FTC denied if competent authority not used in transfer pricing cases.

• Author: Reavey, Edwin
• Position: Foreign tax credit

In Rev. Rul. 92-75, the IRS held that a taxpayer must take steps to reduce the foreign taxes of its controlled foreign corporation (CFC) following a U.S. transfer pricing adjustment between the U.S. parent company and the CFC. These steps include requesting competent authority assistance if the CFC is located in a treaty country. Failure to do so may result in denying the U.S. parent company Sec. 901 deemed-paid foreign tax credit (FTC) on the CFC's foreign taxes.

In the ruling, P, a U.S. parent company, sold goods to S, its wholly owned foreign subsidiary located in country FC during 1986 and 1987. S presumably resold the goods, reported the income and paid tax to FC. Subsequently, the Service initiated an examination of P's 1986 and 1987 returns and determined that P's sales of its products to S were at prices below P's cost. The IRS then allocated income to P under Sec. 482 to reflect an arm's-length selling price for the products to S. P agreed to the adjustment.

In addition, in 1986 and 1987 P received dividends from S and claimed a Sec. 902 deemed-paid FTC for the foreign taxes paid by S. The dividend paid by S to P in 1986 was paid out of earnings and profits (E&P) accumulated in 1986. The dividend paid in 1987 was paid from post-1986 E&P. Following the U.S.-initiated Sec. 482 adjustment, S did not seek a refund from FC of those foreign taxes paid attributable to the income that was reallocated to P, notwithstanding that "a refund might be obtained" if FC accepted the Sec. 482 adjustment. Furthermore, FC and the United States had entered into an income tax treaty, and that treaty contained a mutual agreement article that provided for competent authority to either claim an FC refund or eliminate - in some other fashion - the double taxation that resulted from the Sec. 482 adjustment. S did not request similar assistance from the FC competent authority.

In the ruling, the Service stated that Sec. 902(a) does not authorize a U.S. corporation to take a deemed-paid FTC for all payments made by its foreign subsidiary to a foreign country. Rather, deemed-paid credits may only be taken if the payments quality as an "income tax" under Sec. 901. Thus, citing Regs. Sec. 1.901-2(e)(5), the IRS stated that an amount paid to a foreign country "is not a compulsory payment, and thus is not an amount of tax paid, to the extent that the amount paid exceeds the amount of liability under foreign law for tax."

The Service then indicated that an amount...