[1][additional citation(s) needed] This is generally referred to as a foreign tax credit.
[3] Rules defining taxes eligible for credit may refer to one or more of the following characteristics of such tax: For example, the system in the United States allows FTC, subject to limitations, for foreign compulsory levies based on net income or withheld from gross receipts.
[8] Canada similarly allows credits but limits the portion of foreign tax subject to deduction with respect to an oil or gas business.
[13] Some systems allow the credit with the tax would be recognized in financial statements.
Some systems base the timing of recognition on the method of accounting of the taxpayer, possibly with an election by a cash basis taxpayer to recognize the tax at the time properly accrued.
Thus, for example, Canadian and US federal governments allow credits from all foreign levels,[15] while Canadian provinces and US states tend to allow a credit for income taxes paid to other provinces and states but not for taxes paid to sovereign jurisdictions (countries).
For example, the US system, in 2009, permitted taxpayers to apply excess FTCs to reduce US federal income tax for the first prior year (carry back) and then successively for each of the next succeeding 10 years (carry forward).
[citation needed] Various countries have, at one point or another, limited FTC based on type of income.
The US baskets are currently passive, consisting of foreign personal holding company income (interest, dividends, rents, royalties, and certain gains, with significant exceptions) and all other (general limitation), with some exceptions generally not applicable.
[28] Where a system imposes limits on FTC based in some manner on foreign source income (FSI), the system generally provides rules for determining whether income is foreign or domestic source.
For example, income from merchandise trading is sourced to where the sales are habitually completed, but other relevant factors may be considered.
[citation needed] Canadian individuals determine the source of income from employment under three different approaches.
Income from sale of purchased inventory is sourced to place of title passage.
[42] However, purchases from certain related parties are effectively ignored and the inventory may be considered produced by the taxpayer.
Such mechanisms tend to be complex[44] or rely on local accounting rules or judgments.
[45] The process of associating deductions with income is referred to allocation and apportionment in some jurisdictions.
[47] Canadian rules require that deductions reasonably regarded as wholly allocable to income form a particular place be allocated thereto, as well as that portion of other deductions reasonably regarded as applicable to that income.
[48] Under US rules, apportionment of most deductions may be done based on relative sales, gross income (sales less cost of goods sold), space used, headcount, or some other rational and systematic basis.
Most systems require corrective action by taxpayers if the amount of tax previously claimed as FTC changes.
Those taxpayers must reduce the pool of taxes going forward and advise the government of the change.
[56] The deemed paid credit mechanism may be applied up the chain of corporate distributions, and may be subject to ownership limitations.
[57][58] Dividends received by resident individuals and corporations are included in taxable income by most countries.
Carpet Ltd's tax rate in the UK is 33% on its business net income of £1 million.
Differences in expense allocation rules and transfer pricing can impact this result.
Under the Germany/Indonesia tax treaty of 1977 (a typical provision), Germany allowed a credit with respect to dividends, interest and royalties for Indonesian taxes that would have been paid but for the provisions of Indonesian law designed to promote economic development in Indonesia.