International Tax

Indirect Foreign Tax Credits (Portfolio 6040)

  • This Portfolio contains a detailed analysis of the indirect foreign tax credit system as in effect both before and after the enactment of the 2017 tax act.

Description

Tax Management Portfolio, Indirect Foreign Tax Credits, No. 6040, contains a detailed analysis of the indirect foreign tax credit system as in effect both before and after the enactment of the 2017 tax act. The Portfolio contains a detailed analysis of former §902, under which a domestic corporation may have been deemed to have paid, for purposes of the §901 foreign tax credit, foreign income taxes paid by a foreign corporation from which the domestic corporate shareholder received a dividend. The Portfolio comprehensively addresses the threshold requirements to be met to apply §960 under which a domestic corporation that is taxed on earnings and profits of a controlled foreign corporation under §951 may be deemed to have paid foreign income taxes paid by the foreign corporation. The 2017 tax act repealed the indirect foreign tax credit under former §902, and significantly amended the deemed paid credit under §960; both changes are effective with respect to taxable years of foreign corporations beginning after 2017.

The Portfolio also addresses other special situations in which an indirect credit may arise, such as when a U.S. shareholder or a controlled foreign corporation sells stock in a controlled foreign corporation and the gain is re-characterized as a dividend under §1248 or §964(e); when a U.S. shareholder or foreign exchanging shareholder is deemed to receive a dividend in a reorganization or other transaction covered by §367(b); when a U.S. shareholder is taxed on income of a passive foreign investment company; and when a U.S. shareholder receives certain distributions from a DISC or a FSC. The Portfolio also examines the annual election provided by §962, which allows a non-corporate domestic shareholder to claim a foreign tax credit through §960 (and former §902) when including an amount in gross income under §951.

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Table of Contents

DETAILED ANALYSIS —

I. Overview of Indirect Foreign Tax Credits

II. Indirect Credit Under Former §902

A. Overview

B. Qualification for the Former §902 Credit

1. Historical Background

2. Basic Requirements

a. Foreign Corporation Requirement

(1) Classification Issues

(2) Foreign versus Domestic Status

b. Dividend Requirement

C. Domestic Corporate Shareholder Requirement

(1) “Domestic” Requirement

(2) “Corporation” Requirement

3. First-Tier Corporation Ownership Requirement

a. 10% Voting Stock Requirement

(1) In General

(2) Stock Attribution from Corporations

(a) In General

(i) Rev. Rul. 74-459 — Direct Ownership of Nonvoting Stock Only

(ii) Rev. Rul. 85-3 — Consolidated Group Ownership Not Aggregated or Attributed

(b) First Chicago Corp. — Tax Court Follows Rev. Rul. 85-3

(i) Explanation

(ii) Treatment of Consolidated Groups After First Chicago

(3) Stock Attribution from Pass-Through Entities

b. Measurement of Voting Stock Ownership

(1) In General

(2) Rev. Rul. 84-6 — Voting Power Based on Power to Elect Directors

4. Ownership Requirements for Lower-Tier Foreign Corporations

a. In General

b. 10% Direct Ownership Requirement

c. Qualified Group Definition

5. Application of Ownership Requirements to Section 304 Transactions

6. Anti-Splitter Rule

a. Foreign Taxes Paid or Accrued by a §902 Corporation in Taxable Years Ending After February 9, 2015

(1) Reverse Hybrid Income

(2) Foreign Group Relief

(3) Hybrid Instruments

(4) Partnership Inter-Branch Payments

(5) Foreign-Initiated Adjustments

(a) Splitter Arrangements Arising from the Application of §905(c) to Successor Entities

(b) Splitter Arrangements Arising from Distributions Made Before the Payment of Additional Tax Pursuant to Foreign-Initiated Adjustments

(6) Related Income

(7) Anti-Abuse Rule

b. Foreign Taxes Paid or Accrued by a §902 Corporation in Taxable Years Beginning on or After January 1, 2012, and Ending on or Before February 9, 2015

(1) Reverse Hybrid Income

(2) Foreign Consolidated Group Splitting Arrangements and the “Technical Taxpayer” Regulations

(3) Foreign Group Relief

(4) Hybrid Instruments

(5) Partnership Inter-Branch Payments

(6) Distributions of Related Income

(7) Anti-Abuse Rule

c. Foreign Taxes Paid or Accrued by a §902 Corporation in Taxable Years Beginning on or after January 1, 2011, and Before January 1, 2012

d. Foreign Taxes Paid or Accrued by a §902 Corporation in Pre-2011 Taxable Years

(1) Reverse Hybrid Income

(2) Foreign Consolidated Tax Liability

(3) Foreign Group Relief

(4) Hybrid Instruments

(5) Partnership Inter-Branch Payments

(6) Related Income

(7) Transition Rules

e. Transactions Not Currently Listed as Splitter Arrangements

f. “Technical Taxpayer” Rules

(1) Allocation of Combined Income

(2) Changes in Ownership of Disregarded Entities and Partnership Interests

7. Covered Asset Acquisition

a. Section 901(m) — In General

b. Transactions Subject to §901(m)

c. Relevant Foreign Assets

d. Determining the Foreign Taxes Disallowed as a Credit

(1) The Disqualified Portion

(2) Aggregate Basis Difference in Relevant Foreign Assets

e. Application of §901(m)

f. The Disposition Rule

g. Notice 2014-44, Notice 2014-45, and Temporary Regulations

(1) Disposition

(2) Foreign Income Taxes

(3) Asset Received in Exchange for an RFA

h. Proposed Regulations

(1) Proposed 704 Regulations

(2) Key Definitions

(3) New CAAs

(4) Disqualified Tax Amount

(5) Foreign Basis Election

(6) Allocating Cost Recovery and Disposition Amounts

(7) Successor Rules

(8) De Minimis Exception

C. Computation of the Former §902 Credit

1. Former §902 Computational Rules

a. Overview

b. Post-1986 Computational Rules

(1) In General

(2) Post-1986 Foreign Income Taxes

(a) In General

(b) Definition of Foreign Income Taxes

(3) Post-1986 Undistributed Earnings

(4) Dividends

c. Coordination Between Pre-1987 and Post-1986 Computational Rules

(1) In General

(2) Special Effective Date

d. Pre-1987 Computational Rules

(1) In General

(2) Accumulated Profits

2. Special Allocations of Foreign Income Taxes

3. Sourcing of Earnings and Foreign Income Taxes in §304 Deemed Dividends

4. Effect of Losses on Former §902 Credit

a. Effect of Losses on Allocation of Dividend Among Pre-1987 Years

b. Effect of Post-1986 Losses

c. Carryforward of Pre-1987 Losses to Post-1986 Years

d. Carryback of Post-1986 Losses to Pre-1987 Years

5. Distributions from Lower-Tier Corporations

a. In General

(1) Step 1: Compute Taxes Deemed Paid by First-Tier Corporation

(2) Step 2: Compute Taxes Deemed Paid by Domestic Shareholder

b. Repatriation of Earnings of Lower-Tier Corporation from Pre-1987 Years

6. Effect of Intervening Noncontrolled Status on Pooling

III. Indirect Credit Under §960

A. Overview of §960 Credit

B. Background of §960 Credit

1. Pre-2017 Tax Act §960

2. Post-2017 Tax Act §960

C. Qualification for the §960 Credit

1. Overview

2. Section 951(a)(1) Inclusions

3. Section 951(a)(1) Inclusions from Lower-Tier Corporations (Pre-2018)

4. Interaction of Former §902 and §960 Ownership Rules (Pre-2018)

5. Comparison of §951 and §960 Ownership Rules

6. Anti-Hopscotch Rule for Foreign Taxes Deemed Paid Under §956 in Taxable Years Beginning Before 2018

a. Accessing Foreign Tax Credits from Lower-Tier CFCs

b. Former §960(c) — Overview

c. Functional Application of Former §960(c)

d. Determining the Hypothetical Credit

e. Treatment of Foreign Taxes Limited by Former §960(c)

f. General Observations Regarding Former §960(c)

g. Open Issues

7. Anti-Splitter Rule

8. Covered Asset Acquisitions

D. Computation of §960 Credit for §951(a)(1) Inclusions

1. Overview

2. Post-1986/Pre-2018 Computational Rules

a. In General

b. Post-1986 Foreign Income Taxes

c. Treatment of Post-1986 Foreign Income Taxes in Situations Where E&P Reduced but No Shareholder Recognized a Dividend or Deemed Dividend

(1) Background

(2) Calculation of Indirect Credit Prior to the 1986 Act

(3) Changes Made to the Calculation of the Indirect Credit in the 1986 Act

(4) Statutory and Regulatory History Regarding Reduction of Post-1986 Foreign Taxes

(5) AM 2013-006

d. Post-1986 Undistributed Earnings

3. Coordination Between Pre-1987 and Post-1986 Computational Rules

a. In General

b. Special Effective Date

4. Pre-1987 Computational Rules

5. Inclusion of §902 Deemed Paid Taxes Under §960 in Pre-2017 Tax Act Years

6. Losses on §960 Credit

a. Translation of Pre-1987 §964(a) Earnings

b. Carryforward of Pre-1987 Accumulated Deficits to Post-1986 Years

c. Carryback of Post-1986 Deficits to Pre-1987 Years

7. Post-2017 Tax Act Computational Rules

E. Computation of the §960 Credit for §951A Inclusions under the 2017 Tax Act

F. “Properly Attributable” Standard

1. Overview

2. The JCT Report Discussion of “Properly Attributable”

3. Proposed Regulations Guidance Regarding “Properly Attributable”

G. Coordination Rules for Distributions of Previously Taxed Income

1. Overview

a. Post-2017 Tax Act Years

b. Pre-2017 Tax Act Years

2. Tracing of Distributions to Previously Taxed Income

3. Distributions of Previously Taxed Income to Domestic Corporations

a. Post-2017 Tax Act Years

b. Pre-2017 Tax Act Years

4. Additional Foreign Taxes Incurred on Distributions of Previously Taxed Income to Higher-Tier CFCs

5. Increase in Credit Limitation in Year of Distribution

a. Overview

b. Former §960(b) Rules for Taxable Years Beginning Before September 30, 1993

(1) Eligibility Requirements

(2) Amount of Increase in §904 Limitation

c. Section 960(c) (Former §960(b)) Mechanics for Taxable Years Beginning After September 30, 1993

(1) Eligibility Requirements

(2) Amount of Increase in §904 Limitation

d. Transition Rules

H. Proposed Regulations

1. Overview

2. Prop. Reg. §1.960-1

3. Prop. Reg. §1.960-2

4. Prop. Reg. §1.960-3

5. Prop. Reg. §1.960-4, §1.960-5 & §1.960-6

IV. Section 960 Credit for Individuals: Section 962

A. Overview

B. Persons Eligible to Make the §962 Election

C. Making the §962 Election

1. Timing of Election

2. Contents of Election

3. Duration and Scope of Election

D. Consequences of the §962 Election

1. Application of Corporate Income Tax Rates to §951 and §951A Income

2. Availability of §960 Indirect Credit

3. Second Level of Tax on Distributed Income

a. Overview

b. Taxation of Actual Distributions

c. Tracing Distributions to Previously Taxed Earnings

4. Possible Availability of §960(c) Foreign Tax Credit

5. Treatment of §951A GILTI Inclusions

a. Availability of §960(d) Credit

b. Availability of §250 Deduction

E. Deciding Whether to Make the Election

V. Indirect Credit Under §1248

A. Introduction

B. Section 1248 Credit Qualification (Pre-2018)

1. In General

2. First-Tier Corporations

3. Lower-Tier Corporations

C. Section 1248 Credit Computation

1. In General

2. Issues Raised by Lower-Tier Corporations

3. Rules Applicable to Transferees

4. Coordination with §904

5. Application of Rules Under §964(e)

D. Treatment of Individual Shareholders Under §1248(b)

VI. Indirect Credit Under §367(b)

A. Historical Background

B. Computation of §367(b) Credit

VII. Indirect Credit for Passive Foreign Investment Company (PFIC) Taxes

A. Overview of PFIC Rules

B. The Foreign Tax Credit Under the Excess Distribution Regime

1. Overview of §1291 Fund Taxation

2. Foreign Tax Credit with Respect to Excess Distributions

3. Foreign Tax Credit with Respect to Disposition of Stock

C. The Foreign Tax Credit Under the Qualified Electing Fund (QEF) Regime

1. Computation of Indirect Credit Under §1293

a. In General

b. Section 904 Limitation

2. Effect of §1294 Election

3. Coordination with Other Indirect Credit Rules

4. Lower-Tier Issues

VIII. Indirect Credits for Export Subsidiaries

A. Introduction

B. Indirect Credit Under DISC Rules

C. Indirect Credit Under FSC Rules

D. Extraterritorial Income Rules

E. Current Law

IX. Coordination of Indirect Credits with §904

A. Overview

1. Taxable Years Beginning Before 2018

2. Taxable Years Beginning After 2017

B. Pre-1987 Distributions or §951 Inclusions in Pre-1987 Years

C. Post-1986 Distributions or §951 Inclusions from Post-1986 Undistributed Earnings in Pre-2017 Tax Act Years

1. Noncontrolled §902 Corporations

2. Controlled Foreign Corporations

a. More-Than-90% Acquisition Rule

b. Effect of Losses on §904 Limitation

(1) Deficit in Post-1986/Pre-2018 Earnings of §904 Basket

(2) Carryforward of Pre-1987 Deficits to Post-1986 Years

(3) Carryback of Post-1986 Losses to Pre-1987 Years

D. Post-1986 Distributions from Pre-1987 Accumulated Profits

E. Effect of Intervening Noncontrolled Status

F. Post-2017 Taxable Years

1. Foreign Tax Credit Limitation Rules Related to GILTI

2. Foreign Tax Credit Limitation Rules Related to Foreign Branch Income from a QBU

a. Trade or Business Requirement

b. Separate Books and Records Requirement

c. Business Profits Attributable to QBU

3. Pre-2018 Overall Domestic Losses

G. Proposed Regulations

1. Overview

2. Section 951A Category Income

3. Foreign Branch Category Income

4. Other Proposed Rules

5. Applicability Dates

X. Dividend Gross-Up Under §78

A. Background

B. General Rule

C. Timing of the §78 Dividend

D. Amount of the §78 Dividend

E. Proposed Regulations

XI. Collateral Issues

A. Effect of §482 Allocations (Pre-2018 Law)

1. In General

2. Step 1 — Recompute Earnings and Profits of Foreign Corporation

3. Step 2 — Effect of §482 Allocation on Dividend Determination

4. Step 3 — Recompute Foreign Income Tax

B. Section 905(c) Adjustments

1. In General & Regulatory History

a. Pre-1988 Rule

b. 1998 Temporary Regulations

c. 2007 Temporary and Proposed Regulations

2. Historical Background

3. Foreign Tax Redeterminations Made in Taxable Years Beginning Before 1987

4. Foreign Tax Redeterminations Made in Taxable Years Beginning After 1986 but Before 2018

a. Prospective Adjustments

b. Retroactive Adjustments

c. “Relation Back” Approach

5. Foreign Tax Redeterminations Made in Taxable Years Beginning After 2017

C. Statute of Limitations

1. Application to Former §902 and §960 Credits

2. Timing to Begin Counting the 10-Year Period Under §6511(d)(3)(A)

D. Economic Substance — STARS Litigation

1. Bank of New York Mellon Case

2. Subsequent Cases

WORKING PAPERS

David Sotos
David Sotos
Principal, National Tax Services
PwC US
collins-martin-2015
Martin Collins
Tax Partner
PwC LLP
Micah Gibson
Micah Gibson
International Tax Director
PwC
Prae Kriengwatana
Prae Kriengwatana
International Tax Director, WNTS
PwC
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