Task: Valuation and international taxation
Peripatetic Enterprises, a U.S. import-export trading firm, is considering its international tax situation. US tax law requires U.S. corporations to pay taxes on their foreign earnings at the same rate as profits earned in the United States; and this rate is currently 45%. However, a full tax credit is given for the foreign taxes paid up to the amount of the U.S. tax liability. Peripatetic has major operations in Poland, where the tax rate is 20%, and in Sweden, where the tax rate is 60%. The profits, which are fully and immediately repatriated, and the foreign taxes paid for the current year are shown here:
Poland Sweden
Earnings before interest and taxes (EBIT) $80 million $100 million
Host country taxes paid $16 million $60 million
Earnings before interest after taxes $64 million $40 million
Q1. What is the U.S. tax liability on the earnings from the Polish subsidiary assuming the Sweden subsidiary did not exist?
Q2. What is the U.S. tax liability on the earnings from the Swedish subsidiary assuming the Polish subsidiary did not exist?
Q3. Under the U.S. Tax law, Peripatetic is able to pool earnings from its operations in Poland and Sweden when computing its U.S. tax liability on foreign earnings. Total EBIT is thus $180 million and the total host country taxes paid is $76 million. What is the total U.S. tax liability on foreign earnings? Show how this relates to the answer in parts (1) and (2).