Foreign Tax Credit - Examples

Examples

1. Effect of FTC on worldwide tax burden Facts: Carpet Ltd is a UK resident company publicly traded company which buys and sells carpets through offices in UK and Germany. Carpet Ltd's tax rate in the UK is 33% on its business net income of £1 million. Carpet Ltd is also subject to tax in Germany on the equivalent of £100,000 at a tax rate of 37%, or £37,000. The UK limits FTC to the amount of UK tax that would be on the foreign (non-UK) source income. If Carpet Ltd has no other foreign source income under UK concepts, Carpet Ltd's UK tax is £330,000 less FTC of £33,000, or £297,000. Total taxes would be £297,000 + £37,000 or £334,000. On the other hand, if Carpet Ltd had additional foreign source trading profits of £20,000, the FTC limit would be sufficient to use all of the German tax as credits, and UK tax after FTC would be £293,000. Thus, worldwide tax rate with FTC tends to be at a minimum the home country tax rate and at a maximum a foreign country tax rate, if higher.

2. Effect of expense allocation Differences in expense allocation rules and transfer pricing can impact this result. If, in the base example above, Carpet Ltd had £10,000 of expenses of the Germany operation which Germany disallowed as not allocable to German income under German concepts, the German tax would increase to £40,700 while the UK FTC limitation would remain £33,000. This would increase worldwide taxes by the German tax on the disallowed expenses, to a total of £337,300.

3. Deemed paid credit Assume a German 100% subsidiary of a U.S. company has earned $1,000 of pre-tax income and paid $380 of German taxes over its history. If the Germany company pays a dividend of $100, the U.S. company will, subject to limitations, be entitled to $38 of FTC.