Foreign tax credit: when is it too late to change your mind?

• Author: Ward, Travis S.

Many multinational corporations rely on the ability to claim a foreign tax credit for the foreign taxes directly or indirectly paid to other countries. The credit is paramount to sustaining a competitive effective tax rate and avoiding double taxation. For this reason, both internal tax departments and external tax advisers spend much time and energy on the effective use of foreign tax credits. Unfortunately, simply paying a foreign tax does not guarantee a taxpayer a credit against current or future U.S. tax liability. A complex set of rules in the Code can limit or even completely prevent a taxpayer from using its foreign tax credits (see Sec. 904 and the attendant regulations).

Taxpayers whose foreign tax credits have been limited can either deduct the foreign taxes in the year paid or carry any excess taxes forward for 10 years in the hope that the limitation will allow the credit to be used in future years (Sec. 904(c)). After 10 years, the credits will expire, and the taxpayer will not realize any tax benefit. Obviously, a credit, if not limited, is more beneficial than a deduction, but the interaction of the limitation rules and the threat of expiration often can make a deduction the most beneficial option or even the only option for realizing a U.S. tax benefit from the payment of foreign taxes.

Given the uncertainty of future events, taxpayers frequently do not know whether they will be able to use any foreign tax credits that are limited in the year the credits first become usable. Luckily, a taxpayer may wait and see before it is effectively locked in to one choice or the other, or at least that was the prevailing wisdom before a relatively recent Chief Counsel advice (CCA). Generally, a taxpayer is given up to 10 years to change its mind about whether to claim a credit or deduction for foreign taxes paid in a given year, as opposed to the general three-year window on amending tax returns (Secs. 901 and 6511(d)(3); Regs. Sec. 1.901-1(d)).This seemingly generous provision has long been relied on by taxpayers and their advisers, and taxpayers often amend returns within that 10-year time frame to switch between claiming a credit or a deduction as events unfold and circumstances change that make one option more beneficial than the other. However, this practice has come under fire by the IRS in the past few years.

The IRS's Position

In CCA 201204008, released in early 2012, the IRS effectively made the special 10-year window for...