In this chapter we will focus on the taxation of residents on active income, and the central focus will be on the foreign tax credit. The foreign tax credit may be the most important element in U.S. multinational tax planning, and it is important to understanding the ways in which companies structure their operations. In addition, as a general international tax matter, every country that has a global tax system and hopes to avoid double taxation must give a foreign tax credit.

A foreign tax credit is different from a deduction. A deduction is an item that reduces gross income to net taxable income and therefore has a worth equal to the tax rate. For an American corporation with a tax rate of 35 percent, each dollar in deduction is worth 35 cents. By contrast, a credit is an item that reduces the actual tax paid. For the same American business in the 35 percent bracket, a dollar of credit is worth one full dollar. Thus, even though the American foreign tax credit is elective, a credit is preferable to a deduction in almost all cases.

Consider an American corporation with a foreign income of 100 subject to foreign tax at a rate of 35 percent and U.S. tax at a rate of 35 percent. The company's U.S. gross income before deduction is 100, and its U.S. net income is 65 (the original 100 less the foreign tax).