The IRS has announced forthcoming regulations (Notice 2016-52
) under Section 909 dealing with foreign tax credits after a foreign adjustment.
The guidance will identify two new foreign tax credit splitter arrangements relating to certain foreign corporations that pay foreign income taxes pursuant to “foreign-initiated adjustments.” In the notice, the IRS stated it is aware certain taxpayers may take steps to separate the anticipated tax payments resulting from foreign-initiated adjustments from the related income. Foreign-initiated adjustments may arise, for example, under the highly politicized European Union (EU) state aid rulings, to the extent EU state aid payments result in creditable foreign taxes. The notice looks to prevent this prospective tax planning by suspending (or deferring the right to claim) foreign tax credits under Section 909 until the related earnings are repatriated.
Although the notice seems to target a relatively small number of large U.S. multinationals effected by the state aid investigations, its reach is broader – impacting many U.S. multinationals with foreign-initiated adjustments exceeding $10 million.
Section 909(a) provides that if there is a foreign tax credit splitting event with respect to a foreign income tax paid or accrued by a taxpayer, such tax shall not be taken into account for federal tax purposes before the taxable year in which the related income is taken into account by the taxpayer. If there is a foreign tax credit splitting event with respect to a foreign income tax paid or accrued by certain foreign corporations, the tax will not be taken into account for purposes of Section 902 or Section 960, or for purposes of determining earnings and profits under Section 964(a), before the taxable year in which the related income is taken into account. Thus, Section 909 suspends foreign income taxes paid or accrued by certain foreign corporation unless or until the related earnings are repatriated.
Sections 901 and 905(a) generally provide a credit for foreign taxes accrued even if such taxes have not been paid. Section 905(c) requires an adjustment if the ultimate foreign tax liability differs from the amount accrued. Such difference may be the result of an income tax audit adjustment to foreign taxes imposed by a foreign country. Under current law, neither Section 905(c) nor the related regulations provide guidance on the treatment of additional payments of foreign tax by certain foreign corporations where as the result of a liquidation, reorganization or other corporate transaction, the taxpayer that makes the additional payment is different from the taxpayer that would have paid the tax had it been paid in the year to which the tax relates.
The notice provides that forthcoming regulations will be issued adding two new foreign tax credit splitter arrangements arising from: (1) the application of Section 905(c) to successor entities, and (2) distributions made before the payment of additional tax pursuant to “foreign-initiated adjustments.” These arrangements apply to covered taxes, which is defined in the notice to include taxes that: (1) are taken into account by adjusting the payer’s earnings and profits, and tax pools pursuant to Section 905(c); and (2) result from a “specified foreign-initiated adjustment” to the amount of foreign income tax accrued with respect to one or more prior taxable years.
A “specified foreign-initiated adjustment” is a foreign-initiated adjustment (or series of related adjustments to more than one taxable year) that results in additional foreign income tax liability that is greater than $10 million, regardless of whether such liability is actually paid in one or more taxable years.
In broad terms, a splitting event occurs under the notice when, before a payment is made pursuant to a “specified foreign-initiated adjustment,” a taxpayer either: (1) consummates a transaction, or series of transactions, whereby such taxes are not paid by the foreign corporation that would have paid the tax if the taxes had been paid or accrued in the year to which the adjustment relates, or (2) causes the foreign corporation to make certain distributions, so that the subsequent tax payment can be used to generate a substantial amount of foreign tax credits, without repatriating and including in U.S. taxable income the earnings and profits to which the tax relates.
The notice provides that transactions or distributions described under both splitting arrangements are generally presumed to have a principal purpose of separating the additional tax pursuant to foreign-initiated adjustment from the earnings to which it relates, or reducing the earnings that include the earnings to which the taxes relate. These presumptions are rebuttable only with “clear and convincing evidence” from the taxpayer that either (1) the transaction or series of related transactions were not structured with a principal purpose of separating that tax from the earnings, or (2) the distribution was not made with the principal purpose of reducing the undistributed earnings that include the earnings to which the covered taxes relate.
The forthcoming regulations described in the notice will apply to foreign income taxes paid on or after Sept. 15, 2016.
Partner, National Tax Standards Group
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