Corporate foreign tax credit, 2003.

For Tax Year 2003, corporations filing a U.S. tax return claimed $50 billion in foreign tax credits, an all-time high for this credit and increase of over $7.5 billion from Tax Year 2002. The foreign tax credit reported by these corporations reduced their U.S. tax on worldwide income by 33.5 percent, from $149.2 billion to $99.3 billion. Additional credits, including the general business credit and the U.S. possessions tax credit, further reduced their total U.S. tax liability to $88.9 billion.

The 5,409 corporations claiming a foreign tax credit for 2003 earned $424.5 billion in worldwide taxable income and paid $140.5 billion in worldwide income taxes. $205.1 billion of the worldwide taxable income (48.3 percent) were derived from foreign sources, while foreign taxes accounted for $51.6 billion (36.7 percent) of the worldwide income taxes. The United Kingdom, Canada, Japan, the Netherlands, and Switzerland combined for the largest share of foreign-source taxable income, accounting for 38.0 percent ($77.9 billion) of the total, as well as 39.4 percent ($20.4 billion) of all foreign taxes. The United Kingdom alone was responsible for 11.9 percent ($24.5 billion) of foreign-source taxable income, the most from any one country. Europe was the source of 42.9 percent of foreign-source taxable income and 45.8 percent of foreign taxes, outpacing any other continent or region.

Corporations whose primary business was manufacturing accounted for the largest share of foreign income, tax, and foreign tax credit. These corporations claimed $33.1 billion (66.2 percent) in foreign tax credits, earned $133 billion (64.8 percent) in foreign-source taxable income, and paid $34.9 billion (67.5 percent) of total foreign taxes. By individual region, Europe accounted for the largest share of manufacturing foreign-source taxable income, with $62.8 billion (47.2 percent), and total manufacturing foreign taxes, with $18.3 billion (52.4 percent). In terms of one country, $11 billion (8.3 percent) in manufacturing foreign-source taxable income and $4.5 billion (12.8 percent) in total manufacturing foreign taxes were accounted for by the United Kingdom and Spain, respectively, the most from any single country. Looking beyond manufacturing, the services industry had the second-largest share of foreign tax credits (11.2 percent) and foreign taxes (11.3 percent) and was third in foreign-source taxable income (9.4 percent). Finance, insurance, real estate, and rental and leasing corporations claimed the second-largest share of foreign-source taxable income (13.1 percent) with $26.9 billion.

For 2003, U.S. corporations computed a separate foreign tax credit for a defined group of statutory categories of foreign-source income or "baskets" (each of these is described separately in the Explanation of Selected Terms section). The total foreign tax credit claimed is the sum of credits allowed in each separate limitation category.

As has been the case for several years, corporations allocated the majority of their foreign-source taxable incomes (75.9 percent) and foreign taxes (80.5 percent) to the general limitation income basket. The financial services income basket was responsible for the second-largest share of these amounts, with 18.3 percent of the foreign-source taxable income and 14.7 percent of foreign taxes. Two new income baskets, dividends from each 10/50 PFIC and dividends from 10/50 corporations, were introduced for Tax Year 2003, effectively replacing the noncontrolled section 902 corporation basket from prior years. These income categories accounted for a combined 1.3 percent of foreign-source taxable income and 2.2 percent of foreign taxes.

Data Sources and Limitations

The statistics in this data release were compiled based on corporation income tax returns with a foreign tax credit that were included in the 2003 Statistics of Income sample of returns with accounting periods ending between July 2003 and June 2004. These returns were selected after administrative processing but prior to any amendments or audit examination. The 2003 corporation income tax return sample included Forms 1120, 1120-F, 1120-L, 1120-PC, and 1120-REIT.

The foreign tax credit is provided under section 901 of the Internal Revenue Code. Corporations report the foreign income and taxes related to the credit on Form 1118, Computation of Foreign Tax Credit--Corporations, filed with their income tax returns. The statistics in this data release are based on information reported on Forms 1118 and related corporate returns. In addition to current-year foreign taxes, foreign taxes available for credit shown in this data release include only those carried forward to 2003 from previous years. Corporations with an "alternative minimum tax" (AMT) liability are required to compute a separate "alternative minimum tax foreign tax credit." The AMT foreign tax credit data are not reflected in the statistics in this data release, even if the corporation reported both the "regular" foreign tax credit and the AMT foreign tax credit. Corporations reporting only the AMT computation had no regular tax and therefore were not included in the foreign tax credit statistics.

There are small discrepancies between the more complete foreign tax credit data presented in this data release and those published in Statistics of Income--2003, Corporation Income Tax Returns. These differences can be attributed to several factors, including, but not limited to, the following reasons: Some of the returns designated for the Statistics of Income sample were received too late to be included in the regular corporation statistics, but were included in the foreign tax credit statistics presented in this data release. Certain corporations submitted preliminary data on their original returns because they lacked complete information on their foreign operations at the time of filing. On a case-by-case basis, additional information was requested directly from the taxpayer. However, amended returns filed at a later date, including those with carrybacks of foreign taxes to be credited for 2003, were not included in the statistics.

The 2003 foreign tax credit statistics in this data release do not represent the final amounts credited that year. A complete foreign tax credit amount for 2003 would reflect the results of any audits, as well as the carryback of any foreign tax credits from 2004 and 2005. Also, some corporations did not file Form 1118 because they did not have a U.S. income tax liability, and were thus unable to credit any foreign taxes paid, accrued, or deemed paid for 2003. Finally, other corporations could have deducted their foreign taxes from their gross incomes instead of claiming a foreign tax credit. Accordingly, foreign income and taxes are understated in this data release to the extent that they were not reported on Form 1118.

Because the estimates are based on a sample, they are subject to sampling error. Coefficients of Variation (CVs) are used to measure the magnitude of this sampling error. The CV concept is defined in the section on sampling variability in the "SOI Sampling Methodology and Data Limitations" appendix of this publication. Figure A presents CVs for foreign tax credits by selected North American Industry Classification System (NAICS) divisions, industrial sectors, and sectors. The smaller the CV, the more reliable the estimate is judged to be.

The industry classification used in this data release is based on NAICS, created under the auspices of the governments of the United States, Mexico, and Canada in response to the North American Free Trade Agreement (NAFTA). NAICS is unique among industry classifications in that the economic units that have similar production processes are classified in the same industry. In 1997, NAICS replaced the Standard Industrial Classification (SIC) of the United States. Prior to 1996, the SIC system was the basis for industrial groupings in data releases by Statistics of Income on the foreign tax credit.

Description of Tables 1-3

Table 1, columns 2 through 15, presents statistics on assets, receipts, income, and taxes reported on the basic corporation income tax returns for those corporations claiming a foreign tax credit. Columns 16 through 51 present statistics from Form 1118, Foreign Tax Credit--Corporations. Columns 16 through 35 present statistics on foreign income (i.e., income from sources outside the United States, including U.S. Possessions) and deductions, reported primarily on Form 1118, Schedule A, Income or Loss Before Adjustments.

Although the amounts of oil and gas income and deductions (columns 23 and 35, respectively) are included in the summary columns (i.e., columns 16 through 22 and 26 through 34), these amounts are also reported separately (on Form 1118, Schedule I, Reduction of Oil and Gas Extraction Taxes) because oil and gas extraction income is subject to special rules under Internal Revenue Code section 907, which effectively requires a separate limitation calculation for taxes related to oil and gas extraction income. This may result in a reduction of foreign taxes available for credit. Reductions in creditable oil and gas extraction income taxes are included with several other types of reductions in column 40 of Table 1.

Similarly, foreign branch income is also included in the summary amounts reported in columns 16 through 22 of Table 1, and is also reported separately (on Form 1118, Schedule F, Gross Income and Definitely Allocable Deductions for Foreign Branches) in column 24 of Table 1. For Tax Year 2003, Code section 863(b) income (income partly from within and partly from outside the United States) is included in the summary amounts reported in columns 16 through 22 of Table 1, and is aggregated on Form 1118, Schedule A, Income or (Loss) Before Adjustments, using a special country code.

Total deductions not definitely allocable to specific types of income (column 31 of Table 1) are equal to the sum of columns 32 through 34, relating to research and development, interest, and any other "not definitely allocable expenses" (any differences are due to taxpayer reporting). Total foreign-source gross income (Table 1, column 16) less total foreign deductions (Table 1, column 25) is equal to foreign-source taxable income before adjustments (Table 1, column 36).

Adjustments to foreign-source taxable income (reported in column 37 of Table 1) include the allocation of: (1) current-year foreign-source losses, (2) overall foreign losses, and (3) current-year U.S.-source losses, as well as the recapture of prior-year overall foreign losses and recharacterization of prior-year foreign-source losses. These adjustments (reported on Schedule J, Separate Limitation Loss Allocations and Other Adjustments Necessary To Determine Numerators of Limitation Fractions, Yearend Recharacterization Balances, and Overall Foreign Loss Account Balances) affect the numerator of the limitation fraction used to compute the foreign tax credit. The income after adjustments (the numerator of the limitation fraction) is reported in column 38 of Table 1. The limitation fraction, foreign-source taxable income divided by total taxable income from all sources, is applied to the total U.S. tax against which the credit is allowed to determine any limitation on the foreign tax credit. Taxpayers are required to calculate this limitation for each income basket.

Statistics on foreign taxes are reported in columns 39 through 51 of Table 1. Data on foreign income taxes paid, accrued, and "deemed paid" (through Controlled Foreign Corporations) from Form 1118, Schedule B, Foreign Tax Credit--Corporations, are reported in columns 42 through 51 of Table 1. Total foreign taxes paid or accrued (Table 1, column 43) are the sum of columns 44 through 50 (any differences are due to taxpayer reporting). Table 1, column 41 shows carryovers of excess or unused taxes from prior years, which can be added to the 2003 pool of creditable foreign taxes. Total foreign taxes paid, accrued, and "deemed paid," plus carryover, are then adjusted for certain items (e.g., reductions of foreign taxes related to oil and gas extraction income under Internal Revenue Code section 907 and reductions of foreign taxes related to income earned in sanctioned countries under Internal Revenue Code section 901(j), as well as other reductions of creditable taxes) in column 40. Thus, total foreign taxes available for credit (Table 1, column 39) are equal to total foreign taxes paid, accrued, and "deemed paid" (column 42), plus any carryover of prior-year excess or unused foreign taxes (column 41), less any reduction in foreign taxes (column 40).

Tables 2 and 3 are similar in column format to Table 1 except that they provide data only from Form 1118 without the data from the basic corporation income tax return (for example, total assets and total receipts). Table 2 presents data reported by industrial grouping and separate income basket, while Table 3 presents data by selected geographic region and country.

Explanation of Selected Terms

Adjustments to taxable income--This includes several types of adjustments reported on Schedule J of Form 1118, Computation of Foreign Tax Credit--Corporations. These include the allocation of current-year foreign losses, overall foreign losses, and current-year U.S.-source losses. Adjustments due to prior-year loss allocations are also made, including the recapture of foreign-source losses and the recharacterization of foreign-source income. The overall result of these adjustments is shown in column 37 of Table 1 and column 23 of Table 2.

Carryover of foreign taxes--Under Internal Revenue Code section 904, "U.S. persons" are allowed a 2-year carryback and 5-year carryforward of excess or unused foreign taxes for purposes of computing the final foreign tax credit for those years. Such taxes were included in the computation of the current-year foreign tax credit to the extent that they did not exceed the credit limitation for the current year. The 2003 statistics used for this article include only those foreign taxes that were carried forward from previous years (1998-2002). See column 41 of Table I and column 27 of Table 2.

Controlled foreign corporation (CFC)--Under Internal Revenue Code section 957, a foreign corporation is a "controlled foreign corporation" if more than 50 percent of its outstanding voting stock, or more than 50 percent of the value of all its outstanding stock, is owned (directly, indirectly, or constructively) by "U.S. shareholders" on any day during the foreign corporation's tax year. Internal Revenue Code section 951(b) defines a "U.S. shareholder" as a U.S. person with 10 percent or more of the total combined voting stock of the foreign corporation. Ownership attribution rules are provided in Internal Revenue Code section 958. See also Deemed dividends and Subpart F.

Current-year foreign taxes--Current-year foreign taxes include foreign income taxes paid, accrued, or "deemed paid" and are shown in column 42 of Table 1, column 28 of Table 2, and column 14 of Table 3. Current-year foreign taxes do not include any carryback or carryforward of foreign taxes from other tax years.

Deemed dividends--Certain types of income earned by controlled foreign corporations (CFCs) are recognized under Subpart F of the Internal Revenue Service Code as current-year income of the U.S. corporation, even if no income is actually received from the CFC in the current tax year. In such cases, the U.S. corporation is deemed to have received a pro-rata share of this income and required to report it as a "deemed dividend" on Form 1118, Schedule A. See Internal Revenue Code section 951(a) for a more detailed description of income reported as deemed dividends. See also controlled foreign corporation and Subpart F income.

Dividend gross-up--Since a dividend represents a distribution from after-tax earnings, the amount of income that a domestic corporation recognizes on receiving a dividend from a foreign corporation is net of all the foreign income taxes paid by that foreign corporation. U.S. corporations that satisfy ownership and other requirements are permitted to take an indirect foreign tax credit for taxes paid on the profits from which the dividends were distributed. Under Internal Revenue Code section 78, these taxes are "deemed paid" by the U.S. corporations under Internal Revenue Code sections 902 and 960(a). Consequently, the dividend income is "grossed-up" by the amount of the taxes deemed paid on the income from which the dividend was paid. This prevents U.S. corporations from crediting the foreign taxes deemed paid and deducting the same taxes in computing foreign-source taxable income.

Financial services income--This separate limitation category or basket applies to certain income from financial services activities. Financial services income includes all income, including "passive income" (see below), that is generated from banking, insurance, financing, or similar activities, and from certain types of insurance investments. Financial services income excludes "high withholding tax interest," dividends from noncontrolled foreign corporations as defined in Internal Revenue Code section 902, and certain types of export financing interest.

Foreign oil and gas extraction income (FOGEI)--FOGEI is the gross income from the extraction of oil and gas, as well as from the sale of assets used in the extraction of oil and gas, or from related services, working capital, dividend and partnership distributions, and any other oil and gas extraction income. In general, a foreign tax credit is not permitted for foreign taxes paid, accrued, or deemed paid in connection with the purchase or sale of oil or gas extracted in a foreign country if the taxpayer has no economic interest in the oil or gas and if the purchase or sales price differs from the fair market value.

Foreign sales corporation (FSC)--A foreign sales corporation was a company incorporated abroad and controlled by a "U.S. person." A portion of the FSC's "foreign trade income" was exempt from U.S. taxation. Although these statistics do not include FSC returns (Forms 1120-FSC), FSC dividends received by corporations claiming a foreign tax credit are included. Dividends and interest generated by a FSC or former FSC comprise a separate limitation category. In July 1999, the World Trade Organization (WTO) declared FSC provisions to be an illegal export subsidy. Congress repealed the FSC provisions and created the Extraterritorial Income Exclusion Act in November 2000, which allowed U.S. corporations to continue operating FSCs until December 2001.

Foreign-source taxable income--Foreign-source taxable income is equal to gross income (less loss) less deductions from sources outside the United States, including U.S. possessions, and is included in the taxable income of U.S. corporations.

Foreign trade income--This includes gross receipts from foreign trade earned by a foreign sales corporation (FSC) from: 1) the sale of "export property," 2) the leasing of export property for use outside the United States, or 3) services in connection with the sale or leasing of export property. The related separate limitation category, taxable income attributable to foreign trade income, is unusual in the 2003 statistics. Code section 923(b), which permits the foreign trade income basket, has since been repealed, effective September 30, 2000.

General limitation income--This separate limitation category or basket comprises foreign income not included in any other separate limitation category.

High withholding tax interest--This separate limitation category or basket includes interest income subject to a withholding tax greater than or equal to 5 percent. This basket does not include interest received from the financing of certain export activities.

Income resourced by bilateral tax treaty--Selected U.S. income tax treaties contain provisions reclassifying certain income items from being U.S.-source income to foreign-source income (for instance, when the tax treaty allows the other country to tax what would otherwise be U.S.-source income). Certain dividends and income from a U.S.-owned foreign corporation can be included in this category. A separate foreign tax credit limitation has to be computed for each amount resourced by a tax treaty.

Domestic international sales corporation (DISC)--DISCs (now referred to as IC-DISCs) were small domestic corporations formed to export U.S. products. A DISC could defer the tax liability on a portion of its income but had to ultimately pay the deferred tax plus interest. Under the DISC provisions, a U.S. manufacturer could set up a DISC (located in the United States) whose income was not taxed at the DISC level. Instead, the corporate shareholder was taxed directly on a portion of the DISC's income that was deemed distributed. The portion of the income not deemed distributed was not subject to U.S. taxation until it was actually distributed. The foreign trading partners of the United States that are party to the General Agreement on Tariffs and Trade (GATT) maintained that the DISC provisions constituted an illegal export trade subsidy because they allowed indefinite deferral of direct taxes on income from exports earned in the United States. Essentially, this pre-1985 system of tax deferral for export income was replaced by the exemption system of Foreign sales corporations (FSCs), now also repealed. To elect DISC status, at least 95 percent of the corporation's gross receipts had to be "qualified export receipts," and at least 95 percent of its assets "qualified export assets." Distributions from a DISC or former DISC are a separate limitation category.

Noncontrolled section 902 corporation--A noncontrolled foreign corporation is defined by Internal Revenue Code section 902 as a foreign corporation in which a U.S. corporation possesses at least 10 percent of the voting stock and the U.S. shareholders own no more than 50 percent of the stock measured by voting power or value. These foreign corporations are also referred to as "10/50 companies." Each noncontrolled section 902 foreign corporation is treated individually, with dividends from each corporation placed in separate categories or baskets to avoid the averaging of high-taxed and low-taxed dividends. Under Internal Revenue Code section 904(d)(1)(E), dividends paid by 10/50 corporations that are not passive foreign investment companies (PFICs) are treated in the aggregate as a separate category of income and are placed in this basket. Tax year 2003 was the first to include this income basket.

Passive foreign investment company (PFIC)--A PFIC is a passive investment company, one whose income is mainly passive or that uses at least half of its assets to create passive income.

Passive income--This separate limitation category or basket includes dividends, interest (with the exception noted below), rents, royalties, annuities, and net capital gains, as well as commodity transactions not connected with the active conduct of a trade or business. High-taxed passive income is excluded from this basket and is included, instead, under financial services income. Interest subject to a high withholding tax is categorized in a separate basket (see High withholding tax interest, above). Furthermore, income that by definition is passive, yet is subject to a foreign tax rate exceeding the highest applicable U.S. rate, is placed in the general limitation basket instead of the passive income basket.

Section 901(j) income--Internal Revenue Code section 901(j) denies credit for taxes paid or accrued to select foreign governments that the United States deems ineligible. These countries include the following: (1) countries not recognized by the United States, (2) countries with which the United States has severed or does not conduct diplomatic relations, or (3) countries identified by the United States as providing support for terrorism. For 2003, countries subject to these restrictions were Cuba, Iran, Iraq, Libya, North Korea, Sudan, and Syria. Income and deductions from section 901(j) countries are reported on Form 1118, even though these taxes are not creditable. A separate limitation credit is computed for informational purposes and is not included in the foreign tax credit of the corporation.

Shipping income--This separate limitation category or basket applies to certain income from shipping-related activities. Shipping income includes the following: (1) all income from the use (or leasing for use) of a vessel or aircraft in foreign commerce, (2) income from services directly related to the use of a vessel or aircraft, (3) gains on the sale or exchange of a vessel or aircraft used in the performance of such services, and (4) income generated from other space and oceanic activities not included elsewhere. Income that would be foreign-base company shipping income for purposes of determining the income received from controlled foreign corporations, under Internal Revenue Code section 954(f), is also classified as shipping income.

Specifically allocable income--Internal Revenue Code section 863(b) provides special rules for determining taxable income from sources outside the United States with respect to gross income derived partly from within and partly from outside the United States. The income apportioned to sources outside the United States under these special rules is commonly referred to as "section 863(b) income."

Subpart F income--Provisions of the Internal Revenue Code limit the ability of U.S. taxpayers to defer U.S. taxes by shifting certain types of income to lower-tax foreign countries. Subpart F (i.e., Internal Revenue Code sections 951-965) identifies certain types of income, primarily passive investment income, earned by certain controlled foreign corporations (CFCs), and requires the U.S corporation to report a pro-rata share of this current-year income for U.S. tax purposes, regardless of whether or not the income was actually repatriated to the U.S. corporation in the current tax year. See also Controlled foreign corporation and Deemed dividends.

Tax deemed paid--See Dividend gross-up.

U.S. person--A U.S. person is any citizen or resident of the United States, domestic partnership, corporation, association, company, or any estate or trust that is not considered foreign. See Internal Revenue Code section 7701 for more information on the definition of a U.S. person.

Robert Singmaster is an economist with the Special Studies Returns Analysis Section. This data release was prepared under the direction of Chris Carson, Chief.

Figure A

Coefficients of Variation for Foreign Tax Credit, by
Selected Sector or Group, Tax Year 2003

  All industries                                       0.03
Agriculture, forestry, fishing, and hunting            0.08
Mining                                                 0.21
Utilities                                              0.03
Construction                                           1.76
Manufacturing                                          0.01
  Food manufacturing                                   0.01
  Beverage and tobacco Products                        [1]
  Petroleum and coal products manufacturing            [1]
  Chemical Manufacturing                               0.02
    Pharmaceutical and medicine manufacturing          0.01
  Fabricated metal products                            0.06
  Machinery manufacturing                              0.09
  Computer and electronic product manufacturing        0.02
  Transportation equipment manufacturing               0.07
Wholesale and retail trade
Transportation and warehousing                         0.21
Information                                            0.29
  Publishing (except Internet), motion picture and
  sound recording                                      0.19
Finance, insurance, real estate, rental, and leasing   0.03
  Finance and Insurance                                0.03
  Securities, commodity contracts, etc                 0.09
  Insurance and related activities                     [1]
Services                                               0.17
  Management of holding companies                      0.18

[1] Less than 0.005 percent