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Q: I attended the distant learning
course in Denver
The example included with the handout for the "Special Issues in
Claiming the Extraterritorial Income Exclusion" session (slides 15
through 17) shows a much smaller adjustment to foreign source income for
foreign tax credit purposes when utilizing the ETI exclusion.
Could you please explain the difference between these two calculations
and if one or both or these are correct.
The course was very informative. A: To
answer your question, both answers are right - the fact patterns are
different, however. In
Phil's outline, slide 39 illustrates the foreign tax credit reduction or
"haircut" taken by companies that claim foreign tax credit
benefits on certain export sales. (Philip
Zukowski with KPMG LLP in Miami is in charge of the firm’s FSC /ETI
practice.) The reduction
occurs where companies claim both ETI (FSC) and foreign tax credit
benefits on the same export sale. This
overlap arises where U.S. manufactured products are sold overseas and
where title to the goods passes outside the United States. For example, slide 39
illustrates how the ETI exclusion first reduces the total net income
from $1,000 to $850. Under
the ordinary foreign source income (FSI) rules (Sec. 863(b)), up to 50%,
or $425, of the balance would be treated as foreign source income, which
can be used to absorb excess foreign tax credits. Under the FSC/ETI
"haircut", the amount of FSI would be limited to what the
amount of FSI was under the DISC rules, which is 50% x $1,000 x 50%, or
$250. See Secs. 927(e) and
943(c). Thus, the bottom of
the slide shows the net FSI of $250.
This calculation affects the foreign tax credit limitation of the
exporter.
The second set of examples, prepared by Bruce Stelzner at KPMG LLP in
San Diego and Costa Mesa, involves a CFC (foreign subsidiary), which has
made a check-the-box election to be treated as a U.S. company
(taxpayer). Thus, its
income is subject to a direct and indirect (withholding) tax in its
country of incorporation, and the U.S. shareholder can claim a foreign
tax credit to offset its U.S. tax liability. In this situation, assuming the
income of the CFC is the only U.S. income being reported in the United
States, the CFC can claim an ETI exclusion of $15 (Slide 17). Under the ETI legislation, the
foreign tax credit (FTC) is reduced - to the extent it is attributable
to excluded income ($30 x 15% = $4.50). This slide illustrates that the election to be treated as a
U.S. company is not advantageous to the extent the CFC has a tax rate
(direct and indirect taxes) in excess of the U.S. rate of 35%.
The irony is, in putting these examples together, a company may engage
in the foreign title passage transaction in the first situation, to
increase foreign source income and absorb excess credits in the second
transaction. This is part of the job of the international tax
department at a company to manage the foreign income and taxes generated
during the year.
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