By Anthony Diosdi
In order to provide the Internal Revenue Service (“IRS”) with the information necessary to claim a foreign tax credit, a U.S. corporation claiming a foreign tax credit must attach Form 1118 otherwise known as “Foreign Tax Credit – Corporations,” to its tax return. This is the third of a series of articles designed to provide a basic overview of the Form 1118. This article is designed to supplement the instructions for the Form 1118 promulgated by the IRS.
Introduction to Schedule C
Schedule C is utilized to report taxes paid by the domestic corporation under Section 960(a) with respect to Section 951(a) subpart F inclusions. inclusions under Section 951(a)(1). However, Schedule C should not be utilized to report 965 inclusions.
Column 1a. Name of Foreign Corporation
For column 1a, the preparer should enter the name of the foreign corporation whose earnings were included by the domestic corporation.
Column 1b. EIN Reference Number
For column 1b, the preparer should enter the EIN number or reference number of the foreign corporation whose earnings were included by the domestic corporation.
Column 2. Tax Year End
For column 2, the preparer should enter the year and month in which the foreign corporation’s U.S. tax year ended using format YYYYMN.
Column 3. Country of Incorporation
For column 3, the preparer should enter the applicable two-letter codes from the list at IRS.gov/CountryCodes when stating the foreign corporation’s country of incorporation.
Column 4. E&P for Tax Year Indicated (in Functional Currency)
For column 4, the preparer must enter the foreign corporation’s current year E&P in functional currency by subpart F income group defined in Treasury Regulations Section 1.960-1(d)(2)(ii)(B)(1) for the tax year indicated in column 2. If there is a subpart F inclusion related to more than one subpart F income group, complete a separate line for each subpart F income group.
Column 5. Foreign Taxes Paid for Tax Year Indicated
For column 5, the corporation should enter the foreign taxes paid or accrued by subpart F income group by the foreign corporation in U.S. dollars for the tax year indicated in column 2. The preparer should keep in mind the possibility of foreign tax credit timing mismatches. Internal Revenue Code Section 960(c) provides a timing mismatch fix for distributions of a PTEP under Section 959 that are made in a tax year subsequent to a subpart F inclusion. According to Section 960, a distribution of a PTEP is not treated as an income inclusion to the recipient in the year in which the PTEP distribution occurs. If a foreign country imposes a withholding tax on a distribution, Section 904(a) could deny a credit for such a tax because a PTEP distribution is not taxable gross income. Section 960(c) provides relief for such a scenario by increasing the Section 904(a) limitation in this situation.
Column 6a. Functional Currency
For column 6a, the preparer must enter the subpart F inclusion in functional currency. The U.S. corporation’s subpart F inclusion is determined with reference to the percentage of the corporation’s stock owned by the corporation.
Column 6b. U.S. Dollars
For column 6b, the preparer must enter the subpart F inclusion in U.S. dollars.
Column 7. Tax Deemed Paid
For column 7, the preparer must enter the tax deemed paid computed under Section 960(a). Below, please find an example provided in the IRS’ instructions as to how to calculate the Section 960(a) tax credit.
USC is a domestic corporation. CFC1 and CFC2 are controlled foreign corporations incorporated in Country X. The U.S. tax year for USC, CFC1, and CFC2 ends on December 31. At all relevant times, 1u = $1. For its U.S. tax year ending December 31, 2019, after foreign taxes, CFC1 has 1,000,000u of E&P attributable to passive category divided income subject to a withholding tax of less than 15% (“CFC1 income group 1”) and 2,400,000u of E&P attributable to passive category interest income subject to no withholding tax (“CFC1 income group 2”). CFC1 has current year taxes (including the withholding tax) of $50,000 in CFC1 income group 1 and $240,000 in CFC1 income group 2. USC has a subpart F inclusion with respect to CFC1 of which 800,000u is attributable to CFC1 income group 1 and 1,920,000u is attributable to CFC1 income group 2. For its U.S. tax year ending December 31, 2019, after foreign taxes, CFC2 has 1,800,000u of passive category gain from commodities transactions subject to no withholding tax (“CFC2 income group”). CFC2 has current year taxes of $450,000 in the CFC2 income group. USC has a subpart F inclusion of 1,440,000u attributable to the CFC2 income group.
USC completes Schedule C of its Form 1118 with respect to the passive category as follows:
USC makes the following entries on the first three lines on Schedule C:
Column Entry
1a CFC1
1b 100011
2 201912
3 OC
4 1,000,000
5 50,000
6a 800,000
6b 800,000
7 40,000
USC makes the following entries on the second of three lines on Schedule C
Column Entry
1a CFC1
1b 100011
2 201912
3 OC
4 2,400,000
5 240,000
6a 1,920,000
6b 1,920,000
7 192,000
USC makes the following entries on the third of three lines on Schedule C
Column Entry
1a CFC2
1b 100012
2 201912
3 OC
4 1,800,000
5 450,000
6a 1,440,000
6b 1,440,000
7 360,000
Conclusion
Completing Form 1118 for purposes of claiming foreign tax credits is extraordinarily complex. If your domestic corporation is attempting to claim foreign tax credits, you should consult with an attorney well versed in international tax planning and compliance. We provide international compliance assistance and international tax planning services to domestic corporations. We also assist other tax professionals who need guidance regarding international tax compliance matters.
Anthony Diosdi is a partner and attorney at Diosdi Ching & Liu, LLP, located in San Francisco, California. Diosdi Ching & Liu, LLP also has offices in Pleasanton, California and Fort Lauderdale, Florida. Anthony Diosdi advises clients in tax matters domestically and internationally throughout the United States, Asia, Europe, Australia, Canada, and South America. Anthony Diosdi may be reached at (415) 318-3990 or by email: adiosdi@sftaxcounsel.com.
This article is not legal or tax advice. If you are in need of legal or tax advice, you should immediately consult a licensed attorney.