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TAX TAKE: Proposed Foreign Tax Credit Regulations Will Offer Some Relief – But Will Treasury Remain Under Pressure to Make Further Modifications?

Tax Alert

The Treasury Department says its long-awaited notice of proposed rulemaking addressing particular issues associated with the final foreign tax credit regulations is just days from release. The controversial final regulations pose myriad issues for taxpayers and call into question the creditability of foreign taxes long understood to be creditable under prior iterations of the rules. In response to what can fairly be characterized as an avalanche of negative taxpayer feedback in the wake of the publication of the final regulations, Treasury signaled a willingness to "clarify" some key aspects of the rules. 

Chief among them is a softening of the cost recovery requirement, such that taxpayers are afforded more flexibility when comparing the allowable deductions to gross income permitted under foreign income tax regimes to those under U.S. federal income tax principles to arrive at net income. The relaxation of the net gain requirement was previewed in a technical correction Treasury issued earlier this summer, and the articulation of the rule in the proposed regulations is not expected to differ in a material way.

Treasury is also expected to issue a "safe harbor" of sorts to relax the requirement that for foreign withholding taxes to be creditable, the sourcing rules of the foreign country imposing the withholding taxes must mirror those in force in the U.S. For taxpayers subject to withholding on inbound royalty payments, those taxes would not be creditable to the extent the foreign country's sourcing rules did not impose withholding based on a place of use standard. This is true even where the foreign country's rules are silent as to the sourcing rule or have a hybrid rule that determines source either based on residence or place of use. Statements from Treasury officials over the past few months suggest that the sourcing rules could be relaxed such that the foreign sourcing rule would be deemed to be consistent with that of the U.S., i.e., based on a place of use standard, if the taxpayer can demonstrate that the intellectual property giving rise to the royalty is used in the same country imposing the withholding.

While the proposed rules, if issued along these lines, will offer welcome relief to many taxpayers, there remain many significant issues that will not be addressed, including the creditability of withholding taxes on payments for services and of direct and indirect taxes imposed by countries whose transfer pricing rules do not comport with the arm's length standard. 

Will this proposed package be the final word or the first in a series of potential reconsiderations of controversial rules? If taxpayers are hoping for the latter, it is advisable to keep the pressure up and take the opportunity afforded by the notice and comment period for the proposed regulations to continue offering feedback on all aspects of the final regulations that merit the drafters' attention. #TaxTake

Upcoming Speaking Engagements and Events

On November 2, Loren will be in Los Angeles to present "Trends in International Tax Controversy Including IRS Campaigns, Appeals, and ICAP," at the IFA USA/TEI Los Angeles International Tax Conference.

Loren will speak on a tax policy panel at the ABA 33rd Annual Philadelphia Tax Conference on November 15.

In the News

In Politico Morning Tax, Jorge discussed the lack of a Senate-confirmed IRS Commissioner and the agency's need to provide an implementation plan for new funding received from the Inflation Reduction Act. Jorge said the plan will be "a very important document, because it's the first document that's going to put the IRS's thinking on paper." He added that while it is not ideal to craft the plan without the new commissioner in place, once confirmed they will have plenty of time to put their stamp on the funding strategy. 

Jorge commented on the prospects of nominating and confirming a new IRS commissioner once the term of the current chief expires in November in Tax Notes. Jorge said the confirmation of a new commissioner could take a while. On the prospects of Douglas O'Donnell, the current IRS Deputy Commissioner for Services and Enforcement, taking over as the Acting Commissioner, Jorge said "he's excellent." 



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