The IRS has issued final regulations affecting foreign tax credits, which will alter the lease versus buy equation for those lessees with expiring foreign tax credits. Expiring foreign tax credits are another reason why lessees choose to lease their equipment, due to the interaction of owned assets and the foreign tax credit limitation. The new regulations allow an election for measuring depreciable assets which, if taken, can result in a higher foreign tax credit.
Under the US tax system, a corporation must pay taxes on its worldwide income, even though taxes also are paid on the foreign component of that worldwide income. The IRS mitigates this double taxation by allowing its taxpayers to recover the excess taxes paid. This recovery can occur through either a deduction of the foreign taxes paid or a credit against current US tax for the foreign taxes paid..
Instead of claiming a deduction for foreign taxes paid, a taxpayer may elect under Internal Revenue Code (IRC) §901 to claim a credit for those foreign income taxes. The IRC, however,limits the foreign tax credit to an amount equal to the pre-credit US tax on the taxpayer's foreign source income. One of the components used to determine foreign source income is interest expense. Interest expense is allocated to domestic or foreign sources based on the tax assets held in that source. The connection to leasing is that the interest expense allocated to a location decreases as more assets are leased in that location.
The use of tax assets to apportion interest expense can result in a disparity between the tax basis of domestic and foreign assets of the taxpayer since property in the US is depreciated using MACRS. Equipment used outside the US, on the other hand, is generally depreciated on a straight-line method, which results in more interest expense being allocated to foreign source income. The consequence? A reduction in the lessee's foreign tax credit limitation.
The final regulations, however, allow taxpayers to determine the tax book value of their equipment subject todepreciation using the straight-line method, conventions, and recovery periods of the Alternative Depreciation System. This method will increase the amount of interest expense allocated to US operations which, in turn, will increase the amount of the foreign tax credit available to be used. Keep in mind that this method is for interest allocation purposes only – equipment in the US may continue, for domestic tax purposes, to be depreciated using MACRS.
Whew! I think that is more than even I wanted to know, but it is important if you are a lessee with any foreign tax credit carryforwards, or, as a lessor whose customers have foreign tax credit carryforwards. The consequence to lessees of this new rule is that the purchase alternative in the lease versus buy analysis is now penalized less by the foreign tax credit.
Hi
Here is a scenerio: I'm a US citizen residing in the US. If I invest in a wind based power plant outside of US - in the US, there is accelerated depreciation available along with tax credits because this is renewable energy. since I need to declare the income from foriegn source, can I also take advantage of the tax credits from renewable energy - regarless of the locaiton of the windmill - and the depreciation benefits?
Thanks in advance
Posted by: Prakash | March 26, 2006 8:20 AM | Permalink to Comment