Madrid Corporation is a 100 percent owned Spanish subsidiary of DoubloonCorporation, a U.S. corporation. Madrid had post-1986 earnings and profits of€4,200,000 and post-1986 foreign taxes of $2,700,000. During the current year, Madrid paid a dividend of €2,100,000 to Doubloon. Assume an exchange rate of €1 = $1.50. Compute the tax consequences to Doubloon as a result of this dividend.

Question

Quizplus · Accepted Answer

The taxable income of Doubloon will be the gross amount of the dividend received from its Spanish subsidiary, which is €2,100,000 converted to dollars at the given exchange rate of €1=$1.50, resulting in $3,150,000. 
The deemed paid foreign tax credit will be the lesser of the foreign taxes actually paid (€2,700,000) or the foreign tax credit limitation, which is calculated by multiplying the U.S. tax on the dividend ($3,150,000 x 21%) by the ratio of the post-1986 earnings and profits to the foreign dividend ($4,200,000/€2,100,000).

Deemed paid foreign tax credit = $3,150,000 x 21% x ($4,200,000/€2,100,000) = $1,350,000.

Therefore, the correct answer is D, with a taxable income of $4,500,000 and a deemed paid foreign tax credit of $1,350,000.

Madrid Corporation Is a 100 Percent Owned Spanish Subsidiary of DoubloonCorporation