A tax audit in a foreign jurisdiction may affect the amount of foreign tax credit that a taxpayer claimed on a U.S. return for a prior year. To obtain the benefit of an increased foreign tax credit, the U.S. taxpayer’s claim for credit or refund must be timely.
Generally, if the foreign audit results in higher foreign tax liability, U.S. taxpayers have a special 10-year statute of limitation for filing a claim for an increased foreign tax credit that starts with the year for which the additional foreign taxes were paid or accrued. This 10-year period starts on the due date of the tax return (excluding extensions) for the year for which the foreign tax was paid or accrued (Sec. 6511(d)(3)(A)). By contrast, if the foreign tax audit results in lower foreign tax liability, the IRS has an indefinite period of time to assess the additional U.S. tax liability created by the loss of foreign tax credit (see Secs. 6501(c) (5) and 905(c)(1) and Temp. Regs. Sec. 1.905-4T(b)).
When a foreign jurisdiction notifies a foreign affiliate of a U.S. corporation about a tax examination in that jurisdiction, the U.S. taxpayer should file a protective U.S. claim for credit or refund for the year or years that may be affected.
Example: Q, a calendar-year corporation, is under examination in a foreign jurisdiction for tax years 1997 and 1998. The foreign jurisdiction ultimately assesses an additional liability equivalent to $2 million of tax for the 1997 year and authorizes a refund of $1 million of tax for the 1998 year. The special 10-year statute for filing a claim for the 1997 year expired on March 15, 2008. Q is therefore time barred from obtaining a refund for the additional foreign taxes that otherwise would have been creditable. The IRS, however, may assess additional U.S. tax for the 1998 year at any time.To avoid such an outcome, the taxpayer should have invoked U.S. competent authority as soon as the foreign jurisdiction notified the foreign affiliate that it was under examination.
While the IRS may appear to have the advantage, taxpayers may invoke a countervailing strategy if a tax treaty is in place that allows the taxpayer to use the assistance of the U.S. competent authority as soon as the taxpayer learns a foreign affiliate is under examination. In fact, Treasury regulations require the taxpayer to inform the U.S. competent authority of the examination (see Regs. Sec. 1.901-2(e)(5)). The U.S. competent authority may allow a claim for credit or refund to be filed even if the regular 10- year statute under Sec. 6511(d)(3)(A) has closed.
Taxpayers should carefully follow the procedure set forth in Rev. Proc. 2006-54 for invoking U.S. competent authority. Protective claims for refund should be filed within the 10-year statute because taxpayers should not assume that the U.S. competent authority will always allow an untimely claim to be treated as timely. The taxpayer should file protective claims not only for the years the taxpayer knows are under examination in the foreign jurisdiction but also for all carryback and carryforward years to which additional foreign tax credits might be carried under U.S. tax rules.
Finally, taxpayers should be prepared to sign a Form 872, Consent to Extend the Time to Assess Tax, if requested by U.S. competent authority. Form 872 gives the IRS the right to raise offset to a claim that the taxpayer files for a year covered by the consent, but a taxpayer that refuses to sign the form may find that the U.S. competent authority is unwilling to accept a claim that otherwise is not timely.
Annette Smith is with PricewaterhouseCoopers LLP, Washington National Tax Services, in Washington, DC.
Unless otherwise noted, contributors are members of or associated with Pricewater-houseCoopers LLP.
For additional information about these items, contact Ms. Smith at (202) 414-1048 or firstname.lastname@example.org.