Taxpayers hoping to take advantage of the temporary relief when determining whether a foreign tax is eligible for a foreign tax credit (FTC) still have time to do so, although the deadline is quickly approaching by the end of 2023.
Background and Context
According to Notice 2023-55, which was issued by the Internal Revenue Service (IRS) on July 21, 2023, foreign taxes paid during tax years 2022 and 2023 may apply the (i) former Section 901 rules before the 2022 FTC final regulations were amended and (ii) existing Section 903 rules without attribution. This notice was a welcome development for taxpayers who have been struggling to comply with the complex new FTC rules.
Section 901 allows a tax credit for foreign income, war profits, and excess profits taxes (collectively “foreign income taxes”). Section 903 allows a credit for taxes paid in lieu of generally imposed foreign income taxes. The final regulations for FTCs were meant to specifically address any “novel extraterritorial taxes” that deviated from U.S. tax guidance and other general international tax guidance – specifically digital services tax (DST), which is based on gross income, meaning it is not creditable for U.S. tax purposes. According to the final regulations, a creditable tax has four main aspects: realization, gross receipts, cost recovery and attribution. The IRS and Treasury received specific critical feedback regarding the stricter rules for cost recovery and attribution, which contributed in part to the release of temporary relief in Notice 2023-55.
DSTs in particular will continue to be not credible, and Section 1.903-1 can be applied to them as well, minus the application of jurisdiction to tax-excluded income or source-based attribution requirements.
Takeaways
The IRS has said it will continue to consider future changes or modifications to FTC regulations; however, the IRS is also clear that it does not plan to change its position regarding DSTs being based solely on gross income.
The final regulations for FTCs released in 2022 included strict guidance regarding the attribution requirement and cost recovery requirement, without applying any predominant character standard. Notice 2023-55 provides relief to these restrictions by providing more favorable tax treatment to certain foreign taxes under the 2022 final regulations, including nonresident capital gain taxes, services and royalty withholding taxes and creditable foreign income taxes.
It should be noted that Notice 2023-55 technically only provides one year of relief to taxpayers who have a year-end other than December 31. This means taxpayers with alternative year-ends should assess how to support creditability of foreign taxes in the future that may not have been creditable according to the 2022 final regulations.
Notice 2023-55 does not require any specific statement or form to indicate they are applying the relief provisions to FTCs. However, they must apply modified regulations from the notice to all foreign taxes paid or accrued in the relief year and to all foreign taxes paid by other persons in the relief tax year. Temporary relief may not be applied in order to claim credit when a deduction was allowed in the relief year or any other taxable year.
Action Items for Taxpayers
- Taxpayers who have already filed their 2022 tax return and also had any FTC limitations as a result from the 2022 final regulations should consult their tax advisor to consider filing an amended return to take advantage of the temporary FTC relief.
- Taxpayers should also evaluate each of the foreign taxes that had been disallowed as an FTC per the 2022 final regulations to determine whether those disallowed taxes may be now creditable under Sections 901 or 903 during the relief period.
- Taxpayers should work with their tax advisor to determine what other actions may be necessary to support the future creditability of foreign taxes that may not have been creditable under the 2022 final regulations.
Windham Brannon Can Help
Taxpayers should consult with their tax advisor to determine whether the temporary relief provided by Notice 2023-55 could be beneficial to their tax situation. Our International Tax Practice can help you understand how to apply FTC guidance as well as determine if an amended tax return is right for you to take advantage of the temporary relief. For questions or more information, reach out to Brandi M. Samuel.
