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US Treasury to Tighten Rules for Foreign Tax Credits

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Sep 20th 2016
Managing Editor/Author Thomson Reuters
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Following the European Commission’s state-aid decision regarding Apple (see BEPS Action 5), the US Treasury Department issued Notice 2016-52 on Sept. 15 stating that the IRS and Treasury intend to issue new regulations under Code Section 909 that will prevent a company that has been the subject of a foreign-initiated adjustment from obtaining foreign tax credits where the related income has not been included in US taxable income.

This is commonly referred to as a foreign tax credit splitting event.

In anticipation of a large foreign-initiated adjustment that relates to a prior taxable year, a taxpayer may take steps to separate the additional payment of foreign income tax from the income to which it relates. Such foreign-initiated adjustments may arise under European Commission state aid, to the extent state aid payments result in creditable foreign taxes.

Before a payment is made pursuant to a foreign-initiated adjustment, a taxpayer may attempt to change its ownership structure or cause the Section 902 corporation (defined in section 909(d)(5)) to make an extraordinary distribution so that the subsequent tax payment creates a high-tax pool of post-1986 undistributed earnings that can be used to generate substantial amounts of foreign taxes deemed paid, without repatriating and including in US taxable income the earnings and profits to which the taxes relate.

The notice says that the intended regulations will address changes in ownership structures that, in connection with a foreign-initiated adjustment, result in a foreign tax credit splitting event. These regulations will provide that a splitter arrangement arises when, as a result of a “covered transaction,” a Section 902 corporation pays “covered taxes” during a taxable year (the “splitter year”).

Treasury and the IRS are asking for comments on the rules described in the notice, including the following:

  • Whether the transactions addressed in section 3 of the notice would be more appropriately addressed pursuant to rules under Section 905(c), providing that additional payments of tax be accounted for through adjustments to the pools of post-1986 foreign income taxes and post-1986 undistributed earnings of Section 902 corporations that are not the same entity as the payor of the tax.
  • Whether an objective test, rather than a subjective test based on taxpayer intent, should be used to determine when the transactions described in sections 3.01 and 3.02 of the notice are treated as splitter arrangements.

Treasury and IRS are making no inferences as to whether:

  • Payments made pursuant to any particular foreign-initiated adjustment, including those arising under European Commission state aid, qualify as payments of creditable foreign income taxes, or
  • Taxes paid by a US person pursuant to a foreign-initiated adjustment to the tax liability of a Section 902 corporation are eligible for a direct foreign tax credit under Section 901.

The regulations described in section 3 of the notice will apply to foreign income taxes paid on or after Sept. 15, 2016. Comments must be received by Dec. 14, 2016.

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