|Code Section||Effective Date||Name of Act||Name of Provision||10yr Revenue Estimate ($millions)|
|909||*12/31/2010||The Air Traffic Control Act||Rules to Prevent Splitting Foreign Tax Credits from the Income to Which They Relate||4,250|
* Notes on Effective Date
In general, the provision is effective with respect to foreign income taxes paid or accrued by U.S. taxpayers and section 902 corporations in taxable years beginning after December 31, 2010. The provision also applies to foreign income taxes paid or accrued by a section 902 corporation in taxable years beginning on or before December 31, 2010 (and not deemed paid under section 902(a) or section 960 on or before such date), but only for purposes of applying sections 902 and 960 with respect to periods after such date (the ‘‘deemed-paid transition rule’’). Accordingly, the deemedpaid transition rule applies for purposes of applying sections 902 and 960 to dividends paid, and inclusions under section 951(a) that occur, in taxable years beginning after December 31, 2010. However, no adjustment is made to a section 902 corporation’s earnings and profits for the amount of any foreign income taxes suspended under the deemed-paid transition rule, either at the time of suspension or when such taxes are subsequently taken into account under the provision.
Rules to Prevent Splitting Foreign Tax Credits from the
Income to Which They Relate
Explanation of Provision
The provision adopts a matching rule to prevent the separation of creditable foreign taxes from the associated foreign income. In general, the provision states that when there is a foreign tax credit splitting event with respect to a foreign income tax paid or accrued by the taxpayer, the foreign income tax is not taken into account for Federal tax purposes before the taxable year in which the related income is taken into account by the taxpayer. In addition, if there is a foreign tax credit splitting event with respect to a foreign income tax paid or accrued by a section 902 corporation, that tax is not taken into account for purposes of section 902 or 960, or for purposes of determining earnings and profits under section 964(a), before the taxable year in which the related income is taken into account for Federal income tax purposes by the section 902 corporation, or a domestic corporation that meets the ownership requirements of section 902(a) or (b) with respect to the section 902 corporation. Thus, such tax is not added to the section 902 corporation’s foreign tax pool, and its earnings and profits are not reduced by such tax.
In the case of a partnership, the provision’s matching rule is applied at the partner level, and, except as otherwise provided by the Secretary, a similar rule applies in the case of any S corporation or trust. The Secretary may also issue regulations to establish the applicability of this matching rule to a regulated investment company that elects under section 853 for the foreign income taxes it pays to be treated as creditable to its shareholders under section 901.
For purposes of the provision, there is a ‘‘foreign tax credit splitting event’’ with respect to a foreign income tax if the related income is (or will be) taken into account for Federal income tax purposes by a covered person.1160 A ‘‘foreign income tax’’ is any income, war profits, or excess profits tax paid or accrued to any foreign country or to any possession of the United States. This term includes any tax paid in lieu of such a tax within the meaning of section 903. ‘‘Related income’’ means, with respect to any portion of any foreign income tax, the income (or, as appropriate, earnings and profits), calculated under U.S. tax principles, to which such portion of foreign income tax relates. For purposes of determining related income, the Secretary may provide rules on the treatment of losses, deficits in earnings and profits, and certain timing differences between U.S. and foreign tax law. Moreover, it is not intended that differences in the timing of when income is taken into account for U.S. and foreign tax purposes (e.g., as a result of differences in the U.S. and foreign tax accounting rules) should create a foreign tax credit splitting event in cases in which the same person pays the foreign tax and takes into account the related income, but in different taxable periods.
With respect to any person who pays or accrues a foreign income tax (hereafter referred to in this paragraph as the ‘‘payor’’), a ‘‘covered person’’ is: (1) any entity in which the payor holds, directly or indirectly, at least a 10-percent ownership interest (determined by vote or value); (2) any person that holds, directly or indirectly, at least a 10-percent ownership interest (determined by vote or value) in the payor; (3) any person that bears a relationship to the payor described in section 267(b) or 707(b) (including by application of the constructive ownership rules of section 267(c)); and (4) any other person specified by the Secretary Accordingly, the Secretary may issue regulations that treat an unrelated counterparty as a covered person in certain sale-repurchase transactions and certain other transactions deemed abusive.
A ‘‘section 902 corporation’’ is any foreign corporation with respect to which one or more domestic corporations meets the ownership requirements of section 902(a) or (b).
Except as otherwise provided by the Secretary, in the case of any foreign income tax not currently taken into account by reason of the provision’s matching rule, that tax is taken into account as a foreign income tax paid or accrued in the taxable year in which, and to the extent that, the taxpayer, the section 902 corporation, or a domestic corporation that meets the ownership requirements of section 902(a) or (b) with respect to the section 902 corporation (as the case may be) takes the related income into account under chapter 1 of the Code. Accordingly, for purposes of determining the carryback and carryover of excess foreign tax credits under section 904(c), the deduction for foreign taxes paid or accrued under section 164(a), and the extended period for claim of a credit or refund under section 6511(d)(3)(A), foreign income taxes to which the provision applies are first taken into account, and treated as paid or accrued, in the year in which the related foreign income is taken into account. Notwithstanding the preceding rule, foreign taxes are translated into U.S. dollars in the year in which the taxes are paid or accrued under the general rules of section 986 rather than the year in which the related income is taken into account. The Secretary
may issue regulations or other guidance providing additional exceptions.
The Secretary is also granted authority to issue regulations or other guidance as is necessary or appropriate to carry out the purposes of the provision. Such guidance may include providing successor rules addressing circumstances such as where, with respect to a foreign tax credit splitting event, the person who pays or accrues the foreign income tax or any covered person is liquidated. This grant of authority also allows the Secretary to provide appropriate exceptions from the application of the provision as well as to provide guidance as to how the provision applies in the case of any foreign tax credit splitting event involving a hybrid instrument. It is anticipated that the Secretary may also provide guidance as to the proper application of the provision in cases involving disregarded payments, group relief, or other arrangements having a similar effect.
An example of a foreign tax credit splitting event involving a hybrid instrument subject to the provision is as follows: U.S. Corp., a domestic corporation, wholly owns CFC1, a country A corporation. CFC1, in turn, wholly owns CFC2, a country A corporation. CFC2 is engaged in an active business that generates $100 of income. CFC2 issues a hybrid instrument to CFC1. This instrument is treated as equity for U.S. tax purposes but as debt for foreign tax purposes. Under the terms of the hybrid instrument, CFC2 accrues (but does not pay currently) interest to CFC1 equal to $100. As a result, CFC2 has no income for country A tax purposes, while CFC1 has $100 of income, which is subject to country A tax at a 30 percent rate. For U.S. tax purposes, CFC2 still has $100 of earnings and profits (the accrued interest is ignored since the United States views the hybrid instrument as equity), while CFC1 has paid $30 of foreign taxes. Under the provision, the related income with respect to the $30 of foreign taxes paid by CFC1 is the $100 of earnings and profits of CFC2.