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Chapter 25 Taxation Of International Transactions
Problems
16. LO.4, 5 BlueCo, a domestic corporation, incorporates GreenCo, a new wholly owned entity in Germany. Under both German and U.S. legal principles, this entity is a corporation. BlueCo faces a 35% U.S. tax rate.
GreenCo earns $1,500,000 in net profits from its German activities and makes no dividend distributions to BlueCo. How much U.S. income tax will BlueCo pay for the current year as a result of GreenCo’s earnings, assuming no deemed dividend under Subpart F? Ignore any FTC implications.
17. LO.3 Emma, a U.S. resident, received the following income items for the current tax year. Identify the source of each income item as either U.S. or foreign.
a. $600 interest from a savings account at a Florida bank.
b. $5,000 dividend from U.S. Flower Company, a U.S. corporation that operates solely in the eastern United States.
c. $7,000 dividend from Stern Corporation, a U.S. corporation that had total gross income of $4 million from the active conduct of a foreign trade or business for the immediately preceding three tax years. Stern’s total gross income for the same period was $5 million.
d. $10,000 dividend from International Consolidated, Inc., a foreign corporation that had gross income of $4 million effectively connected with the conduct of a
U.S. trade or business for the immediately preceding three tax years. International’s total gross income for the same period was $12 million.
e. $5,000 interest on Warren Corporation bonds. Warren is a U.S. corporation that derived $6 million of its gross income for the immediately preceding three tax years from operation of an active foreign business. Warren’s total gross income for this same period was $7.2 million.
18. LO.3 Gloria Martinez, an NRA, is a professional golfer. She played in seven tournaments in the United States in the current year and earned $250,000 in prizes from these tournaments. She deposited the winnings in a bank account she opened in Mexico City after her first tournament win.
Gloria played a total of 30 tournaments for the year and earned $800,000 in total prize money. She spent 40 days in the United States, 60 days in England, 20 days in
Scotland, and the rest of the time in South America. Write a letter to Gloria explaining how much U.S.-source income she will generate, if any, from her participation in these tournaments and whether any of her winnings are subject to U.S. taxation.
Gloria’s address is AV Rio Branco, 149-4#, Rio de Janeiro, RJ 20180, Brazil.
19. LO.3 Determine whether the source of income for the following sales is U.S. or foreign.
a. Suarez, an NRA, sells stock in Home Depot, a U.S. corporation, through a broker in San Antonio.
b. Chris sells stock in IBM, a U.S. corporation, to her brother, Rich. Both Chris and
Rich are NRAs, and the sale takes place outside the United States.
c. Crows, Inc., sells inventory produced in the United States to customers in
Europe. Title passes in the international waters of the Atlantic Ocean.
d. Doubles, Inc., a U.S. corporation, manufactures equipment in Malaysia and sells the equipment to customers in the United States.
20. LO.3 Chock, a U.S. corporation, purchases inventory for resale from distributors within the United States and resells this inventory at a $1 million profit to customers outside the United States. Title to the goods passes outside the United States.
What is the sourcing of Chock’s inventory sales income?
21. LO.3 Willa, a U.S. corporation, owns the rights to a patent related to a medical device.
Willa licenses the rights to use the patent to IrishCo, which uses the patent in its manufacturing facility located in Ireland. What is the sourcing of the $1 million royalty income received by Willa from IrishCo for the use of the patent?
22. LO.3 USCo incurred $100,000 in interest expense for the current year. The tax book value of USCo’s assets generating foreign-source income is $5 million. The tax book value of USCo’s assets generating U.S.-source income is $45 million. How much of the interest expense is allocated and apportioned to foreign-source income?
23. LO.3 Create, Inc., produces inventory in its foreign manufacturing plants for sale in the United States. Its foreign manufacturing assets have a tax book value of $5 million and a fair market value of $15 million. Its assets related to the sales activity have a tax book value of $2 million and a fair market value of $5 million. Create’s interest expense totaled $400,000 for the current year.
a. What amount of Create’s interest expense is allocated and apportioned to foreign-source income using the tax book value method? Using the fair market method?
b. If Create wants to maximize its FTC, which method should it use?
24. LO.4 Honk, Inc., a U.S. corporation, purchases weight-lifting equipment for resale from HiDisu, a Japanese corporation, for 60 million yen. On the date of purchase, 120 yen is equal to $1 U.S. (¥120:$1). The purchase is made on December
15, 2016, with payment due in 90 days. Honk is a calendar year taxpayer. On December
31, 2016, the foreign exchange rate is ¥124:$1.
On February 2, 2017, the invoice is paid when the exchange rate is ¥125:$1. What amount of foreign currency gain or loss, if any, must Honk recognize for 2016 as a result of this transaction? For 2017?
25. LO.4, 5 Teal, Inc., a foreign corporation, pays a dividend to its shareholders on
November 30. Red, Inc., a U.S. corporation and 7% shareholder in Teal, receives a dividend of 10,000K (a foreign currency). Pertinent exchange rates are as follows.
November 30 .9K:$1
Average for year .7K:$1
December 31 .95K:$1
What is the dollar amount of the dividend received by Red, Inc.? Does Red recognize a foreign exchange gain or loss on receipt of the dividend?
26. LO.5 Packard, Inc., a domestic corporation, operates a branch in Mexico. Over the last 10 years, this branch has generated $30 million in losses. For the last
3 years, however, the branch has been profitable and has earned enough income to entirely offset the prior losses. Most of the assets are fully depreciated, and a net gain would be recognized if the assets were sold.
Packard’s CFO believes that Packard should incorporate the branch now, so that this potential gain can be transferred to a foreign corporation, thereby avoiding U.S. tax and, as an added benefit, avoiding U.S. taxes on future income. Draft a memo to Samuel
Henderson, the CFO, addressing the tax issues involved in the proposed transaction.
27. LO.5 USCo owns 65% of the voting stock of LandCo, a Country X corporation.
Terra, an unrelated Country Y corporation, owns the other 35% of LandCo.
LandCo owns 100% of the voting stock of OceanCo, a Country Z corporation.
Assuming that USCo is a U.S. shareholder, do LandCo and OceanCo meet the definition of a CFC? Explain.
28. LO.5 Hart Enterprises, a U.S. corporation, owns 100% of OK, Ltd., an Irish corporation.
OK’s gross income for the year is $10 million. Determine OK’s Subpart F income (before any expenses) from the transactions that it reported this year.
a. OK received $600,000 from sales of products purchased from Hart and sold to customers outside Ireland.
b. OK received $1 million from sales of products purchased from Hart and sold to customers in Ireland.
c. OK received $400,000 from sales of products purchased from unrelated suppliers and sold to customers in Germany.
d. OK purchased raw materials from Hart, used these materials to manufacture finished goods, and sold these goods to customers in Italy. OK earned $300,000 from these sales.
e. OK received $100,000 for the performance of warranty services on behalf of
Hart. These services were performed in Japan for customers located in Japan.
f. OK received $50,000 in dividend income from investments in Canada and Mexico.
29. LO.5 Brandy, a U.S. corporation, operates a manufacturing branch in Chad, which does not have an income tax treaty with the United States. Brandy’s worldwide
Federal taxable income is $30 million, so it is subject to a 35% marginal tax rate. Profits and taxes in Chad for the current year are summarized as follows.
Compute Brandy’s foreign tax credit associated with its operations in Chad.
Income Item
Chad Income
This Year
Chad Tax
Rate
Chad
Tax Paid
Manufacturing profits $2,500,000 20% $500,000
Dividend 300,000 5% 15,000
30. LO.5 Weather, Inc., a domestic corporation, operates in both Fredonia and the
United States. This year, the business generated taxable income of $600,000 from foreign sources and $900,000 from U.S. sources. All of Weather’s foreignsource income is in the general limitation basket. Weather’s total taxable income is $1.5 million. Weather pays Fredonia taxes of $228,000. What is Weather’s FTC for the tax year? Assume a 34% U.S. income tax rate.
31. LO.5 Blunt, Inc., a U.S. corporation, earned $600,000 in total taxable income, including $80,000 in foreign-source taxable income from its German branch’s manufacturing operations and $30,000 in foreign-source taxable income from its
Swiss branch’s engineering services operations. Blunt paid $32,000 in German income taxes and $1,800 in Swiss income taxes. Compute Blunt’s U.S. tax liability after any available FTCs. Blunt’s marginal U.S. tax rate is 34%.
32. LO.5 Dunne, Inc., a U.S. corporation, earned $500,000 in total taxable income, including $50,000 in foreign-source taxable income from its branch manufacturing operations in Brazil and $20,000 in foreign-source income from interest earned on bonds issued by Dutch corporations. Dunne paid $25,000 in Brazilian income taxes and $3,000 in Dutch income taxes. Compute Dunne’s U.S. tax liability after any available FTCs. Assume that the U.S. tax rate is 34%.
33. LO.5 ABC, Inc., a domestic corporation, reports $50 million of taxable income, including $15 million of general limitation foreign-source taxable income, on which ABC paid $5 million in foreign income taxes. The U.S. tax rate is 35%. What is
ABC’s foreign tax credit?
34. LO.1, 5 Indeco, a U.S. C corporation, operates Grange, a sales branch in Staccato.
Indeco’s U.S. corporate marginal tax rate is 35%; it is 20% for Staccato.
Grange’s pre-tax profit for the year is $1 million. There is no income tax treaty between the United States and Staccato. Staccato’s currency is the U.S. dollar. Compute
Indeco’s combined U.S. and foreign income tax on the Grange profits, under each of the following assumptions.
U.S.
Income Tax
Staccato
Income Tax
Combined
Tax Liability
a. U.S. income tax law allows no deduction or credit for foreign income taxes paid.
b. U.S. income tax law allows only a deduction for foreign income taxes paid.
c. U.S. income tax law allows only an exclusion of foreign branch profits.
d. U.S. income tax law allows only a credit for the full amount of foreign income taxes paid.
e. U.S. income tax law allows only a credit for the full amount of foreign income taxes paid.
The applicable Staccato tax rate is now 40%.
f. U.S. income tax law allows only a credit for the full amount of foreign income taxes paid, but limited currently to the corresponding tax on this income at U.S. rates. The applicable
Staccato tax rate is now 40%.
35. LO.5 Mary, a U.S. citizen, is the sole shareholder of CanCo, a Canadian corporation.
During its first year of operations, CanCo earns $14 million of foreign-source taxable income, pays $6 million of Canadian income taxes, and distributes a $2 million dividend to Mary. Can Mary claim a deemed-paid (indirect) FTC on her Form 1040 with respect to receipt of the dividend distribution from CanCo? Why or why not?
36. LO.5 Elmwood, Inc., a domestic corporation, owns 15% of Correy, Ltd., a Hong
Kong corporation. The remaining 85% of Correy is owned by Fortune Enterprises, a Canadian corporation. At the end of the current year, Correy has $400,000 in undistributed E & P and $200,000 in foreign taxes related to this E & P.
On the last day of the year, Correy pays a $40,000 dividend to Elmwood. Elmwood’s taxable income before the dividend is $200,000. What is Elmwood’s tax liability after consideration of the dividend and any allowed FTC, assuming a 34% U.S. tax rate?
37. LO.5 Warwick, Inc., a U.S. corporation, owns 100% of NewGrass, Ltd., a foreign corporation.
NewGrass earns only general limitation income. During the current year, NewGrass paid Warwick a $10,000 dividend. The deemed-paid foreign tax credit associated with this dividend is $3,000. The foreign jurisdiction requires a withholding tax of 10%, so Warwick received only $9,000 in cash as a result of the dividend. What is Warwick’s total U.S. gross income reported as a result of the cash dividend?
38. LO.5 Night, Inc., a domestic corporation, earned $300,000 from foreign manufacturing activities on which it paid $90,000 of foreign income taxes. Night’s foreign sales income is taxed at a 50% foreign tax rate. What amount of foreign sales income can Night earn without generating any excess FTCs for the current year?
Assume a 34% U.S. tax rate.
39. LO.4, 5 Partin, Inc., a foreign subsidiary of Jones, Inc., a U.S. corporation, reports pretax income of 200,000 euros for the current year. Partin accrues 60,000 euros in foreign taxes on this income. The average exchange rate for the tax year to which the taxes relate is 1.15e:$1. None of the income is Subpart F income. If the net earnings of 140,000 euros are distributed when the exchange rate is 1.25e:$1, what are the deemed-paid taxes available to Jones? Assume that this is Partin’s first year of operation.
40. LO.5 Money, Inc., a U.S. corporation, has $500,000 to invest overseas. For U.S. tax purposes, any additional gross income earned by Money will be taxed at
34%. Two possibilities for investment are:
a. Invest the $500,000 in common stock of Exco (a foreign corporation). Exco common stock pays a dividend of $3 per share each year. The $500,000 would purchase 10,000 shares (or 10%) of Exco’s only class of stock (voting common).
Exco expects to earn $10 million before taxes this year and to be taxed at a flat rate of 40%. Its current E & P before taxes is estimated to be $9.4 million. Exco’s government does not withhold on dividends paid to foreign investors.
b. Invest the $500,000 in Exco bonds that pay interest at 7% per year. Assume that the bonds will be acquired at par, or face, value. Exco’s government withholds
25% on interest paid to foreign investors.
Analyze these two investment opportunities, and determine which would give
Money the better return after taxes. Make sure you consider the effect of the FTC.
Write a letter to Money’s CFO Jeffrey Howard, advising the corporation of your findings.
Money’s address is 9201 West South Street, Woodstock IL 60098.
41. LO.2, 6 IrishCo, a manufacturing corporation resident in Ireland, distributes products through a U.S. office. Current-year taxable income from such sales in the United States is $12 million. IrishCo’s U.S. office deposits working capital funds in short-term certificates of deposit with U.S. banks. Current-year interest income from these deposits is $150,000.
IrishCo also invests in U.S. securities traded on the New York Stock Exchange. This investing is done by the home office. For the current year, IrishCo records realized capital gains of $300,000 and dividend income of $50,000 from these stock investments. Compute
IrishCo’s U.S. tax liability, assuming that the U.S.-Ireland income tax treaty reduces withholding on dividends to 15% and on interest to 5%. Assume a 34% U.S. tax rate.
42. LO.6 Clario, S.A., a Peruvian corporation, manufactures furniture in Peru. It sells the furniture to independent distributors in the United States. Because title to the furniture passes to the purchasers in the United States, Clario reports $2 million in U.S.-source income. Clario has no employees or operations in the United States related to its furniture business.
As a separate line of business, Clario buys and sells antique toys. Clario has a single employee operating a booth on weekends at a flea market in Waldo, Florida.
The antique toy business generated $85,000 in net profits from U.S. sources during the current year.
What is Clario’s effectively connected income for the current year?
43. LO.6 Trace, Ltd., an Allegro corporation, operates a trade or business in the United
States. Trace’s U.S.-source income effectively connected with this trade or business is $800,000 for the current year. Trace’s current-year E & P is $600,000.
Trace’s net U.S. equity was $8.2 million at the beginning of the year and $8.6 million at year-end. Allegro has no income tax treaty with the United States.
Prepare a letter to Tanner Martin, Trace’s Tax VP, reporting Trace’s branch profits tax liability for the current year, along with at least one planning idea for reducing the branch profits tax. Trace uses the following address for its U.S. affairs: 9148
Church Street, Marietta GA 30060.
44. LO.6 Martinho is a citizen of Brazil and lives there year-round. He has invested in a plot of Illinois farmland with a tax basis to him of $1 million. Martinho has no other business or investment activities in the United States. He is not subject to the alternative minimum tax. Upon sale of the land for $1.5 million to Emma, an Illinois person, what are the Federal income tax consequences to Martinho?
45. LO.6 Continue with the facts of Problem 44. What are the Federal income tax withholding requirements with respect to Martinho’s sale? Who pays the withheld amount to the U.S. Treasury?
46. LO.6 John McPherson is single, an attorney, and a U.S. citizen. He recently attended a seminar where he learned he could give up his U.S. citizenship, move to Bermuda (where he would pay no income tax), and operate his law practice long distance via the Internet with no U.S. tax consequences. Write a letter informing John of the tax consequences of his proposed actions. His address is 1005
NE 10th Street, Gainesville, GA 32612.