Question

Blackwater Company has a foreign branch that earns income before income taxes of $500,000. Income taxes paid to the foreign government are $150,000 or 30%. Sales and other taxes paid to the foreign government are $100,000. Blackwater Company must include the $500,000 of foreign branch income in determining its home country taxable income. In determining its taxable income, Blackwater can choose between taking a deduction for all foreign taxes paid or a credit only for foreign income taxes paid. The corporate income tax rate in Blackwater’s’ home country is 40%.

1. Determine whether Blackwater would be better off taking a deduction of a credit for foreign taxes paid (FTC).
2. If foreign tax rate increased from 30% to 50%, how would it change your answer?
3. If foreign tax rate decreased from 30% to 10%, how would it change your answer?
4. If parent country’s tax rate decreased from 40% to 20%, how would it change your answer?
5. If local taxes were $250,000, how would it change your answer?

Answer 1

SOLUTION

	Calculation of Home Country Tax Liability
		Deduction	Credit
	Foreign source income	500,000	500,000
	Deduction for all foreign taxes paid	250,000	0
	Home taxable income	250,000	500,000
	Income tax rate	40%	40%
	Income tax before FTC	100,000	200,000
	FTC allowed*	0	150,000
	Net home country tax liability	100,000	50,000
	* Calculation of FTC allowed
	(a) Actual foreign taxes paid	500,000	0.3	150,000
	(b) Overall FTC limitation	500,000	0.4	200,000
	FTC allowed -- lesser of (a) and (b)			150,000