TAX 509 - Fundamentals of International Taxation

TAX 509 – Fundamentals of International Taxation
Course Syllabus
TAX 509 – Fundamentals of

International Taxation
Copyright 2003, 2004, 2005, 2006, 2007, 2009, 2010, 2011, 2012, 2014, 2015,
2016, 2018, 2020
The Taft University System, Inc.
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permission in writing from the copyright holder.
Course Syllabus
Introduction
Important: You should take the time to carefully read this syllabus and the Student Handbook
before you begin the assignments for this course.
This course provides the student with a practical command of the tax issues raised by international
transactions and how these issues are resolved by U.S. tax laws. The text is divided into four major
components. Part 1 provides an overview of the U.S. tax system for taxing international transactions
and also discusses U.S. jurisdictional rules and source of income rules. Part 2 explains how the U.S.
taxes the foreign activities of U.S. persons, and includes the foreign tax credit, anti-deferral
provisions, foreign currency translation and transactions, export tax benefits, planning for foreign
operations, and state taxation of foreign operations. In Part 3, the authors describe how the U.S.
taxes the U.S. activities of foreign persons, including the taxation of U.S. source investment income
and U.S. trades or businesses. In addition, planning for foreign owned U.S. operations is discussed.
The final Part discusses common issues encountered with both outbound and inbound activities,
including intercompany transfer pricing, tax treaties, cross border mergers and acquisitions, and
international tax practice and procedure.
Consistent with the Statement on Standards for Continuing Professional Education (CPE) Programs
issued jointly by the American Institute of Certified Public Accountants and the National Association
of State Boards of Accountancy, the University recommends fifteen CPE credits (hours) be awarded
for each semester unit completed. Generally, a grade report reflecting the completion of the course is
sufficient documentation. If requested by an accountancy board an official transcript will be provided
at no cost. CPE credits are earned at the time a course is completed. While no Taft University
student has ever been denied CPE credit for this course, state boards of accountancy have the final
authority on the acceptance of individual courses for CPE credit.
With respect to continuing education credit for IRS Enrolled Agents, Enrolled Retirement Plan
Agents, and Registered Tax Return Preparers, courses within the Program also meet the standards
of Treasury Department Circular 230. Due to the special reporting requirements of the IRS, you
should notify the Taft University Student Services Representative if you hold either of these
credentials.
Continuing legal education requirements vary greatly from state-to-state. The University will
provide reasonable documentation of course contents and completions to any state bar upon
request. However, the University makes no representations that any University course will qualify for
CLE credits.
Course Syllabus
Expected Student Learning Outcomes

After successful completion of this course you will be able to appraise federal income tax compliance,
formulate tax planning, and evaluate opportunities and potential hazards related to:
• The taxing of the foreign income of its citizens.
• The taxing of the U.S. income of non-citizens.
• The fiscal residence of companies.
• Rules for determining income and expenses.
• Obstacles to flow of funds between parent and subsidiary entities.
• Tax incentives in developing countries.
• Public international law and taxation.
• The comparison of the United States income tax system to that imposed by other countries around the
world.
Required Materials
Misey, R. & Schadewald, M. (2020). Practical guide to U.S. taxation of international transactions
12/E. Riverwoods, IL: Wolters Kluwer.
ISBN 9780808055310
Peroni, R. (2020) International income taxation code and regulations 2020 – 2021 Edition. Riverwoods, IL:
Wolters Kluwer
ISBN 9780808054702
For all courses in the program, you must also have access to the Internal Revenue Code and related
regulations. (The complete Code and regulations are available through Lexis. For students preferring
a printed copy, Warren, Gorham, & Lamont offers a paperback version.).
Optional Readings:
Journals such as the Journal of International Taxation provide current topical and supplemental
coverage for those areas of student interest beyond required coursework
Lexis/Nexis®
The University has purchased a license from Lexis/Nexis® which permits its tax/law students to access
its database in connection with their studies.
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Course Syllabus
Lexis/Nexis® is a leading global provider of content-enabled workflow solutions designed specifically for
professionals in the legal, risk management, corporate, government, law enforcement, accounting, and academic
markets.
Through the integration of information and technology, Lexis/Nexis® uniquely unites proprietary
brands, advanced Web technologies and premium information sources. Across the globe, Lexis/Nexis®
provides customers with access to billions of searchable documents and records from more than
45,000 legal, news and business sources.
You should have been provided with login information at the time of enrollment. If you have not used
Lexis/Nexis® in the past, it is recommended that you take advantage of the tutorials here:
https://www.taft.edu/lexis
Suggestions for getting the most out of this course:

• Read professional journals and periodicals.
• Participate in the course discussion forums and learn from the experience and knowledge of your faculty
mentor and fellow students.
• If possible, form a relationship with someone who works in an area related to your course. Explain that
you would like to obtain their insights and perspectives from time to time.
Academic Engagement
Each academic course at William Howard Taft University is assigned a semester unit value equivalent
to the commonly accepted and traditionally defined units of academic measurement in accredited
institutions. Credit bearing courses are measured by the learning outcomes normally achieved
through 45 hours of student work for one semester unit. For example, a course with a value of 3
semester units would require a typical student to commit 135 hours of academic engagement and
preparation to complete the course requirements.
Lesson Assignments
This course contains a number of lesson assignments. Work through the lessons one at a time.
Unless otherwise instructed, you should complete all assignments for a particular lesson in one
WORD document. When you complete all of the assignments in a lesson, submit it to the faculty for
grading and feedback. Submit only one lesson at a time, completing them in sequence. Continue on to
the next lesson, but be sure to incorporate any feedback received on previous lessons into your
subsequent assignments – if necessary. Completed and submitted Lesson Assignments will be graded
with feedback within 10 days.
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Course Syllabus
Format
Unless otherwise instructed, Lesson Assignments must be prepared in Microsoft Word ® using the Times
New Roman font, 12 point, single space, double space between paragraphs. Each page must be
numbered and your last name and student number included on the upper left hand corner of each
page.
Your lesson assignment responses should be evidenced from the course textbook and/or from peer-
reviewed sources not more than 5 years old. In general, Wikipedia is not a professionally- reviewed
resource and should not be used as an assignment reference.
You must cite your references so that readers can verify your conclusions, and easily determine
what is your work, and what is paraphrased or taken directly from other sources. 7 Failure to give
credit for the work of others in your assignments and writing projects constitutes plagiarism.
Citation Machine:
http://citationmachine.net/index2.php?start=&reqstyleid=2&newstyle=2&stylebox=2
Citation Machine is an online tool to assist in proper citation of researched information. We recommend APA
format, although you may use other approved formats as long as you remain consistent.
Form of Writing
Throughout the program, it is important you carefully review what form of writing is required of each
writing assignment. Assignments may include writing a memorandum to the client’s file, a letter to a
client, a “brief” of a case or correspondence to the Internal Revenue Service. Your grade will be
negatively affected if you don’t follow the specific instructions (i.e., if you are requested to write a
letter to a client but you instead write a memo to the file.)
Memorandums to the file should follow the format used in the Karlin text (the text used in the TAX521
- Tax Research Techniques introductory course) and include appropriate citations. Client letters should
be formatted consistent with normal business communications. Letters should be written in such a
manner a reasonable business person (i.e., a non-accountant or non-attorney) could understand the
communication.
Case briefs should be in a style similar to the technique set forth in the Legal Research, Writing &
Analysis text used in your TAX521 - Tax Research Techniques course.
Memorandums to the file and communications with the Internal Revenue Service should generally
contain a greater number and more specific citations than letters to clients.
Final Examination
Final examination requirements and procedures are set forth in the Student Handbook. Notwithstanding any other
provision in this syllabus, if you are required to take a Final Examination for this course you must pass the exam
to pass the course.
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Course Syllabus
Academic Integrity
It is the policy of the University that any student found guilty of cheating and/or plagiarism will be subject to
immediate dismissal from the University. All students are required to sign a Coursework Certification Form for
each course. This form is provided as a link in the last lesson of each course.
Evaluation
Your grade will be influenced by the accuracy of your research and the quality of your writing. The extent of
research necessary will vary from assignment to assignment. In most cases, your work product should not
simply consist of quoting from the assigned text.
When grading your assignments, the faculty will consider three general components:
1. A demonstrated understanding of the material and the learning objectives.

2. Your ability to articulate, synthesize and analyze the concepts and issues presented in the material.
3. Clear and logical composition supported by examples and appropriate references.
If at any time you desire additional feedback, you should contact your faculty advisor directly via email. Feel free
to ask questions about course progress, grades, etc., at any time, and remember that the faculty and
administration are interested in helping you learn and succeed.
The final grade for the course is determined by the sum of each of the grades in the Lesson Assignments. Each
of the lesson assignments is weighted equally in determining your grade for the course. Total Possible Points
= 800 (100 Points per lesson).
Grade GPA Percentage Comments

A 4 90-100 (Outstanding)
A- 3.67 88-89
B+ 3.33 84-87
B 3 80-83 (Satisfactory)
B- 2.67 78-79
C+ 2.33 74-77
C 2 70-73 (Passing but below the standard accepted in graduate study)
C- 1.67 68-69
D+ 1.33 64-67
(Does not meet standard for graduate study, coursework must be
D 1 60-63 repeated for credit)
D- 0.67 59
F <0.67 58 or below (Failure)
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Course Syllabus
Faculty Mentors will refer to the following grading rubric when evaluating your assignments:
Above Needs
Excellent Satisfactory Unsatisfactory
Average Improvement
Understandi Provides marginally

Demonstrates a
ng of Demonstrates a Demonstrates an Responses are complete and/or
marginal
thorough adequate generally accurate, inaccurate responses
Material and understanding of understanding of but at times lacking
understanding of the
showing little
material and lesson
Lesson the material. material coherence. understanding of the
objectives.
Objectives material
Work is primarily
Work is articulated Work paraphrased or
No individual analysis
consistent with the demonstrates a Work demonstrates quoted directly from
Articulation, degree level solid knowledge an elementary the text or other
of concepts.
Synthesis integrating or of concepts and knowledge of sources.
Work is poorly
and Analysis synthesizing theories with concepts but lacks
articulated and/or
concepts in an some individual original thought and Responses
of Concepts original and analysis of analysis. demonstrate little or
derived entirely from
the textbook.
innovative way. issues. no individual
analysis.
Work is
Work presented in Frequent errors in
Work presented grammatically
a logical and Work contains composition,
is grammatically sound with a few
coherent way frequent grammatical grammar and
Composition, supported by
sound. minor errors.
errors. presentation.
Presentation, sound resources.
Resources are Resources may be
and Resources are few, Quoted material is
appropriate and of questionable
Citations are non-existent, or may incorporated without
References composed in
cited in proper authority but are
be of questionable the use of quotation
format with few cited in proper
proper format with authority. marks or citation
errors. format with few
few or no errors. (plagiarism).
errors.
Course Completion Requirements

The course will be deemed completed only when all the following has been accomplished:
• You have completed the lesson assignments and they have been received by the University.
• You have passed the course Final Examination .
• You have completed the Course Certification Form and it has been received by the University.
• You have completed the Course Evaluation Survey.
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Course Syllabus
Lesson 1 – Overview of U.S. Taxation of International

Transactions
Introduction
U.S. taxation of international transactions is a developing area. We encourage students to keep a close
watch on new law developments. In addition to resources provided through Lexis, the textbook
publisher’s tax home page at http://tax.cchgroup.com posts tax briefings that are freely available to
the public on substantial new tax law developments.
This lesson begins with an overview of topics covered in the text and proceeds with a conceptual
overview to international tax jurisdiction; i.e., when can a country impose its tax?
There are two types of taxing jurisdiction: (i) residence based taxation, where a country taxes
individuals who are citizens or residents of the country and (ii) source based taxation, where a country
taxes income that is derived from or “sourced” in that country. Due to overlapping taxing authorities
(i.e., the same income may be subject to tax by more than one country, especially when income is
earned in one country by a resident of a different country), a country will either
(i) exclude income sourced outside its boundaries or (ii) give the taxpayer a credit for tax paid to a
foreign jurisdiction. To the extent that a particular country wishes to address the issue of double tax
due to overlapping jurisdiction, the country may enter into a tax treaty that avoids or limits double
taxation.
The U.S. adopts a hybrid of residence-based taxation and source based taxation, with a credit to avoid
double tax. Under its residence-based system, U.S. citizens, resident aliens (i.e., green card holders),
domestic corporations, domestic partnerships and domestic estates and trusts are subject to U.S. tax.
The U.S. then gives a credit to U.S. taxpayers for the income tax they pay to a foreign jurisdiction.
However, under the credit system, the U.S. limits the amount of credit against U.S. tax to the amount
of tax the U.S. would impose on the foreign income. The U.S. also allows U.S. citizens who work
abroad to exclude their foreign-earned income from U.S. taxation.
A person who has the legal right to reside in the U.S. (a “resident alien”) is taxed by the U.S. in the
same manner as a U.S. citizen. Aliens are classified as residents if either of two tests is met:
(i) the green card test, where an alien has the status of a lawful permanent residence, and (ii) the
substantial presence test. Under the substantial presence test, an alien who is present in the United
States for 183 days in the year is deemed a U.S. resident. When determining whether an alien has
been present in the United States for 183 days, a three-year look back rule applies; days in the current
year count as a full day, days in the past year count as one-third of a day, and days in the second past
year are counted as one-sixth of a day.
While under normal circumstances, a U.S. citizen is taxed by the U.S. on worldwide income, regardless
of where it is earned, under the foreign earned income exclusion, the U.S. will allow a U.S. citizen or
resident who works abroad to exclude up to $91,400 (in 2009) of income and taxable fringe benefits
from U.S. tax. In order to qualify for the exclusion, the U.S. citizen must be present in the foreign
country for 330 days during a 12-month period and have a tax home in the foreign country. The
exception also allows the U.S. citizen to exclude a housing cost amount.
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Course Syllabus
U.S. persons are subject to U.S. tax on their worldwide income, whereas foreign persons are subject to
U.S. tax only on certain types of U.S. source income. This difference in treatment could lead U.S.
persons to strategically forfeit their U.S. citizenship. To combat such tax-motivated expatriations,
Congress created a special tax regime applicable for the 10 years following expatriation to tax all U.S.
source income (which, for these purposes, includes gain on the sale of stock) at progressive U.S. rates
if the expatriate meets certain requirements.
The current U.S. jurisdictional system reflects a variety of tax policy objectives, including fairness, the
need to collect tax revenues, economic neutrality, and enforcement constraints. The concept of
fairness encompasses both horizontal equity and vertical equity. Horizontal equity requires similar
treatment of taxpayers in similar economic situations, whereas vertical equity requires higher tax
burdens for higher-income taxpayers.
Lesson Learning Objectives
By the conclusion of this Lesson you should be able to demonstrate knowledge with respect to:
• The U.S. Jurisdictional System.
• The definition of a Resident Alien.
• The exclusion for foreign-earned income.
• The rules regarding expatriation.
Reading
Study Chapters 1 and 2 of the Practical Guide to U.S. Taxation of International Transactions
Suggested Internal Revenue Code Sections: 871; 881; 882; 911; 1441; 1442 and 7701.
Assignments
The following Assignment Questions should be completed and submitted to the course faculty via
the learning platform for evaluation and grading. Submit your responses to these questions in one
WORD document. List the question first, and then your response. Your response must adequately
cover the question without being wordy or relying on “yes” or “no” responses.
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Course Syllabus
Assignment Questions
1. U.S. tax law contains a two-pronged system for taxing the U.S.-source income of foreign persons.
Briefly explain this system.
2. Assume you are on the staff of a U.S. Senator from your home state. The Senator is interested in
reforming the U.S. tax system, and has asked you for your opinion of the current system for
taxing the foreign operations of U.S. companies, as well as potential alternative systems for
taxing such income. The Senator is particularly interested in the relative effects of these different
systems on U.S. tax revenues and the competitiveness of U.S. companies in foreign markets.
Prepare a one to two-page memorandum that you could use to brief the Senator on these
issues.
3. USA Company is a domestic corporation that manufactures products in the U.S. for distribution in
the U.S. and abroad. During the current year, USA Company derives a pre- tax profit of $10
million, which includes $1 million of foreign-source income derived from a country X sales office
that is considered an unincorporated branch for U.S. tax purposes. The country X corporate
income tax rate is 50% and the U.S. tax rate is 21%.
a. What would be the worldwide effective tax rate on the $1 million of foreign profits,
assuming the U.S. taxes the worldwide income of domestic corporations, but allows an unlimited
credit for foreign income taxes?
b. What would be the worldwide effective tax rate on the $1 million of foreign profits,
assuming the U.S. allows a credit for foreign income taxes, but the credit is limited to the
U.S. tax attributable to foreign-source income?
c. What would your answer to part (b) change if the foreign tax rate was 30% rather than
50%?
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Course Syllabus
Lesson 2 – Source-of-Income Rules and Foreign Tax

Credit
Introduction
U.S. persons are taxed on their worldwide income, whereas foreign persons are taxed only on income
sourced in the United States. This lesson begins with an overview of the rules governing when income
has its source inside versus outside the United States.
If a U.S. taxpayer has paid more foreign taxes than are creditable, it is said to be in an “excess credit
position;” if all the foreign taxes paid by the U.S. taxpayer are creditable, it is said to be in an “excess
limitation position.” With regard to foreign persons, the source rules play a much different role; to the
extent income is sourced here, the U.S. imposes an income tax.
There are various rules and exceptions that apply to determine the source of income. Interest is
generally sourced based on the residence of the payer. Dividend income is also sourced based on the
residence of the payer, subject to a different look through rule. Income from personal services is
sourced where the services are performed. Rent and royalty income is sourced based on where the
underlying property is used. Income from the disposition of real property is sourced based on the
location of the real property. Additionally, the sale of stock of a U.S. corporation may give rise to U.S.
source income if the corporation was a U.S. real property holding company, which applies when 50%
or more of a domestic corporation’s assets consist of real property interests located in the United
States. Income from the sale of personal property is generally sourced according to the residence of
the seller. Thus, income from the sale of stock of a foreign affiliate is generally sourced in the U.S.
unless: (i) the affiliate is a foreign corporation, (ii) the sale occurs in the foreign jurisdiction, and (iii)
over 50% of the foreign affiliate’s gross income over the preceding three years was derived from the
active conduct of a foreign business, in which case the gain from the sale of the affiliate is foreign
source.
Income from the sale of inventory is sourced where the sale occurs if the inventory is not
manufactured by the taxpayer (i.e., if it is bought for resale). Manufactured inventory is generally
sourced under the 50-50 method, which requires that 50% of the sale be sourced using a sales activity
factor and the other 50% be sourced using a production activity factor. The 50% sourced under the
sales activity factor is apportioned between U.S. source and foreign source based on the ratio of
foreign source export sales to all export sales. The 50% sourced under the production activity factor is
apportioned based on the ratio of the adjusted basis of production assets located abroad to the
adjusted basis of all production assets.
Generally, deductions are sourced according to a two-step process; first, deductions are allocated to
their related income producing activity. Second, deductions are apportioned between the U.S. and
foreign source gross income based on one of several factors, including gross income, number of units
sold, salaries paid, etc. Specialized rules apply to certain deductions, most notably, interest expense.
Interest deductions generally are sourced based upon the ratio of foreign assets to worldwide assets.
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Course Syllabus
Next we will explore foreign tax credit. The U.S. taxes U.S. persons on their worldwide income,
regardless of source. Since other countries frequently impose their tax on income sourced within their
jurisdiction, income earned by a U.S. person can be subject to double tax. In order to mitigate the
effects of this double tax on U.S. persons, the U.S. allows U.S. persons to claim a credit against U .S.
taxes for foreign taxes paid.
Computing the foreign tax credit is a three-step process:
1. Compute the pool of creditable foreign taxes. In order to be creditable, the “tax” must be a tax
on income, similar to the U.S. income tax.
2. Calculate the foreign tax credit limitation. The maximum amount of foreign taxes that can be
credited against U.S. tax is the portion of that U.S. tax attributable to foreign source income.
3. The foreign tax credit equals the lesser of creditable foreign taxes (step 1) or the foreign tax
credit limitation (step 2). Excess foreign tax credits can be carried back one year and forward
ten years.
If the taxpayer is in an “excess credit position,” he has paid more in foreign taxes than are creditable
against U.S. tax. Strategies to reduce the excess foreign taxes include (i) reducing foreign taxes by
using credits, exemptions, deductions, etc. in the foreign countries, (ii) increasing the amount of
income that is classified as foreign source income for U.S. tax purposes, and (iii) cross crediting, that
is, the blending of low tax and high tax foreign source income within the same foreign tax credit
limitation.
In order to restrict the ability of U.S. taxpayers to engage in cross-crediting, separate limitations must
be computed for separate categories of income. In other words, a separate foreign tax credit is
determined with regard to each category of income. Cross crediting is still allowable, however, to the
extent the taxpayer has income from different countries within the same category of income.
For tax taxable years beginning after 2006, there are two separate income categories, passive category
income and general category income.
For taxable years beginning before 2007, there were eight separate income categories, including:
1. passive income
2. high withholding tax interest
3. financial services income
4. shipping income
5. certain dividends from a domestic international sales corporation (DISC) or former DISC
6. foreign sales corporation (FSC) taxable income attributable to foreign trade income
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Course Syllabus
7. certain distributions from a FSC or former FSC
8. general limitation income (residual basket).
For purposes of computing the taxpayer’s foreign tax credit limitation, special rules apply when a
taxpayer has either an overall foreign loss, or a foreign loss within one of the separate basket
limitations. Foreign income taxes that are not creditable due to the limitation may be carried back one
year and carried forward up to ten years (but must stay within their respective baskets).
U.S. persons can use foreign tax credits to offset not only their regular income tax for the year, but
also their alternative minimum tax.
A U.S. corporation that has an 80% or more owned domestic subsidiary is not subject to tax on the
dividends from its subsidiary because of a 100% dividend received deduction. However, since a U.S.
corporation with a foreign subsidiary cannot claim a dividend received deduction for a dividend
received from that foreign subsidiary, income earned by the foreign subsidiary is subject to tax both by
the foreign jurisdiction and by the U.S. To reduce the double tax, a U.S. corporation with a foreign
subsidiary may claim a foreign tax credit for a portion of the taxes paid by the subsidiary to the foreign
jurisdiction. Since the dividend received is net of the foreign taxes, the U.S. corporation must include in
income not only the dividend received, but also the amount of foreign taxes the subsidiary paid with
respect to those earnings (the “gross up”).
In order to claim the deemed foreign tax credit, a U.S. corporation must own 10% or more of the
voting stock of a foreign corporation and receive a dividend from that foreign corporation. If a
U.S. corporation has a chain of foreign subsidiaries, the relevant ownership percentages are
determined by multiplying the percentage ownership of each 10% owned subsidiary by the percentage
ownership of that subsidiary’s subsidiary, and the indirect ownership must equal 5%. For example, if a
U.S. corporation owns 50% of the first tier foreign subsidiary, which in turn owns 20% of the second
tier foreign subsidiary, the U.S. corporation indirectly owns 10% of the second tier subsidiary, in which
case a deemed paid credit is allowed with respect to the taxes paid by the second tier foreign
subsidiary. As soon as the constructive ownership drops below 5%, no deemed foreign tax credit is
allowable. Fourth-, fifth, and sixth-tier foreign corporations must be CFCs in order to qualify for a
deemed paid credit.
In order to determine the amount of foreign income taxes attributable to a dividend from a foreign
corporation, all post-1986 earnings and profits of the foreign subsidiary are pooled as are all post-1986
foreign income taxes paid. Thus, foreign taxes are pulled out to the U.S. parent corporation
proportionately with respect to the amount of the dividend.
If the foreign corporation making the dividend distribution is a “controlled foreign corporation” (i.e., the
foreign corporation is owned more than 50% by U.S. shareholders, counting only U.S. shareholders
who own at least 10% of the foreign corporation’s stock), the character of the dividend income is the
same as that of the foreign subsidiary’s underlying earnings. A look- through rule also applies to
dividends received by a domestic corporation from a noncontrolled Code Sec. 902 corporation (or
“10/50 company”). A foreign corporation is a 10/50 company if a domestic corporation owns between
10% and 50% of the foreign corporation (in which case the U.S. corporate shareholder satisfies the
10% or more ownership requirement for claiming a deemed paid credit with respect to a dividend from
the foreign corporation), but the foreign corporation does not meet the more than 50% U.S. ownership
requirement for CFC status.
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Course Syllabus
A corporation claiming a foreign tax credit must attach Form 1118, Foreign Tax Credit- Corporations, to
its tax return. An individual claiming a foreign tax credit must attach Form 1116, Foreign Tax Credit, to
his or her tax return. Taxpayers must complete a separate Form 1118 (or Form 1116) for each
separate category of income limitation.
If a U.S. corporation has a subsidiary in a high tax foreign jurisdiction, no U.S. tax will be due on a
repatriated dividend since the deemed foreign tax credit associated with the dividend will exceed the
U.S. tax otherwise due on that dividend. Alternatively, repatriated dividends from corporations
operating in low tax foreign jurisdictions will be partially subject to U.S. income tax since the deemed
paid foreign tax credit will not fully offset the U.S. tax liability on the dividend. Thus, the U.S.
corporation should attempt to coordinate dividends from high and low taxed jurisdictions (as well as
other sources of high and low taxed foreign-source income) so as to be in a neutral foreign tax
position.
By the conclusion of this lesson you should be able to demonstrate knowledge with respect to:
• The importance of source rules for income and deductions.

• Creditable foreign income taxes.
• Excess credit versus excess limitation positions.
• The restrictions on cross crediting.
• Excess credit carryovers.
• Computing the alternative minimum tax foreign tax credit.
• Taxation of dividend repatriations.
• Computing the deemed paid credit.
Reading
Suggested Internal Revenue Code Sections: 243; 245, 861, 862, 863, 865, 871, 881, 882, 904, and 901–
905.
Assignments
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Course Syllabus
1. Engco, a domestic corporation, produces industrial engines at its U.S. plant for sale in the
United States and Canada. Engco also has a plant in Canada that performs the final stages of
production with respect to the engines sold in Canada. All of the output of the Canadian plant is
sold in Canada, whereas only one-third of the output of the U.S. plant is shipped to Canada. The
Canadian operation is classified as a branch for U.S. tax purposes. During the current year, Engco’s
total sales to Canadian customers were $10 million, and the related cost of goods sold is $7
million. The average value of property, plant and equipment is $30 million at the U.S. plant, and $5
million at the Canadian plant. Engco sells all goods with title passing at the Canadian plant in the
case of Canadian sales and at the U.S. plant in the case of U.S. sales.
a. How much of Engco’s export gross profit of $3 million is classified as foreign source for
U.S. tax purposes?
b. Now assume that the facts are the same as in part (a), except that the Canadian factory
is structured as a wholly-owned Canadian subsidiary, rather than a branch. Engo’s sales
of semi-finished engines to the Canadian subsidiary (which still represent one-third of its
output) were $6 million during the year and the related cost of goods sold was $4 million.
The Canadian subsidiary’s total sales of finished engines to Canadian customers (which
represents all of its output) was $10 million and the related cost of goods sold is $7
million. The average value of property, plant and equipment is still $30 million at the U.S.
plant, and $5 million at the Canadian plant, and Engco sells all goods with title passing at
its U.S. plant. How much of Engco’s export gross profit of $2 million is classified as
foreign source for U.S. tax purposes?
c. How would your answer to part (b) change if Engco sold its goods with title passing at
the customer’s location?
2. In Peter Stemkowski v. Comm’r, 690 F2d 40 (1982), why was the taxpayer arguing that the salary
he received for playing hockey for the New York Rangers covered not only the regular hockey
season and playoffs, but also the off-season and training camp?
3. Quantco, a domestic corporation, is an engineering consulting firm that has its main offices in San
Diego, California. Because Quantco does a considerable amount of business in China, it has a
branch office in Beijing. During the current year, Quantco generates a total pre-tax profit of $100
million (all from active business operations), including $80 million of profits from its U.S.
operations and $20 million of profits from its Chinese operations. Assume the U.S. tax rate is 35%
and the Chinese rate is 40%.
Compute Quantco’s creditable foreign income taxes, foreign tax credit limitation, and excess
credits (if any).
Now assume that Quantco has a second foreign branch office in Singapore which generated $10
million of profits (all from active business operations), on which Quantco pays Singapore taxes at
a rate of 25%. Recompute Quantco’s creditable foreign income taxes, foreign tax credit
limitation, and excess credits. What is the name of the phenomenon by which the Singapore
profits resulted in the elimination of the excess credits on the Chinese profits?
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Course Syllabus
4. Trikeco, a domestic corporation, manufactures mountain bicycles for sale both in the United States
and Europe. Trikeco operates in Europe through Trike1, a wholly owned Italian corporation that
manufactures a special line of mountain bicycles for the European market. In addition, Trike1 owns
100% of Trike2, a U.K. corporation that markets Trike1’s products in the United Kingdom.
5. At end of the current year, the undistributed earnings and foreign income taxes of Trike1 and
Trike2 are as follows:
Trike1 Trike2
Post-1986 undistributed earnings ............ $90 million............ $54 million
Post-1986 foreign income taxes .............. $36 million............ $27 million
During the current year, Trike2 distributed a $10 million dividend to Trike1, and Trike1 distributed
a $10 million dividend to Trikeco. To simplify the computations, assume that neither dividend
distributions attracted any Italian or U.K. withholding taxes, and that the dividend received by
Trike1 was exempt from Italian taxation.
Compute Trikeco’s deemed paid foreign tax credit, as well as the residual U.S. tax, if any, on the
dividend Trikeco received from Trike1. Assume the U.S. tax rate is 35%.
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Course Syllabus
Lesson 3 – Anti-Deferral Provisions and Foreign

Currency Transactions
Introduction
A U.S. person who owns stock in a foreign corporation is not subject to U.S. tax on income earned by
that foreign corporation until the earnings are repatriated in the form of a dividend distribution.
Accordingly, a U.S. person can potentially accumulate earnings in a foreign corporation free from U.S.
income tax until the corporation repatriates the earnings. In order to prevent abuses, U.S. tax law
contains a number of anti-deferral regimes. These regimes subject U.S. shareholders of foreign
corporations to immediate taxation on certain types of income earned by the foreign corporations,
regardless of whether the earnings are actually repatriated.
Subpart F applies to a “controlled foreign corporation” (CFC). A CFC is a foreign corporation whose
stock is owned more than 50% by “U.S. shareholders.” A U.S. shareholder is any U.S. person who
owns 10% or more of the foreign corporation’s stock.
If a foreign corporation is a CFC, all U.S. shareholders must include in income a deemed dividend equal
to their pro-rata portion of the CFC’s tainted earnings, which include Subpart F income and earnings
invested in U.S. property.
Subpart F income primarily includes insurance income and foreign base company income, as follows.
(i) Insurance income. Since premiums and other income from insurance represents the type of
income that is easily shifted to a foreign corporation in order to avoid or defer U.S. taxation,
income from insurance policies is included Subpart F income to the extent that the insurable
interest is located outside the CFC’s country of incorporation.
(ii) Foreign base company income. There are four categories of foreign base company income, as
follows:
(a) foreign personal holding company income, which is passive investment income
earned by a foreign corporation;
(b) foreign base company sales income, which consists of income from property purchased
from or sold to a related party if the property is manufactured outside and sold for use
outside the CFC’s country of incorporation;
(c) foreign base company services income, which is income derived from performing
services outside the CFC’s country of incorporation for a related party; and
(d) foreign base company oil related income, which consists of certain types of income
derived from selling or processing petroleum or related products.
Tainted earnings also include earnings of the CFC invested in U.S. property. Examples of U.S. property
include loans to U.S. shareholders, stock of a related domestic corporation, and tangible property
located in the United States, such as U.S. manufacturing facilities.
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Course Syllabus
When determining Subpart F income, various special rules apply, including:
1. If a CFC’s Subpart F income is less than both $1 million and 5% of the CFC’s income for the
year, none of the CFC’s income is treated as Subpart F income (de minimis rule).
2. If a CFC’s Subpart F income exceeds 70% of the CFC’s income for the year, all of the CFC’s
income is treated as Subpart F income (de maximis rule).
3. A U.S. shareholder can elect to exclude from its taxable income any Subpart F income that is
subject to an effective foreign tax rate that exceeds 90% of the maximum U.S. corporate tax
rate (high tax exception). This rule reflects the reality that a CFC is paying foreign taxes at a
rate that exceeds 90% of the U.S. rate; there is little or no residual U.S. tax to be collected.
A deemed dividend under Subpart F carries with it a deemed paid foreign tax credit computed in the
same manner as for an actual dividend distribution. In addition, a U.S. shareholder that receives an
actual dividend distribution from a CFC may exclude that dividend from U.S. taxable income to the
extent the distribution is out of earnings taxed to the U.S. shareholder in a prior taxable year.
The Subpart F provisions prevent U.S. shareholders of a foreign corporation from deferring U.S.
income tax on the foreign corporation’s earnings only if the foreign corporation is closely held.
However, U.S. shareholders of foreign mutual and investment funds fall outside those provisions due
to their widespread ownership. The passive foreign investment company (“PFIC”) regime was enacted
in 1986 to address this gap.
A PFIC is a foreign corporation if 75% or more of its income is passive income or 50% or more of its
assets are passive investment assets. If a foreign corporation is a PFIC, all U.S. shareholders
(regardless of percentage ownership) are taxed on the PFIC’s undistributed earnings using one of the
following three methods:
1. Qualified electing fund. U.S. shareholders may elect to be taxed as though the PFIC were a
pass-through entity, with U.S. shareholders reporting their pro rata share of the PFIC’s
earnings for the current year.
2. Excess distributions. If the U.S. shareholder does not make a qualified electing fund election,
the U.S. shareholder will be subject to an interest charged on the amount of the U.S. income
tax that is deferred by accumulating income in the PFIC rather than paying current dividends.
The interest rate is based on the rate applicable to an underpayment of income tax, and is
imposed on (i) a gain realized on the sale of the PFIC stock, or (ii) a distribution that is an
“excess distribution.” An excess distribution is a current year distribution that exceeds 125% of
the average actual distributions over the preceding three-year period. If the distribution is an
excess distribution, the distribution is treated as though it were received ratably over the entire
period that the shareholder held the PFIC stock, and interest is imposed on the underpayment
of tax attributable to the inclusion of the deemed dividend over each of those prior years.
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Course Syllabus
3. Mark-to-market election. A U.S. shareholder of a PFIC may make a mark-to-market election

with respect to the stock of the PFIC if such stock is marketable. Under this election, any
excess of the fair market value of the PFIC stock at the close of the tax year over the
shareholder’s adjusted basis in the stock is included in the shareholder’s income. The
shareholder may deduct any excess of the adjusted basis of the PFIC stock over its fair market
value at the close of the tax year.
Given the overlapping definitions, a foreign corporation could be classified as both a FC and a PFIC,
thereby subjecting U.S. shareholders to both anti-deferral regimes. A CFC that falls within the definition
of a PFIC will not be classified as a PFIC with regard to 10% U.S. shareholders. As a result, U.S.
shareholders who are taxed on the foreign corporation’s Subpart F income will not be subject to a PFIC
inclusion. However, U.S. shareholders who own less than 10% will still be subject to the PFIC regime.
If a U.S. shareholder sells stock of a foreign corporation that at any time during the last five years was
a CFC, the gain is taxed as a dividend to the extent of the corporation’s post-1962 accumulated
earnings and profits. Gain in excess of the post-1962 accumulated earnings and profits is taxed at
capital gain rates.
The American Jobs Creation Act of 2004 repealed both the foreign personal holding company regime
and the foreign investment company regime, effective for tax years beginning after 2004.
This lesson continues with an overview of the issues that arise when a U.S. person transacts business
in foreign currency.
A foreign branch that is a qualified business unit (QBU) will first determine its profits and losses using
the local currency, and then translate that net profit or loss into U.S. dollars using the average
exchange rate for the year. Foreign income taxes incurred by an accrual basis taxpayer are translated
into U.S. dollars using the average exchange rate for the taxable year.
Currency exchange gains and losses arise from dispositions of nonfunctional currency, as well as three
types of transactions denominated in a nonfunctional currency. These transactions include
(a) lending or borrowing funds pursuant to a debt instrument, (b) accruing receivables and
payables when the receivable or payable will be satisfied at a future date, and (c) the disposition of a
foreign currency option, forward, or futures contracts.
The entire amount of gain or loss arising from the disposition of a nonfunctional currency or a
transaction involving a foreign currency contract is a currency exchange gain or loss. Currency
exchange gains and losses are ordinary in nature and sourced based on the residence of the taxpayer.
In contrast, gains and losses from debt instruments and receivables and payables denominated in a
nonfunctional currency are treated as currency exchange gains and losses only to the extent such
gains and losses are attributable to a fluctuation in the currency exchange rate between the date the
item was accrued (“booking date”) and the date the item was paid (“payment date”).
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Course Syllabus
To protect against this risk, U.S. taxpayers frequently enter into hedging transactions that “lock in” the
foreign currency exchange rate. In such cases, the taxpayer may integrate the accounting for the
hedge with that of the underlying business transaction. The types of transactions that are eligible for
this treatment include: (i) hedged debt instruments, where a taxpayer lends or borrows funds; (ii)
hedged executory contracts for the sale or purchase of goods and services; and (iii) hedged stock
purchases and sales of publicly traded stock or securities.

• Insurance income.
• Foreign base company income.
• Passive foreign investment companies.
• Gain from the sale or exchange of a cfc’s stock.
• Former foreign personal holding company and foreign investment company regimes.
• Foreign currency translation and transactions.
Reading
Suggested Internal Revenue Code Sections: 951–965; 985 – 989, 1248; and 1291–1298
Assignments
1. Tenco, a domestic corporation, manufactures tennis rackets for sale in the United States and
abroad. Tenco owns 100% of the stock of Teny, a foreign marketing subsidiary that was
organized in Year 1. During Year 1, Teny had $15 million of foreign base company sales income,
paid $3 million in foreign income taxes, and distributed no dividends. During Year 2, Teny had no
earnings and profits, paid no foreign income taxes, and distributed a $12 million dividend.
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Course Syllabus
Assuming the U.S. corporate tax rate is 35%, what are the U.S. tax consequences of Teny’s
Year 1 and Year 2 activities?
2. Beatco, an accrual basis domestic corporation, manufactures musical instruments for sale both in
the United States and abroad. Beatco’s functional currency is the U.S. dollar. Two years ago,
Beatco established a branch sales office in Switzerland. The sales office qualifies as a qualified
business unit with the Swiss franc (SF) as its functional currency. The branch’s tax attributes for its
first two years of operations are as follows:
Year 1 Year 2
Taxable income SF40 million None
Foreign income taxes (paid at SF15 million None
end of year)
Remittance to Beatco (paid at None SF25 million
end of year)
The Swiss franc had an average daily value of $0.50 during Year 1, $0.65 during Year 2, and was
worth $0.60 at the end of Year 1, and $0.75 at the end of Year 2.
What are the U.S. tax consequences of the branch’s activities in Year 1 and Year 2?
3. Joltco, a domestic corporation, manufactures batteries for sale in the United States and abroad.
Joltco markets its batteries in Europe through its wholly owned foreign marketing subsidiary,
Jolti. Jolti was organized in Year 1, and its functional currency is the pound (£). Jolti’s tax
attributes for its first two years of operations are as follows:
Year 1 Year 2
Taxable Income £100 million None
Foreign income taxes (paid at the end of the year) £20 million None
Net Subpart F income (included in £100 million) £40 million None
Actual dividend distributions (paid at end of None £8 million
year)
The pound had an average value of $1.50 during Year 1, $1.65 during Year 2, and was worth
$1.60 at the end of Year 1, and $1.70 at the end of Year 2.
What are the U.S. tax consequences of Jolti’s results from operations in Year 1 and Year 2?
Assume that the dividend distribution in Year 2 was not subject to foreign withholding taxes.
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Course Syllabus
Lesson 4 – Export Benefits and Planning for Foreign

Operations
Introduction
This lesson provides an overview of the various regimes Congress has enacted over the years to
provide a tax benefit for export sales by U.S. manufacturers.
In 1971, Congress enacted the Domestic International Sales Corporation (DISC) regime in an attempt
to stimulate U.S. exports. A DISC allowed a U.S. exporter to defer U.S. tax on a portion of its export
profits by allocating those profits to a special type of domestic subsidiary known as a DISC. In 1984,
Congress enacted the Foreign Sales Corporation (FSC) provisions as a replacement for the DISC. In
1999, the World Trade Organization (WTO) ruled that the FSC regime was an illegal export subsidiary
and called for its elimination. In response to the WTO’s ruling, the United States enacted into law the
FSC Repeal and Extraterritorial Income Exclusion Act of 2000.
The WTO has ruled that the extraterritorial income exclusion (ETI) is similarly an illegal export
subsidiary and called for its elimination. In the American Jobs Creation Act of 2004, Congress phased
out the ETI exclusion, while phasing in the Code Sec. 199 domestic production deduction.
The IC-DISC is designed as a means by which a U.S. exporter could borrow funds from the U.S.
Treasury. An IC-DISC is a domestic corporation but, is not subject to the regular U.S. corporate income
tax. Instead, the ICDISC’s U.S. shareholders are subject to tax on deemed dividend distributions from
the IC-DISC. These deemed distributions do not include income derived from the first $10 million of
the IC-DISC’s qualified export receipts each year. Therefore, an IC-DISC allows a U.S. shareholder to
defer paying U.S. tax on the income derived from up to $10 million of qualified export receipts each
year. The U.S. shareholder must pay an interest charge on its IC-DISC-related deferred tax liability,
however.
There are three requirements for an IC-DISC to receive income from a sale of export property:
1. The property must be manufactured, produced, grown or extracted in the United States by a
person other than the IC-DISC
2. The export property must be held primarily for sale, lease or rental for direct use, consumption
or disposition outside the United States
3. The export property must have a minimum of 50 percent U.S. content.
The income of an IC-DISC from sales of export property is in an amount constituting:
• 4 percent of qualified export receipts
• 50 percent of the combined taxable income
• The arm’s length amount determined under the transfer pricing principles of Section 482.
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Course Syllabus
Taxpayers rarely use the section 482 transfer pricing method to determine the arm’s length amount of
income in the IC-DISC. These methods to determine the IC-DISC’s income apply regardless of whether
the IC-DISC is a “commission” IC-DISC or a “buy-sell” IC-DISC. The IC- DISC may also add 10 percent
of its export promotion expenses to the commission, but the export promotion expenses are typically
negligible. Any of these transfer pricing methods for the IC-DISC combined with the 15 percent rate of
tax on dividends by domestic corporations to U.S. individual shareholders, creates tremendous tax
savings from this export benefit.
The qualified export receipts method allocates 4 percent to the qualified export receipts from the
export sales to the IC-DISC. The combined taxable income method allocates 50 percent of the taxable
income from the export sales to the IC-DISC.
An exporter can use any of the transfer pricing methods to achieve the greatest IC-DISC income
possible. The IC-DISC rules permit the use of different methods to different sales based on product
lines, recognized industry or trade usage, and even by transaction. Most of the decisions will be
between the qualified export receipts and combined taxable income methods. As a simple rule of
thumb, the combined taxable income method results in the largest IC-DISC income when exports have
a net pretax margin of 8.7 percent or greater. On the other hand, the qualified export receipts method
provides the largest IC-DISC income when the net pre-tax margin is less than 8.7 percent. If the net
pre-tax margin on exports is lower than worldwide net pre-tax margins, which often occurs due to the
extra shipping and administrative expenses of foreign sales, the marginal costing of combined taxable
income may result in the largest commission. Finally, the exporter can maximize the IC-DISC’s income
by ignoring loss sales.
The IC-DISC comprehensive example illustrates the following concepts:
1. The use of the apportionment base by which expenses are allocated to qualified export
receipts for purposes of determining combined taxable income
2. The choice of using the 4 percent of qualified export receipts or 50 percent of combined
taxable income to determine the amount of the IC-DISC’s commission
3. The election of marginal costing for the combined taxable income method.
In terms of tax relief for businesses, the most significant component of the American Jobs Creation Act
of 2004 is the new Code Sec. 199 deduction equal to a percentage of the taxpayer’s qualified
production activities income. When it is fully phased in for tax years beginning after 2009, the
deduction will equal 9 percent of the lesser of the taxpayer’s qualified production activities income or
taxable income for the year.
This lesson continues with an overview of some of the planning issues that a U.S. company must
consider when doing business overseas.
A U.S. company entering a foreign market for the first time may initially export its goods through
independent agents. This will allow the U.S. company to sell its goods overseas without having to
become familiar with a foreign jurisdiction’s tax rules and trade regulations, but at the cost of splitting
its profits with the independent sales agents.
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Course Syllabus
As the business volume grows, it may be expeditious to invest in educating and training an in-house
foreign sales department in order to avoid having to split profits with independent agents. This may be
done by stationing employees in the foreign jurisdiction. If a U.S. company has employees stationed
overseas, the employees may be considered a permanent establishment, thereby subjecting the profits
attributable to the foreign operations to taxation by the foreign jurisdiction. Finally, to the extent
business volume demands, a branch or subsidiary may be the next logical step. This, however, will
definitely cause the taxpayer’s profits to be subject to foreign tax.
When a U.S. company plans foreign operations, one consideration is whether the profits earned by the
taxpayer are subject to the foreign taxation. This is relevant for two reasons: (i) the administrative
costs associated with complying with a foreign country’s tax laws, and (ii) if the foreign jurisdiction’s
tax is greater than U.S. tax, the foreign operations will result in greater overall taxes. Whether a
foreign country will impose its taxing jurisdiction over profits earned by a U.S. company will depend on
several factors, including the scope of the business activities conducted in the foreign jurisdiction and
the foreign jurisdiction’s internal laws. Generally, a foreign country will tax all profits sourced in that
jurisdiction. However, if the foreign country has an income tax treaty with the U.S., only those
business profits attributable to a permanent establishment would be subject to foreign taxation.
There are several pros and cons of each form of doing business in a foreign jurisdiction. A branch, or
unincorporated arm of a domestic taxpayer, does not have the advantage of U.S. income tax deferral
since profits earned by the branch are subject to immediate U.S. taxation. From the foreign
jurisdiction’s standpoint, a branch will generally be considered a permanent establishment and
therefore subject to foreign tax. To the extent foreign taxes are paid, the U.S. taxpayer may be able to
offset U.S. income taxes with the foreign tax credit. Profits repatriated from the branch to the U.S.
taxpayer are not subject to U.S. tax, and to the extent that the foreign branch experiences losses, the
losses are fully deductible against the U.S. income tax.
A subsidiary is a separate foreign corporation and will be subject to the foreign country’s tax. However,
income earned by the subsidiary will not be taxed by the U.S. until repatriated. Thus, there exists the
potential for deferral of U.S. income tax. Dividends repatriated by the foreign subsidiary to the U.S.
parent corporation will be subject to U.S. tax, but that tax can be offset by the foreign tax credit.
Unlike a branch, a subsidiary is a separate entity, and therefore transfers between the parent
corporation and the subsidiary corporation are subject to the transfer pricing provisions of Code Sec.
482, which requires that transactions between the parent corporation and its foreign subsidiary must
be conducted at arm’s length prices. The pros and cons of each form of operation are summarized in
the chart below:
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Course Syllabus
BRANCH SUBSIDIARY
A branch, as an unincorporated arm of the domestic A subsidiary allows more control

taxpayer, will not allow the domestic taxpayer to over the timing of income
defer income in the foreign jurisdiction. All income recognition for U.S. tax purposes,
earned by the branch will be subject to immediate and allows the U.S. taxpayer to
Deferral of income
U.S. taxation. However, all losses experienced by the defer U.S. taxation until the funds
foreign branch will be deductible in full against U.S. are repatriated. However, these
income. repatriated funds will be subject to
U.S. tax, which may be offset, in
part or in full, by the foreign tax
credit.
Local tax incentives Local tax incentives may not be available to a Local tax incentives may be
branch. available to an incorporated
subsidiary.
If a domestic taxpayer sells stock
A branch may only sell its assets, which may be
Sale of foreign of a foreign subsidiary, the gain
subject to tax in the foreign jurisdiction.
operations may be exempt from the foreign
jurisdiction’s tax.
The transfer of assets to a foreign

subsidiary can be a taxable event
The transfer of assets to a foreign branch is a (Code Sec. 367), in which case the
Transfer of assets
nontaxable event. U.S. taxpayer will pay tax on the
difference between the assets’
adjusted bases and their fair
market value.
If the domestic taxpayer is an S corporation, the S S corporation shareholders cannot

corporation can have a branch in the foreign claim a deemed paid foreign tax
jurisdiction, and the S corporation shareholders will credit for foreign taxes incurred by
S corporations be entitled to claim the foreign tax credit for foreign
a foreign subsidiary of an S
taxes by the branch.
corporation.
Dividends expatriated by a
Expatriated profits Expatriated profits from a branch may not be
subsidiary generally are subject to
subject to foreign taxation.
foreign withholding taxes.
Operating as a branch will not insulate the domestic A subsidiary, as a separate foreign
taxpayer from liabilities arising from business corporation, will likely limit the U.S.
Limited liability
operations in the foreign jurisdiction. taxpayer’s liability from business
operations.
While operating a subsidiary in a

While registering a branch in a foreign jurisdiction
foreign jurisdiction may require
Ease of may be easier than registering a subsidiary, a
more administrative difficulties, a
operations branch may not present the same local image to
subsidiary, as a separate corporate
and local potential customers and employees.
entity in the local jurisdiction, may
image
present a better image to local
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Course Syllabus
A U.S. multinational corporation will want to structure its activities to minimize the overall taxes it pays
to the U.S. and foreign jurisdictions. This can be done by locating subsidiaries in low tax jurisdictions
and repatriating funds only as needed, thereby gaining the benefit of deferral, sourcing more income
outside the U.S. (for example, by passing title outside the U.S. and making passive investments outside
the U.S.) for foreign tax credit purposes and, to the extent possible, cross crediting income earned in
higher taxed jurisdictions with income earned in lower taxed jurisdictions. Additionally, the U.S.
taxpayer will want to take advantage of any local tax incentives, such as tax holidays, accelerated
depreciation write-offs, etc.
When planning foreign operations, a U.S. taxpayer may want to consider using a hybrid entity. A
hybrid entity is one that is classified differently under U.S. versus foreign law. The most common
hybrid entity is one that is classified as a partnership under U.S. law and a corporation under foreign
law. This can be accomplished under the “check-the-tax” regulations. While certain foreign
corporations are excluded from hybrid treatment, most are eligible for this favorable treatment, with
the attendant benefits of pass through U.S. taxation (including pass through of foreign tax credits),
while still maintaining their status as a corporation in the host country.
The globalization of U.S. business has increased the importance of understanding how a U.S.
multinational corporation’s foreign operations impact the effective tax rate it reports in its financial
statements. When evaluating a U.S. corporation’s effective tax rate, the de facto benchmark is the U.S.
statutory rate. For large U.S. corporations, the statutory tax rate has been 35 percent since 1993.
However, a U.S. company’s foreign operations can cause its effective tax rate to diverge from 35
percent. For example, operations in high-tax foreign jurisdictions can give rise to excess foreign tax
credits that increase a firm’s effective tax rate. Likewise, operations in low-tax foreign jurisdictions can
reduce a firm’s reported effective tax rate if management intends to permanently reinvest those
earnings.
Some of this was impacted by the Tax Cuts and Jobs Act of 2017. This effectively reduced the
corporate tax rate in the United States from 35% to 21%. This aligned the US corporate tax rate more
to what multinational corporations see abroad in terms of tax rate. While many of the scenarios we
review in this section still apply, some higher tax rate countries might now be more attractive to
repatriate revenues made in those foreign subsidiaries as a result.
Survey of Foreign Entity Classification. — This survey lists entities in selected foreign countries,
discusses whether the foreign country imposes an entity level tax, describes the treatment for U.S. tax
purposes if an election is not made (whether the entity is a per se corporation or has default status as
a corporation or flow through entity), and considers the possibility for treatment as a hybrid or reverse
hybrid entity. In each listed country, U.S. owners may operate as a sole proprietorship or a branch,
which is not treated as a separate entity under the check-the box rules.
• The IC-DISC, as a means by which a U.S. exporter could borrow funds from the U.S.
Treasury.
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Course Syllabus
• The sales of export property.
• Domestic production deduction.
• Determinants of host country taxation.
• Structuring foreign operations.
• The basics of outbound tax planning.
• Financial reporting implications of international tax planning.
• Foreign entity classification.
Reading
Suggested Internal Revenue Code Sections: 114, 199, 367; 482; 904; 991 – 997, and 7701(a)
Assignments
1. Acme, Inc., a domestic corporation, manufactures goods at its U.S. factory for sale in the United
States and abroad. Acme has established an IC-DISC. During the current year, Acme’s qualified
export receipts are $4,000, and the related cost of goods sold is $2,400. Acme has $1,200 of
selling, general and administrative (SG&A) expenses related to the qualified export receipts.
Acme’s gross receipts from domestic sales are $96,000, the related cost of goods sold is $65,600,
and the related SG&A expenses are $18,800. In sum, Acme’s results for the year (before
considering any income allocated to its IC-DISC via a commission payment), are as follows:
Qualified
export Other
Total receipts sales
Gross receipts $100,000 $4,000 $96,000
Cost of goods sold
(direct material and labor) − 68,000 − 2,400 − 65,600
Gross profit $32,000 $1,600 $30,400
SG&A − 20,000 − 1,200 − 18,800
Net income $12,000 $400 $11,600
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Course Syllabus
What is the maximum amount of income that Acme can allocate to its IC-DISC? (Assume
combined taxable income equals the $400 of net income from qualified export receipts.)
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Course Syllabus
2. Growco, a domestic corporation, is a tire manufacturer. Growco is planning to build a new

production facility, and has narrowed down the possible sites for this new plant to either
Happystan (a low tax foreign country) or Sadstan (a high tax foreign country). Growco will
structure the new facility as a wholly owned foreign subsidiary, Sproutco, and finance Sproutco
solely with an equity investment. Growco projects that Sproutco’s results during its first year of
operations will be as follows:
Sales ................................................................................... $400,000,000

Cost of goods sold ................................................................(290,000,000)
Selling, general and administrative expenses .......................... (60,000,000) Net profit
..............................................................................$50,000,000
Assume that the U.S. corporate tax rate is 35%, the Happystan rate is 20%, and the Sadstan rate
is 40%. Further assume that both Happystan and Sadstan impose a 5% withholding rate on
dividend distributions, but neither country imposes withholding taxes on interest or royalty
payments. Compute the total tax rate (U.S. plus foreign) on Sproutco’s profits under the following
assumptions:
a. The new production facility is located in Happystan and Sproutco repatriates none of its
profits during the first year.
b. The new production facility is located in Happystan and Sproutco repatriates 30% of its
profits during the first year through a dividend distribution.
c. The new production facility is located in Sadstan and Sproutco repatriates none of its
profits during the first year.
d. The new production facility is located in Sadstan and Sproutco repatriates 30% of its
profits during the first year through a dividend distribution.
e. The new production facility is located in Sadstan and Growco modifies its plans for
Sproutco as follows:
▪ finance Sproutco with both debt and equity, such that Sproutco will pay Growco
$15 million of interest each year
▪ charge Sproutco an annual royalty of $10 million for the use of Sproutco’s
patents and trade secrets
▪ eliminate Sproutco’s dividend distribution.
What do the results of these various scenarios suggest regarding the differential tax costs of
operating in low versus high tax countries?
3. Six years ago, NewCo, Inc., a domestic manufacturer of mold-injection systems, established a
sales and service operation in Madrid, Spain. The Madrid office was structured as a Spanish
corporation, but NewCo made a check-the-box election to treat the operation as a branch in order
to obtain a U.S. tax deduction for the branch’s start- up losses.
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The Spanish operation has become quite profitable and NewCo wishes to change its U.S. tax
classification from a branch to a subsidiary by filing a new check-the- box election (this is feasible
since five years had passed since the first election). At the time of the conversion, the Spanish
operation’s assets includes some local currency, accounts receivable from Spanish customers, an
inventory of spare parts, and an extensive database of information regarding Spanish customers
that the marketing personnel had painstakingly developed over the years. NewCo’s CFO has asked
you to brief her regarding the U.S. tax consequences of the incorporation transaction. Briefly
outline your response.
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Lesson 5 – Foreign Persons Investing and Doing Business

in the United States
Introduction
This lesson explores how the United States taxes foreign corporations and nonresident aliens who
derive U.S. source investment-type income.
The U.S. has a two-prong system for taxing the U.S. source income of foreign persons:
1. Income derived from the conduct of a U.S. trade or business is taxed on a net basis at the
regular graduated rates.
2. U.S. source investment-type income is taxed on a gross basis at a 30% rate. This 30% tax rate
is subject to various exceptions that reduce or eliminate the U.S. tax, such as treaty
exemptions, capital gains relief and the portfolio interest exemption.
U.S. payers of U.S. source investment-type income to foreign persons are required to withhold
U.S. income tax at the rate of 30%. The amount of withholding is determined with regard to the gross
income. No deductions are allowed against U.S. source income. There are exemptions for income
effectively connected with a U.S. trade or business, income from the sale or exchange of personal
property, and portfolio interest income. Finally, tax treaties often reduce the applicable withholding tax
rate to 15% or less.
Treaty reductions in withholding tax rates are available only to non-U.S. beneficial owners that reside
in a treaty country. A non-U.S. beneficial owner that does not reside in a treaty country should incur
withholding at a rate of 30%. The regulations under Sec. 1441 discuss the documentation that the
payee must provide to the payer to obtain the benefit of a reduced withholding tax rate.
Under the Foreign Investment in Real Property Tax Act of 1980 (“FIRPTA”), any gain realized by a
foreign person on the sale of a U.S. real property interest is taxed in the same manner as income
effectively connected with a U.S. trade or business. A U.S. real property interest is any ownership
interest in real property located in the U.S., including stock in a U.S. real property holding company. A
U.S. real property holding company is any domestic corporation if 50% or more of the corporation’s
assets are U.S. real property interests. Publicly traded stock is exempt from U.S. real property holding
company status. Under FIRPTA, a U.S. person purchasing property from a foreign person must
withhold 10% of the gross amount realized and remit it to the U.S. Treasury as an advance payment of
tax on the foreign person.
This lesson continues with a discussion of how the United States taxes nonresident aliens and
foreign corporations who are engaged in a U.S. trade or business.
A foreign person who wishes to operate a business in the U.S. may do so in any of several methods.
Initially, the foreign person may employ independent sales agents located in the U.S.
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This will generally not subject the foreign person to U.S. tax, provided that the foreign person does not
have a permanent establishment in the U.S. Alternatively, the foreign person may establish a branch or
subsidiary in the U.S. and begin to actively conduct a trade or business located in the U.S. Once the
foreign person is actively conducting a trade or business in the U.S., the profits associated with that
trade or business will be taxed at the normal graduated income tax rates applicable to U.S. taxpayers.
While the threshold of when a foreign person is actively conducting a trade or business in the U.S. is
not clearly established, a foreign person will be engaged in the active conduct of a trade or business in
the U.S. if the business activities are “considerable, continuous and regular.”
If a foreign person does conduct an active trade or business in the U.S., all income effectively
connected with that trade or business will be subject to U.S. tax. Income effectively connected with a
U.S. trade or business includes certain U.S. source income, foreign source income attributed to the
U.S. office, deferred income that would be attributed to the U.S. trade or business if realized
immediately, and income from real property if the foreign investor elects to have it treated as such.
U.S. lawmakers enacted the branch profits tax in 1986 in order to equalize the tax treatment of a
branch of a foreign corporation with the U.S. subsidiary of a foreign corporation. The branch profits tax
equals 30% of the branch’s annual “dividend equivalent amount.” The dividend equivalent amount
equals the branch’s earnings and profits effectively connected with a U.S. trade or business, reduced
by any increase in U.S. net equity.
Profits earned by a domestic subsidiary of a foreign corporation are subject to two levels of tax: the
subsidiary’s profits are taxed at the regular corporate rates, and any dividend distributions are subject
to U.S. withholding tax. Alternatively, payments structured as interest on loans would normally give
rise to a deduction at the subsidiary level and may be eligible for lower withholding tax rates under
applicable treaties. Accordingly, it may be beneficial to expatriate funds as deductible interest
payments. In order to strip earnings from a domestic subsidiary in this manner, the debt in question
must be a valid loan under applicable U.S. principles, and not represent equity. In addition, under Code
Sec. 163(j), a U.S. subsidiary that has a debt-to-equity ratio in excess of 1.5 to 1 will be denied a
deduction for “disqualified interest” to the extent of its “excess interest expense.”
A foreign corporation conducting business in the U.S. must file Form 1120-F, U.S. Income Tax Return
of a Foreign Corporation, while nonresident aliens conducting business in the U.S. must complete Form
1040-NR, U.S. Nonresident Income Tax Return.
By the conclusion of this lesson you should be able to demonstrate knowledge with respect to:
• The U.S. system for taxing foreign persons.
• Withholding on U.S. source investment-type income.
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• Withholding procedures.
• The Taxation of U.S. real property interests.
• Taxation of a U.S. trade or business.
• Branch profits tax.
• Anti-earnings stripping provisions.
• The returns and payment of tax.
Reading
Suggested Internal Revenue Code Sections: 163(j), 864, 871; 881, 882, 884, 897; 1441–1446
Assignments
1. Hans, a citizen and resident of Argentina, is a retired bank executive. Hans does not hold a
green card. At the start of Year 1, Hans paid $2.5 million for a 20-unit apartment complex
located in the suburbs of Washington, D.C. Hans does not actively manage the building, but
rather leases it to an unrelated property management company that subleases the building to
the tenants. During Year 1, Hans had rental income of $300,000 and operating expenses
(depreciation, interest, insurance, etc.) of $220,000. On the advice of his accountant, Hans
made a Code Sec. 871(d) election in Year 1.
At the start of Year 2, Hans sold the building for $350,000. Hans’ adjusted basis in the building
at that time was $290,000. What are the U.S. tax consequences of Hans’ U.S. activities?
2. Cholati is a foreign corporation that produces fine chocolates for sale worldwide. Cholati
markets it chocolates in the United States through a branch sales office located in New York
City. During the current year, Cholati’s effectively connected earnings and profits are $3 million,
and its U.S. net equity is $6 million at the beginning of the year, and $4 million at the end of
the year. In addition, a review of Cholati’s interest expense account indicates that it paid
$440,000 of portfolio interest to an unrelated foreign corporation, $200,000 of interest to a
foreign corporation which owns 15% of the combined voting power of Cholati’s stock, and
$160,000 of interest to a domestic corporation.
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Compute Cholati’s branch profits tax, and determine its branch interest withholding tax
obligations. Assume that Cholati does not reside in a treaty country.
3. Wheelco, a foreign corporation, manufactures motorcycles for sale worldwide. Wheelco markets
its motorcycles in the United States through Wheely, a wholly-owned U.S. marketing subsidiary
that derives all of its income from U.S. business operations. Wheelco also has a creditor interest
in Wheely, such that Wheely’s debt to equity ratio is 3 to 1, and Wheely makes annual interest
payments of $60 million to Wheelco. The results from Wheely’s first year of operations are as
follows:
Sales ................................................. ............180 million

Interest income ................................................ $6 million
Interest expense (paid to Wheelco) ................. ($60 million)
Depreciation expense ..................................... ($30 million)
Other operating expenses ............................... ($81 million) Pre-tax
income ................................................ $15 million
Assume the U.S. corporate tax rate is 21%, and that the applicable tax treaty exempts Wheelco’s
interest income from U.S. withholding tax. Compute Wheely’s interest expense deduction.
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Lesson 6 – Planning for Foreign-Owned U.S.

Operations, and Transfer Pricing
Introduction
This lesson provides an overview of some of the planning issues that a foreign company must consider
when doing business in the United States.
A central tax issue for a foreign company is whether its import profits will be subjected to U.S.
taxation. As a general rule, the U.S. asserts jurisdiction over all trade or business income derived from
sources within its borders. However, most tax treaties contain a permanent establishment article under
which a foreign company’s business profits are exempt from U.S. taxation unless those profits are
attributable to a permanent establishment located within the United States.
A foreign company that is establishing a sales, distribution, service, or manufacturing facility in the U.S.
can also structure the U.S. operation as either a branch or a subsidiary. Even if a foreign company
forms a limited liability company in the United States, the foreign company will have to choose whether
it will treat the limited liability company as a subsidiary or branch for tax purposes under the entity
classification regulations. The option of forming a domestic hybrid entity or a reverse domestic hybrid
entity is also available.
Inbound tax planning involves the interplay of the tax laws of two or more countries. From a foreign
corporation’s perspective, the objective of inbound tax planning is to reduce the U.S. and foreign taxes
on U.S.-source income. U.S. taxes increase a foreign corporation’s total tax costs only to the extent
they are not creditable for foreign tax purposes. The primary concern of foreign corporations operating
in the United States is repatriation—sending money back to the foreign corporation at the lowest
possible tax cost.
Survey of U.S. Entity Classification. — This survey lists common entities in the United States,
describes the treatment for U.S. tax purposes if an election is not made (whether the entity is a per se
corporation or its default status is a corporation or pass through entity) and considers the possibility for
treatment as a domestic hybrid or domestic reverse hybrid entity.
This lesson continues with an evaluation of transfer pricing. If there were no restrictions on
intercompany transfer prices, U.S. companies with affiliates in low tax foreign jurisdictions could
structure their activities such that much of their profits are recognized in the low tax foreign
jurisdiction. This concern has led U.S. lawmakers to impose restrictions that require U.S. affiliates to
report their fair share of the worldwide profits of the multinational corporate group. This chapter gives
an overview of these restrictions.
The operating units of a multinational corporation usually engage in a variety of intercompany

transactions. A “transfer price” must be computed for these controlled transactions in order to satisfy
various financial reporting, tax, and other regulatory requirements. Although transfer prices do not
affect the combined income of a controlled group of corporations, they do affect how that income is
allocated among the group members.
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The transfer pricing provisions are contained in Code Sec. 482, and are designed to ensure that
intercompany transactions are accounted for using “arm’s length” prices, that is, the prices that would
be charged to unrelated corporations.
With regard to payments for tangible property, the Regulations specify five methods for determining an
arm’s length price: the comparable uncontrolled price method, the resale price method, the cost plus
method, the comparable profits method and the profit split method. The taxpayer must choose the
method that most accurately reflects the correct arm’s length price. There are three transfer pricing
methods for intangible property: the comparable uncontrolled transaction method, the comparable
profits method, and the profit split method. Again, the taxpayer must choose the method that most
accurately reflects an arm’s length price. Transfers of intangibles are also subject to the requirement
that the income recognized by the transferor is commensurate with the income actually earned from
the use of that intangible in future years.
In order to monitor transfers between related parties to ensure that the transfer pricing provisions are
being followed, a domestic corporation that has a 25% or greater foreign shareholder must file Form
5472, Information Return of a 25% Foreign Owned U.S. Corporation or a Foreign Corporation Engaged
in a U.S. Trade or Business. This form requires information about transactions with related foreign
corporations. Additionally, U.S. shareholders of a controlled foreign corporation must file Form 5471,
Information Return of U.S. Persons with Respect to Certain Foreign Corporations.
If a taxpayer fails to comply with the transfer pricing provisions, it is potentially subject to two special
penalties. The transactional penalty applies if the transfer price used by the taxpayer is 200% greater
or 50% less than the correct transfer price. The net adjustment penalty applies if the net increase in
taxable income due to a transfer pricing adjustment exceeds the lesser of $5 million or 10% of gross
receipts. Both penalties are imposed at the rate of 20% (40% at higher thresholds) and are applied to
the tax underpayment.
The need for a “penalty-proof” transfer price is driven in part by the risk of IRS scrutiny, which
depends on the volume of international transactions. If the U.S. taxpayer believes itself at significant
risk due to a large volume of related party international transactions, the taxpayer may obtain an
advanced pricing agreement with the IRS. This is an agreement entered into with the IRS whereby the
U.S. taxpayer requests that the IRS examine and approve the taxpayer’s transfer price before it is
used.
By the conclusion of this Lesson you should be able to demonstrate knowledge with respect to the U.S. system for
taxing foreign persons.
Reading
Suggested Internal Revenue Code Sections: 482 and 6662(e)
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Assignments
1. A foreign corporation can structure its U.S. operations as either a branch or a subsidiary. What
are the tax advantages of operating in the United States through a separately incorporated
subsidiary? What are the tax advantages of operating in the United States through an
unincorporated branch? What general business factors should be considered when choosing
between the branch and subsidiary forms of doing business in the United States?
2. In each of the following independent situations involving transfers of tangible property, determine
which transfer pricing methods applies and compute a transfer price using the appropriate
method. Show all of your computations.
a. Dougco, a domestic corporation, owns 100% of Thaico, a Thailand corporation. Dougco

manufactures top-of-the-line office chairs at a cost of $300 per unit and sells them to Thaico,
which resells the goods (without any further processing) to unrelated foreign customers for
$450 each. Independent foreign distributors typically earn commissions of 20% (expressed as
a percentage of the sales price) on the purchase and resale of products comparable to those
produced by Dougco.
b. Clairco, a domestic corporation, owns 100% of Shuco, a foreign corporation that manufactures
women’s running shoes at a cost of $30 each and sells them to Clairco. Clairco attaches its
trade name to the shoes (which has a significant effect on their resale price), and resells them
to unrelated customers in the United States for $80 each. Independent foreign manufacturers
producing similar running shoes typically earn a gross profit mark-up (expressed as a
percentage of the manufacturing costs) of 15%.
c. Tomco, a domestic corporation, owns 100% of Swissco, a Swiss corporation. Tomco

manufactures riding lawn mowers at a cost of $2,500 per unit, and sells them to unrelated
foreign distributors at a price of $3,750 per unit. Tomco also sells the equipment to Swissco,
which then resells the goods to unrelated foreign customers for $4,250 each. The conditions
of Tomco’s sales to Swissco are essentially equivalent to those of the sales made to unrelated
foreign distributors.
3. Mikco, a foreign corporation, owns 100% of Flagco, a domestic corporation. Mikco

manufactures a wide variety of flags for worldwide distribution. Flagco imports Mikco’s finished
goods for resale in the United States. Flagco’s average financial results for the last three years
are as follows:
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Sales ............................................................................ $20 million

Cost of goods sold .........................................................($15 million)
Operating expenses ....................................................... ($4 million)
Operating profit ..............................................................$1 million
Flagco’s CFO has decided to use the comparable profits method to assess Flagco’s exposure to an IRS
transfer pricing adjustment by testing the reasonableness of Flagco’s reported operating profit of $1
million. An analysis of five comparable uncontrolled U.S. distributors indicates that the ratio of
operating profits to sales is the most appropriate profitability measure. After adjustments have been
made to account for material differences between Flagco and the uncontrolled distributors, the
average ratio of operating profit to sales for each uncontrolled distributor is as follows: 6%, 8%, 10%,
10%, and 14%. Using this information regarding comparable uncontrolled U.S. distributors, apply the
comparable profits method to assess the reasonableness of Flagco’s reported profits. In addition, if an
adjustment to Flagco’s reported profits is required, compute the amount of that adjustment.
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Lesson 7 – Tax Treaties and Transfers

Introduction
In order to encourage international trade and reduce double taxation, the U.S. frequently enters into
tax treaties with other countries. These treaties generally reduce the host country’s taxation on income
arising in the host country, as well as provide agreements between the countries for the disclosure of
information on nonresidents doing business in that country, clarify issues regarding when income is
sourced in a country, and establish procedures that should be used when a country acts inconsistently
with a tax treaty.
Consistent with the intention to stimulate international investment, a major purpose of a tax treaty is
to reduce or eliminate double taxation by tax reductions or exemptions on certain types of income
derived by residents of one country from sources within another country. The U.S. has tax treaties with
over 60 countries. Although each tax treaty is unique, the United States Model Income Tax Convention
of November 15, 2006 (“U.S. Model Treaty”) reflects the general pattern of most treaties.
The benefits of a tax treaty are restricted to residents of the respective treaty countries. A corporation
or other entity is a resident of a country if the corporation is subject to that country’s tax laws by virtue
of domicile, place of management, place of incorporation or similar criteria. There are various rules that
act as tie breakers in the event that a taxpayer is deemed to be a resident of both countries. Generally,
these tie breakers provide that a taxpayer is a resident in the country with which the taxpayer has the
most significant relationship.
Since the application of a tax treaty will usually reduce a person’s tax liability, there is an incentive for
taxpayers who are not residents of treaty countries to structure their business transactions to realize
income in treaty countries. This can be done, for example, by forming a corporation in a treaty
country, making investments out of that corporation, and attempting to claim treaty benefits. This is
known as “treaty shopping.” The U.S. Model Treaty contains a limitations-on-benefits provision that is
designed to restrict treaty benefits to actual residents of the treaty countries.
Treaties also address the issue of whether a resident of one country is doing business in a foreign
country and is subject to that foreign country’s tax and reporting requirements. If a taxpayer has a
“permanent establishment” in a foreign country, the taxpayer will be subject to that country’s tax on
the profits attributable to the permanent establishment. A permanent establishment includes a fixed
place of business, such as an office, place of management, branch, factory, workshop, or a mine, well,
quarry, or other place of natural resource extraction. However, a permanent establishment will not
include a fixed place of business if the fixed place of business is used solely for activities auxiliary to
the taxpayer’s business, such as a warehouse for purchasing, storing, displaying or delivering
inventory.
Certain types of income are entitled to receive special treatment under treaties. For example,
dividends, interest and royalties are subject to tax at reduced rates, and gain from the sale of personal
property generally is taxed only by the taxpayer’s resident country. In addition, treaties
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usually provide a de minimis rule for the personal services income of a dependent agent. Specifically,
the income will not be subject to host country taxation if:
(i) the dependent agent is not present in the foreign country for over 183 days in a year; (ii) the
employer is not a resident of the host country; and (iii) the income is not borne by a permanent
establishment located in the host country.
Any taxpayer that claims the benefits of a treaty by taking a tax return position that is in conflict with
the Internal Revenue Code must disclose the position. A tax return position is considered to be in
conflict with the Code, and therefore treaty-based, if the U.S. tax liability under the treaty is different
from the tax liability that would have to be reported in the absence of a treaty. This reporting
requirement is waived in various situations.
Outbound Transfers of Property to Foreign Corporations. — Code Sec. 367 curtails tax- free
treatment for many corporate transactions if one or more of the corporations is a foreign corporation,
whereas the same transaction would be accorded tax-free treatment if all the parties were U.S.
corporations. If Code Sec. 367 applies, a U.S. taxpayer who transfers property outside the U.S. is
treated as though the property were sold to the foreign corporation for fair market value. There are
exceptions for transfers of property that would result in a loss, and certain transfers of assets for use
in an active foreign business.
A special branch loss recapture rule applies when a domestic corporation that has a foreign branch
incorporates that branch. If a domestic corporation was operating a branch in the U.S. and
incorporated that branch, the incorporation transaction would be accorded tax-free treatment.
However, if a U.S. corporation has a foreign branch that has operated at a loss, the corporation will
recognize gain on the branch’s incorporation. This rule is designed to prevent a
U.S. corporation from deducting a foreign branch’s start-up losses against its U.S. taxable income and
then converting that branch to a subsidiary when the branch becomes profitable so that the
U.S. corporation can then take advantage of deferral.
Acquisitive Reorganizations. — The five major type of acquisitive reorganizations are:
1. a statutory merger (“Type A”)
2. an exchange of the shares of the acquiring corporation for the shares of the target corporation
(“share-for-share acquisitions,” also known as “Type B”)
3. an exchange of the shares of the acquiring corporation for the assets of the target corporation
(“shares-for-asset acquisitions,” also known as “Type C”)
4. forward triangular mergers
5. reverse triangular mergers.
The policy behind taxing the U.S. shareholders that are a party to an acquisitive reorganization is to
tax the appreciation in their shares before the shares leave the U.S. taxing jurisdiction. In each of the
five types of acquisitive reorganizations, the outbound toll charge would apply to tax the appreciation
of the U.S. shareholders in their shares of a U.S. target.
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A limited-interest exception applied if the U.S. shareholders obtain less than half of the transferee
foreign corporation, management and 5 percent or greater shareholders do not own more than 50
percent of the foreign corporation after the transaction, the foreign corporation satisfies an active trade
or business test, and the value of the foreign corporation is equal to or greater than the value of the
U.S. target. Furthermore, U.S. shareholders acquiring 5 percent or more of the foreign corporation
must enter a gain recognition agreement with the IRS.
Over the last few years, many U.S.-based corporations have expatriated themselves to a tax- haven
jurisdiction via an inversion transaction. Pursuant to these inversions, the operations of a
U.S. corporation become a subsidiary of a foreign parent. In many of these inversions, the only tax
cost of U.S. shareholders paying gain on the exchange of low basis shares of U.S. corporation for high-
value shares of the new foreign corporation was outweighed by the tax benefit of avoiding the U.S.
taxing jurisdiction over the structure’s worldwide income.
If U.S. shareholders own 80 percent or more of the foreign corporation as a result of the inversion and
both the U.S. corporation transfers all its operations to a foreign parent and the worldwide group does
not have substantial business activities in the foreign corporation’s country of operation, the foreign
corporation is subject to tax on its worldwide income as if it were a U.S. corporation. If the inversion
transaction results in U.S. shareholders owning at least 60 percent of the foreign corporation, any
applicable gain may not be offset by any net operating losses or foreign tax credits for 10 years
following the inversion transaction.
Just as outbound transfers to foreign corporations are taxed, inbound transfers such as subsidiary
liquidations (which would otherwise be tax-free if the subsidiary and the parent were U.S.
corporations) are taxable events. For example, in the case of an inbound repatriating liquidation of a
foreign subsidiary, the recipient U.S. parent corporation must include in gross income a dividend equal
to the subsidiary’s post-1962 undistributed earnings and profits.
Provisions similar to those governing inbound repatriating liquidations of foreign subsidiaries also
govern a variety of other exchanges involving inbound transfers of property made by foreign
corporations. The principal purpose of these provisions is to preserve the ability of the United States to
tax, either currently or at some future date, the earnings and profits of a foreign corporation
attributable to shares owned by U.S. shareholders.
As with the outbound acquisition rules, the failure to require an inclusion of a dividend for a foreign
corporation’s earnings and profits would allow the foreign corporation’s earnings and profits to avoid
the U.S. taxing jurisdiction forever. When a U.S. C corporation receives the dividend, the U.S. C
corporation will be entitled to the benefits of indirect foreign tax credits, which may shelter any
additional U.S. tax. To the extent the dividend is received by a U.S. individual, the dividend will be
taxed at only 15 percent.
Provisions similar to those governing inbound repatriating liquidations of foreign subsidiaries also
govern a variety of other exchanges involving transfers of property from one foreign corporation to
another foreign corporation. The principal purpose of these provisions is to preserve the ability of the
United States to tax, either currently or at some future date, the earnings and profits of a foreign
corporation attributable to shares owned by U.S. shareholders. The inclusion of a dividend typically
occurs when a U.S. shareholder of a CFC exchanges shares of the CFC for shares of a foreign
corporation whereby the U.S. person is not a U.S. shareholder of a CFC.
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When a U.S. C corporation receives the dividend, the U.S. C corporation will be entitled to the benefits
of indirect foreign tax credits, which may shelter any additional U.S. tax. To the extent the dividend is
received by a U.S. individual, the dividend will be taxed at only 15 percent.
• The common treaty provisions.
• Disclosure of treaty-based return positions.
• Outbound transfers of property to foreign corporations.
• Acquisitive reorganizations.
• Outbound transfers in an acquisitive reorganization.
• Anti-inversion provisions of Code Sec. 7874.
• Inbound liquidation of a foreign subsidiary into its domestic parent.
• Inbound transfers in an acquisitive reorganization.
• Foreign-to-foreign transfers in an acquisitive reorganization.
Reading
Suggested Internal Revenue Code Section: 367
Suggested reading: United States Model Income Tax Convention of November 15, 2006
Assignments
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1. Stoolco, a domestic corporation, produces a line of low cost bar stools at its facilities in Missouri
for sale throughout the United States. During the current year, Stoolco’s management has
decided to begin selling it stools overseas and has begun exploring the idea of establishing branch
sales offices in some key countries in Europe and Asia. If possible, Stoolco’s management would
like to avoid establishing a taxable presence in these countries.
Stoolco’s management has asked you to advise them on the types of marketing activities they can
conduct within these countries without creating a taxable nexus. For purposes of this analysis,
assume that the United States has entered into an income tax treaty with the countries in question
that is identical to the United States Model Income Tax Convention of November 15, 2006.
2. Erica is a citizen of a foreign country and is employed by a foreign-based computer

manufacturer. Erica’s job is to provide technical assistance to customers who purchase the
company’s mainframe computers. Many of Erica’s customers are located in the United States. As
a consequence, Erica consistently spends about 100 working days per year in the United States.
In addition, Erica spends about 20 vacation days per year in Las Vegas, since she loves to
gamble and also enjoys the desert climate. Erica does not possess a green card. Assume that the
United States has entered into an income tax treaty with Erica’s home country that is identical to
the United States Model Income Tax Convention of November 15, 2006.
How does the United States tax Erica’s activities? How would your answer change if Erica were a
self-employed technician rather than an employee?
3. Finco is a wholly owned Finnish manufacturing subsidiary of Winco, a domestic corporation that
manufactures and markets residential window products throughout the world. Winco has been
Finco’s sole shareholder since Finco was organized in 1990. At the end of the current year, Winco
sells all of Finco’s stock to an unrelated foreign buyer for
$25 million. At that time, Finco had $6 million of post-1986 undistributed earnings, and
$2 million of post-1986 foreign income taxes that have not yet been deemed paid by Winco.
Winco’s basis in Finco’s stock was $5 million immediately prior to the sale.
Assume Winco’s capital gain on the sale of Finco’s stock is not subject to any foreign taxes, and
that the U.S. corporate tax rate is 21%. What are the U.S. tax consequences of this sale for
Winco?
Now assume that instead of selling the stock of Finco, Winco completely liquidates Finco, and
receives property with a market value of $25 million in the transaction. As in the previous scenario,
at the time of the liquidation, Finco had $6 million of accumulated earnings and profits, and $2
million of foreign income taxes that have not yet been deemed paid by Winco. Assume that
Winco’s basis in Finco’s stock was $5 million immediately prior to the liquidation, and that the U.S.
corporate tax rate is 21%. What are the U.S. tax consequences of this liquidation for Winco?
43
Course Syllabus
Lesson 8 – State and International Taxation

Introduction
This lesson begins with an examination of how the United States taxes foreign corporations and
nonresident aliens who derive U.S. source investment-type income.
Forty-four states and the District of Columbia impose a net income tax on corporations, with tax rates
ranging from roughly 4% to 12%.
Federal tax law plays an important role in state taxation of a domestic corporation’s foreign earnings
because most states use either federal taxable income before the net operating loss and dividends-
received deductions (federal Form 1120, line 28) or federal taxable income (federal Form 1120, line
30) as the starting place for computing state taxable income.
States employ a wide variety of consolidation rules for a group of commonly controlled corporations. A
handful of states require each group member that is taxable in the state to file a return on a separate
company basis. About 25 states permit a group of commonly controlled corporations to elect to file a
state consolidated return, but only if certain requirements are met. About 20 states require members
of a unitary business group to compute their taxable income on a combined basis. Roughly speaking, a
unitary business group consists of two or more commonly controlled corporations that are engaged in
the same trade or business, as exhibited by such factors as functional integration and centralized
management.
In those states that require combined unitary reporting, there are two approaches to dealing with
unitary group members that are incorporated in a foreign country or conduct most of their business
abroad. One approach is a worldwide combination, under which the combined report includes all
members of the unitary business group, regardless of the country in which the group member is
incorporated or the country in which the group member conducts business. The alternative approach is
a water’s-edge combination, under which the combined report excludes group members that are
incorporated in a foreign country or conduct most of their business abroad.
Most states allow corporations to claim some form of dividends-received deduction with respect to
dividends received from other corporations, and states generally extend their dividends- received
deductions to dividends received from foreign corporations.
If a domestic corporation operates abroad through an unincorporated foreign branch rather than a
separately incorporated subsidiary, the foreign-source income of the branch represents income earned
directly by the domestic corporation. States generally conform to the federal check-the- box rules for
income tax purposes. Thus, a foreign entity that is a corporation for foreign tax purposes but is a
branch or partnership for U.S. federal tax purposes is generally treated as a branch or partnership for
state income tax purposes.
44
Course Syllabus
Although the states generally do not permit a corporation to claim a credit for foreign income tax
payments, some states allow a corporation to deduct its foreign income taxes. However, the allowance
of the deduction is generally predicated on whether the corporation elects to deduct the foreign
income taxes for federal tax purposes. A handful of states allow a state deduction when the taxpayer
claims the credit for federal purposes.
This lesson concludes with an overview of international tax practice and procedures. While many of the
same procedural issues present in audits of domestic businesses are germane, there are other unique
problems facing U.S.-based multinationals (outbound investment) as well as U.S. subsidiaries of
foreign parent companies (inbound investment).
Organization of the Internal Revenue Service International Offices. — The office of Assistant
Commissioner (International) in Washington, D.C. functions as the U.S. competent authority. The
international examiners are assigned to the industry groups within the Large and Mid-Size Business
Division and the Office of Appeals.
The IRS has retrained many of its agents as international examiners. Due to the increased emphasis by
the IRS on intercompany transfer pricing, IRS economists are also becoming involved in the audit
process.
The primary authority for recordkeeping requirements of an entity potentially liable for U.S. tax is Code
Sec. 6001 of the Internal Revenue Code and the related Regulations. The IRS also has the specific
authority to examine any books, papers, records or other data that may be relevant or material to
ascertaining the correctness of any return, determining the tax liability of any person or collecting any
tax.
At the conclusion of the examination, the international examiner will prepare a report summarizing the
findings. The report is then incorporated into the field agent’s report. Any disputed issues from the
international examiner’s report may be pursued with the Appeals Office along with other domestic
issues raised during the examination.
Upon completion of an international examination, the examining office may issue the taxpayer a thirty-
day letter proposing a deficiency. The taxpayer may object to any proposed tax adjustments and
request a conference with the Appeals Office by filing a protest with the Appeals Office. The taxpayer
must formally request the conference by means of a document known as a protest.
Generally, if the taxpayer has been unable to agree with the Appeals office on an adjustment that
results in double taxation, the next course of action is to seek competent authority relief. An integral
part of all U.S. Income Tax Treaties is a mutual agreement procedure which provides a mechanism for
relief from double taxation. The Assistant Commissioner (International) acts as the U.S. competent
authority.
A taxpayer may contest an adverse IRS determination in one of three tribunals. A petition may be filed
with the U.S. Tax Court, and assessment and collection of the deficiency will be stayed until the Court’s
decision becomes final. Alternatively, the taxpayer may pay the deficiency including interest and
penalties and sue for a refund in a U.S. District Court or the U.S. Court of Federal Claims.
45
Course Syllabus
• Overview of state corporate income taxes.
• Worldwide versus water’s-edge combined reporting.
• Dividends from foreign subsidiaries.
• Check-the-box foreign branches.
• Treatment of foreign income tax payments.
• State versus federal nexus standards for foreign corporations.
• Organization of the Internal Revenue Service international offices.
• International examinations.
• The appeals division of the IRS.
• Civil actions by taxpayers.
Reading
Suggested Internal Revenue Code Sections: 951A, 882, 875, 965, 960, 982; 6038A and 7602.
Assignments
1. For purposes of computing a corporation’s state taxable income, do states generally permit a
U.S. parent corporation to claim a dividends-received deduction for dividends received from a
foreign country subsidiary?
46
Course Syllabus
2. USA Company wholly owns a foreign subsidiary in Hong Kong called HKco. USA Company sells
HKco the seven components necessary to make sunglasses. Following one page of directions
written in Chinese, HKco employees put the components together to make the sunglasses for
HKco’s sale throughout Europe. In order to determine whether USA Company has any foreign base
company sales income under Subpart F, the IRS needs to analyze whether HKco’s activities
constitute manufacturing.
What procedures can the IRS employ to gather the information needed to make this
determination?
3. USA Company is the wholly-owned U.S. subsidiary of ASIAco and USA Company purchases
automobiles from ASIAco for $20,000. USA Company resells the automobiles for $21,000. The IRS
conducts a transfer pricing examination of USA Company and proposes an adjustment based on
what it believes to be the arm’s length transfer price of
$15,000. USA Company decides to pursue the issue at both Appeals and Competent Authority
under the Simultaneous Appeals Procedure (“SAP”) .
Describe the SAP procedures.
47

TAX 509 - Fundamentals of International Taxation

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TAX 509 – Fundamentals of International Taxation

TAX 509 – Fundamentals of

Expected Student Learning Outcomes

• The taxing of the foreign income of its citizens.

• The taxing of the U.S. income of non-citizens.

• The fiscal residence of companies.

• Rules for determining income and expenses.

• Obstacles to flow of funds between parent and subsidiary entities.

• Tax incentives in developing countries.

• Public international law and taxation.

Suggestions for getting the most out of this course:

1. A demonstrated understanding of the material and the learning objectives.

3. Clear and logical composition supported by examples and appropriate references.

Grade GPA Percentage Comments

Understandi Provides marginally

Course Completion Requirements

• You have passed the course Final Examination .

• You have completed the Course Evaluation Survey.

Lesson 1 – Overview of U.S. Taxation of International

Lesson Learning Objectives

• The U.S. Jurisdictional System.

• The definition of a Resident Alien.

• The exclusion for foreign-earned income.

• The rules regarding expatriation.

Lesson 2 – Source-of-Income Rules and Foreign Tax

Computing the foreign tax credit is a three-step process:

2. high withholding tax interest

3. financial services income

7. certain distributions from a FSC or former FSC

8. general limitation income (residual basket).

Lesson Learning Objectives

• The importance of source rules for income and deductions.

Lesson 3 – Anti-Deferral Provisions and Foreign

When determining Subpart F income, various special rules apply, including:

3. Mark-to-market election. A U.S. shareholder of a PFIC may make a mark-to-market election

Lesson Learning Objectives

• Foreign base company income.

• Passive foreign investment companies.

• Gain from the sale or exchange of a cfc’s stock.

• Foreign currency translation and transactions.

Lesson 4 – Export Benefits and Planning for Foreign

3. The export property must have a minimum of 50 percent U.S. content.

The income of an IC-DISC from sales of export property is in an amount constituting:

• 4 percent of qualified export receipts

• 50 percent of the combined taxable income

The IC-DISC comprehensive example illustrates the following concepts:

A branch, as an unincorporated arm of the domestic A subsidiary allows more control

The transfer of assets to a foreign

If the domestic taxpayer is an S corporation, the S S corporation shareholders cannot

While operating a subsidiary in a

Lesson Learning Objectives

• The sales of export property.

• Domestic production deduction.

• Determinants of host country taxation.

• Structuring foreign operations.

• The basics of outbound tax planning.

• Financial reporting implications of international tax planning.

• Foreign entity classification.

2. Growco, a domestic corporation, is a tire manufacturer. Growco is planning to build a new

Sales ................................................................................... $400,000,000

▪ eliminate Sproutco’s dividend distribution.

Lesson 5 – Foreign Persons Investing and Doing Business

Lesson Learning Objectives