Multinational Tax Planning

Question 1

What are the two types of tax systems a country can have?

Answer 1

• Territorial Tax System

- Worldwide Tax System

Question 2

What is a territorial tax system?

Answer 2

• Taxes domestic income, not foreign income

Question 3

What is a worldwide tax system?

Answer 3

• Taxes all pre-tax income of residents

- Credit/deduction available if individual/corporation is subject to double taxation

Question 4

What are three mechanisms the US government uses to prevent/limit US corporations’ ability to shift income to lower-taxed foreign subsidiaries to avoid/defer US taxation?

Answer 4

(1) Subpart F rules
(2) Transfer pricing rules
(3) Earnings stripping via inter-company debt

Question 5

Explain Subpart F rules.

Answer 5

• Income earned by a controlled foreign corporation that is considered subpart F income (generally passive type income that is easily shifted across controlled entities) will be subject to annual US taxation even if amounts are not repatriated
• Subpart F income will be deemed to be repatriated on an annual basis

Question 6

Explain transfer pricing rules.

Answer 6

Limit ability of corporations to use intra-company transfer prices to shift income to lower-taxed jurisdictions

Question 7

Explain earnings stripping via intercompany debt.

Answer 7

Restricts amount of interest paid or accrued by a US corporation to a related party not subject to US tax

Question 8

What are two basic org. forms a US business can use to organize its foreign operations?

Answer 8

• Foreign branch

- Foreign (subsidiary) corporation

Question 9

Which org. form provides a stronger liability shield for the US parent company? Why?

Answer 9

• Foreign (subsidiary) corporation because US tax is deferred until amounts remitted to US parent
• Whereas, foreign branch’s taxable income subject to annual US taxation

Question 10

Distinguish a worldwide tax system from a territorial tax system.

Answer 10

• Worldwide: taxes both domestic and foreign income

- Territorial: taxes only domestic income

Question 11

Is the US tax system characterized as a worldwide or territorial tax system?

Answer 11

• “Elective” worldwide tax system
• Allows foreign subsidiary to decide when and if to pay taxes on foreign earnings
• Non-resident t/p only taxed on income earned in USA

Question 12

Does US gross income include the after-foreign-tax-income of US owned foreign operations?

Answer 12

• No

- US gross income incomes “PRE” foreign tax income of US owned foreign operations

Question 13

Do the US financial accounting rules provide an incentive for firms to locate operations overseas (compare under US Tax Rules to GAAP)?

Answer 13

• US Tax Rules: Yes, incentive to locate overseas due to deferral of US tax if use a foreign subsidiary corporation
• GAAP: Yes incentive to locate overseas b/c gives you flexibility (PRE or permanently reinvested allows firms to avoid US tax expense on foreign earnings)

Question 14

Why does the US allow a foreign tax credit for foreign income taxes paid or deemed paid?

Answer 14

To mitigate multiple taxation of foreign source income earned by US based cororations

Question 15

What types of foreign taxes are generally eligible for the FTC?

Answer 15

• Income taxes

- Dividend withholding taxes

Question 16

What types of foreign taxes are generally ineligible for the FTC but can be deducted in arriving at taxable income?

Answer 16

• Value added tax

Question 17

While a t/p can elect to forego the FTC and deduct foreign income taxes, why will a t/p generally prefer the FTC over a tax deduction?

Answer 17

• Because FTC provides tax savings equal to the FTC amount (dollar for dollar reduction in US tax liability)
• Deduction provides a tax savings only equal to foreign taxes paid times US federal corporate tax rate

Question 18

What can US based multinational firms with expiring FTC carry-forwards do to maximize US tax savings from expiring FTC carry-forwards?

Answer 18

• Shift income from US to lower taxed country

- Repatriate more income

Question 19

What type of income do Subpart F rules apply to?

Answer 19

Passive income (which is deemed repatriated annually)

Question 20

What is typically included in passive type income?

Answer 20

• Interest income

- Dividend income

Question 21

What type of taxation is a foreign branch subjected to?

Answer 21

Annual taxation

Question 22

What type of taxation is a foreign subsidiary subjected to?

Answer 22

Potentially deferred taxation

Question 23

How do you calculate the gross annual FTC amount?

Answer 23

Gross Annual FTC = Foreign incomes taxes paid + Foreign income taxes deemed paid

Question 24

Can you claim tax credit above US tax on foreign income?

Answer 24

No

Question 25

How do you calculate the annual FTC limit?

Answer 25

Annual FTC limit = (foreign source income included in US taxable income) * (US statutory tax rate)

Question 26

What does the FTC carryforward and carryback provisions allow?

Answer 26

• Allow excess credit due to FTC limit to be carried-back one year and/or forward ten years (subject to limit in carryover year)

Question 27

What is an excess FTC limit position?

Answer 27

• Annual FTC amount less than FTC limit

- Any additional foreign taxes considered paid during the year would be eligible for current tax credit

Question 28

What is an excess FTC credit position?

Answer 28

• Annual FTC amount exceeds FTC limit

- Not all eligible foreign tax credits can be utilized in current period due to operation of annual FTC limit

Question 29

What are the two income baskets at present?

Answer 29

• General category income

- Passive category income

Question 30

What does the US require that the FTC limit be computed separately for?

Answer 30

• For each separate basket of income (2)

Question 31

How do you calculate deemed FTC?

Answer 31

Deemed FTC =
[ Dividend Paid / Accumulated E&P Pool] *
[Post 1986 Foreign Income Taxes Pool]

Question 32

What is the accumulated E&P pool amount reduced for?

Answer 32

For prior dividends

Question 33

What is the post-1986 foreign income taxes pool amount reduced for?

Answer 33

For prior year tax credit amounts

Question 34

When would you prefer to be a foreign branch over a foreign subsidiary?

Answer 34

• If expanding to new markets and expecting losses for awhile, prefer foreign branch over foreign subsidiary
• Can use losses to offset future income

Question 35

What condition must be satisfied for the ATFV equation for a foreign based subsidiary to work?

Answer 35

domestic tax > foreign tax

Question 36

How do you interpret the ATFV for a foreign based subsidiary equation?

Answer 36

equals “after foreign tax rate of return”

minus “deferred net US tax on remitted dividend”

Question 37

Define cross-crediting.

Answer 37

Ability to aggregate across countries

Question 38

Does the US allow cross-crediting?

Answer 38

• Yes

- Countries can aggregate FTC across countries or planning techniques to utilize excess FTC

Question 39

From the FTC extension problems:

Comparing the responses from the “Foreign Branch - Aggregate FTC” example to that from the country-by-country FTC limit, why is the total I/T lower in the present example?

Answer 39

• Since FTC limit aggregated across countries, operations in Country L create an “excess FTC limit position” b/c actual foreign tax payment below implied FTC limit
• Operations in Country H result in “excess FTC position” b/c actual foreign tax payment to Country H exceeds implied FTC limit
• “Excess FTC limit position” in one foreign country netted against “Excess FTC” position in other foreign country
• Additional FTC is claimed by aggregating

Question 40

When can FTC carryforward be used?

Answer 40

FTC carryforward amount can be used in any carryforward year where foreign tax limit not binder
(foreign tax rate < US tax rate)

Question 41

From the FTC extension problems:

Is there a shifting strategy that will allow the company to fully utilize the currently computed FTC carryforward?

Answer 41

• Shift income from US to low-taxed country

- Shifting will allow more of current FTC to be claimed