New 2022 Regulations - Foreign Tax Credits

On January 4, 2022, the IRS and US Treasury issued final regulations regarding whether a foreign tax is eligible to claim as a foreign tax credit applying to tax years beginning on or after December 28, 2021. These regulations greatly complicated the rules governing claiming a foreign tax credit.

Under Section 901, US persons and corporations are entitled to a foreign tax credit for “the amount of any income, war profits, and excess profits taxes paid or accrued during the tax year to any foreign country or any possession of the United States.” Prior to December 28, 2021, a payment of a foreign tax was creditable for US tax purposes if:

•  it was a compulsory payment pursuant to the authority of a foreign government to levy taxes,
• the predominant character of the foreign tax was an income tax in the US sense, and
• a two-part test was completed to satisfy the “predominant character test.”

In 2020, the IRS and Treasury issued proposed regulations that added a Jurisdictional Nexus Requirement to the above requirements in order to claim a credit for a foreign tax. Under the Jurisdictional Nexus Requirement, a foreign tax will be creditable for US tax purposes only if the foreign country imposing the tax has sufficient nexus to a US taxpayer’s business activities, investment of capital, or other assets that gave rise to the foreign income and foreign tax.

For a nonresident taxpayer assessed a foreign tax by a foreign country, sufficient nexus would be satisfied if one of three nexus tests was met. This included an activities-based nexus, source-based nexus, and property-based nexus. Under these three tests, a US taxpayer assessed a foreign tax was creditable for US tax purposes if any allocation of income, gain, deduction, or loss between a resident taxpayer and a related or controlled entity under the foreign country’s transfer pricing rules would follow arm’s-length principles.

The finalized 2022 regulations generally carry over much of the verbiage of the 2020 proposed regulations. However, the 2022 final regulations change the name of the “Jurisdictional Nexus Requirement” to “Attribution Requirement.” The final regulations also require US taxpayers to understand how a transaction is characterized or sourced under foreign law and compare such analysis to the Internal Revenue Code to determine whether such tax is “reasonable.”

The IRS and Treasury recently released a final set of regulations governing the ability of taxpayers to claim foreign tax credits, which add increased complexity and require further analysis to confirm eligibility.

Please reach out to McGuire Sponsel’s Global Business Services team to discuss any situations in more detail.