Chapter 11 – International Taxation
Answers to Questions
1. MNCs can finance their foreign operations by making capital contributions (equity) or
2. In some countries, local governments impose a separate tax on business income in
3. Tax havens are tax jurisdictions with abnormally low corporate income tax rates or no
4. Under the worldwide approach to taxation, all income of a resident of a country or a
5. The combination of a worldwide approach to taxation and the various bases for taxation
can lead to overlapping tax jurisdictions that can lead to double or perhaps triple taxation.
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Chapter 11 – International Taxation
7. U.S. companies are allowed either to (1) deduct all foreign taxes paid or (2) take a credit
for foreign income taxes paid. “Income” taxes include both income taxes and withholding
8. The U.S. treats foreign branches as U.S. residents for tax purposes and taxes foreign
9. The maximum amount of foreign tax credit a U.S. company will be allowed to take related
10. An excess foreign tax credit is created when the amount of taxes paid to the foreign
government on foreign source income is greater than the amount of foreign tax credit
allowed to be taken by the U.S. government. This occurs when the effective tax rate paid
11. The excess FTC generated from one basket of income may only be carried back and
12. Tax treaties are bilateral agreements between two countries as to how companies and
13. Treaty shopping is where a resident of Country A uses a corporation in Country B to get the
14. A controlled foreign corporation is any foreign corporation in which U.S. shareholders hold
more than 50% of the combined voting power or fair market value of the stock. Only those
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Chapter 11 – International Taxation
15. Subpart F income of a controlled foreign corporation (CFC) is taxed currently (like foreign
branch income). The amount of CFC income currently taxable in the U.S. depends upon
the percentage of CFC income generated from Subpart F activities. Assuming that none of
a CFC’s income is repatriated as a dividend:
16. Determining the appropriate U.S. tax treatment of foreign source income can be quite
complicated. The four factors that determine the manner in which income earned by a
17. Foreign branch net income is translated into US$ using the average exchange rate for the
year. Foreign branch net income is then grossed-up by adding taxes paid to the foreign
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Chapter 11 – International Taxation
18. U.S. trading partners argued that both the Domestic International Sales Corporation and
19. The Foreign Earned Income Exclusion allows U.S. taxpayers to exclude a certain amount
20. To qualify for the Foreign Earned Income Exclusion U.S. taxpayers must:
1. have their tax home in a foreign country and
2. meet either (a) a bona fide residence test or (b) a physical presence test.
Solutions to Exercises and Problems
14.
Foreign Branch
Calculation of U.S. taxable income
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Calculation of FTC allowed in U.S.
Calculation of net U.S. tax liability
15.
Foreign Subsidiary
Calculation of Grossed-up Dividend
Calculation of FTC allowed in U.S.
Calculation of net U.S. tax liability
16. Mama Corporation
By purchasing finished goods from its parent company and selling those goods outside of
the Bahamas, Bahamamama Ltd. generates foreign base company sales income, which is
Subpart F income.
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Chapter 11 – International Taxation
a. 80% of Bahamamama’s income is subpart F income, so 100% of its income will be
b. 60% of Bahamamama’s income is subpart F income, so 60% of its income will be taxed
17. Lionais Company
Calculation of Home Country Tax Liability
Deduction Credit
18. Avioco Limited
19. Daisan Company
France Spain Sweden
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Chapter 11 – International Taxation
20. Pendleton Company
a. The South Korean subsidiary generates income from manufacturing and sales (General
Income Basket) and the Japanese subsidiary generates income from passive investments
(Passive Income Basket). The excess FTC in the Passive Income Basket of $6,110 can be
carried back one year and carried forward ten years only to reduce taxes paid to the U.S.
government on Passive Income Basket income. The excess FTC cannot be used to pay
the net U.S. tax liability on General Income Basket income of $6,440.
General
Income Basket
Passive
Income Basket
South Korea Japan
Income before tax 200,000 100,000
Calculation of FTC
*Calculation of FTC allowed
b. The South Korean subsidiary generates income from manufacturing and sales, and the
Japanese subsidiary generates income from sales and distribution, both of which are
allocated to the General Income Basket.
South Korea Japan
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Dividend withholding tax rate 10% 5%
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20. (continued)
Calculation of FTC General
Income
Basket
21. Eastwood Company
Year 1 X Y Z
Calculation of FTC allowed, excess FTC, and net U.S. tax liability
21. (continued)
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Year 2 X Y Z
Calculation of FTC allowed, excess FTC, and net U.S. tax liability
Year 3 X Y Z
21. (continued)
Calculation of FTC allowed, excess FTC, and net U.S. tax liability
Foreign source income 325,000
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Chapter 11 – International Taxation
Summary Year 1 Year 2 Year 3
22. Heraklion Company
a. Ignoring any tax treaty, investment alternative 3 results in the least amount of taxes paid to
the Australian government.
Investment Alternative
Calculation of Interest Expense 1 2 3
Total investment 1,000,000 1,000,000 1,000,000
Calculation of Net Income
Income before interest and taxes 200,000 200,000 200,000
Cash Flows to Parent
Dividends (100% x net income) 140,000 133,000 122,500
Dividend w/h tax rate 30% 30% 30%
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22. (continued)
b. Even with the tax treaty that reduces the dividend withholding rate from 30% to 5%,
investment alternative 3 still results in the least amount of taxes paid to the Australian
government.
Investment Alternative
Calculation of Interest Expense 1 2 3
Total investment 1,000,000 1,000,000 1,000,000
Calculation of Net Income
Income before interest and taxes 200,000 200,000 200,000
Cash Flows to Parent
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