1 / 80

Chapter 16

Chapter 16. Multijurisdictional Taxation. The Big Picture (slide 1 of 3). VoiceCo, a domestic corporation, designs, manufactures, and sells specialty microphones for use in theaters. All of its activities take place in Florida But, it ships products to customers all over the United States.

kmoore
Download Presentation

Chapter 16

An Image/Link below is provided (as is) to download presentation Download Policy: Content on the Website is provided to you AS IS for your information and personal use and may not be sold / licensed / shared on other websites without getting consent from its author. Content is provided to you AS IS for your information and personal use only. Download presentation by click this link. While downloading, if for some reason you are not able to download a presentation, the publisher may have deleted the file from their server. During download, if you can't get a presentation, the file might be deleted by the publisher.

E N D

Presentation Transcript

  1. Chapter 16 Multijurisdictional Taxation

  2. The Big Picture (slide 1 of 3) VoiceCo, a domestic corporation, designs, manufactures, and sells specialty microphones for use in theaters. All of its activities take place in Florida But, it ships products to customers all over the United States. When it receives some inquiries about its products from foreign customers, VoiceCo decides to test the foreign market and places ads in foreign trade journals. Soon it is taking orders from foreign customers.

  3. The Big Picture (slide 2 of 3) VoiceCo is concerned about its potential foreign income tax exposure. Although it has no assets or employees in the foreign jurisdictions, it now is involved in international commerce and has many questions. Is VoiceCo subject to income taxes in foreign countries? Must it pay U.S. income taxes on the profits from its foreign sales? What if VoiceCo pays taxes to other countries? Does it receive any benefit from these payments on its U.S. tax return?

  4. The Big Picture (slide 3 of 3) VoiceCo establishes a manufacturing plant in Ireland. VoiceCo incorporates the Irish operation as VoiceCo-Ireland, a controlled foreign corporation (CFC). So long as VoiceCo-Ireland does not distribute profits to VoiceCo, will the profits escape U.S. taxation? What are the consequences to VoiceCo of being the owner of a so-called CFC? Read the chapter and formulate your response.

  5. U.S. International Tax Provisions(slide 1 of 2) Concerned primarily with two types of potential taxpayers: U.S. persons earning income from outside the United States, and Non-U.S. persons earning income from inside the United States 5

  6. U.S. International Tax Provisions(slide 2 of 2) • Can be organized in terms of: • Outbound taxation • Refers to the U.S. taxation of foreign-source income earned by U.S. taxpayers • Inbound taxation • Refers to the U.S. taxation of U.S.-source income earned by foreign taxpayers

  7. U.S. Taxation of Cross-Border Transactions

  8. Sources of Law(slide 1 of 3) • U.S. individuals and companies • Subject to both U.S. law and laws of other jurisdictions in which they operate or invest • The Internal Revenue Code addresses the tax consequences of earning income anywhere in the world • Must also comply with the local tax law of the other nations in which they operate • For non-U.S. persons, U.S. statutory law is relevant to income they earn that is connected to U.S. income-producing activities

  9. Sources of Law(slide 2 of 3) • Tax treaties exist between the U.S. and many other countries • All tax treaties are organized in the same way • Include provisions regarding the taxation of: • Investment income • Business profits from a permanent establishment (PE) • Personal service income, and • Exceptions for certain persons (e.g., athletes, entertainers, students, and teachers)

  10. Sources of Law(slide 3 of 3) • Tax treaty provisions generally override the treatment otherwise called for under the Internal Revenue Code or foreign tax statutes

  11. Authority to Tax(slide 1 of 2) • The U.S. taxes U.S. taxpayers on “worldwide” income • The U.S. allows a foreign tax credit to be claimed against the U.S. tax to reduce double-taxation (U.S. and foreign) of the same income

  12. Authority to Tax(slide 2 of 2) • Foreign persons may be subject to tax in the U.S. • Generally, subject to tax only on income earned within U.S. borders

  13. Sourcing of Income • Determining the source of income is critical in calculating the U.S. tax consequences to both U.S. and foreign persons • Numerous tax provisions address the income-sourcing rules for all types of income • These sourcing rules generally assign income to a geographic source based on the location where the economic activity producing the income took place

  14. Allocation and Apportionment of Deductions (slide 1 of 2) • Deductions and losses must be allocated and apportioned between U.S.- and foreign-source income • Deductions directly related to an activity or property are allocated to classes of income to which they directly relate • Then, deductions are apportioned between statutory and residual groupings

  15. The Big Picture – Example 8Income Sourcing (slide 1 of 2) Return to the facts of The Big Picture on p. 16-1. Assume that VoiceCo makes an overseas investment and generates $2 million of gross income and a $50,000 expense, all related to its microphone manufacturing and sales. The expense is allocated and apportioned on the basis of gross income.

  16. The Big Picture – Example 8Income Sourcing (slide 2 of 2)

  17. Allocation and Apportionment of Deductions (slide 2 of 2) • Interest expense is allocated and apportioned to all activities and property regardless of the specific purpose for incurring the debt • Allocation and apportionment is based on either FMV or tax book value of assets

  18. The Big Picture – Example 9Apportionment Of Interest Expense Return to the facts of The Big Picture on p. 16-1. Assume that VoiceCo generates U.S.- source and foreign-source gross income for the current year. VoiceCo’s assets (tax book value) are as follows. Assets generating U.S.-source income $18,000,000 Assets generating foreign-source income 5,000,000 $23,000,000 VoiceCo incurs interest expense of $800,000 for the current year. Using the tax book value method, interest expense is apportioned to foreign-source income as follows. $5,000,000 (foreign assets) $23,000,000 (total assets) X $800,000 = $173,913

  19. Foreign Tax Credit • Foreign tax credit (FTC) provisions are designed to reduce the possibility of double taxation • Allows a credit for foreign taxes paid or accrued • Credit is a dollar-for-dollar reduction of U.S. income tax liability • FTC may be “direct” or “indirect” • The FTC is elective for any particular tax year • If FTC is not elected, § 164 allows a deduction for foreign taxes paid or incurred • Cannot take a credit and deduction for same foreign taxes • In most situations the FTC is more valuable to the taxpayer

  20. Direct Foreign Tax Credit • Available to taxpayers who pay or incur a foreign income tax • Only person who bears the legal burden of the foreign tax is eligible for the direct credit • Direct credit is not available to a U.S. corporation operating in a foreign country through a foreign subsidiary

  21. Indirect Foreign Tax Credit (slide 1 of 5) • The indirect credit is available to U.S. corporations for dividends received (actual or constructive) from foreign corporations • Foreign corp pays tax in foreign jurisdiction • When foreign corp remits dividends to U.S. corp, the income is subject to tax in the U.S.

  22. Indirect Foreign Tax Credit (slide 2 of 5) • Foreign taxes are deemed paid by U.S. corporate shareholders in same proportion as dividends bear to foreign corp’s post-1986 undistributed E & P • Indirect FTC = Actual or constructive dividend X Post-1986 foreign taxes Post-1986 undistributed E & P • Corporations choosing the FTC for deemed-paid foreign taxes must gross up dividend income by the amount of deemed-paid taxes

  23. Indirect Foreign Tax Credit (slide 3 of 5) • Example • Wren Inc, a domestic corp, receives a $120,000 dividend from Finch Inc, a foreign corp. Finch paid $500,000 of foreign taxes on post-1986 E & P totaling $1,200,000 (after taxes)

  24. Example (cont’d)-Wren’s deemed-paid foreign taxes for FTC purposes are $50,000 Cash dividend from Finch $120,000 Deemed-paid foreign taxes $500,000 × $ 120,000 . 50,000 $1,200,000 Gross income to Wren $170,000 Wren includes $170,000 in gross income for the year As a result of the dividend received, Wren can claim a credit for the $50,000 in deemed-paid foreign taxes Indirect Foreign Tax Credit (slide 4 of 5)

  25. Indirect Foreign Tax Credit (slide 5 of 5) • Only available if domestic corp owns 10% or more of voting stock of foreign corp • Credit is available for 2nd and 3rd tier foreign corps if 10% ownership requirement is met at the 2nd and 3rd levels • Credit is also available for 4th through 6th tier foreign corps if additional requirements are met

  26. Limit is designed to prevent foreign taxes from being credited against U.S. taxes on U.S.-source taxable income FTC cannot exceed the lesser of: Actual foreign taxes paid or accrued, or U.S. taxes (before FTC) on foreign-source taxable income, calculated as follows: U.S. tax × Foreign-source taxable income before FTC Worldwide taxable income Foreign Tax Credit Limitations (slide 1 of 3)

  27. Foreign Tax Credit Limitations (slide 2 of 3) • Limitation can prevent total amount of foreign taxes paid in high-tax jurisdictions from being credited • Generating additional foreign-source income in low, or no, tax jurisdictions could alleviate this problem • However, a separate limitation must be calculated for certain categories (baskets) of foreign source income

  28. Foreign Tax Credit Limitations (slide 3 of 3) • For tax years beginning after 2006, there are only two baskets: • Passive income, and • All other (general) • The FTC limitations can result in unused (noncredited) foreign taxes for the tax year which may be carried over • Carryback period is 1 year • Carryforward period is 10 years

  29. The Big Picture – Example 13Foreign Tax Credit Limit (slide 1 of 2) Return to the facts of The Big Picture on p. 16-1. Assume that VoiceCo invests in the bonds of non-U.S. corporations. VoiceCo’s worldwide taxable income for the tax year is $1,200,000, consisting of $1,000,000 of profits from U.S. sales, and $200,000 of interest income from foreign sources. All of the foreign income is in the passive basket. Foreign taxes of $90,000 were withheld by tax authorities on these interest payments.

  30. The Big Picture – Example 13Foreign Tax Credit Limit (slide 2 of 2) VoiceCo’s U.S. tax before the FTC is $420,000 $1,200,000 X 35%. Its FTC is limited to $70,000. $420,000 X ($200,000/$1,200,000). Thus, VoiceCo’s net U.S. tax liability on this income is $350,000 after allowing the $70,000 FTC. The remaining $20,000 ($90,000 foreign tax paid - $70,000 FTC benefit) of foreign taxes may be carried back one year or forward 10 years, for use within the passive basket.

  31. Controlled Foreign Corporations (slide 1 of 4) • To minimize current tax liability, taxpayers often attempt to defer the recognition of taxable income • One way to do this is to shift the income-generating activity to a foreign entity that is not within the U.S. tax jurisdiction. • A foreign corporation is the most suitable entity for such an endeavor • Because of the potential for abuse, Congress has enacted various provisions to limit the availability of deferral

  32. Controlled Foreign Corporations (slide 2 of 4) Pro rata share of Subpart F income generated by a controlled foreign corporation (CFC) is currently included in income of U.S. shareholders 32

  33. Controlled Foreign Corporations (slide 3 of 4) • Examples of Subpart F income include: • Passive income such as interest, dividends, rents, and royalties • Sales income where neither the manufacturing activity nor the customer base is in the CFC’s country and either the property supplier or the customer is related to the CFC • Service income where the CFC is providing services on behalf of its U.S. owners outside the CFC’s country

  34. Controlled Foreign Corporations(slide 4 of 4) • A CFC is any foreign corp in which > 50% of total voting power or value is owned by U.S. shareholders on any day of tax year • U.S. shareholder is a U.S. person who owns (directly or indirectly) 10% or more of voting stock of the foreign corp

  35. Transfer Pricing Example (slide 1 of 3) §482 gives the IRS the power to reallocate income, deductions, credits or allowances between or among related persons when Necessary to prevent the evasion of taxes, or To reflect income more clearly The IRS can use this power to address perceived abuses, as reflected in the following transfer pricing example. 35

  36. Transfer Pricing Example (slide 2 of 3) 36

  37. Transfer Pricing Example (slide 3 of 3) 37

  38. Inbound Issues (slide 1 of 2) • Generally, only the U.S.-source income of nonresident alien individuals and foreign corporations is subject to U.S. taxation • A person is treated as a resident of the U.S. for income tax purposes if he or she meets either: • The green card test, or • The substantial presence test • If either test is met, the individual is deemed a U.S. resident for the year • A foreign corp is one that is not domestic

  39. Inbound Issues (slide 1 of 2) • Generally, only the U.S.-source income of nonresident alien individuals and foreign corporations is subject to U.S. taxation • A person is treated as a resident of the U.S. for income tax purposes if he or she meets either: • The green card test, or • The substantial presence test • If either test is met, the individual is deemed a U.S. resident for the year • A foreign corp is one that is not domestic

  40. Inbound Issues (slide 1 of 2) • Generally, only the U.S.-source income of nonresident alien individuals and foreign corporations is subject to U.S. taxation • A person is treated as a resident of the U.S. for income tax purposes if he or she meets either: • The green card test, or • The substantial presence test • If either test is met, the individual is deemed a U.S. resident for the year • A foreign corp is one that is not domestic

  41. Inbound Issues (slide 2 of 2) The United States may also tax the foreign-source income of nonresident alien individuals and foreign corporations when that income is effectively connected with the conduct of a U.S. trade or business. 41

  42. U.S. Taxation of Nonresident Aliens (slide 1 of 3) • Non-resident alien income not “effectively connected” with U.S. trade or business • Includes dividends, interest, rents, royalties, etc • 30% tax must be withheld by payor of income, unless this rate is reduced by treaty with the payee’s country of residence • No deductions can offset this income

  43. U.S. Taxation of Nonresident Aliens (slide 2 of 3) • Example: German resident earns $1,000 dividend from U.S. corporation • Absent a U.S.-German treaty, $300 U.S. tax is withheld, and the German resident receives $700 • Treaties frequently reduce the withholding rates on dividends and interest • The payor corporation remits the tax to the IRS

  44. U.S. Taxation of Nonresident Aliens (slide 3 of 3) • Non-resident alien income effectively connected with U.S. trade or business • This income is taxed at the same rates that apply to U.S. citizens • Deductions for expenses related to the income may be claimed

  45. U.S. Taxation of Nonresident Aliens (slide 3 of 3) • Non-resident alien income effectively connected with U.S. trade or business • This income is taxed at the same rates that apply to U.S. citizens • Deductions for expenses related to the income may be claimed

  46. U.S. Taxation of Nonresident Aliens (slide 3 of 3) • Non-resident alien income effectively connected with U.S. trade or business • This income is taxed at the same rates that apply to U.S. citizens • Deductions for expenses related to the income may be claimed

  47. U.S. Taxation of Nonresident Aliens (slide 3 of 3) • Non-resident alien income effectively connected with U.S. trade or business • This income is taxed at the same rates that apply to U.S. citizens • Deductions for expenses related to the income may be claimed

  48. State Income Taxation • 46 states and District of Columbia impose a tax based on corp’s taxable income • Majority of states “piggyback” onto Federal income tax base • Essentially, they have adopted part or all of the Federal tax provisions

  49. UDITPA and the Multistate Tax Commission • Uniform Division of Income for Tax Purposes Act (UDITPA) is a model law relating to assignment of income among states for multistate corps • Many states have adopted UDITPA either by joining the Multistate Tax Commission or modeling their laws after UDITPA

  50. UDITPA and the Multistate Tax Commission • Uniform Division of Income for Tax Purposes Act (UDITPA) is a model law relating to assignment of income among states for multistate corps • Many states have adopted UDITPA either by joining the Multistate Tax Commission or modeling their laws after UDITPA

More Related