On July 21, 2023, the IRS issued Notice 2023-55, delaying the application of the complex final foreign tax credit (FTC) regulations under Internal Revenue Code Sections 901 and 903 originally issued on January 4, 2022. The final regulations were issued as a response to the rise of the digital economy and substantially revised the requirements for foreign taxes to be claimed as an FTC. The regulations generally required detailed analysis of foreign local country law to determine if the foreign taxes were imposed on a tax base that substantially conformed with U.S. tax principles. Furthermore, the final regulations added a new “attribution” requirement that foreign taxes must be attributable to the activities within the foreign country. Thus, foreign taxes based on location of customers or other destination-based factors would be excluded. The IRS had received extensive comments on the FTC regulations, which taxpayers viewed as difficult to apply and burdensome.
Notice 2023-55 provides relief. The Notice permits taxpayers to use the former §§901 and 903 regulations during a relief period for taxable years beginning on or after December 28, 2021 and ending on or before December 31, 2023. During this time, the IRS is continuing to analyze the final 2022 regulations and is considering proposing amendments.
However, the Notice specifically retains FTC limitations related to taxes based on digital services (DST) which are imposed on gross receipts or gross income. The Notice replaces language in former Regulation §1.901-2(b)(4)(i) with new language aimed at the DST:
No foreign tax whose base is gross receipts or gross income satisfies the net income requirement, except in the case of a foreign tax whose base consists solely of investment income that is not derived from a trade or business, or wage income (or both).”
Since a DST is a tax based on gross income and does not consist solely of investment income not derived from a trade or business, a DST is not creditable for U.S. tax purposes.
The Notice provides that these relief provisions apply to all foreign taxes paid by U.S. taxpayers, including a controlled foreign corporation (CFC) of which the taxpayer is a U.S. shareholder for the CFC’s taxable year that ends with or within the U.S. shareholder’s relief year.
Notice 2023-55 provides welcome relief to U.S. taxpayers for 2022 and 2023 while the IRS considers further modifications for the FTC regulations. However, the Notice also makes clear that the IRS is not considering changing its position on DSTs based on gross income. Taxpayers who already filed their 2022 returns and had FTC limitations due to the new regulations may want to consider amending their returns.
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