Tax & Accounting Blog

Treasury and IRS Issue Foreign Tax Credit Guidance in Response to State Aid Investigations

BEPS, Blog, Checkpoint, ONESOURCE, Transfer Pricing September 19, 2016

Following the European Commission's (EC’s) state aid decision regarding Apple (see BEPS Action 5), the U.S. Department of the Treasury (Treasury) issued Notice 2016-52 stating that the U.S. Internal Revenue Service (IRS) and Treasury intend to issue new regulations under Internal Revenue Code (IRC) section 909 that will prevent a company that has been the subject of a foreign-initiated adjustment from obtaining foreign tax credits where the related income has not been included in U.S. taxable income. This is commonly referred to as a foreign tax credit splitting event.

In anticipation of a large foreign-initiated adjustment that relates to a prior taxable year, a taxpayer may take steps to separate the additional payment of foreign income tax from the income to which it relates. Such foreign-initiated adjustments may arise under EU state aid, to the extent state aid payments result in creditable foreign taxes. Before a payment is made pursuant to a foreign-initiated adjustment, a taxpayer may attempt to change its ownership structure or cause the section 902 corporation (defined in section 909(d)(5)) to make an extraordinary distribution so that the subsequent tax payment creates a high-tax pool of post-1986 undistributed earnings that can be used to generate substantial amounts of foreign taxes deemed paid, without repatriating and including in U.S. taxable income the earnings and profits to which the taxes relate. See section 902.

The notice says that the intended regulations will address changes in ownership structures that, in connection with a foreign-initiated adjustment, result in a foreign tax credit splitting event. These regulations will provide that a splitter arrangement arises when, as a result of a “covered transaction,” a section 902 corporation pays “covered taxes” during a taxable year (the “splitter year”).

Treasury and the IRS are asking for comments on the rules described in the notice, including the following:

  • Whether the transactions addressed in section 3 of the notice would be more appropriately addressed pursuant to rules under section 905(c), providing that additional payments of tax be accounted for through adjustments to the pools of post-1986 foreign income taxes and post-1986 undistributed earnings of section 902 corporations that are not the same entity as the payor of the tax.
  • Whether an objective test, rather than a subjective test based on taxpayer intent, should be used to determine when the transactions described in sections 3.01 and 3.02 of the notice are treated as splitter arrangements.

Treasury and IRS are making no inferences as to whether (1) payments made pursuant to any particular foreign-initiated adjustment, including those arising under EU state aid, qualify as payments of creditable foreign income taxes, or (2) taxes paid by a U.S. person pursuant to a foreign-initiated adjustment to the tax liability of a section 902 corporation are eligible for a direct foreign tax credit under section 901.

The regulations described in section 3 of the notice will apply to foreign income taxes paid on or after September 15, 2016. Comments must be received by December 14, 2016.

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