Guidance on foreign tax credit splitter transactions.

• Author: Jones, Donald

On Feb. 14, 2012, Treasury published temporary regulations to provide guidance on the Sec. 909 foreign tax credit splitter event provisions that were enacted in August 2010 as part of the Education Jobs and Medicaid Assistance Act of 2010, P.L. 111-226. The temporary regulations expand on the rules outlined in Notice 2010-92 and identify certain fact patterns that give rise to a foreign tax credit splitting event. The effective date of the temporary regulations is for tax years beginning after Jan. 1, 2012.

General Overview of the U.S. Foreign Tax Credit Regime

U.S. individuals and corporations are generally subject to U.S. taxation on their worldwide income, without regard to where the income is sourced. As a result, U.S. persons with foreign income are subject to the risk of double taxation. To mitigate this risk, U.S. taxpayers are allowed a credit under Sec. 901 against their U.S. tax liability (subject to certain formulary limitations) for foreign taxes paid or accrued during the tax year. Specifically, foreign income taxes, war profits taxes, and excess profits taxes, or other foreign taxes that are imposed "in lieu" of such taxes, are eligible for credit against U.S. tax. Similarly, under Sec. 902, a domestic corporation that owns at least 10% of the voting stock of a foreign corporation is allowed a "deemed paid" credit for foreign taxes paid by the foreign corporation that the domestic shareholder is treated as having paid when the foreign corporation's earnings are distributed or otherwise included in the U.S. shareholder corporation's income.

Why the Foreign Tax Credit Splitter Rules Arose

One question that has historically weighed on U.S. tax authorities (and one that is critical in determining whether a U.S. taxpayer has the right to claim a foreign tax credit) is who, for U.S. tax purposes, is considered as actually having paid or accrued the foreign tax to be credited. The difficulty of this question, which had been debated in the courts for years, was brought to the forefront by the decision in Guardian Industries Corp., 477 F.3d 1368 (Fed. Cir. 2007). In this case, a U.S. corporation, Guardian, conducted business operations in Luxembourg through a wholly owned Luxembourg subsidiary, Guardian Industries Europe S.a.r.1. (GIE), which was treated for U.S. tax purposes as a disregarded entity. GIE was the parent of a Luxembourg consolidated group of operating companies, which were treated for U.S. tax purposes as corporations.

Under Luxembourg law, GIE was liable for paying the consolidated Luxembourg income tax liability on behalf of the group. Guardian took the position that because of GIE's disregarded status, it had the right to claim as a foreign tax credit all taxes paid by GIE on behalf of the...