McGraw-Hill © 2005 The McGraw-Hill Companies, Inc. All rights reserved.

McGraw-Hill © 2005 The McGraw-Hill Companies, Inc. All rights reserved.

ChapterChapter

International Business Expansion

International Business Expansion

1111

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Slide 11-3US Taxation of Foreign Operations

US Taxation of Foreign Operations

United States taxes world wide income of all US citizens, resident aliens and domestic corporations

Significant possibility of double taxation of these entities on income earned outside United States

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Slide 11-4

Tax TreatiesTax Treaties

US has tax treaties with over 50 foreign countries

Common treaty provisionsRestrictions on ability to taxFavorable ratesIncome exclusionsPermanent establishment before business

subject to tax

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Slide 11-5

Common Foreign TaxesCommon Foreign Taxes

Personal income tax Corporation income tax Payroll taxes Value added tax Property tax

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Slide 11-6Foreign Taxation of Corporations-Common Features

Foreign Taxation of Corporations-Common Features

Imputation of corporation income to shareholders to relieve effects of double taxation

Various methods of depreciationRates varying from 10% to 45%Various tax incentives

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Slide 11-7

Value Added TaxValue Added Tax

Imposed on producers and distributors of products and services at each stage of production and distribution process

Tax imposed on “value added”Value added is difference between sale price of

product or service and non-labor costs of production

Typical rates between 5% to 25%

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Slide 11-8

Foreign Tax CreditForeign Tax Credit

Designed to minimize or eliminate double taxation

Only allowed for creditable taxes such as income tax

FTC limitation= (foreign source income/world wide income) x US tax on world wide income

Actual foreign tax credit is lesser of limitation or foreign taxes paid or accrued

Unused credits may be carried back 2 years and forward 5 years

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Slide 11-9

Foreign Tax Credit ExampleForeign Tax Credit Example

J Co earns $300,000 of income in US and $150,000 in Belgium. It pays Belgian tax of $60,000. US tax liability before credits is $153,000

$51,000x$153,000$450,000

$150,000

Foreign tax credit equal to limitation of $51,000

Carryover of $9,000

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Slide 11-10

Foreign Tax Credit-BasketsForeign Tax Credit-Baskets

Foreign tax credit is computed separately for different types of income. Limitation applies to each separately

Baskets:Passive incomeHigh withholding tax incomeFinancial services incomeShipping incomeCertain foreign dividends

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Slide 11-11Sourcing of Incomeand Deductions

Sourcing of Incomeand Deductions

Determines numerator of foreign tax credit limitation fraction The larger the amount of income that is foreign

sourced, the larger the credit allowable

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Slide 11-12Sourcing of Incomeand Deductions

Sourcing of Incomeand Deductions

Service income sources to where services performed

Rental income sourced to location of propertyRoyalty income sources to country where

intangible asset usedInterest income sourced to residence of debtorDividend income sourced to location of dividend

paying company

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Slide 11-13

Sourcing of sales of propertySourcing of sales of property

Gain or loss on real property sources to place property location

Gain or loss on personal property sourced to residence of seller

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Slide 11-14

Sourcing of sales of propertySourcing of sales of property

Exceptions to general rules:Depreciation recapture sourced to where

property depreciatedInventory

Generally sourced to where title passesExceptions:

Manufactured inventory sourced to where manufactured Inventory manufactured in US for sale abroad sourced

50% foreign 50% US

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Slide 11-15

Deduction SourcingDeduction Sourcing

Generally sourced same way as incomeIndirect expenses apportioned between US

and foreign source Interest sourced on assetsIRS has broad reallocation powers under

section 482

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Slide 11-16

Forms of Foreign OperationsForms of Foreign Operations

Local agentBranchPartnershipControlled subsidiary

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Slide 11-17

Controlled US SubsidiariesControlled US Subsidiaries

Subject to US tax on world wide income Can utilize foreign tax creditMay be included in US consolidated return

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Slide 11-18

Controlled Foreign SubsidiariesControlled Foreign Subsidiaries

Not subject to US taxation until earnings distributedParent may get deemed foreign tax credit on

dividends for foreign subsidiary

May not be included in US consolidated return

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Slide 11-19

Subpart F Income-EffectSubpart F Income-Effect

Subpart F income earned by controlled foreign subsidiary subject to US tax when earned by subsidiary

Controlled foreign subsidiary - More than 50% of stock owned by US shareholdersStock owned by U.S. shareholders owning less

than 10% of stock excluded

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Slide 11-20

Subpart F IncomeSubpart F Income

Sales to a related party if income recorded but generated in a low tax country

Passive incomeIncome from countries subject to boycott or

which the US has severed relationsPayments of illegal bribes

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Slide 11-21

Subpart F IncomeSubpart F Income

Controlled corporations must keep track of both Subpart F income and income that is not Subpart F income

Distributions first made from Subpart F earnings and profits and nontaxable

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Slide 11-22

Transfer PricingTransfer Pricing

Section 482 used to prohibit arbitrary shifting of profits between controlled entities due to transfer pricing

Goal is to get price in comparable uncontrolled transaction

Methods:Resale price methodCost-plus methodComparable profitsProfit split methodOther method proposed by taxpayer

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Slide 11-23

Advanced Pricing AgreementAdvanced Pricing Agreement

Agreement between taxpayer and Internal Revenue Service on transfer pricing method to be used on a specific transaction