owned subsidiary of the a U S Corp incorporated in atlantus earned $100.What is foreign tax Credit In order to mitigate the potential for double taxation the Income tax systems generally offer a foreign tax credit. taxes based on income). Deemed paid credit= Foreign subsidiaries paid dividend X foreign tax paid Foreign subsidiaries after –tax earnings . The fact that US Corp owns 100% of the Atlantus subsidiary does not change the fact that the atlantus subsidiary is a separate legal entity. of which $ 40 is paid in tax to atlantus and $60 was paid to the us government. Hence. and/or another manner. overall. foreign. The foreign tax payment is considered as a down payment on the domestic tax payers U S tax liability to that income. was using and eventually getting tax utility from a tax paid by someone else.S Corp. Some terminology was needed to convey the idea that U. or by country) and timing of recognition of income. as well as rules for associating deductions with income. Most income tax systems therefore contain rules defining source of income (domestic. Example: In order to get the down payment the information required is taxable income in the foreign subsidiary and the foreign tax for which credit is required. When a business is conducted through a foreign subsidiary the U S model for avoiding double taxation agreement is triggered by the remittance of $60 dividend. The credit generally applies only to taxes of a nature similar to the tax being reduced by the credit (i. This credit is often limited to the amount of tax attributable to foreign source income. deductions.the term “Deemed paid or alternatively derivative “serves that purpose. and taxes.

The tax is designed to ensure all foreign profits of U. either by the U. companies paid nearly $100 billion in income taxes to foreign governments on taxable income of $392 billion (2007 IRS data).S.LIMITATIONS OF FOREIGN TAX CREDIT: The Foreign Tax Credit claimed on your expatriate tax return cannot exceed the amount of US expat taxes paid on foreign income.S. include interest received from foreign banks. marginal tax rates are. companies of stowing money abroad to “avoid paying taxes” is disingenuous. President Barack Obama proposed creating a “minimum tax” on foreign earnings of U. multinationals in order to prevent this. To determine the amount of the limitation. They do this because U.S. multinationals are taxed once at a minimum rate.S.S. dividends received from foreign corporations and rental income from foreign properties. you can use the following formula: Foreign source taxable income (FSTI) should include all income earned in a foreign country. U. Some financial experts say the high cost of repatriating foreign earnings has led to billions of dollars in capital becoming “frozen” in the financial systems of more tax-friendly countries.S.-based companies operating internationally have kept their foreign earnings in subsidiaries overseas rather than bringing them back to the United States. In his 2012 State of the Union Address. Critics of the president‟s proposal say accusing U.S. corporate tax rates. Is your income earned both in and out of the US? The income should be allocated based on days worked in the US and days worked in the foreign country. U. or another country. Also. According to the Tax Foundation. the highest in the developed world. Any deductions directly related to this income claimed on the expatriate tax return can and should be removed before arriving at the final FSTI.S. by some measures. Veronique de Rugy of the Mercatus Center points out the president fails to acknowledge that the punishing nature of the current tax system is responsible for this . Repatriation of foreign earnings: To avoid high U.

25%. and then use the earnings to create more American jobs and/or expand operations in the U. because multinationals can defer paying taxes on foreign earnings until they decided to send the earnings back in the form of a dividend. the government's rationale is that the tax break would act as a good incentive for American multinationals to send their foreign earnings back to the U. The U. Pros and Cons of a merger compared to an acquisition of stock Indirect costs of Expatriation Employee satisfaction with expatriation and repatriation is critical to the success of MNCs because these employees often play a pivotal role in managing and coordinating the 3 http://www.com/ask/answers/06/repatriatedtaxbreak. and why is it so controversial? In 2004.S. which gave U. companies less competitive in international markets.S. Previously.S.S.S. multinational corporations a one-time tax break on money earned in foreign countries. corporate tax system makes U.S.org/policy-documents/research-commentary-repatriation-foreign-earnings .asp#axzz1zOkMK39d http://heartland.3 Critics of the idea believe that because the companies aren't required to use the repatriated earnings for the sole purpose of American job creation (but the bill does prevent companies from using the money for executive compensation. it is not assured that the tax break will increase job creation. What is the purpose of a "repatriated tax break".behavior.investopedia. dividends and stock investments).Ultimately.. The tax break allows foreign earnings to be taxed at a rate of 5. much of the earnings derived from foreign countries were not transferred back to the U.S.-based businesses. which is significantly lower than the usual corporate tax rate of 35%. Tax Cost of the Corporation becoming a citizen of another country The U. One of the results of the act was the implementation of a repatriated tax break. so keeping money overseas is often the most cost-effective move for U. Congress passed the American Jobs Creation Act to create new jobs in an effort to boost the economy. target corporation or its shareholders must receive not more than 50% of the voting power and fair market value of the acquiring company.S.

federal tax obligations for the preceding 5 years and provides any evidence of compliance required by the IRS . The public reaction is negative which aroused in the Stanley Works case which raised the tax burden and affect the operating results.S.Renunciation of Personal Citizenship When an individual renounces his U.00.operations of the extended enterprise. The public shareholders have protection of federal securities law. Expatriation. Shareholders on the other hand have less legal protection.S. citizenship he remains subject to income and transfer tax rules following the loss of citizenship. meets one of the following criteria‟s:    Has an average annual net income tax for the 5 preceding years that exceeds $124000 has a net worth as of the date of expatriation of $2.000 or more fails to certify under penalty of perjury that he/she complied with all U.