November 18, 2022
BREAKING TAX NEWS | Treasury releases latest proposed regulations on foreign tax credit
Today, the Treasury Department released proposed regulations (REG-112096-22; Proposed Regulations) on foreign tax credits.
The Proposed Regulations would amend the final foreign tax credit regulations published on January 4, 2022 (TD 9959; Final Regulations, as amended by technical corrections to those regulations published on July 27, 2022).
Highlights of the Proposed Regulations include the following:
- The Proposed Regulations would significantly relax the cost recovery requirement by providing that a foreign tax law need only allow for recovery of "substantially all" of each item of significant cost or expense, regardless of what the principles underlying any disallowances are. This "substantially all" determination would apply based on the foreign tax law (not a particular taxpayer's individual facts).
- For purposes of applying the "substantially all" test, the Proposed Regulations introduce two safe harbors. The first would treat the foreign tax as not failing the "substantially all" test if the underlying foreign tax law disallows no more than 25% of one or multiple cost items. The second would treat the foreign tax as not failing the "substantially all" test if the underlying foreign tax law limits recovery of a single item of significant cost or expense or multiple items within a single category of per se significant costs or expenses based on a "qualifying cap." A qualifying cap is defined as a foreign tax law that caps cost recovery based on no less than 15% of gross receipts, gross income, or a "similar measure." A qualifying cap also includes a foreign tax law that caps cost recovery based on no less than 30% of taxable income or a similar measure.
- The Proposed Regulations introduce an example concluding that a foreign tax does not fail the cost recovery requirement even though the underlying foreign tax law disallows deductions for stock-based compensation.
- A new prong to the source-based attribution requirement for royalties would allow a taxpayer to satisfy the requirement if it has a licensing agreement expressly limiting use of intangible property to the country imposing the tax (the single-country rule). The single-country rule would further permit a licensing agreement to bifurcate a license payment between payment for use within versus outside the country imposing the tax. Taxpayers would not satisfy the single-country rule if they know, or have reason to know, that the licensing agreement misstates the territory in which the intangible property is used or overstates the royalties otherwise eligible for the single-country rule. The Proposed Regulations would require the licensing agreement to be executed no later than the date of the royalty; an exception exists for certain agreements executed no later than May 17, 2023.
- The Proposed Regulations would revise the rules on disregarded reallocation transactions under Treas. Reg. Section 1.861-20 by providing that disregarded payments received in exchange for property do not constitute reattribution assets for purposes of allocating and apportioning taxes upon a disregarded remittance.
- The rules on the cost recovery and attribution requirements would apply to foreign taxes paid in tax years ending on or after November 18, 2022. In contrast, the rules on disregarded payments would apply to tax years ending on or after the date that final regulations are filed with the Federal Register. In both cases, taxpayers may choose to apply the rules contained in the Proposed Regulations to earlier tax years if they do so consistently. Taxpayers may also rely on the Proposed Regulations before their finalization, subject to certain requirements.
A more detailed Tax Alert is forthcoming. A webcast on the regulations is scheduled for December 1, 2022, at 2 p.m. EST. To register for the webcast, please click here.