Question

Which of the following payments by Intercontinental Solutions Inc., a Delaware corporation, qualifies for the foreign tax credit?

a. Income tax paid to Great Britain, covered by an existing treaty.

b. Income tax paid to Lesotho, with which the United States has no income tax treaty.

c. Value added tax paid to Jargetto, with which the United States has no income tax treaty.

d. Oil extraction tax paid to Tenesto, with which the United States has no income tax treaty.

e. Transportation tax paid to Santa Rucia, with which the United States has no income tax treaty. The tax is reduced dollar for dollar when Intercontinental provides consulting services in designing Santa Rucia’s new bullet train system. This year, Intercontinental incurred $1 million in taxes, but it earned a $600,000 reduction for its services.

Answer 1

Generally, the following four tests must be met for any foreign tax to qualify for the credit:

1. The tax must be imposed on you
2. You must have paid or accrued the tax
3. The tax must be the legal and actual foreign tax liability
4. The tax must be an income tax (or a tax in lieu of an income tax)

The following are some foreign taxes for which you cannot take a foreign tax credit:

• Taxes on excluded income (such as the foreign earned income exclusion),
• Taxes for which you can only take an itemized deduction,
• Taxes on foreign mineral income,
• Taxes from international boycott operations,
• A portion of taxes on combined foreign oil and gas income,
• Taxes of U.S. persons controlling foreign corporations and partnerships who fail to file required information returns,
• Taxes related to a foreign tax splitting event, and
• Social security taxes paid or accrued to a foreign country with which the United States has a social security agreement.

Answer to your Question:

a. Income tax paid to Great Britain, covered by an existing treaty: Eligible for tax credit

b. Income tax paid to Lesotho, with which the United States has no income tax treaty: Eligible for tax credit

c. Value added tax paid to Jargetto, with which the United States has no income tax treaty: Not eligible for tax credit as the tax is not a income tax.

d. Oil extraction tax paid to Tenesto, with which the United States has no income tax treaty. Not eligible for tax credit because you cannot take credit of Taxes on foreign mineral income.

e. Transportation tax paid to Santa Rucia, with which the United States has no income tax treaty. Not eligible for tax credit because credit is not available for which you can only take an itemized deduction.