 Hello and welcome to the session. This is Professor Farhad. In this session we would look at foreign tax credit and this will be part one of two. I will have two parts for the foreign tax credit. If you really want to cover the foreign tax credit you could have five different parts, but this part will be the basic. In the next session I will work a little bit further with multi-branch situation. This topic is covered in international accounting or taxation course also covered on the CPA exam as well as the ACCA exam. As always I would like to remind you to connect with me only then if you haven't done so. YouTube is where I house my 1500 plus accounting, auditing, tax and finance lectures. Here's a list of all the courses that I cover. Please check out my YouTube. On my website I do have additional resources where you have the PowerPoint slides, notes, multiple choice questions, true false questions, 2000 CPA questions. I strongly suggest you check out my website. StudyPal.co is an artificial intelligence driven study body platform that matches you with a CPA, CFA or any other for any other test prep candidate. They are located in 85 countries and 2800 cities. What are the prior sessions that are helpful for this session? You need to know the difference between you need to know about branch income, US branch income. You need to know about controlled foreign corporation and sub-chapter F income. I do have the link for any prerequisite in the description. If you don't find the link please email me. Let's talk about foreign tax credits. That's the basic idea of this chapter. Well, we learned from prior chapter and this is why from prior lessons that foreign branch income and foreign subsidiary sub-chapter F income must be included in the US taxable income in the year earned. Now, in determining the net US tax liability on these sources because they are taxable, US companies are allowed to either, so because you don't want to be double taxed, you're either allowed a deduction notice. This is a deduction on all foreign taxes paid on the related foreign income or a credit. So here I'm going to highlight those two words because they mean two different things. You could either get a credit or you could either get a deduction. The deduction will be for all the taxes paid that are related to your business, to that foreign income business, and the credit is for income taxes paid on the foreign income. And we'll see how the difference between whether you took the deduction or the credit, which one is more beneficial for you than there's another overall limitation, but this is generally what you are allowed. So income taxes that are given credit for include withholding taxes on dividend, but sales tax, excise tax, and other type of tax are not included. So remember when you are going to be taking the tax credit, you're going to be taking tax credit on withholding taxes on dividend and income taxes. So basically the income taxes that you paid on your income and withholding on dividend. Unless, okay, unless the credit taxes other than income tax are substantial, it's more advantageous for a company to take the foreign tax credit rather than the tax deduction. Simply put, what are we saying here? In general, in general, companies end up taking credit. And you know, if you know anything about you at the US tax system, credits generally speaking are worth much more than deduction because credits give you dollar for a dollar refund or dollar for a dollar tax satisfaction versus a deduction. Well, if they give you a $100 deduction, okay, simply put, if you're paying 21%, you're going to get $21 in basically in benefit, but if they gave you $100 tax credit, guess what? That's mean $100 equal to $100 deduction. So the tax credit generally speaking, not generally speaking, they are worth more than deduction. And we'll look at an example anyhow. So let's take a look at an example. Assume a USD, which is a US company's foreign branch, earns income before income taxes of $100,000. Income taxes paid to the foreign government are $15,000. That's how much they paid in taxes. Sales and other taxes to the foreign government are $10,000. Now, this company must include $100,000 of foreign branch income in its US tax return and computing their US taxable income because this is what they have to include. Well, we're going to look at both options if they took the deduction versus the credit and determine which one is more beneficial. Let's take a look at this. Let's assume they want to go with the deduction. Well, their foreign source income is $100,000. This is how much they have to report minus the deduction on all foreign taxes paid. Now, we are dealing with the deduction. So the deduction, they paid $10,000 in sales and other taxes and $15,000 in income taxes. So all in all, they can deduct $25,000 from their taxable income. Their US taxable income becomes $75,000. They have to pay 21%. Well, foreign taxes paid for income, foreign tax credit. You can't take foreign tax credit because you took the deduction. So you cannot take both. So this basically doesn't apply for this example. Your liability in the US, you have to pay $15,750. Let's assume we use now the credit. Now, we're going to see if you used the credit option. Your foreign source income is $100,000. You cannot use the deduction. So this is nothing. US tax income before credit is 21%. So you have to pay to the US government 21,000. Now, the US government will give you $15,000 tax credit because you paid $15,000 tax credit on your income. Well, what end up to be your liability? Your liability end up to be $6,000. So clearly, as you can see, taking the tax credit is much more beneficial than taking the $25,000 deduction. So the deduction reduce your taxable income. The tax credit give you $1 for a dollar tax credit for the taxes that you paid overseas. So you cannot have both. You have to choose one. You cannot have both. So the foreign tax credit provide $1 for a dollar reduction, $1 for a dollar. This is the benefit of the tax credit for every dollar of income taxes paid to the foreign government. The company is allowed a dollar reduction in the amount of income taxes paid to the US government. So you paid $15,000, we're going to give you a credit of $15,000. Now, there is a limitation for that credit. We're going to talk about the limitation shortly, but this is the overall idea. So simply put in this example, the foreign tax credit result in a considerably less US tax liability than a deduction. Okay. In the case of foreign branch income, the credit allowed known as a direct foreign tax credit because the company is giving credit for taxes, it paid directly to the foreign government. So simply put, it's called direct foreign income tax. We used to have an indirect foreign income tax, but we no longer have it. Prior to 2018, foreign subsidiaries income was taxed in the United States when dividend were paid by the foreign subsidiary to the US, to the US parent company. This is before the Tax Cuts and Jobs Act. When that existed, dividend paid from foreign sources were included in the calculation of the US taxable income and an indirect foreign tax credit, indirect foreign tax credit was allowed to the foreign taxes actually paid by the foreign subsidiary, but deemed to have been paid by the US government. So they used to say, okay, once we bring the income, we're going to deem that you have paid the taxes and here's your credit. That's that no longer exists because you know, now we exempt an income by exempting dividend received from foreign subsidiaries from the US taxation beginning in 2018. The tax cuts and jobs acts also eliminated this indirect foreign tax credit. Simply put, there is no more indirect foreign tax credit because now you can bring your money, the dividend, you can pay dividend and you can get you can get a dividend received reduction, which did not exist before within certain limitation view my related lecture to that topic. So the computation of a foreign tax credit, as I told you, you are allowed either a deduction or a credit, but you are limited. So it's not like every dollar you pay overseas, you're going to get a credit for it. Let's look at the overall, overall limitation. The rules governing the calculation of the direct tax foreign direct foreign tax credit are very complex, but we're going to try to simplify it. The foreign tax credit is allowed equal to the amount lower off. So this is what you are limited by the actual taxes paid by the by the four to the foreign government, what you actually paid, or the amount of taxes that would have been paid if the income has been earned in the US. So they compare two things. They would say, this is how much you actually paid. You actually paid $3,000. If that income was, was, was earned in the US, you would have paid $2,500. So they would only give you credit for $2,500, the lower of these two, or let's assume you paid $5,000 and the amount of taxes paid. If you earn this in the US, it's $6,000 that you would only get what you actually paid. Okay, you get credit for you actually paid. So keep that in mind. And it's pretty, pretty straightforward. Number two here, the amount taxes that you would have paid can be computed by multiplying the amount of foreign sources taxable income by the US corporate rate. And this is easy. It used to be much more difficult because now it's 21%. This is how you find out. And this is known as the overall foreign tax credit limitation. This is the limitation. Simply put, the US will not allow you a foreign tax credit greater than the amount of taxes that would have been paid in the US. So simply put, you paid more taxes overseas, we are not going to give you credit for that. Simply put, if they do give you credit, it's like as if they are giving you a refund for taxes you paid overseas. So they will give you the credit up to what would they have been, what you would have been charged if that income was earned in the US. Okay, so to allow a foreign tax credit greater than the amount of taxes that would have been paid in the US, this would technically, what we're saying the US government is is giving you a refund for higher taxes paid in foreign countries. And that's not going to happen. Okay, so, so I want to make sure you understand the overall foreign tax credit is you can pay as many taxes as you want to overseas. But when the only credit the US government will give you is they would say, okay, if you earned this income in the US, this would have been your taxes. And this is the credit that we will give you. Okay, so they're going to give you a refund for taxes paid overseas. So this is how you compute the overall limitation, you will take your foreign source taxable income divided by your worldwide taxable income multiplied by the US taxes before the foreign tax credit, whatever that numbers are, I'm going to look at it would look at an example. So the overall foreign tax limit, a foreign tax credit limitation must be computed separately for foreign branch income and controlled foreign corporation sub chapter F income. So you have to compute that separately for each one of these incomes. Let's take a look at an example in the next session we'll cover more, we'll cover this topic a little bit more. So let's take a look at an example. Assume that two different US based companies have foreign branches. Alpha has a branch in country A and Zeta has a branch in country C. The amount of income before taxes earned for each branch is as follows. So here's the amount of income for a 100,000 for Zeta 100,000. The branch in country A paid 11% in taxes, which is $11,000. The branch in country Z paid 23% taxes, which is $23,000. Now both companies Alpha and Zeta would report 100,000 of foreign branch income on the US tax return and each will determine their tax liability in the US, which is 21%. So in the US they have to pay $1,000. For both companies, $21,000 is the amount of US taxes that would have been paid if the foreign branch income has been earned in the US. If you earn this $100,000 in the US, you would pay us $21,000. Well, this is going to give us the overall foreign tax limitation for each company. So each company could have a credit up to $21,000. So here's what's going to happen. Alpha is going to compare their tax, their income tax paid, which is $11,000, to the government of country A and with the limitation of $21,000. Obviously they're going to be short. They're going to take, they're going to give them credit of the two. So you're going to, you're going to get credit for $11,000, but you still have to pay the US an additional $10,000. Zeta compared their actual taxes paid to the government in country Z with the limitation of $21,000. So notice here, they paid a little bit more. So you can only get credit for the lower of these two. The lower of these two is $21,000. Simply put, this is what the picture would look like. Alpha, US taxable income $100,000. In the US they would pay 21% or $21,000. They're going to give them a credit. They're going to get a 100% credit for all the taxes paid because it's less than 21%. They are still responsible for paying 10,000. Zeta company, their income, US taxable income is $100,000. Their taxes in the US is $21,000. The US government, it's going to give them a tax credit for $21,000, no more than that and therefore they have no tax liability in the US. Matter of fact, they have an additional $2,000. It's called access foreign tax credit and we'll talk about this in a moment. So notice Zeta, they have an additional $2,000. We're going to see in a moment what we can do with this $2,000. So Alpha has an US tax liability after the foreign tax credit of $10,000, which is an additional 10% because they have to $10,000 plus $11,000 equal $21,000. The US requires Alpha to pay an effective tax rate of 21%. Simply put, you have to pay 21% or have paid 21% of the foreign country. The Z company, Zeta has no tax liability after the foreign tax credit because we paid enough. Now, but Zeta has already paid more than the US tax rate in country C, so no additional taxes will be paid. Instead, the $2,000 difference between the $23,000 and the $21,000 allowed is called access foreign tax credit. What can we do with this access foreign tax credit? Access foreign tax credit may be used to offset additional taxes paid to the US United States on foreign income in the years in which the foreign tax rate are lower than the US tax rate. So this is what the access tax credit is created. You paid a little bit more than what you should have paid in the US. So what can you do with this access foreign tax credit? You can carry it back one year. The company applies for a refund for additional taxes paid to the US on foreign income in the prior year. Again, you can file an amendment, go back the prior year and if you had foreign source income and you had to pay taxes, you can ask for a refund to use it to get a refund or if you don't have anything in the prior year, you can carry it up to 10 years. The company reduce your future US tax liability in the event that additional taxes must be paid on foreign source income. So this credit only can be used against foreign source income, not for any income. That will be nice. But again, if they do give you credit, it means they are giving you credit for taxes paid in a foreign country. They would only give you credit against foreign source income in the future if that's the case. So in effect, the access foreign tax credit can be used only if in the previous year or in the next 10 years, the average foreign tax rate paid by the US company is less than the US tax rate. So in the next 10 years, if your average tax rate is lower, then you could use that credit. That credit will kick in. Now we need to talk a little bit more about the credit and the only way we can illustrate the concept of this foreign tax credit and the benefit of it is to look at part two. This will be part two. As always, please connect with me, check out my website for additional lectures and additional resources and subscribe to my videos, like them, share them, put them in the playlist. Thank you very much and good luck.