Because of the US policy to tax worldwide income, Foreign Tax Credits (FTC) are very important as a planning tool for multinational corporations and individuals with taxable assets and earnings outside of the US. Aside from treaties, this is one of the only ways available to reduce double taxation where the US and the foreign jurisdiction both impose tax.
Some of the questions that need to be answered to determine if the entity or individual is eligible for a credit are (i) whether the payment is an income tax; (ii) whether the jurisdiction levying the tax is a foreign country; (iii) whether the person attempting to claim the FTC is a qualified US person, as defined under the Internal Revenue Code (“IRC”), and (iv) who is the payor of the tax.
The question that the temporary regulations is attempting to address relates to the determination of whether a US person is considered to have paid a foreign income tax for purposes of the foreign tax credit. The regulations provide additional rules for identifying the person with legal liability to pay the foreign income tax in certain circumstances.
Specifically, the guidance introduces rules for determining the person on whom foreign law imposes legal liability for tax, including in the case of taxes imposed on the income of foreign consolidated groups and entities that have different classifications for U.S. and foreign tax law purposes
According to the IRS background summary, the statutory provision was enacted to address concerns about the inappropriate separation of foreign income taxes and related income. It provides that there is a “foreign tax credit splitting” event if a foreign income tax is paid or accrued by a taxpayer and the related income is, or will be, taken into account by a covered person with respect to such taxpayer. In such a case, the tax is suspended until the taxable year in which the related income is taken into account by the payor of the tax.
The Regulations identify an exclusive list of arrangements that will be treated as giving rise to foreign tax credit splitting events and provides guidance on determining the amount of related income and taxes paid or accrued with respect to splitter arrangements. These splitter arrangements have been defined as:
(a) reverse hybrid structures,
(b) certain foreign consolidated groups,
(c) disregarded debt structures in the context of group relief and other loss-sharing regimes, and
(d) two classes of hybrid instruments.
The IRS may identify additional splitter arrangements for future tax years.
Click here for a link to the temporary regulations.
Written by Marsha Henry ©