Foreign Tax Credit - Limitation On Credit

Limitation On Credit

Most systems limit FTC in some manner. A common limitation is based on the domestic income tax considered generated by the foreign source income subject to tax. This limitation may be applied overall or at one or more of the following subsets:

• By country or region
• By type of income
• By member of a group
• By sub-type of domestic tax

Amounts in excess of this limitation may be allowed to reduce prior period taxes (and thus potentially subject to refund) or future taxes. This period of carryover may be limited to a period of years or unlimited. For example, the U.S. system in 2009 permitted taxpayers to apply excess FTCs to reduce U.S. Federal income tax for the first prior year (carry back) and then successively for each of the next succeeding 10 years (carry forward). The German system in 2007 permitted unlimited carry forward but no carry back.

Various countries have, at one point or another, limited FTC based on type of income. UK individual income tax limits FTC by the types of income taxed separately in the UK system. Thus, foreign taxes incurred with respect to trading income are limited separately from foreign taxes incurred with respect to investment income. From 1987 through 2006 the U.S. limited FTC according to different categories or "baskets" of income, generally described as nine such baskets but in reality occasionally substantially more. The definitions of such baskets were collapsed into two baskets (with exceptions) beginning 2007. The U.S. baskets are currently passive, consisting of foreign personal holding company income (interest, dividends, rents, royalties, and certain gains, with significant exceptions) and all other (general limitation), with some exceptions generally not applicable.

Countries having alternative tax regimes imposing certain minimum income taxes may modify the rules for computing FTC for those minimum taxes.

Generally, where foreign taxes have been deducted or deemed deducted from income, and a credit or reduction of tax is claimed, the amount of income subject to tax is the amount before the reduction by foreign tax.