Foreign tax credit regulations disallow credit for digital taxes
TAX ALERT |
Authored by RSM US LLP
On Sept. 29, 2020, the U.S. Treasury Department and the IRS released a new set of final regulations (T.D. 9922; the Final Regulations) and proposed regulations (REG-101657-20; the Proposed Regulations) covering the determination of foreign tax credits (FTCs) under the Internal Revenue Code (IRC). While the Final Regulations and Proposed Regulations respectively provide a number of clarifications pertaining to FTCs as summarized below, a key issue addressed was the creditability of digital services taxes. Treasury took a firm stance in the Proposed Regulations that digital taxes which are not based on a concept of nexus should not qualify as a creditable income tax.
Numerous countries in the EU and across the world have enacted digital taxes on the grounds that companies are able to derive value from individuals located within their jurisdiction that is going untaxed under current taxing standards. In response to the growing number of extraterritorial taxes, which significantly diverge from traditional international taxing norms, Treasury is proposing the addition of a jurisdictional nexus requirement to the definition of what is deemed a foreign income tax. If the Proposed Regulations become final, any income taxes paid under foreign tax laws that fail to require sufficient nexus between that foreign country and the taxpayer’s activities, investment of capital or other assets that result in the income being taxed will not qualify for the FTC. As the guidance alludes to the laws of the foreign jurisdiction, a careful review of the foreign jurisdiction’s laws will likely be required in order to properly evaluate whether sufficient nexus levels have been met.
The Proposed Regulations provide that in determining sufficient nexus in a country, relevant considerations could include having operations, employees, factors of production or management in that foreign country. A tax imposed by a foreign country on a company lacking such nexus in their country will not be considered an income tax from the U.S. tax perspective and thus should not be eligible for an FTC. As it has become commonplace for companies to carry out their services digitally reaching individual users around the world, this development could have a significant impact on their overall tax burden and potentially affect how business is conducted in the digital economy altogether.
The Final Regulations provide guidance on:
- The allocation and apportionment of foreign income taxes to gross income, including for categorizing section 904(d) categories;
- The allocation and apportionment of deductions such as stewardship, legal damages, research and experimentation (R&E), and certain deductions related to life insurance companies under sections 861 to 865;
- A newly added election under section 905(c) to account for a CFC’s foreign tax redeterminations as it relates to tax years of the CFC beginning prior to Jan. 1, 2018;
- The interplay of the branch loss and dual consolidated loss recapture rules with section 904(f) and (g); and
- Applying the foreign tax credit limitation to consolidated groups.
Some of the key provisions of the Proposed Regulations include:
- Fundamental changes to the definition of what constitutes a creditable foreign income tax by requiring that the foreign income tax must have a jurisdictional nexus in order to be creditable;
- Guidance on the allocation and apportionment of foreign income taxes imposed on dispositions of stock and partnership interests as well as disregarded payments made between “taxable units;”
- The disallowance of foreign tax credits and section 245A deductions in connection with foreign income taxes attributed to dividends with which a section 245A deduction would be allowed;
- Clarification that electronically supplied services in which the value of the service provided to the end user is primarily from the service’s automation or electronic delivery (opposed to human effort), can be considered electronically supplied services for purposes of the FDII deduction; and
- An election that taxpayers can make to capitalize and amortize advertising and R&E expenditures made in connection with apportioning interest expense.
Treasury’s stance on digital taxes aligns with the department’s defense of the U.S. tax base and the proposed rules make it clear that any extra tax paid in the form of a digital services tax to a foreign country will not reduce U.S. tax receipts. Companies with potential exposure to the digital services tax should focus their attention on whether these regulations become final and consult with their tax advisors to analyze potential impacts to their global tax footprint.
Call us at +1 213.873.1700, email us at firstname.lastname@example.org or fill out the form below and we'll contact you to discuss your specific situation.
This article was written by Jamison Sites, Ravi Dadlani and originally appeared on 2020-10-20.
2020 RSM US LLP. All rights reserved.
The information contained herein is general in nature and based on authorities that are subject to change. RSM US LLP guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. RSM US LLP assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein. This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer.
RSM US Alliance provides its members with access to resources of RSM US LLP. RSM US Alliance member firms are separate and independent businesses and legal entities that are responsible for their own acts and omissions, and each is separate and independent from RSM US LLP. RSM US LLP is the U.S. member firm of RSM International, a global network of independent audit, tax, and consulting firms. Members of RSM US Alliance have access to RSM International resources through RSM US LLP but are not member firms of RSM International. Visit rsmus.com/about us for more information regarding RSM US LLP and RSM International. The RSM logo is used under license by RSM US LLP. RSM US Alliance products and services are proprietary to RSM US LLP.
Vasquez & Company LLP is a proud member of RSM US Alliance, a premier affiliation of independent accounting and consulting firms in the United States. RSM US Alliance provides our firm with access to resources of RSM US LLP, the leading provider of audit, tax and consulting services focused on the middle market. RSM US LLP is a licensed CPA firm and the U.S. member of RSM International, a global network of independent audit, tax and consulting firms with more than 43,000 people in over 120 countries.
Our membership in RSM US Alliance has elevated our capabilities in the marketplace, helping to differentiate our firm from the competition while allowing us to maintain our independence and entrepreneurial culture. We have access to a valuable peer network of like-sized firms as well as a broad range of tools, expertise and technical resources.
For more information on how Vasquez & Company LLP can assist you, please call +1 213.873.1700.
Subscribe to receive important updates from our Insights and Resources.