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 fourth 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 D
Schedule D is designed to report foreign taxes deemed paid by a domestic corporation under Section 960(d) with respect to inclusions under the global intangible low-taxed income (“GILTI”) regime or Internal Revenue Code Section 951A. This schedule should only be completed with respect to Form 1118 filed for Section 951A category. In certain cases, Schedule D will need to be prepared to disclose passive foreign source income.
A U.S. corporation that has a GILTI inclusion is treated as having paid foreign income taxes equal to 80 percent of its “inclusion percentage” and the aggregate “tested foreign income taxes” paid or accrued by its controlled foreign corporation (“CFC”). See IRC Section 960(d). A U.S. corporation’s inclusion percentage for a tax year means the ratio (expressed as a percentage) of its GILTI inclusion to the aggregate of its pro rata shares of the tested income of its CFCs. Tested foreign income of a CFC are the foreign income taxes paid or accrued by the CFC that are properly attributable to the tested income of the CFC taken into account by the U.S. corporation under Internal Revenue Code Section 951A.
Part I- Foreign Corporation’s Tested Income and Foreign Taxes
Column 1a. Name of Foreign Corporation
For column 1a, the preparer must state the names of each CFC that has tested income, as defined in Section 951A(c)(2)(A) should be entered.
Column 1b. Tax Year End
For column 1b, the preparer must state EIN or reference number of the foreign corporation.
Column 2. Tax Year End
For column 2, the preparer must enter the year and month in which the CFC’s U.S. tax year ended using the format YYYYMM.
Column 3. Country of Incorporation
For column 3, the preparer should enter the applicable two-letter codes from the list at IRS.gov/CountryCodes to enter the CFC’s country of incorporation.
Column 4. Pro Rata Share of CFC’s Tested Income
For column 4, the preparer should enter each CFC’s tested income as reported on Form 8992, Schedule A, column (e). For purposes of preparing Schedule D, the preparer should not offset tested income by tested losses of another CFC.
In order to answer column 4, the preparer must determine the tested income of each CFC. A U.S. corporation’s CFC tested income for a tax year equals the excess (if any) for the taxable year over that shareholders “net deemed tangible income return” for the taxable year. Net CFC tested income with respect to any U.S. shareholder or corporation is the excess of the aggregate of the shareholder’s pro rata share of the “tested income” of each CFC with respect to which the shareholder is a U.S. shareholder over the aggregate of that shareholder’s pro rata share of “tested loss” of each CFC.
The tested income of a CFC is the excess (if any) of the gross income of the CFC determined without regard to certain items (stated below) over deductions (including taxes) property allocable to that gross income, applying rules similar to Section 954(b)(5). See IRC Section 951A(c). The items excluded from gross income are:
(a) Any item of income described in Section 952(b) (generally any U.S. source income effectively connected with the conduct by such corporation of a trade or business within the United States);
(b) Any gross income taken into account in determining the subpart F income of such corporation;
(c) Any gross income excluded from the foreign base company income (as defined in Section 954) and the insurance income (as defined in Section 953) of such corporation by reason of Section 954(b)(4) (i.e., the high-tax exception);
(d) Any dividend received from a related person as defined in Section 954(d)(3)) and
(e) Any foreign oil and gas extraction income (as defined in Section 907(c)(1)) of such corporation.
Column 5. Pro Rata Share of Tested Foreign Income Taxes Paid or Accrued by the CFC
For column 5, the preparer must enter the pro rata share of foreign income taxes paid or accrued by the CFC which are properly attributable to tested income of such foreign corporation. The Treasury and IRS have released proposed regulations under Section 951A and regulations under Section 960 providing taxpayers with computational rules regarding allocation of pro-rata share of tested foreign income taxes paid or accrued by a CFC. Generally, under Section 960(a) and (b), a U.S. shareholder with a GILTI inclusion of foreign taxes corresponds to the amount of foreign taxes paid by the U.S. shareholder.
Part II – Foreign Income Tax Deemed Paid
Column 1. Global Intangible Low-Taxed Income
For column 1a, the preparer should enter the Section 951A inclusion. A Section 951A inclusion can be expressed formulaically as:
GILTI = Net CFC Tested Income – Net Deemed Tangible Income Return
= [Tested Income – Tested Loss] – [1% of QBAI – Certain Interest Expense]
The tested income of a CFC is discussed above. The tested income of a CFC is the excess (if any) of the associated deductions that exceed tested income. See IRC Section 951A(c).
The “net deemed tangible income return with respect to a U.S. shareholder is the excess (if any) of 10 percent of the shareholder’s pro rata share of the qualified business asset investment (“QBAI”) of each CFC, over the amount of interest expense allocable to net CFC tested income for the taxable year to the extent the interest income attributable to such expense is not taken into account in determining net CFC tested income.
QBAI equals the CFC’s average aggregate adjusted basis for Specified Tangible Property during the taxable year. See IRC Section 951A(d). QBAI is measured at the close of each quarter and adjusted basis is determined by using the alternative depreciation system under Section 168(g). Depreciation is allocated ratably to each day during the period in the taxable year to which such depreciation relates. Specified tangible property is any tangible property used in the production of tested income, which property is used in a trade or business of the CFC and depreciable under Section 167. See IRC Section 951A(d)(2). If the property produces both tested income and other income, the property is treated as specified tangible property in the same proportion that the tested income the property produces bears to total gross income it produces.
For column 1, the preparer should enter the Section 951A inclusion.
Column 2. Inclusion Percentage
For column 2, the preparer should enter the inclusion percentage. “Inclusion percentage” means, with respect to a domestic corporation, the ratio of such corporate income inclusion for the taxable year to the aggregate of such corporation’s pro rata share of the positive income of each CFC as to which it is a U.S. shareholder for the taxable year. A U.S. shareholder’s pro rata share is determined using the same rules that apply in determining the amount of a U.S. shareholder’s share of subpart F income under Section 951(a)(2).
Column 3.
Column 3 asks the preparer to disclose the Section 78 gross-up with respect to an inclusion under Section 951A. A preparer must understand the mechanics of a deemed paid foreign tax credit for purposes of GILTI in order to answer column 3. A U.S. corporation that has a GILTI inclusion is treated as having paid foreign income taxes equal to 80 percent of the product of its “inclusion percentage” and the aggregate “tested foreign income taxes” paid or accrued by its CFC. See IRC Section 960(d). The deemed paid foreign tax credit for GILTI purposes expressed can be expressed as the following formula:
80% x Inclusion Percentage x Aggregate tested foreign income taxes paid or accrued = 80% x [GILTI Inclusion] / Aggregate Tested Income x [Foreign Income Taxes Property Attributable to the Tested Income of Such CFC].
Under the GILTI rules, foreign tax credits deemed paid are only 80 percent of the product determined above. With that said, 100 percent of the above product is treated as dividends for purposes of Section 78. For purposes of column 3, the tested income taxes of a CFC is the foreign income taxes paid or accrued by the CFC that is properly attributable to the tested income of the CFC taken into account by the U.S. corporation under Section 951A.
Column 4. Tax Deemed Paid or GILTI Basket Foreign Tax Credit Calculation
Column 4 is utilized to calculate the GILTI foreign tax credit or Section 960(d) deemed paid taxes with respect to a GILTI inclusion.
The deemed paid tax = 80 percent (inclusion percentage x aggregate tested foreign income taxes).
“Inclusion percentage” from Part II column 2 of Schedule D means the ratio of the domestic corporation’s inclusion for the taxable year to the aggregate of such corporation’s pro rata share of the positive income of each CFC as to which it is a U.S. shareholder for the taxable year.
The tested foreign income (determined in column 5 of Part 1 of Schedule D is a U.S. shareholder’s foreign income taxes paid or accrued by the CFC which is properly attributable to the tested income of the corporation taken into account under Section 951A.
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.