How ASC 740 Applies to Foreign Tax Provisions

How do foreign taxes affect the ASC 740 income tax provision?

Foreign source income and the related foreign tax credits are tracked in several categories, known as “baskets.”

Those baskets are:

• Section 951A basket. Section 951A income, also known as Global Intangible Low Tax Income (GILTI), is earned by foreign affiliates of U.S. companies from intangible assets, such as patents, trademarks, and copyrights.
• Foreign branch basket. Foreign branch category income consists of the business profits of U.S. persons attributable to one or more qualified business units (QBUs) in one or more foreign countries.
• Passive basket. The passive basket generally includes investment income such as interest, dividends, rent and royalties.
• Certain income re-sourced by treaty basket. If the U.S. has an income tax treaty with a country, and a sourcing rule in that treaty treats U.S. sourcing income as foreign source, the taxpayer can elect to apply the treaty. The tax treaty provision converts (i.e., re-sources) U.S. source income into foreign source, thus allowing foreign tax credits to offset the U.S. income tax imposed on it.
• General limitation basket. The general basket includes all other types of foreign source income that do not fit into another category. Some examples include salary and wages, taxable employee benefits, active trade or business income, and gains from the sale of inventory or depreciable property used in a trade or business.

U.S. Taxation of International Operations

Certain expenses are “not definitely allocable” to either the U.S. or foreign operations of a company. These expenses, such as state income taxes, research and development costs, stewardship costs, and interest expenses, are apportioned to the various baskets of foreign source income, therefore reducing the limitations for the respective baskets. Reg. §1.861 includes various allowable methodologies for allocation and apportionment.

Essentially, these expenses are not allocated to the activities of the entity or entities that incur them but are instead allocated between U.S. source income and foreign source income.

Report: Your Guide to ASC 740

Find answers to the technical and process challenges that arise when calculating your ASC 740 income tax provision with this comprehensive guide.

What effect do foreign branches have on the income tax provision?

A foreign branch is a foreign taxpayer that is also either:

1. A disregarded entity or flow-through entity for U.S. income tax purposes, or
2. A U.S. entity

The foreign tax credits associated with foreign branches are §901 or direct credits. Direct credits are for taxes paid directly to the foreign country by a U.S. taxpayer based on net income.

The foreign source income and related foreign tax credits from foreign branches are accounted for in the Branch FSI basket.

Historic general and passive foreign tax credit carryovers from before 2018 cannot be used against Branch income. Conversely, new foreign tax credits in the Branch basket cannot be used against general basket foreign source income, such as Subpart F.

The Branch FTC basket has the effect of segregating the activities of branches from those of controlled foreign corporations.

Accounting for Foreign Branch Operations

A foreign branch will calculate a separate current, deferred, and non-current income tax provision for each jurisdiction in which it is subject to tax.

U.S. deferred taxes are recognized to reflect the future U.S. income tax consequences of any foreign deferred tax accounts. If a company is claiming a foreign tax credit, the existence of a foreign branch deferred tax asset or deferred tax liability gives rise to a future reduction or increase in U.S. foreign tax credits (anticipatory FTCs).

A deferred tax asset for an anticipatory FTC carryover would be subject to analysis to determine if a valuation allowance is needed. If a valuation allowance has been recorded in the foreign country against its deferred tax assets and no net deferred taxes exist, no U.S. anticipatory FTCs should be recorded. Under this scenario, the company has concluded that it is not more-likely-than-not that the foreign deferred tax assets will be realized, and therefore those deferred items will not give rise to a U.S. tax consequence.

For a company deducting foreign taxes rather than claiming a foreign tax credit, U.S. deferred taxes are taken into account based on the foreign deferred taxes by applying the appropriate federal and state rate to the foreign deferred tax assets and deferred tax liabilities.

Learn more: How ASC 740 Applies to Controlled Foreign Corporations

ASC 740 governs how companies, including U.S. parents of controlled foreign corporations, recognize the effects of income taxes on their financial statements under U.S. GAAP.