��Chapter 11:�International Taxation���

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Learning Objectives

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

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Learning Objectives

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

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Impact of Taxes—International Business Decisions

• Impact of Taxes
• International location decisions
• Legal form of operation
• Method of financing

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Types of Taxes and Tax Rates

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

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Corporate Income Tax

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

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Corporate Income Tax

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

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Withholding Tax Regimes

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

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Value-added tax

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

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Tax Jurisdiction

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

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Tax Jurisdiction

• Basis for taxation
• Source
• Followed by most of countries
• Citizenship
• Taxes citizens regardless of
• Source
• Residence
• Residence
• Taxes residents regardless of
• Source
• Citizenship

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Tax Jurisdiction

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

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Double taxation

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

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Double taxation

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

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Double taxation

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

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Double taxation

• FTC – Example

​

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

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Calculation of Foreign Tax Credit

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FTC baskets

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

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Indirect FTC (for subsidiaries)

​

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

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Controlled Foreign Corporations

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

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Subpart F Income

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

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�Summary of foreign source income taxation�

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

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Tax Treaties

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

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Model treaties

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

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U.S. Tax Treaties

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

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Translation of foreign branch income

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

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Translation of foreign subsidiary income

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

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Tax Incentives

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

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U.S. export incentives

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

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American Jobs Creation Act of 2004 (AJCA)

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

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End of Chapter 11

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