1 Chapter 16: U.S. Taxation of Foreign-Related Transactions
Jan 18, 2016
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Chapter 16:U.S. Taxation ofForeign-Related
Transactions
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U.S. TAX OF FOREIGN-U.S. TAX OF FOREIGN-RELATED TRANSACTIONSRELATED TRANSACTIONS
Jurisdiction to taxTaxation of U.S. citizens & residentsTaxation of nonresidentsU.S. taxation of foreign activity
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Jurisdiction to TaxJurisdiction to Tax
Taxpayer’s country of citizenshipTaxpayer’s country of residenceType of income earnedLocation where the income is
earned
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Taxation of U.S. Citizens Taxation of U.S. Citizens and Residentsand Residents
U.S. citizens and resident aliens taxed on worldwide income
Income earned in foreign countries or U.S. possessions receives special treatment
Foreign tax creditForeign earned exclusion
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Foreign Tax Credit (FTC)(1 of 3)
FTC permits U.S. citizens and residents to avoid double taxation
Directly reduces U.S. tax liabilityFTC limited to lesser of
Foreign tax actually paid OR
foreign taxable income_ U.S. taxworldwide taxable income x liability
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Foreign Tax Credit (FTC)(2 of 3)
Source of income rules on p. C16-6– Used to determine numerator of FTC
formulaFTC deducted after nonrefundable
credits for 2004 and later years
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Foreign Tax Credit (FTC)(3 of 3)
Unused FTC carried back two years and forward five years on a FIFO basis to a year where taxpayer has an excess credit limitation
Special FTC limitation– Ten separate baskets of income
»Foreign tax credit calculated for each basket of income»See page C16-7 for partial list of baskets
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Foreign Earned Income Exclusion (FEI) (1 of 5)
FEI available to U.S. citizens and resident aliens working abroad
Eligibility– Bona fide resident test
»Resident of foreign country uninterrupted for entire tax year and maintain tax home in foreign country
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Foreign Earned Income Exclusion (FEI) (2 of 5)
Eligibility (continued)– Physical presence test
»Taxpayer must be physically present in a foreign country for 330 full days during a 12-month period, AND
»Maintain a tax home in a foreign country during that period
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Foreign Earned Income Exclusion (FEI) (3 of 5)
Foreign earned income– Wages, salaries, & fees as compensation for personal
services actually renderedAmount of exclusion
– Lesser of »$80,000, OR»Foreign earned income for current year, OR»$218.58 ($80k/366 days in 2004) x no. of qualifying days in
current yr
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Foreign Earned Income Exclusion (FEI) (4 of 5)
Additional exclusion for taxable housing allowance– Limitation lesser of
»Actual housing amount included in income,OR»$11,581 (.16 x Step1 GS-14 rate) x (qualifying days/366)
– Housing costs incurred in excess of $11,581 are a for AGI deduction
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Foreign Earned Income Exclusion (FEI) (5 of 5)
Housing allowance exclusion (continued)– Housing allowance exclusion reduces
amount eligible for FEI
FTC and FEI are mutually exclusive– Claim either the FTC or the FEI on foreign
earned income, but not both
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Taxation of NonresidentTaxation of NonresidentAliens Aliens (1 of 5)(1 of 5)
Resident aliens are taxed same as U.S. citizens
Nonresident aliens generally taxed only on U.S. source income
Taxpayer is a resident alien if they meet one of the two tests
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Taxation of NonresidentTaxation of NonresidentAliens Aliens (2 of 5)(2 of 5)
Resident alien tests– Green-card test
»Permanent resident w/ “green card” visa – Physical presence test
»Present 31 days during current calendar year AND present 183 weighted average days during a three year period
• Current year: 1 day counted as 1 day• Prior year: 1 day counted as 1/3 day • 2nd prior year: 1 day counted as 1/6 day
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Taxation of NonresidentTaxation of NonresidentAliens Aliens (3 of 5)(3 of 5)
Most U.S. source passive or investment income is taxed at 30%– 30% applied to gross amount
– U.S. payer must withhold tax»U.S. payer responsible for tax if not withheld
– Tax rate often reduced by tax treaties
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Taxation of NonresidentTaxation of NonresidentAliens Aliens (4 of 5)(4 of 5)
Income exempt from U.S. taxation– Non-USToB capital gains if individual
physically present < 183 days during year– Non-USToB interest from banks or other
financial institutions not taxed– Portfolio interest– Income from casual sale of personal property
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Taxation of NonresidentTaxation of NonresidentAliens Aliens (5 of 5)(5 of 5)
Individuals must itemize deductions– Cannot claim standard deduction
Normal deductions apply for items “effectively connected” to a USToB– Gains from real property considered “effected
connected” to a USToB
Tax treaties often reduce or eliminate U.S. for many types of income
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Taxation of U.S. BusinessTaxation of U.S. BusinessOperating AbroadOperating Abroad
Domestic corporationsForeign corporationsDeemed paid foreign tax creditControlled foreign corporations§482 rules and tax avoidanceForeign Sales Corporations
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Domestic Corporations
Domestic subsidiary corporations– Can file consolidated return w/parent– Parent protected from foreign creditors of
subsidiary
Foreign branches– Income and losses taxed currently– Eligible for direct FTC (described earlier)
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Foreign Corporations(1 of 2)
If domestic corp owns 10% of foreign corp, domestic corp eligible for “deemed paid credit” for dividends received from foreign corp
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Foreign Corporations(2 of 2)
10% domestic corp owner can also claim dividends received deduction
U.S. tax on foreign sub’s income deferred until dividends received
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Deemed PaidForeign Tax Credit
Deemed paid credit calculation
Div paid to domestic corp
(from post 1986 undist earningsAll post 1986 undistributed
earnings
X
Creditable taxes paid or accrued by
foreign corp (post 1986)
=Deemed
paid foreign tax
credit
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Controlled ForeignCorporations (CFC) (1 of 3)
Typical tax-avoidance scenario of a CFC
U.S.Manufacturing
Corporation(Chicago)
Foreign SalesSubsidiary
(Island Corporation)
ForeignPurchasers
of U.S.Manufacturer’s
Products
Billing of tax haven sales subsidiary by U.S. manufacturer
Billing of foreign purchasers by tax haven
sales subsidiary
Physical flow of goods
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Controlled ForeignCorporations (CFC) (2 of 3)
CFC definition– > 50% of foreign corp stock owned by U.S.
shareholders»U.S. shareholder defined as owning 10% of
stock
Some income forms (Subpart F income) of the CFC are taxed in the year in which they are earned.
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Controlled ForeignCorporations (CFC) (3 of 3)
Tax-deferred earnings can be taxed under Subpart F when invested in U.S. property.
Previously taxed income is distributed tax-free.
Special rules apply to the sale or exchange of CFC stock.
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§482 Rules & Tax Avoidance(1 of 3)
Tax avoidance opportunity high for domestic parent and 100% owned subsidiary (see slide #23)– U.S. parent sells goods/services at less
than FMV to 100% foreign sub, OR– Foreign sub pays less than FMV for use
of U.S. parent’s intangibles (e.g., patents)
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§482 Rules & Tax Avoidance(2 of 3)
§482 authorizes IRS to distribute, apportion, or allocate gross income, deductions, credits or allowances between or among controlled entities
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§482 Rules & Tax Avoidance(3 of 3)
§482 Regs hold that transaction of tangible property between entities must meet arm’s-length standard– Consistent w/ transactions between
uncontrolled entities»Comparable transaction under comparable
circumstances
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Foreign SalesCorporations (FSC) (1 of 4)
FSC is a special export entity– Must meet certain mandated administrative
and economic activity requirements.
Part or all of FSC’s foreign trade income exempt from U.S. taxation– Exempt amount based on transfer pricing
method used. »May use other-than-arm’s-length pricing.
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Foreign SalesCorporations (FSC) (2 of 4)
Dividend distributions may be eligible for a 100% dividends-received deduction.
Foreign tax credit also available for taxes withheld on dividends.
FSC status restricted to foreign corps having made FSC election before 10/1/2000.
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Foreign SalesCorporations (FSC) (3 of 4)
In 2000, the World Trade Organization declared that FSCs are illegal export subsidies
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Foreign SalesCorporations (FSC) (4 of 4)
In 2001, U.S. replaced FSCs with extraterritorial income rules– In 2002, WTO declared extraterritorial
income rules an illegal export subsidy– Congress proposed to repeal
extraterritorial income rules and replace with other economic incentives
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Comments or questions about PowerPoint Slides?Contact Dr. Richard Newmark atUniversity of Northern Colorado’s
Kenneth W. Monfort College of [email protected]