1. Navigating Section 905(c)
Navigating Section 905(c)
Carl Dubert
Elizabeth Nelson

2. Navigating Section 905(c)
Questions under current law

3. Section 905(c) – Generally
Specifies how taxpayers are to account for foreign tax redeterminations.
A foreign tax redetermination includes the following:
Accrued taxes that when paid differ from the amounts claimed as credits by the taxpayer
Accrued taxes that are not paid before the date 2 years after the close of the taxable year to which such taxes relate
Any tax paid that is refunded in whole or in part
Navigating Section 905(c)

4. Section 905(c) – Generally
Two methods:
Retrospective Adjustments: taxpayers generally adjust the amount of foreign taxes treated as paid or accrued in the foreign tax year at issue.
Prospective Adjustments: in some circumstances, taxpayers adjust their foreign taxes in the year of the adjustment.
Prospective adjustments intended to eliminate the need to recompute past indirect credits under sections 902 and 960.
Code and Regulations provide overlapping and inconsistent rules for applying retrospective and prospective adjustments.
Navigating Section 905(c)

5. Section 905(c) – Background
As originally enacted in 1954, section 905(c) read, in relevant part:
(c) Adjustments on Payment of Accrued Taxes.– If accrued taxes when paid differ from the amounts claimed as credits by the taxpayer, or if any tax paid is refunded in whole or in part, the taxpayer shall notify the Secretary, who shall redetermine the amount of the tax for the year or years affected.
The amount of tax due on such redetermination, if any, shall be paid by the taxpayer on notice and demand by the Secretary, or the amount of tax overpaid, if any, shall be credited or refunded to the taxpayer …
In such redetermination by the Secretary of the amount of tax due from the taxpayer for the year or years affected by a refund, the amount of taxes refunded for which credit has been allowed under this section shall be reduced by the amount of any tax described in section 901 imposed by the foreign country or possession of the United states with respect to such refund;
but no credit under this subpart, and no deduction under section shall be allowed for any taxable year with respect to such tax imposed on the refund.
Navigating Section 905(c)

6. 1988 Temporary regulations (T.D. 8210)
The 1988 temporary regulations contain a relatively straightforward mechanism for imposing retrospective or prospective adjustments.
Temp. Reg. § T(d)(1) generally requires a retrospective adjustment for foreign taxes paid or accrued by a U.S. person:
“[A] redetermination of the United States tax liability is required for the taxable year for which the foreign tax was claimed as a credit.”
Navigating Section 905(c)

7. 1988 Temporary regulations (T.D. 8210)
Temp. Reg. § T(d)(2) generally requires a prospective adjustment for foreign taxes paid or accrued by a foreign corporation:
“[A] redetermination of United States tax liability is not required to account for … a redetermination of foreign tax paid or accrued by a foreign corporation on the foreign taxes deemed paid by a United States corporation under sections 902 or 960.”
However, retrospective adjustments are required in certain cases:
Tax liability is in a hyperinflationary currency;
Redetermination creates a deficit in any of the foreign corporation’s tax pools; or
PTI distribution on which withholding tax is imposed.
At the IRS’s discretion, if a foreign tax redetermination reduces the foreign tax liability by at least 2 percent.
Navigating Section 905(c)

8. Section 905(c)(1) and (2) – Two-Year Rule
Enacted in 1997, section 905(c)(1) and (2) create a statutory prospective adjustment rule that differs from the rule in the 1988 regulations.
Section 905(c)(2) provides a special rule for accrued taxes that are not paid before the date two years after the close of the taxable year to which such taxes relate (“Two Year Rule”):
Section 905(c) Adjustments to accrued taxes
(2) Special rule for taxes not paid within 2 years
(A) In general
Except as provided in subparagraph (B), in making the redetermination under paragraph (1), no credit shall be allowed for accrued taxes not paid before the date referred to in subparagraph (B) of paragraph (1).
(B) Taxes subsequently paid Any such taxes if subsequently paid—
(i) shall be taken into account—
(I) in the case of taxes deemed paid under section 902 or section 960, for the taxable year in which paid (and no redetermination shall be made under this section by reason of such payment), and
(II) in any other case, for the taxable year to which such taxes relate, and
(ii) shall be translated as provided in section 986(a)(2)(A).
Navigating Section 905(c)

9. Two-Year Rule – Differing Interpretations
Differing interpretations of the Two-Year Rule’s relevance.
IRS Interpretation:
Requires:
An additional foreign tax assessment, and
At the time of the foreign tax redetermination, two or more years have passed since the year to which the tax relates.
Then:
Additional tax is taken into account in the year paid for section 902 or 960 credits. Otherwise, the foreign taxes are adjusted retrospectively.
Navigating Section 905(c)

10. Two-Year Rule – Legislative History
This interpretation may be inconsistent with the legislative history.
Example in 1997 JCT Blue Book describes a taxpayer that accrues a foreign tax credit in year 1 but fails to pay the tax in the following two years:
[A]ssume that in year 1 a taxpayer accrues 1,000 units of foreign tax that relate to year 1 and that give rise to a foreign tax credit under section 901 … . Further assume that as of the end of year 1 the tax is unpaid.
In this case, the Act provides that the taxpayer translates the 1,000 units of accrued foreign tax into U.S. dollars at the average exchange rate for year 1. If the 1,000 units of tax are paid by the taxpayer in either year 2 or year 3, no redetermination of foreign tax is required.
If any portion of the tax so accrued remains unpaid as of the end of year 3, however, the taxpayer is required to redetermine its foreign tax accrued in year 1 to eliminate the accrued but unpaid tax, thereby reducing its foreign tax credit for such year. If the taxpayer pays the disallowed taxes in year 4, the taxpayer again redetermines its foreign taxes (and foreign tax credit) for year 1, but the taxes paid in year 4 are translated into U.S. dollars at the exchange rate for year 4.
Navigating Section 905(c)

11. 2007 Temporary regulations (T.D. 9362)
The 2007 temporary regulations made various revisions to the temporary regulations, while maintaining the same general framework.
Temp. Reg. § T(d)(1) generally requires a retrospective adjustment for foreign taxes paid or accrued by a U.S. person.
Temp. Reg. § T(d)(3) generally requires a prospective adjustment for foreign taxes paid or accrued by a foreign corporation, but with exceptions:
Tax liability is in a hyperinflationary currency;
PTI distribution on which foreign tax is reduced;
Redetermination creates a deficit in any of the foreign corporation’s tax pools; or
A foreign tax redetermination would reduce a domestic corporation’s foreign taxes deemed paid in the relation back year by at least 10% if adjusted retrospectively.
Navigating Section 905(c)

12. State of the Regulations
The 2007 temporary regulations expired in 2010, but identical proposed regulations remain.
Proposed regulations have no legal effect until they are adopted as final, but per CC , taxpayers generally may rely on proposed regulations that do not conflict with existing final or temporary regulations.
CCA also stated that taxpayers could rely on the proposed regulations.
1988 temporary regulations were issued prior to amendment to § 7805(e), so have not expired.
Did the 1988 temporary regulations spring back into their original form when the 2007 temporary regulations expired?
Navigating Section 905(c)

13. Conversion to DE (i.e., liquidation) and redetermination thereafter
PLR
In PLR , a CFC liquidated into its U.S. corporate owner for U.S. tax purposes while remaining in existence for foreign tax purposes. Thereafter, the foreign entity’s foreign taxes were redetermined.
The IRS concluded that the prospective adjustment rule of section 905(c)(2)(B)(i)(I) did not apply to redetermine the U.S. corporation’s indirect foreign tax credits when the foreign law taxpayer was a disregarded entity of the U.S. corporation at the time of the redetermination.
The ruling applies the prospective and retrospective adjustment rules of the Two-Year Rule.
The IRS concluded that the retroactive adjustment rule of section 905(c)(2)(B)(II) applied because the foreign corporation’s tax pools could not be adjusted. US
Year 1
Year 2
Conversion to DE (i.e., liquidation) and redetermination thereafter
CFC
Navigating Section 905(c)

14. Example 1
In year 1, taxpayer accrues and pays 100 units of foreign tax.
In year 7, foreign tax authority levies an additional assessment of 50 units.
Taxpayer paid its year 1 foreign tax properly in year 1 and likely could not have anticipated the year 7 foreign tax redetermination.
What is the result?
Navigating Section 905(c)

15. Example 2
In year 1, foreign subsidiary pays 40 units of foreign tax on 200 units of E&P.
In year 2, foreign subsidiary pays 100 units of dividend to its U.S. parent, so that the latter is deemed to have paid 20 units of foreign tax under section 902.
In year 6, foreign tax authority audits foreign subsidiary and assesses 20 units of additional foreign taxes with respect to year 1.
What is the result?
Navigating Section 905(c)

16. Example 3 – Refunds
In year 3, a CFC receives a refund of foreign tax originally imposed and collected in year 1.
What is the result?
Does the retrospective adjustment rule apply as in PLR ?
Does the Two-Year Rule apply?
Navigating Section 905(c)

17. Example 4 – Mirror image of PLR 200127011
In year 1, a foreign disregarded entity owned by a U.S. corporation pays 100 of foreign tax.
In year 4, the foreign entity elects to become a foreign corporation for U.S. tax purposes.
In year 7, following a foreign audit, the foreign tax authority assesses additional year 1 foreign tax.
What is the result?
Does the retrospective adjustment rule apply as in PLR ?
Does the Two-Year Rule apply?
Navigating Section 905(c)

18. Example 5 – Sale of DE to a Related CFC
In year 1, to which the tax relates, CFC 1 owned a disregarded entity, DE.
In year 3, CFC 2 purchased DE.
In year 4, foreign tax authority assessed DE additional tax for year 1.
What is the result?
Does the Two-Year Rule apply?
Does a prospective or retrospective rule of the regulations apply?
Navigating Section 905(c)

19. Example 6 – Asset reorganization
In year 1, CFC1 pays foreign tax.
In year 2, CFC1 pays a dividend to its U.S. corporate shareholder, such that the latter is deemed to have paid some or all of the year 1 foreign taxes.
In year 3, CFC1 is acquired by CFC2 in an asset reorganization (e.g., A, C, or D).
In year 6, the foreign tax authority adjusts CFC1’s year 1 tax following a foreign audit.
Does a prospective or a retrospective adjustment rule apply?
Navigating Section 905(c)

20. Recent Developments

21. Notice 2016-52 – Sections 905(c) and 909
Notice announced future section 909 regulations in which foreign- initiated adjustments to which section 905(c) would apply would be treated as foreign tax credit splitter arrangements.
Preamble specifically references retroactive adjustments for prior-year taxes under EU state aid rules, expresses concern that taxpayers may change their ownership structure or cause a section 902 corporation to make an extraordinary dividend to alter the treatment of a prospective adjustment.
Two new types of splitter arrangements to the exclusive list in the current section 909 regulations:
Arrangements arising from the application of section 905(c) to successor entities; and
Arrangements arising from distributions made before payment of additional tax required by foreign-initiated adjustments.
Navigating Section 905(c)

22. Notice 2016-52 – Example Facts
CFC 1 owns CFC 2 and DE. Before a foreign initiated assessment for DE’s earlier years, CFC 1 transfers DE to CFC 2 in a section 351 transaction.
Foreign taxes are subsequently assessed.
Section 905(c) Result:
Foreign taxes go into the post foreign tax pool of CFC2 in the year of payment.
Corresponding prior-year E&P on which such tax is imposed remains in the post-1986 section 902 earnings pool of CFC 1 in the prior years.
USP
CFC 1
CFC 2 DE
No E&P
No foreign tax paid

23. Sotiropoulos v. Commissioner T.C. Memo. 2017-075
Facts
U.S. citizen working in the United Kingdom invests in film partnerships that (she claims) reduce her U.K. income tax liability. HMRC returns taxpayer’s wage withholding, but taxpayer expects her liability to be challenged in connection with the film investments.
Issue
Did taxpayer receive a “refund” for purposes of section 905(c)?
Held
“Petitioner's averments [that her ultimate entitlement to refunds remained under investigation] are irrelevant For U.S. tax purposes, the term ‘refund’ does not connote finality or the final determination of a tax liability. In short, the fact that a taxpayer may ultimately have to repay the money initially refunded to her does not mean that she did not get a ‘refund.’”
Navigating Section 905(c)

24. Tax Reform
Both the House (section 4101) and Senate legislation (section 14301) amend section 905(c)(1) and section 905(c)(2)(B)(i) to provide for retrospective adjustments only.
Treatment of foreign tax redeterminations in the year of mandatory repatriation?
Treatment of foreign tax redeterminations in future years?
Navigating Section 905(c)