On December 28, 2021, the U.S. Department of the Treasury (Treasury) and the Internal Review Service (IRS) published final regulations addressing several issues central to foreign tax credits. The Final Regulations generally adopted the proposed foreign tax credit regulations released on November 12, 2020. Specifically, the new rules will limit foreign tax credits for foreign taxes that were clearly creditable under prior law and will raise practical and interpretive issues for taxpayers. The rules limit foreign tax credits to foreign income taxes that conform closely to U.S. tax law, including with respect to the application of the arm’s length principle, the allowance of deductions, and the sourcing of income earned by non-residents. In particular, withholding taxes on services and royalties imposed on the basis of the residence of the payor or on a similar basis will not be creditable except when imposed directly on a U.S. taxpayer that benefits from a U.S. tax treaty that permits a credit. These taxes are common outside of the U.S. tax treaty network.
Transfer pricing rules that are consistent with the arm’s-length standard under Code Sec. 482, or with the Organization for Economic Cooperation and Development’s Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations, will satisfy this requirement. However, it is irrelevant whether taxpayers apply arm’s-length principles in their transactions or even engage in related-party transactions. Creditability is denied where the foreign country’s transfer pricing rules themselves, as generally applicable to all taxpayers, don’t adopt arm’s-length principles, or where those rules use destination-based criteria.
You can anticipate many uncertainties whether a foreign tax remains creditable under the final regulations. Therefore, taxpayers will have to evaluate the creditability of foreign taxes to which they are subject and consider whether it is possible to mitigate or avoid the negative outcomes under the rules. McGuire Sponsel’s Global Business Services team can assist researching and analyzing your client’s fact pattern to determine the appropriate treatment of foreign tax credits and any tax efficient planning strategies.
If you have any questions about our team or any global business issue, do not hesitate to reach out.
Jason Rauhe, CPA is a Principal in the firm’s Global Business Services practice and is responsible for assisting clients and adding depth in all areas of the firm’s international tax consulting services including transfer pricing, and the firm’s compliance expertise.
Rauhe previously served as Director of International Tax at a Top 100 CPA Firm, where he was responsible for the firm’s international tax division and major industry alliance networks.