think critically about hypothetical situations to determine how to handle the given problem for tax purposes.

Unit 3 Problems

1. Drumco, an accrual basis domestic corporation, manufactures musical instruments for sale both in the United States and abroad. Drumco’s functional currency is the U.S. dollar. Two years ago, Drumco established a branch sales office in Norway. The sales office is a qualified business unit with the Norwegian krone (kr) as its functional currency. In Year 1, the branch had kr80 million of taxable income and paid kr30 million in Norwegian income taxes. The Norwegian krone had an average exchange rate in Year 1 of kr1 equals $1.20 and the spot rate on the date the income tax was paid was kr1 equals $1.15.

What are the United States tax consequences of the branch’s activities in Year 1?

2. Biz, a domestic corporation, is a manufacturer. Biz is planning to build a new production facility, and has narrowed down the possible sites for this new plant to either Country L (a low-tax foreign country) or Country H (a high-tax foreign country). Biz will structure the new facility as a wholly owned foreign subsidiary, Biz-Fco, and finance Biz-Fco solely with an equity investment. Biz projects that Biz-Fco’s results during its first year of operations will be as follows:
 

Sales…………………………………………………………………………. $400,000

Cost of goods sold………………………………………………………. ($290,000)

Selling, general, and administrative expenses…………………… ($60,000)

Income before income taxes……………………………………………. $50,000

Assume that the United States corporate tax rate is 21%, the Country L rate is 10%, and the Country H rate is 30%. Further assume that neither Country L nor Country H imposes withholding taxes on interest or royalty payments paid by a local subsidiary to its U.S. parent company. Compute the total tax rate (United States plus foreign) on Biz-Fco’s profits under the following assumptions:

1. The new production facility is located in Country L.
2. The new production facility is located in Country H.
3. The new production facility is located in Country H,       but Biz modifies its plans. Specifically, Biz will finance Biz-Fco with both       debt and equity, such that Biz-Fco will pay Biz $15,000 of interest each       year. Biz will also charge Biz-Fco an annual royalty of $10,000 for the       use of Biz-Fco’s patents and trade secrets.

3. Egor, a United States citizen, is engaged in numerous, diverse operations and pays U.S. income tax at a rate of 37%. Egor owns MY LLC, a disregarded entity for U.S. tax purposes. MY LLC manufactures the ubiquitous product, widgets. U.S. sales result in $100,000 of taxable U.S.-source income. Egor projects that he could earn approximately $100,000 of net income in the United Kingdom (the U.K.), where the corporate income tax rate is 20%. To further limit his liability (widgets being a very dangerous product); Egor’s MY LLC forms a private limited company in the United Kingdom. The private limited company in the U.K. is not a “per se” entity and, therefore, Egor (via the MY LLC) would consider checking-the-box to treat the private limited company in the U.K. as a disregarded entity. Assume both that the withholding tax rate on any dividends from a U.K. private limited company to the United States is 15% and that the title on all widget sales passes in the U.K.

1. If the U.K. private limited company is       “checked,” what is Egor’s foreign tax credit position in Year 1       if an $80,000 dividend is distributed for U.K. tax purposes?
2. If the U.K. private limited company is       “checked,” what is Egor’s foreign tax credit position in Year 1       if a dividend is not distributed for U.K. tax purposes?
3. What is Egor’s foreign tax credit position in Year 1       if the U.K. private limited company is not “checked” as a       disregarded entity and pays a dividend of $80,000 to the MY LLC?
4. What is Egor’s foreign tax credit position in Year 1       if the U.K. private limited company is not “checked” as a       disregarded entity and does not pay a dividend?

Reference

Misey, J., & Schadewald, M. S. (2018). Practical guide to U.S. taxation of international transactions (11th ed.). CCH.