Foreign Tax Credit Research Articles

All of a Piece Throughout: The Four Ages of U.S. International Taxation

This paper divides up the history of U.S. international taxation into four periods, on the basis of what was the basic theoretical principle underlying the major legislative enactments made in each period. The first period lasted from the adoption of the Foreign Tax Credit in 1918 to the end of the Eisenhower administration, and was dominated by the concept of the right to tax as flowing from benefits conferred by the taxing state. The second period lasted from 1960 until the end of the Carter administration and was dominated by the concept of capital export neutrality and an emphasis on residence-based taxation. The third period lasted from 1981 until 1997, and was driven by the need to preserve the competitiveness of the U.S. economy in an increasingly globalized marketplace, resulting in an emphasis on source-based taxation, albeit with significant exceptions. The last period began with the decision to cooperate with the OECD's harmful tax competition project in 1998, and is marked by a continuous attempt to coordinate residence and source taxation to prevent both double taxation and double non-taxation. Three general observations can be made on this evolution: 1. In some ways, surprisingly little has changed in the course of the last hundred years: U.S. international taxation is still dominated by the need to balance the desire to prevent both double taxation and complete tax avoidance with sustaining the competitive position of U.S. businesses. 2. Although it is possible to detect some measure of cyclicality, in that the emphasis shifts from source to residence to source and back to residence again, the underlying balance does not shift very significantly, and the various theories advanced appear more as convenient support for pre-existing policy preferences than the real reason for policy changes. 3. On the basis of the history, it seems unlikely that the U.S. will in the near future make a clean break with the past either by abandoning all source-based taxation of foreigners or all residence-based taxation of U.S. persons.

Letter to OECD Beps (Base Erosion and Profit-Shifting) - Recommending Approach to Change Behavior of Multinationals Re Profit Shifting into Low-Tax Countries

The OECD through its BEPS initiative should strongly recommend to OECD member and non-member countries that they abandon the territorial and deferral systems that they currently use. To replace these systems, they would implement full-inclusion systems under which all foreign income, including profits in foreign subsidiaries, would be currently taxed by each MNE’s home country. A foreign tax credit mechanism would prevent double-taxation.This action would eliminate or significantly reduce the motivation of multinationals to shift profits into tax havens and other low-tax countries. As such, there would be significantly reduced MNE profit-shifting structures that erode the tax bases of all countries and require considerable time and resources of all tax authorities as well as of the multinationals that must create and maintain complicated supply-chain and other tax-motivated structures.Other benefits include an expanded tax base for all countries, simplification through elimination of home country transfer pricing issues and need for CFC rules, and a more level-playing field competitively both for competition between multinationals headquartered in different countries and for competition between pure domestic companies and multinationals headquartered in that country. And the expanded tax base could allow a reduction in the overall corporate tax rate, a factor that could make the change to this full-inclusion system more politically acceptable.The basic concept is simple. By being subject to current home-country taxation on its worldwide earnings, a multinational’s motivation for complicated structures that shift profits into tax havens from countries where operations, sales and services take place is significantly reduced or eliminated.

Book Reviews

Book Reviews

Double or Nothing: A Tax Treaty for the 21st Century

The current tax treaty network was developed in the 1920s and 1930s in order to prevent double residence/source taxation. This kind of double taxation rarely exists any more because most countries have adopted either an exemption system or a foreign tax credit regime in their domestic (non-treaty) law, which effectively prevents residence/source double taxation even in the absence of a treaty. Instead, as Tsilly Dagan has pointed out, the current treaties serve mostly to transfer revenue from the source country to the residence country. This suggests that treaties may be unnecessary because exemption from withholding taxes by source countries can be done unilaterally. However, in the era of globalization (post 1980), the treaties have developed two new functions, both of which apply primarily to individual taxpayers: First, to prevent double non-taxation by ensuring that withholding taxes are collected if there is no assurance of taxation by the residence country. Second, to enforce residence based taxation of individuals by having source countries provide information to residence countries about income derived by their residents in the source country. The paper proposes ways to update the US model treaty to reflect these new functions.

Foreign Tax Credit – Is a Carry-Forward Obligatory?

The authors, in this article, explore what could be the legal basis for the granting of a tax credit carry-forward in respect of foreign taxes, with emphasis on the three legal bases for this, i.e. national law, EU law and treaty law.

Foreign Tax Credit versus Foreign Earned Income Exclusion Under the New Law

This paper deals with the recent new law concerning foreign earned income exclusion and foreign housing cost allowance exclusion. It points out that the former is $95,100 in 2012, while the latter has a certain limit depending on the location in the world. Nevertheless, both exclusions do not give rise to the reduction of marginal tax rate. Instead, a taxpayer’s tax bracket is determined as if no exclusions were taken. This new tax rule has far-reaching consequences on a U.S. expatriate’s foreign tax credit and tax liability. This paper demonstrates many examples. It also investigates the problem of foreign qualified dividend in determining foreign tax credit. This paper further develops many tax planning strategies for foreign tax credit. The decision depends on whether a foreign country has high or low income and tax rate.

The European Court of Justice in Banco Bilbao: You Can't Have Your Cake and Eat It Too

This note examines the recent decision of the ECJ in the Banco Bilbao case, wherein the Court addressed the issue of the free movement of capital in the context of the denial of a foreign tax credit in Spain for withholding tax that was not actually paid, but was exempted, in the source state (Belgium).

The New US Foreign Tax Credit Rules

In this article, the authors consider the most recent in a long line of changes to the US foreign tax credit rules, as well as the implications of the changes.

Structuring a tax efficient international operation

Abstract International taxation is rapidly increasing in importance in the U.S. business environment. As a student preparing for a career in public accounting or industry, it is vital that you have familiarity with key international tax issues. In this case, you will participate in a detailed tax-planning exercise involving a multinational corporation that is restructuring its tax operations. In the process, you will be exposed to a wide-ranging array of real-world tax issues: tax theory, source of income, transfer pricing, foreign tax credits, the foreign earned income exclusion and Subpart F income. The case also incorporates questions designed to help you explore the financial accounting implications of tax planning. The case consists of three tax modules and each module emphasizes two to three specific tax issues. Two of the modules also contain a subset of tax-related financial accounting questions. To complete the case successfully, you will be required to understand basic international tax theory, to engage in the tax research process and to apply your theoretical knowledge in analyzing complex business scenarios.

Key Practical Issues To Eliminate Double Taxation of Business Income

The author provides a detailed description of the Japanese foreign tax credit system and critically analyses the issues that arise in applying the system to taxpayers.

The Foreign Tax Credit Pooling System

This article provides a brief description of recent reform to Singapore’s foreign income taxation regime and highlights the features of the new foreign tax credit pooling system.

Repos, the Technical Taxpayer Rules, and Foreign Tax Credit Splitter Rules (Section 909)

Sale-and-repurchase transactions (“repos”) are financing transactions used primarily to transfer cash from one party, typically a party that wants to lend money on a short-term secured basis, to a second party, in exchange for (usually) highly rated and very liquid securities like U.S. Treasury obligations that are temporarily transferred from the second party to the first party. They are an essential component of the capital markets, regularly used by the Federal Reserve Bank of New York, financial institutions and institutional investors. Trillions of dollars worth of repos are outstanding at any moment in time. One might think, as a result, that the U.S. tax rules for repos are well-established and non-controversial.In the case of repos on securities that are subject to non-U.S. withholding tax, however, that is not the case. Examples of repos of this kind are repos on stock that pays dividends subject to withholding tax and repos on corporate bonds that pay interest subject to withholding tax. An important question for repos of this kind is which party to the repo is treated as paying the withholding tax, because that is the taxpayer that is entitled to credit or otherwise benefit from the tax. Ordinarily the tax rules treat the same taxpayer that earns income that is subject to withholding tax as the taxpayer liable for the tax – that is, the income and the related tax are both attributable to the same taxpayer. This article first discusses the current U.S. tax rules that apply to repos of this kind. It then describes a proposal that the government has made to change (or, arguably, clarify) current law (under section 901 of the Internal Revenue Code) in a way that could prevent the taxpayer that earns the interest or dividends on a repoed security from obtaining a credit or other benefit from the related withholding tax, by treating different taxpayers as earning the income and paying the tax (a “foreign tax credit splitter”). Foreign tax credit splitters are generally considered contrary to good tax policy. The article then discusses several other provisions of the Code that the government might use to fix the foreign tax credit splitter problem that it has proposed to create (sections 901(k), 901(l) and newly enacted section 909), and concludes that these rules do not solve the problem. The article ends by recommending a modest change to the government’s section 901 proposal to clarify the law and provide appropriate rules for conventional repo transactions.

Cash Drain Transactions and Tax Deductibility of Certain Expenses

The Belgian tax authorities have had increasing success in challenging perceived abusive foreign tax credit schemes. This article considers the current state of those challenges, as well as a recent decision of the Brussels Court of First Instance involving a foreign tax credit scheme and the deductibility of certain expenses and losses.

The Case Against Foreign Tax Credits

In international tax policy debate, it is usually assumed that, if one chooses not to exempt residents’ foreign source income, the preferred system would offer foreign tax credits. This assumption is mistaken, given the bad incentives created by the credits’ marginal reimbursement rate (MRR) of 100 percent and the unpersuasiveness of common rationales for granting them, such as those based on aversion to ‘‘double taxation’’orsupport forcapital exportneutrality.While taxingforeign source income at the full domestic rate with only deductions for foreign taxes would overtaxoutboundinvestment,atleast in principal creditability is dominatedbya burdenneutral shift to deductions plus a reduced tax rate for such income. And even if such a shift is unfeasible or unwise, the incentive problems resulting from a 100 percent MRR for foreign taxes paid may illuminate various more practical tax issues, such as the merits of (1) shifting to an exemption system,which features implicit deductibility, and (2) various proposed reforms, such as removing disincentives in subpart F for foreign tax planning by U.S. multinationals.

Multi-Jurisdictional Tax Incentives and the Location of Innovative Activities

Research and development (R&D) tax incentives offered by foreign countries and differences between U.S. and foreign tax rates provide opportunities that may affect the location of U.S. multinationals' innovative activities. Using firm-level patenting data to help identify the country-specific location of innovations from 1986 to 2000, I examine the relation between innovative activities performed in a foreign country and these tax incentives. I find evidence that the foreign percentage of innovative activities is associated with the attractiveness of foreign R&D tax incentives. In addition, the results suggest that firms in excess foreign tax credit positions decrease the amount of R&D activities in a foreign location with increased foreign tax rates, consistent with income shifting incentives. In contrast, I find that the firms in deficit foreign tax credit positions increase their foreign R&D activities with increasing foreign tax rates.

Implications Of The Selection Of A Method To Allocate State Income Taxes In Order To Determine Net Foreign-Source Income

Internal Revenue Code Sections 861-864 determine the source of income and Sections 861(a) and 862(a) specifically allocate certain items of gross income to sources within or without the United States. Sections 861(b) and 862(b) state generally how to determine taxable income for a taxpayer with income sources within or without the United States after such source has been determined. Regulation § 1.861-8 provides more information on allocating state and local taxes to U.S. - and foreign-source income. Regulation § 1.861-8 is based on the factual relationship of deductions to gross income test. This Regulation provides a concise rule requiring that the deduction for state, local, and foreign income, war profits, and excess profits taxes under Section 164 are definitely related and allocable to the gross income with respect to which such taxes are imposed. Under Regulation § 1.861(e)(6) if foreign-source of a corporation related by ownership to a corporate taxpayer is attributed to the activities conducted by the taxpayer in a state and is subject to state income tax, as in a state unitary income tax, the state tax deduction is allocable to the foreign-source income of the related corporation for purposes of the foreign tax credit used § 904. This paper first considers the most common methods for allocating state income taxes, the presumptive, analytic, and state-by-state methods. In the Chevron case, the Tax Court was asked to consider whether any of the following methods comply with the regulations; these methods are the gross income, factor operations, statutory notice, the pro rata, and the example methods. This paper will also consider the requirements and validity of related regulations.

The Paradox of Gross Taxation at Source

Taxation at source on a gross basis is not just a form of double taxation but a tax obstacle to cross-border income flows in its own, and with even more detrimental consequences. Unlike double taxation, gross taxation can by itself render profitable transactions loss-making and remains unrelieved domestically. Paradoxically, and while residence countries unilaterally relieve double taxation but increasingly limit their foreign tax credit by reference to the net income, the international tax framework remains focused on double taxation. Where taxpayers most require protection is where the international tax framework has less to offer, prompting taxpayers to adopt ‘defensive tax planning’ and gross-up clauses as their sole protection against what may be the main tax obstacle to international flows today.

RETHINKING FOREIGN TAX CREDITABILITY

International tax policy experts often mistakenly conflate two distinct margins: (1) the overall tax burden on outbound investment, and (2) the marginal reimbursement rate (MRR) for foreign taxes paid, which is 100 percent under a foreign tax credit system, but equals the marginal tax rate for foreign source income under an explicit or implicit deducibility system (such as exemption). From a unilateral national welfare standpoint, whatever the right answer at margin (1), deducibility is clearly optimal, and creditability dangerously over-generous, at margin (2).

Rethinking Foreign Tax Creditability

International tax policy experts often mistakenly conflate two distinct margins: (1) the overall tax burden on outbound investment, and (2) the marginal reimbursement rate (MRR) for foreign taxes paid, which is 100 percent under a foreign tax credit system, but equals the marginal tax rate for foreign source income under an explicit or implicit deductibility system (such as exemption). From a unilateral national welfare standpoint, whatever the right answer at margin (1), deductibility is clearly optimal, and creditability dangerously over-generous, at margin (2).

Double Taxation of Foreign Dividends: The Damseaux Case Aiming at the Wrong Target! Criticism Should Be Directed towards France and Not Belgium

The Damseaux judgment of 16 July 2009 (Case C-128/08) marks the unsuccessful end of the efforts deployed by Belgian taxpayers and by the European Commission (Case C-307/08, Commission v. Belgium, presumably to be dropped shortly) to have Belgium shoulder responsibility (by way of the grant of a foreign tax credit) for the French withholding tax on outbound dividends received by Belgian taxpayers. We will review these efforts hereinafter, and the factors that appear to have led to their unsuccessful outcome. We will also argue that Mr Damseaux might have been more successful in his efforts to avoid the double taxation of his French dividends if he had, instead, lodged a claim against the French tax authorities: He could have argued that the French withholding tax is levied in breach of European law following the end of the reimbursement by the French tax authorities to Belgian resident shareholders of the French ‘Avoir Fiscal’.