The Future of the Foreign Tax Credit Steptoe Johnson.pptx

thefutureoftheforeigntaxcredit philipr weststeptoe johnsonllp universityofchicagolawschool64thannualfederaltaxconferencenovember11 12 2011 overviewofforeigntaxcreditrules 2 basicoverview u s taxpayersaregenerallysubjecttou s taxontheirworldwideincome butmaybeprovidedataxcreditforforeignincometaxespaidoraccrued directcredit taxpayerreceivesthecreditfortaxesitpaiditself indirect or deemedcredit u s corporationthatownsatleast10percentofthevotingstockofaforeigncorporationmayreceiveacreditfortheforeigntaxespaidbyitssubsidiarieswhentherelatedincomeisdistributedasadividendorincludedintheu s corporation sincomeundersubpartfalternatively ataxpayermaydeductforeigntaxes 3 briefforeigntaxcredithistory enactedintherevenueactof1918 whichpassedin1919 aseparatelimitationfornon businessinterestincomewasaddedin1962 1919 1921 1932 1954 1960 2010 2004 1986 1976 4 whoisthetaxpayerentitledtothecredit technicaltaxpayer rule thetaxpayerentitledtothecreditisthetaxpayerlegallyliablefortheforeigntaxunderforeignlawbiddlewhathappenswheretaxpayerthatislegallyliablefortheforeigntaxisdifferentfromthetaxpayerthattakestheassociatedforeignincomeintoaccount guardianproposedlegalliabilityregulationssection909 5 whatforeigntaxesarecreditable mustbeataxcompulsorypaymentleviedpursuanttotheauthorityofaforeigncountrytolevytaxesnotataxtotheextentapersonreceivesaspecificeconomicbenefitinexchangeforpaymenttwomaintypesoftaxessection901 foreigntaxeson income warprofitsorexcessprofits predominantcharacter ofthetaxmustbeofanincometaxintheu s sensetaxmustbe likelytoreachnetgaininthenormalcircumstancesinwhichitapplies imposedonorsubsequenttorealizationimposedonthebasisofgrossreceiptsbaseofthetaxmustbecomputedbyreducinggrossreceiptstopermitrecoveryofsignificantcostsanexpensesliabilitymustnotbedependentontheavailabilityofacreditforthetaxinanothercountry i e mustnotbea soak up tax section903 foreigntaxesimposed in lieu of anincometaxmustbeimposedasasubstitutionforanincometaxmustnotbea soak up tax 6 whatforeigntaxesarecreditable recentcaselaw incompaniondecisionsinpplcorp v commissioner 135t c no 15 sept 9 2010 andentergyv commissioner t c memo 2010 166 thetaxcourtrecentlyconcludedthata1997windfallprofitstaximposedbytheu k governmentisacreditabletaxforpurposesofsection901 intheearly1990s theu k governmentprivatizedwhathadpreviouslybeengovernment ownedutilities onceprivatized thecompaniesbecameveryprofitable in1997 thenewgovernmentannounceda windfallprofits taxonthecompanies thetaxwasaone time23 taxonthe windfall tothecompanies whichwascalculatedasthedifferencebetweenthecurrentvalueofthecompany calculatedbyreferencetoaveragebookprofitsofthecompanyoverthefirstfouryearsfollowingprivatizationmultipliedbyaprice to earningsratioofnine andthevalueplacedonthecompanyuponprivatization 7 whatforeigntaxesarecreditable recentcaselaw theirsarguedthatonlythetermsofthewindfalltaxstatuteitselfcouldbeconsideredandthat consideringonlythewordsofthestatute thetaxfailedthepredominantcharactertest thetaxpayerarguedthatextrinsicevidenceofthepurposeandeffectofthetaxshouldbeconsideredindeterminingcreditability thetaxpayercitedexperttestimonythatthewindfalltaxwas insubstance ataxonincome andthatthetaxcouldberestatedalgebraicallytomakeclearthatitoperatedasanexcessprofitstaximposedatanapproximately51 7 rate thecourtheldforthetaxpayer thecourtstatedthatcasespredatingthecurrent predominantcharacter regulations andcitedinthepreambletothoseregulations wererelevant thosecasesconsideredtheformandeffectoftheforeigntaxesindeterminingcreditability thecourtthenconcludedthatthetaxmetthe predominantcharacter standard statingthat aforeignlevy can bedirectedatnetgainorincomeeventhoughitis byitsterms imposedsquarelyonthedifferencebetweenthetwovalues thecaseshavebeenappealedtotheu s courtofappealsforthethird ppl andfifth entergy circuits 8 whenisataxcompulsory paymentisnotcompulsorytotheextentthattheamountpaidexceedstheamountofliabilityunderforeignlawfortaxanamountdoesnotexceedliabilityifamountisdeterminedbythetaxpayerinamannerthatis consistentwithreasonableinterpretationandapplicationofthesubstantiveandproceduralprovisionsofforeignlaw includingapplicabletaxtreaties insuchawayastoreduce overtime thetaxpayer sreasonablyexpectedliabilityunderforeignlawfortax must exhaust alleffectiveandpracticalremedies includinginvocationofcompetentauthorityprocedures 9 whenisataxcompulsory recentcaselaw intherecentcaseprocter gambleco v unitedstates 106a f t r 2d2010 5311 s d ohio2010 afederaldistrictcourtheldthatataxpayermustinitiatecompetentauthorityproceedingsevenwheredoubletaxationarisesbecauseofconflictingclaimsbytwoforeigncountries asopposedtobetweentheunitedstatesandaforeigncountry p g u s p gnea singapore japaneseandkoreancustomers products p gnea sprincipalofficewaslocatedinjapanp gwithholdsandpaystaxtojapan10 ofroyaltypaymentsrelatingtoallsaleskoreantaxauthoritiesclaimtheroyaltiespaidwithrespecttosalestokoreancustomersarekorean sourceandsubjecttokoreanwithholdingtaxata15 rate aswellasalocalsurcharge royaltiesassociatedwithproductssold 10 whenisataxcompulsory recentcaselaw procter gamble p g claimedacreditforjapanesetaxespaidinseveraltaxableyears inalateryear thekoreantaxauthorizesdeterminedthattheincomewithrespecttowhichthejapanesetaxeshadbeenpaidwasalsosubjecttotaxinkorea theirsdisallowedp g sclaimforaforeigntaxcreditforthekoreantaxes thecourtheldthat a lthoughp gwasrequiredtopaykoreantax andwasreasonablyadvisedastothelegalityandaccuracyofthekoreanclaimbyitskoreancounsel p gfailedto exhaustalleffectiveandpracticalremediesincludinginvocationofcompetentauthorityproceduresavailableunderapplicabletaxtreaties toreducethetaxliabilityowedtojapan althoughtheirshadchallengedthecreditabilityofthekoreantaxandnotthejapanesetax thecourtdeterminedthatthejapanesepaymentswerenotcompulsoryandthatp gwasentitledtoacreditforonlythepaymentsmadetokorea althoughthecourtultimatelydidnotpermitacreditforbothtaxes itstated i tmaywellbethatmultiplecountriescanclaimtaxonasinglesourceofincomeandthattheirsisrequiredtograntcreditsfortheseclaims 11 whatamountofforeigntaxesiscreditable aforeigntaxcreditgenerallyislimitedtoataxpayer su s taxliabilityonitsforeign sourcetaxableincome computedunderu s taxaccountingprinciples foreigntaxcreditlimitation limitationisappliedseparatelytobaskets passivecategoryincomegeneralcategoryincomesourcerulesandallocation apportionmentruleskeyincalculatingforeigntaxcredit 12 whatamountofforeigntaxesiscreditable interestallocationrules interestallocationundercurrentlaw undersection864 e anaffiliatedgroupmustallocateandapportionitsinterestexpensebasedonafractioncomputedbyreferencetotheassets measuredbyfairmarketvalueorbasis oftheentiregrouprecognizesmoneyisfungible butextendsthisprincipleonlytothewater sedge i e obligationsandassetsofforeignaffiliatesareexcluded stockofforeignaffiliatesistreatedasaforeignasset 13 u s group cfc u s group 1 000interestexpense 1 000u s sourcetaxableincomeafterinterestexpense cfc 1 000interestexpense 1 000foreign sourceincomeafterinterestexpense 300foreigntaxes assume50 foreignassetscfc sinterestexpenseisallocatedentirelyagainstitsforeignsourceincomeu s group sinterestexpenseisallocatedinpartagainstu s sourceincomeandinpartagainstforeign sourceincomebecauseu s grouphas1 2foreignassets 50 ofthe 1 000interestexpenseisallocatedtoforeignsourceincomeforpurposesoftheftclimitation u s grouphas 500foreignsourceincome 700 300gross up 500 andwillhavea 175ftclimitation 35 x 2 000 x 500 2000 givingit 175increditsand 125carryover 700 whatamountofforeigntaxesiscreditable interestallocationrules in2004 congressenactedaworldwideinterestallocationrule whichwouldallowtheinterestexpenseandassetsofforeignaffiliatestobetakenintoaccount interestexpenseofdomesticmembersofworldwideaffiliatedgroupisallocatedandapportionedtoforeign sourceincomeonlytotheextentthat 1 thetotalinterestexpenseoftheworldwideaffiliatedgroup multipliedbytheratiowhichtheforeignassetsofthegroupbeartothetotalassetsofthegroup exceeds 2 theinterestexpenseoftheforeignmembersoftheworldwidegroupthattheywouldhaveallocatedandapportionedtoforeignsourceincomehadtheyformedtheirownseparategrouptheeffectivedateofthisrule originallytaxableyearsbeginningafterdecember31 2008 however hassincebeendelayeduntiltaxableyearsbeginningafterdecember31 2020 14 assume50 foreignassetsstep1 totalinterestexpense 2 000 x50 foreignassets 1 000step2 interestexpensethatwouldbeallocatedtocfcifcfcwereonlyentity 1 000 x100 foreignassets 1 000resultinstep1minusresultinstep2 0interestexpenseofu s groupisallocatedtoforeignsourceincomeforpurposesoftheftclimitation u s grouphas 1 000foreignsourceincome 700 300gross up 0interestallocation andwillhavea 350ftclimitation 35 x 2 000 x 1 000 2 000 andthuscanfullycreditthe 300inforeigntaxes u s group cfc u s group 1 000interestexpense 1 000u s sourcetaxableincomeafterinterestexpense cfc 1 000interestexpense 1 000foreign sourceincomeafterinterestexpense 300foreigntaxes 700 recentdevelopments 15 splitting offoreigntaxcredits guardianindustries guardian u s ihc u s gie lux luxsubsidiaries luxsubsidiaries luxsubsidiaries legallyliablefortheforeigntaxespaidonthesubsidiaries incomeunderluxembourglaw soentitledtoaforeigntaxcreditfortaxespaidonthesubsidiaries income asaresult inthisstructure iftheoperatingsubsidiariesdonotgeneratesubpartfincomeordistributedividendstotheholdingcompany theu s holdingcompanyisentitledtoforeigntaxcreditsonforeignincomenotsubjecttou s tax seeguardianindustriesv unitedstates 77f 3d1368 fed cir 2007 aff g65fedcl 50 2003 16 proposedlegalliabilityregulations in2006 treasuryandtheirsproposedregulations the proposedlegalliabilityregulations amendingthetechnicaltaxpayerregulations withrespecttoforeignconsolidated typeregimesinwhichforeigntaxisimposedonthecombinedincomeoftwoormorepersons includingthosewherethemembersofthegrouparenotjointlyandseverallyliableforthegroup stax aswasthecaseinguardian theproposedregulationsprovidethattheforeigntaxmustbeapportionedamongallthemembersproratabasedontherelativeamountsofnetincomeofeachmemberascomputedunderforeignlaw theregulationsprovide however thattheforeigntaxwouldnotbeconsideredimposedoncombinedincomemerelybecauseforeignlaw a permittedonepersontosurrenderalosstoanotherunderagroupreliefregime b requiredshareholderstoincludeamountsinincomeattributabletocorporatetaxesunderanintegratedtaxsystem or c requiredshareholderstoincludeinincomeamountsunderananti deferralregime theregulationsalsowouldrevisethetechnicaltaxpayerregulationstoprovidethatareversehybrid i e anentitythatisacorporationforu s taxpurposesbutaflow throughforforeigntaxpurposes isconsideredtohavelegalliabilityunderforeignlawforforeigntaxesimposedontheownersofthereversehybridinrespectofeachowner sshareofthereversehybrid sincome thereversehybrid sforeigntaxliabilitywouldbedeterminedbasedontheproportionoftheowner staxableincome computedunderforeignlaw thatisattributabletotheowner sshareofthereversehybrid sincome 17 recentforeigntaxcreditlegislation p l 111 226 officiallythe actof signedintolawaugust10 2010 containedseveralinternationaltax relatedprovisionsaffectingforeigntaxcreditstooffseteducationandmedicaidspending rulestopreventsplittingofforeigntaxcreditsdenialofcertainforeigntaxcreditsforcoveredassetacquisitionsseparateforeigntaxcreditlimitationforcertainitemsresourcedundertreatieslimitationonforeigntaxesdeemedpaidwithrespecttosection956inclusions 18 18 splitting offoreigntaxcredits section909 enactedinaugust2010 section909createsamatchingruletopreventtheseparationofcreditableforeigntaxesfromtheassociatedforeignincome ingeneral wherethereisa foreigntaxcreditsplittingevent withrespecttoforeignincometaxpaidoraccruedbythetaxpayer theforeignincometaxisnottakenintoaccountforu s taxpurposesbeforethetaxableyearinwhichtherelatedincomeistakenintoaccountbythetaxpayer rulealsoappliesforindirectcredits foreignincometaxpaidbyasection902corporation i e acorporationwithrespecttowhichau s corporationcanclaimadeemedpaidforeigntaxcredit aspartofasplittingeventistakenintoaccountinthetaxableyearinwhichtherelatedincomeistakenintoaccountbythatsection902corporation 19 19 splitting offoreigntaxcredits section909 a foreigntaxcreditsplittingevent ariseswithrespecttoaforeignincometaxiftherelatedincomeis orwillbe takenintoaccountforu s taxpurposesbya coveredperson a coveredperson is anyentityinwhichthepayorholds directlyorindirectly atleasta10 ownershipinterest determinedbyvoteorvalue anypersonthatholds directlyorindirectly atleasta10 ownershipinterest byvoteorvalue inthepayor anypersonthatbearsarelationshiptothepayordescribedinsection267 b or707 b andanyotherpersonspecifiedbythesecretary effectivedate appliestoforeignincometaxespaidoraccruedafterdecember31 2010 20 20 splitting offoreigntaxcredits section909 reversehybridexample usco adomesticcorporation whollyownscfc1 cfc1isorganizedincountryaandistreatedasapass throughentityforcountryapurposes cfc1istreatedasacorporationforu s taxpurposes cfc1isengagedinanactivebusinessthatgenerates 100ofincome countryahasa30 taxrate forcountryataxpurposes cfc searningspasstousco undercountryalaw uscoistreatedashavingpaid 30ofcountryatax undertheoldlaw theunitedstatesviewscfc1ashaving 100ofe pnotsubjecttocurrentu s taxanduscoashaving 30offoreigntaxesforwhichuscomayclaimadirectforeigntaxcredit underthenewlaw the 30directforeigntaxcreditissuspendeduntiltherelatedincomeisrecognizedforu s taxpurposes cfc1mustdistributeitsnetincomeof 100touscobeforethe 30directforeigntaxcreditisallowed cfc1 usco 50tax 100e p 21 21 splitting offoreigntaxcredits section909 othersituationsaffected disregardedpaymentsgroupreliefliquidationofpersonwhopaysoraccruestheforeignincometaxtransferpricingadjustments contributionsofinventoryresultinginshiftofdeductions differencesinthetimingofwhenincomeistakenintoaccountforu s andforeigntaxpurposes 22 22 splitting offoreigntaxcredits section909 notice2010 92 ondecember6 2010 treasuryandtheirsreleasednotice2010 92 thefirstofseveralitemsofpublishedguidance concerningtheforeigntaxcreditprovisionsofsection909 theguidanceprimarilyaddressestheapplicationofsection909toforeignincometaxespaidoraccruedbyasection902corporationintaxableyearsbeginningonorbeforedecember31 2010 futureguidancewilladdresstheapplicationofsection909toforeignincometaxespaidoraccruedinpost 2010taxyears thenoticeprovidesan exclusivelistofarrangements thatwillbetreatedasgivingrisetoforeigntaxcreditsplittingeventsforpurposesofapplyingsection909toforeignincometaxespaidoraccruedbyasection902corporationinpre 2011taxableyears pre 2011taxes thesearrangementsinclude certainreversehybridstructures certainforeignconsolidatedgroupstotheextentthatthetaxpayerdidnotallocatetheforeignconsolidatedtaxliabilityamongthemembersoftheforeignconsolidatedgroupbasedoneachmember sshareoftheconsolidatedtaxableincomeincludedintheforeigntaxbaseundertheprinciplesoftreas reg 1 901 2 f 3 certainarrangementsinvolvinggroupreliefanddisregardeddebtinstruments andcertainotherarrangementsinvolvinghybridinstruments 23 denialofcertainforeigntaxcreditsforcoveredassetacquisitions section901 m thenewrulesareintendedtopreventcertainu s taxelectionsortransactionsfromresultinginthecreationofadditionalassetbasiseligibleforcostrecoveryforu s taxpurposeswithoutacorrespondingincreaseinthebasisofsuchassetsforforeigntaxpurposes section901 m deniesaforeigntaxcreditforthe disqualifiedportion ofanyforeignincometaxpaidoraccruedinconnectionwitha coveredassetacquisition a coveredassetacquisition means aqualifiedstockpurchase i e transactionsundersection338 g and h 10 anytransactionthatistreatedastheacquisitionofassetsforu s taxpurposesandastheacquisitionofstock orisdisregarded forforeignincometaxpurposes anyacquisitioninapartnershipthathasanelectionineffectundersection754 anysimilartransactiontotheextentprovidedbytreasury the disqualifiedportion ofanyforeignincometaxespaidoraccruedwithrespecttoacoveredassetacquisitionis theaggregatebasisdifferencesallocabletosuchtaxableyearwithrespecttoallrelevantforeigntaxes dividedbytheincomeonwhichtheforeignincometaxisdeterminedtheterm basisdifference means withrespecttoanyrelevantforeignasset theexcessof 1 theadjustedbasisofsuchassetimmediatelyafterthecoveredassetacquisition over 2 theadjustedbasisofsuchassetimmediatelybeforethecoveredassetacquisition 24 denialofcertainforeigntaxcreditsforcoveredassetacquisitions section901 m usco targetshareholders foreigntargetstock assumetheexcessofthepurchasepriceofforeigntargetstockoverthebasisofforeigntarget sassetsresultsinanaggregatebasisdifferenceof 200 asseta 150basisdifferenceand15 yearrecoveryperiod 10annualbasisdifference assetb 50basisdifferenceand5 yearrecoveryperiod 10annualbasisdifference underpriorlaw uscohasadditionalassetbasiseligibleforcostrecoveryforu s taxpurposes withnocorrespondingincreaseinthetaxbasisofsuchassetsforforeigntaxpurposes assumetarget sforeignincomeforyear1is 100andforeigntaxesare 25 undernewsection901 m the disqualifiedportionofforeignincometaxespaid isaggregatebasisdifferences incomeonwhichforeignincometaxisdetermined 20 100 20 ofthe 25thatcouldbecreditable 20 5 willbedisallowedasaforeigntaxcredit butmaybedeductible foreigntarget foreigntarget 25 denialofcertainforeigntaxcreditsforcoveredassetacquisitions section901 m provisioniseffectiveforcoveredassetacquisitionsafterdecember31 2010butdoesnotapplyforcoveredassetacquisitionswheretransferorandtransfereearenotrelated undersection267and707 b iftheacquisitionis 1 madepursuanttoawrittenagreementthatwasbindingonjanuary1 2011 2 describedinarulingrequestsubmittedtotheirsonorbeforejuly29 2010 or 3 describedinapublicannouncementorfilingwiththeseconorbeforejanuary1 2011 treasuryisgivenregulatoryauthorityandmayissueregulationsorotherguidance necessarytocarryoutthepurposeoftheprovision including anexemptionforcertaincoveredassetacquisitions andanexemptionforrelevantforeignassetswithrespecttowhichthebasisdifferenceisdeminimis 26 separateforeigntaxcreditlimitationforcertainitemsresourcedundertreaties section904 d 4 certainu s taxtreatiesprovidea re sourcing rule underwhichau s taxpayermaytreata