A U. S. company is planning to form a foreign subsidiary to undertake a profitable project in a country where the tax rate is 25%. The company’s tax rate in the United States is 35%.
a. If the withholding tax rate on dividends paid from the foreign country to the United States is 20%, how much U. S. taxable income will be recognized for each dollar of dividends received by the U. S. parent?
b. Assuming this income is the only foreign- source income for the U. S. company, what will be the additional U. S. tax liability after foreign tax credit for each dollar of dividend received?
c. Suppose all foreign profits could be repatriated to the U. S. parent by way of interest payments on debt rather than by way of dividend payments. This move would reduce foreign taxable income to zero. How much more or less worldwide profit after tax would result for a 1- year investment horizon per dollar of foreign income before interest and foreign taxes if withholding tax rates on interest were 0%? If withholding tax rates on interest were 30%?
d. Suppose that profits earned in the foreign country can be reinvested at a rate of 10% before interest and taxes, the same as in the United States. How does the desirability of debt versus equity financing change as the investment horizon increases?