U.S. companies with overseas subsidiaries may want to heed the warning of an older tax case that discusses what constitutes ownership for purposes of foreign tax credits.

As the global economy begins to show signs of recovery, it may be a good time to review an Internal Revenue Service ruling, upheld by two courts, related to income generated by foreign subsidiaries of U.S. corporate taxpayers. Indeed, it may not always be possible for a parent company to aggregate subsidiary ownership as a way to steer clear of double taxation.

To set the stage, consider that relief from international double taxation is generally accomplished by means of the foreign tax credit rules. Typically, the rules allow a U.S. taxpayer to offset the foreign taxes it has paid — or deemed to have paid — against the U.S. taxes otherwise due on foreign earnings.

In the case of a U.S. corporation that conducts its foreign business activities through foreign subsidiaries, Section 902 of the Internal Revenue Code provides important guidance. The section says that a domestic corporation that owns at least 10% of the voting stock of a foreign corporation from which it receives dividends is deemed to have paid the fraction of foreign taxes on the profits of the foreign corporation that is equal to the following ratio: the dividends received to the total profits of the foreign corporation. The question put to the IRS focused on ownership, specifically direct versus indirect ownership.

Click here for full article!