Regs. Curb Artificially Generated Foreign Tax Credits

Regulations

The IRS issued final regulations on determining the amount of taxes paid for purposes of the foreign tax credit (T.D. 9634). The regulations are designed to curb certain transactions that the IRS says “produce inappropriate foreign tax credit results.” They finalize proposed regulations issued in 2011 with no substantive change (REG-126519-11) and remove the temporary regulations issued at the same time (T.D. 9536). A portion of the regulation specifically added in the final regulations clarifies the treatment of withholding taxes.

The regulations provide that amounts paid to a foreign taxing authority that are attributable to a “structured passive investment arrangement” are not treated as an amount of tax paid for purposes of the foreign tax credit. Structured passive investment arrangements are generally designed to exploit differences between U.S. and foreign tax law by artificially creating a foreign tax liability that allows the U.S. party to claim a U.S. foreign tax credit and a foreign counterparty to claim a duplicative foreign tax benefit. The U.S. and foreign parties share the cost of the purported foreign tax payments through pricing of the arrangement, the IRS said in the preamble to the 2008 temporary regulations (T.D. 9416).

The final regulations are effective for payments that would be considered paid or accrued on or after July 13, 2011, if those payments were an amount of tax paid. The new portion of the regulations (the last sentence of Regs. Sec. 1.901-2(e)(5)(iv)(B)(1)(ii) on withholding taxes) applies to payments paid or accrued on or after Sept. 4.