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IRS releases new rules on foreign tax credits

On Behalf of | Jan 27, 2022 | Tax Law

Americans now have to catalog the various foreign taxes and decide themselves if a foreign tax credit, or FTC, is available for their situation. The new regulations limit the creditability of particular extraterritorial taxes for people in New York and other states.

Attribution requirement for income taxes

Banking and finance law has been under the prior treasury regulations since 1983. A foreign levy counts as income as long as a majority of income was from the U.S. A foreign levy needs to meet three requirements to count as income. The foreign levy can’t surpass the measure of the gross receipts requirements. In addition, the foreign levy should allow the recovery of a majority of the attributable costs for the net income requirement.

The final regulations retain the realization, net income and gross receipts requirements but are more stringent. There are new attribution requirements that affect citizens or non-residents differently. Citizens need allocations of income using the arm’s length principles. Non-residents need costs and gross receipts to satisfy three conditions:

  • Attribution limits activities within the country
  • Attribution limits the sources of income within the country
  • Attribution of property such as stocks or interest can only tax non-residents where the U.S. already would

Which FTCs could the final regulation deny?

The Treasury and IRS said they now have a much broader range of foreign taxes. Many common foreign withholding taxes that weren’t in doubt are no longer the basis of an FTC claim. Royalty withholding taxes now require a person to hold an IP in that foreign country. For withholding technical service payment taxes, it’s necessary to follow the same steps as royalties. Other examples of FTCs that the IRS can deny include capital gains taxes on share disposal, taxes on sales of copyrighted articles, diverted profits taxes and digital services taxes.

These regulations change the foreign tax credit banking and finance law for the first time since 1983. There are some differences between the regulation’s effects on residents and non-residents. There are tighter requirements and new attributes, which can stop many FTCs for foreign withholding taxes. People with foreign income may need to consider alternative structures.