Question

Can the MNC apply all of its local taxes as a credit against its U.S. taxes? If not, which subsidiaries can it use to get a credit against its U.S. taxes. Explain your rationale briefly.

Answer 1

Suppose if a Parent company of US having it's subsidiary in India, has earned profit of $1000 in India. That subsidiary company has to pay local taxes of that country and after payment of those taxes suppose the amount that remains with that company (profit after tax) is $850 and now compnco re-invets $500 in that company, and remaining amount of $350 is transferred to Parent company (Dividends or other) is subject to US tax under US tax Law. The maximum that the parent company has to pay out of $350 is 35%. Here we can clearly understand that the companies are not supposed to pay two taxes on the same amount. This avoid dual taxation between these kind of companies. For example, a US-based multinational firm facing the 35 percent maximum corporate income tax rate earns $800 in profits in its Australian subsidiary. The 12.5 percent Irish corporate tax reduces the after-tax profit to $700. Suppose the firm then repatriates $70 of this profit and reinvests the remaining $630 in its Australian operations. The firm must then pay US tax on a base of $80 (the $70 plus the $10 in Australian tax paid on that portion of its profits), or $28, but it claims a credit for the $10 Irish tax, leaving a net US tax of $18. If the firm has excess foreign tax credits from operations in high-tax countries, it can offset more (or possibly all) of the US tax due on its repatriated Australian profit. Meanwhile, deferral allows the remaining profit ($630) to grow abroad, free of US income tax until it is repatriated.