Question

Blackwater Company has a foreign branch that earns income before income taxes of $500,000. Income taxes paid to the foreign government are $150,000 or 30%. Sales and other taxes paid to the foreign government are $100,000. Blackwater Company must include the $500,000 of foreign branch income in determining its home country taxable income. In determining its taxable income, Blackwater can choose between taking a deduction for all foreign taxes paid or a credit only for foreign income taxes paid. The corporate income tax rate in Blackwater’s’ home country is 40%.

Determine whether Blackwater would be better off taking a deduction of a credit for foreign taxes paid (FTC).

a. If foreign tax rate increased from 30% to 50%, how would it change your answer?
b. If foreign tax rate decreased from 30% to 10%, how would it change your answer?
b. If parent country’s tax rate decreased from 40% to 20%, how would it change your answer?
c. If local taxes were $250,000, how would it change your answer?

Answer 1

Blackwater Company

a. It is generally better for Blackwater to take a credit for foreign taxes paid than taking it as a deduction.

A good look at the tables below show that from (a) to (c) there is no change in the above answer.

Step-by-step explanation:

a) Data and Calculations:

Foreign income before taxes = $500,000

Foreign Taxes a deduction from home taxable income:

Foreign Foreign FTC as a Home Tax

Tax Rates Income Deduction Payable

30% $500,000 $150,000 $140,000 ($500,000 - $150,000*40%)

50% $500,000 $250,000 $100,000 ($500,000-$250,000*40%)

10% $500,000 $50,000 $180,000 ($500,000 - $50,000*40%)

30% $500,000 $150,000 $70,000 ($500,000 - $150,000*20%)

30% $500,000 $150,000 $250,000

Foreign Taxes treated as a credit:

Foreign Foreign FTC as a Home Tax

Tax Rates Income Home Tax (40%) Credit Payable

30% $500,000 $200,000 (40%) $150,000 $50,000

50% $500,000 $200,000 (40%) $250,000 ($50,000)

10% $500,000 $200,000 (40%) $50,000 $150,000

30% $500,000 $100,000 (20%) $150,000 ($50,000)

30% $500,000 $250,000 (0%) $150,000 $100,000