2024 Chapter 13 PPT.pptx

2024 Edition Chapter 13 The U.S. Taxation of Multinational Transactions Taxation of Business Entities © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC. Learning Objectives 1. Describe the basic U.S. framework for taxing mult...

2024 Edition Chapter 13 The U.S. Taxation of Multinational Transactions Taxation of Business Entities © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC. Learning Objectives 1. Describe the basic U.S. framework for taxing multinational transactions and the role of the foreign tax credit limitation. 2. Apply the U.S. source rules for common items of gross income and deductions. 3. Explain the role of income tax treaties in international tax planning. 4. Identify creditable foreign taxes and compute the foreign tax credit limitation. © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC. 13-2 U.S. Framework for Taxing Multination al Transaction s (1 of 12)  The United States taxes citizens, residents, and certain U.S. corporations on their worldwide income and nonresidents on their U.S. source income.  In the Tax Cuts and Jobs Act, Congress moved the worldwide approach toward a territorial approach for U.S. corporations earning foreign-source income through 10 percent-or-more owned foreign corporations.  Congress also added a new antideferral provision (GILTI) that prevents income earned in excess of a “normal rate of return” (10 percent) from being excluded from income. © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC. 13-3 U.S. Framework for Taxing Multination al Transaction s (2 of 12)  The criteria chosen by a government to assert its right to tax a person or transaction is called nexus.  Source-based jurisdiction  The United States taxes only the U.S. source income of non-U.S. resident individuals and foreign corporations. © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC. 13-4 U.S. Framework for Taxing Multination al Transaction s (3 of 12)  Residence-based jurisdiction  The United States taxes the worldwide income of U.S. citizens and residents (individuals).  Primary jurisdiction: U.S. source income  Residual jurisdiction: non-U.S. source income © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC. 13-5 U.S. Framework for Taxing Multination al Transaction s (4 of 12)  U.S. Taxation of a Nonresident  U.S. source income earned by a nonresident is classified into two categories:  Effectively connected income (ECI)  Taxed on a net basis (gross income − deductions) at 21 percent  Fixed, determinable, annual, or periodical gains, profits, and income (FDAP)  Taxed on a gross basis through a flat withholding tax (0–30%) © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC. 13-6 U.S. Framework for Taxing Multination al Transaction s (5 of 12)  Definition of a resident for U.S. tax purposes  A noncitizen is treated as a U.S. resident alien for income tax purposes if the individual is a permanent resident (green card test) or meets a physical presence test (substantial presence test). © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC. 13-7 U.S. Framework for Taxing Multination al Transaction s (6 of 12)  Substantial presence test  The individual is physically present in the United States for at least 31 days during the current year, and  Days present in the current year + (1/3 × number of days during first preceding year) + (1/6 × number of days during the second preceding year) ≥ 183. © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC. 13-8 Example U.S. Framework for Taxing Multination al Transaction s (7 of 12) Lars is a citizen of Belgium. He has a full-time job in Belgium and has lived there with his family for the past 30 years. In 2020, Lars came to the United States for business and stayed for 210 days. Lars came to the United States again on business in 2021 and stayed for 180 days. In early 2022 he came back to the United States on business and stayed for 90 days. Does Lars satisfy the 183-day test for purposes of the substantial presence test in 2022? © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC. 13-9 Answer: Yes. Lars meets the 31day test in 2022. U.S. Framework for Taxing Multination al Transaction s (8 of 12) 185, computed as 90 + 1/3 (180) + 1/6 (210)  fewer than 183 days in 2022, could argue “closer connection” to Belgium  Also, the “tiebreaker” rules of Article 4 of the U.S.–Belgium treaty would treat Lars as a resident of Belgium for tax purposes because he has his permanent home there. © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC. 13-10 U.S. Framework for Taxing Multination al Transaction s (9 of 12)  Overview of U.S. foreign tax credit (FTC) system  The U.S. tax rules mitigate the double taxation of foreign source income earned by a U.S. person (U.S. and host country) through the FTC system.  To preserve the U.S. right to assert primary taxing jurisdiction over U.S. source income, the FTC is limited to the U.S. tax that would be paid had the income been earned in the U.S. © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC. 13-11 U.S. Framework for Taxing Multination al Transaction s (10 of 12)  The mechanism through which this principle is achieved is the foreign tax credit limitation.  FTC limitation formula © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC. 13-12 U.S. Framework for Taxing Multination al Transaction s (11 of 12)  The FTC limitation is computed separately for four primary categories (“baskets”) of foreign source income:  Foreign branch income  Global intangible low-taxed income  Passive income  General income © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC. 13-13 U.S. Framework for Taxing Multination al Transaction s (12 of 12)  A taxpayer can carry an excess FTC for the current year that arises in the branch, passive, or general basket back one year (mandatory) and then forward 10 tax years.  An excess FTC that arises in the GILTI basket cannot be carried back or forward.  No FTC is allowed on income eligible for the 100 percent DRD. © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC. 13-14 U.S. Source Rules for Gross Income (1 of 8)  Multinational transactions require taxpayers to determine the jurisdictional source of their gross income.  Source-of-income rules  Determine if income or deductions are treated as U.S. source or foreign source.  For a U.S. taxpayer, the source rules primarily determine foreign source taxable income in the calculation of the FTC limitation. © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC. 13-15 U.S. Source Rules for Gross Income (2 of 8)  For a non-U.S. taxpayer, the source rules determine what income is subject to U.S. taxation.  The source rules are definitional in nature—they do not impose a tax liability, create income, or allow a deduction. © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC. 13-16  Interest U.S. Source Rules for Gross Income (3 of 8)  General rule: the source of interest income is determined by the residence of the borrower at the time the interest is paid.  Although interest income paid by a U.S. bank to a nonresident is U.S. source income, it is exempt from U.S. withholding or other income taxation under section 871(i).  This exception is designed to attract foreign capital to U.S. banks. © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC. 13-17  Dividends U.S. Source Rules for Gross Income (4 of 8)  Source of dividend income is determined by the residence of the corporation paying the dividend.  Compensation for services  Source is determined by the location where the service is performed.  Compensation for “labor and personal services” includes:  Activities of employees, independent contractors, artists, entertainers, and athletes. © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC. 13-18  Limited commercial traveler exception U.S. Source Rules for Gross Income (5 of 8)  Individual was present in the United States for not more than 90 days during the current taxable year.  Compensation for the services does not exceed $3,000.  Services are performed for a nonresident alien, foreign corporation, or foreign partnership or for the foreign office of a domestic corporation.  Treaties often modify the exempt compensation amounts and the maximum length of stay.  Maximum amount of compensation: Unlimited  Length of stay modification: Not more than 183 days © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC. 13-19  Rents and royalties U.S. Source Rules for Gross Income (6 of 8)  Rent has its source where the property generating the rent is located.  Royalty income has its source where the intangible property or rights generating the royalty is used.  Gain on the sale of realty is sourced based on where the property sold is located. © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC. 13-20 U.S. Source Rules for Gross Income (7 of 8)  Gain or loss from sale of purchased personal property including investments such as stocks  Has its source based on the seller’s residence  Exception—gross income from the sale of purchased inventory is sourced where title passes © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC. 13-21 U.S. Source Rules for Gross Income (8 of 8)  Inventory produced within the United States and sold outside the United States (§863(b) sales)  Taxpayer sources the gross income from sales based on where the assets to manufacture the inventory are located. © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC. 13-22  Source-of-deduction rules U.S. Source Rules for Deductions (1 of 3)  General principles of allocation and apportionment  Definitely related deductions  Not definitely related deductions  Sourced based on a factual relation between the expense and the “class” of income with which it is associated  Advertising expenses related to sale of merchandise © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC. 13-23  Special apportionment rules U.S. Source Rules for Deductions (2 of 3)  Apply to nine categories of deductions  Interest, research and experimental expenses, stewardship expenses, supportive expenses, state and local income taxes, losses on property disposition, legal and accounting fees, charitable contributions © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC. 13-24 U.S. Source Rules for Deductions (3 of 3)  Interest expense (after limitation under §163(j)) is allocated to all gross income using as a basis the assets that generated such income.  Interest can be apportioned based on average tax book value (most common) or average adjusted tax book value (tax basis using ADS election). © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC. 13-25  Treaties are designed to encourage cross-border trade by reducing the double taxation of such income by the countries that are parties to the treaty. Treaties  Treaties define when a resident of one country has nexus in the other country.  Treaties reduce or eliminate the withholding tax imposed on cross-border payments such as interest, dividends, and royalties. © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC. 13-26 Foreign Tax Credits (1 of 7)  Only income taxes can be claimed as a credit on a U.S. tax return.  The current-year foreign tax credit cannot exceed the FTC limitation in each category (“basket”) of foreign source income. © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC. 13-27  Creditable foreign taxes Foreign Tax Credits (2 of 7)  Direct taxes (paid by the taxpayer directly)  In lieu of taxes (withholding taxes imposed on FDAP income paid to the taxpayer) © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC. 13-28  Four categories of FTC income  Passive category income Foreign Tax Credits (3 of 7)  Investment-type income that traditionally is subject to low foreign taxes  Includes interest, certain dividends, rents, royalties, and annuities © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC. 13-29  Foreign branch company income Foreign Tax Credits (4 of 7)  Branch income is income earned through unincorporated “business enterprises” outside the United States (actual branch or a disregarded entity treated as a branch for U.S. tax purposes). © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC. 13-30 Example—USCo operates through a low-tax branch LoTax income $200.00 × U.S. rate × Pre-credit U.S. tax - FTC Net U.S. tax 21% $ 42.00 − 25.00 $200 income $ 17.00 LoTax tax = $25 FTC limitation = $200/$200 × $42 = $42 Excess “limitation” = $17.00 ($42 − $25) Worldwide ETR on the branch income = $42/$200 = 21% Foreign Tax Credits (5 of 7) © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC. 13-31  Global low-taxed intangible income (GILTI) Foreign Tax Credits (6 of 7)  TCJA created a new category of income not eligible for deferral called global intangible lowtaxed income.  There is an 80 percent limitation on the creditability of foreign income taxes associated with GILTI.  The GILTI inclusion is “grossed up” by 100 percent of the foreign income taxes associated with GILTI.  The GILTI basket includes GILTI and the associated gross-up amount under §78. © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC. 13-32  General category income Foreign Tax Credits (7 of 7)  Any foreign source income that is not classified as passive category income, GILTI, or foreign branch income is pooled in the general category income FTC basket. © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC. 13-33 End of Presentation © McGraw Hill LLC. All rights reserved. No reproduction or distribution without the prior written consent of McGraw Hill LLC. 13-34