Chapter 5 Solution - Unit 5 FOREIGN TAX CREDIT THE DEEMED...

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Unit 5 FOREIGN TAX CREDIT: THE “DEEMED PAID” CREDIT A. CODE AND REGULATION PROVISIONS Code §§ 78; 902(a), (b). Reg. §§ 1.902-1(a)(1)–(5),(a)(9)(iii), (b)(1). B. PROBLEMS FOR CLASS DISCUSSION 5-1. Throughout Year 1, USC, a domestic corporation, owned all of the shares of the single class of stock of FC, a Fijian corporation formed on January 1, Year 1. FC engages in the manufacture of machinery in Fiji. The machinery is sold by FC in Fiji. FC had gains, profits, and income of $100,000 for Year 1 and paid foreign income taxes imposed on those gains, profits, and income of $40,000. On December 31, Year 1, FC paid a dividend of $30,000 to USC. What is USC’s taxable income and net United States tax liability with respect to the dividend, assuming that USC’s United States tax rate is 35 percent? 5-1. USC HAS $50,000 IN TAXABLE INCOME AND A UNITED STATES TAX LIABILITY OF $0, PLUS A CARRYOVER OF $2,500 IN EXCESS FOREIGN TAX CREDITS. In contrast to branch operations for which a corporation is entitled to credit any foreign income taxes paid by its branch, operations through a separate foreign subsidiary do not automatically give rise to a foreign tax credit. The subsidiary is a separate taxable entity and is generally not subject to United States taxation on its foreign income. Even though the net earnings of the subsidiary reflect a reduction for foreign taxes paid, the parent corporation is not the taxpayer responsible for the payment of the tax. Therefore, it cannot qualify for a § 901 (direct) credit. 5-1. In the parent-subsidiary setting, there are two possibilities for foreign tax to be imposed: (1) a tax on the foreign subsidiary by a foreign jurisdiction as it earns income and (2) a withholding tax by a foreign jurisdiction on the payment of dividends by the foreign subsidiary to the parent company. The former requires the use of § 902 for foreign tax credit purposes, while the latter, which is actually a tax on the income of the parent company, requires the use of § 901. As no foreign withholding taxes are imposed on the dividends in the facts presented, the focus of the calculations is on § 902.
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