USAco, a domestic corporation, plans to locate a new factory in either country L or country H.

USAco will structure new fac

as a wholly owned foreign subsidiary, FORco, and finance FORco solely with an equity investment. USAco projects that in
first year of operations, it will generate 10 million of taxable income, all from active foreign manufacturing activities. Assume
U.S. corporation tax rate is 35%. To simplify the analysis, further assume that USAco's only item of income during the year
derived from FORco.

The total tax rate on FORco earnings will vary significantly, depending on a number of factors including:
1 Whether FORco is located in a low tax or high tax foreign country

2 The extent to which USAco repatriates FORco's earnings

3 Whether USAco repatriates FORco's earnings through dividend distributions, as opposed to interest, rental, or royalty paym

4 The availability of favorable tax treaty withholding rates on dividends, interest, and other payments made by FORco to USA
y H. USAco will structure new facility
vestment. USAco projects that in FORco's
manufacturing activities. Assume that the
y item of income during the year is that

ors including:

to interest, rental, or royalty payments, and

ayments made by FORco to USAco

Case 1 Low-Tax Country with No Dividends

Country L has corporate tax rate of 25%, which is 10 percentage points lower than the US rate.
If USAco locates FORco in country L and FORco pays no dividends, the total tax rete on its earnings will be
25%, computed as follows;

Foreign Income Tax

FORco's taxable income $10,000,000
Country L income tax rate 0.25
Country L income tax $2,500,000

Foreign withholding taxes on repatriated earnings $0

US tax on repatriated earnings $0

Total taxes $2,500,000

Worldwide tax rate 25%

This example illustrates that USAco can reduce the current year worldwide tax rate on the new manufacturing fa
the U.S. tax rate of 35% by locating the factory in L, a low tax foreign country

Case 2 Low-Tax Country that Pays Dividend with Tax Treaty

Assume that country L has a tax treaty with the United States that provides a 10% withholding tax rate on divide
USAco locates FORco in country L and repatriates half of FORco's after tax earnings through a dividend distribu
total tax rate on its repatriate and unrepatriated earnings will be 30%, computed as follows

Foreign Income Tax

FORco's taxable income $10,000,000
Country L income tax rate 25%
Country L income tax $2,500,000

Foreign withholding taxes on repatriated earnings

FORco's after-tax earnings $7,500,000
Percentage repatriated through dividend 50%
Dividend distribution $3,750,000
Withholding tax rate (per treaty) 10%
 Country L withholding tax $375,000

US tax on repatriated earnings

Dividend from FORco $3,750,000
Code Sec. 78 gross-up 1,250,000
USAco's taxable income $5,000,000
US tax rate 35%
Pre credit U.S. tax $1,750,000
Foreign tax credit ($1,625,000)

US income tax $125,000

Total taxes $3,000,000

Worldwide tax rate 30%

Foreign withholding taxes

Deemed paid taxes 2500000*(3750000/7500000) $2,500,000 $3,750,000
Creditable foreign taxes (375000 + 1250000) $375,000 $1,250,000
General limitation: $1750000*($5000000/$5000000) $1,750,000 $1

Thus, by repatriating half of FORco's earnings through a dividend distribution, USAco increases the worldwide
tax rate on FORco's earnings from 25% in Case 1 to 30% in Case 2. The 30% rate is a blended rate, whereby th
$5 million of income that USAco recognizes by virture of the dividends is, in effect, taxed one time at the U.S. rat
35%, and FORco's remaining $5 million of earnings is taxed one time at the country L rate of 25%

Case 3: Low Tax Country That Pays Dividend with No Tax Treaty

An important assumption in Case 2 is that country L had a tax treaty with the United States that provided
for a 10% withholding tax rate on dividends. Now assume that there is no tax treaty between the United States a
country L, and that country L's statutory withholding rate on dividends is 30%. The lack of a favorable treaty with
increases the total tax rate on FORco's repatriated and unrepatriated earnings from 30% in case 2 to 36.25% in
computed as follows.

Foreign Income Tax

FORco's taxable income $10,000,000
Country L income tax rate 25%
Country L income tax $2,500,000

Foreign withholding taxes on repatriated earnings

 FORco's after-tax earnings $7,500,000
Percentage repatriated through dividend 50%
Dividend distribution $3,750,000
Withholding tax rate (per treaty) 30%
Country L withholding tax $1,125,000

US tax on repatriated earnings

Dividend from FORco $3,750,000
Code Sec. 78 gross-up 1,250,000
USAco's taxable income $5,000,000
US tax rate 35%
Pre credit U.S. tax $1,750,000
Foreign tax credit ($1,750,000)

US income tax $0

Total taxes $3,625,000

Worldwide tax rate 36.25%

Foreign withholding taxes

Deemed paid taxes $2,500,000 $3,750,000
Creditable foreign taxes $1,125,000 $1,250,000
General limitation: $5,000,000 $1

Thus, assuming USAco repatriates some of FORco's earnings through a dividend distribution, the availability of
treaty withholding rate on dividends is critical to the ability of USAco to obtain the benefits of lower tax rates abro

Case 4 High-Tax Country with No Dividends

Country H has a corporate tax rate of 45%, which is ten points higher than the U.S. rate. If USAco locates FORc
in country H and FORco pays no dividends, the total tax rate on its earnings will be 45%, computed as follows

Foreign Income Tax

FORco's taxable income $10,000,000
Country L income tax rate 0.45
Country L income tax $4,500,000

Foreign withholding taxes on repatriated earnings $0

US tax on repatriated earnings $0

Total taxes $4,500,000

Worldwide tax rate 45%

The 45% worldwide tax rate indicates that the total tax rate on USAco's new manufacturing facility will exceed
the US tax rate of 35% if USAco locates the factory in H, a high tax foreign country

Case 5: High-tax Country that Pays Dividend with Tax Treaty

Assume that country H has a tax treaty with the United States that provides a 10% withholding tax rate on divide
If USAco locates FORco country H and repatriates half of FORco's after tax earnings through a dividend distribu
total tax rate on its repatriated and run repatriated earnings will be 47.75%, computed as follows

Foreign Income Tax

FORco's taxable income $10,000,000
Country L income tax rate 45%
Country L income tax $4,500,000

Foreign withholding taxes on repatriated earnings

FORco's after-tax earnings $5,500,000
Percentage repatriated through dividend 50%
Dividend distribution $2,750,000
Withholding tax rate (per treaty) 10%
Country L withholding tax $275,000

US tax on repatriated earnings

Dividend from FORco $2,750,000
Code Sec. 78 gross-up 2,250,000
USAco's taxable income $5,000,000
US tax rate 35%
Pre credit U.S. tax $1,750,000
Foreign tax credit (1,750,000)

US income tax $0

Total taxes $4,775,000

Worldwide tax rate 47.75%

Foreign withholding taxes

Deemed paid taxes $4,500,000 $2,750,000
Creditable foreign taxes $275,000 $2,250,000
General limitation: $1,750,000 $5,000,000

By repatriating half of FORco's earnings through a dividend distribution, USAco increased the worldwide tax rate
earnings from 45% in Case 4 to 47.75% in case 5. The foreign withholding tax on the dividend distribution is resp
the the increase in the total tax rate.
Case 6: High Tax Country the Pays Dividend with no Tax Treaty

A comparison of Cases 4 and 5 indicates that repatriating half of of FORco's earnings through a dividend distribu
through a dividend distribution increases the worldwide tax rate on FORco's earnings from 45% ti 47.75%. Now
that there is no tax treaty between the United States and country H, and that country H's statutory withholding ra
dividends is 30%. The lack of a favorable treaty withholding rate increases the total tax rate on FORco's repatria
and unrepatriated earnings from 47.75% in Case 5 to 53.25% ub Case 6, computed as follows:

Foreign Income Tax

FORco's taxable income $10,000,000
Country L income tax rate 45%
Country L income tax $4,500,000

Foreign withholding taxes on repatriated earnings

FORco's after-tax earnings $5,500,000
Percentage repatriated through dividend 50%
Dividend distribution $2,750,000
Withholding tax rate (per treaty) 30%
Country L withholding tax $825,000

US tax on repatriated earnings

Dividend from FORco $2,750,000
Code Sec. 78 gross-up 2,250,000
USAco's taxable income $5,000,000
US tax rate 35%
Pre credit U.S. tax $1,750,000
Foreign tax credit (1,750,000)

US income tax $0

Total taxes $5,325,000

Worldwide tax rate 53.25%

Foreign withholding taxes

Deemed paid taxes $4,500,000 $2,750,000
Creditable foreign taxes $825,000 $2,250,000
General limitation: $1,750,000 $5,000,000

Case 7: High Tax Country with Earnings Stripping and Tax Treaty
 If USAco locates FORco in country H, one strategy for reducing the excess credits on FORco's earnings is to en
in earnings stripping, that is, to repatriate FORco's profits through deductible interest, rental, and royalty paymen
nondeductible dividend distributions. For example, assume that USAco modifies its plans for FORco, as follows

1 Finance FORco with both debt and equity, such that Forco will pay USAco $3 million of interest each year
2 Charge FORco an annual royalty of $2 million for the use of USAco's patents and trade secrets, and
3 Eliminate FORco's dividend distribution

Assume that the applicable tax treaty withholding rate is 0% for both interest and royalties. As the following
computations indicate, debt financing charges for technology transfers reduce the total tax rate on country
earnings from 47.75% in Case 5 to 40%, computed as follows

Foreign Income Tax

FORco's income before interest and royalties $10,000,000
Interest paid to USAco (3,000,000)
Royalties paid to USAco (2,000,000)
FORco's taxable income 5,000,000
Country H income tax rate 45%

Country H income tax $2,250,000

Foreign withholding taxes on repatriated earnings

Withholding tax on interest (per treaty) $0
Withholding tax on royalties (per treaty) $0
Country H withholding tax $0

US tax on repatriated earnings

Interest from FORco 3,000,000
Royalties from FORco 2,000,000
USAco's taxable income $5,000,000
US tax rate 35%
Pre credit U.S. tax $1,750,000
Foreign tax credit -

US income tax $1,750,000

Total taxes $4,000,000

Worldwide tax rate 40.00%

Foreign withholding taxes

Deemed paid taxes $0 $0
Creditable foreign taxes $0 $2,000,000
General limitation: $1,750,000 $5,000,000

The 40% worldwide tax rate on country H earnings is a blended rate, whereby $5 million of unrepatriated earning
one time at the US rate of 35%, and $5 million of unrepatriated earnings is taxed one time at the country H rate o
Thus, earnings stripping can be an effective method for reducing the worldwide tax rate on the earnings of a high
subsidiary

Case 8: Low Tax Country with Earnings Stripping and Tax Treaty

In contrast to the benefits illustrated in Case 7, debt financing and charges for technology transfers will have no
on FORco's total tax rate if FORco is located in country L (the low tax country). As in Case 2, where FORco repa
its earnings through dividend distributions, the worldwide tax rate on FORco's repatriated and unrepatriated earn
computed as follows

Foreign Income Tax

FORco's income before interest and royalties $10,000,000
Interest paid to USAco (3,000,000)
Royalties paid to USAco (2,000,000)
FORco's taxable income 5,000,000
Country H income tax rate 25%

Country H income tax $1,250,000

Foreign withholding taxes on repatriated earnings

Withholding tax on interest (per treaty) $0
Withholding tax on royalties (per treaty) $0
Country H withholding tax $0

US tax on repatriated earnings

Interest from FORco 3,000,000
Royalties from FORco 2,000,000
USAco's taxable income $5,000,000
US tax rate 35%
Pre credit U.S. tax $1,750,000
Foreign tax credit -

US income tax $1,750,000

Total taxes $3,000,000

Worldwide tax rate 30.00%

Foreign withholding taxes

Deemed paid taxes $0 $0
Creditable foreign taxes $0 $2,000,000
General limitation: $1,750,000 $5,000,000
 on its earnings will be

n the new manufacturing facility below

hholding tax rate on dividends. If

through a dividend distribution, the
 375,000
$7,500,000 1,250,000
1,625,000
1,750,000

increases the worldwide

a blended rate, whereby the
ed one time at the U.S. rate of

tates that provided

etween the United States and
k of a favorable treaty withholding rate
0% in case 2 to 36.25% in Case 3
 3,750,000
$7,500,000 1,250,000
2,375,000
5,000,000

ribution, the availability of a favorable

efits of lower tax rates abroad

te. If USAco locates FORco

%, computed as follows
uring facility will exceed

hholding tax rate on dividends.

through a dividend distribution, the

2,750,000
$5,500,000 2,250,000
2,525,000
$5,000,000 1,750,000

sed the worldwide tax rate on FORco's

dividend distribution is responsible for
 through a dividend distribution
from 45% ti 47.75%. Now assume
H's statutory withholding rate on
x rate on FORco's repatriated

2,750,000
$5,500,000 2,250,000
3,075,000
$5,000,000 1,750,000
 FORco's earnings is to engage
rental, and royalty payments, rather than
ans for FORco, as follows

of interest each year

e secrets, and

lties. As the following

l tax rate on country

-
$0 -
2,000,000
$5,000,000 1,750,000

on of unrepatriated earnings is taxed

time at the country H rate of 45%
e on the earnings of a high tax foreign

ogy transfers will have no effect

Case 2, where FORco repatriated
ted and unrepatriated earnings is 30%,

-
$0 -
2,000,000
$5,000,000 1,750,000