Professional Documents
Culture Documents
Chapter Topics
Taxes and international business decisions.
Differences in national corporate tax and withholding tax
regimes.
Overlapping tax jurisdictions and double taxation.
Foreign tax credits.
Controlled foreign corporations, Subpart F income, and foreign
tax credit baskets.
Tax treaties.
Foreign currency translation for tax purposes.
Tax incentives.
11-2
Learning Objectives
1. Describe differences in corporate income tax and withholding tax
regimes across countries.
2. Explain how overlapping tax jurisdictions cause double taxation.
3. Show how foreign tax credits reduce the incidence of double taxation.
4. Demonstrate how rules related to controlled foreign corporations,
subpart F income, and foreign tax credit baskets affect U.S. taxation of
foreign source income.
5. Describe some of the benefits provided by tax treaties.
6. Explain and demonstrate procedures for translating foreign currency
amounts for tax purposes.
7. Describe the tax incentives provided by countries to attract FDI and
stimulate exports.
11-3
The location of international investments is affected by
relative tax rates in the alternative countries.
11-4
Types of Taxes
Corporate income taxes are direct taxes on business income.
These are imposed by most governments.
The tax rates vary from zero percent in tax havens to over
forty percent.
Another type of taxes are withholding taxes.
Withholding taxes are taxes on dividends and some other
amounts paid to foreign citizens.
Learning Objective 1
11-5
Corporate income tax rates
Learning Objective 1
11-6
Corporate income tax rates
Since the mid 1980s, there has been a worldwide trend
toward reduced tax rates.
The U.S. started this trend with many other countries
following suit in order to be competitive in attracting foreign
investments.
Tax haven countries take this trend to the extreme with
some of these jurisdictions having zero percent tax rates.
The Organization for Economic Cooperation and
Development (OECD) has established guidelines to mitigate
the negative impact of tax havens.
Learning Objective 1
11-7
Withholding taxes
These taxes typically apply to three types of payments:
dividends, interest, and royalties.
Similar to corporate income taxes, withholding taxes vary
across countries and by type of payment and recipient.
Variation in withholding rates impact on tax planning.
For example, a higher tax rate on dividends than interest
payments would encourage relatively more debt financing
and less equity financing.
Heavy debt financing is referred to as thin capitalization.
Learning Objective 1
11-8
Value-added tax
A substitute for sales taxes.
These taxes are added into the price of the product or service
at each stage.
Learning Objective 1
11-9
Double taxation
When two countries tax the same income, this is referred to
as double taxation.
Learning Objective 2
11-10
Taxation approaches
Worldwide (nationality) approach – all income of a resident
or company of a country is taxed by that country, regardless
of where it is earned.
Learning Objective 2
11-11
Basis for taxation
The three most common bases for taxation are source, citizenship,
and residence.
Almost all countries tax income earned within their borders--that is,
at its source.
Learning Objective 2
11-12
Basis for taxation – The U.S. approach
The U.S. taxes on the basis of source, citizenship, and residence.
Learning Objective 2
11-13
Background – Causes of double taxation
Double taxation usually arises when a company is taxed on
income earned in a foreign country and taxed on that same
income by its country of residence.
Learning Objective 3
11-14
Background – Solutions to double taxation
One solution is for a country to adopt the territorial
approach, exempting foreign source income from taxation.
Learning Objective 3
11-15
FTC – The U.S. approach
The Internal Revenue Service (IRS) allows companies one of
two options.
Learning Objective 3
11-16
FTC – Example
Assume that GCO is a U.S. company which has a branch in
Mexico where the corporate income tax rate is 33%.
The U.S. corporate income tax rate is 35%.
GCO has foreign source income in Mexico of $50,000.
GCO pays $16,500 of corporate income tax in Mexico and
$20,000 of other taxes.
GCO decides to do a calculation to choose between using
taxes paid in Mexico as a deduction or tax credit.
Learning Objective 3
11-17
FTC – Example
Deduction Credit
Foreign source income $50,000 $50,000
Deduction for all taxes paid $36,500 $ 0
U.S. taxable income $13,500 $50,000
U.S. income before tax credit $ 4,725 $17,500
Foreign tax credit $ 0 $16,500
Net U.S. tax liability $ 4,725 $ 1,000
Learning Objective 3
11-18
FTC – Other
The U.S. will not allow the credit to exceed the FTC limitation.
OR the taxes that would have been paid if the income was
earned in the U.S.
Learning Objective 3
11-19
FTC baskets
The Tax Reform Act of 1986 created nine FTC baskets.
These baskets were defined by different types of foreign
income.
FTC was calculated separately for each of the nine baskets.
FTC from different baskets could not be netted against one
another.
The American Jobs Creation Act of 2004 reduced the number
of baskets to two, which reduced the likelihood that excess
FTC’s would go unused:
General income
Passive income
Learning Objective 3
11-20
FTC baskets under TRA 86
Passive income.
High withholding tax interest.
Financial services income.
Shipping and aircraft income.
Dividends of domestic international sales corporations
(DISCs).
Foreign trade income of a foreign sales corporation (FSC).
Dividends from an FSC.
Foreign oil and extraction income.
All other income.
Learning Objective 3
11-21
Indirect FTC (for subsidiaries)
The U.S. allows an indirect FTC on foreign taxes paid by a foreign
subsidiary of a U.S. parent.
This FTC is not allowed until the income of the subsidiary is taxed in
the U.S.
Learning Objective 3
11-22
Controlled foreign corporation (CFC)
A foreign corporation where U.S. shareholders own more than
50 percent of the combined voting power or fair value of the
stock.
A U.S. shareholder is a U.S. taxpayer that owns at least 10
percent of the stock.
Much CFC income is referred to as Subpart F income.
Unlike the deferral of tax on foreign subsidiaries until receipt of
a dividend, Subpart F income is taxable currently.
There is a safe harbor for such income in jurisdictions with tax
rate > 90% of the U.S. rate.
Learning Objective 4
11-23
Summary of foreign source income taxation
What is the legal form of the foreign operation?
Learning Objective 4
11-24
Tax treaties – bilateral agreements regarding how individuals
from one country are taxed on income earned in the other
country.
Learning Objective 5
11-25
Model treaties
The OECD model treaty is the basis for most bilateral treaties of
developed countries.
A key part of the OECD model is that host countries only tax
business profits of foreign companies associated with permanent
establishments.
Learning Objective 5
11-26
U.S. tax treaties
The U.S. also has a model tax treaty that serves as a starting point
when negotiating tax treaties.
This model has zero percent withholding tax for interest and
royalties and 15 percent for dividend payments.
Learning Objective 5
11-27
Translation of foreign branch income
Net income is translated into U.S. dollars at the average exchange
rate for the year. Net income is income after foreign taxes paid.
Learning Objective 6
11-28
Translation of foreign subsidiary income
Dividends paid to the U.S. parent are translated at the spot
rate on the date of payment.
Learning Objective 6
11-29
Tax holidays
The term tax holiday refers to an incentive used by a
government that partially or completely exempts a taxpayer
for a period of time.
Learning Objective 7
11-31
American Jobs Creation Act of 2004 (AJCA)
The AJCA was an attempt to spur job growth in the U.S.
manufacturing sector, broadly defined.
Learning Objective 7
11-32