States has sought bilateral relief through income tax treaties where the foreign coun-
try has an imputation system that discriminates against American investors while fa-
voring local investors.
(c) Who Is Subject to Tax? Countries typically exercise jurisdiction either over the
taxpayer or over the income or property. The United States claims both jurisdictions.
Thus, it taxes American corporations and citizens on their worldwide income—
income earned from sources within the United States, as well as income earned from
foreign sources. In addition, it taxes foreign corporations and foreign residents on in-
come earned from sources within the United States or property located within the
United States. Some countries only exercise taxing jurisdiction on income from
sources within a country and exempt or spare from taxation income earned outside
their borders. Although many countries exercise only this “source-jurisdiction,” the
methods of determining source are not uniform. In addition, those countries that claim
taxpayer jurisdiction do not apply this method in a uniform way. For example, most
countries tax residents but not citizens who are not residents, whereas the United States
taxes its U.S. citizens working abroad even if they are not resident in the United States.
Because jurisdiction on the basis of jurisdiction over the taxpayer as well as juris-
diction over income or property can lead to double taxation, a method has to be cre-
ated that would avoid a multiplicity of taxes that would discourage international ac-
tivities. In the United States, this takes the form of a foreign tax credit (discussed
below), or tax sparing, for a specified amount of income earned by U.S. citizens
working abroad.
(d) Determination of Tax Base. In determining the magnitude of a country’s tax, one
tends to focus on tax rates. It is, however, at least equally important to focus on how
the tax base is determined. One only has to think back to the 1986 Tax Reform Act
in the United States, in which tax rates were lowered; however, the tax liability of
most taxpayers increased, because the tax base was expanded by means of eliminat-
ing deductions for certain expenditures. Consequently, in analyzing the tax impact on
an anticipated business activity, it is necessary to determine both the tax base and the
tax rate. We, therefore, distinguish between statutory tax rates and effective tax rates.
Business is generally interested in effective tax rates, that is, the tax burden on its in-
come as determined under its method of accounting.
(e) Rates. There has been a worldwide tendency, starting in the United Kingdom and
spreading to the United States and then the rest of the world, for income tax rates to
decline, with a corresponding base broadening, in order to maintain the level of taxes
raised by the government. In analyzing the impact of income taxes on business prof-
its earned by a U.S. corporation in a foreign country, one should consider not only the
direct income taxes paid on that business activity but also the possibility of additional
taxes paid when the profits are repatriated to the United States. Consequently, there
can be a difference in the effective tax on retained profits and repatriated profits.
30.3 U.S. TAXATION OF A FOREIGN OPERATION
(a) Foreign Branches of U.S. Corporations. Because the United States exercises tax-
ing jurisdiction over the worldwide income of U.S. corporations, the income derived
by a foreign branch of a U.S. corporation is subject to U.S. tax in the same manner
30.3 U.S. TAXATION OF A FOREIGN OPERATION 30 • 3