 Hello and welcome to this session. This is Professor Farhad and this session we would look at foreign tax credit part two. Part two means I already covered part one. Please look in part one in the description. Specifically, I'm going to look. I'm going to work an example that deals with the access foreign access foreign tax credit as well as the FTC baskets, which is the foreign tax credit baskets. This topic is covered international accounting or taxation. It's also covered on the CPA exam and the ACCA exam. As always, if you have not connected with me on LinkedIn, please do so. YouTube is what I house my 1000 plus 1500 plus accounting, auditing, tax and finance. And here's a list of all the courses that I cover on my website. You can find additional additional information such as the PowerPoint slides, multiple choice practice questions, as well as 2000 CPA questions. Please check out my website. StudyPal.co is an artificial intelligence driven study platform that matches you with someone who's studying for the CPA, CFA or any other certification. They are they have users in 85 countries and 2500 cities. The prerequisite for this session is the foreign tax credits part one. The link will be in the description. If you cannot find the link, please email me. So the access foreign tax credit and this is basically this is where we end up the prior session. Basically, any access foreign tax credit may might be used to offset additional taxes paid to the United States on the foreign source income in the years in which the foreign tax rate are lower than the U.S. tax rate. So what happened if you have any access foreign tax credit, you can take that tax credit, carry it back one year because you paid more overseas. This is where we have access. So you can go back one year and apply for a refund. Basically, and this refund has to be due to paying taxes on foreign source income in that prior year. So you cannot apply for U.S. income. It has to be foreign source income. Or if you if you don't have if you can go back to the prior year, you can carry it forward 10 years. You can go back one, carry it forward 10 in the next 10 years. Again, you have to know where to use it. You can only use it on foreign source income. You can only use it against foreign source income. So you cannot use it on any other source income. So basically, in effect, the access foreign tax credit can be used only in the previous year or in the next five years. Your average foreign tax rate paid is less than the U.S. It means you did not pay enough. Now you have the chance to offset your to use that foreign tax credit. And the best way to illustrate this is always to work in example. And here's an example. Assume the company foreign branch in country Z has $50,000 pre-tax income in year one, 70,000 in year two, 100,000 in year three. So they have three years of taxable income. Assume the effective rate, effective income tax rate in country Z in year one was 20%. And obviously 20% is less than 21. What does it mean less than 21? It means the U.S. tax rate is 21. In year two, country Z increased their corporate income tax rate to 23. It becomes more than the U.S. corporate tax rate more than 21. So the U.S. tax rate in each year is 21%. So again, I told you this. We're comparing this to U.S. tax rate. And this is what the company would look like. Let's see what happened under those circumstances. So here's what we have. Year one, we have foreign source income of 50,000. In the host country, we paid 20%. In the U.S., we should have paid 10,500. Well, the foreign tax credit allowed in the U.S. only 10,000. They're only going to give you credit for 10,000. What does that mean? It means you are responsible for paying $500. So year one, you have to write a check to Uncle Sam for an additional $500 because you already paid 10,000 in country Z. Let's move on to year two. Okay. Year two, your income is 70,000. Now in year two, remember the hosting country increased the rate to 23%. Now you paid 16,100. If you paid taxes in the U.S., you only paid 14,700. Well, which credit are you allowed? You are allowed a credit of 14,700. Why? Because they would only assume you earned that money in the U.S. and you will have to pay 21%. What does that mean? It means you paid 16,100. They gave you a credit for 14,700. So you have a remaining credit of 1,000, oops, remaining access credit of 1,400. Now what can you do with this credit? Well, what can you do? You can go back to the prior year and file an amendment. I don't know the form for that type of amendment, but you have to file a form with the U.S. government and claim you can get back the $500. Simply put, you have 1,400. You're going to file a claim and use up $500 to get your $500 that you paid last year and you will have remaining, you will have, after you file the return and get your money, assuming no issues, you have an access foreign tax credit of $900. Let's look at year three. Year three, you have a foreign source income of $100,000. You paid 23%, which is you paid $23,000 to the hosting country. Your tax in the U.S. is only 21% and they're only going to give you credit for 21%. Although you paid 23%, I'm sorry, we're not going to give you credit for more than $21,000. You don't have to pay any taxes in the U.S. and now you have $2,000 in an access foreign tax credit. Now remember, you have 900 from year two and now you have 2,000 from year three. What are you going to do with this? Well, you're going to carry those forward, offsetting any foreign tax, offsetting any taxes on foreign source income in case your tax rate in that hosting country was lower than 21%. So as long as the, simply put, as long as the host country, their tax rate is more than 21, there's nothing you can do with that tax credit. You only can use it if the hosting country tax rate is less than 21, then you could use those access foreign tax credit to offset your income. So this is basically what I just said, what the rules are, so this is what would happen to that money. Now let's talk about something called foreign tax credit baskets because remember, when you operate overseas, you could be operating as a branch. The branch could have different type of income. They could have passive income. They could have active income. Passive income means stocks, bonds, income that you're not actively working for. So if you have different businesses, you could have a subsidiary versus a branch. So how does it work? How does it work? So it's a good idea to have a historical overview just to kind of show you how it works. All the way up to 1986, simply put, up to 1986, all foreign source income was combined to determine a single foreign tax credit limitation. So simply put in a single amount for foreign tax credit allowed. So really they did not care the type of the business you have. All that income, all that, all the taxes and all the businesses that you have overseas, you bunch them all into one computation and you computed your foreign tax limitation. Remember, your limitation is what you paid or what you should have paid in the U.S. And we'll work an example. Then in 2004, the Jobs Act, the American Jobs Creation Act, which is known by the jobs, require foreign taxable income to be classified into two categories or into two baskets. So now you have to differentiate your foreign source income into two baskets. One is a general income basket, basically your active income. And the other one is the passive income basket with the FTC computed separately for each basket. So now what's going to happen is you cannot combine everything. It's good to combine everything because if you combine everything, your limitation will go up. So you have a higher limitation. So you have a higher tax credit. Now, this is again, this is no longer valid anymore. This is no longer valid anymore. Here comes the Tax Cuts and Jobs Act of 2017. And here's what happened. Now we have one, two, three different baskets. So now as a result of this change of the Tax Cuts and Jobs Act, what's going to happen? An additional foreign tax basket for foreign branch income is created. Here's what's going to happen. As a result of this change, controlled foreign corporation support F income must be allocated if that income is coming to either a general income basket. So we have, this is the, you write this down. This is the general income. And this is controlled foreign corporation or passive income. So now what's going to happen, the controlled foreign corporation, sub chapter F income, they'll have to break the income down. Between general income and passive income. Then we have foreign branch. And this is the foreign branch. What does that mean? It means we have to keep, we have to compute for each basket separately. And when we net them, we cannot net one, one basket against the other. So companies are not allowed to net foreign tax credit across basket. So you might have, you might have access here. You might have access here, access for an income tax credit, but you cannot use this access to offset the passive income from the controlled foreign corporation nor offset the branch and same thing applied to passive. If you have any access foreign tax credit, you cannot utilize it somewhere else. Okay. In other words, the access foreign tax credit from one basket cannot be used to reduce the additional taxes owed to another basket. So what can you do if you have additional foreign tax credit? Just that access will stay with you and it will offset general income in the future, either going back one year. So simply put that access tax credit can only be used against the general income. The access tax credit here can only be used against the passive income and the access foreign tax credit and the foreign branch. It has to be used there. Again, the best way to illustrate this is to actually look at an example. So let's assume we have Alpha company has a branch in country A and they have a branch in country Z. So it's the same company branches into different countries. This is their taxes in country A. I'm sorry, income, income before taxes. This is how much taxes they paid. This is their income before taxes in country in Alpha company in Brent and Z country. And this is the taxes paid. Now, let's assume. Okay, this is Alpha company. Let's assume that the branch in country A makes passive investment in stocks and bonds. That's their income. And the branch in country Z is a manufacturing operation, basically active income. So you have active income in one branch in one country, passive income in another branch in another country. It does not matter. They're both branches. So if it's a branch under the current US tax rule, the income from both branches would be placed in the foreign branch income. Therefore, they can upset each other. What's going to happen? The total income of 200,000. So therefore the total branch income is 200,000. The foreign tax limitation and the foreign tax allowed is 34,000. Why 34,000? Because we're going to combine them. We can combine those two because they paid 34,000. We can combine them. If you could not combine them, it's not as advantageous. Now, you still have in the US tax liability on the branch income will be 8,000. You did not pay enough. You did not pay enough. Let me show you why you did not pay enough. Because together 200,000 in the US, you should have paid 21%, which is 42,000. You only are allowed is 34,000. So this is what you actually paid versus how much you should have paid. You compare those two and you only can take credit for 34,000. But your US liability now is only 8,000. You were able to combine them, which is good. If you could not combine them, we're going to see in a moment, we're going to change the scenario. And if you cannot combine them, it's not as advantageous. It's not as advantageous. So let's take a look at the same scenario again. Alpha company branch in a country and Alpha company branch and Z. Now assume that the entity in country A is incorporated as a subsidiary and that subsidiary or earn passive income. And the tax rate is less than 90% of US corporate tax rate, which is less. They're paying less, which is technically a tax haven. The operation in country B is a branch. The operation in country B is a branch. So this is a branch and this is a sub. This is a branch and this is a sub. Now the subsidiary in country A, remember the A generated passive income, which must be allocated to the passive income basket. So this income is passive income basket. Why? Because it's a subsidiary and it's passive income. If it was a branch, it would not be a big deal. We'll be able to combine them. So Alpha company will have an additional taxes. So those two cannot be combined now. They cannot be combined. So Alpha company will have an additional $10,000. Because again in the US it's 100,000 times 21%. The responsible for 21,000, they only paid 11,000. They cannot use the access from the other business from the branch. So they are responsible for 2,000. So country Z branch, country Z, this is not country B, country Z. Country Z branch is placed in a separate foreign income, foreign tax credit basket, and Alpha company has an access of 2,000. So this company, the country Z branch, country Z branch, they only have to pay 21,000 and they pay 23. They have an access of 2,000. Well, this access of 2,000 cannot help the subsidiary in country A. Although they're both the same company, but they have to stay separated. They have to stay separated. Alpha is not allowed to use the access foreign tax credit of $2,000 from the foreign branch basket to offset the additional tax of $10,000. So it's basically, this is the point here is you cannot. So basically we're back to here, back to the baskets. What happened under this scenario? We have the subsidiary. So the subsidiary has passive income. We have a sub with passive income and they were short. They had to pay an additional $10,000. They had to pay an additional $10,000. Now the branch, they had access of 2,000. We cannot net them. We cannot net them. In contrast to this example, in this example, they were both branches and we net them out. I hope you, I hope with the numbers it make a little bit more sense, a little bit more sense to you. Okay. That's the same thing. So I guess I have the slide twice. That's fine. In the next session, I will take a look at US tax treatment of foreign operation income. And basically in the next session, you need to know everything that we learned up to this point because we're going to look at a comprehensive example of how the US treat foreign source income. We're going to look at different sources and we're going to try to see what's combinable, what's not, what can we combine, what can we not combine, so on and so forth. As always, I would like to remind you to visit my website for additional resources. If you like this video, please like it, share it, put it in a playlist. If it's benefiting you, it means it will benefit other people. Thank you very much. Study hard and good luck.