A Tennessee District Court has ruled in FedEx Corp. et al. v. United States (No. 2:20-cv-02794) that Section 965 regulations were invalid, and FedEx is entitled to $89 million in foreign tax credits denied by the IRS.
The U.S. District Court for the Western District of Tennessee granted FedEx’s motion for partial summary judgement on the treatment of foreign tax credits related to the distribution of Section 965(b) previously taxed earnings (referred to as “offset earnings” in the case). A similar case is pending in the Tax Court and the issue could affect many taxpayers with similar facts. The issue revolves around whether foreign taxes associated with “offset earnings” were considered deemed paid under Section 960.
FedEx argued that the government cannot deny the foreign tax credit by using a regulation to rewrite the statutory text. In its ruling, the District Court held that the relevant Section 965 regulation that prevented foreign tax credits from being considered deemed paid was invalid based on the plain language of the Code.
Prior to the amendments under the Tax Cuts and Jobs Act, Section 960(a)(1) allowed foreign tax credits as a deemed paid credit under Section 902 when earnings of foreign subsidiary corporations were included in the income of the U.S. parent corporation under Section 951(a) as Subpart F income. Section 960(a)(2) provided that when a U.S. corporation received a subsequent distribution of previously taxed earnings excluded from income Section 959, the associated taxes that were previously deemed paid in a prior year under Section 960(a)(1) could not be claimed as a foreign tax credit again in the year of distribution. Section 960(a)(3), however, provided that distributions of earnings from foreign subsidiary corporations excluded from the income of the U.S. parent under Section 959 should be treated as a dividend for purposes of Section 902 to allow as a deemed paid credit foreign taxes that had not been deemed paid under Section 960(a)(1). In simpler terms, Section 960(a)(3) would allow a credit for foreign taxes that had not been previously deemed paid under Section 960(a)(1) in current or prior years.
FedEx’s argument in the case was that it should be allowed a foreign tax credit under Section 960(a)(3) as the Section 965(b) earnings that were being distributed were never included in income under Section 951 and, as such, FedEx never received a credit for the foreign taxes related to those earnings under Section 960(a)(1). The government’s counter position was that while the earnings were not included in the income of the U.S. corporation, they are treated as if they were included in the income for purposes of Section 959 and Section 960(a) under Section 965(b)(4)(A). Further, the government argued that Treas. Reg. § 1.965-5(c)(1)(ii) disallowed foreign tax credits for foreign taxes paid or accrued associated with “offset earnings.”
One of the key points that the District Court focused on in its analysis was that the statute under Section 965(b)(4)(A) specifically states that the provision applies for the purposes of Section 959, so application of the statute is limited to Section 959 and cannot be expanded to further apply for other purposes within the Code, such as Section 960. The District Court ruled that the language of Section 960(a)(3) was clear, and that FedEx was entitled to a foreign tax credit and the relevant Section 965 regulation was invalid.
The same issue is present in a recent petition filed with the Tax Court in Sysco Corp. v. Commissioner. Taxpayers with distributions of PTEP related to offset earnings during the transaction tax year should carefully evaluate the impact of this case (and the pending Sysco case) on their Section 965 liability. Taxpayers with the specific issue addressed by the court should also consider the relevant statute of limitations, including whether the 10-year statute of limitations related to foreign tax credits under Section 6511(d)(3) may apply.
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