Deemed Paid Foreign Tax Credit U.S.A
If a domestic Corporation receives dividends from foreign Corporation it usually cannot claim a deduction for dividends received. These dividends will be treated as taxable income to Domestic Corporation.
Code Section 902 (a)
(a) Taxes paid by foreign corporation treated as paid by Domestic Corporation
For purposes of this subpart, a domestic corporation which owns 10 percent or more of the voting stock of a foreign corporation from which it receives dividends in any taxable year shall be deemed to have paid the same proportion of such foreign corporation’s post-1986 foreign income taxes as—
(1) The amount of such dividends (determined without regard to section 78), bears to
(2) Such foreign corporation’s post-1986 undistributed earnings.
Deemed paid foreign tax credit protects domestic corporations, that have foreign subsidiaries, from double taxation. Domestic parent company can claim a foreign tax credit for any withholding tax paid dividends.
Structure of TIER Corporations.
In a typical setup, tier 2 companies supply companies in tier 1. Tier 3 companies will supply to tier 2 corporations and so on. If a domestic company operates through different tiers of foreign corporations, it may qualify to claim deemed paid credits for taxes paid by second through sixth tier foreign corporations. U.S Citizens, permanent residents and “S” corporations cannot claim deemed paid foreign tax credit.
Domestic corporations that deduct taxes by their foreign subsidiaries must gross up their dividend income by the amount deemed paid foreign taxes to avoid double taxation.
If a foreign corporation is operating in a high tax jurisdiction there will be no tax due on dividends paid by this corporation. It is because the available deemed paid foreign tax credits will exceed the pre credit U.S Tax.
Code Section 904 (d) (3)
According to this code section controlled foreign corporations look through rules can make it possible to cross credit dividends from low tax and high tax jurisdictions. The excess credit on dividends can be used to offset balance tax payable on dividends from low tax foreign subsidiaries.
Domestic companies can also use tax treaties for reduction of foreign taxes. Once can own a foreign subsidiary through a foreign holding company located in treaty favorable jurisdiction.
Foreign subsidiaries can repatriate earnings through interest or royalty payments instead of dividends. This way it becomes a foreign tax deduction for the foreign corporation. However, Domestic Corporation may lose deemed paid credit advantage by this transaction.
Disclaimer:
This information is for educational purposes only. It does not constitute any legal advice or opinion. Please do not use any of its contents without seeking a professional advice.
References:
www.jct.gov/publications.html
http://www.law.cornell.edu
http://www.irs.gov/publications
U.S Taxation of International Transactions by Robert J. Misey, Michael S. Schadewald
Introduction to United states International Taxation by Paul R. McDaniel, Hugh j. Ault and James R. Repetti
International Taxation by Joseph Isenbergh
International Taxation in a nutshell by Richard L. Doernberg.
International Income Taxation, Code and Regulations by Robert J. Peroni – CCH
Mansoor Suhail (Mani)
Accountant
BSBA – EA – ICIA – RA
Tax for Canada and U.S.A
Web: www.theaccountingandtax.com and www.taxservicesguru.com
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