What Is IRC 960 and How Does the Deemed Paid Credit Work?
Explore IRC 960 and understand how the deemed paid credit functions, its coordination with Subpart F, GILTI interactions, and reporting essentials.
The Internal Revenue Code (IRC) 960 is a key provision for U.S. taxpayers with foreign income, addressing the deemed paid credit mechanism. It allows domestic corporations to claim credits for taxes paid by their foreign subsidiaries, mitigating double taxation and fostering global business competitiveness.
Calculating the Deemed Paid Credit
The deemed paid credit under IRC 960 enables U.S. corporations to treat a portion of foreign taxes paid by their subsidiaries as if they were paid directly by the U.S. parent company. This is particularly relevant when foreign subsidiaries distribute dividends, requiring an accurate accounting of foreign taxes.
To calculate the credit, the foreign subsidiary’s earnings and profits (E&P) must first be determined by adjusting its financial statements to align with U.S. tax principles. Then, foreign income taxes attributable to these earnings are identified, focusing solely on taxes directly tied to the E&P.
The credit is calculated using a fraction: the numerator is the foreign taxes paid, and the denominator is the total E&P. This fraction is applied to the dividend received by the U.S. parent to determine the credit amount. However, the credit is capped under IRC Section 904, which limits it to the U.S. tax liability on the foreign-source income.
Coordination with Subpart F Income
The interaction between IRC 960 and Subpart F Income is a critical aspect of international taxation. Subpart F Income, defined under IRC Sections 951–965, includes certain income earned by Controlled Foreign Corporations (CFCs) that U.S. shareholders must include in their taxable income, even if not distributed. This provision prevents tax deferral on passive or mobile income.
When a U.S. corporation receives Subpart F Income, the deemed paid credit under IRC 960 offsets U.S. tax liability by allowing credits for foreign taxes paid on this income. This avoids double taxation. Calculating the credit requires precise allocation of foreign taxes attributable to Subpart F Income, necessitating detailed analysis of the CFC’s financial and tax records in accordance with IRC 960 and related regulations.
Interaction with GILTI
The interplay between IRC 960 and the Global Intangible Low-Taxed Income (GILTI) provision presents additional challenges. GILTI, introduced by the Tax Cuts and Jobs Act of 2017, targets income from intangible assets held by foreign subsidiaries to discourage profit shifting to low-tax jurisdictions. U.S. shareholders must include GILTI in their taxable income.
IRC 960 allows U.S. corporations to offset foreign taxes paid on GILTI, but only 80% of the foreign tax credits attributable to GILTI are permitted, and these credits cannot be carried forward or back. GILTI is also taxed at a reduced effective rate through a deduction under IRC Section 250.
Managing these provisions requires careful analysis of varying foreign tax rates and their impact on the company’s overall foreign tax credit position. Tax professionals must evaluate the operations of CFCs to ensure compliance and optimize tax outcomes.
Reporting Requirements
Complying with IRC 960’s reporting requirements demands detailed documentation of foreign tax payments and income to substantiate the deemed paid credit. This involves maintaining accurate records of foreign subsidiaries’ financial activities aligned with U.S. tax principles. The information is reported on Form 5471, which is essential for the IRS to monitor international tax compliance.
Schedules within Form 5471, such as Schedule E (foreign taxes paid or accrued) and Schedule I-1 (GILTI inclusion), require precise calculations and allocations of foreign taxes to specific income categories. Errors or omissions can result in significant penalties, making accuracy and thoroughness critical.