[4830-01-p]
DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
Guidance Related to the Foreign Tax Credit
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Notice of proposed rulemaking.
SUMMARY: This document contains proposed regulations relating to the foreign tax credit, including guidance with respect to the reattribution asset rule for purposes of allocating and apportioning foreign taxes, the cost recovery requirement, and the attribution rule for withholding tax on royalty payments.
DATES: Written or electronic comments and requests for a public hearing must be received by January 23, 2023.
ADDRESSES: Commenters are strongly encouraged to submit public comments electronically. Submit electronic submissions via the Federal eRulemaking Portal at www.regulations.gov (indicate IRS and REG-112096-22) by following the online instructions for submitting comments. Once submitted to the Federal eRulemaking Portal, comments cannot be edited or withdrawn. The Department of the Treasury (the “Treasury Department”) and the Internal Revenue Service (the “IRS”) will publish for public availability any comment submitted electronically, and on paper, to its public docket. Send hard copy submissions to: CC:PA:LPD:PR (REG-112096-22), Room 5203, Internal Revenue Service, PO Box 7604, Ben Franklin Station, Washington, DC 20044. Submissions may be hand delivered Monday through Friday between the hours of 8 a.m. and 4 p.m. to CC:PA:LPD:PR (REG-112096-22), Courier’s Desk, Internal Revenue Service, 1111 Constitution Avenue, NW, Washington, DC 20224.
FOR FURTHER INFORMATION CONTACT: Concerning §§1.901-2 and 1.903-1, Teisha Ruggiero, (646) 259-8116; concerning §1.861-20, Suzanne Walsh, (202) 317-4908; concerning submissions of comments and requests for a public hearing, Regina Johnson, (202) 317-6901 (not toll-free numbers) or by sending an email to publichearings@irs.gov (preferred).
SUPPLEMENTARY INFORMATION:
On December 17, 2019, the Treasury Department and the IRS published proposed regulations (REG-105495-19) addressing changes made by the Tax Cuts and Jobs Act (Pub. L. 115-97, 131 Stat. 2054 (2017)) (the “TCJA”) and other related foreign tax credit rules in the Federal Register (84 FR 69124) (the “2019 Foreign Tax Credit (“FTC”) proposed regulations”). Correcting amendments to the 2019 FTC proposed regulations were published in the Federal Register on May 15, 2020 (85 FR 29368). The 2019 FTC proposed regulations were finalized as part of TD 9922, published in the Federal Register (85 FR 71998) on November 12, 2020 (the “2020 FTC final regulations”). On the same date, the Treasury Department and the IRS published proposed regulations (REG-101657-20) in the Federal Register (85 FR 72078) (the “2020 FTC proposed regulations”). The 2020 FTC proposed regulations addressed changes made by the TCJA and other foreign tax credit issues. Correcting amendments to the 2020 FTC final regulations were published in the Federal Register on October 1, 2021 (86 FR 54367). A public hearing on the 2020 FTC proposed regulations was held on April 7, 2021. The 2020 FTC proposed regulations were finalized in TD 9959, published in the Federal Register (87 FR 276) on January 4, 2022 (the “2022 FTC final regulations”). Correcting amendments to the 2022 FTC final regulations were published in the Federal Register on July 27, 2022 (87 FR 45018 and 87 FR 45021).
This document contains proposed regulations (the “proposed regulations”) addressing the following issues: (1) the definition of a reattribution asset for purposes of allocating and apportioning foreign income taxes; (2) the application of the cost recovery requirement; and (3) the application of the source-based attribution requirement to withholding taxes on certain royalty payments.
Section 1.861-20 provides rules for allocating and apportioning foreign income taxes to the statutory and residual groupings, including the categories described in section 904 that apply for purposes of calculating a taxpayer’s foreign tax credit limitation. In general, §1.861-20 operates by first assigning the foreign gross income on which the foreign income tax is imposed to statutory and residual groupings based upon the character of the item of U.S. gross income that corresponds to the foreign gross income (the “corresponding U.S. item”). §1.861-20(c) and (d). Foreign income tax expense is allocated to the grouping to which the foreign gross income is assigned, and if foreign gross income is assigned to more than one grouping, deductions computed under foreign law are allocated and apportioned to the groupings and foreign tax expense is apportioned among the groupings based upon foreign taxable income in the groupings. §1.861-20(e) and (f).
The 2022 FTC final regulations provide rules for allocating and apportioning foreign income tax arising from a disregarded payment. Foreign gross income included by reason of the receipt of a disregarded payment has no corresponding U.S. item because Federal income tax law does not give effect to the payment as a receipt of gross income. Section 1.861-20(d)(3)(v) therefore characterizes the disregarded payment under Federal income tax law for purposes of assigning this foreign gross income to the statutory and residual groupings. These rules treat the portion of a disregarded payment, if any, that causes U.S. gross income of the payor taxable unit to be reattributed under either §1.904-4(f)(2) (in the case of a taxpayer that is an individual or domestic corporation) or §1.951A-2(c)(7)(ii)(B) (in the case of a taxpayer that is a foreign corporation) to the recipient taxable unit as a “reattribution payment.” §1.861-20(d)(3)(v)(E)(7); see also part I.B of this Explanation of Provisions for a description of the reattribution payment rules. The excess of a disregarded payment over the portion that is a reattribution payment is treated either as a contribution from one taxable unit to another taxable unit owned by the first taxable unit, or as a remittance of a taxable unit’s current and accumulated earnings. §1.861-20(d)(3)(v)(E)(2) and (8). Section 1.861-20(d)(3)(v)(D) provides a special rule for characterizing disregarded payments that are made in exchange for property and are not reattribution payments.
Section 1.861-20(d)(3)(v)(B) assigns foreign gross income from a disregarded payment that is a reattribution payment to the same statutory and residual grouping as the U.S. gross income that is reattributed to the recipient taxable unit. This assignment occurs before taking into account any reattribution payments made by the recipient taxable unit.
Foreign gross income included by reason of a remittance is assigned to the statutory and residual groupings by reference to the proportion of the tax book value of the assets of the remitting taxable unit in the groupings as assigned for purposes of apportioning interest expense. §1.861-20(d)(3)(v)(C)(1)(i). In other words, the character of the assets of the remitting taxable unit is a proxy for the character of the current and accumulated earnings out of which the remittance is made. To more accurately reflect the character of the remitting taxable unit’s earnings, the reattribution asset rule in §1.861-20(d)(3)(v)(C)(1)(ii) requires that a reattribution of income from one taxable unit (payor taxable unit) to another taxable unit (recipient taxable unit) result in a concomitant reattribution of the tax book value of the assets of the payor taxable unit that generated the reattributed income (“reattribution assets”) from the payor taxable unit to the recipient taxable unit.
After further study, the Treasury Department and the IRS have concluded that the reattribution asset rule is not needed for allocating and apportioning foreign tax on a remittance in the case of disregarded property sales, and particularly with respect to disregarded sales of inventory property. For example, consider a domestic corporation that directly owns two taxable units that are disregarded for U.S. Federal income tax purposes: DE1, which manufactures inventory property, and DE2, which distributes inventory property to unrelated customers. DE1 sells the manufactured inventory to DE2 in exchange for a disregarded payment. The disregarded payment that DE1 receives for the sale of inventory property to DE2 becomes a reattribution payment when DE2 on-sells the inventory property and generates gain in a transaction that is regarded for U.S. tax purposes. Accordingly, gain from the sale of the inventory is reattributed from the distributing taxable unit to the manufacturing taxable unit, and a portion of the distributing taxable unit’s assets is reattributed to the manufacturing taxable unit. Although the assets of the manufacturing taxable unit contributed to the production of the income of both taxable units, the tax book value of the manufacturing taxable unit’s assets is not reattributed to the distributing taxable unit. As a result, the reattribution asset rule, by reattributing assets only from the distributor taxable unit to the manufacturing taxable unit, does not more accurately balance among the taxable units all of the assets that produced the gain from the inventory sale. The reattribution of assets instead changes the ratios of the assets considered held by the taxable units such that a greater percentage of the distributor taxable unit’s assets consist of non-inventory assets (for example, cash), and a greater percentage of the manufacturing taxable unit’s assets consist of inventory.
Accordingly, proposed §1.861-20(d)(3)(v)(E)(6) retains the general definition of reattribution asset but excludes any portion of the tax book value of property transferred in a disregarded sale from being attributed back to the selling taxable unit. Comments are requested on whether similar revisions should be made to the reattribution asset rule in situations other than disregarded property sales. Comments are further requested on other issues related to the allocation and apportionment of foreign income taxes to disregarded payments, which may be considered in future guidance projects.
Section 901 allows a credit for foreign income, war profits, and excess profits taxes, and section 903 provides that such taxes include a tax in lieu of a generally-imposed foreign income, war profits, or excess profits tax (collectively, “foreign income taxes”). Before its amendment by the 2022 FTC final regulations, §1.901-2(a)(1) provided that a foreign levy was an income tax if and only if (1) it was a tax, and (2) the predominant character of that tax was that of an income tax in the U.S. sense. Under former §1.901-2(a)(3), the predominant character of a foreign tax was that of an income tax in the U.S. sense if the tax (1) was likely to reach net gain in the normal circumstances in which it applied (the “net gain requirement”), and (2) was not a “soak-up” tax. To satisfy the net gain requirement, a foreign tax needed to meet the realization, gross receipts, and net income requirements. See former §1.901-2(b).
The 2022 FTC final regulations revised the net gain requirement to better align the regulatory tests with principles in the Internal Revenue Code (“Code”) for determining the base of a U.S. income tax, as well as to simplify and clarify the application of these tests. The revisions made by the 2022 FTC final regulations ensure that a foreign tax is a creditable net income tax only if the determination of the foreign tax base conforms in essential respects to the determination of taxable income under the Code. In particular, the 2022 FTC final regulations limit the role of the predominant character analysis generally required under the prior regulations, which often required empirical analysis, in determining whether a foreign tax meets each of the net gain requirements. Under the 2022 FTC final regulations, a foreign tax satisfies the net gain requirement only if the tax satisfies the realization requirement, the gross receipts requirement, the cost recovery requirement (formerly the net income requirement), and the attribution requirement. In addition, the 2022 FTC final regulations provide that the determination of whether a foreign tax satisfies each component of the net gain requirement is generally based on the terms of the foreign tax law governing the computation of the tax base and not based on empirical analysis. §1.901-2(b)(1). The 2022 FTC final regulations also maintained the long-standing all-or-nothing rule; that is, a foreign tax either is or is not a foreign income tax, in its entirety, for all persons subject to the foreign tax. §1.901-2(a)(1)(i).
Consistent with the net income requirement in former §1.901-2(b)(4), the 2022 FTC final regulations require, under the cost recovery requirement, that the base of a foreign tax permits the recovery of significant costs and expenses attributable, under reasonable principles, to the gross receipts included in the tax base. §1.901-2(b)(4)(i)(A). However, to ensure that a foreign tax is a foreign income tax only if the foreign tax allows for the recovery of costs and expenses in a manner that conforms in essential respects to the determination of taxable income under the Code, and to limit the empirical analysis that would otherwise be required, the 2022 FTC final regulations modified the cost recovery requirement in several respects. For example, the 2022 FTC final regulations provide a list of costs and expenses that are always treated as significant (costs and expenses related to capital expenditures, interest, rents, royalties, wages or other payments for services, and research and experimentation). §1.901-2(b)(4)(i)(C)(1). Whether other costs and expenses are significant continues to be determined under an empirical analysis; that is, based on whether, for all taxpayers in the aggregate to which the foreign tax applies, the item of cost or expense constitutes a significant portion of the taxpayers’ total costs and expenses. Id.
However, the 2022 FTC final regulations also recognized that, similar to the United States, foreign countries limit the recovery of certain significant costs and expenses. As a result, §1.901-2(b)(4)(i)(C)(1) provides that foreign tax law is considered to permit the recovery of significant costs and expenses, even if recovery of certain significant costs and expenses is disallowed in whole or in part, if such disallowance is consistent with any principle underlying the disallowances required under the Code (“principles-based exception”).
Following the publication of the 2022 FTC final regulations, the Treasury Department and the IRS have received a number of questions regarding the application of the cost recovery requirement as well as requests to modify the requirement. In particular, taxpayers and other stakeholders identified a number of foreign tax laws that impose disallowances or other limitations on the recovery of costs and expenses that are not clearly matched to a principle underlying a similar disallowance under the Code, even though, in the view of these stakeholders, the foreign tax as a whole is consistent with a net income tax in the U.S. sense. Moreover, taxpayers noted that, in some instances, it was difficult to determine the principle underlying the foreign disallowance because of a lack of information from the foreign country.
The Treasury Department and the IRS agree that, in certain instances, the cost recovery requirement should be satisfied even if the foreign tax law contains a disallowance or other limitation on the recovery of a particular cost or expense that may not reflect a specific principle underlying a particular disallowance in the Code. The income tax provisions of the Code contain a number of disallowances and other limitations on the deductibility of certain costs and expenses. In some instances, the principle or principles behind the limitation is clear, either because the motivation is articulated in legislative history or because it is possible to determine the principle from the terms of the limitation itself. However, the principles underlying other limitations may be less apparent, making it difficult to determine whether a foreign limitation on the deductibility of certain costs and expenses is consistent with any principle underlying the disallowances under the Code.
As explained in the preamble to the 2022 FTC final regulations, section 901 allows credits for foreign taxes that are income taxes in the U.S. sense, and this standard is met if there is substantial conformity in the principles used to calculate the foreign tax base and the U.S. tax base. Complete conformity between the rules for determining the foreign tax base and the U.S. tax base is not required. Accordingly, the proposed regulations provide additional guidance for evaluating disallowances under foreign tax law that may not mirror the expense disallowance rules in the Code, but that nonetheless do not prevent the foreign tax from being a tax imposed on net income.
Proposed §1.901-2(b)(4)(i) retains the general cost recovery requirement under the 2022 FTC final regulations, but provides that the relevant foreign tax law need only permit recovery of substantially all of each item of significant cost or expense. Consistent with the general approach of the 2022 FTC final regulations, whether a foreign tax permits recovery of substantially all of each item of significant cost or expense is determined based solely on the terms of the foreign tax law. Proposed §1.901-2(b)(4)(i)(C)(1).
Proposed §1.901-2(b)(4)(i)(C)(2) provides a safe harbor for purposes of applying this requirement. Under the safe harbor, a disallowance of a stated portion of an item (or multiple items) of significant cost or expense does not prevent a foreign tax from satisfying the cost recovery requirement if the portion of the item (or items) that is disallowed does not exceed 25 percent. This safe harbor also permits the foreign tax law to cap deductions of a single item of significant cost or expense or multiple items that relate to a single category of per se significant costs and expenses described in proposed §1.901-2(b)(4)(i)(B)(2) so long as the cap, based solely on the terms of the foreign tax law, is not less than 15 percent of gross receipts, gross income, or a similar measure, or in the case of a cap based on a percentage of taxable income, or a similar measure, the cap is not less than 30 percent. A foreign law limitation that caps deductions of multiple items that relate to different categories of per se significant costs and expenses at a stated percentage (for example, a cap on the deduction of all interest and royalties, combined, at 15 percent of gross receipts), or that caps deductions of multiple items of significant costs or expense that are significant under proposed §1.901-2(b)(4)(i)(B)(1) at a stated percentage, would not meet the safe harbor. The safe harbor is intended to provide additional certainty where a foreign tax law disallowance is in the form of a stated portion or cap. Taxpayers will not need to identify a corresponding principle underlying the disallowances required under the Code for foreign tax law disallowances that meet the safe harbor. If the foreign tax law contains a disallowance that is not within the safe harbor, and that otherwise prevents the recovery of substantially all of an item of significant cost or expense, then the limitation would be examined under the principles-based exception from the 2022 FTC final regulations, retained in proposed §1.901-2(b)(4)(i)(F)(1), which permits more substantial disallowances (including complete disallowances) of an item of significant cost or expense that are consistent with any principle underlying the disallowances required under the Code. The proposed regulations make additional clarifications to this rule, to provide that the principle must be reflected in a disallowance within the income tax provisions of the Code, and if the disallowance addresses a non-tax public policy concern, then such concern must be similar to the non-tax public policy concerns reflected in the Code. In addition, the proposed regulations remove the example of a limit on recovery of interest based upon a measure of taxable income from this principles-based exception because such a limitation would generally be covered by the safe harbor. See proposed §1.901-2(b)(4)(iv)(H) (Example 8). If the foreign law disallowance does not meet the safe harbor or otherwise permit recovery of substantially all of each item of significant cost or expense, the principles-based exception would be relevant for determining whether the foreign tax could satisfy the cost recovery requirement.
Additionally, proposed §1.901-2(b)(4)(iv)(F) through (J) provide new examples illustrating the application of the cost recovery requirement. The proposed regulations also reorganize the provisions of the cost recovery requirement to accommodate the addition of these new provisions, as well as to better reflect the structure of the requirement.
The 2022 FTC final regulations added an attribution requirement in §1.901-2(b)(5) as an element of the net gain requirement to require that a foreign tax conform to the concepts of taxing jurisdiction reflected in the Code that define an income tax in the U.S. sense. The purpose of the attribution requirement is to allow a credit for a foreign tax only if the country imposing the tax has sufficient nexus to the taxpayer’s activities or investment of capital that generates the income included in the tax base. This result is consistent with the statutory purpose of the foreign tax credit to relieve double taxation of income through the United States ceding its own taxing rights only where the foreign country has the primary right to tax the income.
With respect to a foreign levy imposed on nonresident taxpayers, the attribution requirement limits the scope of gross receipts and costs included in the base of a foreign tax to those that satisfy the activities-based attribution, source-based attribution, or property-based attribution tests. §1.901-2(b)(5)(i). These tests are consistent with U.S. income tax principles reflected in the Code’s provisions that only tax foreign persons’ income that is effectively connected with a U.S. trade or business or attributable to U.S. real property, or that is fixed or determinable annual or periodical (FDAP) income sourced in the United States.
Under the source-based attribution requirement in §1.901-2(b)(5)(i)(B), a foreign tax imposed on the nonresident’s income on the basis of source meets the attribution requirement only if the foreign tax law’s sourcing rules are reasonably similar to the sourcing rules that apply for Federal income tax purposes. In the case of gross income arising from royalties, §1.901-2(b)(5)(i)(B)(2) provides that the foreign tax law must source royalties based on the place of use of, or the right to use, the intangible property, consistent with how the Code sources royalty income.
For foreign taxes imposed in lieu of an income tax, the 2022 FTC final regulations also modified the substitution requirement in §1.903-1, including by adding an attribution requirement. Under §1.903-1(c)(2)(iii), a foreign withholding tax must meet the source-based attribution requirement in §1.901-2(b)(5)(i)(B) to qualify as a “covered withholding tax” that may be creditable as a tax in lieu of an income tax. Thus, a withholding tax on a royalty payment is creditable only if the foreign tax law sources royalties based upon the place of use of, or the right to use, the intangible property, consistent with how the Code sources royalty income. The 2022 FTC final regulations also maintained the all-or-nothing rule for the substitution requirement; that is, a foreign tax either is or is not a tax in lieu of an income tax, in its entirety, for all persons subject to the foreign tax. §1.903-1(b)(1). Accordingly, a withholding tax on royalties that is imposed on the basis of the residence of the payor of the royalty is not creditable, whether or not the relevant intangible property is in fact used within the territory of the taxing jurisdiction. §1.903-1(d)(3) and (4) (Examples 3 and 4).
The determination of whether a foreign levy meets the requirements under §§1.901-2 and 1.903-1 is made on a levy-by-levy basis. Section 1.901-2(d) provides rules for determining whether one foreign levy is separate from another foreign levy. In general, §1.901-2(d)(1)(ii) provides that separate levies are imposed on particular classes of taxpayers if the tax base is different for those taxpayers. The 2022 FTC final regulations added a special rule for withholding taxes imposed on nonresidents that treats each such tax as a separate levy with respect to each class of gross income (as listed in section 61) to which the tax applies. §1.901-2(d)(1)(iii). This rule allows withholding taxes that are imposed on classes of income that are subject to different sourcing rules of the taxing jurisdiction to be analyzed as separate levies under the covered withholding tax requirement in §1.903-1(c)(2). The 2022 FTC final regulations also provided that if a foreign country imposes a withholding tax on two or more subsets of a separate class of income and a different source rule applies to each subset of income, then separate levies are considered imposed on each subset of that separate class of income. §1.901-2(d)(1)(iii). These special rules reflect the general principle in §1.901-2(d)(1) that the separate levy determination is based upon U.S. principles and not whether foreign tax law imposes the levy or levies pursuant to a single or separate statutes. The rules also enable testing the creditability of a withholding tax on a more granular basis. This approach better reflects the purpose of the attribution requirement to allow a foreign tax credit only where, in the U.S. view, the taxing jurisdiction has the primary right to tax the income.
Following the publication of the 2022 FTC final regulations, the Treasury Department and the IRS received questions regarding the application of the source-based attribution requirement to certain royalty withholding taxes. In addition, the Treasury Department and the IRS received requests (including a petition for rulemaking) to change the requirement, by allowing a credit even if a foreign country sources royalties based on the residence of the payor or by applying a different standard.1
As an initial matter, some taxpayers questioned whether the sourcing rule for royalties was applied differently than that for services because §1.901-2(b)(5)(i)(B)(1) includes a reference to the use of “reasonable principles” for purposes of applying the source-based attribution requirement to a payment for services, while the equivalent rule in §1.901-2(b)(5)(i)(B)(2) for royalties does not. Since the introductory text in §1.901-2(b)(5)(i)(B) states that, in all instances, sourcing rules must be reasonably similar to the sourcing rules under the Code, the same standard applies regardless of whether the relevant payment is for services or for royalties. However, to avoid further confusion, the proposed regulations conform the language of §1.901-2(b)(5)(i)(B)(1) and (2).
Additionally, the Treasury Department and the IRS are aware that, in some cases, a taxpayer may license intangible property for use solely within the foreign country in which the licensee is resident, but the foreign country sources royalties based on the residence of the payor. In these cases, notwithstanding the actual use of the licensed property in the taxing jurisdiction, a credit would not be allowed for the royalty withholding tax under the source-based attribution requirement for royalties in §1.901-2(b)(5)(i)(B). However, in these cases, the foreign country imposing tax on the royalty income should, from a U.S. perspective, have the primary taxing right over the royalty income because the intangible property giving rise to the royalty is in fact being used solely in that foreign country. That is, notwithstanding the difference in sourcing rules for royalty income, there is complete overlap between the jurisdiction with the primary right to tax based on U.S. tax principles and the taxing rights exercised by the taxing jurisdiction.
The Treasury Department and the IRS have concluded that it is appropriate to provide a limited exception to the source-based attribution requirement of the 2022 FTC final regulations where the taxpayer can substantiate that a withholding tax is imposed on royalties received in exchange for the right to use intangible property solely within the territory of the taxing jurisdiction. The Treasury Department and the IRS have concluded that it would be unduly burdensome for both the taxpayer and the IRS to determine the place of use of all intangible property on a country-by-country basis based on each taxpayer’s facts and circumstances. While taxpayers may need to determine the place of use of certain intangible property to determine whether the royalty income is U.S. or foreign source, or for other purposes, those determinations generally do not require taxpayers or the IRS to separately determine the use in a specific foreign country. For this reason, this limited exception applies only if the taxpayer has a written license agreement that provides for the payment of the royalty and that limits the use of the intangible property giving rise to the royalty payment to the territory of the foreign country imposing the tax.
Reflecting this new limited exception, proposed §1.903-1(c)(2)(iii) provides that a tested foreign tax satisfies the source-based attribution requirement if the tax meets either the source-based attribution requirement in §1.901-2(b)(5)(i)(B) or the exception in proposed §1.903-1(c)(2)(iii)(B) (the “single-country exception”).
In general, the single-country exception applies where (1) the income subject to the tested foreign tax is characterized as gross royalty income, and (2) the payment giving rise to such income is made pursuant to a single-country license. Proposed §1.903-1(c)(2)(iii)(B). Consistent with §1.901-2(b)(5)(i)(B), proposed §1.903-1(c)(2)(iii)(B) provides that foreign tax law generally applies for purposes of determining whether the gross income or gross receipts arising from a transaction are characterized as a royalty, except in the case of a transaction that is considered the sale of a copyrighted article under §1.861-18, which is not treated as a license of intangible property but as a sale of tangible property.
A payment is made pursuant to a single-country license if the terms of the written license agreement under which the payment is made characterize the payment as a royalty and limit the territory of the license to the foreign country imposing the tested foreign tax. Proposed §1.903-1(c)(2)(iv)(A). However, a payment (or portion of a payment) may be treated as made pursuant to a single-country license even if the written agreement does not limit the territory of the license to the foreign country imposing the tax or provides for payments in addition to those for the use of intangible property (for example, for related services), if the agreement separately states the portion (whether as a specified amount or as a formula) of the payment subject to the tested foreign tax that is characterized as a royalty and that is with respect to the part of the territory of the license that is solely within the foreign country imposing the tax. See proposed §§1.903-1(c)(2)(iv)(B) and (d)(9) (Example 9).
The Treasury Department and the IRS are aware that, to qualify for the single-country exception, taxpayers may need to revise existing license agreements. Additionally, because certain withholding taxes may remain non-creditable, taxpayers may be incentivized to maximize the portion of a payment that is made pursuant to a single-country license. For example, a taxpayer that receives royalty payments pursuant to a related-party license agreement that grants the licensee rights to several different types of intangible property—some of which will be exploited solely within the taxing jurisdiction and some outside of the taxing jurisdiction—may be incentivized to amend the related-party license agreement to separately state a royalty amount that purports to qualify for the single-country exception but that may exceed an amount that, under the arm’s length principles of section 482 and sourcing principles of section 861, is attributable to the exploitation of the intangible property within the taxing jurisdiction. Additionally, taxpayers may be disincentivized from revising existing agreements to reflect changes in facts and circumstances if doing so would decrease the amount of the royalty that is eligible for the single-country exception.
To address these concerns, proposed §1.903-1(c)(2)(iv)(C) provides that a payment is treated as not made pursuant to a single-country license if the taxpayer knows, or has reason to know, that the required agreement misstates the territory in which the intangible property is used or overstates the amount of the royalty with respect to the part of the territory of the license that is solely within the foreign country imposing the tax. Thus, the required agreement must reflect the relevant facts and circumstances, as known by the taxpayer or as would be known by a reasonably prudent person in the position of the taxpayer, regarding both the amount of the relevant royalty and the territory in which the intellectual property is actually used.
In general, a taxpayer cannot qualify for the single-country exception without satisfying the documentation requirement in proposed §1.903-1(c)(2)(iv)(D). Under proposed §1.903-1(c)(2)(iv)(D), the required agreement pursuant to which the qualifying royalty is paid must be executed no later than the date on which the royalty is paid. However, recognizing that the single-country exception is proposed to be applicable to periods preceding the release of this notice of proposed rulemaking, a special transition documentation rule is provided for royalties paid on or before May 17, 2023. In that case, to satisfy the documentation requirement, the required agreement must be executed no later than May 17, 2023 and the agreement must state (whether in the terms of the agreement or in recitals) that royalties paid on or before the execution of the agreement are considered paid pursuant to the terms of the agreement.
The required agreement must be maintained by the taxpayer and provided to the IRS within 30 days of a request by the Commissioner or another period as agreed between the Commissioner and the taxpayer. Id. For purposes of the rule, the term taxpayer includes a partnership upon which foreign law imposes a tax. See §1.901-2(f)(4) and (g)(7). Therefore, if the royalty withholding tax is imposed at the partnership level, the documentation required by the proposed regulations must be maintained by the partnership, even though the party that claims the credit is the partner and not the partnership. The Treasury Department and the IRS request comments as to whether special rules may be necessary to address the documentation requirement in the case of partnerships.
Finally, proposed §1.903-1(d)(3) and (8) through (11) provide new examples illustrating the application of the source-based attribution rule and single-country exception for covered withholding taxes on royalties.
The proposed regulations also modify the separate levy rule in §1.901-2(d)(1)(iii) for withholding taxes imposed on nonresidents. Specifically, §1.901-2(d)(1)(iii)(B)(3) provides that a withholding tax that is imposed on a royalty payment made to a nonresident pursuant to a single-country license is treated as a separate levy from a withholding tax that is imposed on other royalty payments made to such nonresident and from any other withholding taxes imposed on other nonresidents. As with the special separate levy rule for withholding taxes on different classes of income or different subsets of income within a class of income, this rule may result in a foreign withholding tax being considered a separate levy in cases where the foreign tax law considers only a single levy to be imposed. In contrast to a net income tax, this separate levy rule can be applied to withholding taxes because withholding taxes on royalties are imposed on gross income and on a payment-by-payment basis. In addition, as with the other special levy rules, this separate levy rule better aligns the outcomes of the test with the purposes of the foreign tax credit rules, including that of the attribution requirement. The proposed regulations also reorder and reorganize the paragraphs of proposed §1.901-2(d)(1)(iii) to accommodate the addition of this new provision, and to reflect the structure of the rules more logically.
In general, except for proposed §1.861-20(d)(3)(v)(E)(6), the proposed regulations are proposed to apply to taxable years ending on or after November 18, 2022. However, once the proposed regulations are finalized, taxpayers may choose to apply some or all of the final regulations to earlier taxable years, subject to certain conditions.
Proposed §1.861-20(d)(3)(v)(E)(6) is proposed to apply to taxable years ending on or after the date final regulations adopting these rules are filed with the Federal Register. Taxpayers may choose to apply the rules of §1.861-20(d)(3)(v)(E)(6), once finalized, to taxable years that begin after December 31, 2019, and end before the date final regulations adopting these rules are filed with the Federal Register provided they apply §1.861-20(d)(3)(v)(E)(6) consistently to their first taxable year beginning after December 31, 2019, and any subsequent taxable year ending before the date final regulations adopting these rules are filed with the Federal Register.
Proposed §1.901-2(b)(4)(i) and (iv), (b)(5)(i)(B)(2), and (d)(1)(iii) and proposed §1.903-1(c)(2) and (d)(3), (4), and (8) through (11) are proposed to apply to foreign taxes paid in taxable years ending on or after November 18, 2022. Taxpayers may choose to apply the rules of §1.901-2(b)(4)(i) and (iv), once finalized, for foreign taxes paid in taxable years beginning on or after December 28, 2021, and ending before November 18, 2022, provided that they consistently apply those rules to such taxable years. Taxpayers may also choose to apply the rules of §§1.901-2(b)(5)(i)(B)(2) and (d)(1)(iii) and 1.903-1(c)(2) and (d)(3), (4), and (8) through (11), once finalized, for foreign taxes paid in taxable years beginning on or after December 28, 2021, and ending before November 18, 2022, provided that they consistently apply those rules for such taxable years.
Finally, until the effective date of final regulations, a taxpayer may rely on all or part of the proposed regulations, subject to certain conditions. Specifically, a taxpayer may choose to rely on the provisions addressing the reattribution asset rule (proposed §1.861-20(d)(3)(v)(E)(6)) for taxable years that begin after December 31, 2019, and end before the effective date of final regulations adopting these rules. A taxpayer may also choose to rely on the provisions addressing the cost recovery requirement (proposed §1.901-2(b)(4)(i) and (iv)) for foreign taxes paid in taxable years beginning on or after December 28, 2021, and ending before the effective date of final regulations adopting these rules. Finally, a taxpayer may choose to rely on the provisions addressing the attribution requirement for royalty payments (proposed §1.901-2(b)(5)(i)(B)(2) and (d)(1)(iii) and proposed §1.903-1(c)(2) and (d)(3), (4), and (8) through (11)) for foreign taxes paid in taxable years beginning on or after December 28, 2021, and ending before the effective date of final regulations adopting these rules.
If a taxpayer chooses to rely on any of the three portions of the proposed regulations described in the preceding paragraph, the taxpayer and its related parties, within the meaning of sections 267(b) (determined without regard to section 267(c)(3)) and 707(b)(1), must consistently follow all proposed regulations with respect to that portion for all relevant years until the effective date of the final regulations adopting the rules.
The Treasury Department and the IRS intend to make conforming amendments to other regulations, including the cost recovery rules that are not being revised in these proposed regulations and the examples in §§1.901-2(b)(4)(iv) and 1.903-1(d), upon finalization of the proposed regulations.
The Administrator of the Office of Information and Regulatory Affairs (“OIRA”), Office of Management and Budget, has determined that this proposed rule is not a significant regulatory action, as that term is defined in section 3(f) of Executive Order 12866. Therefore, OIRA has not reviewed this proposed rule pursuant to section 6(a)(3)(A) of Executive Order 12866 and the April 11, 2018, Memorandum of Agreement between the Treasury Department and the Office of Management and Budget (“OMB”).
The Paperwork Reduction Act of 1995 (44 U.S.C. 3501-3520) (“PRA”) requires that a federal agency obtain the approval of the OMB before collecting information from the public, whether such collection of information is mandatory, voluntary, or required to obtain or retain a benefit.
The collection of information in these proposed regulations is in proposed §1.903-1(c)(2)(iv)(D). As discussed in part II.C.3 of the Explanation of Provisions, proposed §1.903-1(c)(2)(iii)(B) provides an exception (the “single-country exception”) to the source-based attribution requirement if a taxpayer can substantiate that the payment on which the royalty withholding tax is imposed was made pursuant to an agreement that limits the right to use intangible property to the jurisdiction imposing the tested foreign tax. Proposed §1.903-1(c)(2)(iv)(A). The exception applies only where the taxpayer has a written license agreement that provides for the payment of the royalty and that limits the use of the intangible property giving rise to the royalty payment to the territory of the foreign country imposing the tax. A payment may also qualify for the single-country exception if the agreement separately states the portion (whether as a specified amount or as a formula) of the payment subject to the tested foreign tax that is characterized as a royalty and that is with respect to the portion of the territory of the license that is solely within the foreign country imposing the tax. Proposed §1.903-1(c)(2)(iv)(B).
Proposed §1.903-1(c)(2)(iv)(D) requires taxpayers who claim eligibility for the exception to provide an agreement described in proposed §1.903-1(c)(2)(iv)(A) or (B), as applicable, (the “required agreement”) within 30 days of a request by the Commissioner or another period as agreed between the Commissioner and the taxpayer. Proposed §1.903-1(c)(2)(iv)(D) also provides a transition rule in the case of a royalty paid on or before May 17, 2023 that requires the required agreement to be executed no later than May 17, 2023.
The Treasury Department and the IRS intend that the information collection requirement in proposed §1.903-1(c)(2)(iv)(D) will be set forth in the forms and instructions identified in Table 1.
Table 1. Tax Forms Impacted
Collection of Information |
Number of respondents (estimated) |
Forms to which the information may be attached |
Proposed §1.903-1(c)(2)(iv)(D) |
42,0302 |
Form 1116 and Form 1118
|
Source: IRS’s Compliance Data Warehouse
The estimate for the number of impacted filers with respect to the collection of information in proposed §1.903-1(c)(2)(iv)(D) is based on the number of U.S. corporations that filed a return that had a Form 1118 that reported an amount of withholding tax on rents, royalties, and license fees on Schedule B, Part I, column e; U.S. corporations that filed a return that had a Form 1118 that reported an amount of deemed paid taxes and a Form 5471 that reported an amount of gross royalties and license fees on Schedule C (and thus may have incurred a withholding tax on those royalties); and U.S. individuals that filed a return and had a Form 1116 that reported an amount of withholding tax on rents and royalties on Part II, column n.3 This represents an upper bound of potentially affected taxpayers: not all taxpayers that have reported an amount of royalty withholding tax paid to a foreign country or that have royalty income on which they may have paid a withholding tax are expected to claim a credit for such tax, and not all taxpayers who claim such a credit are expected to rely on the single country exception in proposed §1.903-1(c)(2)(iii)(B).
The Treasury Department and the IRS expect that taxpayers subject to the collection of information in proposed §1.903-1(c)(2)(iv)(D) will not have a significant increase in burden (if any) because some taxpayers may already have existing license agreements that qualify for the single-country exception in place for a variety of tax and non-tax law reasons, and other taxpayers may not elect to take advantage of the single-country exception. The reporting burden associated with this collection of information will be reflected in future PRA submissions associated with Form 1118 (OMB control number 1545-0123), Form 1065 (OMB control number 1545-0123), and Form 1116 (OMB control numbers 1545-0074 for individuals, and 1545-0121 for estates and trusts). The collection of information in proposed §1.903-1(c)(2)(iv)(D) will be reflected in future Paperwork Reduction Act submissions that the Treasury Department and the IRS will submit to OMB for these forms. The current status of the Paperwork Reduction Act submissions related to these forms is summarized in Table 2.
Because the proposed regulations, including the collection of information in proposed §1.903-1(c)(2)(iv)(D), are proposed to apply to taxes paid in taxable years ending on or after the date the proposed regulations are filed with the Federal Register, the Treasury Department and the IRS have submitted the collection of information in proposed §1.903-1(c)(2)(iv)(D) to the OMB for review in accordance with the Paperwork Reduction Act and requested a new OMB control number (the “temporary OMB control number”). After the rulemaking is finalized, the information collection contained within the regulations will be incorporated into the OMB control numbers described in Table 2.
Table 2. Status of Current Paperwork Reduction Submissions.
Form |
Type of Filer |
Temporary OMB Control Number |
Incorporated into OMB Control Number(s) after Final Rulemaking |
Form 1116 |
Trusts & estates |
1545-NEW |
1545-0121 |
Individual |
1545-NEW |
1545-0074 |
|
Form 1118 |
Business |
1545-NEW |
Commenters are strongly encouraged to submit public comments electronically. Comments and recommendations for the proposed information collection should be sent to https://www.reginfo.gov/public/do/PRAMain, with electronic copies emailed to the IRS at pra.comments@irs.gov (indicate REG-112096-22 on the subject line). This particular information collection can be found by selecting “Currently under Review - Open for Public Comments” then by using the search function. Comments can also be mailed to OMB, Attn: Desk Officer for the Department of the Treasury, Office of Information and Regulatory Affairs, Washington, DC 20503, with copies mailed to the IRS, Attn: IRS Reports Clearance Officer, SE:W:CAR:MP:T:T:SP, Washington, DC 20224. Comments on the collections of information should be received by January 23, 2023.
The likely respondents associated with the temporary OMB control number are U.S. persons who pay or accrue foreign withholding taxes on royalty income.
Estimated total annual reporting burden: 420,300 hours
Estimated average annual burden per respondent: 10 hours
Estimated number of respondents: 42,030
Estimated frequency of responses: Annually.
The Treasury Department and the IRS expect to add the burden for this temporary OMB control number to OMB control numbers 1545-0123, 1545-0074, and 1545-0121 after the final rulemaking. For 1545-0123 and 1545-0074, the Treasury Department and the IRS estimate burdens on a taxpayer-type basis rather than a provision-specific basis.
Pursuant to the Regulatory Flexibility Act (5 U.S.C. chapter 6), it is hereby certified that the proposed regulations will not have a significant economic impact on a substantial number of small entities within the meaning of section 601(6) of the Regulatory Flexibility Act.
The proposed regulations provide guidance affecting individuals and corporations claiming foreign tax credits. The domestic small business entities that are subject to the foreign tax credit rules in the Code and in the proposed regulations are generally those that operate in a foreign country or that have income from sources outside of the United States and pay foreign taxes. The reattribution asset definition in proposed §1.861-20(d)(3)(v)(E)(6) applies only to taxable units that make or receive disregarded payments that are considered reattribution payments which result in the reattribution of assets from one taxable unit to another. §1.861-20(d)(3)(v)(C)(1)(ii). In addition, some provisions of these proposed regulations, such as proposed §1.903-1, apply only to entities that license intellectual property for use in a foreign country and receive royalty payments that are subject to foreign withholding tax. The Treasury Department and the IRS do not expect that the proposed regulations will likely affect a substantial number of domestic small business entities because it is infrequent for domestic small entities to engage in significant foreign operations or in the types of transactions giving rise to the foreign taxes addressed by these proposed regulations. However, the Treasury Department and the IRS do not have adequate data readily available to assess the number of small entities potentially affected by the final regulations.
The Treasury Department and the IRS have determined that the proposed regulations will not have a significant economic impact on domestic small business entities. To provide an upper bound estimate of the impact these final regulations could have on business entities, the Treasury Department and the IRS calculated, based on e-file data for the 2020 tax year, foreign tax credits as a percentage of four different tax-related measures of annual receipts (see Table 3 for variables) by corporations. As demonstrated by the data in Table 3 below, foreign tax credits as a percentage of all four measures of annual receipts are substantially less than the three to five percent threshold for significant economic impact for corporations with business receipts less than $250 million.
Table 3. FTCs as Percentage of Annual Receipts
Size (by Business Receipts) |
Under $500k |
$500k to $1M |
$1M to $5M |
$5M to $10M |
$10M to $50M |
$50M to $100M |
$100M to $250M |
$250M or more |
FTC/Gross Receipts |
0.00% |
0.00% |
0.00% |
0.01% |
0.01% |
0.02% |
0.03% |
0.05% |
FTC/Business Receipts |
0.00% |
0.00% |
0.00% |
0.00% |
0.01% |
0.02% |
0.03% |
0.05% |
FTC/Total Income |
0.00% |
0.00% |
0.00% |
0.01% |
0.02% |
0.04% |
0.07% |
0.57% |
FTC/(Total Income-Total Deductions) |
-0.02% |
0.03% |
0.05% |
0.11% |
0.16% |
0.41% |
0.72% |
3.33% |
Source: RAAS:KDA (Tax Year 2020 CDW E-File Data 9-26-22) |
||||||||
Note: Business Receipts = Total Income + Cost of Goods Sold |
||||||||
The Treasury Department and the IRS anticipate that only a small fraction of existing foreign tax credits would be impacted by these regulations, and thus, the economic impact of these regulations will be considerably smaller than the effects shown in Table 3. A portion of economic impact of these proposed regulations derive from the collection of information requirement in proposed §1.903-1(c)(2)(iv)(D). The Treasury Department and the IRS do not have readily available data to determine the incremental burden that this collection of information will have on small business entities. However, the Treasury Department and the IRS believe this collection of information will only marginally increase taxpayers’ burdens because some taxpayers may already have existing license agreements that qualify for the single-country exception for a variety of tax and non-tax law reasons, and other taxpayers may not elect to take advantage of the single-country exception. Furthermore, as demonstrated in Table 3 in this Part III of the Special Analyses, foreign tax credits do not have a significant economic impact for any gross-receipts class of business entities. Therefore, proposed §1.903-1(c)(2)(iv)(D) will not have a significant economic impact on small business entities. Accordingly, it is hereby certified that the proposed regulations will not have a significant economic impact on a substantial number of small entities.
IV. Section 7805(f)
Pursuant to section 7805(f), these proposed regulations will be submitted to the Chief Counsel for Advocacy of the Small Business Administration for comment on its impact on small businesses. The Treasury Department and the IRS also request comments from the public on the certifications in this Part III of the Special Analyses.
V. Unfunded Mandates Reform Act
Section 202 of the Unfunded Mandates Reform Act of 1995 (UMRA) requires that agencies assess anticipated costs and benefits and take certain other actions before issuing a final rule that includes any Federal mandate that may result in expenditures in any one year by a state, local, or tribal government, in the aggregate, or by the private sector, of $100 million in 1995 dollars, updated annually for inflation. This proposed rule does not include any Federal mandate that may result in expenditures by state, local, or tribal governments, or by the private sector in excess of that threshold.
VI. Executive Order 13132: Federalism
Executive Order 13132 (entitled “Federalism”) prohibits an agency from publishing any rule that has federalism implications if the rule either imposes substantial, direct compliance costs on State and local governments, and is not required by statute, or preempts State law, unless the agency meets the consultation and funding requirements of section 6 of the Executive order. This proposed rule does not have federalism implications and does not impose substantial direct compliance costs on state and local governments or preempt State law within the meaning of the Executive order.
Before these proposed regulations are adopted as final regulations, consideration will be given to any comments that are submitted timely to the IRS as prescribed in this preamble under the ADDRESSES heading. The Treasury Department and the IRS request comments on all aspects of the proposed rules, and specifically on the issues identified in Parts I.B and II.C.3 of the Explanation of Provisions. All comments will be available at www.regulations.gov or upon request.
A public hearing will be scheduled if requested in writing by any person that timely submits written comments. Requests for a public hearing are encouraged to be made electronically. If a public hearing is scheduled, notice of the date and time for the public hearing will be published in the Federal Register. Announcement 2020-4, 2020-17 IRB 1, provides that until further notice, public hearings conducted by the IRS will be held telephonically. Any telephonic hearing will be made accessible to people with disabilities.
The principal authors of the proposed regulations are Jeffrey L. Parry, Teisha M. Ruggiero, and Suzanne M. Walsh of the Office of Associate Chief Counsel (International). However, other personnel from the Treasury Department and the IRS participated in their development.
Income taxes, Reporting and recordkeeping requirements.
Accordingly, the Treasury Department and IRS propose to amend 26 CFR part 1 as follows:
PART 1--INCOME TAXES
Paragraph 1. The authority citation for part 1 continues to read in part as
follows:
Authority: 26 U.S.C. 7805 * * *
Par. 2. Section 1.861-20 is amended by revising paragraphs (d)(3)(v)(E)(6) and (i) to read as follows:
* * * * *
* * * * *
Par 3. Section 1.901-2 is amended:
By revising paragraph (b)(4)(i)(A).
By redesignating paragraphs (b)(4)(i)(B), (b)(4)(i)(C)(3), and (b)(4)(i)(D) as paragraph (b)(4)(i)(G), (b)(4)(i)(D), and (b)(4)(i)(E), respectively.
By adding new paragraph (b)(4)(i)(B).
By revising paragraph (b)(4)(i)(C).
By revising the first sentence of newly redesignated paragraph (b)(4)(i)(D).
By adding paragraph (b)(4)(i)(F).
In newly redesignated paragraph (b)(4)(i)(G)(1), by removing the language “one or more significant costs and expenses” and adding the language “substantially all of each item of significant cost or expense” in its place.
In paragraph (b)(4)(iv)(A)(2), by removing the language “significant costs and expenses” and adding the language “substantially all of each item of significant cost or expense” in its place.
In paragraph (b)(4)(iv)(B)(2), by removing the language “(b)(4)(i)(B)(2)” and adding the language “(b)(4)(i)(G)(2)” in its place.
By removing and reserving paragraph (b)(4)(iv)(C).
In paragraphs (b)(4)(iv)(D)(2) and (b)(4)(iv)(E)(2), by removing the language “(b)(4)(i)(C)(2)” and adding the language “(b)(4)(i)(F)(2)” in its place.
By adding paragraphs (b)(4)(iv)(F) through (J).
By revising paragraphs (b)(5)(i)(B)(2), (d)(1)(iii), and (h).
The revisions and additions read as follows:
* * * * *
(D) * * * A foreign tax law permits recovery of substantially all of each item of significant cost or expense even if such item of cost or expense is recovered earlier or later than it is recovered under the Internal Revenue Code unless the time of recovery is so much later as effectively to constitute a denial of such recovery. * * *
* * * * *
(2) Analysis. Under paragraph (b)(4)(i)(B)(2) of this section, each item of cost or expense related to interest, rents, royalties, and payments for services is always treated as a significant cost or expense, and therefore, under paragraph (b)(4)(i)(A) of this section, absent an exception, Country X tax law must permit recovery of substantially all of each item of cost or expense related to interest, rents, royalties, and payments for services. Country X tax law does not permit recovery of any portion of any item of significant cost or expense that is subject to the anti-hybrid rules. As a result, the safe harbor in paragraph (b)(4)(i)(C)(2) of this section does not apply to such item. Further, because a deduction is disallowed for any item of cost or expense that is subject to the Country X anti-hybrid rules, the Country X tax law completely disallows certain items of cost and expense related to interest, rents, royalties, and payments for services and thus does not permit recovery of substantially all of each item of significant cost or expense related to interest, rents, royalties, and payments for services. However, under paragraph (b)(4)(i)(F)(1) of this section, a disallowance of all or a portion of an item of significant cost or expense does not prevent a foreign tax from satisfying the cost recovery requirement if the disallowance is consistent with any principle underlying the disallowances required under the income tax provisions of the Internal Revenue Code. The income tax provisions of the Internal Revenue Code, specifically section 267A, contain disallowances of deductions based on the principle of limiting base erosion or profit shifting. Country X’s disallowance of deductions for any payment, including interest, royalties, rents, or payments for services also reflects the principle of limiting base erosion or profit shifting. Accordingly, because Country X’s anti-hybrid rules are consistent with the principle of limiting base erosion or profit shifting, the Country X tax satisfies the cost recovery requirement.
(2) Analysis. Under paragraph (b)(4)(i)(B)(2) of this section, each item of cost or expense related to wages or other payments for services is always treated as a significant cost or expense, and therefore, under paragraph (b)(4)(i)(A) of this section, absent an exception, Country X tax law must permit recovery of substantially all of each item of cost or expense related to wages or other payments for services. Country X tax law denies a deduction for any stock-based payments for services, and therefore the safe harbor in paragraph (b)(4)(i)(C)(2) of this section is not satisfied. Further, given that no deduction is allowed for stock-based payments for services, the Country X tax law completely disallows an item of cost or expense related to wages or other payments for services and thus does not permit recovery of substantially all of each item of significant cost or expense related to wages or other payments for services. However, under paragraph (b)(4)(i)(F)(1) of this section, a disallowance of all or a portion of an item of significant cost or expense does not prevent a foreign tax from satisfying the cost recovery requirement if such disallowance is consistent with any principle underlying the disallowances required under the income tax provisions of the Internal Revenue Code. The income tax provisions of the Internal Revenue Code contain targeted disallowances or limits on the deductibility of certain items of compensation in particular circumstances based on non-tax public policy reasons, including to influence the amount or use of a certain type of compensation in the labor market. For example, section 162(m) imposes limits on deductions for compensation of certain highly-paid employees, and section 280G limits the deductibility of certain “parachute payments” provided to individuals when an entity undergoes a change of control. Country X’s targeted disallowance of deductions for the portion of payments for services attributable to stock-based compensation also reflects a principle of influencing the amount or use of a certain type of compensation (stock-based compensation) in the labor market. Accordingly, because the Country X tax law’s disallowance is consistent with a principle underlying the disallowances required under the income tax provisions of the Internal Revenue Code, the Country X tax satisfies the cost recovery requirement.
* * * * *
* * * * *
Par 4. Section 1.903-1 is amended:
By revising paragraphs (c)(2) introductory text and (c)(2)(iii).
By adding paragraph (c)(2)(iv).
By revising paragraph (d)(3).
By removing and reserving paragraph (d)(4).
By adding paragraphs (d)(8) through (11).
By revising paragraph (e).
The revisions and additions read as follows:
* * * * *
* * * * *
* * * * *
Melanie R. Krause,
Acting Deputy Commissioner for Services and Enforcement.
1 The Treasury Department and the IRS received a petition for rulemaking with respect to the attribution requirement as applied to a tax on a resident but declined to engage in rulemaking on that subject. The Treasury Department and the IRS have determined that the attribution requirement as contained in the 2022 FTC final regulations, including as applied to residents, is appropriate to ensure that a foreign tax is consistent with the general principles of income taxation reflected in the Code. These principles include not only those related to determining realization, gross receipts, and cost recovery, but also principles for determining the scope of the items of gross receipts and costs that may be properly taken into account in computing the tax base on which the foreign tax is imposed.
2 The estimated number of respondents in this Table 1 is based on the number of respondents from the 2020 tax year.
3 As explained in part II.C.3 of the Explanation of Provisions, the collection of information in proposed §1.903-1(c)(2)(iv)(D) also impacts partnerships and S corporations that pay a withholding tax that is imposed at the partnership or S corporation level under foreign law even though it is the partners or S corporation shareholder that claims the credit for those taxes. The Treasury Department and the IRS lack sufficient data to identify the number of partnerships and S corporations that pay foreign withholding taxes on royalty income. However, the IRS and Treasury Department do not expect that this will impact the number of affected taxpayers since the partners and shareholders that claim a credit for the royalty withholding tax would be captured within the Form 1116 and Form 1118 filers.
| File Type | application/vnd.openxmlformats-officedocument.wordprocessingml.document |
| File Modified | 0000-00-00 |
| File Created | 2023-08-31 |