1. Foreign Taxes Paid by a U.S. Company Conducting Business Activities Directly in a Foreign Country or through a Foreign Branch
- C Corporation – A U.S. company that is a C corporation which conducts business in a foreign country directly or through a foreign branch may claim a foreign tax credit for foreign taxes paid on income earned in the foreign country. The foreign tax credit is subject to limitation and is offset against the U.S. tax liability on the U.S. federal income tax return.
- U.S. Partnership or S Corporation – A U.S. partnership or S corporation which conducts business in a foreign country directly or through a foreign branch will pass through foreign source income and foreign taxes paid to the respective partners in the partnership or shareholders in the S corporation. The partners and shareholders may claim a foreign tax credit (subject to limitation) to offset their U.S. tax liability on their U.S. federal income tax return.
- Foreign Tax Credit Limitation – The foreign tax credit limitation is the U.S. tax liability against which the foreign tax credit is claimed multiplied times a fraction which is the U.S. taxpayer’s foreign source taxable income divided by the U.S. taxpayer’s worldwide taxable income for the tax year.
2. Foreign Taxes Paid by a Foreign Company Classified as a Foreign Partnership or Foreign Disregarded Entity for U.S. Tax Purposes
If a U.S. person owns an interest in a foreign partnership or foreign disregarded entity, the income earned and the foreign taxes paid by the foreign entity will pass through to the U.S. owner. If the U.S. owner is an individual or a C corporation, the foreign taxes are claimed as a foreign tax credit on the U.S. federal tax return subject to limitation. If the U.S. owner is a U.S. partnership or an S corporation, the foreign source income and foreign taxes pass through to the partners of the partnership or the shareholders of the S corporation. The foreign taxes are claimed as a foreign tax credit on the U.S. federal tax return of the respective partners in the U.S. partnership or the shareholders of the S corporation.
3. Foreign Taxes Paid by a Foreign Company Classified as a Foreign Corporation for U.S. Tax Purposes
Only a U.S. shareholder that is a C corporation which owns at least 10% of a foreign corporation and which receives an actual dividend distribution from the foreign corporation may claim a foreign tax credit for the foreign taxes paid by the foreign corporation.
If the foreign corporation is a CFC (more than 50% of the vote or value is owned by U.S. shareholders who each own at least 10% of the voting stock), the U.S. corporate shareholder is subject to special Subpart F rules under the U.S. Internal Revenue Code to determine the calculation of the foreign tax credit depending on the taxable Subpart F income inclusions of undistributed earnings.
For example, Section 960 of the Internal Revenue Code allows the U.S. corporate shareholder to qualify for a foreign tax credit with respect to the foreign taxes paid by the CFC on the undistributed earnings that are taxable to the U.S. shareholder as Subpart F income. The provision prevents the U.S. shareholder from claiming a foreign tax credit twice with respect to the same earnings that are then subsequently distributed as a dividend.
For more information, please contact our international tax advisor at 301.231.6200.