Since U.S. companies which do business overseas have to abide by those
countries’ tax laws, they have a means of avoiding being doubly
taxed by the U.S. by filing Form 1118 and claiming foreign tax credits
against the income tax they have already paid. How much foreign credit
they can earn can be limited depending on the type of income and the particular
county’s tax rate.
Foreign tax credits are determined based on a company’s separate
passive and active income. Passive income is income from a stock sale,
dividend, or interest, according to the IRS. Active income, on the other
hand, stems from business activities including banking, insurance, and
While foreign companies can use U.S. tax credits for taxes they pay on
income earned while doing business in the U.S., this does not apply if
they do not earn business or trade income from the country.
Limits exist to how much foreign tax a U.S. company can offset. IRS regulations
prohibit a company from taking a foreign tax credit which is more than
its corporate tax rate. To take credits in the first place, corporations
need to pay tax which is specifically related to earned income to the
appropriate foreign taxing authority.
Foreign tax credits do not apply to value-added taxes, or goods and services
taxes. Neither do they apply to license or permit taxes, consumption tax,
sales, or capital tax.