A U.S. corporation that incurs a dual consolidated loss (DCL) generally is prohibited from using the loss to reduce U.S. taxable income. A DCL is a net operating loss, as determined under U.S. tax law, of a U.S. corporation that is also subject to an income tax in a foreign country on either a worldwide or a residence basis. The DCL rules in Sec. 1503(d) generally provide that a DCL of a dual-resident corporation, or a DCL of a separate unit of a U.S. corporation, may not be considered in the computation of taxable income of a U.S. corporation, a U.S. consolidated group, an unaffiliated U.S. dual resident corporation, or an unaffiliated U.S. domestic owner.
The U.S. regulations further prohibit a domestic corporation from using a DCL from a foreign country if the law of that foreign country also prohibits a domestic company from using a foreign loss. Regs. Sec. 1.1503(d)-3(e)(1) refers to such a prohibition under foreign law as “mirror legislation” because the U.S. rules also restrict a U.S. company from using a DCL incurred by the company. The U.S. regulations state that a foreign company is deemed to use a DCL if the domestic law of the foreign country in which the foreign company is organized denies any opportunity for the foreign company to use the foreign DCL in the year the loss was incurred.
However, in certain circumstances a U.S. corporation may use a DCL in calculating U.S. taxable income. The taxpayer should be aware that special rules apply if the DCL is subject to mirror legislation. Generally, a U.S. company may use a DCL in determining U.S. taxable income if the corporation:
- Attaches a DCL domestic use election statement to its original U.S. return for the loss year; and
- Certifies in a statement attached to the company’s original U.S. returns filed for the subsequent five years that the DCL identified in the election statement has not been used, and will not be used, to offset income taxed in a foreign jurisdiction.
Failure to file a timely domestic use election statement and failure to file timely annual certifications are triggering events that require payment of the U.S. tax plus underpayment interest due to recapture of the DCL.
If the DCL is from a loss incurred by a company organized under the laws of the United Kingdom, the U.S. company must comply with additional reporting requirements because of the U.K. mirror legislation. The U.K.’s Income and Corporation Taxes Act 1988 (ICTA) restricts a U.K. company from using a DCL to reduce U.K. taxable income. Under the ICTA, a loss incurred by a foreign permanent establishment under U.K. law may not be considered when calculating U.K. taxable income if the loss may also be used to reduce the taxable income of a company outside the taxing jurisdiction of the United Kingdom. The mirror legislation in the United States is set forth in Regs. Sec. 1.1503-1.
In 2006, U.S. and U.K. competent authorities finalized the only example to date of a U.S. agreement with a foreign government to allow the domestic use of a foreign loss in circumstances where mirror legislation would otherwise prohibit the use of the foreign loss and result in double taxation. Under the United Kingdom/United States Dual Consolidated Loss Competent Authority Agreement, entered into under paragraph 3 of Article 26 (Mutual Agreement Procedure) of the U.S.-U.K. tax treaty, a U.S. company may elect to use a DCL to offset taxable income of U.S. affiliates as long as the loss is surrendered by the U.K. permanent establishment under applicable ICTA provisions. The election is irrevocable.
The U.S. company must also comply with the domestic use election and annual certification requirements of Regs. Secs. 1.1503-2(g)(2)(i) and 1.1503(d)-8(b)(1), as modified by the competent authority agreement. For example, the domestic use election statement must contain the caption “Election Under Section 1.1503-2(g)(1) to Use a Dual Consolidated Loss of a UK Permanent Establishment under US/UK Competent Authority Agreement” at the top of the page. The election statement must also state that (1) the U.S. company is eligible to use the DCL under the competent authority agreement and (2) the U.S. and U.K. competent authorities will be notified of a triggering event no later than the due date of the U.S. return for the year of the triggering event. A copy of the election statement must be provided to the U.S. and U.K. competent authorities on or before the due date for filing the election statement with the U.S. company’s federal income tax return. (See Announcement 2006-86.)
A U.S. company that fails to timely file the required domestic use election statement and has reasonable cause for the failure must seek relief for it under Regs. Secs. 1.1503(d)-1(c)(1) and 1.1503(d)-8(b)(3)(i). The company should be careful to follow the modified notification procedures described above when submitting a request for an extension of time to file an election statement. It should provide a copy of the reasonable cause submission to the U.K. competent authority when it submits the request to the IRS. The company should also provide proof of mailing to the U.K. competent authority as part of the submission to the IRS so the examiner assigned to review the reasonable cause request knows that the company has complied with the requirements of Announcement 2006-86.
Editor: Annette B. Smith, CPA
Annette Smith is a partner with PricewaterhouseCoopers LLP, Washington National Tax Services, in Washington, DC.
For additional information about these items, contact Ms. Smith at (202) 414-1048 or firstname.lastname@example.org.