Chapter 13 - Jurisdictional Issues in Business Taxation

Chapter 13 Jurisdictional Issues in Business Taxation

Questions and Problems for Discussion
1.

Corporations can deduct state income tax paid in the computation of federal taxable income.
Therefore, the after-tax cost of the state tax payment must reflect the federal tax savings from the
deduction, which is a function of the corporations marginal tax rate.

2.

a. NY has nexus with Pennsylvania because it has a physical presence (the retail outlets) in the
state.
b. NY does not have nexus with Pennsylvania because its in-state activity (solicitation of orders
for sales of tangible goods) is immune under P.L. 86-272.
c.

NY does not have nexus with Pennsylvania because it does not carry on any in-state activity
and has no physical presence in the state, even though it sells goods to customers residing
in Pennsylvania.

d. NY does have nexus with Pennsylvania because it carries on an in-state activity (repair and
maintenance service) that is not immune under P.L. 86-272.
3.

Physical presence nexus means that a corporation owns or uses tangible property located in a
state or has employees working in the state. Economic nexus means that a corporation conducts
a regular commercial activity by transacting with clients or customers residing in the state.

4.

The federal government does not require states to use a specific apportionment formula.
However, the federal courts have held that states must use a rational and fair method to
determine the portion of income from interstate commercial enterprises subject to the states
income tax.

5.

Each states laws could provide a different definition of taxable income subject to apportionment,
a different apportionment formula, or different definitions of the factors included in the
apportionment formula.

6.

If a state has a relatively low (or even no) corporate tax, a multistate business might want to
create nexus with the state to shift a portion of its income from interstate commercial activities to
the state.

7.

The home country is the country in which the business owners reside or in which the business is
incorporated. A host country is any country in which a foreign firm or corporation conducts a
business or commercial activity.

8.

A bilateral income tax treaty is an agreement between two countries that provides unique rules
defining and limiting each countrys jurisdiction to tax the residents of the other.

9.

The nature and extent of Leftys business activity within County Y may be insufficient to create
jurisdiction. Country Y may have an income tax treaty with the United States providing that
neither country will tax a corporation formed under the laws of the other unless that corporation
maintains a permanent establishment in the host country. In this case, Lefty apparently does not
have a permanent establishment in Country Y.

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Chapter 13 - Jurisdictional Issues in Business Taxation

10. a. Posse cannot file a consolidated tax return that includes its Country J subsidiary.
Consequently, the subsidiarys operating losses will not reduce Posses taxable income and
will not generate any U.S. tax savings.
b. If Country Js tax law allows corporations to carry operating losses into future years as NOL
deductions, the subsidiarys operating losses may eventually reduce future income subject to
Country J tax.
11. a. Halifax would gross up the $5 million dividend by the Country U tax paid, compute tax on the
grossed-up dividend at 34 or 35 percent, then claim a deemed paid foreign tax credit to
reduce the U.S. tax on the repatriated income to zero.
b. In this case, the deemed paid foreign tax credit would be less than the pre credit U.S. tax on
the grossed-up dividend. Consequently, Halifax would pay some U.S. tax (14 or 15 percent)
on the repatriated earnings.
12. a. The subsidiarys income from the clothing sales is subpart F income because the clothing is
purchased from a related party and is neither manufactured nor sold for use within Country
H.
b. The income from the coffee bean sales is not subpart F income because the coffee is grown
in Country H.
c.

The income from the building material sales is not subpart F income because the materials
are sold to Country H customers.

13. a. Column can file a consolidated return that includes the activities of both domestic
subsidiaries. Therefore, the income generated by the Country Z operation is reduced by the
losses generated by the Country A operation.
b. In this case, the two foreign subsidiaries cannot be included in Columns consolidated tax
return, and the Country A losses cannot reduce the Country Z income.
14. Each partner will compute a foreign tax credit for any foreign income tax paid during the year
(including the partners share of foreign income tax paid directly by Delta). Each partners credit is
limited to the U.S. tax on the partners foreign source income for the year. Therefore, the partners
must know their share of Deltas foreign source income to compute the correct limitation.
15. Because Sub 2 is operating in a jurisdiction with a tax rate lower than the U.S. corporate rate, the
IRS would be concerned that Kantor is shifting income to Sub 2 through its transfer pricing. If
Kantors transfer pricing for its Sub 1 sales are not at arms length, Kantor is most probably
shifting income away from this subsidiary and to its own U.S. tax return (which is just fine with the
IRS).
16. The United States is a tax haven for international business operations that also operate in
jurisdictions with corporate tax rates in excess of 35 percent.

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Chapter 13 - Jurisdictional Issues in Business Taxation

Application Problems
1.

a. Net profit before tax

Deduction for state income tax
Taxable income for federal purposes
Tax rate
Federal income tax

$9,877,000
(804,000)
$9,073,000
.34
$3,084,820

b. Mesas combined tax rate is 39.37% ([$804,000 state tax + $3,084,820 federal tax]
$9,877,000)
2.

Oldham has the following apportionment percentages in each state.

Sales factor (percentage of in-state gross receipts)
Payroll factor (percentage of in-state payroll)
Property factor (percentage of in-state property)
State M apportionment percentage:
State N apportionment percentage

State M

State N

28.57
40.00
47.37
115.94

71.43
60.00
52.63
184.06

115.94 3 = 38.65
184.06 3 = 61.35

Oldhams income tax in each state is computed as follows.

State M
Total taxable income subject to apportionment
Apportionment percentage
State taxable income
Tax rate
State tax
3.

$3,000,000
.6135
$1,840,500
.07
$128,835

This change in facts does not affect the computation of State M tax. State Ns tax is computed as
follows.
State N apportionment percentage

(2[71.43] + 60.00 + 52.63) 4 = 63.87

Total taxable income subject to apportionment

Apportionment percentage
State taxable income
Tax rate
State tax
4.

$3,000,000
.3865
$1,159,500
.045
$52,178

State N

$3,000,000
.6387
$1,916,100
.07
$134,127

State Ms payroll factor would increase to 95%, and State Ns payroll factor would decrease to
5%. Each states apportionment percentage would change as follows.
State M apportionment percentage:
State N apportionment percentage

170.94 3 = 56.98
129.06 3 = 43.02

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Chapter 13 - Jurisdictional Issues in Business Taxation

Oldhams income tax in each state is recomputed as follows.
State M
Total taxable income subject to apportionment
Apportionment percentage
State taxable income
Tax rate
State tax

$3,000,000
.5698
$1,709,400
.045
$76,923

State N
$3,000,000
.4302
$1,290,600
.07
$90,342

Oldhams total state tax in Problem 2 ($52,178 + $128,835) $181,013

Oldhams recomputed total state tax
(167,265)
State income tax savings
$13,748
5.

a. Apportionment factors:
Sales
Payroll
Average property

A
$6/$10 = 60%
$2/$3.2 = 62.5%
$1/$1.8 = 55.56%

B
$4/$10 = 40%
$1.2/$3.2 = 37.5%
$0.8/$1.8 = 44.44%

Formula:
A: (60% + 62.5% + 55.56%)/3 = 59.37%
$2 million * 59.37% = $1,187,400 income apportioned to state A
$1,187,400 * 5% = $59,470 state A tax liability
B: (2 * 40% + 37.5% + 44.44%)/4 = 40.49%
$2 million * 40.49% = $809,800 income apportioned to state B
$809,900 * 6% = $48,588 state B tax liability
b. This change would not alter state A liability. State B liability would decline slightly to $48,000
($2 million * 40% * 6%).
6.

7.

a. Net profit before tax

Deduction for state income tax
Taxable income for federal purposes
Tax rate
Akitas U.S. tax

$8,000,000
(450,000)
$7,550,000
.34
$2,567,000

b. Net profit before tax

Deduction for state income tax
Taxable income for federal purposes
Tax rate
Precredit U.S. tax
Foreign tax credit
Akitas U.S. tax

$8,000,000
-0$8,000,000
.34
$2,720,000
(450,000)
$2,270,000

Taxable income
Tax rate
.34
Precredit U.S. tax
Foreign tax credit (actual tax paid)
Zenons U.S. tax

$2,140,000

Foreign tax credit limitation: $727,600

$727,600
(33,000)
$694,600

$240,000 foreign source income = $81,600

$2,140,000 taxable income

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Chapter 13 - Jurisdictional Issues in Business Taxation

8.

In this case, Zenons U.S. taxable income is $1,900,000 and its U.S. tax is $646,000.

9.

Taxable income
Tax rate
Precredit U.S. tax
Foreign tax credit (limited)
Jacksons U.S. tax
Foreign tax credit limitation: $7,521,500

$21,490,000
.35
$7,521,500
(941,500)
$6,580,000
$2,690,000 foreign source income = $941,500
$21,490,000 taxable income

10. In this case, Jacksons U.S. taxable income is $18,800,000, and its U.S. tax is $6,580,000.
11. a. Taxable income is $400,000. U.S. tax before credits is $136,000. Maximum foreign tax
credit equals the lesser of (1) $28,000 or (2) $136,000 * $60,000/$400,000 = $20,400. FTC =
$20,400. Net U.S. tax after credits = $115,600.
b. FTC = $10,000. Net U.S. tax after credits = $126,000.
c.

In the case where foreign taxes paid are $10,000, the foreign tax rate (16.667%) is less than
the U.S. rate of 34%. Use of a foreign subsidiary would defer the incremental U.S. tax of
$10,400 [$60,000 * (34% - 16.667%)] until the income is repatriated.

12. Taxable income

Tax rate
.34
Precredit U.S. tax
Foreign tax credit (limited)
Axtells U.S. tax

$7,070,000
$2,403,800
(1,853,000)
$550,800

Foreign tax credit limitation: $2,403,800 $5,450,000 foreign source income = $1,853,000
$7,070,000 taxable income

13. a. If Transcom does not maintain a permanent establishment in Canada, Transcoms foreign
source income (from Canadian sales) is not subject to Canadian tax. Therefore, Transcoms
U.S. tax is $350,200 ($1,030,000 taxable income 34%).
b. If Transcom does maintain a permanent establishment in Canada, Transcoms foreign source
income (from Canadian sales) is subject to Canadian tax. Therefore, Transcom paid
$132,000 of foreign tax ($330,000 40%) and its U.S. tax is computed as follows.
Taxable income
Tax rate
Precredit U.S. tax
Foreign tax credit (limited)
Transcoms U.S. tax

$1,030,000
.34
$350,200
(112,200)
$238,000

Foreign tax credit limitation: $350,200 $330,000 foreign source income = $112,200
$1,030,000 taxable income

14. U.S. source income

Foreign source income
Share of partnership foreign source income
Taxable income
Tax rate
.34
Precredit U.S. tax
Foreign tax credit (share of partnership foreign tax)
Aquas U.S. tax
13-5

$2,000,000
190,000
346,000
$2,536,000
$862,240
(132,000)
$730,240

Chapter 13 - Jurisdictional Issues in Business Taxation

Foreign tax credit limitation: $862,240

$536,000 foreign source income = $182,240

$2,536,000 taxable income

15. a. Trio
Subsidiary 1
Consolidated taxable income

$412,000
(180,000)
$232,000

b. Trio
Subsidiary 2
Subsidiary 3
Consolidated taxable income

$412,000
389,000
600,000
$1,401,000

16. a. Consolidated taxable income

Tax rate
Precredit U.S. tax
Consolidated foreign tax credit (actual tax paid)
U.S. tax

$9,360,000
.34
$3,182,400
(2,730,000)
$452,400

Foreign tax credit limitation: $3,182,400 $8,200,000 foreign source income = $2,788,000
$9,360,000 taxable income

b. Comet taxable income

Tax rate
U.S. tax for Comet

$600,000
.34
$204,000

Sub 1 taxable income

Tax rate
Precredit U.S. tax
Foreign tax credit (actual tax paid)
U.S. tax for Sub 1

$3,650,000
.34
$1,241,000
(380,000)
$861,000

Foreign tax credit limitation: $1,241,000 $3,500,000 foreign source income = $1,190,000
$3,650,000 taxable income

Sub 2 taxable income

Tax rate
Precredit U.S. tax
Foreign tax credit (limited)
U.S. tax for Sub 2

$5,110,000
.34
$1,737,400
(1,598,000)
$139,400

Foreign tax credit limitation: $1,737,400 $4,700,000 foreign source income = $1,598,000
$5,110,000 taxable income

Aggregate tax (Comet and both subs) $1,204,400

c.

On the consolidated return, Sub 1s foreign source income, which was taxed at about a 10
percent rate, was blended with Sub 2s foreign source income, which was taxed at a 50
percent rate. Consequently, Sub 2s excess foreign tax credit was used against Sub 1s
excess limitation, and the consolidated group could credit the entire foreign tax paid against
precredit U.S. tax. On a separate company basis, Sub 2 can credit only $1,598,000 of the
$2,350,000 foreign tax paid.

17. Veloxs 2009 taxable income

Tax rate
.34
Precredit U.S. tax

$500,000
$170,000
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Chapter 13 - Jurisdictional Issues in Business Taxation

Foreign tax credit (limited)
U.S. tax
Foreign tax credit limitation:

(68,000)
$102,000
$170,000 $200,000 foreign source income = $68,000
$500,000 taxable income

Veloxs 2010 taxable income

Tax rate
.34
Precredit U.S. tax
Foreign tax credit:
($151,000 actual tax paid + $14,000 carryforward)
U.S. tax

$900,000
$306,000
(165,000)
$141,000

Foreign tax credit limitation: $306,000 $630,000 foreign source income = $214,200
$900,000 taxable income

18. a.

2007

2008

2009

$89,330
(21,000)
$68,330

$289,000
(152,000)
$137,000

$503,200
(224,400)
$278,800

b. Precredit U.S. tax on $2 million 2010 taxable income

Foreign tax credit (limited)
Mindens U.S. tax

$680,000
(306,000)
$374,000

Precredit U.S. tax

Foreign tax credit*
Mindens U.S. tax
* Actual tax paid each year

Foreign tax credit limitation: $680,000 $900,000 foreign source income = $306,000
$2,000,000 taxable income

c.

Minden can carryback $6,800 of its $64,000 excess credit from 2010 to 2009 to generate a
$6,800 refund.
2009
Foreign tax credit limitation
Foreign tax credit on original return
Excess limitation
2009 excess credit carryback
Remaining limitation

$231,200
(224,400)
6,800
(6,800)
-0-

Foreign tax credit limitation: $503,200 $680,000 foreign source income = $231,200
$1,480,000 taxable income

19. a. Omahas dividend received from Franco

Gross up for 20% foreign tax paid by Franco
Tax rate
Precredit tax on dividend
Deemed paid foreign tax credit
CSs U.S. tax on Franco dividend
b. Omahas dividend received from Franco
Gross up for 45% foreign tax paid by Franco
Tax rate
Precredit tax on dividend
Deemed paid foreign tax credit (limited)
Omahas U.S. tax on Franco dividend
13-7

$50,000
12,500
$62,500
.35
$21,875
(12,500)
$9,375
$50,000
40,910
$90,910
.35
$31,819
(31,819)
-0-

Chapter 13 - Jurisdictional Issues in Business Taxation

20. a. U.S. source branch income

$4,922,000
Foreign source branch income
1,031,000
Dix-Col dividend
249,000
Gross up for 20% foreign tax paid by Dix-Col
62,250
Dix-Per dividend
186,000
Gross up for 37% foreign tax paid by Dix-Per 109,238
Dixies taxable income
$6,559,488
Dixies taxable income consists of $4,922,000 U.S. source and $1,637,488 foreign source
income. Dixies foreign tax payments (actual plus deemed paid) total $574,388.
b. Dixies taxable income
Tax rate
Precredit U.S. tax
Deemed paid foreign tax credit (limited)
Dixies U.S. tax

$6,559,488
.34
$2,230,226
(556,746)
$1,673,480

FTC limitation: $2,230,226 $1,637,488 foreign source income = $556,746

$6,559,488 taxable income

21. a. Jumper must recognize a $320,000 constructive dividend from the CFC (40% $800,000
subpart F income) on which it must pay $108,800 U.S tax.
b. Jumpers basis in its CFC stock at the beginning of 2008
Increase for 2008 constructive dividend
Jumpers basis at the beginning of 2009

$660,000
320,000
$980,000

22. The $120,000 distribution received by Jumper in 2010 is considered a distribution of the 2009
subpart F income on which Jumper already paid tax. Consequently, the distribution is nontaxable
and reduces Jumpers basis in the CFC stock to $860,000.
23. Yasmin must treat the $1 million loan as a constructive dividend from Luna on which it owes
$235,294 U.S. tax.
Constructive dividend received
Gross up for 15% foreign tax paid by Luna
Tax rate
Precredit tax on dividend
Deemed paid foreign tax credit
Yasmins U.S. tax on Luna dividend

$1,000,000
176,471
$1,176,471
.35
$411,765
(176,471)
$235,294

24. The IRS could invoke Section 482 to allocate $560,000 income to Alamo. The allocation equals
the $8 excess of the $108 arms length transfer price over the $100 price that Alamo charged
Vega for each component multiplied by the 70,000 components sold during the year. The
allocation would increase Alamos taxable income to $1,460,000. However, Vega is a Mexican
corporation and the IRSs determination that it did not pay an arms length price for the
components has no effect on its taxable income or the Mexican tax liability on that income.
25. a. The company would prefer a low transfer price, in order to shift more profit to Country X. A
transfer price of $14 (U.S. cost) would tax all profit in Country X.
b. The company would prefer a high transfer price, in order to shift more profit to the U.S. A
transfer price of $75 (U.S. cost + total profit) would tax all profit in the U.S.

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Chapter 13 - Jurisdictional Issues in Business Taxation

26. a. $16 ($30 transfer price- $14 U.S. cost) of profit per shirt will be taxed in the U.S.
b. $45 ($90 sales price - $30 transfer price - $15 Country X cost) of profit per shirt will be taxed
in Country X.
c.

Because the tax rate in Country X is lower than the U.S. rate, Cotton Comfort has an
incentive to shift income to X by using a lower transfer price. The IRS is likely to argue for a
higher price, taxing more profit in the U.S.

Issue Recognition Problems

1.

Does the State E excise tax discriminate against interstate commerce? Is the State E excise tax
unconstitutional because it provides a preferential rate for intrastate wine businesses?

2.

Is ABCs royalty income subject to apportionment and taxable by the six states in which it
operates its meat and poultry business?

3.

In computing the sales factor for inclusion in the UDITPA formula for State N and State O, should
Durbin include the sales to State P in the denominator? Should the UDITPA sales factors for
State N and State O reflect each states percentage of total sales, even if 11 percent of total sales
are attributable to a state to which Durbin does not pay tax?

4.

Can Silas derive the tax benefits under the U.S/U.K. treaty by operating through an artificial U.K.
entity?

5.

How much (if any) of Bentons $1 million fee is foreign source income? How is the $1 million fee
characterized as either U.S. source or foreign source income?

6.

How is the $620,000 net income characterized as either U.S. source or foreign source income?

7.

Can Funk claim a foreign tax credit for the $750,000 gross receipts tax? Does the gross receipts
tax qualify as a foreign income tax for purposes of the foreign tax credit?

8.

In computing its foreign tax credit limitation for tax paid on export sales of paper products, can
Lincoln treat the interest income as foreign source income? Can Lincoln cross credit the excess
foreign tax paid on export sales of paper products against the excess limitation created by the
foreign source interest income?

9.

Will Hastings and the foreign subsidiary both pay tax on the $10 million included in the
subsidiarys taxable income but allocated to Hastings under Section 482?

10. Does the sealing and labeling of the toys in Carnema represent a manufacturing activity within
the country? Does Williamss shipping of the toys to Carnema for sealing and labeling prevent the
subsidiarys profit from the toy sales from classification as subpart F income?
11. Does the subsidiarys purchase of stock in a U.S. corporation represent a repatriation of foreign
income that Bertrand must recognize as a constructive dividend?

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Chapter 13 - Jurisdictional Issues in Business Taxation

Research Problems
1.

According to the Corporate Income and Replacement Tax Return, Illinoiss apportionment
percentage is based on a single factor: the ratio of total sales within Illinois over total sales
everywhere. According to the Corporate Franchise Tax Report, Ohios apportionment percentage
is based on a three-factor formula in which the property and payroll factors are each weighted 20
percent and the sales factor is weighted 60 percent.

2.

This problem introduces students to the income sourcing rules of Sections 861-865. Section
863(c) provides sourcing rules for certain transportation income, defined in Section 863(c)(3) as
income derived from, or in connection with, the use of a vessel or aircraft. Section 863(c)(1)
states that income attributable to transportation that both begins and ends in the United States is
U.S. source income. Section 863(c)(2) states that 50 percent of income attributable to
transportation that begins (or ends) in the United States but that ends (begins) in a foreign
jurisdiction is U.S. source income. Based on these sourcing rules, Endless Summers
transportation income is sourced as follows.
U.S. source income:
Income from round trip cruises
50% income from one-way cruises

$4,912,000
2,509,000
$7,421,000

Foreign source income:

50% income from one-way cruises
3.

$2,509,000

This problem requires student to read and apply Section 1248(a), which provides that the gain
recognized by a U.S. parent corporation on the sale of stock in a foreign subsidiary is treated as
a dividend to the extent of the subsidiarys earnings and profits attributable to the stock. Because
of this characterization rule, Jensons entire $6 million gain on the sale of its Bestmark stock is
treated as a foreign source dividend. Jenson must gross up the dividend by $4,909,091 German
income tax deemed paid by Bestmark attributable to the dividend. As a result, Jenson recognizes
$10,909,091 foreign source taxable income ($6,000,000 Section 1248 dividend + $4,909,091
gross-up) on which its precredit U.S. tax is $3,818,182. However, Jenson is entitled to a deemed
paid foreign tax credit for the German tax (limited to $3,818,182), which reduces its U.S. tax on
the $6 million gain to zero.

Tax Planning Cases

1.

If locate the new facility in P:

Sales
Payroll
Average property

P
$3,400,000
1,400,000
2,200,000

Q
$2,400,000
500,000
800,000

Apportionment:
P: (3.4/5.8 + 1.4/1.9 + 2.2/3)/3 = 0.6855
$1,800,000 * 0.6855 = $1,233,900
$1,233,900 * 5% = $61,695 state P tax
Q: (2 * 2.4/5.8 + 0.5/1.9 + 0.8/3)/4 = 0.3394
$1,800,000 * 0.3394 = $610,920
$610,920 * 9% = $54,983 state Q tax

13-10

Total
$5,800,000
1,900,000
3,000,000

Chapter 13 - Jurisdictional Issues in Business Taxation

Total state tax if locate new facility in P = $116,678 ($61,695 + $54,983)

If locate the new facility in Q:
Sales
Payroll
Average property

P
$3,400,000
1,000,000
1,200,000

Q
$2,400,000
900,000
1,800,000

Total
$5,800,000
1,900,000
3,000,000

Apportionment:
P: (3.4/5.8 + 1/1.9 + 1.2/3)/3 = 0.5042
$1,800,000 * 0.5042 = $907,560
$907,560 * 5% = $45,378 state P tax
Q: (2 * 2.4/5.8 + 0.9/1.9 + 1.8/3)/4 = 0.4753
$1,800,000 * 0.4753 = $855,540
$855,540 * 9% = $76,999
Total state tax if locate new facility in Q = $122,377 ($45,378 + $76,999)
Based solely on state income tax considerations, Lydell should locate the new facility in state P.
2.

3.

Minden should operate the branch in Country R rather than Country S to maximize after-tax
profit. Because Mindens tax rate on the branch income will be the higher U.S. rate, the difference
in the foreign tax rate between Country R and Country S is a neutral factor in the decision.
Before-tax branch profit in Country R
Country R tax ($700,000 20%)
U.S. tax ([$700,000 35%] $140,000 foreign tax credit
After-tax branch profit

$700,000
(140,000)
(105,000)
$455,000

Before-tax branch profit in Country S

Country S tax ($550,000 10%)
U.S. tax ([$550,000 35%] $55,000 foreign tax credit
After-tax branch profit

$550,000
(55,000)
(137,500)
$357,500

Echo must compare the NPV of the after-tax income from the branch office and the foreign
subsidiary. If the business is operated as a branch office, Echo will pay U.S. tax on the income.
Income from branch office
Country J tax ($5,000,000 18%)
U.S. tax ([$5,000,000 35%] $900,000 foreign tax credit)
After-tax foreign source income

$5,000,000
(900,000)
(850,000)
$3,250,000

If the business is operated through a foreign subsidiary, Echo can defer U.S. tax until year 4, thus
reducing the U.S. tax cost in present value terms.
Income from foreign subsidiary
$4,750,000
Country J tax ($4,750,000 18%)
(855,000)
U.S. tax cost of repatriation in Year 4:
([$4,750,000 35%] $855,000 deemed paid credit) $807,500
Discount factor at 6%
.792
Present value of U.S. tax cost
(639,540)
After-tax foreign source income
$3,255,460
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Chapter 13 - Jurisdictional Issues in Business Taxation

The value of the U.S. tax deferral is greater than the incremental legal costs of the foreign
subsidiary. Consequently, Echo should use a foreign subsidiary to conduct business in Country J.
4.

If Rand does not repatriate Flos after-tax income but invests the income in Europe, its annual
after-tax earnings on the investment will be $3,430.
Before-tax annual income
Portuguese income tax
After-tax amount invested
After-tax rate of return in Europe
(7% tax at 30%)

$100,000
(30,000)
$70,000
.049
$3,430

If Flo distributes its $70,000 after-tax income to Rand as a dividend, Rand must pay an additional
5 percent U.S. tax on the repatriated income before it can invest the income in the United States.
However, even with the higher U.S. tax rate, the 9 percent before-tax rate of return results in
annual after-tax earnings of $3,803. Consequently, repatriation is the better option.
Before-tax annual income
Portuguese income tax
U.S. income tax
After-tax amount invested
After-tax rate of return in U.S.
(9% tax at 35%)

$100,000
(30,000)
(5,000)
$65,000
.0585
$3,803

5. Here is the computation of Chloes global after-tax income if it opens a branch office in Country D.
In this case, Chloe will pay $435,250 foreign tax ($380,000 to Country A + $55,250 to Country D).
U.S. source income
Country A foreign source income
Country D foreign source income
Taxable income
Precredit tax
Foreign tax credit (actual tax paid)
U.S. tax

$2,000,000
1,000,000
425,000
$3,425,000
.34
$1,164,500
(435,250)
$729,250

FTC limitation: $1,164,500 $1,425,000 foreign source income = $484,500

$3,425,000 taxable income

Global income
Foreign tax paid
U.S. tax
After-tax global income

$3,425,000
(435,250)
(729,250)
$2,260,500

Here is the computation of Chloes global after-tax income if it opens a branch office in Country G.
In this case, Chloe will pay $552,250 foreign tax ($380,000 to Country A + $172,250 to Country G).
U.S. source income
Country A foreign source income
Country G foreign source income
Taxable income
Precredit tax
Foreign tax credit (limited)
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$2,000,000
1,000,000
530,000
$3,530,000
.34
$1,200,200
(520,200)

Chapter 13 - Jurisdictional Issues in Business Taxation

U.S. tax

$680,000

FTC limitation: $1,200,200 $1,530,000 foreign source income = $520,200

$3,530,000 taxable income

Global income
Foreign tax paid
U.S. tax
After-tax global income

$3,530,000
(552,250)
(680,000)
$2,297,750

Consequently, Chloe should open its second branch office in Country G to maximize global aftertax income.
Comprehensive Problems for Part Four
1.

a. Net profit on Schedule C is $95,950 (See the following Schedule C). The interest and
dividend income, long-term capital gain, charitable contribution, and general business credit
are not reported on Schedule C.

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Chapter 13 - Jurisdictional Issues in Business Taxation

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Chapter 13 - Jurisdictional Issues in Business Taxation

b. Ordinary income from business activities on page 1, Form 1065 is $95,950. The interest and
dividend income, long-term capital gain, charitable contribution, and general business credit
are separately stated on Schedule K. (See the following page 1 and Schedule K, Form 1065.)

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Chapter 13 - Jurisdictional Issues in Business Taxation

c.

Corporate taxable income is $102,881, and the tax on that income is $21,574 ($23,374 tax
on $102,881 $1,800 general business credit). (See the following page 1, Form 1120.)

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Chapter 13 - Jurisdictional Issues in Business Taxation

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Chapter 13 - Jurisdictional Issues in Business Taxation

2.

a. Dollins pretax income from worldwide sales

Virginia apportionment factor
Apportioned business income
U.S. source dividend income ($8,400 $5,880 DRD)
Virginia taxable income
Virginia state income tax
Dollins pretax income from worldwide sales
North Carolina apportionment factor
North Carolina taxable income
North Carolina state income tax
Dollins pretax income from worldwide sales
South Carolina apportionment factor
South Carolina taxable income
South Carolina state income tax
b. Dollins net income from sales:
Domestic sales
U.K. sales (foreign source income)
Dividend income ($33,800 foreign source income)
Gross-up of French Dollin dividend
for French tax paid (foreign source income)
Deduction for state income tax paid
DRD for Brio dividend
Federal taxable income
Federal income tax before foreign tax credit
Foreign tax credit*
Federal income tax

$1,382,900
.4319
$597,275
2,520
$599,795
.06
$35,988
$1,382,900
.1102
$152,396
.0775
$11,811
$1,382,900
.3952
$546,522
.05
$27,326
$967,900
415,000
$1,382,900
42,200
17,000
(75,125)
(5,880)
$1,361,095
.34
$462,772
(158,372)
$304,400

* Dollins foreign tax paid totaled $166,200 ($149,200 U.K. tax + $17,000 deemed paid
French tax). However, Dollins foreign tax credit is limited to $158,372.
Precredit U.S. tax $462,772 $465,800 foreign source income = $158,372
$1,361,095 taxable income

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