The IRS has issued guidance (Notice 2022-42) that would provide relief from the final foreign tax credit regulations under Section 901 for certain U.S. taxpayers amending Puerto Rican tax decrees.
The FTC regulations generally provide that amounts remitted to a foreign country exceeding the taxpayer’s liability for foreign income tax are not considered compulsory and are thus not a creditable foreign tax (see Tax Flash 2022-01 for more background on the final FTC regulations). This has created a potential problem for U.S. taxpayers who are able renegotiate tax decrees under the new Puerto Rican Act 52-2022, enacted on June 30, 2022.
Many U.S. taxpayers have in the past negotiated tax decrees with Puerto Rico for more favorable tax treatment. Under existing decrees, certain types of taxes, such as excise tax and modified effectively connected income (ECI) tax, may still apply. The Puerto Rican Act 52-2022 allows taxpayers to amend existing decrees. Taxpayers that elect to amend will no longer be subject to the excise tax and modified ECI tax, but the decree may result in a greater total amount of tax. This could result in the excess tax being considered noncompulsory under the FTC regulations, and therefore not creditable.
Notice 2022-42 provides that the IRS intends to issue proposed regulations under Section 901 to treat the amount of foreign income tax paid or accrued pursuant to an amended Puerto Rico tax decree as a compulsory payment under Treas. Reg. Sec. 1.901-2(e)(5) if the existing tax degree is amended pursuant to Act 52-2022 on or before Dec. 31, 2022, and the taxpayer’s Puerto Rico income tax liability under the tax decree is less than under the generally applicable Puerto Rico tax laws (in absence of any decree). In addition, the Notice revokes Notice 2011-29, which treated the excise tax as a tax paid in lieu of an income tax under Section 903. The revocation is effective for the excise tax paid or accrued in taxable years beginning on or after Jan. 1, 2023.
Taxpayers with existing Puerto Rico tax decrees should immediately evaluate the notice to determine how their foreign tax credit determinations may be impacted by the changes. Treasury has indicated that proposed FTC regulations may be forthcoming later this year or early next year so taxpayers should continue to monitor developments to ensure compliance.
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