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U.S. TAXATION OF FOREIGN SOURCE

INCOME-DEFERRAL AND THE FOREIGN
TAX CREDIT

PREPARED FOR THE USE OF THE

COMMITTEE ON WAYS AND MEANS
BY THE STAFF OF THE

JOINT COMMITTEE ON INTERNAL REVENUE TAXATION

SEPTEMBER 27, 1975

U.S. GOVERNMENT PRINTING OFFICE

W0165O0 WASHINGTON :-1975 J081978
 CONTENTS

Page
I. Introduction -------------------------------- ___- __--_-- 1
II. U.S. Taxation of Foreign Income-An Overview---------------1
III. Deferral---------- ----------------------------------------- 7
Present Law -------------------------------------------- 7
Issues------------------------------------------------ 8
Alternative Proposals------------------------------------11
IV. Foreign Tax Credit ------------------------------------ --..-
- 12
Present Law ------------------------------------------- 12
Issues ------------------------------------------------ 14
1. Limitation on the Credit---------------------------- 18
Alternative Approaches------------------------------ 21
Special Limitation.----------------------------- 21
ForeignTaxCredit Determined on Overall Basis--... 21
Recapture of Foreign Losses----------------------22
2. Dividends from Less-Developed Country Corporations. 22
Alternative Approaches ..----------------------------- 23
8. Treatment of Capital Gains-.-------------------------- 23
Alternative Approaches ..----------------------------- 24
4. Treatment of Exempt Income.----------------------24
Alternative Approaches..----------------------------- 24
(MI)
 I. INTRODUCTION
There are two generally recognized bases for any country's jurisdic-
tion to tax income: (1) jurisdiction over the recipient of the income,
and (2) jurisdiction over the activity which produces the income (i.e.,
the source of the income). Thus, a country may tax the worldwide
income of persons subject to its jurisdiction or it may tax income
earned within its borders, or it may tax both.
Tax jurisdiction over an individual may be obtained, as. in the
United States, by the residency or citizenship of an individual. Tax
jurisdiction over a corporation is determined by place of residency,
which in the United States is the place of corporate organization.
In addition, most countries' tax laws and regulations contain rules
(called source rules) for determining whether, and the extent to which,
income is earned from activities conducted within that country or
within some other country.
Since most sovereign nations apply the above principles in taxing
their residents and in taxing income from sources within their borders,
two nations often claim the right to tax the same income. Most nations
have developed principles to accommodate these competing claims and'
thus avoid what could be called a double taxation of income. One
principle is that the country of the source of income, particularly in
the case of business profits earned through an office in the source
country, has the primary jurisdictional right to tax that income. The
country of residence retains a residual right to tax that income. Since
a double tax on this income would tend to discourage capital and indi-
viduals from crossing borders and thus inhibit international commerce,
most countries which exercise the residual right to tax their residents
and corporations on a worldwide basis allow a tax credit for income
taxes paid to the source country.
II. U.S. TAXATION OF FOREIGN INCOME-AN OVERVIEW
Under present law, the United States imposes its income tax upon
the worldwide income of any corporation organized under the laws of
any of the States or the District of Columbia, whether this income
is derived from sources within or from without the United States.'
A tax credit (subject to limits) is allowed for foreign taxes imposed
on their foreign source income.
Foreign corporations generally are taxed by the United States only
to the extent they are engaged in business in the United States (and
to some extent on other income derived here). As a result, the United
States generally does not impose a tax on a foreign corporation even
though it is owned or controlled by a U.S. corporation or group of U.S.
, Exceptions to this general rule are provided for corporations who primarily operate
in the possessions and for DISCs. Also, a reduced rate of tax (34 percent) Is provided
for Western Hemisphere trade corporations.
 corporations (or by U.S. citizens or residents). Such a corporation
is subject to tax, if any, by the foreign country or countries in which it
operates. Generally, the foreign source income of a foreign corpora-
tion only will be subject to U.S. income taxes when it is actually re-
mitted to the U.S. corporate or individual shareholders as a dividend.
The tax in this case is imposed on the U.S. shareholder and not the
foreign corporation. The fact that no U.S. tax is imposed in this case
until (and unless) the income'is distributed to the U.S. shareholders
(usually corporations) is what is generally referred to as tax deferral.
There are, however, exceptions to the general rules set out above
where income of a controlled foreign corporation is taxed to the U.S.
shareholders, usually a corporate shareholder, before they actually
receive the income in the form of a dividend. The procedures (subpart
F of the code) set forth in present law treat certain income as if it were
remitted as a dividend. Under these provisions income from so-called
tax haven activities conducted by corporations controlled by U.S.
shareholders is deemed to be distributed to the U.S. shareholders and
currently taxed to them. The rules generally apply in the case of for-
eign corporations more than fifty percent of whose shares are owned by
.S. persons, each with a 10 percent or more ownership interest.
Under present law, a U.S. taxpayer who pays foreign income taxes
on his income from foreign sources is allowed a foreign tax credit
against his U.S. tax on his foreign source income. The credit is pro-
vided only for amounts paid as income, war profits or excess profits
taxes paid or accrued during the taxable year to any foreign coun-
try or to a possession of the United States. This foreign tax credit
system is based on the principle that the country in which busi-
ness activity is conducted has the primary right to tax the income from
that activity and the home country of the individual or corporation
has a residual right to tax that income, but only so long as double
taxation does not result. While some countries, such as France and
the Netherlands, avoid international double taxation by exempting
all income from foreign operations, most of the other industrial na-
tions-including the United States, Great Britain, Germany, Canada
and Japan-use the credit system to avoid double taxation of income.
Present law permits taxpayers subject to U.S. tax on foreign income
to take a foreign tax credit for the amount of foreign taxes paid on in-
come from sources outside of the United States. The credit is provided
only for amounts paid as income, war profits or excess profits taxes
paid or accrued during the taxable year to any foreign country or to
a possession of the United States.
The foreign tax credit is allowed not only for taxes paid on income
derived from operations in a specific country, but it is also allowed for
dividends received from foreign corporations operating in foreign
countries and paying foreign taxes. This latter credit, called the
deemed-paid credit, is provided for dividends paid by foreign corpora-
tions to U.S. corporations which own at least 10 percent of the voting
stock of the foreign corporation. Dividends to these U.S. corporations
are considered as carrying with them a proportionate amount of the
foreign taxes paid by the foreign corporation. The computation of
the amount of the foreign taxes allowed as a deemed-paid credit in the
 :3
case of a dividend distribution differs depending upon whether or not
the payor of the dividend is a less developed country corporation.
In order to prevent a taxpayer from using foreign tax credits to
reduce U.S. tax liability on income from sources within the United
States, two alternative limitations on the amount of foreign tax
credits which can be claimed are provided by present law. Under
the overall limitation, a taxpayer aggregates his income and taxes
from all foreign countries. A taxpayer may credit taxes from any
foreign country as long as the total amount of foreign taxes applied
as credits in each year does not exceed the amount of tax which the
United States would impose on the taxpayer's income from all sources
outside of the United States.
The alternative to the overall limitation is the per-country limita-
tion. Under this limitation, the same calculation made under the over-
all limitation is made on a country-by-country basis. A taxpayer's
credits from any country are limited to the U.S. tax on the amount of
income from that country. Taxpayers are required to use the per-
country limitation unless they elect the overall limitation. Once the
overall limitation is elected, it cannot be revoked except with the con-
sent of the Secretary or his delegate.
In cases where the applicable limitation on foreign tax credits re-
duces the number of tax credits which can be used by the taxpayer to
offset the U.S. tax liability in any one year, present law provides that
the excess credits not used may be carried back for two years or car-
ried forward for five years.
The significance of the present overseas operation of U.S. firms is
indicated by the fact that the sales of U.S. multinational foreign
affiliates were $292 billion in 1973. The U.S. share of the book value
of U.S. overseas affiliates in 1973 stood at $107.3 billion-an increase
of $12.9 billion over 1972-of which $4.9 billion represented net capi-
tal outlays from the United States and $8.1 billion represented rein-
vested earnings of these affiliates. Data on U.S. direct investment since
1966 are shown in table 1.
TABLE 1.-U.S. DIRECT INVESTMENT ABROAD BY SELECTED
INDUSTRY GROUP, 1966-73
fin millions of dollarsi

Balance-
Book value at Net capital Reinvested of-payments
yearend outflows earnings' Earnings mcome

All industries:
1966 --------------------------- 54,790 3661 1,739 5364 3707
1967 ---------------------------- '9,491 3,137 1,598 5650 4,133
1968--------------------------- 64,983 3,209 2,175 6,538 4,489
1969 --------- ------------------ 71, 033 3,271 2,604 7,544 5,074
1970--------------------------- 7&178 4,410 2,948 8118 .5,330
1971------------------------ 86198 4,943 3,157 9,389 6,385
197--------------------4, 337 3, 1 ,1 11,485 6,925
197329-------------------------- 107,268 4,872 8, 124 17,495 9,415
Mini. ad smelting:
I1------------------------------ 4,365 305 129 659 524
1967 ---------------------------- 4,876 330 135 746 596
1968 ---------------------------- 5,435 440 134 795 644
1969 ---------------------------- 5,676 93 167 78 664
1970 ---------------------------- 6,168 393 111 675 553
1971 ---------------------------- 6,685 510 23 499 482
1972-------- -------------------- 7,110 382 41 419 395
19731L'-------------------------- .7,483 201 143 675 548
 4
TABLE A-1.-U.S. DIRECT INVESTMENT ABROAD BY SELECTED
INDUSTRY GROUP, 1966-73-Continued
[in millions of dollars]

Balance-
Book value at Net capital Reinvested of-payments
yearend outflows earnings Earnings income'

Petroleum:
19616----------------------..... I,222 885 106
967-----------.. -------.- 1,530 1,443
17,399 1,069 175 1,736 1,604
1968.--------------------------- 18,887 1,231 239 1965 1,787
1969--------------------------- 19,882 919 -59 1868 2,054
1970...-----------------_-__-_-_-_
-_--. 21,714 1,460 425 2 264 1 937
1971---------------------------- 24, 152 1,950 500 2,946 2,532
1972----------------------..-.- 26, 263 1,603 563 3,311 2,826
Manufuring:---------------------- 29,567 1,417 1,927 6,183 4,325
1966--------------------------- 22,078 1,752 983 2,104 1,116
1967..--.......------_---- - 24,172 1,234 847 2,055 1,193
19689-_--------------------------26,414 945 1,261 2,519 1,265
1969--------------------------- 29,527 1,160 1,939 3,287 1,337
1970--------------------------- 32, 261 1,295 534 3,416 1,859
1971----------------------------- 3632 556 854 3834 1,950
1972----------------------------- 39,716 1,100 2,991 5,172 2,144
Othe973--------------------------- 45,791 1,820 4,408 7,286 2,757
1966..-----------_-__---_ ----- _-_-_ 12,134 718 520 1,071 624
1967_---------------------------13,044 504 442 1,112 740
1968..---------_ ------ _-_-.--....-. 14,248 592 541 1,259 793
1970--------------------------- 15,948 1,099 557 1,606
19701---------------------------18,035 1,020
1,262 877 1764 981
1971__---------------------------19,728 927 780 2,111
1972--------------- 1,422
----------- 21,249 433 1,118 2,583 1,560
19738...---------------------_--.-. 24,427 1,434 1,645 3,351 1,785

a U.S
SRepresents share in the reinvested earnings of its foreign-incorporated affiliates.
drporter
3includes interest, dividends, and branch earnings.
Preliminary.
Source: U.S. Department of Commerce, "Survey of Current Business," pt. II, August 1974,pp. 16, 17.

The earnings, after foreign income taxes, of these foreign, invest-

ments were $17.5 billion, $4.1 billion of which represented earnings of
U.S. branches. Of the $13.4 billion of earnings of foreign affiliates, $5.3
billion or 39 percent was distributed as dividends to the U.S. share-
holders. The net amount received by shareholders, after foreign with-
holding taxes, was $4.6 billion. An additional $3.6 billion was re-
ceived as interest, fees, and royalties. The composition of foreign
source earnings is shown in table 2 and the dividend payout ratios
in table 3.
TABLE 2.-EARNINGS, RELATED ITEMS AND MEASURES OF RETURN:
DERIVATION AND RELATIONSHIP
[Millions of dollarsi

1973 amount and source

1. Net earnings of foreignaincorporated affiliates ----------- -----.....

2. Nt earnings of foreign branh3----------------------------------------- 13.407 reported.
4 da reported.
3. Earnings.--------------------------------------------------. 495=1+2.
4. Gross dividends (on common stock)-------------------------------- 5,83-5+6.
5. Foreign withholding tax (on common stock dividends)-- ------------------ 690 reported.
6. Dividends(oncommon stock)_--------------------------------- 4 593 reported.
7. Preferred dividends------------------------------------------- 1ff reported.
8. Interest -------------------------------------------------- 717 reported.
9. Fees and royalties2p----------------------------------------a238 reported.
10. AdJusted earnia ----------------------------------------.--- I 39-3-5+7-(8
1. Renetd eari------------- ---------------- 8124 1--4 or 3-2-4.
12. Balance of payments Income-------------------------------------- 9 415=2+8+7+8 or 10-11.
13. Balance of payments recepts ------------------------ : i254-9+12.
14. Direct Investor's ownership benefits----------------------------------- ,377-9+10.

Note. Figures are preliminary estimates derived from sample date. Estimates may not add tototals because of rounding
Source: U.S.Department of Commerce, "Survey of Current Business," pt. II, August 1974, p.40.
 TABLE 4.-DIVIDEND PAYOUT RATIO OF FOREIGN-INCORPORATED
AFFILIATES
[Millions of dollars, or ratiosi

All areas Developed countries Other areas I

Item and industry 1971 19722 19738 1971 1972a 19738 1971 19723 19739

All Industries:
Larnings-..7,178 9,109 13,407 4,941 6,449 9,669 2,238 2,660 3,738
Sross dividends.....------4, 02Z. 4,394 5,283 2, 504 2,739 3,522 1,518 1,655 1,761
Ratio, gross dividends to
earnings.----------------
. 56 .48 .39 .51 .43. .36 168 .62 .47
Petroleum: -
Earning1-------------------1,554 1,811 3,239 470 616 1,507 .1,085 1,1,S 1,733 -
Gross viends--------------1,054 1,248 1,312 -219 .192. 340 836 1,056 -972
Ratio, grossdividendstoearnings- .68 .69 .40 .47 .31 .23 .77 .88 .56
Manufacturing:
Eauring .3,736 5,074 7,156 3,149 4,302 6,110 588 772- 1,046
Gross 2,083 2,748
-ividends----.......-..----1,882
1,584 1,765 2,369 299 318 379
Ratio, gross dividends to earnings. .50 .41 .38 .. 50 .41 .39 .51 .41 ,36
Other:
Earnings-...................1,888 2,223 3,011 1,322 1,531 2,052 566 693 959
Grossdividends--------------..
. .1,085 1,063 1,223 700 782 812 384 281 410
Ratio, gross dividends to earnings. .57 .48 .41 .53 .51 .40 .68 .41 .43

I Includes developing countries, International and unallocated.

Revised.
5 Preliminary.
Note.-Details may not add to totals because of rounding. Reported earnings are also equal to the sum of dividends
foreign withholding taxes, and reinvested earnings. Estimates are drawn from table 12.Gross dividends exclude prefrrei
dividends, but include foreign withholding taxes.
Source: U.S.Department of Commerce, "Survey of Current Business," pt II, August 1974, p. 12.

From the point of view of the U.S. investors, the return on this in-
vestment in 1973 was $20.4 billion (including interest, royalties, and
fees), an increase of $6.3 billion over 1972. This represents a rate of
return of 21.6 percent on the book value of the investment as of the
beginning of 1973.
Of the $20.4 billion of earnings in 1973, $12.3 billion represents a
balance-of-payments inflow (receipts of income on U.S. direct invest-
ment), while $8.1 billion is reinvested earnings. This $12.3 billion
inflow represents a rate of return of 13 percent on the book value of
investment at the end of 1972. Of the $12.3 billion inflow, $4.1 billion
is earnings of U.S. branches and $8.2 billion is dividends, interest,
royalties, and fees paid by U.S. subsidi.ries to their parent corpora-
tions. Dividends account for $4.6 billion of the $8.2 billion, royalties
and fees account for $2.8 biion, and interest accounts for $0.7 billion.
Table 4 shows the balance-of-payments flows related to direct in-
vestment abroad for developed and under developed countries for the
years 1971 through 1973.
 TABLE 4.-IDENTIFIABLE U.S. CORPORATE TRANSACTIONS WITH FOREIGNERS'
(MIllions of dollars, balance of payments signs: debits (-), credits (+)

All areas Developed countries Other areasa Change, 1972-73

Line Item 1971,s 19723 19734 1978 173'1972,

1971, 972
1918 173'
19736 197 a
19713 1975 173 All Developed Other
19723 19734 areas countries areas
1 Not flowa0--------------------------------- 3,994 7,607 7,092 2,266 5,125 2,930 1,728 2482
2 Change In corporate claims on foreigners --------------- -9,037 4162 -515 -:2,195 1,680 --
-9,765 -15,649 -6,036 -6,640 -,540 -3,001 -3,126 -4,1109 -5,884 -4,900 -983
3 Addition to direct investment position------------ -- 8,020 -8,.140 -12, 930 -5,427 -5, 676 -9 726 -2 593 -2,465
4 Net capital outflows- . ..---------------------- 4,943 -3,204 -4, 7900 4, 050 :-739
-3,517 -4,872 -2,988 -1,988 -3,631 -1,955 -1,529 -1,241 -1,355 -1,643 288
5 Reinvested earnings ---------------------. -3,157 -4,715 -8,124 -2, 437 -3,710 -6,147 -720 -1,005 -1,977
6 Valuation adjutmente---------------------- -3,409 -2,437 -972
80 92 66 -1 23 52 81 69 14 -26 29 -55
7 ChangeIn other corporate claims.------ -... -- 1,017 -1,625 -2,719 -609 -964 -1,814 -408 -661
Long-term---------------------------- -905 -1,094 -850 -244
-- 168 -253 -464 - -156 -276 -70 -97 -188 -211 -120 -91
Short-term:
9 Liquid-------------------------------- -531 -505 -841 -404 -277 -565 -127 -228
10 NolifuId?-----.-.-...-...... -276 -336 -288 -48
--.. -... -- 496 -214 -1,413 -266 -172 -972 -230 -42 -441 -1,199 -800 -399
1 Adlumns------------------------- 178 -653 -1 159 -359 -1 19 -294----------- 652
Chan in orprae liabilities to foreignerso-------------1,846 358 294
3,580 2,207 1564 3,224 1,671 282 356 536 -1,373 -1,553 180
13 aewissues of securities sold abroad byU.S.corpora-
Ions'------------------------------------ 1,181 2,002 1,222 1,181 2,002 1,222 ---------------------------
14 Change in corporate liabilities other than new Issues.-. -780 -780------
665 1,578 985 383 1,222 449 282 356 536 -593 -773 180
15 Long-term-------------------------------384 594 264 289 561 118 95 33
16 Short-term7------------------------ 146 -330 -443 113
---- 22 160 943 -162 10 553 184 150 390 783 543 240
17-------------- ------------------------------- 259 824 -222 256 651 -222 3 173---------- -1,046
18 Drc invesors' ownership benefits------------------11 702 -873. -173
14,055 20,377 7,152 8,856 12,628 4,550 5,200 7,749 6,322 3,772 2,549
19 RaeaIts on U.S.direct investments--------------8 545 9, 340 12, 253 4,715 -5, 146 6,481 3,830 4,195 5,772 2,913
20 royaltiesand fees ---------------------.. 2. 160 1,335 1,:577
2,415 2,838 1,594 1,816 2,182 566 600 656 423 366 56
21 Dividends and interest.. ..------------------4, 174 4, 548 5,327 2,648 2,899 3,637 1,526 1,649 1,690 779
22 Branch earnings' --------------------- 2211 377 738 41
23 4,088 473 431 662 1,738 1,946 3,426 1,711 231 1,480
Reinvested earnings----------------------.3., 157 4,715 8,124 2,437 3,710 6,147 720 1,005 1,977 3,409 2,437
24 Offset toadjustments...--. .. __------------------------
517 -263 157 -414 972
-315 171 -103 52 -14 420 486 -66
I Some balance ofpayments flows associated with U.S.corporate transactions are not separately I Excludes brokerage claims andliabilities.
identified inthe U.S.balance ofpayments data and therefore are not reflected in the estimates given aExcludes funds obtained abroad byU.S.corporations through bank loans and other credits
in this table. See test for further explanation. Claims and liabilities of U.S.banking and brokerage
institutions are excluded, also excludes securities issued bysubsidiaries incorporated abroad. However, securities issuedand
by
finance subsidiaries incorporated inthe Netherlands Antilles are treated asIfthey hadbeen Issued by
Includes developing countries, international and unallocated. U.S. corporations t the extent that thenproceeds of such issues are transferred to U.S.parent
8 Revised, companies.
4Preliminary. 2 sPetroleum branch earnings have been revised asdescribed inthe Technical Notes.
4Sum of lines 2 plus 12pius 18plus 24.
aThese adjustmentsplus balance of payments flows are equal to the changes inthe international Note: Details may not addto totals because of rounding.
investment position. Such adjusents do not enter the balance of payments flow figures. Line 24Is Source: U.S.Department of Commerce, "Survey of Current Business," pt. II, August, 1974, p.11.
the sum of ines 6, 11,and 17,with sign reversed.
 A somewhat different perspective on the foreign and U.S. tax posi-
tion of U.S. controlled foreign corporations is provided by data de-
rived from tax returns for 1972 (the latest year available). The data
show that the earnings and profits for .1972 before tax were $14.5 bil-
lion, foreign taxes paid were $6.7 billion, the amount distributed to
U.S. parent corporations was $3.9 billion, the after-tax payout ratio 2
was 46.6 percent, and the foreign effective tax rate was 46.3 percent.
III. DEFERRAL
Present Law
Generally, the foreign source income of a foreign corporation. is
subject to U.S. income taxes only when it.is actually remitted to the
U.S. corporate or individual shareholders as a dividend. The tax in
this case is imposed on the U.S. shareholder and not the foreign cor-
poration. The fact thatno U.S. tax is imposed until (and unless) the
income is distributed to the U.S. shareholders (usually corporations)
is what is generally referred to as tax deferral.'
Present law, however, provides for an exception to the general rule
of deferral. under the so-called subpart F provisions of the code.
Under these provisions income from so-called.tax haven activities
conducted by corporations controlled by U.S. shareholders is deemed
to be distributed to the U.S. shareholders and currently taxed to them
before they actually receive the income in the form of a dividend. .
The rules generally, apply to U.S. persons owning 10 percent or
more of the voting power of a foreign corporation, if more than 50
percent of the voting power in the corporation is owned by U.S. per-
sons owning 10 percent interests.
Prior to the Tax Reduction Act of 1975 the categories of income sub-
ject to current taxation as tax haven income were. foreign personal
holding company income; sales income from property purchased from,
or s6d to, a related person if the property is manufactured and sold
for use, consumption, or disposition outside the country of the corpora-
tion's incorporation; 'and service income from services also performed
outside the country of the corporation's incorporation for or on behalf
of any related persons. The statute refers to these types of income as
"foreign base company income." In addition, present law provides for
the current taxation of the income derived by a controlled foreign
corporation from the insurance of U.S. risks. Foreign base company
income and income from the insurance of U.S. risks are collectively re-
ferred to as subpart F income.
Present law also provides, with certain exceptions, that earnings of
controlled foreign corporations are to be taxed currently to U.S. share-
holders if they are invested in U.S. property. In general terms, U.S.
property is defined as all tangible and intangible property located in
the United States.
See Taestion of Poregs Sosve Income: Btatistical Data. Table C-2.
* Where it is not anticipated that the income will be brought back to the United States
for financial accounting purposes (in accounting for the Income of a consolidated group
consisting of one or more domestic corporations and its foreign subsidiaries) this income
is often shown as income exempt from U.S. tax.
 8
Prior to the enactment of the Tax Reduction Act of 1975 there were
a number of significant exceptions to the rules providing for current
taxation of tax haven income. By repealing these exceptions, the Tax
Reduction Act of 1975 substantially expanded the extent to which for-
eign subsidiaries of U.S. corporations are subject. to current U.S.
taxation on tax haven types of income, under the subpart F rules of the
code. The Act repealed the minimum distribution exception to the sub-
part F rules, which permitted deferral of U.S. taxation on tax haven
types of income in cases where the foreign corporation (or various
combinations of foreign-related corporations) distributed certain
minimum dividends to their U.S. shareholders. This provision was the
main device used by multinational corporations for avoiding taxation
of their tax haven income, and its repeal will result in the current
taxation of all tax haven income of foreign subsidiaries of U.S.
corporations.
The Act also repealed the exception to the subpart F rules which
permitted deferral of taxation in cases where the tax haven income was
reinvested in less developed countries. In addition, the Act provided
that the deferral of U.S. tax for shipping income received by a for-
eign subsidiary of a U.S. corporation is to be continued only to the
extent that the profits of these corporations are reinvested in shipping
operations. Finally, the Act modified the subpart F provision which
permitted corporations having less than 30 percent of their gross in-
come in the form of tax haven income to avoid the current taxation
provisions of subpart F. The Act provided that this tax haven income
is to be taxed currently under the subpart F rules in any case where it
equals or exceeds 10 percent of gross income. The provisions of the Act
apply to taxable years beginning after December 31, 1975.
It is estimated that when fully effective these provisions will raise
$225 million in revenue.
While the above-described provisions in the 1975 Act all resulted
in the elimination or tightening of exceptions to the current taxation
of income rules under subpart F, one modification was made in the
1975 Act which resulted in a loosening of those rules. This amendment
provides that base company sales income (i.e., income from selling
activities in a tax haven) does not include the sale of agricultural
commodities which are not grown in the United States in commercially
marketable quantities. This amendment was intended to provide a nar-
row exception to the base company sales income rules in cases where
farm products cannot be grown in the United States. Technical amend-
ments may be needed to make it clear that the exception does not apply
to agricultural products which are of a different grade or varying type
of the product grown in the United States.
Issues
The merits of the present system of deferral have been frequently
debated in recent years. In 1962 the Administration proposed an almost
total elimination of deferral. Congress responded by focusing on the
abuses of tax haven activities and eliminating deferral for the types
of income which are normally susceptible to tax haven arrangements.
 However, the general debate over whether to eliminate deferrdI coin-
pletely or to limit its use for all taxpayers has continued. No one dis-
putes the fact that deferral permits foreign corporations controlled by
U.S. persons to avoidor postpone paying some U.S. tax by retaiing
their earnings abroad. But whether deferral constitutes a significant
incentive for foreign investment and, if so, whether that incentive
means more or less investment (and jobs) in the United States are still
subjects for debate. Further, it is not clear that funds not invested
abroad will necessarily be invested in the United States.
Advocates of the elimination of deferral believe that deferral does
constitute an incentive for foreign investment which leads to a loss
of U.S. jobs.Further, it is argued that deferral has tended to encourage
countries to set up tax havens and their use by U.S. multinationals.
On the other hand, those who advocate retention of deferral argue
that it is necessary to maintain neutrality between competing over-
seas companies. Since other countries provide deferral for overseas in-
come, the elimination. of deferral for U.S. corporations would put
them at a competitive disadvantage.
They argue that overseas investment, rather than resulting in a de-
crease of jobs in the United States, in fact tends to create U.S.
employment by enabling U.S. companies to penetrate foreign markets.
Although part of whatis sold in the foreign markets is manufactured
overseas, a part also is manufactured. in the United States for sale
or for further processing abroad.
Advocates of deferra also note that the abuse problems of tax
havens can be dealt with without the total elimination of deferral.
They point to the Tax Reduction Act of 1975, which eliminated some
of the tax avoidance rules pertaining to deferral.
Thus, the present tax treatment of U.S. foreign subsidiaries is seen
by those defending deferral as essentially neutral from the perspective
of the effect on U.S. companies operating abroad and competing with
foreign companies. On the other hand, those who favor repeal of de-
ferral see it from the perspective of providing incentives in favor
of foreign investment in comparison with domestic investment.
A measure of the advantage of deferral of U.S. tax by not repatri-
ating profits of overseas subsidiaries can be seen by measuring the effec-
tive foreign income tax rate relative to the effective U.S. tax rate. While
the U.S. effective tax rate for 1968 was 41.6 percent, the average rate for
controlled foreign corporations was 37 percent and ranged from a low
of 16.8 percent in Switzerland to a high of 45.6 percent in France.
These lower foreign tax rates and the problems associated with defer-
ral have, in the past, led the Treasury to recommend the end of deferral
in the case of runaway plants and tax holiday corporations.
To put the issue in perspective,- total elmination of deferral would
result in additional revenues of $365 million per year. Over $100
million of this amount would be attributable to foreign flag shipping,
which presently pays little tax any place in the world. The balance
of less than $265 million would be attributable to manufacturing and
other operations overseas. Thus, the total elimination of deferral would
result in less than a two percent reduction in after-tax earnings from
 overseas investments which would be a reduction of less than one-half
of one percent in the rate of return on that investment.
There are, of course, many reasons for making investments abroad
in addition to tax reasons. Commercial laws, tariffs and import re-
strictions, currency laws, or merely the attitude of government offi-
cials or the public generally may make it advisable to invest abroad
rather than in the United States, if a corporation is to sell its products
in a foreign market. Similarly, labor costs, transportation costs, or
perhaps merely location in a country which provides favorable access
to the Common Market may be the factors requiring investment over-
seas rather than in the United States. Of course, tax concessions in one
country may influence the choice of a location in that particular coun-
try after the decision to produce outside the United States has been
made for nontax reasons.
While it is difficult to evaluate the incentive effects of tax deferral
generally, clearly the longer the tax deferral period and the higher
the rate of return on the amount deferred relative to the difference
between the United States and foreign tax burden, the greater the in-
centive to invest abroad. Thus, the present tax treatment of controlled
foreign corporations probably does in some cases provide some induce-
ment to reinvest abroad earnings from foreign sources.
The present rules of taxation of foreign income are complicated due
to the tension created in the law by providing for deferral but yet
placinglimitations as to when deferral ceases. Thus, permitting
eferral has created the need for rules dealing with tax haven type
income (the subpart F provisions, sec. 951 through 964), rules for
determining when earnings are repatriated (secs. 367 and 1248), rules
for pricing between related parties to prevent shifting of profits to
a foreign subsidiary (sec. 482), and rules to prevent untaxed earnings
from being transferred outside the United States and escaping U.S.
taxing jurisdiction (sec. 367). Thus, regardless of the merits of retain-
ing or elimating deferral, the termination of deferral would greatly
simplify the Internal Revenue Code and eliminate many sources of
confht between the Internal Revenue Service and taxpayers.
Eliminating deferral might, however, have aparcular impact in
a few specific areas. Over $100 million of revenue would be gained from
foreign flag shipping companies controlled by U.S. corporations. These
compaies are often based in countries (such as Panama and Liberia)
which do not tax shipping income. Since the shipping income of the
foreign competitors of these taxpayers is also untaxed, taxing the
income of U.S. owned companies could lead to a competitive disad-
vantage. Some argue that this disadvantage would lead some U.S.
compames to charter ships owned by foreigners not subject to U.S.
tax rather than use their own ships to carry their products. Foreign
ownership of these ships could produce difficulties if international
emergencies occur.
In addition, the elimination of deferral could have a significant
impact on some developing nations which have a policy of encouraging
foreign investment through tax holidays and other special tax pro-
visions. These countries believe that the tax incentives are an essential
aid to their economic growth. The eliminination of deferral would
mean that U.S. taxpayers would not benefit from these foreign tax
holidays or other special tax provisions (since the income would be
taxed by the United States) which might discourage some investments
in less developed countries. However, there are alternative methods
(such as subsidized capital financing) available to most foreign gov-
ernments to attract investment without relying on tax incentives.
The balance of payments impact from any elimination of deferral
would be small and to the extent that future foreign investment is
discouraged and future overseas profits are reduced, the net result
could be adverse. While under present conditions it may well be
preferable to emphasize domestic investment over investments abroad,
it would also appear undesirable to abandon foreign investments to
foreign competitors. While fundamental revisions in the foreign tax
credit might result in U.S. corporations disposing of their foreign
investments, the elimination of tax deferral would not generally in
and of itself be a significant factor causing such a disposition.
As an alternative to the complete elimination of deferral the com-
mittee might want to consider a provision of general application to in-
come of controlled foreign subsidiaries. Such an alternative could pro-
vide that if a controlled foreign corporation failed to distribute one-
half of its after-tax earnings and profits to its U.S. shareholders, a
deemed distribution would result to the extent of the shortfall.
The requirement of a 50-percent repatriation could be justified be-
cause, as a rule, domestic corporations distribute close to 50 percent of
their after-tax income to their shareholders. 4 On this basis, it would
not appear unreasonable to expect controlled foreign corporations to
contribute their equitable share of the funds to be paid out to the share-
holders. In fact, in a number of years, controlled foreign corporations
as a group have distributed one-half of their earnings to their U.S.
parents.5
Alternative proposals
Mr. Ullman
Controlled foreign corporations not repatriating 50 percent of their
earnings would be subject to tax on deemed distributions (resulting
to the extent of the shortfall) under the existing statutory framework
used to tax tax haven income presently (e.g., the subpart F pro-
visions of the Internal Revenue Code).
The U.S. parent corporation would be given the option of satisfying
the required distribution on a worldwide basis for all of its controlled
foreign subsidiaries. Under this consolidated approach, a U.S. parent
corporation would satisfy the 50-percent requirement if it brought back
' In the period 1974 back to 1967 the percentage of profits after tax distributed were
as follows: 1974, 38.5 percent; 1973, 40.6 percent; 1972. 47.8 percent 1971, 54.3 per-
cent; 1970, 62.9 percent; 1969, 54.2 percent; 1968 49.4 percent; and 1 67, 45.9 percent.
5See tables A-4 and A-S of the pamphiet, "IT'axationof Foreign Sources Income:
Statistical Data."
 12
one-half of its worldwide consolidated earnings and profits. To the
extent that there is a shortfall of the required distribution, the short-
fall would be made up by providing for deemed distributions on a pro
rata basis from those controlled foreign corporations which did not
distribute one-half of their earnings and profits.
Earnings which are distributed would be entitled to the foreign tax
credit under the normal Internal Revenue Code provisions dealing
with credit for taxes paid on foreign source income. Earnings which
are deemed distributed would be subject to the special foreign tax
credit provisions which are provided under present law for subpart F
income.
Losses of one controlled foreign corporation under this approach
would be offset against the earnings and profits of other controlled
foreign corporations. Earnings and profits for purposes of the 50-
percent deemed distribution provision would be determined (under
the provisions of section 964(a)) with adjustments for U.S. account-
in purposes only for items which are material in nature.
In some cases, foreign countries have made it difficult to make the
actual distributions either by prohibiting or by imposing heavy pen-
alties or taxes on dividend distributions. In some cases, however, the
companies are allowed to make royalty or management fee payments to
the parent corporation with respect to patents or fees based upon tech-
nical know-how. While the present subpart F provisions provides some
relief for blocked currency, treating royalties and management fees
paid from controlled foreign corporations as payments in satisfaction
of the 50-percent requirement will substantially lessen any problem.
Additionally, since branch income is taxed on a current basis under
present law, that income could be treated as income which is 100 per-
cent repatriated for purposes of satisfying the 50-percent requirement
on an overall basis.
Mears. Vanik, Corman, Green, Gibbons, Karth,Rangel, Stark,
Jacobs, Mikva, Fisher and Mrs. Keys
The proposal would eliminate deferral completely.
Mr. Vander Veen
The proposal would eliminate tax deferral over several years.
Mr. Pickle
The proposal would deny tax deferral to runaway plants.
IV. FOREIGN TAX CREDIT
Present Law
As discussed above (in the Overview section), present law permits
taxpayers subject to U.S. tax on foreign income to take a foreign tax
credit for the amount of foreign taxes paid on income from sources
outside of the United States. The credit is provided only for amounts
paid as income, war profits or excess profits taxes to any foreign
country or to a possession of the United States.
The foreign tax credit is allowed not only for taxes paid on income
derived from operations in a foreign country, but it is also allowed for
dividends received from foreign corporations operating in for-
eign countries and paying foreign taxes. This latter credit, called the
deemed-paid credit, is provided for dividends paid by foreign corpora-
tions to U.S. corporations which own at least 10 percent of the voting
stock of the foreign corporation. Dividends to these U.S. corporations
are considered as carrymg with them a proportionate amount of the
foreign taxes paid by the foreign corporation.8
The computation of the amount of the foreign taxes allowed as a
deemed-paid credit in the case of a dividend distribution differs de-
pending upon whether or not the payor of the dividend is a less
developed country corporation. Initially, a question arose as to how
much of the foreign taxes for purposes of this credit should be attrib-
uted to the earnings out of which dividends were paid and how much
should be attributed to the portion of earnings used to pay the foreign
taxes. This was decided in the Supreme Court case, American Chicle
Companyj which required the foreign taxes paid for purposes of the
credit to be allocated between the dividend distribution and the por-
tion of the earnings used to pay the foreign taxes. The Congress in
1962, however, recognized that this resolution obtained less than the
full U.S. tax on the dividend income because it omitted from the U.S.
tax base the portion of the earnings used to pay the foreign tax. Where
the foreign tax was less than the U.S. tax (but above zero), this gave
an advantage to dividend income over income subject to the full United
States tax. In 1962, the Congress corrected this problem for all corpo-
rations other than less developed country corporations.
The correction made in 1962 took the form of requiring the earnings
used to pay the foreign tax allowed as a credit in the distribution
base and then allowing the credit for foreign taxes paid to be based
upon the earnings, including the amount paid as foreign taxes, and not
merely the portion paid as a dividend.
In order to prevent a taxpayer from using foreign tax credits to
reduce U.S. tax liability on income from sources within the Uni'ed
States, two alternative limitations on the amount of foreign tax
credits which can be claimed are provided by present law. Under
the overall limitation, the amount of foreign tax credits which a tax-
payer can apply against his U.S. tax liability on his worldwide
income is limited to his U.S. tax liability multiplied by a fraction
the numerator of which is taxable income from sources outside the
United States (after taking all relevant deductions) and the denomi-
nator of which is his worldwide taxable income. Under this limita-
tion, the taxpayer thus aggregates his income and taxes from all
foreign countries; a taxpayer may credit taxes from any foreign
country as long as the total amount of foreign taxes applied as a
credit in each year does not exceed the amount of tax which the United
States would impose on the taxpayer's income from all sources with-
out the United States.
0These rules for the deemed-paid credit apply to distributions to a domestic corporation
from a first-tier foreign corporation in which the domestic corporation is a 10-percent
shareholder and to distributions from a second-tier or third-tier foreign corporation
(through a first-tier foreign corporation), as long as each receiving corporation in the
chain of dividend distributions is a 10-percent shareholder In the corporation making the
distribution. However, distributions originating from a foreign corporation that in more
than three tiers beyond the domestic corporate shareholder do not carry with it any
deemed-paid foreign tax credit.
7 Ameriean chicle Compan v. United States, 316 U.S. 450 (1942).
 The alternative limitation to the overall limitation is the per-
country limitaticn. Under this limitation the same calculation made
under the overall limitation is made on a country-by-country basis.
The allowable credits from any single foreign country cannot exceed
an amount equal to U.S. tax on worldwide income multiplied by a
fraction the numerator of which is the taxpayer's taxable income from
that country and the denominator of which is his worldwide taxable
income. Taxpayers are required to use the per-country limitation un-
less they elect the overall limitation. Once the overall limitation is
elected, it cannot be revoked except with the consent of the Secretary
or his delegate.
The Tax Reduction Act of 1975 prohibits the limitation on the
foreign tax credit on income from oil and oil-related activities from
being calculated under the per-country method. Instead, this income
(and any losses) are computed under a separate overall limitation
which applies only to oil-related income. Any losses from oil-related
activity are to be "recaptured" in future years through a reduction in
the amount of allowable foreign tax credits which can be used to offset
subsequent foreign oil-related income.
In addition, the Tax Reduction Act of 1975 requires that the amount
of any taxes paid to foreign governments which will be allowed as tax
credit on foreign oil extraction income is limited to 52.8 percent of that
income (after deductions) in 1975. 50.4 percent in 1976 and 50 percent
in subsequent years.
In computing taxable income from any particular country or from
all foreign countries for purposes of the fractions used in the tax
credit limitations, all types of income are included as well as the
deductions which relate to that income and a proportionate part of
deductions unrelated to any specific item of income. Thus, for exam-
ple, income from capital gains is included in the numerator and de-
nominator of. the limiting fraction as well as the deductions allocable
to those gains (e.g., the 50-percent exclusion of capital gains for
individuals) 8
In cases where the applicable limitation on foreign tax credits re-
duces the amount of tax credits which can be used by the taxpayer
to offset U.S. tax liability in any oneyear, present law provides that
the excess credits not use may be carried back for two years or carried
forward for five years. However, if a person using the per-country
limitation in any year elects subsequently to use the overall limitation,
no carryovers are permitted from years in which the per-country
limitation was used to years in which the overall limitation was
elected.
Issues
A preliminary problem in discussing the problems of the foreign
tax credit is whether any credit should be allowed at all. Some argue
that foreign taxes should be treated as business expenses (or State
* However, an exception is provided for interest income If that income is not derived from
the conduct of a banking or financing business, or is not otherwise directly related to the ac-
tive conduct of a trade or business in the foreign country. Such interest income and the taxes
paid on It are subject toa separate per-country limitation to be calculated
to the other foreign income of the taxpayer. without regard
taxes) and be deducted rather than credited. If foreign taxes were
deducted, individuals and corporations investing in foreign countries
would bear a greater total tax burden than investors in the United
States and than other foreign investors. The result would be that trade
and capital movement between countries would-be diminished.
Furthermore, determining tax policy on the foreign tax credit based
on an analogy between the deduction for State taxes and deducting
foreign taxes is not necessarily appropriate. State governments, of
course, are not independent sovereign entities as are the foreign govern-.
ments. These governments are instead comparable to the U.S. Federal
Government rather than to the States. Thus, the analogy between
State and Federal Government is probably inappropriate because
the foreign taxes on a sovereign nation should be treated as compara-
ble to taxes paid to the U.S. Federal Government and thus should be
credited against U.S. taxes.
With the growth of U.S. investment abroad and the rise in foreign
tax rates, the foreign tax credit has become a relatively more important
provision in recent years. Foreign statutory tax rates for 1973 and
1974 were 48 percent or greater in 7 out of 20 developed countries, and
were 40 percent or greater in 14 out of 20 developed countries. Also,
in 21 out of 30 African and South American less developed countries,
statutory tax rates for those years were 40 percent or greater. As is
indicated by Table 5 for 1968, effective tax rates are somewhat less
than the statutory rates. If withholding taxes on dividends paid to
U.S. investors, which range from 5 to 30 percent in various countries,
are added to these foreign tax rates, the foreign tax rate in most coun-
tries exceeds the U.S. tax rate applicable to that income.
 TABLE 5.-1968 STATUTORY AND REALIZED AND 1973-74 STATUTORY CORPORATE INCOME
TAX RATES'

1973/74 statutory rates

1968 statutory rates
Dividend
Distributed 1968
realized rates 4 Cith
Local Minin Distributed Local Mining holding
Corporate profits if income and/or All Mansfsc- Corporate, profits If income
Country tas rate different taxes I petroleum I industries aod/er rate to United
taring Mining tax rate. different taxesI petroleum 3 states'

Developed countries:
Canada------------------------- 50.0-------------- 12.0.........--
Austria------------------------- 44.0 22.0 14.0 ------ 39.1 42.8 8.4 48.0-------------- 13.0.....
42.6 42.7 () 55.0 27.5 it.........-- *15.0
Belgium -------------- 385 33O0 6.0 ------ 34.0 34.4 0 42.0 - - - -- - - - - - - - - - - - - - 5.0
erancer ------------------------- 36.0 31.1 32.5 36.2 36.0.........................------ 15.0
Germany ------------------------ 45.5 48.0 34.3 50.0 --------------- --- toa
52.5.... .5... .5............ 41.4 to0
Greece-------------------------38.24 43.0 .1 52.6 its8 i5.o ------ 15.0
Ireland------------------------- 50.0 11.7 11.9 (1) 38.24 - - - - - - - -- - - -- - - - - - 30.0
13.4 12.7 0 50.0 - - - - - - - - - - - - - - - - - -
"taI------------------------- 41-----0 ------------ () .
42.1 41.1 49.8 43.8 -------- 5.0
Lu~mborg
---------------- 40.0 -------------- 10.0.........-- 5.0
Netherlands---------------------- 46.0 ------------------ 14.5 17.1 0 40.0 ------- 1.P--------------
Norway------------------------ -30.0-------------- 32.7 34.5 26.1 48.0 --- --- ---- --- - ---- 5.0
Spain--------------------------
19.0 ------ 51.8 45.8 46.4 26.5-------------- 21.3..........-- 5.0
42.8 ------------------ 35.3 10.0
Sween ----------
-------- 40.0 ----------- 39.5 32.8..............
9--------- 41.0 15.0
Switzerland-----------------------
United Kingdom..........
Australia - - - - - - - - - - - - -
7.2-------------- 24.0.........--
450------------------45.0-------
45.0 - - - - - - - - - - - - - - - - - -
16.7
38.7
43.1F
22.2
38.6 48A
( 40. 0--------------2......
8.8 -------- 20------------2......
50.0............................----
5.0
to0
40.2 40.6 36.0 47.5............................----- 15.0
South Africa---------------------- 50.5 4&7 45.0-----------------33.3 15.0
36.7-------------------------- (Q) to0
Japan-------------------------- 35.0 26.0..................---- 34.8 35.8 A3------------
4.0 1 15.0
South America: 41.1 41.5 Q) 36.75 26.0 --- .0.........----
2- 10.0.
Mexico------------------------- 42.0 ------------------
Argentina------------ .... 3.0-------------- 40.7 42.2 20.0
Brazil-------------------------- 30.0 38.5 ------------ 21:8 21.7 12.0
27.6 30.0 96.7 30.3 33.5
Chie ---------------------
Colombia ------------------------ 37.2------------------------- (1) 24.5 33.0 2t.0
36.0...--........................---- 41.7 4.43 .------------------------.. . 40.0
Ecuador ------------------------- 20.0 25.0-------------- (a) 424 47.3' 17.5 36.0 ........................... 20.0
Paraguay ------------------------ 25.0------------------- 24.3 1. 33.3 20.0 .. . 0----------...... 40.0
10.0
Veneua----------------------- 21.0............................---- 2
15.7 14.1 30.0
Veosta ic---------------------- 50.0 ------------------------ 2t. 0
ElSalvador ---------------------- 30.0 ------------------
52.0 28.1
15.1
30.0
25.3 12 .14-.--.---------.. 15.0
15.0
Guatemala ----------------------- 6.6 7.6 40.0
HonSuras--------------------------
15.0 ---------------- 16.8 21.0 38.0
HNdua-------------40.0 ------------------ 52.8 10.0
21.7 25.2 48.0
Dom inican Rie
public------- --- 1------------------------.....
--- 10.6 1.8 30............... o
Jamaica----- 9. ------------------------------ 16.3 20.6 S 41.14 --------------- 18.0
Puerto RICO367-----------------------------367 14.0 21.3 37.5
Trinidad 17.2 11.2 4. 40. ..........................-----
Tobago--------------------45-0 4and 28.2 36.7 -----
-----
45. -- ---
----- 15.0
10.0
Africa: .0
l0.0 . . . . . . ..-----------------------------. 1.
Algeria.......--------------------50.0 ..-------------------------. --. 32.5 0
Morocco.. . ...-------------------- 40.0 .---------------------------. 43.1 45.4 48.0..- . .. 20
..-----------------------------
UAR........---------------------34.45. .....------------------------------ NA NA 34.45.. . .. . 34.45
..-----------------------------
Ethiopia .. . ..--------------------- 40.0 ... .. . 23.3
..----------------------------- 386 40.0 ---.------------------------------ 0
Kenya.. . 40.0
..---------------------- . . ..--------------------- 22.5 27.6 19.0 40.0 22.5
.--------------------- 125
Tanzania ... ..--------------------40.0 . . ..--------------------- 22.5 46.6 400.---------------------22.5
1) 1.5
Nigeria. . . 50.0 .
..--------------------- . ..--------------------- 50.0 11.2 5.2 45.0 ...-- . .--------------------- 1055.0
Malawi. . . . 37.5.-----------...
..--------------------- ------------------ 42.1
Rhodesia ..-.-------------------- 36.25 .. . . .. 34.9
..----------------------------- 28. 40.0 ..--------.--------------------- 1......150
Zambia.. .....-------------------- 45.0 .---------------------- (0) 31.4 28.0 0-----------------------( IL0
Middle East:
Iran ..------------------------- NA-----.- . . ..------------------------ 10.5 9.7 NA 10.0 55.0 3.35.------------60.0
55.0 -------------------------------- NA 55o---------50 0
Is1l.------------------------
Iraq, ----------- A 56:05 ------4.0 ---------------------- 30.0
47.0
Kuwa rbl.....................40...------------------------------.NA 32.3
32.0----------------------
10.0----------
39.0
15?42.
------ 0
5500-------------1.----------10.0
-------------
Lebanon------------42.0-------------
Saudi Arabia----------------------- 40.0---------------------- 5.(0 () 45.0.---------------------- ) 0

j
Asia: --... -.... 39.3
(Sri Lanka)--------------- 50.0 33.3--------------------- 27.5 17.7 60.0 33.3---....
ICeyln
n60.0---------------6.----------------------------- 57.1 57. 0. -.-- - ....-- .....
.60.0...- 25. 725
60.0. ..-...----------------------------- 48. 5 NA 45.0--------- . .------------... 20.0
Indonesia......----------------- - 29. 45.0------------------------- 350.0
40.0
..----------------------------
Malaysia. . ..--------------------- 40.0. ..-.. 26.9
..----------------------------- 27.9 40.0. .. . .
Pakistan . ..--------------------- 60.0 ----------------------------- 52.5 52.6 60.0. . ..---------------------------- 15.0
Philippines ..-------------------- 35.0.. . .. . 29.6
..----------------------------- 26.9 NA 40.0----------.--.... ------ -- 40.0
Singapore. . 40.0---- .
..-------------------- ..-.------------------------- 26.4 9
NA: 40:o-----------
40.0 .. . . .
----- -----
- 54.0
..--------------------- 5.0
South Korea ..------------------- 45.0...-. . 0
..-----------------------------NA
6.0 25.0 . . .. . .. .-.--
China (Taiwan).----------------- 25.0. .. . .. 7.8
..----------------------------- . .. . .. . 10.0
----------------------------- 17.7 12.4 30.0.. ..---------------------------- 25.0
Thailand.----..-----------------25.0
Low-tax countries: 5.1 8.9 0. ------------------------ -20
Bahamas . . .O.---------------------.0... ..------------------------------ 10.2 .3 NA
Bermuda .. . 0..
...---------------------. ..------------------------------- 9.9 0 .------------------------------ 00
17.1 15.5 (0) 15.0---------- . ------
.-------------..
Hong Kong.-------.------------- 15.0 ..-.. ...-----------------------------
Liberia. . . ..----------------------45.0...-. 5.7
...----------------------------- NA 15.3 45.0 ..--- .------------------------- 15.0
Netherlands Antilles.--------------34.0.------------15.0.------------4.5 NA NA 34.0.------------..--.......... 0
Panama ......------------------- 45.0 . ..-.. 9.S
..----------------------------- 13.9 .5.4 50.0.. . ..-. 10.0
..----------------------------

I This tabledoes not include taxes on capital, net worth, and other special taxes. It covers corporate Sources: Statutory rates: Diamond, Walter H. "Foreign Tax and Trade Briefs," Federation of
Income and dividend withholding taxes only. Rates do not take Into account tax holidays orincentives British industries. 'Taxation in Western Europe 1964-N- Grundy, Milton. "Tax Havensa" 1969;
for new or special industries. International Bureau of Fiscal Documentation. 'Corpoo xation in Africa;" International Bureau
I Local taxes where significant. of Fiscal Documentation." Corporate Taxation In Latin America"; international Bureau of Fiscal
aStatutory rates are cited for mining and petroleum if the rates differ from the general statutory Documentation. "European Taxation"; international Bureau of Fiscal Documentation. "Tax News
rate. However, dateon special rates for mining and petroleum industries are not always available. Service"; Japan Tax Association. 'Aan Taxation" 1968; Price Waterhouse and Co."Corporate
'0 Indicates that no taxes were paid but some income was reported. Taxes In 70Countries," August1973- Price Waterhouse and Co."Information Guides" (various
SForeign withholding rate ondividends paid to the U.S.parent Where a tax treaty with the U.S. countries various yea and Uitedingdom, Board of Inland Revenue. "Income Taxes utside
exists, the applicable treaty rate Isused. the United ingom"71i. In addition, iformi~on contained In the International Tax Stallfilies
I NoIncome was reported byany controlled foreign corporations In that industry. was used. "Relized Rates": IRS, Preliminary Data, forms 1120and 2952, 1968, table 14a.
7 Included In corporate tax rate.
I The rate is computed according to special formula or several rates exist.
NA Dataeither unavailable or not usable because of disclosure problems.
Note: Reprinted from "National Tax Journal," vol. XXVIII, No. 1, March 1975.
 These high foreign taxes can.be shown from the amount of taxes
actually paid to foreign governments in 1972 and claimed as foreign
tax credits. In that year $6.3 billion in foreign tax credits were claimed
by U.S. corporations. Disregarding oil companies, the amount of taxes
claimed as credits increased from $3.3 billion in 1972 to about $4.7
billion in 1974.9
1. Limitation on the Credit
The two alternative limitations on foreign tax credits present differ-
ent advantages for different taxpayers. The use of the per-country
limitation often permits a U.S. taxpayer who has losses in a
foreign
country to obtain what is, in effect, a double tax benefit. Since the limi-
tation is computed separately for each foreign country, branch losses
in any foreign country do not have the effect of reducing the amount
of credits allowed for foreign taxes paid in other foreign countries
from which other income was derived. Instead, such losses reduce
U.S. taxes on U.S. source income by decreasing the worldwide tax-
able income on which the U.S. tax is based. In addition, when the
business operations in the loss country become profitable in
quent tax year, a credit will be allowed for the taxes paid ainsubse- that
country. Thus, if the foreign country in which the loss occurs does
not have a net operating loss carryforward rovision (or some similar
method of using prior losses to reduce subsequent taxable
the taxpayer receives a second tax benefit when income isincome), derived
from that foreign country because no U.S. tax is imposed on the in-
come from the country (to the extent of foreign taxes paid on that
income) even though earlier losses from that country have reduced
U.S. tax liability on U.S. source income.
Because this double benefit can in some cases result in considerable
tax savings, companies which frequently incur sizable losses
on new ventures) often use the per-country limitation. These (usually
com-
panies have included in the past most oil companies, which
have
losses on new drilling operations (in part because of the deduction large
for intangible drilling). Hard mineral companies, which generally
incur substantial losses from new mines, are currently the
beneficiaries of the per-country computation. primary
The overall limitation does not allow this same advantage to be
gained from foreign losses, because these losses are offset against in-
come from other foreign countries rather than against U.S. income.
Thus, the losses reduce the amount of overall foreign income on
which a foreign tax credit can be claimed. However, where a com-
pany has a net loss from all foreign operations the total net loss would
still reduce U.S. taxes on U.S. income under the overall limitation in
its present form. This situation occurs primarily in the case of cor-
porations just beginning their first foreign operations.
In spite of the fact that in most cases foreign losses do not reduce
U.S. tax liability under the oveirall limitation,most companies that
operate in more than one country elect to use this limitation because
it is substantially less complex and does offer other advantages for
'It in estimated that the
billion, largely as a resultofamount of credits claimed in 1974 has increased to about $17.8
the OPEC increase in oil prices which were charged to oil com-
panies In the form of taxes.
companies which do not incur substantial losses. Under the overall
limitation, a company averages together all of its foreign income and
taxes from all foreign countries. Thus, an individual or company which
annually pays taxes in one foreign country at a rate higher than the
U.S. tax rate (and thus would have some tax credits disallowed under
the per-country limitation) is able to average those taxes with any
taxes which might be paid at lower rates in other foreign countries'
when applying the overall limitation.
The result is that a taxpayer can use more of the taxes paid in high
tax countries as credits against U.S. tax on foreign.income under the
overall limitation if he also has income from relatively low-tax coun-
tries against which the highly taxed income can be averaged. 0
In many cases this averaging of foreign taxes would appear be ap-
propriate. Many businesses do not have separate operations in each
foreign country but have an integated structure that covers an entire
region (such as Western Europe). In these cases a good case can be
made for allowing the taxes paid to the various countries within the
region to be added together for purposes of the tax credit limitation.
However, the overall limitation also permits averaging of the taxes
paid on the income from busineseses which are not integrated.
A special situation exists in the case of oil companies which are.
presently making up to 90 percent of their payments to the OPEC
countries for producing and selling oil through what are called taxes
but what in reality may in part to royalty payments. The capability of
companies to use these credits in effect to shelter low-taxed foreign in-
come led to the Congress' decision in the Tax Reduction Act of 1975 to
limit the amount of payments for oil and gas extraction which would
be treated as creditable taxes to 52.8 percent of taxable extraction
income in 1975, 50.4 percent in 1976, and 50 percent in 1977. Other
than the oil industry, there is no general area where comparably high
foreign taxes are normally paid.
In addition, even the per-country limitation permits some averag-
ing of income since a taxpayer often has considerable discretion in
deciding in which country income is to be sourced. Under existing
source rules, dividend income is attributable to the country in which
the foreigi corporation paying the dividend to the U.S. shareholder
is incorporated. Thus, a corporation could, for example, interpose a
first-tier Bermudan corporation as the parent of second-tier subsidiary
corporations operating in Germany and Panama. The taxes paid by the
German and Panamanian corporations would be carried along (under
the deemed paid tax credit) with any dividend paid to the Bermudan
company and then when that company in turn pays a dividend to the
U.S. shareholder the taxes paid to both countries are combined and
treated as if the Bermudan 'company had paid them to Bermuda. A
similar result can be obtained with sales income because the source
rules attribute that income to the country in which title to the goods
sold passes. A company can often pass title on the sale of goods in a
10
For example, a company earning $100 each in countries A & B and paying $60 in
tax in A on that income and $30 In tax In B could use all $90 In foreign taxes under the
overall limitation (the limitation would be 48 percent of $200 or $96). Under the per-
country limitation only $48 of the taxes paid to country A would be creditable, thus limit-
ing total credits to $78.
 country where it has exces tax credits which can be used to prevent any
U.S. tax from arising on that sale. Thus, the benefit of averaging,
which is obtained automatically under the overall limitation, can also
be obtained under the per-country limitation if a taxpayer.makes
some effort to structure his operations.
A second but equally important consideration in comparing the
overall limitation with the per-country limitation is the relative bur-
den which each places on taxpayers and on the IRS. The per-country
limitation requires that a separate computation must be made for each
country in which a taxpayer operates. Each of these computations re-
quire the taxpayer to calculate the gross income and deductions to be
allocated to each country. Since, as discussed above, many large cor-
porations operate on an integrated basis in a number of countries,
assigning the income and deductions to each of the various countries
in which a corporation operates is often a complicated process leading
to an arbitrary result. It constitutes a substantial burden for taxpayers
and places the IRS in the difficult position of attempting (upon audit)
to review a company's operations in every country around the world.
These administrative and enforcement problems are greatly allevi-
ated under the overall limitation since the only allocation of income
and deductions that is required is between the United States and all
other foreign countries as a group.
Applying a strict per-country limitation concept at a 48-percent rate
would of course create the greatest number of administrative and en-
forcement problems. However, these problems are not eliminated by
applying a per-country type of limitation at a 50-percent rate. The
same difficulties in determming source of income are present at a 50-
percent or higher rate. Moreover, this limitation would apply to most
countries. Even in the United States, if the 50-percent limitation were
applied to foreign investors. some foreign tax credits would be dis-
allowed since to the 48-percent tax rate must be added the additional
withholding tax of 30 percent of dividends paid (where no treaty
is in effct), producing an aggregate rate of tax of over 63 percent.
Further, many of the differences between U.S. and foreign effective
rates can be attributed to questions of timing as to when income and
deductions are taken into account under the tax laws of the United
States and the other taxing jurisdiction. This difference in effective
rates can be further exacerbated by gains or losses arising from
changes in the rate of exchange of the U.S. dollar and the foreign
currency. Thus, in one year it is quite possible for a foreign subsidiary
to have a very low effective rate of tax and in the following year to
have a high effective rate of tax primarily due to the impact of ex-
change rates gains and losses. Thus, a per-country type of limitation
on the credit would result in disallowance of a foreign tax credit when
viewed over a number of years no foreign taxes at a rate higher than
the U.S. rate are being paid. Taking these differences into account by
providing for a carryback and carryforward of these taxes would
somewhat solve the problem but would necessitate a separate carry-
back and carryforward provision for each country for which a tax-
paver engages ina trade or business.
It has been suggested that applying a 50-percent limitation to the
foreign tax credit is an extension of the limitation which was added
by the 1975 Tax Reduction Act in the case of the foreign extraction
operations of the petroleum companies. The problem dealt with, in the
case of the petroleum companies, is different than that which arises in
the case of multinationals in general. The question with petroleum
companies was whether payments made to foreign governments were
in the nature of a creditable income tax or a deductible royalty pay-
ment. Since it is generally quite difficult to distinguish between royal-
ties and taxes in the case of the foreign operation of petroleum com-
panies, it was felt necessary to provide for a special limitation on these
payments. There is no question in the taxation of multinationals in gen-
eral that the payments made to foreign governments are creditible
foreign taxes. The question with respect to multinationals is to what
extent these valid foreign taxes should be entitled to the averaging
benefits of the overall limitation.
Alternative Approaches
Some of the alternative approaches focus on the loss problem while
others on the averaging question. In addition, some of the approaches
deal with both questions.
Special limitation
1974 committee bill
Last year's bill contained no limitation on the foreign tax credit of
multinational corporations. However, it did contain a limitation on
the foreign operations of petroleum companies which was enacted
into law as part of the Tax Reduction Act of 1975.
Mr. Vanik
The proposal would substitute a deduction for the foreign tax
credit.
Me88r. Corman, Green, Gibbon, Karth, Rangel, Stark, Jacob8,
Mikva and Mr8. Key8
The proposal would lower the percentage limitation for foreign oil
extraction income in the Tax Reduction Act of 1975 to 48 percent and
apply it and all other provisions of section 601 of the 1975 Act to the
extraction of all other natural resources.
Mes8r8. Corman, Karth, Vander Veen, and Rangel
The proposal would make the foreign tax credit subject to both the
per-country and the overall limitations.
Mr. Karth
He recommends that for all foreign income, all excess tax credits be
eliminated. To the extent foreign taxes paid exceed the U.S. tax and,
as a result are not subject to credit under this recommendation, they
would be deductible as a business expense.
Foreign Tax Credit Determined on Overall Basis
1974 committee bill
.Last year's bill repealed the per country limitation on the foreign
tax credit for all industries.
 Mr. Ullman
His proposal is the same as.that in the 1974 committee bill.
Mr. Waggonmer
The proposal would allow taxpayers engaged in mining to retain
the option to elect the per country limitation.
Recapture of Foreign Losses
1974 committee bill
Last year's bill had a provision that required any foreign losses
which offset U.S. income to be recaptured in future years when foreign
income is earned.
Mr. Ullman
His proposal is the same as that in the 1974 committee bill.
Mr. Corman
The proposal would deal with one aspect of the loss offset problem
by excluding income, deductions, and losses from the exploration and
operation of mineral property located outside of the United States
from the U.S. tax base.
2. Dividends from less-developed country corporations
Under present law, the amount of dividend from a less developed
country corporation included in income by the recipient domestic cor-
poration is not increased (i.e., grossed up) by the amount of taxes
which the domestic corporation receiving the dividend is deemed to
have paid to the foreign government. Instead the amount of taxes is
reduced by the ratio of the foreign taxes paid by the less developed
country corporation to its pretax profits.
The failure to grossup the dividend by the amount of the foreign
taxes that are deemed paid results, in effect, in a double allowance for
foreign taxes. The problem arises from the fact that the amount paid
in foreign taxes not only is allowed as a credit in computing the U.S.
tax of the corporation receiving the dividend, but also is allowed as a
deduction (since the dividends can only be paid out of income remain-
ing after payment of the foreign tax). The result is that the combined
foreign and U.S. tax paid by the domestic corporation is less than 48
percent of the taxpayer's income in cases where the foreign tax rate
of the less developed country corporation is lower than the 48 percent
U.S. corporate tax rate (but not zero or lower).- In cases where the
U For example, assume that a foreign country imposes a 30-percent tax on $1,000 of
income. If the foreign corporation earns $1,000 as a less developed country corporation in
that country, a distribution by that corporation of the remaining $700 to its U.S. parent
Corporation would result in $700 income to the U.S. parent. The parent's U.S. tax would
be 336 before allowance of a foreign tax credit In calculating the foreign tax credit,
the $300 amount of foreign taxes paid would be reduced by 300/1000 to $210. The *210
could then be credited against 1U.. tax liability of $336, leaving a net liability of *126.
Thus, the combined U.S. tax and foreign tax la ty on the original $1 000 of income
would be $420 ($300 foreign taxes plus $126 U.S. tax), not the $480 which should be
paid at a 48Mpercent rate.
If that same foreign corporation earning $1,000 were not a less developed country
corporation, the entire $1,000 would be included In the parent corporation's income if it
received a dividend of $700 which would carry with it foreign taxes of $300. In this case,
the U.S. tax before credit would be $480. The entire $300 of foreign taxes would be
credited, leaving a U.S. tax liability of $180. The combined U.S. tax and foreign tax
liabilities would be $480.
foreign tax rate exceeds 48 percent, the dividend does not bring with it
all the foreign taxes that were paid and thus the size of foreign tax
credit carryover is reduced.
The size of the tax differential which exists in the case of dividends
from less developed country corporations varies with the foreign tax
rate. Further, the tax differential disappears either when the foreign
tax rate equals or exceeds the U.S. tax or when there is no foreign
tax imposed at all. The maximum tax differential, given a 48-percent
U.S. tax rate, occurs when the foreign tax is half that, or 24 percent.
The differential at this point is 5.76 percentage points.
Alternative Approaches
1974 committee bill
Last year's bill provided that dividends received by U.S. sharehold-
ers from less developed country corporations are to be "grossed up"
by the amount of taxes paid in the less developed country both for
purposes of computing U.S. income and for purposes of computing the
U.S. foreign tax credit applicable to that income (in the same manner
as is presently true in the case of dividends from developed countries).
Mr. Ullman
His proposal is the same as that in the 1974 committee bill.
3. Treatment of Capital Gains
The present foreign tax credit limitation creates a number of prob-
lems in the treatment of capital gains income stemming from the fact
that capital gains are taxed differently than ordinary income. In many
cases the source of income derived from the sale or exchange of an asset
is determined by the location of the asset, or, if the asset is personal
property. by the place of sale (i.e., the place where title to the property
passes). In the latter cases, taxpayers presently can often exercise a
choice of the country from which the income from the sale cf tangible
personal property is to be derived. It has thus been possible, in
some cases, for a taxpayer to plan sales of personal property (includ-
ing stocks or securities) in such a way as to maximize his use of foreign
tax credits within the per-country or overall limitations by arranging
that the sale of that property take place in a certain country.
Since many foreign countries do not tax any gain from sales of
personal property, and most countries that do tax these gains do not
apply the tax to sales by foreigners (if the sales are not connected
with a trade or business in that country), the present system permits
taxpayers to plan sales of their assets in such a way so that the in-
come from the sale results in little or no additional foreign taxes and
yet the amount of foreign taxes they can use as a credit against their
U.S. tax liability is increased.
Further problems in the treatment of income from the sale or ex-
change of assets for purposes of the foreign tax credit limitations are
presented by the rules for netting long-term and short-term gains and
losses in cases where some gains or losses are U.S. source income while
other gains or losses are foreign source income.
 24
A fipI problem with the treatment of capital gains under the for-
eignTax credit system is presented by the fact that the credit limita-
tions are not adjusted to reflect the lower tax rate on capital gains
income received by corporations." Under present law, corporations
having a net long-term capital gain in most instances pay only a 30-
percent rate of tax on that gain. But for purposes of determining
foreign source and worldwide income in the limiting fraction of the
foreign tax credit limitation income from long-term capital gain is
treated the same as ordinary income (i.e., as if it were subject to a 48-
percent rate of tax).13 Similarly, a taxpayer who has a capital gain
income from U.S. sources and has foreign source income that is not
capital gain income does not receive a full credit for the amount of
U.S. tax attributable to foreign source income.24
Alternative Approaches
1974 committee bill
Last year's bill provided that in cases where a U.S. taxpayer sells
a capital asset in a foreign country, the amount of any income received
from the sale is not to be included as foreign source income for pur-
poses of computing the taxpayer's foreign tax credit limitation if no
substantial foreign tax is paid upon the sale of the asset. In this case
and in cases where U.S. source capital gains are realized, the foreign
tax credit limitation is to be adjusted to the extent of the capital gains.
Mr. Ullman
His proposal is the same as that in the 1974 committee bill.
4. Treatment of Exempt Income
There are other Code provisions which provide for the exemption
or nonrecognition of certain income. Taxpayers who derive exempt
income or are not required to recognize certain income may pay foreign
income taxes on that income and use those foreign taxes as an offset
against U.S. tax on other foreign source income.
Alternative Approaches
Mes8r8. Corman and Rangel
The proposal would deny the foreign tax credit on income exempt
from U.S. tax.
2A similar problem exists to a much lesser extent for capital gains income of individuals
under the alternative tax (sees. 1201 (b) and (c)).
niFor example, if a corporation has worldwide income of $20 million. $10
which is ordinary income from sources within the United States and $10 millionmillion of
of which
is income from the sale of an asset from sources without the United States, that corporation
is allowed a foreign tax credit equal to one-half (10/20) of his U.S. tax liability, even
though only $3 million of the $7.8 million in U.S. tax liability is attributable to foreign
source income. Present law thus favors the taxpayer with
since his U.S. tax on U.S. ordinary Income of $10 million isforeign source capital gain
not treated as being $4.8
million but as $3.9 million.
1 For example, if such a taxpayer had $10 million of U.S. source capital gain and $10
million of foreign ordinary income, the foreign tax credit limitation would limit the credit
to $3.9 million even though he would be liable for $4.8 million of U.S. tax on his foreign
source income.