Foreign tax credit (FTC)
Generally, in any year, a taxpayer can choose whether to take as a credit (subject to limitation) or as a deduction foreign income, war profits, and excess profit taxes paid or accrued during the tax year to any foreign country or US possession. An FTC reduces US income tax liability dollar for dollar, while a deduction reduces the US income tax liability at the marginal rate of the taxpayer. For taxpayers with NOLs, the FTC is of no value in such year. However, a benefit might be received either in an earlier year (through a refund of previously paid taxes) or a later year (through a reduction of future taxes). It also should be noted that a taxpayer has an ability to switch from deduction to credit at any time in a ten-year period commencing when the foreign taxes were paid or accrued. Generally, an FTC may be carried back one year and, if not fully used, carried forward ten years.
In addition, the FTC goes beyond direct taxes to include foreign taxes paid 'in lieu of' a tax upon income, war profits, or excess profits, which would otherwise generally be imposed. It also includes deemed-paid (indirect) taxes paid for certain US corporate shareholders of non-portfolio foreign corporations. FTCs (and foreign tax deductions) are disallowed for foreign taxes paid on amounts that are eligible for the new 100% DRD. Furthermore, the FTC system has numerous other limitations to mitigate the potential abuses of the credit by the taxpayer.
General business credit
Various business credits are available to provide special incentives for the achievement of certain economic objectives. In general, these credits are combined into one 'general business credit' for purposes of determining each credit's allowance limitation for the tax year. The general business credit that may be used for a tax year is limited to a tax-based amount. In general, the current year's credit that cannot be used in a given year because of the credit's allowance limitation may be carried back to the tax year preceding the current year and carried forward to each of the 20 years following the current year.
In general, the current year business credit is a combination of the following credits for 2020:
- Investment credit.
- Work opportunity credit.
- Alcohol fuels credit.
- Research credit.
- Low-income housing credit.
- Disabled access credit for certain eligible small businesses.
- Renewable electricity production credit.
- Indian employment credit.
- Employer social security credit.
- Orphan drug credit.
- New markets tax credit.
- Small employer pension plan start-up cost credit for eligible employers.
- Employer-provided child care credit.
- Railroad track maintenance credit.
- Biodiesel fuels credit.
- Low sulphur diesel fuel production credit.
- Distilled spirits credit.
- Non-conventional source fuel production credit.
- New energy efficient home credit.
- Energy efficient appliance credit.
- A portion of the alternative motor vehicle credit.
- A portion of the alternative fuel vehicle refuelling property credit.
- Mine rescue team training credit.
- Agricultural chemicals security credit.
- Employer differential wage payments credit.
- Carbon oxide sequestration credit.
- A portion of the new qualified plug-in electric drive motor vehicle credit for vehicles that will vary based on the date of purchase.
A Work Opportunity Tax Credit (WOTC) is available through 2025 for qualified wages paid to certain types of workers. 'Qualified' wages generally are the first USD 6,000 of wages paid to each qualified employee for the year. The credit is a general business credit equal to 25% of qualified first-year wages for employees employed at least 120 hours but fewer than 400 hours, and 40% of qualified wages for those employed 400 hours or more, for a maximum credit of USD 2,400 per qualified employee.
Qualified tax-exempt organisations may claim the WOTC as a credit against payroll taxes for hiring qualified veterans.
Research credit and orphan drug credit
The Credit for Increasing Research Activities under Section 41 (R&D credit) is available for companies that incur qualified research expenditures (QREs) to develop new or improved products, manufacturing processes, or software in the United States. The R&D credit was enacted in 1981 on a temporary basis to help increase R&D spending in the United States. Since then, the R&D credit has been extended on a temporary basis about 16 times, but was extended, retroactively to 1 January 2015, on a permanent basis as part of the Consolidated Appropriations Act, 2016.
The R&D credit generally is computed by calculating current-year QREs over a base. The base is calculated using either the regular research credit (RRC) method or the alternative simplified credit (ASC) method. Under the RRC method, the credit equals 20% of QREs for the tax year over a base amount established by the taxpayer in 1984 to 1988 or by another method for companies that began operations after that period.
The ASC equals 14% (for the 2009 tax year and thereafter) of QREs over 50% of the average annual QREs in the three immediately preceding tax years. If the taxpayer has no QREs in any of the three preceding tax years, the ASC may be 6% of the tax year’s QREs. The taxpayer must make a timely ASC election on Form 6765 attached to an originally filed return filed by the due date for that return (including extensions), or, pursuant to final regulations published in February 2015, an amended return (subject to certain limitations).
Taxpayers may take a 20% credit for incremental payments made to qualified organisations for basic research. For tax years ending after 8 August 2005, taxpayers also may take the Energy Research Consortium Credit, which provides a 20% credit for expenditures on qualified energy research undertaken by an energy research consortium.
The deduction for R&D expenditures under Section 174 must be reduced by the entire amount of the R&D credit unless an election is made on Form 6765 to reduce the amount of the credit.
The orphan drug credit (ODC), found in Section 45C, provides a credit for qualified clinical trial expenses (QCTEs) relating to so-called 'orphan drugs' (i.e. certain drugs intended to treat rare diseases or conditions that are designated as such by the FDA). For tax years beginning prior to 1 January 2018, the ODC equals 50% of QCTEs for the tax year. For years beginning on or after 1 January 2018, the ODC rate is reduced to 25% of such amounts and taxpayers may consider a reduced credit election. Similar to the research credit, the deduction for ODC expenditures under Section 174 must be reduced by the entire amount of the ODC credit unless an election is made on Form 8820 to reduce the amount of the credit.
For ODC purposes, QCTEs, as defined in Section 45C(b)(1)(A), are amounts paid or incurred by the taxpayer that would be described as QREs under Section 41(b), with two modifications. First, ‘clinical testing’ is substituted for ‘qualified research’ in Sections 41(b)(2) and (3). Second, 100% (as opposed to 65% or 75%) of contract research expenses is treated as clinical testing expenses.
For more information about the ODC, please see the pertinent PwC Tax Insight from Pharmaceutical and Life Sciences and Research & Development at www.pwc.com/us/en/tax-services/publications/insights/assets/pwc-clinical-testing-costs-incurred-after-aad-count-toward-odc.pdf.
Inbound investment incentives
There generally are limited incentives related to inbound investment at the federal level, such as certain portfolio debt and bank deposit exceptions and trading safe harbours. The portfolio debt exception enables non-residents and foreign corporations to invest in certain obligations (which must meet certain statutory and regulatory requirements to qualify as 'portfolio debt') in the United States without being subject to US income (or withholding) tax on the interest income. The bank deposit exception allows non-US investors to deposit funds in US banking institutions without being subject to US tax on the interest earned, provided that the investment meets the statutory definition of a ‘deposit’ and the funds are held by persons carrying on a banking business, or certain other supervised institutions. There also are statutory securities and commodities trading safe harbours that provide exceptions from being treated as engaged in a US trade or business for non-US persons trading in stocks, securities, or commodities through a resident broker, commission agent, custodian, or other independent agent. Certain state and local benefits may also be available.
Qualified private activity bonds
Interest income received on certain qualified private activity bonds generally is exempt from federal income tax. This enables a business enterprise to issue the bonds at a lower interest rate.
Other credits and incentives
The federal, state, and local governments provide numerous incentives to encourage business investment and, thus, employment in their jurisdictions. Credits and incentives can assist in the reduction of costs and may provide cash to help offset costs related to investments, job creation, expansion, and the opening of new facilities. Some of the most common credits and incentives include cash grants, property and sales/use tax abatement, utility rate reductions, and other tax benefits, such as credits and tax holidays.