Foreign Tax Credits

A common assumption is that the receipt of interest or dividends from a foreign corporation, or a subpart F income inclusion with respect to a controlled foreign corporation, is foreign source income for purposes of Code Sec. 904 and related foreign tax credit calculations. The payor is a foreign corporation and, therefore, one assumes the income must be foreign source under the Code Sec. 862 sourcing rules. This assumption is frequently incorrect. A foreign corporation may easily earn domestic source income, and the resulting earnings and profits may retain the domestic source for purposes of foreign tax credit calculations. Under Code Sec. 904(h), certain categories of income derived by a US shareholder from a foreign corporation may be domestic source. A literal application of Code Sec. 904(d)(2) at the foreign corporation level to account for separate categories of earnings appears to require the inclusion of domestic source earnings in either the general basket or passive basket.