Final Regs. Determine Amount of Tax Paid for Purposes of the Foreign Tax Credit

Editor: Michael Dell, CPA

Foreign Income & Taxpayers

The IRS issued final regulations (T.D. 9634) on determining the amount of taxes paid for purposes of the foreign tax credit (FTC). The 2013 final regulations adopted 2011 proposed regulations (REG-126519-11), which were also issued as temporary regulations (T.D. 9536), without substantive changes.

Under Regs. Sec. 1.901-2(e)(5)(iv) of final regulations issued in 2011 (the 2011 final regulations, T.D. 9535), amounts paid to a foreign taxing authority that are attributable to a “structured passive investment arrangement” (SPIA) are not treated as an amount of tax paid for purposes of the FTC. The 2011 final regulations describe six conditions that, if satisfied, result in an arrangement’s being treated as an SPIA. The first of these conditions is that the arrangement uses an entity that meets two requirements: (1) substantially all of the entity’s gross income, as determined under U.S. tax principles, is attributable to passive investment income, and substantially all of the entity’s assets are held to produce the passive investment income; and (2) there is a foreign tax payment attributable to income of the entity, as determined under the laws of the foreign country to which the foreign payment is made.

The IRS and Treasury became aware that taxpayers could enter into arrangements that could generate duplicative foreign tax credit benefits involving foreign withholding taxes imposed on distributions made by an entity to a U.S. party. For example, if the parties undertook a transaction in which interests in an entity are transferred by the U.S. party to a counterparty subject to a repurchase obligation, withholding taxes imposed on distributions from the entity could be claimed as creditable in both jurisdictions. To address this problem, the 2011 final regulations eliminated the exception for withholding taxes imposed on distributions or payments to U.S. parties. In addition, the 2011 temporary regulations introduced a new provision stating that a foreign payment attributable to income of an entity includes a withholding tax imposed on a dividend or other distribution (including distributions made by a passthrough entity or an entity that is disregarded as an entity separate from its owner for U.S. tax purposes) regarding the equity of the entity. The 2013 final regulations adopt that language without substantive change (Regs. Sec. 1.901-2(e)(5)(iv)(B)(1)(ii)).

Implications

Structured transactions resembling those described in these regulations are no longer commonplace (because of these regulations). Nonetheless, the IRS and Treasury clearly continue to be concerned about SPIA transactions, which is why they believed that it was important to issue final regulations before the temporary regulations lapsed. Taxpayers should continue to monitor their FTC structures to ensure that they do not inadvertently violate the rules.

EditorNotes

Michael Dell is a partner at Ernst & Young LLP in Washington, D.C.

For additional information about these items, contact Mr. Dell at 202-327-8788 or michael.dell@ey.com.

Unless otherwise noted, contributors are members of or associated with Ernst & Young LLP.