International Taxation and Foreign Tax Credits

Introduction

International taxation deals with determining taxes that persons or business establishments pay based on different tax laws of nations (Miller & Oats, 2012). Governments set limits concerning the extent to which persons or companies should be taxed when they are sending incomes from abroad. Global tax systems are aimed at offering foreign tax credits to entities to minimize the potential of double taxation (Gustafson, Peroni & Pugh, 2011). Concerning the US taxation system, multinational corporations are exempted from certain taxes so that both the US government and the government of the country in which they operate cannot tax them twice. This paper discusses several aspects of international taxation and foreign tax credits regarding a US taxpayer who is interested in expanding a business into foreign markets.

Types of organizations

For the client to establish business operations in a foreign market, there should be a focus on utilizing various methods of entry (Gustafson et al., 2011). However, it is important to note that two types of organizations would be formed. First, the client might consider forming a direct exporting organization, which would offer a basic mode of exporting products to overseas markets. The firm would help the entrepreneur to capitalize on the economies of scale concerning production systems that are in the US, and ensure better control over distribution. In this context, no intermediaries would be involved in distributing goods to foreign markets.

The type of company would be typified by high taxation, both in the US and foreign markets. This would be since the business establishment would be actively involved in the running of all commercial activities. Second, the client might consider forming an indirect exporting organization, which would have domestic intermediaries. In this context, the client would not have control over the firm’s goods. One tax impact of this type of organization is that it would have relatively few taxes (Gustafson et al., 2011). This would be for the reason that the indirect exporting firm and intermediaries in foreign markets would pay various taxes collectively (Miller & Oats, 2012).

A strategy for repatriating earnings

Sometimes, some firms from the US adopt strategies for repatriating earnings from overseas while mitigating or avoiding the US tax impacts (Gustafson et al., 2011). Based on the US foreign taxation system, companies operating abroad are required to pay up to thirty-five percent of their profits in the form of taxes. The client would be advised to find a legal way to avoid tax in America. For example, the business can focus on importing its earnings from foreign markets by indicating that it would like to acquire another company in the US. The rationale for the approach is that business acquisitions in America are not taxed heavily in comparison with taxing profits earned by firms operating in foreign markets. This would be a legal way that would attract fewer taxes, enabling the business establishment to make significant savings.

The management might think about the economic implications of giving wrong figures of profits. Over the years, giant companies with origins in the US have been involved in repatriation activities that do not attract high rates of taxation (Gustafson et al., 2011). For example, in 2009, Pfizer Inc. repatriated about $30 billion from foreign markets by associating the finds with its acquisition of Wyeth. In fact, the company minimized tax on its profit in a great manner.

Foreign tax credits

In the context of the US foreign taxation system, it is worth noting that many non-refundable business credits are available (Gustafson et al., 2011). On several occasions, “excesses of credits of a certain year are required by the law to be carried forward to counterbalance taxes in the future” (Radebaugh, Gray & Black, 2006, p. 98). Three tax credits may be used. First, the company would benefit from an alternative motor vehicle credit. For example, if it would purchase many vehicles that do not use gasoline, then it would apply for this type of credit. Second, it may benefit from disaster relief credits.

For example, if the firm would be operating in a nation that would require it to pay taxes in relation to disasters, then it would not be expected to pay similar taxes in America (Radebaugh et al., 2006). Third, the business establishment may gain from tax credits with regard to increasing research expenses. For example, the firm might be involved in conducting many research studies on its goods, which might be taxed heavily in foreign markets. Fortunately, it would be exempted from research-based taxes in the US.

Accumulated earnings tax (AET)

The federal government introduced AET to deter business firms from adopting decisions for not issuing dividends to shareholders (Gustafson et al., 2011). The rationale for this form of tax is that if the company retains all its earnings, then its stock would appreciate it remarkably. The overall impact of AET is that the firm would be required to pay more amounts of money in the form of taxes than it would pay its shareholders.

Thus, negative impacts would be registered in its financial statements. Although retained earnings would have positive impacts on the business establishment, the government would be negatively impacted as a result of a tax revenue decrease (Razin & Slemrod, 2008). The firm can avoid paying the tax in a number of ways. First, it can aim at paying dividends during a tax year. For example, the management can set up systems that calculate the real dividends that should be offered to investors during a tax year. Second, the company can maintain a balance that is allowed by the US taxation system (Schadewald & Misey, 2005). For example, the management may concentrate on accumulated earnings that are not more than $250,000, which cannot attract taxation.

The US and foreign losses

Regarding the US and foreign-sourced losses, the federal government rules are very clear (Schadewald & Misey, 2005). The US losses should be allocated. However, the “allocation should be done among incomes on a proportionate basis” (Gustafson et al., 2011, p. 123). For example, foreign-sourced losses should be allocated among distinct limits in relation to income categories, which might include passive category income and general category income. Regarding the US losses, the rules require firms to allocate net losses that are incurred in the US among many categories of incomes from foreign sources (Razin & Slemrod, 2008). For example, the client can “allocate foreign sources of losses, but the number of net losses in the US should be equal to the excess of foreign sources of taxable income” (Razin & Slemrod, 2008, p. 78).

Conclusion

This paper has demonstrated that there are various aspects of international taxation and foreign taxes, which should be well understood by the client. In this context, the firm might form two organizations in the overseas markets, but it should be willing to repatriate its earnings legally and pay dividends to its shareholders.

References

Gustafson, C. H., Peroni, R. J., & Pugh, R. C. (2011). Taxation of international transactions (4th ed.). St.Paul, MN: Thomson West Law Group.

Miller, A., & Oats, L. (2012). Principles of international taxation. London, United Kingdom: A&C Black.

Radebaugh, L. H., Gray, S. J., & Black, E. L. (2006). International accounting and multinational enterprises. New York, NY: Wiley.

Razin, A., & Slemrod, J. (Eds.). (2008). Taxation in the global economy. Chicago, IL: University of Chicago Press.

Schadewald, M. S., & Misey, R. J. (2005). Practical Guide to United States Taxation of International Transactions. New York, NY: CCH Tax and Accounting.