Foreign Tax Credit - Credit For Foreign Income Taxes

Credit For Foreign Income Taxes

A reduction of tax (credit) is often provided in income tax systems for similar income taxes paid to other countries (foreign taxes). This is generally referred to as a foreign tax credit (FTC). Amounts in excess of income tax are usually nonrefundable.

The credit is generally limited to those taxes of a nature similar to the tax against which the credit is allowed (e.g., taxes on net income after allowance of deductions). Rules defining taxes eligible for credit may refer to one or more of the following characteristics of such tax:

• Nature of the foreign levy (compulsory, payment for services, optional, discretionary as to rate, etc.),
• Whether the foreign country allows a similar credit,
• Whether the two countries have a tax treaty,
• Nature of the base on which the levy is imposed (gross receipts, income net of deductions, deemed profits, property or other basis),
• Form in which payments are made (withholdings, payment by check or giro, payments in kind),
• Political considerations (boycotts by taxing country, etc.),
• Conditions imposed by levying body on taxpayers (information disclosure, etc.), or
• Services or property provided by levying body or related persons as a result of the tax.

For example, the U.S. system allows FTC, subject to limitations, for foreign compulsory levies based on net income or withheld from gross receipts. It also denies FTC for taxes paid to countries requiring participation in certain boycotts or taxes paid in exchange for goods or services provided by the taxing authority for services. The UK allows FTC, subject to limitations, for foreign taxes of a nature similar to the income or corporation tax. This is allowed under tax treaties or as a unilateral credit. Canada similarly allows credits, but limits the portion of foreign tax subject to deduction with respect to an oil or gas business.

Some countries do not tax persons whether resident of that country or not except on income considered to be from sources in that country or remitted to that country. Those countries tend to allow FTC only to residents and only with respect to taxes imposed on the income subject to tax in the home country. Singapore grants FTC only to residents and only with respect to income taxed in Singapore.

Many systems specify the time at which a foreign levy meeting the requirements for FTC becomes eligible for such credit, such as when the levy is withheld from income or otherwise paid or settled in cash or property. Some systems allow a credit when the tax would be properly chargeable under the domestic system. Others allow FTC by reference to the time the foreign item of income is chargeable to home country income tax. Some systems allow the credit with the tax would be recognized in financial statements. Some systems base the timing of recognition on the method of accounting of the taxpayer, possibly with an election by a cash basis taxpayer to recognize the tax at the time properly accrued.

Many income tax treaties require that the governments party to the treaty grant FTC even where the domestic law of such party do not grant such credit.

Note that federal systems, such as the Canada, Switzerland, and the U.S., may have different rules for allowing a credit for extra-jurisdictional credits at the federal and state levels. Such rules may differ among sub-federal (provincial, cantonal, state) jurisdictions. Thus, for example, Canadian and U.S. Federal governments allow credits from all foreign levels, while Canadian provinces and U.S. states tend to allow a credit for income taxes paid to other provinces and states, but not for taxes paid to sovereign jurisdictions (countries). Sub-federal taxes may or may not be covered by income tax treaties.