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Foreign Tax Credit

February 19, 2021

Taxpayers who have paid or accrued foreign income taxes to a foreign country or U.S. possession may generally credit those taxes against their U.S. income tax liability on foreign-source income. The foreign tax credit is designed to relieve taxpayers from double taxation when income is subject to both U.S. and foreign tax.

What is the foreign tax credit?

The foreign tax credit is a dollar-for-dollar credit equal to the amount of foreign income taxes paid or deemed paid by the taxpayer. Subject to various limitations, the amount of tax paid to foreign countries and U.S. possessions on foreign-source income offsets any U.S. tax that would be paid on the same income.

The 2017 Tax Cuts and Jobs Act (TCJA) made significant changes to the foreign tax credit and related rules for allocating and apportioning expenses for purposes of determining a FTC limitation under §904, which spurred a flurry of regulatory guidance.

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Download: 2022 Final Foreign Tax Credit Regulations

Changes could be coming to the international tax provisions of the TCJA. This resource summarizes the Senate Finance Committee’s draft legislation, including changes to the subpart F regime and foreign tax credit, and changes to GILTI.

How is foreign income tax defined?

A “foreign income tax” means a foreign income tax as described in Reg. §1.901-2(a), that is, each separate levy that is an income, war profits, or excess profits tax, or a tax in lieu of such taxes within the meaning of §903 and the regulations thereunder, paid or accrued to a foreign country or U.S. possession, including any such tax deemed paid by a CFC. Treasury and the IRS published final regulations in January 2022 that would revise the definition of a foreign income tax by providing that a foreign income tax means a foreign levy that is a foreign tax and that is either a net income tax or an in-lieu-of tax.

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Download: Final Foreign Tax Credit Regulations Roadmap

This roadmap covers the 2019 and 2020 proposed and final regulations relating to the foreign tax credit, as introduced by the 2017 Tax Cuts and Jobs Act.

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What is the difference between a direct and an indirect foreign tax credit?

Direct FTCs are credits for foreign income taxes paid directly by a U.S. taxpayer or by a foreign branch of a U.S. taxpayer, as well as foreign withholding taxes. Indirect FTCs (also referred to as deemed paid FTCs) are based on foreign income taxes paid by foreign subsidiaries and deemed paid by a U.S. corporation that meets the 10% ownership threshold for U.S. shareholder status.

If a U.S. corporation receives a dividend from a foreign subsidiary, is it entitled to a foreign tax credit for foreign income taxes paid or accrued by the foreign subsidiary?

For taxable years of foreign corporations beginning after 2017, the answer is no. However, if a U.S. corporation owns at least 10% (by vote or value) of a foreign corporation from which it receives a dividend, the U.S. corporation is allowed to deduct an amount equal to the foreign-source portion of that dividend, in effect providing a U.S. tax exemption for that portion of the dividend and eliminating the need for a foreign tax credit to prevent double taxation.

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Download: The OECD/G20’s Two Pillar Approach

On July 1, 2021, the OECD/G20 Inclusive Framework issued a statement saying that a broad agreement of more than 130 members had been reached on a Two Pillar approach. This presentation summarizes the Pillars.

Is there a limitation on the amount of foreign income taxes that can be credited in a particular taxable year?

Foreign tax credits are limited annually to the amount of U.S. tax on foreign-source taxable income as computed under U.S. tax principles. Thus, if the U.S. person pays more tax to the source country on the foreign-source income than is due to the U.S. on the same foreign-source income, the U.S. will limit the amount of taxes paid to the source country that can be used as credits against U.S. tax liability. The foreign tax credit limitation is computed as a taxpayer’s pre-credit U.S. tax liability multiplied by a ratio (not to exceed one), the numerator of which is the taxpayer’s foreign-source taxable income and the denominator of which is the taxpayer’s worldwide taxable income for the year.

Foreign income taxes not credited because of the limitation can generally be carried back one year or forward to the ten succeeding taxable years, subject to the limitations for those years. However, foreign income taxes paid or accrued with respect to amounts includible in gross income under the GILTI regime may not be carried back or carried forward.

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Subscriber-Only Resource: Tax Practice Series: U.S. Persons — Worldwide Taxation

This section of the Tax Practice Series covers the two kinds of credits that comprise the foreign tax credit, generally referred to as the “direct” credit, and the “indirect” or “deemed-paid” credit.

Key IRC Sections

Bloomberg Tax is pleased to offer the full text of the current Internal Revenue Code free of charge. This site is updated continuously and includes Editor’s Notes written by expert staff at Bloomberg Tax & Accounting indicating when a section has been repealed or when there is a delayed effective date, allowing you to see the current and future law. Links to related code sections make it easy to navigate within the IRC.


§78

Gross Up For Deemed Paid Foreign Tax Credit

§841

Credit For Foreign Taxes

§853

Foreign Tax Credit Allowed To Shareholders

§901-909

Subpart A — Foreign Tax Credit

§960

Deemed Paid Credit For Subpart F Inclusions

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Portfolio

PORTFOLIO

Portfolio 6020-1st: The Creditability of Foreign Taxes – General Issues

This Tax Management Portfolio provides a detailed discussion of the rules under §901 for determining what is a creditable income tax, rules relating to who can claim the foreign tax credit, rules for determining the amount of creditable foreign tax, and more.

Portfolio

PORTFOLIO

Portfolio 6060-1st: The Foreign Tax Credit Limitation Under Section 904

Learn about one part of the U.S. foreign tax credit mechanism – the foreign tax credit limitation under §904. The basic purpose of the limitation is to ensure that the United States does not allow foreign taxes to be used as a credit against U.S. tax on U.S.-source income.

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PORTFOLIO

Portfolio 6040-1st: Indirect Foreign Tax Credits

Tax Management Portfolio No. 6040 contains a detailed analysis of the indirect foreign tax credit system under the U.S. federal income tax law as in effect both before and after the enactment of the Tax Cuts and Jobs Act in 2017.

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