Question

Magruder company is a domestic company and owns 100% of the stock of Hyacinth company. Magruder’s functional currency is the USD. Hyacinth is also a domestic company and files a consolidated income tax return with its parent, Magruder. Hyacinth conducts business in France and uses the French franc as it functional currency. Magruder generates net income of $1,000,000 in 2017 and Hyacinth generates income of 200,000 in French francs.

How would your answer change if Hyacinth were a French corporation and instead distributed a taxable dividend of 200,000 (all of its after French tax profits) to Magruder and paid creditable French income taxes of 50,000 French francs. The dividend was paid on December 31,2017. Describe the tax consequences to Magruder and Hyacinth.

Answer 1

Parent companies may submit consolidated tax returns when the company presents itself and its subsidiaries as a single taxpayer. This is done when the parent company wishes to offset the losses of one company against the profits of another. However, the parent company can only combine the financial statements and tax returns of subsidiaries in which it owns at least 80 percent of the shareholding and voting rights. In the given case, Magruder company is a domestic company and owns 100% of the stock of Hyacinth company. Also it files a consolidated income tax return with its parent, Magruder. Thus , income of Hycinth earned in french franc shall be converted in US$ and shall be added in total income of parent company ie Magruder.

However, The profits of a foreign subsidiary corporation are ordinarily not subject to tax in the United States because the general Internal Revenue Service rule is that foreign subsidiaries are not considered U.S. corporations even if they are wholly owned. However, when the subsidiary pays dividends to the U.S. parent company as a shareholder, the IRS deems the amount as taxable income for which the parent company has to pay tax. The income is not taxed if it stays within the foreign subsidiary, but when it is paid to the U.S. parent company, a 35 percent corporate tax rate applies. This rule allows companies such as Apple to establish foreign subsidiaries where they can invest heavily and park their profits.

Thus in the given case, Hyacinth were a French corporation and instead distributed a taxable dividend of 200,000 (all of its after French tax profits) to Magruder and paid creditable French income taxes of 50,000 French francs. The dividend was paid on December 31,2017.The amount of dividend of $ 200000 shall be added to the income of Magruder and shall be taxable at a flat rate of 35% even though it has already been taxed in franc.