Number: RL34494
Title: The Foreign Tax Credit's Interest Allocation Rules
Authors: Jane G. Gravelle and Donald J. Marples, Government and Finance Division 
Abstract: The foreign tax credit alleviates the double-taxation that would result if U.S. investors' overseas income were to be taxed by both the United States and a foreign country. U.S. taxpayers credit foreign taxes paid against U.S. taxes they would otherwise owe, and in doing so concede that the country where income is earned has the primary right to tax that income. But the United States retains the primary right to tax U.S.-source income, placing a limit on the foreign tax credit: foreign taxes can only offset the part of a U.S. taxpayer's U.S. tax that falls on foreign source income. It is this limit to which the American Jobs Creation Act of 2004 (P.L. 108-357, Jobs Act) applied. To calculate the limit, a firm separates its revenue and costs, for tax purposes, into those having a foreign source and those having a U.S. source. Foreign taxes can offset U.S. tax on revenue "sourced" abroad; in effect, foreign-source income is exempt from U.S. tax for firms whose foreign tax credits exceed the limit (firms with "excess credits"). But because deductions allocated abroad reduce U.S. tax, the effect is the same as if deductions allocated to foreign sources can not be claimed for U.S. tax purposes.
Pages: 14
Date: September 29, 2008