Problem 1. Tax Time. Smithy International Inc. is a domestic corporation that earns $50 million of income from operations from U.S. sources and $50 million of income from operations from foreign sources, $40M of the foreign source income is earned through a qualified 10% owned foreign subsidiary in Luxemborg called Smithy-Lux and $10M its foreign source income is earned through a branch in Canada. Smithy also pays $1,000,000 in interest (not deducted to determine income from domestic or foreign operations above) on its company line of credit to Deutsch Bank, a foreign bank with 15% U.S. operations.

a. Assuming Smithy pays $1,500,000 in taxes on its Canadian income in Canada, what will be the U.S. tax liability associated with Smithy's income from its Canadian branch? How might Smithy reduce its tax liability associated with this income?

b. If Smithy-Lux is taxed as a partnership in Luxemborg and as a corporation in the U.S., what are the tax consequences under the default rules? How might the OECD BEPS program close this gap to ensure that profits in foreign subsidiaries do not "disappear" from taxation?

c. Assume that included in Smithy-Lux's income is a $5M royalty paid by Smithy (deducted by Smithy against its U.S. income) for intellectual property that was assigned to Smithy-Lux five years ago. If the tax rate in Luxemborg is only 2.5% then how much taxes savings does this royalty arrangement generate for Smithy (disregarding the FDII, GILTI, and BEAT)? If Smithy's total deductions are $75M, calculate how the BEAT would likely impact the tax incentives for this royalty arrangement. Also, describe how FDII and GILTI might impact this and future similar royalty arrangements.