The Foreign Tax Credit Limitation Under Section 904 (Portfolio 6060)
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This Tax Management Portfolio discusses one part of the U.S. foreign tax credit mechanism—the foreign tax credit limitation under §904. The basic purpose of the limitation is to ensure that the United States does not allow foreign taxes to be used as a credit against U.S. tax on any U.S.-source income.
Description
Tax Management Portfolio 6060 T.M., The Foreign Tax Credit Limitation Under Section 904, discusses one part of the U.S. foreign tax credit mechanism — the foreign tax credit limitation under §904. The basic purpose of the limitation is to ensure that the United States does not allow foreign taxes to be used as a credit against U.S. tax on U.S.-source income.
This Portfolio discusses in general terms the computation of the taxpayer’s foreign tax credit limitation. This computation involves: (1) determining the taxpayer’s gross income; (2) separating the taxpayer’s gross income into U.S.-source and foreign-source income; (3) separating the taxpayer’s foreign-source gross income into foreign tax credit limitation categories (e.g., passive category income or general category income); (4) determining the expenses allowed to be deducted in determining the taxpayer’s total U.S. taxable income; (5) allocating and apportioning the allowable deductions to the taxpayer’s U.S.-source gross income and foreign-source income; (6) deducting the allocated and apportioned deductions; (7) determining final total taxable income by deducting net operating loss carryovers; (8) offsetting separate limitation gains with separate limitation losses; and (9) determining the taxpayer’s foreign tax credit limitation for each separate limitation category by multiplying the taxpayer’s total U.S. tax by the ratio that the final separate limitation income determined for each category bears to the total taxable income.
This Portfolio also addresses the impact of capital gains and losses on the computation of the foreign tax credit limitation, the special re-sourcing rules in §904(h), and the special rules established to prevent taxpayers from avoiding the foreign tax credit limitation rules through deconsolidation.
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Table Of Contents
DETAILED ANALYSIS —
I. Introduction
II. Summary of How to Compute the Limitation
III. Legislative History
A. Revenue Act of 1918
B. Revenue Act of 1921
C. Revenue Act of 1932
D. Internal Revenue Code of 1954
E. Technical Amendments Act of 1958
F. Public Law 86-780 (1960 Amendments)
G. Revenue Act of 1962
H. Foreign Investors Tax Act of 1966
I. Revenue Act of 1971
J. Tax Reform Act of 1976
1. Per-Country Limitation
2. Overall Foreign Losses
3. Capital Gains and Losses
a. Sourcing Rules
b. Netting Capital Transactions
c. Rate Differential Adjustments
d. Foreign-Source Capital Losses
K. Revenue Act of 1978
L. Deficit Reduction Act of 1984
1. Tracing U.S.-Source Income
2. Expansion of Separate Limitation for Non-Business Interest
M. Tax Reform Act of 1986
1. Proliferation of Separate Limitation Categories
2. Look-Through Rules
3. Separate Limitation Losses
a. Allocation of Foreign Losses to U.S. Income
b. Allocation of U.S. Losses to Foreign Income
c. Allocation of Foreign Losses to Foreign Income
d. Recharacterization of Separate Limitation Income
N. Technical and Miscellaneous Revenue Act of 1988
O. Omnibus Budget Reconciliation Act of 1989
P. Taxpayer Relief Act of 1997
Q. American Jobs Creation Act of 2004
1. Reduction to Two Limitation Categories
2. Look-Through for 10-50 Corporations
3. Overall Domestic Losses
4. Revision of §904(c) Carryover Periods
5. Elimination of the AMT Foreign Tax Credit “Haircut”
6. Clarification of Limitation Category for §367(d) Transfers
7. Expansion of the OFL Recapture Regime
R. Education Jobs and Medicaid Assistance Act of 2010
S. American Taxpayer Relief Act of 2012
T. Tax Increase Prevention Act of 2014
U. Protecting Americans from Tax Hikes Act of 2015
IV. Passive Income Category
A. Foreign Personal Holding Company Income
1. Overview
a. Categories of FPHCI
b. Priority Rules Within FPHCI
c. Changes in Use or Purpose for Which Property Is Held
(1) Subpart F Regulations
(2) “Check and Sell” Transactions
d. Interaction with the “Brown Group” Regulations
2. Subpart F De Minimis and Full-Inclusion Exceptions
3. Active Finance and Active Insurance Exceptions
4. Dividends
5. Interest
a. Overview
b. Export Financing Interest Versus Related Person Factoring Income
c. Definition of Export Financing Interest
d. Definition of Related Person Factoring Income
e. FPHCI Exception for Export Financing Interest from Banking Activities
f. Section 904(d) Exception for Export Financing Interest
6. Rents and Royalties
a. Overview
b. Same Country Exception
c. Subpart F Active Rents and Royalties Exception
(1) Rents
(2) Royalties
d. Active Rents and Royalties Exception
7. Annuities
8. Net Gain from Passive Assets
a. Overview
b. Net Gain from Passive Income Property
c. Net Gain from Non-Income Property
d. Dual Character Property
e. Look-Through Treatment for Certain Partnership Sales
f. Inventory Property
g. Dealer Property
9. Commodity Transactions
a. Overview
b. Commodities Transactions Covered by §954(c)(1)(C)
c. Exceptions
(1) Qualified Active Sales
(2) Qualified Hedging Transactions
10. Foreign Currency Gains
a. Overview
b. Section 988 Transactions
c. Exceptions to §988
d. Business Needs Exceptions
(1) In General
(2) Dealer Property
e. Special Elections
(1) Election to Match Subpart F Categories
(2) Net Inclusion Election
11. Income Equivalent to Interest
a. Overview
b. Interest-Rate Swaps
(1) Current Regulations
(2) Subsequent Enactments
c. Factoring Income
d. Conversion Transactions
e. Certain Income from Services Transactions
f. Loan Commitment Fees
g. Income from the Transfer of Debt Securities Subject to §1058
12. Income from Notional Principal Contracts
13. Payments in Lieu of Dividends
14. Income from Personal Services Contracts
B. Foreign Personal Holding Companies
C. Passive Foreign Investment Companies
D. Passive Income Exceptions
1. Income in Other Categories
2. High-Tax Kick-Out
a. Overview
b. Grouping Rules
(1) Conceptual Example
(2) Mechanics
(a) General Rule
(b) Exceptions for Subpart F Inclusions, 10-50 Dividends, and QBU Income
(c) Additional Special Rules
c. Subsequently Imposed Taxes
(1) General Rule
(2) Section 905(c) Adjustments
(3) Successor U.S. Shareholders
d. Subsequent Reduction in Taxes
(1) Integrated Tax Systems
(2) Effect of §954(b)(4)
(3) Distribution Ordering Rules
V. General Category Income
A. In General
B. Financial Services Income
1. Background
2. How to Earn Financial Services Income
3. Financial Services Income
a. Definition
b Active Financing Income
c. Incidental Income
4. Financial Services Entity
a. Definition
b. Income from Related Persons
c. Partnerships
d. Financial Services Group
VI. Miscellaneous Limitation Categories
VII. Pre-2007 Limitation Categories
A. High Withholding Tax Interest Category (Pre-2007)
1. Background
2. Definition
3. Repeal
B. Shipping Income Category (Pre-2007)
1. Background
2. Definition
3. Exceptions
4. Repeal
C. Category for Dividends from 10-50 Corporations (Pre-2007)
1. Background
2. Qualification as a 10-50 Corporation
3. Definition of a 10-50 Dividend
4. Coordination with §907
5. Pre-2003 Coordination Rules
a. High Withholding Tax Interest
b. Financial Services Income and Shipping Income Categories
D. Category for Dividends from a DISC (Pre-2007)
E. FSC-Related Separate Limitation Categories (Pre-2007)
1. Background
2. Foreign Trade Income Limitation Category
3. FSC Dividend Limitation Category
VIII. Look-Through Rules
A. Background
B. CFC Look-Through Rules
1. Overview
2. Subpart F Income
a. Subpart F De Minimis Rule
b. Subpart F Full-Inclusion Rule
3. Interest Look-Through Rules
a. Related Person Interest Income
b. Allocation Methodology
c. Multiple Recipients of Related Person Interest
d. Exception for High Withholding Tax Interest
4. Rents and Royalties
5. Dividends
a. Allocation Methodology
b. Earnings and Profits
c. Income Subject to the Subpart F High-Tax Exception
d. Anti-Avoidance Rule for Certain Related Party Loans
e. Distributions from an FSC
6. QEF Inclusions Under §1293
C. 10-50 Look-Through Rules
1. 10-50 Dividends to the Domestic Corporate Shareholder
2. 10-50 Dividends to Related Look-Through Entities
3. Pre-Acquisition Earnings
4. Reconstruction of Pre-2003 Look-Through Earnings and Taxes
5. Carryforward and Carryback of Excess 10-50 Taxes
6. Election to Defer Application of the 10-50 Look-Through Rules
D. Other Look-Through Rules
1. Certain Payments by U.S. Corporations
2. Payments by Partnerships and Other Pass-Through Entities
a. General Rule
b. Less-than-10% Partners
c. Section 707 Payments
d. Sale of a Partnership Interest
3. Payments by Related Look-Through Entities
4. QEF Inclusions
E. Ordering Rules
F. Coordination with §904(h)
G. Effective Dates
IX. Allocation and Apportionment of Taxes
A. Allocation of §901 Taxes
B. Allocation of §902 Taxes
C. Special Rules
X. Carryforward and Carryback of Taxes
A. Overview
B. Reduction of Excess Credits Carried Past a Deduction Year
C. Foreign Tax Redeterminations
1. Relation-Back of Foreign Income Taxes
2. Statute of Limitations for Refund Claims
D. Interaction with Overall Foreign Loss and Overall Domestic Loss Recapture
E. Interaction with §909
F. Affiliated Groups
1. Group Limitation
2. Consolidated Unused Foreign Taxes
a. Taxes Generated in Consolidated Years
b. Taxes Generated in Separate Return Years
G. Effect of Carryback on Interest Computations
XI. Transition Rules
A. Tax Reform Act of 1986
B. American Jobs Creation Act of 2004
1. Carryforward of Unused Taxes
2. Carryback of Unused Taxes
3. Reconstruction of Pre-2007 Undistributed Earnings and Taxes
XII. Losses and the Foreign Tax Credit Limitation
A. Background
1. Purpose of Overall Foreign Loss Recapture
2. Background of Overall Domestic Loss Recapture Rules
3. Basic Structure of Loss Recapture Rules
4. Overview of Computation Steps
B. Computation of Losses After 2006
1. Preliminary Income or Loss
2. NOL Carryovers
a. NOLs that Can Be Completely Absorbed
b. NOLs that Cannot Be Completely Absorbed
3. Allocation of Losses
C. Prior Law: Computation of Losses Before 2007
1. NOL Carryover Rules
a. Post-1986 Carryovers into Post-1986 Years
(1) NOLs that Can Be Completely Absorbed
(2) NOLs that Cannot Be Completely Absorbed
b. Pre-1987 NOL Carryforwards
c. Post-1986 NOL Carrybacks
2. Allocation of Losses Before 2007
3. Pre-2007 Examples
a. One SLL to Multiple Limitation Categories
b. One SLL to Multiple Limitation Categories and U.S.-Source Income
c. Two SLLs to Other Limitation Categories
d. Two SLLs to U.S.-Source Income
e. U.S. Loss to Multiple Limitation Categories
f. U.S.-Source Loss and an SLL to Other Limitation Categories
D. Maintaining OFL, SLL, and ODL Accounts
1. OFL and SLL Accounts
2. ODL Accounts
E. Recapture and Recharacterization
1. OFL Recapture
2. SLL Recharacterization
3. ODL Recapture
4. Special Recapture Rule for Dispositions of Property
a. Definitions
(1) Property Used in a Trade or Business
(2) Disposition
(3) Property Used Predominantly Outside the United States
b. Recognized Gain
c. Unrecognized Gain
d. Multiple Dispositions
e. CFC Stock
F. Special Issues
1. Treatment of Foreign Taxes
2. Taxpayers that Deduct Foreign Taxes
3. Capital Gains and Losses
4. Domestic Trusts
a. General Application
b. Accumulation Distributions from a Trust
5. Consolidated OFLs, SLLs, and ODLs
a. Group-Level Computation
b. Entering or Departing Group Members
c. Intercompany Transactions
G. Transition Rules
1. Pre-1987 OFLs Carried Post-1986
2. OFLs and SLLs Attributable to 10-50 Dividends
3. Pre-2007 OFLs and SLLs After 2006
XIII. Capital Gains and Losses
A. Overview
B. Sourcing Rules
1. Legislative Purpose
2. Source Rules for Capital Transactions
C. Netting of Capital Gains and Losses
1. Legislative Purpose
2. Gain Netting Rule
3. Allocation Rules
D. Capital Gain Rate Differential Rules
1. Legislative Purpose
2. Operation
a. Existence of a Capital Gain Rate Differential
b. Computation of the Rate Differential Portion
E. Capital Loss Rate Differential Rule
1. Legislative Purpose
2. Operation
F. Coordination with §904(f)
XIV. Re-Sourcing of Income
A. Background
B. Operation
1. Definition of United States-Owned Foreign Corporation
2. Dividend Income
3. Interest
4. Inclusions Under §951(a) and §1293
5. Interaction with §904(f)
6. Coordination with Treaties
a. Section 904(h)(10)
b. Section 904(d)(6)
XV. Deconsolidation to Avoid the Foreign Tax Credit Limitation
A. Background
B. Operation
1. Affiliation
2. Amount of Limitation
C. Stapled Stock Interests
Partner
Covington & Burling LLC