1. FROM PRINCIPLES TO PLANNING
Foreign Tax Credits – Advanced Topics

2. Jerry Jonckheere, Plante & Moran PLLC
Foreign Tax Credits – Advanced Topics
Jerry Jonckheere, Plante & Moran PLLC
Michael Schwartz, WeiserMazars LLP
Bill Henson, Plante & Moran PLLC
Tim Bloos, MNP LLP

3. Agenda . Requirements to claim a foreign tax credit Limitations
Overall foreign loss
Overall domestic loss
Separate loss limitations
Foreign tax credit splitters
New section 909
Covered asset acquisitions
New section 901(m)
Planning for excess foreign tax credits
Questions .
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4. Creditable Taxes Requirements for a tax to be creditable
It must be a tax
It must be based on income
It must be paid or accrued during the taxable year
It must be paid or accrued to a foreign country or a U.S. possession
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5. Creditable Taxes What is a tax?
Compulsory payment pursuant to the authority of a foreign country to levy taxes
It does not include payments to a foreign government for which the taxpayer receives a specific economic benefit
It does not include
Penalties, fines, interest, customs duties, etc
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6. Creditable Taxes Tax must be based on income
The predominant character of the base of the tax must be an income tax
Foreign tax must be likely to reach the net gain in which it applies
Foreign tax must not depend on the availability of a foreign tax credit in another country – aka “soak-up” tax
In lieu of taxes are permissible
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7. Creditable Taxes
Paid or accrued to a foreign country or U.S. Possession
Any foreign state and any political subdivision of any foreign state
U.S. possessions include
Puerto Rico
U.S. Virgin Islands
Guam
Northern Mariana Islands
American Samoa
The amount paid or accrued must be a “reasonable approximation of the final tax liability to the foreign country”
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8. Creditable Taxes Paid or accrued by the taxpayer
Tax is considered paid by the person who is legally liable for the tax
Person who is required to take the income into account for foreign income tax purposes
Even if another person is obligated to remit the tax, such as a withholding agent
Joint and several liability and tax on the combined income of two or more persons
Each persons foreign tax liability is the amount allocable based on their pro rata share of the combined foreign income
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*** Best practice is to use no more than 7 words per bullet and no more than 7 bullets per page in order to keep your audience engaged.

9. Creditable Taxes Paid or accrued by the taxpayer
Identity of the technical taxpayer has been the source of substantial controversy and, as a result of taxpayer victories, changes in the law
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*** Best practice is to use no more than 7 words per bullet and no more than 7 bullets per page in order to keep your audience engaged.

10. Section 904(f) and (g) – OFL, ODL, SLL, NOL
Ordering Rules under Reg. §1.904(g)-3T:
Allocate net operating loss and net capital loss carry forward deductions
Allocate foreign losses
Allocate separate limitation losses
Allocate overall foreign losses
Allocate overall US source losses
Recapture overall foreign loss
Recapture separate limitation loss
Recapture overall domestic loss
Allocate net operating loss and net capital loss carryback deductions
Perform steps 2 and 3 again after carryback deductions

11. Section 904(f) and (g) – OFL, ODL, SLL, NOL
Net Operating Losses – Reg. §1.904(g)-3T(b)
In a year where an NOL is generated, a taxpayer must source and categorize the NOL between U.S. source and the various foreign income categories
If an NOL from a particular taxable year is deducted in its entirety in a carryover year, the U.S. source losses and foreign source losses in separate categories that are part of the NOL are combined with the U.S. income or loss and the foreign source income or loss in the same separate categories in the carryover year

12. Section 904(f) and (g) – OFL, ODL, SLL, NOL
Net Operating Losses (con’t)
If an NOL from a particular taxable year is partially deducted in a carryover year, the source of the NOL deduction is determined using the following ordering rules from Reg. §1.904(g)-3T(b)(3):
U.S. source NOL to the extent of any U.S. source income in the carryover year
Foreign source NOL in each separate limitation category to the extent of any foreign source income in each separate limitation category
Foreign source NOL in each separate limitation category to the extent of any remaining foreign source NOL after step 2
U.S. source NOL to the extent of any remaining U.S. source NOL after step 1

13. Section 904(f) and (g) – OFL, ODL, SLL, NOL
Overall Foreign Losses (OFL) - §904(f)
An OFL is created when a taxpayer has an overall foreign source taxable loss that offsets U.S. source taxable income.
Distinguish between a foreign source NOL carryover which has not yet offset any income and an OFL which has offset U.S. source taxable income
An OFL is carried forward indefinitely to future years where the taxpayer must recapture the OFL as U.S. source income
The OFL recapture does not affect the total amount of taxable income, rather it reclassifies how much of the taxable income is foreign source vs. U.S. source

14. Section 904(f) and (g) – OFL, ODL, SLL, NOL
Separate Limitation Losses (SLL) - §904(f)(5)
An SLL is created when a taxpayer has a loss one separate limitation foreign income category that offsets income in another foreign income category
An SLL is carried forward indefinitely to future years where the taxpayer must recapture the SLL
There is no 50% income limitation on the recapture of separate limitation losses as there is with OFLs and ODLs

15. Section 904(f) and (g) – OFL, ODL, SLL, NOL
Overall Domestic Losses (ODL) - §904(g)
The American Jobs Creation Act of 2004 added the ODL provisions of §904(g) effective for tax years beginning after December 31, For tax years beginning before 2007, there was no ODL recapture provision in effect.
An ODL is created when a taxpayer has an overall U.S. source taxable loss that offsets foreign source taxable income in any year beginning after December 31, 2006 in which the taxpayer elects under §901 to take a foreign tax credit.
Distinguish between a U.S. source NOL carryover which has not yet offset any income and an ODL which has offset foreign source taxable income
An ODL is carried forward indefinitely to future years where the taxpayer may recapture the ODL as foreign source income

16. Section 904(f) and (g) – OFL, ODL, SLL, NOL
Overall Domestic Losses (ODL) - §904(g) (con’t)
ODL recapture equals the lesser of:
50% of the taxpayer’s U.S. source income for the year, or
the amount of ODL carry forward to the tax year
Even though the ODL recapture comes after the OFL recapture in the Reg. §1.904(g)-3T ordering rules, the 50% U.S. source income limitation on the ODL recapture is based on the U.S. source income before the OFL recapture.

17. Section 904(f) and (g) – OFL, ODL, SLL, NOL
Case Study – click on PDF icon to access a case study on OFLs, ODLs, SLLs, and NOLs (case study also provided as separate file)

18. Paid or accrued by the taxpayer
Splitters
Paid or accrued by the taxpayer
Identity of the technical taxpayer has been the source of substantial controversy and, as a result of taxpayer victories, changes in the law

19. Guardian Industries Corp & Subs v. United States
Splitters
Guardian Industries Corp & Subs v. United States
Luxembourg
Fiscal Unity Group US
Under Luxembourg law, the Lux parent of the group was responsible for paying taxes for the fiscal unity group
Lux
Holding
Lux
Opco 1
Lux
Opco 2
Lux
Opco 3

20. Guardian Industries Corp & Subs v. United States
Splitters
Guardian Industries Corp & Subs v. United States
Both the Court of Claims and the Federal Circuit ruled in favor of the taxpayer
The courts relied on literal reading of regulation section 901-2(f)(1) and Lux law to conclude that the Lux Holding company was responsible for the payment of Lux income taxes
The courts told the government to change the regulations of they wanted a different result

21. Splitters
Government has taken several steps to attempt to eliminate taxpayers ability to split taxes from the income to which they relate
2006 – regulations proposed under section 901 addressing the technical taxpayer
2006 – section 704 regulations amended to require that foreign tax credits be allocated among the partners in accordance with their interests in the partnership.
Special allocations no longer permissible
2008 – Government issued temporary and proposed regulations that provide that a foreign tax payment is not a compulsory payment, and thus not creditable, if the foreign tax payment is attributable to “structured passive investment arrangements”
2010 – codification of economic substance doctrine
2010 – codification of anti-splitter statutes in code section 909

22. Splitters
New code section 909 – Suspension of credits and taxes until related income taken into account
If there is a FTC splitting event, such tax shall not be taken into account before the taxable year in which the income is taken into account (section 909(a))
Also applies for purposes of sections 902 and 960 as well as for earnings and profits
Special rules for partnerships and S corporations
Effective date – applicable to years beginning after 12/31/2010
But is then effective retroactively
Retro active application requires taxpayers to recompute E&P

23. What is a “foreign tax credit splitting event”?
Splitters
What is a “foreign tax credit splitting event”?
There is a FTC splitting event with respect to a foreign income tax if the related income is (or will be) taken into account under this chapter by a covered person.

24. What is “related income”?
Splitters
What is “related income”?
The term “related income” means, with respect to any portion of any foreign income tax, the income (or as appropriate, earnings and profits) to which such portion of foreign income tax relates.

25. Who is a “covered person”?
Splitters
Who is a “covered person”?
With respect to any person who pays or accrues a foreign income tax
Any entity in which the payor holds, directly or indirectly, at least a 10 percent ownership interest (determined by vote or value)
Any person which holds, directly or indirectly, at least a 10 percent ownership interest (determined by vote or value) in the payor
Any person which bears a relationship to the payor described in section 267(b) or 707(b), and
Any other person specified by the Secretary

26. Splitters Notice 2010-92 Guidance issued 12/6/2010
Anticipates it will be the first of several guidance concerning section 909
Statute provides expansive language with regard to authority to issue regs “as is necessary or appropriate to carry out the purposes of this section…”
Addresses the implications of foreign income taxes paid or accrued in years beginning before 2011
Provides an exclusive list of arrangements that are treated as FTC splitting events for purposes of section 909 to pre-2011 years

27. Splitters Reverse Hybrids
Reverse hybrid is a corporation for U.S tax purposes but a flow-through or a branch for local country purposes
Owner of the reverse hybrid is subject to tax on the income of the reverse hybrid
Notice requires a section 902 corporation must own the reverse hybrid
Section 909 would apply if the US person owned the Reverse Hybrid directly but Notice is focused on the application of 909 to pre-2011 taxes
US Person
Taxes paid by CFC
CFC
Reverse
Hybrid
E&P stays in the reverse
hybrid

28. Splitters Foreign Consolidated Groups Opco 2 Opco 1 CFC Holding
A foreign consolidated group is a pre-2011 splitter to the extent that the taxpayer did not allocate foreign consolidated tax liability among members of the foreign consolidated group based on each member’s share of consolidated taxable income under the principles of Reg (f)(3)
Applies even if one or more members has a deficit in earnings
Opco 2
Opco 1
CFC Holding
is parent of group
and pays tax for
all the members
US Person
CFC
Holding
Opco 1 & Opco 2
have profits. E&P
stays in Opco 1
& Opco 2

29. Splitters Group Relief
Group relief or other loss-sharing regime exists when one entity with a loss permits the loss to be used to offset the income of one or more other entities.
Three conditions must exist
Instrument treated as indebtedness that is disregarded for U.S. purposes
The owner of the foreign disregarded debt instrument pays a foreign income tax attributable to a payment or accrual on the instrument
The payment or accrual on the debt gives rise to a deduction
US Person
CFC
Opco 1
Opco 2

30. Splitters Hybrid Equity
Hybrid equity where instrument is treated as equity for US purposes but debt for local country purposes
Issuer of hybrid equity must be a covered person
Must involve a 902 corporation
US Person
CFC1 accrues
interest income
on the hybrid
Instrument. CFC1
pays tax on income.
CFC 1
For US purposes,
the instrument is
equity. No accrual
of dividend. CFC2 retains
the E&P
CFC 2

31. Splitters
Hybrid Debt
Hybrid debt where instrument is treated as debt for US purposes but equity for local country purposes
Issuer of hybrid debt must be a covered person
Must involve a 902 corporation
US Person
Reduce E&P for
interest deduction.
No deduction
for local country.
CFC 1
CFC2 has higher
E&P because it
the interest income
for US purposes
CFC 2

32. Splitters Effect of Rev Rule 2010-92 Must re-determine income and E&P
Back to years beginning after 1996
First year of CTB regs
Prior years are unaffected
Must re-determine each category of separate limitation loss
Each covered person and 902 corporation
Related income is deemed to be distributed ratably with other income
However, the taxpayer can make an election so related income is deemed to be distributed first
Do not include PTI
Related income carries over to other corporations
Attribute under section 381

33. Effect of Rev Rule 2010-92 Splitters Must re-determine tax pools
Distributions –
Taxes allocated on a pro rata basis
Pre-2011 taxes retain character as pre-2011 taxes
When distributed
Under 381 carryover transaction
As related income is taken into account, pre-2011 taint is removed.

34. Effect of Rev Rule 2010-92 Splitters
Special rules for partnerships and trusts
Treasury acknowledges that it is possible to comply with 704(b) and still split taxes from the related income (e.g see Reg (b)(5) example 24)
Not a foreign tax credit splitting event for pre-2011 splitter arrangements
But prospective guidance will provide for post-2010 years that such allocations are splitters subject to 909
Example 24 may be modified

35. Splitters
Effect of Rev Rule
Taxes deferred are treated as paid or accrued in the year (section 904(c))
Section 909 does not alter carry forwards
Section 909 does not alter general rules for determining when a foreign tax has been accrued or paid
Suspended taxes are taken into account in the year the related income is taken into account
Redeterminations under 905(c)
If redetermination applies to pre-2011 split taxes, the section 909 applies. If redetermination applies to non-split taxes, section 909 will not apply.

36. Section 901(m) – Covered Assets Acquisitions
New Section 901(m) denies a foreign tax credit for taxes applicable to foreign basis differences in assets due to covered asset acquisitions
Applies to §901 direct foreign taxes and §902 indirect foreign taxes
Any disallowed foreign taxes are permitted as a deduction or a reduction to E&P

37. Section 901(m) – Covered Assets Acquisitions
Applies to covered asset acquisitions after December 31, 2010
Transition rule: does not apply to unrelated party covered asset acquisitions if the acquisition is –
Made pursuant to a written agreement which was binding on, and after January 1, 2011,
Described in a ruling request to the IRS on or before July 29, 2010, or
Described in a public announcement of SEC filing on or before January 1, 2011.

38. Section 901(m) – Covered Assets Acquisitions
A covered asset acquisition includes certain U.S. tax elections or transactions that result in the creation of additional asset basis eligible for amortization or depreciation for U.S. tax purposes without a corresponding increase in the basis of such assets for foreign tax purposes. Examples include:
Qualified stock purchase where a §338 election is made
Acquisition of a partnership interest holding foreign assets where a §754 election is made
Acquisition of stock of disregarded entities
Deemed §331 liquidation from a check-the-box election
Any similar transaction

39. Section 901(m) – Covered Assets Acquisitions
Disqualified Portion: Calculated as the ratio (expressed as a %) of:
Aggregate basis difference (not below zero) allocable to the taxable year with respect to all relevant foreign assets, divided by
The income on which the foreign income tax is determined.

40. Section 901(m) – Covered Assets Acquisitions
Before After
901(m) 901(m)
Net Taxable Dividend $600 $600
Section 78 gross-up $300 $270
Gross Taxable Dividend $900 $870
US Tax $ $296
Foreign Tax Credit ($300) ($270)
Net US Tax $6 $26
Cost of 901(m)
$100 Basis Adjustment
x 30% Foreign Tax Rate
x 66% (1 – US Tax Rate)
= $20 Annual Cost as a result of Sec 901(m)
Section 338(g) Election
Basis Amortization
Foreign Asset Step Up / Amort $1,500 $100
US E&P Local
Pre-tax Income before
E&P adjustments $1,000 $1,000
E&P Adj: §197 Amortization ($100)
E&P / Local Pre-tax Income $900 $1,000
Foreign Tax ($300) ($300)
E&P / Local Net Income $ $700
Disqualified Portion = $100 (Basis Diff.) x $300 = $30
$1,000 (Local Tax base)
Creditable Taxes = $270 ($300 less $30 disqualified)

41. Foreign Tax Credit Planning
Know your facts!
Go through the quantitative analysis to determine your position.
Consider simple strategies first
Many client problems can be fixed with relatively simple tweaks to the facts
Changing shipping terms on intercompany sales
Changing shipping terms on major customer shipments
Reviewing/analyzing classes of income
Revisiting expense allocations – high level

42. Foreign Tax Credit Planning
Then consider more complex planning as appropriate
Structural changes
Sourcing companies
Distribution companies
Partnership holding companies
Expense allocations
Comprehensive expense allocation review
Nitty gritty allocations
Fair market value election

43. Foreign Tax Credit Planning
War stories
A software client that had turned the corner. It had NOLs, OFLs and ODLs…
A manufacturing company owned by PE that has NOLs and one-time recapture option…
A client with NOLs and anticipated future NOLs in the near term…

44. IRS Circular 230 Disclosure
To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code or (ii) promoting, marketing, or recommending to another party any transaction or matter addressed herein.

45. Questions?

46. Jerry Jonckheere, Plante & Moran PLLC
Michael Schwartz, WeiserMazars LLP
Bill Henson, Plante & Moran PLLC
Tim Bloos, MNP LLP