U.S. tax effects of a foreign jurisdiction audit.

• Author: Thompson, Bradley C.

A tax audit in a foreign jurisdiction may affect the amount of foreign tax credit that a taxpayer claimed on a U.S. return for a prior year. To obtain the benefit of an increased foreign tax credit, the U.S. taxpayer's claim for credit or refund must be timely.

Generally, if the foreign audit results in higher foreign tax liability, U.S. taxpayers have a special 10-year statute of limitation for filing a claim for an increased foreign tax credit that starts with the year for which the additional foreign taxes were paid or accrued. This 10-year period starts on the due date of the tax return (excluding extensions) for the year for which the foreign tax was paid or accrued (Sec. 6511(d)(3)(A)). By contrast, if the foreign tax audit results in lower foreign tax liability, the IRS has an indefinite period of time to assess the additional U.S. tax liability created by the loss of foreign tax credit (see Secs. 6501(c) (5) and 905(c)(1) and Temp. Regs. Sec. 1.905-4T(b)).

When a foreign jurisdiction notifies a foreign affiliate of a U.S. corporation about a tax examination in that jurisdiction, the U.S. taxpayer should file a protective U.S. claim for credit or refund for the year or years that may be affected.

Example: Q, a calendar-year corporation, is under examination in a foreign jurisdiction for tax years 1997 and 1998. The foreign jurisdiction ultimately assesses an additional liability equivalent to $2 million of tax for the 1997 year and authorizes a refund of $1 million of tax for the 1998 year. The special 10-year statute for filing a claim for the 1997 year expired on March 15, 2008. Q is therefore time barred from obtaining a refund for the additional foreign taxes that otherwise would have been creditable. The IRS, however, may assess additional U.S. tax for the 1998 year at any time. To avoid such an outcome, the taxpayer should have invoked U.S. competent authority as soon as the foreign jurisdiction notified the foreign affiliate that it was under...