Effect of NOL carryovers on FTC.

• Author: Crocco, Peter
• Position: Net operating losses; foreign tax credit

In the U.S., domestic corporations are taxed on their worldwide income. Regardless of geographical source, the entire income of these taxpayers generally is subject to U.S. income tax, raising problems of international double taxation. To provide relief from double taxation, the U.S. allows a deduction for foreign taxes in computing gross income. Additional relief comes from the foreign tax credit (FTC). Under Sec. 901, domestic corporations (at their option) may credit rather than deduct foreign income taxes.

However, the Code imposes limits on the amount of the allowable FTC. Sec. 904(a) provides that the FTC cannot exceed the same proportion of the tax for which the credit is taken that the taxpayer's foreign-source income bears to worldwide taxable income, as follows:

FTC Limitation:

Creditable foreign tax =

U.S. income tax x Foreign-source income/Worldwide taxable income

In practice, a question often arises about the effect of the FTC limit on "preserving" the source of a net operating loss (NOL) when a domestic corporation carries back or forward an NOL.

It appears that the source should be preserved. In a carryover year, the NOL loss deduction should be allocated only to the gross income of the country in which the loss occurred, regardless of whether there is sufficient taxable income from the country in the year to absorb the loss. Simply put, the loss incurred in the year of the overall NOL should be treated as if incurred in the carryover year.

GCM 39555 (which applied the principles of Regs. Sec. 1.861-8(e)(8) and Rev. Ruls. 69-121 and 71-432) seems to support this conclusion. GCM 39555 discussed the example of a domestic corporation with foreign-source income in 19xx of $300x, domestic-source income of $50x and an NOL carryforward of $200x; the latter was attributable to a domestic loss in the year in which the NOL was...