Question

ABC, Inc., a domestic corporation, owns 100% of HighTax, a foreign corporation. HighTax has $50,000,000 of undistributed E & P, all of which is attributable to general limitation income, and $30,000,000 of foreign income taxes paid. HighTax distributes a $5,000,000 dividend to ABC. The dividend, which is subject to a 5% foreign withholding tax, is ABC's only item of income during the year. The U.S. tax rate is 35%. a. ABC's deemed-paid taxes on the dividends are $_____, and the foreign withholding taxes actually paid are $_____. b. The FTC claimed is $_____ . c. ABC now has excess foreign tax credits of $_____ is in _____(Passive income/General) limitation basket.

Answer 1

Solution:

Foreign Subsidiary (HighTax) Income before taxes = $ 50,000,000

Less : Foreign Income Tax paid = $ 30,000,000

Available for dividends = $20,000,000

Declared as Dividend = $ 5,000,000

Less: Foreign Dividend withholding tax @ 5% = $ 250,000

Cash Dividend actually received by ABC = $ 4,750,000

In calculating the amount of foreign tax credit allowed, ABC Inc. (parent) can take all of the withholding tax plus that portion of foreign income taxed paid that is equal to the proportion of net income available for dividends that is paid out as a dividend. The formula for deternining the amount of creditable deemed-paid tax is:

Dividends received

                                      (including withholding tax)                creditable

Deemed-paid credit =    x     foreign

After-tax net earnings                       taxes

                                         and profits of foreign     

                                             corporation

= 5,000,000 x 30,000,000 = 7,500,000

20,000,000

Consequently, the tax credit calculations would be as follows:

Dividend received (before withholding tax) = $20,000,000

Plus foreign deemed-paid tax = $ 7,500,000

Gross dividend included in U.S. taxable income = $ 27,500,000

U.S. tax thereon at 35 % = $ 9,625,000

Less: Credit for

Foreign income tax paid = $ 7,500,000

Foreign withholding taxes paid = $ 250,000

Additional US tax due = $ 1,875,000

Taxes actually paid ($7,500,000+ $250,000) = $ 7,750,000

Again, additional U.S taxes are due because the U.S tax rates exceeds the combined foreign income and withholding tax rate.

Final Ans:

a. ABC's deemed-paid taxes on the dividends are $ 7,500,000, and the foreign withholding taxes actually paid are $ 250,000.

b. The FTC claimed is $ 7,750,000.

c. ABC now has excess foreign tax credits of $ NIL .