from euros at the exchange rate on the date the taxes were paid. F pays a dividend to
P of 20,000 euros. The deemed paid credit is computed as follows:
The foreign income tax deemed paid is included in income. The dividend is trans-
lated into U.S. dollars at the rate in effect at the time the dividend is received. As-
sume that the rate is 1 to 1 US$. Pās taxable income is as follows:
Dividend received $20,000
Foreign tax deemed paid ______20,000
Total income $40,000____________For years prior to 1987, the denominator is earnings and profits computed annually.
If the foreign income taxes paid or accrued exceed the foreign tax credit limita-
tion, the excess must be carried back two years and forward five years. A credit can-
not be carried to a year in which a deduction for foreignincome taxes is claimed.
These carryover rules apply separately to each limitation basket. If a taxpayer has an
overall foreign loss (i.e., its expenses attributable to foreign source income are in ex-
cess of that foreign income), it must keep track of that overall foreign loss. In a later
year, foreign source income, to the extent of the overall foreign loss, must be recate-
gorized as U.S. source income. The amount of otherwise foreign source income that
is recategorized as U.S. source income is the lesser of the amount of the overall for-
eign loss or 50% of the foreign taxable income for the year. Taxpayers can elect to
have a higher percentage apply. These rules are applied separately to each of the for-
eign tax credit limitation baskets. Losses in a foreign tax limitation basket are allo-
cated on a proportionate basis among (and thereby reduce) the foreign income bas-
kets in which the entity earns income in a loss year. If a foreign loss is allocated to
another basket and if a loss basket has income in a subsequent taxable year, then, to
the extent of the losses allocated to a different basket, the subsequent income is allo-
cated to those different baskets.
This complex provision was enacted because Congress was concerned that tax-
payers would conduct their foreign activities in branch form during the initial start-
up years when the foreign activities are operating at a loss, using the loss to reduce
their U.S. taxable income. Then, in a later year, when the foreign activities are prof-
itable, the foreign tax credit would eliminate the U.S. tax. The following is an exam-
ple of this:
Foreign Source
Taxable Income Foreign Tax
Year 1 ($1,000) 0
Year 2 ______$1,000 $350____
Total ____________ 0 $350________In this example, the $1,000 loss in Year 1 would save $350 of U.S. taxes, and no
U.S. tax would be paid on the Year 2 income because of the foreign tax credit. By con-
verting the Year 2 income to U.S. source income, the foreign tax credit limitation in
Year 2 is zero. This concept applies to each of the foreign tax credit limitation baskets.
20,000
100,000 $100,000$20,00030.4 FOREIGN TAX CREDIT 30 ā¢ 13