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July 26, 2023

US Treasury provides welcome temporary relief from controversial foreign tax credit regulations

  • The notice allows taxpayers to claim foreign tax credits that otherwise may not have been available.
  • The relief period is limited, ending with 2023 tax years. However, Treasury is considering changes to the foreign tax credit regulations and further relief.
  • Taxpayers should evaluate the notice's impact on their pending (or already filed) tax returns, financial statements, and foreign tax credit profile.

In a notice released on July 21, 2023 (Notice 2023-55; Notice), the United States (US) Treasury Department announced temporary relief for taxpayers seeking a foreign tax credit by deferring key components of Treas. Reg. Sections 1.901-2 and 1.903-1, which were issued on 28 December 2021 (TD 9959, 87 FR 276; FTC Creditability Regulations). For tax years ending on or before December 31, 2023, the Notice generally allows taxpayers to apply (1) the former regulations' more permissive standards for determining whether a tax was a creditable net income tax under IRC Section 901, and (2) the current IRC Section 903 "in lieu of" tax rules without regard to the attribution requirement.

Detailed discussion


IRC Section 901 permits a taxpayer to claim a credit against its federal income tax liability for income, war profits, and excess profits taxes (income taxes) that are paid or accrued during a tax year to any foreign country or US possession. IRC Section 903 treats a tax paid in lieu of a generally imposed foreign income tax as an income tax for purposes of IRC Section 901 (an in-lieu-of tax).

FTC Creditability Regulations

Prior regulations

For tax years ending on or before 28 December 2021, regulations under IRC Section 901 (Prior FTC Regulations) treated a foreign levy as an income tax if (i) the foreign levy was a tax, and (ii) the tax's character was predominantly that of an income tax in the US sense (the predominant character test). The predominant character test was met if the foreign tax was likely to reach net gain in the normal circumstances in which it applied (the net gain requirement). The net gain requirement, in turn, was met if the foreign levy satisfied realization, gross receipts and net income requirements.

The Prior FTC Regulations were withdrawn for tax years ending on or before 28 December 2021, and replaced by the FTC Creditability Regulations.

Revised net gain requirement

The FTC Creditability Regulations eliminated the predominant character test, requiring rigorous compliance with a substantially revised net gain requirement. The new standard created widespread uncertainty as to whether certain foreign taxes that were traditionally creditable under the Prior FTC Regulations continued to be creditable. One of the most significant changes to the net gain requirement in the FTC Creditability Regulations was the strict cost recovery requirement, which required a foreign tax law to allow for the recovery of all "significant costs and expenses" attributable to gross receipts in the foreign tax base (with costs and expenses for capital expenditures, interest, rents, royalties, wages or other payments for services, and research and experimentation being treated as "per se" significant costs and expenses). Exceptions applied, but they were difficult to interpret and apply. Technical corrections issued in July of 2022 and proposed regulations issued in November of 2022 (2022 Proposed Regulations) provided taxpayers with relief, addressing much — but far from all — of the uncertainty stemming from the cost recovery requirement.

Other elements of the FTC Creditability Regulations continue to cause uncertainty. The elimination of the predominant character test requires more stringent analysis under the realization and gross receipts requirements, with seemingly minor differences in timing or amount of an item endangering the creditability of a foreign income tax. However, the net gain requirement's most controversial element is the new attribution requirement.

Attribution requirement

Under the attribution requirement, arm's-length principles must be applied to any allocation made under the foreign country's transfer pricing rules that applied to residents, without taking into account as a significant factor the location of customers, users or any other similar destination-based criterion. This rule potentially impacted the creditability of certain major trading partners' income taxes, including, most notably, Brazil. (For discussion of Brazil's new transfer pricing rules, see Tax Alert 2023-1078.)

As applied to non-residents, the attribution requirement denies a credit unless one of three tests is satisfied: an activities-based attribution test, a source-based attribution test, or a property-situs attribution test. While all three raise questions, the source-based attribution test has the broadest effects. Under that standard, gross income subject to tax based on its source may include only gross income arising from sources within the foreign country imposing the tax. Further, the foreign tax law must determine the source of that income based on sourcing rules that are reasonably similar to those that apply under the Internal Revenue Code.

Special rules apply to certain income. For a tax on royalty income, the income must be sourced based on the place of use of, or the right to use, the intangible property. (The 2022 Proposed Regulations include a "single-country license exception," which offers relief from this requirement in certain cases. For more information, see Tax Alert 2023-1764.)

A tax on services income is creditable only if the services income is sourced based on where the services are performed, as determined under reasonable principles (which cannot include determining the services' place of performance based on the location of the service recipient). Taxes imposed on gain are precluded from qualifying under the source-based attribution standard.

The FTC Creditability Regulations incorporate the attribution requirement by cross-referencing the rules defining in-lieu-of taxes. In particular, Treas. Reg. Section 1.903-1(c)(2)(iii) requires a "covered withholding tax" (a withholding tax, as defined in IRC Section 901(k)(1)(B), that applies to gross income of nonresidents) to satisfy the source-based attribution requirement. Far less prevalent than covered withholding taxes, other taxes imposed on a base other than gross income qualify as in-lieu-of taxes only if a hypothetical income base would satisfy the attribution requirement of Treas. Reg. Section 1.903-1(c)(1)(iv) (the "jurisdiction to tax excluded income" rule).

Impact of the attribution requirement

Although formulated in response to novel extraterritorial taxes, the attribution requirement resulted in the likely disallowance of many traditionally creditable foreign taxes, including:

  • Corporate income taxes that did not apply an arm's-length standard, including Brazil's income tax (in 2022, at least)
  • Royalty withholding taxes that apply based on the payor's residence, including virtually all those imposed by emerging markets
  • Service withholding taxes, which typically apply based on the payor's residence and/or the customer's location
  • Nonresident capital gains taxes

Although treaty relief was available in certain instances, the attribution requirement was poised — before the Notice — to have a significantly adverse impact on many taxpayers.

The Notice

Temporary relief under Treas. Reg. Section 1.901-2

Under the Notice, taxpayers may apply Treas. Reg. Section 1.901-2(a) and (b) in the Prior FTC Regulations instead of Treas. Reg. Section 1.901-2(a) and (b) from the FTC Creditability Regulations. Taxpayers may only do so during a specified relief period, which includes tax years beginning on or after December 28, 2021 (i.e., the first tax years to which the FTC Creditability Regulations applied) and ending on or before December 31, 2023.

Thus, the Notice allows taxpayers to apply the Prior FTC Regulations' more favorable predominant character test and net gain requirement. However, the Notice modifies the Prior FTC Regulations in one respect: taxpayers may not apply the "non-confiscatory gross basis tax rule" in Treas. Reg. Section 1.901-2(b)(4)(i), which permitted certain gross basis taxes to qualify as income taxes (rather than being subject to the standards applicable to in-lieu-of taxes). Instead, the Notice states that a gross basis tax does not qualify as an income tax unless the foreign tax base consists solely of investment income that is not derived from a trade or business, wage income, or both. As a result, a gross basis tax imposed on other bases — including, notably, income from the provision of digital services — cannot satisfy the net income requirement.

Temporary relief under Treas. Reg. Section 1.903-1(c)

The Notice also allows taxpayers to disregard Treas. Reg. Section 1.903-1(c)(1)(iv) (jurisdiction to tax excluded income) and (c)(2)(iii) (the source-based attribution requirement applicable to covered withholding taxes). Taken together with the relief under Treas. Reg. Section 1.901-2, this means that the attribution requirement is suspended through the relief period. As a result, many more royalty and service withholding taxes qualify as covered withholding taxes.

However, taxpayers must still apply the remaining rules of Treas. Reg. Section 1.903-1, as contained in the FTC Creditability Regulations. Thus, for example, a tax imposed on a gross base that fails the non-duplication requirement would not be a creditable in-lieu-of tax.

Consistency requirements

To claim relief, taxpayers must follow certain consistency requirements and other conditions. First, a taxpayer must apply this relief to all foreign taxes (i) that the taxpayer or any other person (such as a controlled foreign corporation held by the taxpayer) pay in any relief year (a tax year ending within the relief period), and (ii) for which the taxpayer would be eligible to claim a credit in the relief year (taking the Notice into account). Second, a member of a consolidated group may claim relief only if all members of the same consolidated group apply that relief in the same relief year. Third, taxpayers "may not apply the temporary relief in a relief year to claim a credit, as provided under [IRC Section] 901, for any amount of foreign tax for which a deduction is allowed in the relief year or any other taxable year." The intended scope of this last requirement — which appears to restate current law — is somewhat unclear.

Possible additional guidance

The Notice indicates that Treasury continues to analyze, and is considering amendments to, the FTC Creditability Regulations. Treasury is also considering whether, and under what conditions, to provide additional temporary relief beyond the relief period.

Applicability dates

The temporary relief provided by the Notice applies to all foreign taxes paid or accrued during a relief year.


Taxpayers will welcome relief from the FTC Creditability Regulations. The predominant character test appropriately applies more flexible rules, better accommodating varied and diverse income tax systems worldwide. The deferral of the attribution requirement likely allows taxpayers to claim a credit for many foreign taxes that may not have otherwise been creditable, including certain taxes paid to Brazil, many withholding taxes, nonresident capital gains taxes and others.

The Notice results in several pressing action items. Taxpayers finalizing their 2022 tax returns and certain 2023 fiscal-year tax returns should assess the impact of any additional credits, as well as adjustments for deemed paid credits, IRC Section 904 calculations, eligibility for (and the effects of) the GILTI and subpart F high-tax exceptions and other matters.

No relief is granted for foreign taxes paid in tax years ending after 31 December 2023. Given the temporary nature of the relief, and uncertainty around whether and to what extent it will be extended, taxpayers must simultaneously assess the impact of continued application of the full FTC Creditability Regulations.

The Notice did not grant relief for other foreign tax credit regulations that continue to pose challenges for taxpayers. For example, the Notice offers no relief under Treas. Reg. Section 1.861-20, which provides complex rules for allocating and apportioning foreign taxes. Those rules pose significant compliance and interpretational issues in many common scenarios, Moreover, they can lead to surprising results, including the loss of foreign tax credits in certain cases.


Contact Information
For additional information concerning this Alert, please contact:
Ernst & Young LLP (United States), International Tax and Transaction Services
   • Craig Hillier, Boston (
   • Colleen O’Neill, Washington, DC (
   • JD Hamilton, New York (
   • Enrica Ma, Washington, DC (
   • Martin Milner, Washington, DC (
   • Joshua Ruland, Washington, DC (
   • Ray Stahl, Washington, DC (
   • Anna Voortman, Chicago (
   • Jason Yen, Washington, DC (
   • Jeshua Wright, Washington, DC (
   • Candice James, Washington, DC (
   • Ben Satterthwaite, Washington, DC (

Published by NTD’s Tax Technical Knowledge Services group; Maureen Sanelli, legal editor