1. When a U.S. person is in an excess credit position, the noncreditable foreign income taxes increase the total tax burden on foreign-source income beyond what it would have been if only the United States had taxed that income. Identify two strategies for reducing excess credits.
2. In Cook v. Tait, 265 U.S. 47 (1924), what was the taxpayer's argument for why he should not be subject to U.S. federal income tax? Why did the Supreme Court reject his argument?
3. USAco is a domestic corporation that manufactures products in the U.S. for distribution in the U.S. and abroad. During the current year, USAco derives a pre-tax profit of $10 million, which includes $1 million of foreign-source income derived from a country X sales office that is considered an unincorporated branch for U.S. tax purposes. The country X corporate income tax rate is 50% and the U.S. tax rate is 35%.
a. What would be the worldwide effective tax rate on the $1 million of foreign profits, assuming the U.S. taxes the worldwide income of domestic corporations, but allows an unlimited credit for foreign income taxes?
b. What would be the worldwide effective tax rate on the $1 million of foreign profits, assuming the U.S. allows a credit for foreign income taxes, but the credit is limited to the U.S. tax attributable to foreign-source income?
c. How would your answer to part (b) change if the foreign tax rate was 30% rather than 50%?
4. Engco, a domestic corporation, produces industrial engines at its U.S. plant for sale in the United States and Canada. Engco also has a plant in Canada that performs the final stages of production with respect to the engines sold in Canada. All of the output of the Canadian plant is sold in Canada, whereas only one-third of the output of the U.S. plant is shipped to Canada. The Canadian operation is classifi ed as a branch for U.S. tax purposes. During the current year, Engco's total sales to Canadian customers were $10 million, and the related cost of goods sold is $7 million. The average value of property, plant, and equipment is $30 million at the U.S. plant, and $5 million at the Canadian plant. Engco sells all goods with title passing at the Canadian plant in the case of Canadian sales and at the U.S. plant in the case of U.S. sales.
a. How much of Engco's export gross profi t of $3 million is classified as foreign source for U.S. tax purposes?
b. Now assume that the facts are the same as in part (a), except that the Canadian factory is structured as a wholly- owned Canadian subsidiary, rather than a branch. Engo's sales of semi-finished engines to the Canadian subsidiary (which still represent one-third of its output) were $6 million during the year and the related cost of goods sold was $4 million. The Canadian subsidiary's total sales of finished engines to Canadian customers (which represents all of its output) was $10 million and the related cost of goods sold is $7 million. The average value of property, plant and equipment is still $30 million at the U.S. plant, and $5 million at the Canadian plant, and Engco sells all goods with title passing at its U.S. plant. How much of Engco's export gross profit of $2 million is classified as foreign source for U.S. tax purposes?
c. How would your answer (to part b) change if Engco sold its goods with title passing at the customer's location?
5. Pursco is a domestic corporation that distributes scientific equipment worldwide. During the current year, Pursco had $100 million of sales, a gross profit of $40 million, and incurred $30 million of selling, general and administrative expenses (SG&A), for taxable income of $10 million. Pursco's sales include $20 million of sales to foreign customers. The gross profit on these foreign sales was $10 million. Pursco transferred title abroad on all foreign sales, and therefore the entire $10 million is classified as foreign-source income. A time management survey was recently completed, and indicates that employees devote 90% of their time to the company's domestic operations and 10% to foreign operations. Compensation expenses account for $20 million of the $30 million of total SG&A expenses. Assume Pursco's $10 million of taxable income is subject to U.S. tax at a 35% rate.
Compute Pursco's foreign tax credit limitation under the following independent assumptions.
a. Pursco determines the amount of SG&A expenses allocable to foreign-source income using gross sales as an apportionment base.
b. Pursco determines the amount of SG&A expenses allocable to foreign-source income using gross profi t as an apportionment base.
c. Pursco determines the amount of SG&A expenses allocable to foreign-source income using time as an apportionment base for the compensation component of SG&A, and gross sales as an apportionment base for the all other SG&A expenses.