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Glossary of International Tax Terms

6 min readBy: TF Staff

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Arm’s length transactionAn arm’s length transaction is a transaction between two related or affiliated parties that is conducted as if they were unrelated, so that there is no question of a conflict of interest.

Border taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. adjustments (BTAs)BTAs are a mechanism through which a “tax neutral” setting for international trade and economic competition can be established. The government accomplishes tax neutrality by rebating taxes on exports and applying taxes to imports. The General Agreement on Tariffs and Trade (GATT), which defines the scope of international BTAs, only recognizes consumption taxes or those taxes applied directly to goods and services, as eligible for BTAs. Value Added taxes are BTA-eligible; corporate income taxA corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual income tax. es are not.

Economic v. Statutory Incidence Economic incidence of a tax refers to the individual or group of individuals who ultimately bear the actual cost of the tax. Statutory incidence refers to the individual or group of individuals who are responsible for physically remitting a particular tax to the government. Economic and statutory incidence may or may not coincide. For example, the statutory incidence of the corporate income tax falls on corporate executives. The economic incidence of the tax, however, falls on individual workers in the form of lower wages, individual consumers in the form of higher prices, and/or individual shareholders in the form of lower returns on their investment.

Earnings stripping Earnings stripping is a process by which a firm reduces its overall tax liability by moving earnings from one taxing jurisdiction, typically a relatively high-tax jurisdiction, to another jurisdiction, typically a low-tax jurisdiction. Often, earnings stripping arrangements involve the extension of debt from one affiliate to another. Debt is accumulated in a high-tax jurisdiction that allows a company to deduct interest payments from their taxable incomeTaxable income is the amount of income subject to tax, after deductions and exemptions. For both individuals and corporations, taxable income differs from—and is less than—gross income. . Most restrictions on earnings stripping are contained in section 163(j) of the Internal Revenue Code.

Effective Tax RateThe percent of total income paid in taxes. Effective rates are typically lower than marginal rates because most tax systems have some forms of deductions, exclusions, credits, other adjustments, or a progressive marginal tax structure.

Extraterritorial Income regime (ETI) The Extraterritorial Income regime was implemented in 2000 to replace the Foreign Sales CorporationAn S corporation is a business entity which elects to pass business income and losses through to its shareholders. The shareholders are then responsible for paying individual income taxes on this income. Unlike subchapter C corporations, an S corporation (S corp) is not subject to the corporate income tax (CIT). (FSC) as a mechanism to subsidize U.S. exporters who are unable to take advantage of border tax adjustments because the U.S. has an income, rather than consumption, based tax system. In January 2002, a WTO Appellate Body ruled that the ETI constituted a prohibited export subsidy. In August 2002, the WTO ruled that if the U.S. did not come into compliance with the Appellate decision, then the EU could impose more than $4 billion worth of sanctions against U.S. products.

Foreign Sales Corporation (FSC)Since the early 1960s, the U.S. has maintained a series of export-related tax benefits for export-intensive corporations. While clearly designed to spur U.S. exports, these provisions were also seen as a way of leveling the playing field with countries that employ “border tax adjustments” to remove the Value Added Taxes (VATs) from the price of export products before they are shipped abroad. In 1997, the European Union (EU) challenged the legality of the FSC regime before the World Trade Organization (WTO). A WTO panel eventually agreed with the EU and struck down the FSC regime. The United States replaced the FSC with the Extraterritorial Income (ETI) regime in 2000.

Foreign tax creditsCurrent U.S. tax law allows U.S. companies to claim a credit against their U.S. taxes for taxes paid in other countries. These credits are meant to avoid the double taxationDouble taxation is when taxes are paid twice on the same dollar of income, regardless of whether that’s corporate or individual income. of earnings that arise from the United States’ worldwide tax systemA worldwide tax system for corporations, as opposed to a territorial tax system, includes foreign-earned income in the domestic tax base. As part of the 2017 Tax Cuts and Jobs Act (TCJA), the United States shifted from worldwide taxation towards territorial taxation. . Foreign tax creditA tax credit is a provision that reduces a taxpayer’s final tax bill, dollar-for-dollar. A tax credit differs from deductions and exemptions, which reduce taxable income, rather than the taxpayer’s tax bill directly. s are limited to the U.S. corporate tax rate. Therefore, U.S. corporations pay a minimum of 35 percent on their worldwide earnings.

Foreign tax credit “baskets”Currently, U.S. corporations must divide their foreign-sourced earnings into nine categories, or “baskets.” Foreign tax credits earned in one basket may not be used to offset earnings in another basket.

Inversion (also known as expatriation or re-incorporation) An inversion is the process by which a corporate entity, established in a low-tax country, “buys” an established domestic company. The transaction takes place when the overseas entity purchases either the shares and/or assets of a domestic corporation. The shareholders of the domestic company typically become shareholders of the new foreign parent company. In essence, the legal location of the company changes through a corporate inversion from the domestic to the foreign country. An inversion typically does not change the operational structure or location of a company, however.

Marginal Tax RateThe marginal tax rate is the amount of additional tax paid for every additional dollar earned as income. The average tax rate is the total tax paid divided by total income earned. A 10 percent marginal tax rate means that 10 cents of every next dollar earned would be taken as tax. Marginal tax rate refers to the highest published tax rate at which a taxpayer’s last dollar earned is taxed. The U.S. federal corporate income tax code contains six marginal rates ranging from 15 percent to 39 percent. The vast majority of corporate income is taxed at a 35 percent marginal tax rate.

RepatriationTax repatriation is the process by which multinational companies bring overseas earnings back to the home country. Prior to the 2017 Tax Cuts and Jobs Act (TCJA), the U.S. tax code created major disincentives for U.S. companies to repatriate their earnings. Changes from the TCJA eliminate these disincentives. of earnings The process by which a U.S. parent company moves earnings from its foreign-based affiliates back to the parent company or to shareholders of the parent company in the United States. The U.S. corporate income tax is typically levied at the time that earnings are repatriated.

Section 163(j) The Section of the Internal Revenue Code that sets limitations on earnings stripping activities.

Subpart F The federal government’s system of “anti-deferral” rules, which lead to the taxation of certain kinds of foreign-source income in the year it was earned even though the U.S. parent company did not repatriate those profits during the year. Subpart F refers to the chapter in the U.S. tax code that houses these complex rules.

Territorial tax systemA territorial tax system for corporations, as opposed to a worldwide tax system, excludes profits multinational companies earn in foreign countries from their domestic tax base. As part of the 2017 Tax Cuts and Jobs Act (TCJA), the United States shifted from worldwide taxation towards territorial taxation. A tax system that taxes all companies only on the economic activity that occurs within the geographic boundaries of the country, regardless of the location of the company’s incorporation or operations. For example, an Irish company is not taxed by Ireland, which has a territorial tax system, on the profits earned through sales in the United States. However, both American firms and Irish firms are taxed on profits earned through sales in Ireland.

Transfer pricingThe price that is assumed to have been charged by one part of a company for products and services it provides to another part of the same company, in order to calculate each division’s profit and loss separately. Generally, transfer pricing rules indicate that one affiliate must charge another affiliate the same price as would be demanded in an “arm’s length transaction.” a transaction between two related or affiliated parties that is conducted as if they were unrelated, so that there is no question of a conflict of interest.

World Trade Organization (WTO)The WTO is an international organization dealing with the rules of trade between nations. The WTO is based upon agreements, negotiated and signed by the bulk of the world’s trading nations and ratified in their parliaments. Trade disputes between member countries of the WTO are settled by the organization.

Worldwide tax system A tax system that taxes domestically-incorporated companies on their total earnings from activities domestically and internationally. Typically, a worldwide tax system also taxes foreign firms on their economic activity within the geographic boundaries of the country. For example, an American firm is taxed on profits earned through sales in the United States and in Ireland. An Irish firm is taxed by the United States on profits earned through sales in the United States.