Chapeau Company, a U.S. corporation, operates through a branch in Champagnia. The source rules used by Champagnia are identical to those used by the United States. For 2016, Chapeau has $2,000 of gross income, $1,200 from U.S. sources and $800 from sources within Champagnia. The $1,200 of U.S. source income and $700 of the foreign source income are attributable to manufacturing activities in Champagnia (general category income). The remaining $100 of foreign source income is passive category interest income. Chapeau had $500 of expenses other than taxes, all of which are allocated directly to manufacturing income ($200 of which is apportioned to foreign sources). Chapeau paid $150 of income taxes to Champagnia on its manufacturing income. The interest income was subject to a 10 percent withholding tax of $10. Assume the U.S. tax rate is 35 percent. Compute Chapeau’s allowable foreign tax credit in 2016.

From the information given, we learned that Chapeau company (a U.S corporation) is operating another branch in Champagnia. This implies that Chapeau company is operating a branch in a foreign company.

Since tax is going to be imposed on the corporation, It is crucial to consider the foreign tax credit (FTC).

The foreign tax credit (FTC) is a policy designed to help US taxpayers with foreign-source income and earnings to avoid having to pay numerous taxes in several countries. The FTC is restricted to a limit, which is determined by using the formula:

[tex]{\text{FTC limit }= \dfrac{\text{ Foreign source taxable income}}{\text{Total taxable income}}\times \text{ Precredit Us tax }}[/tex]

The FTC as well as its limitations are calculated differently for general category income and the passive category income.

From the question, In 2016:

∴

The total taxable income = Total gross income - the total expense

The total taxable income = $2000 - $500

The total taxable income = $1500

From the given assumption that the tax rate in U.S = 35%

∴

The Precredit U.S tax = Total taxable income × U.S tax rate

The Precredit U.S tax = $1500 ×  35%

The Precredit U.S tax = $1500 ×  0.35

The Precredit U.S tax = $525

However, from the Total Gross income, we learnt that only $800 was Foreign source income.

Therefore, to compute Chapeau’s allowable foreign tax credit in 2016, we earlier said we are going to calculate it differently based on FTC and its limitations.

To start with General Category income:

Given that:

Then;

The General Category foreign taxable income = total gross income - total expense

The General Category foreign taxable income = $700 - $200

The General Category foreign taxable income = $500

As such, the FTC limit is calculated as:

[tex]{\text{FTC limit }= \dfrac{\text{ Foreign source taxable income}}{\text{Total taxable income}}\times \text{ Precredit Us tax }}[/tex]

[tex]{\text{FTC limit }= \dfrac{\text{ \$500}}{\text{\$1500}}\times \text{\$525 }}[/tex]

[tex]{\text{FTC limit }= \dfrac{\text{ \$1}}{\text{\$3}}\times \text{\$525 }}[/tex]

FTC limit = $175

Provided we are being told that Chapeau paid $150 of income taxes to Champagnia(its foreign company) on its manufacturing income, therefore Chapeau will receive the whole amount paid for tax since it is still within the FTC limit as a foreign tax credit.

On the other hand, For Passive category Income:

Thus, the foreign source taxable income will also be $100

Hence, the FTC limit for this category is calculated as:

[tex]{\text{FTC limit }= \dfrac{\text{ Foreign source taxable income}}{\text{Total taxable income}}\times \text{ Precredit Us tax }}[/tex]

[tex]{\text{FTC limit }= \dfrac{\text{ \$100}}{\text{\$1500}}\times \text{\$525 }}[/tex]

[tex]{\text{FTC limit }= \dfrac{\text{ \$1}}{\text{\$15}}\times \text{\$525 }}[/tex]

FTC limit = $35

From the question, recall that: Chapeau Company paid $10 of the withholding tax to Champagnia (its foreign company), however since the amount is within the $35 FTC limit.

Chapeau Company will receive the total amount paid for tax as a foreign tax credit.

Thus, we can conclude from the above explanations and concepts that  the total Chapeau’s allowable foreign tax credit in 2016 is ($150 + $10)

= $160

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