On July 26, 2022, the U.S. Treasury Department released some long-awaited clarifications on foreign tax credit rules. These technical corrections came as an update to Treasury’s previously issued regulations, which were released in December 2021 and published in January 2022 (2021 Final Regulations). The 2021 Final Regulations sought to introduce new requirements for a foreign tax to be considered creditable along with expense allocation and apportionment rules. From the outset, these regulations were met with pushback from taxpayers who felt the rules were too restrictive and could render some of their foreign taxes ineligible for credit—thus essentially forcing double taxation.
The technical corrections do more to clarify than revise, with most of the wording of the original rules still untouched. This comes as a disappointment to many taxpayers who were hoping for a larger scale reform on these issues. The clarifications attempt to provide greater flexibility to the taxpayer and broaden the scope of who is eligible for the foreign tax credit.
Creditability of Foreign Taxes
The main clarifications addressed the issue of cost recovery, which taxpayers believed to be ambiguous. The 2021 Final Regulations could be read to say that the foreign tax is considered to permit recovery if the foreign tax law is consistent with the principles of the Internal Revenue Code. These corrections explain that a foreign tax law is considered to permit recovery of significant costs and expenses even if recovery of all or a portion of certain costs or expenses is disallowed, if such disallowance is consistent with any principle underlying the disallowances required under the Internal Revenue Code, including the principles of limiting base erosion or profit shifting and public policy concerns. Furthermore, a foreign tax satisfies the cost recovery requirement if items deductible under the Internal Revenue Code are capitalized under the foreign tax law and recovered either immediately, on a recurring basis over time, or upon the occurrence of some future event (for example, upon the property becoming worthless or being disposed of), or if the recovery of items capitalized under the Internal Revenue Code occurs more rapidly than under the foreign tax law.
The corrections broadened the list of ways in which a foreign jurisdiction’s tax laws and domestic tax laws can interact to make a foreign tax credit possible. In addition, several references to specific areas of the tax code were eliminated, which broadens and generalizes the regulations.
Overall, these corrections seek to provide flexibility and simplicity to the 2021 Final Regulations, but they do not go nearly as far as many taxpayers would like and were slightly underwhelming to those expecting significant relief.
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