Question

Spartan Corporation manufactures quidgets at its plant in Sparta, Michigan. Spartan sells its quidgets to customers in the United States, Canada, England, and Australia.

Spartan markets its products in Canada and England through branches in Toronto and London, respectively. Spartan reported total gross income on U.S. sales of $15,000,000 and total gross income on Canadian and U.K. sales of $5,000,000, split equally between the two countries. Spartan paid Canadian income taxes of $600,000 on its branch profits in Canada and U.K. income taxes of $700,000 on its branch profits in the United Kingdom. Spartan financed its Canadian operations through a $10 million capital contribution, which Spartan financed through a loan from Bank of America. During the current year, Spartan paid $600,000 in interest on the loan.

Spartan sells its quidgets to Australian customers through its wholly-owned Australian subsidiary. Spartan reported gross income of $3,000,000 on sales to its subsidiary during the year. The subsidiary paid Spartan a dividend of $670,000 on December 31 (the withholding tax is 0 percent under the U.S.–Australia treaty). Spartan paid Australian income taxes of $330,000 on the income repatriated as a dividend.

Requirement:

1. Compute Spartan’s foreign source gross income and foreign tax (direct and withholding) for the current year.
2. Assume 20 percent of the interest paid to Bank of America is allocated to the numerator of Spartan’s FTC limitation calculation. Compute Spartan Corporation’s FTC limitation using your calculation from part (a) and any excess FTC or excess FTC limitation (all of the foreign source income is put in the foreign branch FTC basket).

Answer 1

a. Foreign source gross income on Canadian sales* $1,250,000

  Foreign source gross income on U.K. sales* 1,250,000

  Dividend from Australian subsidiary 670,000

  §78 gross-up for deemed paid income taxes    330,000

  Foreign source gross income $3,500,000

  Creditable foreign income taxes

    Canadian income taxes   600,000

    U.K. income taxes   700,000

    Deemed paid credit on Australia dividend 330,000

    Total creditable income taxes $1,630,000

* Under §863(b), 50 percent of the gross income from sales is foreign source because title to the goods passes outside the United States.

b. Gross income from U.S. sales   $15,000,000

  Gross income from Canada and U.K. sales 5,000,000

  Gross income from Australia sales   3,000,000

  Dividend from Australia subsidiary   670,000

  §78 gross-up on dividend from Australia subsidiary 330,000

  Total gross income   $24,000,000

  Interest expense      600,000

  Taxable income   $23,400,000

  x U.S. tax rate x 0.35

  Precredit U.S. tax   $  8,190,000

  FTC limitation

    Foreign source gross income (from A above)   $3,500,000

    Less: Apportioned interest expense (20%) 120,000

    Foreign source taxable income   $3,380,000

    Taxable income $23,400,000

  FTC limitation = $3,380,000 / $23,400,000 x $8,190,000   $1,183,000

  Creditable foreign income taxes   1,630,000

  Excess foreign income tax credit $  447,000

  Precredit U.S. income tax   $8,190,000

  Foreign tax credit   1,183,000

  Net U.S. income tax   $7,007,000