Foreign Corporate Taxation

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A majority, although not an overwhelming majority, of developed countries other than the U.S. have what is known as an "integrated" corporate tax system. This means that the system is designed to reduce the extent to which corporate profits earned at the corporate level are taxed again at the individual level, as they are in the United States.

The most common way of doing this is some variant of what is known as the "Dividend Withholding Tax" concept. When profits are earned by a corporation under DWT, they are subject to corporate taxation at a flat rate, often 1/3rd of all profits. Then, when profits are distributed as dividends (if every), the shareholders are treated as if they got a distribution gross up to reflect the taxes taken out of those corporate profits and a tax credit to match.

For example, suppose a corporation has $3,000 of profits in a year. It would pay $1,000 in dividend withholding taxes on those profits, leaving it with $2,000 of cash in the bank. If that money is never distributed, the dividend withholding tax is effectively a final corporate tax. But, suppose that the $2,000 is distributed to a shareholder. That shareholder will have to report a grossed up $3,000 of income on his individual income tax return, but will get a $1,000 tax credit to reflect the taxes already paid at the corporate level. Assuming this taxpayer has a tax rate similar to the corporation, the dividend is effectively tax free income.

However, under most dividend withholding tax schemes, tax exempt shareholders (who have a zero tax rate) don't get to claim a refund of their tax credit, and foreign shareholders both don't get the refund, and don't have to file a tax return in the country where the corporation was taxed.

One argument for integration of corporate and individual income taxes is to give U.S. companies a competitive position from a tax perspective with foreign corporations that have such a regime.

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