Strong US dollar provides multinationals with tax planning opportunities
INSIGHT ARTICLE |
A U.S. multinational corporation generally views a strengthening U.S. dollar as a negative; a strong dollar makes goods produced in the United States more expensive overseas and may therefore reduce foreign sales. Moreover, the income generated from non-U.S. operations, when translated back into U.S. dollars, is diminished. However, for U.S. multinationals with non-U.S. subsidiaries, a strengthening dollar can provide hidden tax opportunities.
US residual tax on non-US subsidiary dividends
When profits are remitted back to a U.S. taxable corporation from its non-U.S. subsidiaries in the form of a dividend, the dividend amount is translated back into U.S. dollars at the spot rate on the day of receipt. To avoid double taxation, the U.S. tax code provides a foreign tax credit for income taxes paid by the subsidiary to their home country. However, the non-U.S. income taxes are translated into U.S. dollars at the average exchange rate for each year in which the non-U.S. subsidiary paid such income taxes. Translated non-U.S. income taxes are maintained in a pool until such time as a dividend is paid by the non-U.S. subsidiary to its U.S. parent corporation. When a dividend is paid for a non-U.S. subsidiary on earnings that were generated in prior tax years, a proportionate amount of that U.S. dollar translated tax pool is recognized as income and a corresponding foreign tax credit is allowed (subject to limitations).
When the U.S. dollar rises in value, the amount of the dividend when translated into U.S. dollars is lower. However, the translated tax pool stays at its higher exchange rate. This results in the dividend received being associated, solely for U.S. tax purposes, with a higher foreign effective tax rate, thereby maximizing the foreign tax credit and reducing, or eliminating, the residual U.S. taxation upon receipt of dividends from non-U.S. subsidiaries.
Remittance of previously taxed non-US income by a US corporation or other US person or entity
A taxable U.S. corporation, subchapter S corporation or U.S. individual may also have deemed income inclusions related to its ownership in a non-U.S. company, which relates to a prior taxable year. These deemed remittances can occur under either the U.S. Subpart F anti-deferral provisions or the investment in U.S. property provisions. Such deemed inclusions can also occur under the U.S. passive foreign investment company provisions.
The amount of the deemed inclusion is reflected in U.S. taxable income at either the average U.S. dollar rate or the year-end rate for the year of inclusion. When an actual inclusion of previously taxed non-U.S. income is received, an exchange gain or loss is recognized in U.S. taxable income. The exchange gain or loss is the difference between the amount included in U.S. dollars for the year of recognition and the spot rate at the time of ultimate receipt. When the dollar strengthens against the local currency, the distribution of that previously taxed income results in a taxable loss which can be utilized to reduce U.S. income tax.
Remittance from a non-US entity treated as a flow-through entity for US tax purposes
Many U.S. persons receive taxable income from non-U.S. entities, such as foreign partnerships, which are treated as flow-through entities for U.S. tax purposes. Income from such entities is translated into U.S. dollars at the average exchange rate for the year the income was generated. When such income is ultimately distributed, an exchange gain or loss is recognized based on the pool of undistributed non-U.S. income.
Similar to the discussion above, when the U.S. dollar appreciates against the non-U.S. local currency, an exchange loss can be recognized when that non-U.S. currency is distributed to the U.S. entity holder. Taxpayers should consider these rules as they plan their transactions in a strengthening dollar environment.