What Is IRS Code 960 for Foreign Tax Credits?
Understand how U.S. corporations use the deemed paid credit under IRS Code 960 to prevent double taxation on income earned by their foreign subsidiaries.
Internal Revenue Code Section 960 provides a mechanism for certain U.S. corporations to claim a tax credit for foreign income taxes paid by their foreign subsidiaries. This provision is a feature of the U.S. international tax system, which generally taxes domestic corporations on their worldwide income. The primary function of this rule is to prevent the same income from being taxed twice: once by the foreign country where it was earned and again by the United States.
Qualifying for the Deemed Paid Credit
Eligibility for the deemed paid credit hinges on the relationship between a U.S. domestic corporation and its foreign subsidiary. The U.S. entity must be a corporate shareholder in what is known as a Controlled Foreign Corporation (CFC). A CFC is a foreign corporation where U.S. shareholders own more than 50% of the total combined voting power or value of the stock.
To qualify for the credit, the U.S. corporation must be a “U.S. shareholder,” which is defined as a U.S. person who owns 10% or more of the total combined voting power or total value of the foreign corporation’s stock. The credit is triggered when the U.S. corporation is required to include certain types of the CFC’s earnings in its own income, even if no cash dividend is actually paid. These income inclusions typically fall under categories like Subpart F income or Global Intangible Low-Taxed Income (GILTI), which are designed to prevent U.S. companies from deferring U.S. tax on certain mobile or passive income earned abroad.
Calculating the Foreign Tax Credit
The calculation of the deemed paid credit is based on the principle that the U.S. corporation is “deemed” to have paid a portion of the foreign taxes properly attributable to the income included on its tax return. For Global Intangible Low-Taxed Income (GILTI) inclusions, the allowable deemed-paid foreign tax credit is limited to 80% of the foreign income taxes paid or accrued that are attributable to that income. Under Internal Revenue Code Section 78, the U.S. shareholder must also increase, or “gross-up,” its income inclusion by the amount of the deemed paid foreign taxes it intends to claim as a credit. This ensures the full pre-tax foreign income is subject to U.S. tax before the credit is applied. These calculations are performed separately for different categories of foreign income, such as the GILTI basket or the general limitation basket, as mandated by Section 904.
Reporting on Form 1118
A corporation claims the deemed paid foreign tax credit by completing and filing Form 1118, Foreign Tax Credit—Corporations. This form is not a standalone return but is attached to the corporation’s primary federal income tax return, such as Form 1120. The form requires the taxpayer to detail its foreign source income and the foreign taxes paid or deemed paid, organized by the separate income baskets. It is on this form that the overall foreign tax credit limitation is calculated, which prevents the credit from offsetting U.S. tax on U.S. source income. The final figure from Form 1118 represents the total credit that reduces the corporation’s U.S. income tax on a dollar-for-dollar basis.