Passive income is income of a kind that would be Subpart F foreign personal hold-
ing company income if derived by a CFC, as described in section 30.3. However, ex-
ceptions are made for passive income subject to a different special limitation, such as
high withholding tax interest, export financing interest, high taxed income (i.e., in-
come which after allocation of expenses is subject to a foreign tax in excess of the
U.S. rate), and foreign oil and gas extraction income.
Financial services income is income derived in the active conduct of a banking, fi-
nancial, or similar business or derived by an insurance company from the investment
of its unearned premiums or on its ordinary and necessary reserves. Exceptions are
provided for export financing interest and high withholding tax interest.
Export financial interest is interest derived from financing the sale (or other dis-
position) for use or consumption outside the United States of any property manufac-
tured, produced, grown, or extracted in the United States by the taxpayer or a related
person if not more than 50% of the fair market value of the exported property is at-
tributable to products imported into the United States. Such income is included in the
general limitation basket.
High withholding tax interest is interest subject to a foreign withholding tax of 5%
or more, determined on a gross basis, unless such interest qualifies as export financ-
ing interest.
A domestic corporation may be entitled to claim credits not only for foreign taxes
that it actually pays but also for foreign taxes paid by its foreign affiliate to the extent
attributable to dividends received by the domestic corporation or included in income
under the Subpart F provisions. A domestic corporation that owns 10% of the voting
stock of a foreign corporation in which it receives a dividend is deemed to have paid
a proportion of any foreign income taxes paid or is deemed to have paid by the for-
eign corporation. The “deemed paid” foreign tax credit is a substitute for the dividend
received deduction available for dividends received from domestic corporations.
A credit is available for foreign income taxes paid by a first-tier foreign corpora-
tion if the domestic corporation owns at least 10% of the voting stock of the foreign
corporation. In addition, if the first-tier corporation owns at least 10% of the voting
stock of a second-tier foreign corporation, the domestic corporation can be deemed
to have paid the foreign income taxes of the second-tier foreign corporation. If the
second-tier foreign corporation owns at least 10% of the voting stock of a third-tier
foreign corporation, the domestic corporation can be deemed to have paid the foreign
income taxes of the third-tier foreign corporation. However, the domestic corporation
must have an overall indirect interest of at least 5% in both the second and third-tier
foreign corporations. Effective for tax years beginning after August 5, 1997, these
provisions have been extended to fourth, fifth, and sixth tiers. To determine a 10%
ownership requirement, only direct ownership is recognized. The ownership test
must be met on the day the dividends are received.
Foreign income tax deemed paid
Assume that P, a U.S. corporation, owns F, a French corporation. F has post-1986
profits of 100,000 euros. It paid $20,000 of French taxes during this period, translated
Creditable taxesDividend
Post-1986 undistributed earnings of the foreign corporation 1 after income taxes 230 • 12 INTERNATIONAL TAXATION