In this video, I explain the dividend received deduction or participation example as it relates to international taxation and covered on tax compliance and planning TCP CPA exam.
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In a territorial tax system, the main way to avoid taxing the same income twice is through either a participation exemption or a dividends-received deduction (DRD). Here's what each means:

Participation Exemption: This rule lets taxpayers not pay taxes on foreign income. Essentially, if a company in one country earns profits through its investments in another country, the home country won't tax those profits.

Dividends-Received Deduction (DRD): This provision allows taxpayers to reduce their taxable income by the amount of dividend income they've received from abroad. In other words, when a company receives dividend payments from its foreign investments, it can deduct those amounts from its income, reducing the total amount of income subject to tax.

Unlike the worldwide tax system, where a country taxes its residents on their global income regardless of where it's earned, the territorial system taxes income only where it's earned. This means if a taxpayer earns income in a country with lower taxes, they won't face additional taxes from their home country to "top up" to the home country's tax rate. Therefore, taxpayers operating in a low-tax jurisdiction are taxed at the same rate as local businesses in that jurisdiction, without facing extra taxes from their home country for bringing that income back home.

In the United States, a corporation can avoid paying U.S. taxes on dividends it receives from foreign companies if it owns at least 10% of the foreign company. This is done by using a 100% dividends-received deduction (DRD), which means the U.S. corporation can deduct the full amount of the foreign dividend from its taxable income, effectively exempting that income from U.S. taxes.

When dividends are sent back to the U.S. from overseas, no additional U.S. taxes are levied on this money. Therefore, the U.S. doesn't tax the repatriated foreign earnings under this rule.

However, this tax benefit is not available to 10% shareholders that are not U.S. corporations. In other words, individual investors or entities that don't qualify as U.S. corporations cannot use the DRD to exempt their foreign dividend income from U.S. taxation, even if they own 10% or more of the foreign company.




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