Background
On March 31, 2023, the U.S. District Court for the Western District of Tennessee (the District Court) awarded a refund to FedEx Corporation and Subsidiaries (FedEx) for more than $89 million related to foreign tax credits. In the District Court’s granting of a partial summary judgment in favor of FedEx, the District Court held that the government’s regulation under Internal Revenue Code (IRC) Section 965 denying taxpayers a foreign tax credit associated with a distribution of IRC §965(b) previously taxed income (PTI) was contrary to the plain terms of the statute.
As part of the transition from a worldwide tax system to a quasi-territorial tax system, the U.S. Congress amended IRC §965 to require all U.S. shareholders to include in taxable income all accumulated earnings of certain foreign subsidiaries for 2017 (the Transition Tax). To mitigate international double taxation on these earnings, the U.S. government allowed a foreign tax credit to be claimed against the U.S. tax on these earnings. In calculating the taxable income inclusion under IRC §965, §965(b) allowed certain foreign subsidiaries with accumulated losses to offset accumulated positive profits of related foreign subsidiaries. As termed by the District Court, these “Offset Earnings” within the foreign subsidiaries with positive accumulated earnings were treated as PTI under IRC §965(b)(4)(A), even though these earnings were never subject to U.S. taxation.
Presumably during the year of the Transition Tax, a foreign subsidiary of the FedEx group had distributed some or all of these Offset Earnings that were treated as PTI to a corporate U.S. shareholder of the FedEx group. FedEx had claimed a foreign tax credit for the taxes associated with these Offset Earnings in the year of the distribution under IRC §901 via §902 and §960. Specifically, FedEx relied on IRC §960(a)(3) that stated:1
Any portion of a distribution from a foreign corporation received by a domestic corporation which is excluded from gross income under section 959(a) [the PTI rules] shall be treated by the domestic corporation as a dividend, solely for purposes of taking into account under section 902 [the deemed paid FTC rules] any [foreign income tax] paid to any foreign country or to any possession of the United States, on or with respect to the accumulated profits of such foreign corporation from which such distribution is made, which were not deemed paid by the domestic corporation … for any prior taxable year [emphasis added].”
Essentially, this section allowed a credit for foreign income taxes associated with PTI earnings that are distributed to a domestic corporation as long as those foreign income taxes were never taken as a foreign tax credit in any prior taxable year. FedEx argued that:
- Since these Offset Earnings were distributed to a domestic corporation,
- Such earnings were excluded from gross income under the PTI rules, and
- The foreign income taxes associated with these Offset Earnings were never deemed paid, i.e., taken as a foreign tax credit, by such domestic corporate shareholder, then such foreign income taxes should be eligible as a foreign tax credit.2
The U.S. government argued that Treasury Regulation §1.965-5(c)(1)(ii) denies FedEx from taking such foreign tax credit on the Offset Earnings. This regulation provides that “[n]o credit is allowed under §960(a)(3) or any other section for foreign income taxes that would have been deemed paid under §960(a)(1) with respect to [Offset Earnings].” In addition, the government argued that allowing the credit would violate the policy of the foreign tax credit to mitigate double taxation because the Offset Earnings were never subject to U.S. taxation.
The District Court held that IRC §960(a)(3) was unambiguous by its plain terms in allowing a foreign tax credit in this particular situation. Thus, the District Court held that the regulation denying the foreign tax credit on Offset Earnings was invalid as contrary to the statute. The District Court also stated that because the statute was unambiguous that it could not consider the policy argument by the government. The District Court reasoned that under IRC §960(a)(3), the Offset Earnings that FedEx distributed were “excluded from gross income under [the PTI rules] and the foreign taxes paid on Offset Earnings were never previously deemed paid … and [u]nder these straightforward and unambiguous statutory terms, FedEx is entitled to foreign tax credits on its Offset Earnings under section 960(a)(3).”
Key Takeaways
The taxpayer-favorable decision was a huge win for FedEx. The case demonstrates the principle that regulations can be invalidated if they are contrary to the plain terms of the statute, even if the application of the statute seems contrary to tax policy. The case was brought in the Western District Court of Tennessee and may possibly be further appealed to the Court of Appeals for the Sixth Circuit and possibly to the U.S. Supreme Court. Taxpayers should determine whether they distributed out Offset Earnings under §965(b) in a year that IRC §960(a)(3) was still part of the IRC before the amendment under the TCJA. Although not an issue decided in the case, the District Court’s findings in FedEx may have application to current §960(b) deemed paid taxes on post-2017 distributions of §965(b) Offset Earnings given the symmetry between pre-TCJA §960(a)(3) and post-TCJA §960(b).3 In either such a case, taxpayers should determine the amount, if any, that they would be entitled to as a foreign tax credit associated with such distribution under the holdings of the FedEx case.
If such amount is material, taxpayers should monitor closely the progression of any appeals and reach out to a professional at FORVIS or submit the Contact Us form below.
- 1This is IRC §960 before it was amended by the Tax Cuts and Jobs Act (TCJA) of 2017.
- 2The foreign income taxes associated with the Offset Earnings were never deemed paid by such domestic corporation because they were never distributed to the U.S. shareholder, nor were they ever included as Subpart F income under §951(a) or as an investment in U.S. property under §956.
- 3The current IRC §960(b) language has added the requirement that such foreign income taxes have to be “properly attributable” to such distribution.