Chapter 11 international taxation

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  Ta

Chapter 11:

International Taxation

Learning Objectives

 Describe differences in corporate income tax and

withholding tax regimes across countries

 Explain how overlapping tax jurisdictions cause

 Describe tax incentives provided by countries to

attract foreign direct investment and stimulate

exports

Impact of Taxes—International Business Decisions

 Impact of Taxes

 International location decisions

 Legal form of operation

 Method of financing

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

Corporate Income Tax

 Significant variation worldwide

 Provides tax planning opportunity

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

Withholding Tax Regimes

Tax J urisdiction

 Worldwide (nationality) approach

 Tax on all income of

Tax J urisdiction

 The basis of U.S taxes

 Includes income in U.S parent

 Not foreign subsidiary

 Only dividend paid taxed

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

Double taxation

 Solutions

 Adoption of territorial approach

 Exemption of foreign source income

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

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

Calculation of Foreign Tax Credit

 Complex calculation in U.S.

 FTC is lower of

 Actual taxes paid to foreign government

 Taxes if the income earned in U.S.

 Maximum FTC

 Taxes if the income earned in U.S.

 Overall FTC limit = ×U.S taxes before FTC

 Excess FTC

 Carried back one year

 Carried forward ten years

  

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 J obs Creation Act of 2004

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

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

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

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

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

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

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

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

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

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

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

American J obs Creation Act of 2004 (AJ CA)

 American J obs 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

End of Chapter 11