Redetermining foreign taxes in a post - TCJA world.

• Author: Sites, David

The U.S. federal income tax system generally subjects U.S. taxpayers to taxation of earnings from all sources, foreign and domestic. To prevent double taxation, a credit against U.S. federal income tax is typically permitted under Sec. 901 for foreign income taxes paid or accrued. Taxpayers not electing the benefit of the Sec. 901 credit are generally entitled to a deduction for foreign taxes paid or accrued. A vast array of complexities, limitations, and restrictions govern the U.S. foreign tax credit--far too many to cover in this article.

That said, one set of rules can be particularly vexing for U.S. taxpayers who pay, or who are deemed to pay, foreign taxes--the foreign tax redetermination (FTR) rules. These rules warrant further attention. Since the passage of the law known as the Tax Cuts and Jobs Act (TCJA), (1) they can result in an immense administrative burden and pose risks to unaware taxpayers.

FTRs: Purpose and applicability

Sec. 905(c), the statute governing FTRs, applies to taxpayers who (1) accrue foreign taxes and ultimately pay a different amount; (2) accrue foreign taxes and do not pay them within two years after the end of the tax year to which they relate; or (3) receive a refund in whole or in part of foreign taxes previously paid. The statute mandates that taxpayers in these situations notify Treasury when one or more of these events take place, and it provides that Treasury shall redetermine the amount of U.S. tax for the year or years affected. With respect to FTRs, taxes due on any redetermination shall be payable on notice and demand by Treasury, while any tax overpayments shall be credited or refunded to the taxpayer in accordance with the rules under Sec. 6511. (2)

In effect, Sec. 905(c) acts as a statutory safeguard to ensure that foreign taxes ultimately relieved reflect the actual liabilities incurred by such taxpayers when the dust settles. While the statute provides a framework and general premise, the mechanics of the redeterminations are left to the regulatory process.

Sec. 905(c) or its predecessor has been in the Internal Revenue Code or its predecessor statutes since the Revenue Act of 1918 and has been rarely amended since then--notably, in 1997 and 2017. The 2017 amendments were made as part of the TCJA to reflect the demise of the pooling system for undistributed foreign earnings and foreign income taxes. The TCJA amendments also removed the regulatory grant that provided Treasury flexibility for adjustments to the pooling of post-1986 foreign income taxes. The amendment was necessary because of the TCJA's repeal of the indirect tax pooling system upon the adoption of a quasi-territorial system.

It is worth pointing out that, pre-TCJA, many taxpayers deferred the repatriation of foreign earnings and thus also deferred the deemed payment of foreign taxes associated with those foreign earnings. Therefore, when an amount of foreign taxes accrued ultimately differed from the amount finally payable, taxpayers often could, under regulatory guidance, more readily adjust their pools on a prospective basis and sometimes even before the amount of the credits affected their U.S. tax liability. This was an attractive option for taxpayers, as it avoided the administrative burden of amending returns. With the dawn of the TCJA system, earnings and tax pooling went by the wayside, leaving taxpayers much more susceptible to FTRs.

Post-TCJA, taxes accrued related to Sec. 951A global intangible low-taxed income (GILTI), for example, are creditable in the Sec. 951A inclusion year, subject to a 20% "haircut," among other limitations. The transition to a current inclusion and credit system under the TCJA exposes taxpayers to a higher risk of FTRs and the administrative burden that follows.

Regulatory changes widen applicability

On Dec. 17, 2019, Treasury and the IRS finalized rules on portions of the previous 2007 temporary and proposed FTR regulations. (3) The temporary 2007 regulations had expired in 2010. By 2019, large portions of the 2007 temporary regulations were no longer applicable due to the enactment of the TCJA and the repeal of Sec. 902. Thus, the 2019 final regulations mainly adopted the general themes of the 2007 package, but much of them were scrapped as their applicability waned post-TCJA. On the same date in 2019, new proposed regulations were issued. (4)

On Nov. 12, 2020, T.D. 9922 was issued, finalizing portions of the 2019 proposed FTR regulations. On the same...