Study Notes on Foreign Tax Relief

The below mentioned article provides a study note on foreign tax relief. After reading this article you will learn about: 1. Introduction to Foreign Tax Relief 2. Expense Deduction 3. Exemption Method 4. Foreign Tax Credit 5. Country Examples of Foreign Tax Relief.

Contents:

1. Introduction to Foreign Tax Relief
2. Expense Deduction
3. Exemption Method
4. Foreign Tax Credit
5. Country Examples of Foreign Tax Relief

---

1. Introduction to Foreign Tax Relief:

The taxes on the income derived in the source State are collected either through a withholding tax or through a tax payment under the assessment procedure. Unless the foreign income is tax-exempt, juridical double tax would arise if it were taxed again in the State of residence.

The foreign-source income of residents may be treated under the domestic law in several ways:

a. The foreign income is taxable despite the taxes paid on the same income in the source country (“double taxation”);

b. The foreign income is taxable but the taxes paid in the source country are allowed as an expense deduction (“deduction method”);

c. The foreign income is exempt from tax (“exemption method”);

d. The foreign income is taxable but the taxes paid on the income are credited against the tax due (“foreign tax credit”);

e. A credit is given for certain notional taxes that are not actually payable in the source country (“tax-sparing credit”); and

f. The foreign income is taxable but at a reduced tax rate (“reduced rate method”).

The first method leads to juridical double taxation with no relief. The last method is seldom used. The other four methods provide for foreign tax relief. Most jurisdictions use a mixture of these four approaches.

Most countries provide unilateral relief measures under the domestic tax law. The treaty relief provisions normally override these measures and vary the relief available under the domestic law either from deduction to exemption or credit, or from credit to exemption.

They may also retain the relief method but provide for more favourable tax treatment. Tax sparing credit may be granted under tax treaties. However, they do not provide for the expense deduction method of relief. Countries that follow the territorial tax regime do not tax foreign-source income and, therefore, they do not normally give relief for the foreign taxes paid.

---

2. Expense Deduction:

The tax treatment varies. For example:

a. The domestic tax law in several countries allows a deduction for foreign tax payments as an expense, provided the foreign income is taxable at home (Examples: Antigua, Barbados, Belgium Czech Republic, Egypt, France, Gibraltar, Jamaica, Kenya, Mozambique, Netherlands, Switzerland).

b. Certain countries allow the taxpayer to elect for either a tax expense deduction or tax credit (Examples: Canada, Guernsey, Germany, Japan, Jersey, Ireland, Luxembourg, Norway, Philippines, Sweden, Thailand, the United Kingdom, the United States).

c. There are some countries that do not give an expense deduction for foreign taxes but provide tax credit or exemption relief under their domestic tax law. (Examples: Australia, Austria, Colombia, Denmark, Finland, Greece, Italy, New Zealand, Spain).

The expense deduction method limits the double tax relief to the foreign tax paid as multiplied by the marginal tax rate. Thus, only partial relief is given for the foreign tax and the juridical double taxation is not fully eliminated.

This tax relief is less desirable than other methods, except in a tax loss situation when the excess foreign tax credit cannot be carried forward. In such cases, the deduction at least increases the loss carry-forward of the taxpayer.

---

3. Exemption Method:

Foreign-source income may be exempted from tax in the residence country for several reasons. For example:

1. The foreign-source income is outside its tax jurisdiction.

2. The foreign-source income is not taxable under the domestic law.

3. The foreign-source income is exempt to prevent juridical double taxation.

4. The foreign-source income is exempt to avoid economic double taxation.

Countries that follow the territorial tax regime exempt the foreign-source income from taxation under the domestic law. Several countries with the worldwide tax regime also exempt, either fully or partly, all or certain foreign income. The exemption may be with or without progression for rate purposes.

Many of them require that the foreign income is “subject to tax” (or taxable at a comparable rate) in the source State. Normally, no deduction is given for the costs related to the foreign income, which is tax-exempt. If the source tax is lower than the residence tax, the tax exemption in the home State is preferable to a foreign tax credit.

The exemption method is consistent with a policy of capital import neutrality. It ensures that the taxpayer is subjected to the same overall tax rate on his income derived in the host country as applicable to a local taxpayer.

Broadly, the civil law countries favour the exemption method, while the jurisdictions based on English common law prefer the credit method. Several countries (Examples: Australia, Canada, Germany) follow a partial or selective exemption system.

Some countries (Examples: Japan, the United Kingdom, the United States) maintain that the partial exemption method is not justified by its benefits. They only provide the credit relief on foreign-source income.

---

4. Foreign Tax Credit:

General:

The credit method provides tax neutrality at home irrespective of whether the income is earned at home or abroad. The Residence State taxes its residents on their worldwide income but provides a credit for the foreign tax payments. The foreign tax credit offsets the foreign tax actually paid against the home tax payable.

If the home tax on the foreign-source income is more than the foreign tax, the taxpayer must pay the deficit as additional tax at home. However, if the foreign tax exceeds the home tax on the same income, the excess tax credit may be carried forward (or back) or forfeited.

The foreign tax credit may be either full credit or ordinary credit. The full credit leaves the taxpayer with the same post-tax income at home, irrespective of the source of the income. The taxpayer receives full credit for the foreign tax paid, and is liable to pay only the difference between the home and foreign tax due on the same income.

If the foreign tax exceeds the home tax, the Residence State refunds the excess tax payment. The full credit method is rarely used. Most countries using the credit method grant ordinary credit relief for foreign taxes.

Under the ordinary credit relief method, the foreign tax credit cannot exceed the domestic tax payable on the income in the country of residence. It limits the tax credit to the tax on the same income, as computed under its domestic tax law, as if it were earned at home in the same accounting period.

Therefore, the taxpayer pays the deficit as tax if the home equivalent tax exceeds the foreign tax paid on the same income, but the excess tax is not refunded if the foreign tax exceeds the home tax. He ends up paying the higher of the source and residence taxes.

Unlike the exemption method, the credit method avoids double taxation within the worldwide tax principle. If the home tax exceeds the foreign tax paid, the difference is payable as a residual tax.

Excess foreign tax credit arises if the foreign tax paid exceeds the foreign tax credit given at home. Some countries allow the excess foreign tax credit to be carried forward or back for offset. Many of them, however, do not have provisions for the carry-over of excess credits, which are then lost.

The foreign tax credit depends not only on the tax rate in the source State, but also on how the home country computes the credit limitation under its domestic law. It may be calculated for each foreign item or source or aggregated by either country, worldwide or on some other basis.

In certain countries, the tax credit on specified sources of foreign income may be limited to a fixed percentage and a deduction given for any excess tax cost (Examples: Canada, Japan, Luxembourg).

Several countries grant the tax credit only for foreign taxes that are similar to the taxes levied in their country (Examples: Belgium, Canada, Denmark, Finland, Italy, Netherlands, Sweden, Switzerland, the United States). Foreign tax credits can be direct credits, indirect credits, or tax sparing credits.

Direct Credit:

The direct credit relief is given for taxes paid by a resident taxpayer in the source country. They may be withholding taxes or the taxes paid on assessment. The taxpayer must have actually paid the tax, or have a legal obligation to pay it, either directly or through the payer.

The tax treatment varies, as follows:

1. A large number of countries grant direct tax credit under their domestic law.

2. Certain countries provide for it only under tax treaties.

3. Some countries give this relief unilaterally to income derived from British Commonwealth countries.

Indirect Credit:

The indirect credit relieves the economic double taxation on foreign dividend income. Besides the direct credit, an indirect credit is given for the pro rata share of the corporate tax paid by the foreign distributing company. It is computed as a percentage of the corporate tax paid by the company that the gross dividend distribution bears to the after-tax profits.

The net dividend received plus the withholding tax (if any) is taken as a percentage of the related after-tax profits of the paying company and multiplied by the corporate tax paid. The dividend is grossed up by the direct and indirect credits to compute the foreign income subject to tax in the home country. The ordinary credit limitation is applied on the grossed-up dividend.

Since the dividends may be paid out of both current and past profits, the domestic law or practice provides the “ordering” rules. These rules relate the dividends to the relevant post-tax profits out of which the distribution is made, and the creditable tax is determined by the effective tax rate imposed on those profits.

The computation is also affected by the exchange rate used to translate the creditable foreign tax. It could be either the rate prevailing at the time of payment of the foreign tax (historical rate), or the rate when the dividend was distributed (current rate). The US law requires that the foreign tax be translated at the historical rate, while the United Kingdom generally applies the current rate.

Several countries give relief for the underlying tax on foreign dividends under their domestic law or tax treaties. Generally, the indirect credit is granted only for substantial participations when the shareholder holds a minimum shareholding or voting rights in the foreign company.

In addition, most jurisdictions provide for a tax credit to the parent company for the foreign tax paid by the subsidiary when its undistributed income is attributed under the controlled foreign corporation rules.

Some countries allow the indirect credit computation to include taxes paid by lower-tier companies. For example, Argentina, Japan and Norway permit the indirect foreign credit up to two tiers of subsidiaries. Spain gives the indirect credit for taxes paid up to three tiers of qualifying foreign subsidiaries, while the United States now grants them up to six tiers.

Australia, Ireland, Mauritius, South Africa and the United Kingdom permit the credit for taxes suffered in all lower-tier companies, provided the prescribed minimum equity or voting rights are maintained at each tier.

Tax Sparing Credit:

The ordinary tax credit method limits the relief to the lower of the domestic tax payable and the foreign tax paid. If the actual foreign tax paid is lower than the domestic tax liability on the same income, the taxpayer must pay the difference as additional tax in the residence country.

Any tax saving through special exemptions or deductions granted in the host country is, therefore, recaptured by the home country unless a matching notional credit is given to spare the tax waived. Without a tax-sparing clause in the treaty, the net result will be a transfer of the tax revenues between the two countries with no ultimate benefit from the incentives to the taxpayer himself.

Tax sparing or deemed credits are seldom found in domestic law. Several countries provide for tax sparing credits in their treaties. They grant a notional tax credit for the tax not paid under special incentive schemes or similar allowances in the source country. These credits are usually attached to dividends, interest and royalty payments, but may also apply to income from foreign branches.

They may relate to all or only certain specified incentives, and may be for either an unlimited or a specified period. Usually, the sparing credit is given only for a limited duration. Many treaties provide that the future tax incentives of a similar nature also qualify under certain conditions.

This credit given by the residence country allows the taxpayer to retain the tax waived (i.e. spared) by the host country. It assumes that the regular tax has been paid in the source country although the tax was actually waived (i.e. not paid) for reasons of economic policy.

The tax sparing credit may also be modified to give more or less tax credit than the amount actually waived. For example, the tax at a rate specified under the treaty may be deemed paid, irrespective of the actual foreign tax liability.

In some countries, this credit is given as an extended or matching credit for a higher amount than the actual tax waived. This approach grants a tax preference (i.e. incentive) even in cases where no tax incentives were provided in the source country, and may amount to a full or partial exemption. The credit may also be computed as a percentage of the tax payable in the residence country. These notional credits may or may not be subject to time limitations.

The tax sparing credit is not based on the actual taxes paid but the tax that has been spared. As the amount of the spared tax is effectively included in the post-tax payment derived from the source country, the taxable income is not grossed up by the “phantom” unpaid creditable tax.

It is increased only by the actual foreign taxes paid, if any. This gross income is generally subject to ordinary credit limitations, and the tax credit, including the tax sparing credit, is restricted to the equivalent domestic tax on that income.

Tax sparing provisions become irrelevant when the recipient country grants a tax exemption. They cannot be applied to income, which is exempted in the residence country. Unlike the exemption method that reduces the tax base, the tax-sparing credit reduces the amount of tax payable.

As a policy, the United States does not grant tax-sparing credits in its bilateral tax treaties. Some developed countries believe that they are an ineffective way to promote foreign investment in developing countries and lead to double non-taxation. Moreover, by reducing the tax cost of repatriating profits to the home country, they discourage reinvestment of the profits in the host country.

Tax sparing is still required by most developing countries to protect the benefits of tax incentives given to foreign investors and is permitted under the UN MC.

The OECD Committee on Fiscal Affairs also accepts that they may be appropriate for developing countries. The Commentary Update 2000 states “tax sparing should be considered only for States whose economic level is considerably below the level in OECD Member States”.

Limitations on Foreign Tax Credit:

Under the ordinary credit rules, the total creditable foreign tax is limited to the domestic tax on the same income in the residence country. This limitation may be computed on a per-item basis that restricts the tax relief to the foreign tax paid on that item only.

A slight variation includes a per-source limitation where the income from the same source in a country may be aggregated. The per-item or per-source method is found in certain countries (Examples: Bangladesh, Cyprus, Finland, Greece, Ireland, India, Malaysia, New Zealand, Mauritius, Pakistan, Singapore, the United Kingdom), or applied in specific cases by other countries.

Most countries allow some level of aggregation. These aggregation methods are generally based on a per-country or worldwide limitation, or various combinations of them:

(i) Per-country limitation:

This method adds up the foreign income derived in a country and the taxes paid on that income. It then applies the ordinary credit limitation on the aggregate income from that country. The foreign tax credit is restricted only if the total foreign tax paid in or allocated to a source country is higher than the tax that would be payable on that income at home.

The country allocation may be based either on the country from where the income is directly derived when it is included in the taxpayer’s income, or traced under the “look-through” rules to the country where it actually arose in an economic sense.

The per-country limitation method allows the averaging of the effective foreign tax rates for calculating the foreign tax credit at the country level. However, it does not allow the averaging of taxes paid in low-tax and high-tax countries (Examples: Austria, Canada, Denmark, Estonia, Finland, France, Greece, Germany, Indonesia, Italy, Luxembourg, Netherlands, New Zealand, Philippines, Poland, Portugal, Spain).

(ii) Worldwide or overall limitation:

Under this method, all foreign income and taxes are aggregated, and the ordinary credit limitation is computed on a worldwide basis. This approach provides for the maximum averaging of foreign taxes. The effective home tax on the total foreign tax, irrespective of the countries involved, should not exceed the total foreign taxes paid.

It is, therefore, possible to combine high and low taxed foreign income to avoid any ordinary credit limitation under the per-country method (Examples; Australia, Belgium, Hungary, Japan, Korea, Luxembourg, Mauritius, Malta, Mexico, Norway, Sweden, Switzerland, Turkey, the United States).

(iii) Per-category limitation:

The aggregation of the foreign income is categorized by line of business, character of income, etc. There may also be separate baskets of high- taxed and low-taxed foreign income (Examples: Australia, Israel, the United States). These methods are usually applied along with the per-country or overall limitation.

For example, the United States applies the foreign tax credit limitation on both the worldwide basis, and by various “baskets” comprising certain types or sources of taxable income. Australia divides the foreign income, unless exempt, into three worldwide baskets, namely passive income, offshore banking income and other income.

Sometimes, the per-country limitation may be more advantageous than the overall limitation method. If the worldwide income is negative due to losses either at home or in one or more foreign countries, there is no tax to pay at home and, therefore, both limitation methods would reduce the foreign tax credit to nil.

Moreover, if the worldwide income is positive but there are losses in one or more foreign countries, these losses would offset the taxable profits in other foreign countries.

As a result, the total foreign income and the allowable foreign tax credit would be reduced (or nil) under the worldwide limitation, but not under the per-country limitation. To overcome these problems, some countries use a modified overall limitation method.

For example, in Sweden the foreign tax credit limitation is based on the gross foreign-source income (not net of foreign losses) as a percentage of the total worldwide income (net of foreign losses).

The tax deductions, allowances and disallowances and the rules for computing the tax base and the tax liability in the home State affect the foreign credit limitation. The method of calculating the foreign tax credit can also make a difference.

For example, the foreign credit limitation is computed at the marginal tax rate in some countries (Example: the United Kingdom), whereas many countries adopt the average rate (Examples: Finland, India, Ireland, Japan, Malaysia, the United States).

The allowable foreign tax credit is calculated as a proportion of the total tax liability based on the ratio of net foreign income divided by the net worldwide income, i.e. at the average tax rate.

The allocation of related expenses to the foreign-source income also affects the amount of the net foreign income and the calculation of the allowable tax credit. In certain cases, domestic expenses may be allocated, partly or fully, to the foreign income.

The larger the allocation of expenses against the foreign income, the smaller such income becomes and the proportionate amount of the total tax as foreign tax credit is reduced accordingly. The foreign tax credit calculation is also affected by the treatment of exchange gains or losses as domestic or foreign-source income or expense.

Excess Foreign Tax Credit:

Excess foreign tax credit represents the excess of foreign taxes paid for which the home State has not granted the tax credit. As most countries limit the total credit for the foreign taxes to the domestic equivalent tax liability under their own tax rules, excess foreign tax credits arise. The excess foreign tax credits may also be due to the limitation method used or tax losses.

Timing differences could cause similar situations. For example, the residence State may treat the foreign tax as paid in the source State in year one, and regard the related income as taxable in year two, or vice versa.

Thus, there may be foreign tax payments with no foreign tax credits or foreign tax credits without any foreign tax payments. In either case, the foreign tax credits may be deferred or lost, unless the Residence State taxes the income and grants the foreign tax credit in the same year.

In some countries, the excess credits may be deducted as an expense. Most countries do not permit the taxpayer to carry forward or back any unused tax credits, and the excess credits are forfeited. There are just a few countries that allow the excess credits to be carried back and/or forward for offset for a specified period.

For example:

Carry-back:

a. Two years: the United States

b. Three years: Canada, Israel, the United Kingdom

c. Eight years: Italy

Carry-forward:

a. One year: Finland

b. Three years: Sweden, Japan

c. Five years: Australia, France, Israel, Portugal, the United States, South Korea

d. Seven years: Canada, Spain

e. Eight years: Italy

f. Ten years: Mexico, Norway

g. Indefinite: Ireland, Netherlands, the United Kingdom

The unused foreign credits represent tax benefits, and their loss is a tax waste to be avoided through proper tax planning.

Comments:

Some common questions affecting foreign tax credits include:

a. What foreign taxes are creditable?

b. How should the limitation on foreign tax credit be calculated? On a per-item basis? On a per-source basis? Per-basket? On a per-country basis? On a worldwide basis? Or, some combination of these methods?

c. What rules should be adopted for determining the source of income and expense for the foreign tax credit calculations? How should the transactions in foreign currencies be translated and the exchange gains or losses treated?

d. Should a credit be allowed for the underlying and/or spared foreign taxes on the income out of which the dividend is paid? How should the timing of the dividend received be matched with the underlying foreign profits?

e. What are the rules for the carry-forward or carry-back of excess foreign tax credits? Can they be relieved under group relief or tax consolidation?

---

5. Country Examples of Foreign Tax Relief:

Argentina:

Argentina grants direct and indirect foreign tax credits on dividends. To qualify, the Argentine company must own directly 25% of the shares of the first-tier subsidiary. Credit is also given for the second tier subsidiary, if the indirect ownership is at least 15%.

Australia:

Australia divides the foreign income, unless exempt, into three worldwide baskets, e.g. passive income, offshore banking income, and other income. The limitations on foreign tax credits are computed separately for each basket. Unused foreign tax credits in each basket can be carried forward for future offset for five years.

The foreign tax credit limitation is calculated using the tax base under the source country rules. Australia grants both direct and indirect credit for the foreign taxes paid on non- portfolio dividend income.

The foreign tax credits are also given for taxes paid by lower-tier subsidiaries, provided there is a direct controlling interest of at least 10% at each tier, and the Australian parent has a minimum 5% direct or indirect voting control of each subsidiary. The above provisions do not apply to qualifying dividends, which are tax-exempt under the participation exemption rules in Australia.

Canada:

The foreign tax credit is given on a per-country basis for the foreign taxes on the net income or gains for the year, regardless of when they are paid. However, no credit may be claimed for the foreign taxes paid on income, which is exempt from Canadian income tax.

Separate rules apply for business and non-business income as follows:

(a) Business income tax (active income):

Unilateral relief is generally given for the foreign taxes as an ordinary credit but not as an expense deduction. The unused foreign tax credits may be carried back three years and forward ten years for credit against the Canadian tax on future income from the same source. The carry-over amounts must be used in the order in which they arise.

(b) Non-business income tax (passive income and employment income):

Ordinary credit is granted for the withholding tax only. The credit is given in the year in respect of which the foreign tax is paid. In case of foreign income from property (other than real estate income), the tax credit is limited to 15% for individuals, and any excess credit may be claimed only as a deduction.

There is no carry-over of the excess foreign tax credits. Non-business income excludes the income of a corporate taxpayer from shares of a foreign affiliate.

Special credit rules apply to income from foreign affiliates received by Canadian corporations. A foreign affiliate is a non-resident foreign corporation in which a Canadian taxpayer, directly or indirectly, owns at least 1% equity and together with related persons, directly or indirectly, owns at least 10% of the shares of any class.

Canadian residents must include the amount of the dividend received from the foreign affiliate in taxable income. However, corporations resident in Canada may claim a deduction for all or a portion of the dividend, depending on whether it is deemed to be paid out of exempt, taxable or pre-acquisition surplus, as follows:

a. Exempt surplus includes active business income from designated treaty countries. Dividends from exempt surplus are fully deductible from the income and, therefore, exempt from Canadian tax. No credit is given for the foreign taxes paid.

b. Taxable surplus includes passive investment income and active income from non-treaty countries. Deductions from income relating to the underlying foreign tax as well as to any foreign withholding taxes applicable to the dividends are granted in respect of dividends from taxable surplus.

c. Pre-acquisition surplus consists of all surplus other than exempt or taxable surplus. Dividends from pre-acquisition surplus are fully deductible from income when received but the amount is deducted from the cost base of the shares, resulting in a higher capital gain on their subsequent disposal becomes negative.

France:

France follows a territorial tax regime for corporate tax purposes. No foreign tax credit is given on foreign branch profits (i.e. active income) since they are tax-exempt. France grants an expense deduction for the foreign taxes paid on non-exempt income under the domestic law.

A direct credit is usually given under the tax treaties for the foreign withholding tax paid on passive income. The credit is given on per-country basis. The excess foreign tax credits cannot be carried forward or backward.

Germany:

The domestic law provides for either ordinary tax credit on a per-country basis or expense deduction for foreign taxes, provided they are similar to German taxes. Excess foreign tax credits cannot be carried back or forward. The company can claim an expense deduction for excess credits.

All foreign-source related expenses are allocated to the income in calculating the foreign tax credit. These expenses include related trade tax, direct and indirect funding costs and costs relating to exchange or default risks. German tax treaties usually exempt income from foreign real estate and permanent establishment.

Ireland:

The foreign tax credit is usually given under tax treaties for each country on a per-source basis. In other cases, the unilateral relief is limited to an expense deduction. However, Ireland allows direct and underlying tax credit (including state and municipal taxes) unilaterally on dividend income from foreign subsidiaries provided it owns, directly or indirectly, at least 5% voting rights.

This credit is also granted for lower-tier companies if they are similarly related to their immediate parent, and connected with the Irish company. A company is connected if at least 5% of its voting rights are held directly or indirectly by the ultimate Irish parent company.

As from 2001, double taxation relief is available to Irish branches of companies resident in other member states of the European Union. This tax relief was extended in 2002 to companies resident in countries with an Irish treaty within the European Economic Area.

Certain activities (e.g. computer software and services, special economic zones, etc.) are entitled to 90% unilateral foreign tax credit. Unilateral tax relief is also given for tax withheld on interest received from a non-treaty country.

As from 2004, companies can mix foreign tax credits on dividends from 5% subsidiaries under “onshore pooling” rules. Excess credits can be carried forward indefinitely for future offset.

Italy:

Italy generally provides foreign tax credit under its domestic law. The ordinary credit relief is given on a per-country limitation basis for foreign taxes paid. The tax credit is limited to the equivalent Italian tax on the foreign income derived from each country, computed at the average tax rate applicable to the aggregate taxable income of the taxpayer after deduction for past losses.

As from 2004, excess credits relating to foreign business income (i.e. income derived from permanent establishments or by foreign subsidiaries consolidated for Italian tax purposes) can be carried back or forward for an eight-year period. Moreover, the foreign tax on the income may be deducted from the Italian taxes even if the actual payment of the tax takes place later.

Japan:

Japan grants unilateral direct credit against its national tax and prefectural and municipal inhabitant tax (but not enterprise tax). The foreign tax credit limitation is calculated on a worldwide basis. Unused foreign tax credits may be carried forward for three years.

The taxpayer cannot elect for ordinary credit and claim an expense deduction for the excess tax credits.

Foreign tax credits are subject to several limitations. For example:

a. The total foreign-source income may not exceed 90% of the worldwide income;

b. Two-thirds of the tax-free or exempt foreign income is deemed to be domestic-source income;

c. If the effective tax rate in a particular foreign country is 50% or more, the excess is not creditable but allowed as a deduction;

d. The income of foreign branches is determined according to Japanese tax law; and

e. The head office expenses must be allocated to a foreign-source on a reasonable and consistent basis.

An indirect foreign tax credit is given on foreign dividends for the underlying tax paid by a first-tier foreign company, provided the Japanese parent company holds direct and indirect ownership or voting rights of at least 25% (or treaty percentage) for at least six months.

Similar credit is also given for a second-tier foreign subsidiary, if 25% or more of the voting shares are held for at least six months by the first- tier foreign subsidiary, and the Japanese parent indirectly owns 25% or more of the voting shares of the second-tier foreign subsidiary.

The indirect credit for each qualifying subsidiary is limited to the amount of the dividend paid minus twice the foreign withholding tax on the dividend. Several tax treaties contain tax sparing credit provisions.

Luxembourg:

A unilateral direct credit is given for the taxes on foreign income that have been subject to comparable tax abroad (at least 15% rate if foreign income was taxed in Luxembourg). The tax credit is granted on a per-country basis. Any excess foreign taxes paid are deductible as expenses.

Luxembourg also allows the corporate taxpayers to elect for a worldwide foreign tax credit on dividend and interest income, provided:

(a) The tax credit on each foreign item of income does not exceed 25% of the income, and

(b) The total tax credits do not exceed 20% of the aggregate tax liability on the same income, when computed under the domestic law. Many treaties provide for an exemption with progression on the foreign-source income or contain a tax-sparing clause.

Malta:

Malta provides four different methods to grant foreign tax relief on a per-source basis, as follows:

(i) The foreign taxes may be relieved through credits under a double tax treaty.

(ii) A Maltese company may claim double tax relief with respect to British Commonwealth income tax.

(iii) Malta grants unilateral tax relief that extends to the underlying tax paid on foreign dividend income, if the taxpayer has proof of the foreign tax suffered.

(iv) If no evidence of foreign taxes paid is available, a company may elect for a deemed flat- rate foreign tax credit (FRFTC) at 25% rate on the net foreign income and gains received.

The net foreign income plus the FRFT credit, less any related expenses, is subject to full Maltese income tax with relief for the deemed credit. This tax credit is limited to 85% of the Maltese tax liability. The deemed credit applies to all foreign-source income allocated to the Foreign Income Account.

Mauritius:

Mauritius grants direct credit for foreign taxes under its domestic law. Indirect credits are given on foreign dividend income for the taxes paid by foreign subsidiaries, provided at least 5% equity is held by the parent company. The tax credit is also given for the taxes paid by all lower-tier subsidiaries that satisfy the same holding requirements as the parent company in Mauritius.

Resident companies can use either the per-source or the worldwide basis for calculating the foreign tax credit, but the per-country method is not allowed. Offshore companies may claim 80% credit against the Mauritius tax payable without any proof of the actual taxes paid abroad. Excess credits cannot be carried forward or back.

Mexico:

Mexico grants unilateral ordinary credit under its domestic law. Direct credit is given on foreign taxed income. An indirect foreign credit is also provided on dividends received from a foreign subsidiary, which is owned at least 10% by a Mexican corporation for a minimum period of six months.

It is calculated on the overseas pre-tax income as multiplied by the Mexican tax rate. The tax credits are granted under the worldwide or overall limitation.

The excess foreign tax credits may be carried forward for ten years for future offset. No credit is given if the foreign tax is conditional on the grant of the credit in Mexico. The second-tier foreign tax credit, previously given, was abolished as from January 2003.

Netherlands:

The domestic law only provides for an expense deduction for foreign taxes paid, unless the “Unilateral Relief Decree” applies. Under the Decree, the Netherlands grants unilateral relief to tax-exempt certain foreign-source income.

They comprise the profits and losses of foreign permanent establishments or dependent agents of residents, the income from foreign immovable property and certain rights managed abroad.

The Decree provides for a modified exemption with progression method applied, as follows:

(i) The qualifying foreign income or loss computed under the Dutch law is included in the worldwide taxable income;

(ii) The total Dutch tax on the worldwide income is computed; and

(iii) The portion attributable to the foreign income reduces the Dutch tax on the worldwide income.

Under a fixed corporate tax rate, the Decree relief effectively grants a tax exemption on the qualifying income. Unused tax credits may be carried forward indefinitely.

The Unilateral Decree also provides for a foreign tax credit for the withholding tax paid on dividends, interest and royalties (including technical service fees) derived from certain developing countries. This credit is given under the worldwide limitation method.

The ordinary credit is limited to the lower of:

(i) The actual foreign taxes paid and

(ii) The pro rata share of the Dutch tax payable on the worldwide income.

The maximum amount of foreign tax paid on dividends is deemed never to be higher than 25%. Any excess credits may be carried forward indefinitely for future offset.

Most treaties provide for exemption with progression relief for active income and credit relief for passive income. Relief is given on a per-country basis. Taxpayers can elect to use a worldwide limitation basis from January 1999 for qualifying dividends, interest and royalties.

They may also elect for expense deduction for foreign taxes on dividend, interest and royalty income; however, part deduction and part credit is not permitted. Under the Unilateral Decree, foreign source income is only eligible for exemption if it is, in principle, subject to income tax in the source state. No relief is given if the foreign income is tax-exempt under domestic law.

Norway:

Norway grants ordinary direct credit under the worldwide limitation method or an expense deduction for foreign taxes paid. Excess credits may be carried forward for ten years. Besides direct credit, Norway also gives indirect tax credit on foreign dividends, if the Norwegian company owns at least 10% equity and voting rights of the foreign subsidiary.

Similar credit is granted for taxes paid by a second-tier subsidiary if:

(i) Both the subsidiaries are resident in the same country, and

(ii) The parent company in Norway indirectly holds at least 25% equity of the second-tier subsidiary.

This tax credit is given for the underlying taxes paid on the current profits and on the profits earned during the previous four years in relation to a dividend distribution. The credit may not exceed the domestic tax due on the grossed-up dividend.

Singapore:

Double tax relief is granted on a source-by-source basis. There are no carry-forward or carry-back provisions. Unilateral relief is given as direct credit for taxes paid in British Commonwealth countries when there is no tax treaty, provided the other country grants reciprocal relief (“Commonwealth relief”).

This relief is limited to 50% of the Singapore rate, but a 100% credit is given if the effective foreign tax rate is less than half the Singapore rate. Therefore, the tax credit is usually limited to the lower of the foreign tax paid or one-half of the Singapore tax payable before foreign tax relief.

A unilateral direct credit is given for the dividend withholding tax. In addition, indirect credit is granted on dividends paid by a 25% (or more) owned foreign subsidiary. The foreign tax credits do not extend to second-tier subsidiaries.

The unilateral tax relief is also given for foreign taxes paid on income derived from professional, consultancy and other services rendered in an overseas territory, income remitted from certain countries, on the foreign employment income of Singapore citizens, and on remittances of royalties (effective from assessment year 2004) and branch profits.

Singapore tax treaties normally provide for ordinary credit for direct and underlying taxes, and often contain tax-sparing provisions.

South Africa:

South Africa grants ordinary tax credit for foreign taxes paid by residents under the worldwide or overall basis. Direct ordinary credit is normally given for the foreign withholding tax. Where the holding in the equity share capital exceeds 25% the dividend is exempt and no credit is given for the foreign tax on that dividend.

If the holding is between 10% and 25%, the shareholder can elect to claim indirect tax credit on the dividend income. This tax credit is also given for lower tier subsidiaries, provided at least 50% equity ownership exists at each tier.

Switzerland:

Switzerland grants foreign tax credits only under tax treaties under a lump sum tax credit system but foreign tax payments may be claimed as an expense deduction under unilateral relief.

Swiss treaties provide relief through exemption with progression, except for foreign-source dividend, interest and royalty income where the ordinary credit method is used on the gross treaty-favoured income less related costs and expenses.

The lump sum credit is calculated on a worldwide limitation basis. Tax sparing credits are given on certain treaties with developing countries. No credit is given if the taxable income is offset by loss carry-forwards. Foreign tax credits may not be carried forward.

Switzerland levies separate taxes at federal, cantonal and communal levels. Generally, federal tax represents around one-third of the cantonal and communal tax liability. The tax credit is allocated to each level and granted if tax is payable at that level for the non-recoverable foreign tax at source.

To qualify for lump sum tax credit, the foreign-source income must be fully taxable in Switzerland and declared in the Swiss tax return. If the income is tax-exempt in Switzerland, the tax credit is denied. No tax credit is given if there is treaty abuse under the 1962 Abuse Decree, as modified.

United Kingdom:

Unilateral relief is given as ordinary tax credit for foreign taxes paid on a per-source basis. A UK company may elect to claim a foreign tax credit as an expense. However, it cannot elect to take part as a credit, and part as an expense. The tax credit is computed under the UK tax principles.

The United Kingdom grants an indirect tax credit on dividend income for the taxes paid by a foreign company and any lower-tier subsidiary companies. To qualify, the UK corporate shareholder must hold at least 10% voting control at each level. The individuals and companies with less than 10% participation are only entitled to a direct credit for the withholding tax.

In 2001, the United Kingdom abolished the use of an offshore “mixer” holding company to average foreign taxes paid by lower-tier subsidiaries abroad. It adopted a restricted form of onshore pooling of dividend income to relieve foreign taxes paid.

The underlying tax on any foreign dividend in the pool is limited to the UK corporate rate (currently 30%). Excess foreign tax credits may be carried back for three years and forward indefinitely for offset against the UK tax on income from the same source. Dividends paid by controlled foreign companies are excluded from the pool.

United States:

The United States allows foreign tax credit for foreign income taxes paid or deemed paid. A taxpayer can choose to claim an expense deduction for foreign taxes paid instead of a tax credit, if he wishes. To qualify for tax credit, the income must be foreign-source income and the tax must be an income tax. Direct credit is permitted on all foreign-source income.

Indirect credit is available for the underlying tax of subsidiaries of corporations (not individuals), provided the ownership interest comprises 10% or more of the voting stock of the first-tier foreign subsidiary.

The second through sixth tiers are similarly treated if the immediate parent owns at least 10% voting stock and a minimum 5% of its equity is held directly or indirectly by the US parent. No indirect credit is given to individual and less than 10% corporate shareholders.

The ordinary tax credit is limited to the US tax on the foreign-source income, as determined under the US tax principles.

Besides the ordinary credit limitation on worldwide foreign income, the tax credits are subject to further limitations, based on separate limitations or “baskets”, as follows:

a. Passive income, e.g. foreign personal holding company and passive foreign investment income.

b. Sale of non-income producing property.

c. Dividend income from each foreign corporation with participation over 10% but not over 50% of voting power or stock value.

d. Interest income subject to foreign withholding tax of at least 5%.

e. Income from banking, financial business and certain insurance companies.

f. Shipping income.

Note:

As from 2007, there will only be two baskets: a passive income basket and a “general limitation income” basket. Foreign tax credits and net operating losses may only reduce the tax liability up to 90% of the alternative minimum tax. Any unused tax credits may be carried back for two years (2007-one year) and forward for five years (2007-ten years).

---