December 31, 2021
BREAKING TAX NEWS | Treasury releases final foreign tax credit regulations
On December 28, 2021, the Treasury Department released final regulations (T.D. 9959; Final Regulations) significantly restricting the ability to credit certain foreign taxes. The Final Regulations address a wide range of topics, including the definition of a foreign income tax, the disallowance of a credit or deduction for certain foreign income taxes, the allocation and apportionment of foreign income taxes, when foreign income taxes accrue, and related rules under the Internal Revenue Code.
The Final Regulations follow the proposed regulations published on November 12, 2020 (Proposed Regulations), but include several notable changes. Highlights of the Final Regulations include the following:
- The Final Regulations overhaul the requirements that a foreign tax must satisfy to be claimed as a credit. The most significant change is that a foreign tax must satisfy a new "attribution requirement" (known as the "jurisdictional nexus requirement" under the Proposed Regulations) for the tax to be creditable under IRC Sections 901 or 903. Under the attribution requirement, foreign taxes are not generally creditable unless the foreign tax law requires a sufficient nexus between the foreign country and the taxpayer’s activities or investments. For example, a foreign tax may satisfy the attribution requirement if its sourcing rules are reasonably similar to US sourcing rules.
- The Final Regulations clarify the attribution requirement in several respects. When foreign law and US law characterize gross income or gross receipts differently, the Final Regulations provide that the foreign law characterization governs (except for the sale of a copyrighted article). This clarification should be particularly significant for cloud-computing and technology-enabled (including digital) transactions, which may be characterized as licenses under foreign law.
- The Final Regulations defer application of the attribution requirement to Puerto Rico's expanded effectively-connected-income regime and excise tax on certain goods and services. The attribution requirement applies to those taxes when they are paid or accrued in a tax year beginning on or after January 1, 2023. In contrast, the attribution requirement applies to other foreign income taxes when paid or accrued in tax years beginning on or after December 28, 2021.
- The Final Regulations follow the Proposed Regulations' rules for allocating and apportioning foreign income taxes imposed on (i) disregarded payments made between "taxable units," (ii) dispositions of stock and partnership interests, and (iii) distributions by partnerships. Treasury rejected comments requesting a delayed applicability date for those provisions. Accordingly, those rules apply to tax years beginning after December 31, 2019 and ending on or after November 2, 2020.
- The Final Regulations overhaul the Proposed Regulations under IRC Section 245A(d), which disallow a credit or deduction for foreign income taxes attributable to "section 245A(d) income" and "non-inclusion income." As revised, the Final Regulations apply to a broader range of transactions than the Proposed Regulations, including certain remittances from a disregarded entity.
- The Treasury Department declined to finalize certain provisions in the Proposed Regulations, including (i) an election to capitalize and amortize R&E and advertising expenditures for purposes of apportioning interest expense under Treas. Reg. Section 1.861-9 and (ii) rules addressing the allocation and apportionment of interest expense incurred by certain foreign bank branches.
A more detailed Tax Alert and an invitation for a webcast are forthcoming.