Chapter 16 Multijurisdictional Taxation Essentials of Taxation © 2016 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part The Big Picture (slide of 3) • VoiceCo, a domestic corporation, designs, manufactures, and sells specialty microphones for use in theaters • All of its activities take place in Florida – But, it ships products to customers all over the United States • When it receives some inquiries about its products from foreign customers, VoiceCo decides to test the foreign market and places ads in foreign trade journals – Soon it is taking orders from foreign customers The Big Picture (slide of 3) • VoiceCo is concerned about its potential foreign income tax exposure • Although it has no assets or employees in the foreign jurisdictions, it now is involved in international commerce and has many questions – Is VoiceCo subject to income taxes in foreign countries? – Must it pay U.S income taxes on the profits from its foreign sales? – What if VoiceCo pays taxes to other countries? • Does it receive any benefit from these payments on its U.S tax return? The Big Picture (slide of 3) • VoiceCo establishes a manufacturing plant in Ireland – VoiceCo incorporates the Irish operation as VoiceCoIreland, a controlled foreign corporation (CFC) • So long as VoiceCo-Ireland does not distribute profits to VoiceCo, will the profits escape U.S taxation? • What are the consequences to VoiceCo of being the owner of a so-called CFC? • Read the chapter and formulate your response U.S International Tax Provisions (slide of 2) • Concerned primarily with two types of potential taxpayers: – U.S persons earning income from outside the United States, and – Non-U.S persons earning income from inside the United States U.S International Tax Provisions (slide of 2) • Can be organized in terms of: – Outbound taxation • Refers to the U.S taxation of foreign-source income earned by U.S taxpayers – Inbound taxation • Refers to the U.S taxation of U.S.-source income earned by foreign taxpayers U.S Taxation of Cross-Border Transactions Sources of Law (slide of 3) • U.S individuals and companies – Subject to both U.S law and laws of other jurisdictions in which they operate or invest • The Internal Revenue Code addresses the tax consequences of earning income anywhere in the world • Must also comply with the local tax law of the other nations in which they operate • For non-U.S persons, U.S statutory law is relevant to income they earn that is connected to U.S income-producing activities Sources of Law (slide of 3) • Tax treaties exist between the U.S and many other countries – All tax treaties are organized in the same way • Include provisions regarding the taxation of: – – – – Investment income Business profits from a permanent establishment (PE) Personal service income, and Exceptions for certain persons (e.g., athletes, entertainers, students, and teachers) Sources of Law (slide of 3) • Tax treaty provisions generally override the treatment otherwise called for under the Internal Revenue Code or foreign tax statutes 10 Payroll Factor (slide of 3) • Only compensation related to production of apportionable income is included in payroll factor – In states that distinguish between business and nonbusiness income, compensation related to nonbusiness income is not included – Compensation related to both business and nonbusiness income is prorated between the two 66 Property Factor (slide of 3) • Property factor generally includes average value of real and tangible personal property owned or rented – Numerator is amount used in the state – Denominator is all of corp’s property owned or rented 67 Property Factor (slide of 3) • Property includes: – Land, buildings, machinery, inventory, etc – May include construction in progress, offshore property, outer space property (satellites), and partnership property • Property in transit is included in numerator of destination state 68 Property Factor (slide of 3) • Property is typically valued at average historical cost plus additions and improvements – Some states allow net book value or adjusted basis to be used • Leased property, when included in the property factor, is valued at eight times its annual rental payments 69 Allocation, Apportionment Example Total allocable income (State A) $100,000 Apportionable income (States A and B) 800,000 Total income $900,000 All sales, payroll, and property is divided equally between states A and B Both states use identical apportionment formulas Taxable income: State A State B 1/2 Apportionable income $400,000 $400,000 Allocable income 100,000 -0Total state taxable income $500,000 $400,000 70 Apportionment Example (slide of 2) Americo, Inc operates in three states with the following apportionment systems: W's factors: average of four factors, sales double-weighted X's factors: average of three factors, equally weighted Y's factors: sales factor only State: Sales: Factor Payroll: Factor Property: Factor W $400,000 40% 90,000 30% 120,000 30% X $100,000 150,000 50% 240,000 60% Y $500,000 10% 60,000 20% 40,000 10% Total $1,000,000 50% 300,000 400,000 71 Apportionment Example (slide of 2) Taxable income for year (all states) $100,000 State: Sales Sales Payroll Property Total Average Taxable income to each state Total taxed in all states: N/A=not applicable X 10% N/A 50% 60% 120% 40% W 40% 40% 30% 30% 140% 35% $35,000 $125,000 $40,000 Y 50% N/A N/A N/A 50% 50% $50,000 72 Apportionment Example Revisited (slide of 2) Americo, Inc moves most personnel and property to state Y State: W X Y Total Sales: $400,000 $100,000 $500,000 $1,000,000 Factor 40% 10% 50% Payroll: 30,000 30,000 240,000 300,000 Factor 10% 10% 80% Property: 40,000 40,000 320,000 400,000 Factor 10% 10% 80% W's factors: average of four factors, sales double-weighted X's factors: average of three factors, equally weighted Y's factors: sales factor only 73 Apportionment Example Revisited (slide of 2) Taxable income for year (all states) $100,000 State: W Sales: 40% 10% Sales 40% Payroll: 10% 10% Property: 10% 10% Total 100% 30% 50% Average 25% 10% Taxable income to each state $25,000 Total taxed in all states: $85,000 N/A = not applicable X 50% N/A N/A N/A Y N/A 50% $10,000 $50,000 74 Unitary Taxation (slide of 2) • Theory: operating divisions are interdependent so cannot be segregated into separate units – Each unit deemed to contribute to overall profits – Unitary theory ignores separate legal existence of companies: all combined for apportionment 75 Unitary Taxation (slide of 2) • For multistate apportionment, all divisions or entities are treated as single unitary base: – Larger apportionment base (all companies’ activities) – Smaller apportionment factors (each state’s %) 76 Refocus On The Big Picture (slide of 3) • Now you can address the questions about VoiceCo’s activities that were posed at the beginning of the chapter • Simply selling into a foreign jurisdiction probably will not trigger any overseas income tax consequences – But, such income is taxed currently to VoiceCo in the United States Refocus On The Big Picture (slide of 3) • When VoiceCo sets up a CFC in Ireland, it benefits from deferral – As long as the income is not distributed to VoiceCo and as long as the income is not ‘‘tainted’’ Subpart F income, VoiceCo can avoid taxes on the profits of VoiceCo-Ireland – If VoiceCo receives dividends from its foreign subsidiary, it can claim foreign tax credits, which help alleviate the double taxation that would otherwise result Refocus On The Big Picture (slide of 3) What If? • VoiceCo is considering building a new manufacturing facility in another state in the United States – How will VoiceCo’s expansion decision be affected by state tax considerations? • In making the decision to expand, VoiceCo should consider a variety of state tax issues including: – Whether the state imposes a corporate income tax at all and, if so, – Whether the state requires unitary reporting • Other relevant issues affecting the tax calculation in the state include: – The apportionment formula used by the state, and – Whether the state has a throwback rule If you have any comments or suggestions concerning this PowerPoint Presentation for South-Western Federal Taxation, please contact: Dr Donald R Trippeer, CPA trippedr@oneonta.edu SUNY Oneonta © 2016 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part 80 ... (slide of 2) • Can be organized in terms of: – Outbound taxation • Refers to the U.S taxation of foreign-source income earned by U.S taxpayers – Inbound taxation • Refers to the U.S taxation of U.S.-source... VoiceCo-Ireland does not distribute profits to VoiceCo, will the profits escape U.S taxation? • What are the consequences to VoiceCo of being the owner of a so-called CFC? • Read the chapter and formulate your... $1,200,000, consisting of – $1,000,000 of profits from U.S sales, and – $200,000 of interest income from foreign sources • All of the foreign income is in the passive basket • Foreign taxes of $90,000 were