Question

How do you compute foreign tax credit? Is it always beneficial for the companies to take foreign tax credit in place of a deduction? Discuss with examples

Answer 1

Foreign tax credit :

It is a tax paid to the foreign governments as a result of income obtained from foreign.

It is a non refunbdable tax credit i.e., we can set off the tax credit amount with taxable amount but we cannot get any refund

Steps to calculate the foreign tax credit :

1) Determination of creditable foreign income taxes

2)Computation of foreign tax limitations

3) Lower of Above

For examle.

'A' company taxable income = 100000

Taxable income includes a foreign income of 30000

Tax paid on foreign income according to their laws = 15000

Suppose let assume tax rate was 35%, then foreign tax credit limit =

total taxable income / foreign income * tax to be paid on total income in US

= 30000*35000/100000

=10500

Foreign tax credit = Lower of 10500 or tax alredy paid 15000 = $ 10500

Therefore company A can carry excess credit of 4500 forward 10 years

Actually it is beneficial for us to take tax credit because, a credit reduces our tax liability whereas deduction reduces over the taxable income.

Tax deductions just lowers our taxable income and they are calculated using the % of marginal tax bracket.

for example if you are on 25% tax bracket, a $1000 tax deduction saves you upto $250

Where as tax credit of $1000 can be taken over fully to reduce the tax liability.