OVERVIEW OF U.S.
INTERNATIONAL TAX POLICY
Presented by:
Carol Dunahoo and Peter Merrill
PricewaterhouseCoopers LLP
with Members of the
International Tax Policy Forum
July 17, 1998
1
Policy Goals
U.S. international tax policy is a
balance between capital export
neutrality (CEN) and competitiveness.
2
Capital Export Neutrality

The aim of CEN is to make sure U.S.
companies bear the same tax burden whether
they operate at home or abroad.

This could be achieved by taxing worldwide
income when earned and allowing an unlimited
credit for foreign taxes paid.
3
Capital Export Neutrality

The U.S. tax system follows CEN principles in
that it taxes worldwide income, including
income earned abroad by U.S.-owned foreign
corporations.
4
Competitiveness

Another goal of U.S. international tax policy is
competitiveness. This requires that U.S.controlled companies operating abroad pay no
more tax than their foreign competitors.
5
Competitiveness (cont.)

This could be achieved by exempting income
earned abroad from tax so that it would bear
tax only at the foreign rate. Such a system is
called a “territorial” tax system.
6
Foreign Income Taxation,
OECD Countries, 1990
No.
Territorial tax system
By statute
Austria
Belgium3
France
Finland
Luxembourg
Netherlands
Switzerland6
1
2
3
4
5
6
7
8
9
1
2
3
4
5
6
By treaty1
Australia4
Canada
Denmark5
Sweden
Germany
Worldwide tax system
By statute
Greece
Iceland
Italy
Japan
New Zealand
Spain
Turkey
U.K.
U.S.
By treaty2
Ireland
Norway
Portugal
For nontreaty countries, worldwide tax with credit.
For nontreaty countries, worldwide tax with deduction.
Exemption of 90% of gross dividend.
Treaty countries with tax system similar to Australia's.
25% ownership requirement and tax system similar to Denmark's.
Credit for Swiss tax on foreign dividends effectively exempts these dividends from
Swiss tax.
Source:
OECD, Taxing Profits in a Global Economy: Domestic and International Issues, 1991,
pp. 63-64.
7
Competitiveness (cont.)

The U.S. strikes a balance between CEN and
competitiveness.

It taxes the worldwide income of U.S.
companies, but promotes competitiveness by
generally deferring U.S. tax on the foreign
income earned by U.S. companies doing
business abroad.
8
Fundamental Concepts

The United States taxes the worldwide income
of U.S. persons
– U.S. corporations
– U.S. citizens
– U.S. residents
9
Choice of Structure

Two Possibilities:
– U.S. person may conduct foreign activities:

directly (through a branch or partnership)

indirectly (through a foreign corporation)

Both direct and indirect activities may be
conducted through a “hybrid entity”

Business considerations for choice of
structure
10
International Double Taxation

If there were no mechanism for avoiding
double taxation, U.S. persons could be subject
to double taxation, both by the foreign country
in which they do business and by the United
States.

Foreign taxes include:
– income taxes
– withholding taxes
11
Foreign Tax Credit:
Law and Policy
12
Purpose of Foreign Tax Credit

Alleviates double taxation of foreign source
income.

The foreign tax credit (FTC) is a dollar-fordollar offset of the foreign tax against U.S. tax
on foreign source income (subject to
numerous limitations).

Only certain types of foreign taxes qualify for
FTC.
13
Foreign Tax Credit Limitation


The credit is limited to the amount of tax the
U.S. would have imposed on the foreign
income (and is subject to many other
restrictions).
For each “basket,” FTC is lesser of:
– Actual foreign taxes paid or accrued, and
– Amount computed under FTC formula:
U.S. tax on worldwide
Foreign source taxable income
X
taxable income
Worldwide taxable income
14
Foreign Tax Credit Baskets

A "basket" is a separate category of foreign
source income for which a separate FTC
limitation calculation must be made.

Purpose: to prevent averaging of taxes among
different types of income.
15
Foreign Tax Credit Baskets

General Limitation
Income

High Withholding Tax
Income

Passive Income

Shipping Income

Financial Services
Income

DISC Dividends

FSC Distributions

Foreign Trade Income

10-50 Dividends
(until 2002)
16
Steps to Compute
Foreign Tax Credit Limitation
1. Determine U.S. and Foreign Source Taxable
Income:
– Gross receipts (minus cost of goods sold)
– Other gross income
2. Determine Deductions Allocable to U.S. and
Foreign Income.
3. Determine Net U.S. and Foreign Source
Income.
17
Steps to Compute
Foreign Tax Credit Limitation
4. Determine FTC Category (“Basket”)
– Characterize Gross Income
– Source Gross Income
5. Allocate and Apportion Deductions among
FTC Categories of Gross Income.
6. Determine Amount of Creditable Foreign
Taxes Within Each Category.
18
Source of Income Rules
Different Source Rules for Different Types of
Income:


Income from the Sale
of Purchased
Inventory
Income from the Sale
of Manufactured
Inventory

Dividends

Interest

Rents

Royalties

Sale of Stock

Sale of Intangibles

Other
19
Expense Allocation Rules
Different Allocation Rules for Different Expenses:

Interest

Research & Development

General & Administrative

Other
20
Example 1




USCO has a foreign subsidiary in Country X that
performs services in Country X.
The subsidiary earns $1,000, on which it pays
Country X income tax at a rate of 35% ($350).
If all the Country X earnings are distributed as a
$650 dividend to USCO, USCO would be allowed
a foreign tax credit of $350.
Foreign tax credit limit =
$1,000 Foreign Income
$1,000 Taxable Income
X
$350 (U.S. tax before FTC)
= $350
21
Example 1 (cont.)

Therefore, USCO would have no net U.S. tax
liability on those earnings.

Deferral would not change this result because
there would be no U.S. tax to defer.
22
Example 2
Allocating and apportioning expenses reduces
the maximum amount of foreign tax credit a U.S.
company may receive.

Same as Example 1, except:
– The foreign subsidiary has $200 of allocable
expenses against foreign income which are not
deductible in calculating foreign-country tax.
23
Example 2 (cont.)
– If all the Country X earnings are distributed as a
$650 dividend to USCO, USCO would be allowed
a foreign tax credit of $280, leaving $70 of
foreign taxes paid for which USCO would
receive no credit.
Foreign tax credit limitation =
($1,000 Foreign Income - $200 Allocable Expenses)
$1,000 Taxable Income
X
$350
(U.S. tax before FTC)
= $280
24
Other Rules




FTC is Elective
When FTC allowed -either when paid or
when accrued
Holding period
Carryover/Carryback
Rules --2 Back and 5
Forward





Overall Foreign
Losses/Recapture
Currency Exchange
Rules
Look-thru Rules
Alternative Minimum
Tax--90% Limitation
No FTC allowed for
taxes paid/accrued to
certain foreign countries
25
Typical Obstacles to
FTC Utilization

Foreign tax rates higher than U.S. tax rate

Separate basket limitations

Required allocation and apportionment of
deductions

OFL recapture
26
Deferral:
Law and Policy
27
Deferral

U.S. generally imposes tax on worldwide
income, regardless of whether it is earned here
or abroad.

However, U.S. generally defers its tax on
foreign earnings until they are remitted.
28
Deferral

Fundamental TIMING principle of U.S. tax law.

Issue under this system is not WHETHER, but
WHEN, U.S. person will be taxed on foreign
earnings.
29
Basic Terminology

If U.S. tax is imposed as foreign earnings are
earned, the earnings are said to be subject to
"current" U.S. tax.

If U.S. tax is imposed at a later time (e.g., when
earnings are paid out to the U.S. shareholders
as dividends), U.S. tax is said to be "deferred."
30
General Rule

U.S. tax is imposed on foreign earnings when
they are earned (or deemed earned) by a U.S.
person (i.e., U.S. corporation, citizen or
resident individual).

Timing of U.S. tax thus depends on how
foreign activities are conducted.
31
If U.S. Person Conducts Foreign
Activities Directly: Current
Taxation

U.S. person is earning the amounts.

Earnings are subject to current U.S. tax.
32
If Foreign Corporation Conducts
the Foreign Activities: Deferral

Foreign person, not U.S. person, is earning the
amounts.

The U.S. cannot tax a foreign person on
foreign earnings.
33
If Foreign Corporation Conducts
the Foreign Activities (cont.)

Instead, the U.S. generally taxes U.S. owners
of the foreign entity only as earnings are
remitted to the U.S. (e.g., as dividends).

U.S. tax is deferred in this case, because it is
imposed when earnings are remitted to the
U.S. and not as they are earned by the foreign
entity.
34
Exceptions to Deferral

The general rule always has been to defer U.S.
tax on foreign earnings.

However, various exceptions to this general
rule have been enacted over the years.
– Subpart F income

Foreign personal holding company income

Foreign base company sales income

Foreign base company services income
35
Exceptions to Deferral (cont.)
– Subpart F income (cont.)

Subpart F insurance income

Subpart F shipping income

Foreign oil and gas extraction income

Foreign oil related income

Illegal payments
– Section 956 Income (investment in U.S.
property)
36
Exceptions to Deferral (cont.)
–
–
–
–

PFIC Income
Personal Holding Company Income
Foreign Personal Holding Company Income
Foreign Investment Company Income
Where an exception applies, a U.S. person may
be subject to current U.S. tax (or an interest
charge) on foreign source income, even
though it has not received the income.
37
Exceptions to Deferral (cont.)

Present law is complex because there are
many sets of potentially overlapping
exceptions.

Application of exceptions to deferral typically
has depended on two factors:
– Level of U.S. ownership
– Type of income involved
38
Policy Issues Regarding Deferral
Arguments against deferral:

“Capital export neutrality”
39
Policy Issues Regarding Deferral
Arguments for deferral for active foreign income
earned through foreign corporations:

Promotes global competitiveness of U.S.
business by providing more level playing field
vis-a-vis foreign competitors.

Does not impose tax until earnings are actually
received and taxpayer has funds to pay tax.
40
Policy Issues Regarding Deferral
(cont.)

Deferral offsets other problems in Code -– Foreign tax credit limitations
– Inability to consolidate profits and losses of
U.S. and foreign affiliates
– Less favorable depreciation and credits for
foreign activities
– Less favorable treatment of foreign losses
41
Domestic Double Taxation
of Corporate Income
in the U.S.
42
U.S. Imposes a Double Tax on
Corporate Income

U.S. shareholders in U.S. corporations are
potentially exposed to four levels of taxation:
– foreign income tax
– foreign withholding tax
– U.S. corporate tax
– U.S. individual tax
43
U.S. Imposes a Double Tax on
Corporate Income
IRS
$26.00 Shareholder Tax
(40% Rate x $65)
Shareholders
$35 Corporate Tax
(35% Rate x $100)
$65 Dividend
$100 of
Operating
Income
Company
61% Tax Rate on Corporate Income
44
Corporate Taxation in OECD
Member Countries, 1990
Classical
income
tax
Netherlands
Switzerland
U.S.
Corporate-shareholder integration
Shareholder level
Corporate level
Imputation
System
Australia
Finland
France
Germany*
Ireland
Italy
New Zealand
Norway
Turkey
U.K.
Tax credit
method
Canada
Portugal
Spain
Special personal
tax rate
Austria
Belgium
Denmark
Greece
Japan
Luxembourg
Sweden
Germany*
Iceland#
*/ Hybrid tax system (relief from double taxation at both corporate and shareholder levels).
#/ Deduction for dividends paid may offset fully the corporate and personal income tax for dividends up to
15% of capital value. Dividends in excess of this limit are fully taxed at both levels.
Sources:
Sijbren Cnossen, Reform and Harmonization of Company Tax Systems in the European Union,
Research Memorandum 9604. Erasmus University, Rotterdam.
OECD, Taxing Profits in a Global Economy: Domestic and International Issues, 1991, p. 57.
45
U.S. Investment Abroad:
Facts & Figures
46
Business Globalization is a
Worldwide Phenomenon
30
25
20
15
10
Average,
G-7
Japan
Italy
United
States
Germany
France
Canada
0
United
Kingdom
5
U.S. investment abroad (as a percentage of GDP) trails
behind the average investment rate of the Group of
Seven industrialized countries. (Source: World
Investment Report 1997, United Nations.)
47
The U.S. Share of Worldwide Foreign
Direct Investment Has Declined Sharply
50%
40%
42%
30%
25%
20%
10%
0%
1980
1996
In 1980, U.S. companies accounted for over 42% of foreign
direct investment by international businesses. By 1996, U.S.
multinational companies’ share of foreign direct investment had
dropped to just 25%. (Source: Price Waterhouse calculations
based on United Nations data.)
48
U.S. Investment and Jobs Abroad Have Not Increased
Relative to Domestic Investment and Jobs
100%
75%
50%
25%
6.9%
5.0%
6.4%
4.8%
Foreign share of investment
Foreign share of employment
0%
1982
1995
Foreign share of investment
Foreign share of employment
Employment in U.S.-controlled foreign corporations dropped
from 5.0 percent of U.S. civilian employment in 1982 to 4.8
percent in 1995. Similarly, gross output of U.S.-controlled
foreign corporations has declined from 6.9 percent of U.S. GDP
in 1982 to 6.4 percent in 1995. (Source: Price Waterhouse
calculations based on U.S Department of Commerce data.)
49
U.S. Companies Operate Abroad to Sell
Into Foreign, Not U.S., Markets
9%
68%
23%
The overwhelming majority of goods and services produced by
U.S.-controlled foreign corporations are sold into foreign markets.
In 1995, less than 10 percent of U.S. controlled foreign corporation
sales were exported to the U.S. (Source: PW analysis based on
50
U.S. Department of Commerce data.)
U.S. Companies Operate Abroad to Sell
Into Foreign, Not U.S., Markets
$
24%
$
62%
$
14%
Three-quarters of the financing of U.S.-controlled foreign corporations
comes from foreign sources and not U.S. parents. Debt and equity
from U.S. parents financed less than 24 percent of the total assets of
U.S.-controlled foreign corporations in 1995. The rest came from
foreign equity and debt, and reinvestment. (Source: Price Waterhouse
calculations based on U.S. Department of Commerce data.)
51
U.S. Companies Boost Return on
Capital By Investing Abroad
U.S. companies are able to use their advanced technology
and efficiency to earn high profits in foreign markets.
11.80%
10.30%
6.70% 6.70%
1985
1990
9.80%
7.60%
1995
1985
1990 1995
Over the last 10 years, U.S. companies have earned a 30%
to 70% higher return on foreign assets as compared to
domestic investment. (Source: PW calculations based
52
on U.S. Dept. of Commerce data.)
THE INTERNATIONAL TAX
POLICY FORUM
Founded in 1992, the International Tax Policy Forum is an independent group of 30 major U.S.
multinationals with a diverse industry representation. The primary purpose of the Forum is to promote
research and education on U.S. taxation of income from cross-border investment. To this end, the Forum
sponsors research and conferences on international tax issues and meets periodically with academic and
government experts to promote a dialogue on these issues. Mr. John M. Samuels, Vice President and Senior
Counsel for Tax Policy and Planning with General Electric Company, serves as Chairman of the Forum.
PricewaterhouseCoopers’ Washington National Tax Services office serves as consultant to the Forum.
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53