Foreign Tax Credit - Corporations

Purpose of Form

Use Form 1118 to compute a corporation's foreign tax credit for certain taxes paid or accrued to foreign countries or U.S. possessions. See Taxes Eligible for a Credit on page 3.

Who Must File

Any corporation that elects the benefits of the foreign tax credit under section 901 must complete and attach Form 1118 to its income tax return.

When to Make the Election

The election to claim the foreign tax credit (or a deduction in lieu of a credit) for any tax year may be made or changed at any time before the end of a special 10-year period described in section 6511(d)(3) (or section 6511(c) if the period is extended by agreement).

Computer-Generated Form 1118

The corporation may submit a computer-generated Form 1118 and schedules if they conform to the IRS version. However, if a software program is used, it must be approved by the IRS for use in filing substitute forms. This ensures the proper placement of each item appearing on the IRS version. For more information, get Pub. 1167, Substitute Printed, Computer-Prepared and Computer-Generated Tax Forms and Schedules.

How to Complete Form 1118

Important: Complete a separate Schedule A; Schedule B, Parts I & II; Schedules C through G; and Schedule I for each applicable separate category of income. See Categories of Income below. Complete Schedule B, Part III; Schedule H; and Schedule J only once.

• Use Schedule A to compute the corporation's income or loss before adjustments for each applicable category of income.
• Use Schedule B to determine the total foreign tax credit after certain limitations.
• Use Schedule C to compute taxes deemed paid by the domestic corporation filing the return.
• Use Schedules D and E to compute taxes deemed paid by lower-tier foreign corporations.
• Use Schedule F to report gross income and definitely allocable deductions from foreign branches.
• Use Schedule G to report required reductions of tax paid, accrued, or deemed paid.
• Use Schedule H to apportion deductions that cannot be definitely allocated to some item or class of income.
• Use Schedule I (a separate schedule) to compute reductions of taxes paid, accrued, or deemed paid on foreign oil and gas extraction income.
• Use Schedule J (a separate schedule) to compute adjustments to separate limitation income or losses in determining the numerators of limitation fractions, year-end recharacterization balances, and overall foreign loss account balances.

Categories of Income

Compute a separate foreign tax credit for each applicable separate category described below.

Passive Income

Generally, passive income is:

• Any income received or accrued that would be foreign personal holding company income (defined in section 954(c)) if the corporation were a controlled foreign corporation (CFC) (defined in section 957). This includes any gain on the sale or exchange of stock that is more than the amount treated as a dividend under section 1248. However, in determining if any income would be foreign personal holding company income, the rules of section 864(d)(6) will apply only for income of a CFC.
• Any amount includible in gross income under sections 551 and 1293 (which relate to foreign personal holding companies and certain passive foreign investment companies).

Passive income does not include:

• Any income that belongs in one of the other separate categories described below,
• Any export financing interest unless it is also related person factoring income (see section 904(d)(2)(G) and Regulations section 1.904-4(h)(3)),
• Any high-taxed income (see General Limitation Income on page 2), or
• Any active rents or royalties. See Regulations section 1.904-4(b)(2) for definitions and exceptions.

Note: Certain income received from a CFC that would otherwise be passive income may be assigned to another separate category under the look-through rules. See Look-Through Rules on page 2.

High Withholding Tax Interest

High withholding tax interest is any interest subject to a withholding tax or other gross basis tax of a foreign country or U.S. possession at a rate of 5% or more.

High withholding tax interest does not include export financing interest (section 904(d)(2)(B)(ii)).

Financial Services Income

Financial services income is income received or accrued while the corporation was a financial services entity if the income is:

• Described in section 904(d)(2)(C)(ii),
• Passive income (determined without regard to section 904(d)(2)(A)(iii)(I) and (III)),
• Export financing interest (section 904(d)(2)(G)) that would be high withholding tax interest but for section 904(d)(2)(B)(ii), or
• Incidental income described in Regulations section 1.904-4(e)(4).

Financial services income does not include:

• Any high withholding tax interest,
• Any dividend from a noncontrolled section 902 corporation, and
• Any export financing interest not described in section 904(d)(2)(C)(i)(III).

Special rules apply for affiliated groups. See Regulations section 1.904-4(e)(3)(ii).

Shipping Income

Shipping income is any income the corporation receives or accrues that is of a kind that would be foreign base company shipping income (section 954(f)).

Shipping income does not include:

• Dividends from a noncontrolled section 902 corporation,
• Financial services income,
• High withholding tax interest, or
• Foreign trade income.

Dividends From Each Noncontrolled Section 902 Corporation

Dividends from each noncontrolled section 902 corporation are treated as a separate category of income. Therefore, the corporation must use a separate Form 1118 for dividends received from each noncontrolled section 902 corporation (see below).

A noncontrolled section 902 corporation is any foreign corporation in which the taxpayer (domestic corporation) meets the stock ownership requirements of section 902(a) (or, in applying the look-through rules (described below), the CFC receiving the dividend meets the requirements of section 902(b)).

Generally, a CFC is not treated as a noncontrolled section 902 corporation for any distribution out of its earnings and profits (E&P) for periods when it was a CFC. Dividends received from a CFC are assigned to other separate categories under the look-through rules. Exceptions apply. See Look-Through Rules below.

Also, see the special rule in section 904(d)(2)(E)(ii) that reduces the creditable taxes on high withholding tax interest of a noncontrolled section 902 corporation. Report the reduction on line E of Schedule G.

If the corporation has dividends from more than one noncontrolled section 902 corporation, complete a separate Form 1118 for dividends received from each of those corporations. Each separate form must identify the name and country of incorporation of each noncontrolled section 902 corporation in the space provided after the check box at the top of page 1. Complete part of an additional Form 1118 that shows the totals of all the separate Forms 1118 for each noncontrolled section 902 corporation. On page 1 of this summary form, enter the word Aggregate in the space provided for Name of Foreign Corporation at the top of the form and complete Schedule A and Schedule B, Part I.

Dividends From a DISC or Former DISC

This category includes dividends from a DISC or former DISC (as defined in section 992(a)) that are treated as income from sources outside the United States.

Taxable Income Attributable to Foreign Trade Income

This category includes taxable foreign trade income within the meaning of section 923(b), as in effect before its repeal.

Certain Distributions From a FSC or Former FSC

This category includes:

• Distributions from a FSC (or former FSC) out of E&P attributable to foreign trade income and
• Interest or carrying charges from a transaction that results in foreign trade income.

Section 901(j) Income

No credit is allowed for foreign taxes imposed by and paid or accrued to certain sanctioned countries. However, income derived from each such country is subject to a separate foreign tax credit limitation. Therefore, the corporation must use a separate Form 1118 for income derived from each such country. On each Form 1118, check the box for section 901(j) income at the top of page 1 and identify the applicable country in the space provided.

Sanctioned countries are those designated by the Secretary of State as countries that repeatedly provide support for acts of international terrorism, countries with which the United States does not have diplomatic relations, or countries whose governments are not recognized by the United States. As of the date these instructions were revised, sanctioned countries include Cuba, Iran, Iraq, Libya, North Korea, Sudan, and Syria. For more information, see section 901(j).

Note: For periods beginning on or after February 1, 2001, the President of the United States has the authority to waive the denial of the credit with respect to a foreign country if it is (a) in the national interest of the United States and will expand trade and investment opportunities for U.S. companies in such foreign country and (b) the President reports to the Congress, not less than 30 days before the waiver is granted, the intention to grant such a waiver and the reason for such waiver.

If the corporation paid taxes to a country that ceased to be a sanctioned country during the tax year, see Rev. Rul. 92-62, 1992-2 C.B. 193, for details on how to figure the foreign tax credit for the period that begins after the end of the sanctioned period.

Income Re-sourced by Treaty

If a sourcing rule in an applicable income tax treaty treats any of the income described below as foreign source, and the corporation elects to apply the treaty, the income will be treated as foreign source.

• Dividends eligible for the dividends received deduction (section 245(a)(10)).
• Certain gains (section 865(h)).
• Certain income from a U.S.-owned foreign corporation (section 904(g)(10)). See Regulations section 1.904-5(m)(7) for an example.

Important: The corporation must compute a separate foreign tax credit limitation for any such income for which it claims benefits under a treaty, using a separate Form 1118 for each amount of re-sourced income from a treaty country. On each Form 1118, check the box for income re-sourced by treaty at the top of page 1 and identify the applicable country in the space provided.

General Limitation Income

This category includes all income not described above. This includes high-taxed income that would otherwise be passive income. Usually, income is high-taxed if the total foreign income taxes paid, accrued, or deemed paid by the corporation for that income exceed the highest rate of tax specified in section 11 (and with reference to section 15, if applicable), multiplied by the amount of such income (including the amount treated as a dividend under section 78). For more information, see Regulations section 1.904-4(c).

Special Rules

Source Rules for Income

Determine income or (loss) for each separate category on Schedule A using the general source rules of sections 861 through 865 and related regulations; the special source rules of section 904(g) described below; and any applicable source rules contained in any applicable tax treaties.

Special source rules of section 904(g). Usually, the following income from a U.S.-owned foreign corporation, otherwise treated as foreign source income, must be treated as U.S. source income under section 904(g):

• Any subpart F income, foreign personal holding company income, or income from a qualified electing fund that a U.S. shareholder is required to include in its gross income, if such amount is attributable to the U.S.-owned foreign corporation's U.S. source income;
• Interest that is properly allocable to the U.S.-owned foreign corporation's U.S. source income; and
• Dividends equal to the U.S. source ratio (defined in section 904(g)(4)(B)).

The rules regarding interest and dividends described above do not apply to a U.S.-owned foreign corporation if less than 10% of its E&P for the tax year is from U.S. sources.

Look-Through Rules

Generally, dividends, interest, rents, and royalties received or accrued by the corporation are passive income. However, if these items are received or accrued from a CFC, they may be assigned to other separate categories under the look-through rules of section 904(d)(3). This includes:

• Interest, rents, and royalties based on the amount allocable to E&P of the CFC in a separate category; and
• Dividends paid out of the E&P of a CFC in proportion to the ratio of the CFC's E&P in a separate category to its total E&P. Dividends include any amount included in gross income under section 951(a)(1)(B).

Look-through rules also apply to subpart F inclusions under section 951(a)(1)(A) to the extent attributable to E&P of the CFC in a separate category.

For more information and examples see section 904(d)(3), Regulations section 1.904-4(g)(3), and Regulations section 1.904-5.

Look-through rules also apply to foreign source interest, rents, and royalties paid by a U.S. corporation to a related corporation. See Regulations section 1.904-5(g).

Reporting Foreign Tax Information From Partnerships

If you received a Schedule K-1 from a partnership that includes foreign tax information, use the rules below to report that information on Form 1118.

Gross income sourced at partner level. This includes income from the sale of most personal property other than inventory, depreciable property, and certain intangible property sourced under section 865. This gross income will generally be U.S.-source and therefore will not be reported on Form 1118.

The remaining lines of the foreign tax section of the Schedule K-1 are reported on Form 1118 as follows.

Foreign gross income sourced at partnership level. Report on Schedule A.

Deductions allocated and apportioned at partner level and partnership level. Report on Schedule A or Schedule H.

Total foreign taxes paid or accrued. Report on Schedule B.

Reduction in taxes available for credit. Report on Schedule G.

Capital Gains

Foreign source taxable income or (loss) before adjustments in all separate categories in the aggregate should include gain from the sale or exchange of capital assets only up to the amount of foreign source capital gain net income (which is the smaller of capital gain net income from sources outside the United States or capital gain net income). Therefore, if the corporation has capital gain net income from sources outside the United States in excess of the capital gain net income reported on its tax return, enter a pro rata portion of the net U.S. source capital loss as a negative number on Schedule A, column 9(d) for each separate category with capital gain net income from sources outside the United States. To figure the pro rata portion of the net U.S. source capital loss attributable to a separate category, multiply the net U.S. source capital loss by the amount of capital gain net income from sources outside the United States in the separate category divided by the aggregate amount of capital gain net income from sources outside the United States in all separate categories with capital gain net income from sources outside the United States.

See section 904(b)(2)(B) for special rules regarding adjustments to account for capital gain rate differentials (as defined in section 904(b)(3)(D)) for any tax year. At the time these instructions went to print, there was no capital gain rate differential for corporations.

Coordination with Section 936

In computing the foreign tax credit limitation, exclude from taxable income any income taken into account in computing the possessions corporation tax credit under section 936 (without regard to sections 936(a)(4) and 936(i)) or section 30A.

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