The Future of the Foreign Tax CreditPhilip R. West Steptoe stock of foreign affiliates is treated as a foreign asset) 13U.S. GroupCFCU.S. Group: $1,000 interest expense $1,000 U.S.-source taxable income after interest expenseCFC: $1,000 interest expense $1,000 foreign-source income after interest expense $300 foreign taxesAssume 50% foreign assetsCFCs interest expense is allocated entirely against its foreign source incomeU.S. Groups interest expense is allocated in part against U.S. source income and in part against foreign-source income Because U.S. Group has 1/2 foreign assets, 50% of the $1,000 interest expense is allocated to foreign source incomeFor purposes of the FTC limitation, U.S. Group has $500 foreign source income ($700 + $300 gross-up -$500) and will have a $175 FTC limitation (35% x $2,000 x $500/$2000), giving it $175 in credits and $125 carryover$700What Amount of Foreign Taxes is Creditable? Interest Allocation RulesIn 2004, Congress enacted a worldwide interest allocation rule, which would allow the interest expense and assets of foreign affiliates to be taken into account. Interest expense of domestic members of worldwide affiliated group is allocated and apportioned to foreign-source income only to the extent that (1) the total interest expense of the worldwide affiliated group, multiplied by the ratio which the foreign assets of the group bear to the total assets of the group, exceeds (2) the interest expense of the foreign members of the worldwide group that they would have allocated and apportioned to foreign source income had they formed their own separate group The effective date of this rule (originally taxable years beginning after December 31, 2008), however, has since been delayed until taxable years beginning after December 31, 2020.14Assume 50% foreign assetsStep 1: Total interest expense ($2,000) x 50% foreign assets = $1,000Step 2: Interest expense that would be allocated to CFC if CFC were only entity: $1,000 x 100% foreign assets = $1,000Result in Step 1 minus result in Step 2 = $0 interest expense of U.S. group is allocated to foreign source incomeFor purposes of the FTC limitation, U.S. Group has $1,000 foreign source income ($700 + $300 gross-up - $0 interest allocation) and will have a $350 FTC limitation (35% x $2,000 x $1,000/$2,000) and thus can fully credit the $300 in foreign taxesU.S. GroupCFCU.S. Group: $1,000 interest expense $1,000 U.S.-source taxable income after interest expenseCFC: $1,000 interest expense $1,000 foreign-source income after interest expense $300 foreign taxes$700Recent Developments“Splitting” of Foreign Tax Credits: Guardian IndustriesGuardian (U.S.)IHC (U.S.)GIE (Lux)Lux SubsidiariesLux SubsidiariesLux SubsidiariesLegally liable for the foreign taxes paid on the subsidiaries income under Luxembourg law (so entitled to a foreign tax credit for taxes paid on the subsidiaries income). As a result, in this structure, if the operating subsidiaries do not generate subpart F income or distribute dividends to the holding company, the U.S. holding company is entitled to foreign tax credits on foreign income not subject to U.S. tax.See Guardian Industries v. United States, 77 F.3d 1368 (Fed. Cir. 2007), affg 65 Fed Cl. 50 (2003).16Proposed Legal Liability RegulationsIn 2006, Treasury and the IRS proposed regulations (the “Proposed Legal Liability Regulations”) amending the technical taxpayer regulations. With respect to foreign consolidated-type regimes in which foreign tax is imposed on the combined income of two or more persons, including those where the members of the group are not jointly and severally liable for the groups tax (as was the case in Guardian), the proposed regulations provide that the foreign tax must be apportioned among all the members pro rata based on the relative amounts of net income of each member as computed under foreign law. oThe regulations provide, however, that the foreign tax would not be considered imposed on combined income merely because foreign law (a) permitted one person to surrender a loss to another under a group relief regime, (b) required shareholders to include amounts in income attributable to corporate taxes under an integrated tax system, or (c) required shareholders to include in income amounts under an anti-deferral regime. The regulations also would revise the technical taxpayer regulations to provide that a reverse hybrid (i.e., an entity that is a corporation for U.S. tax purposes but a flow-through for foreign tax purposes) is considered to have legal liability under foreign law for foreign taxes imposed on the owners of the reverse hybrid in respect of each owners share of the reverse hybrids income. The reverse hybrids foreign tax liability would be determined based on the proportion of the owners taxable income (computed under foreign law) that is attributable to the owners share of the reverse hybrids income. 17Recent Foreign Tax Credit LegislationP