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Abstract
In 2007, the IRS released REG-156779-06, which would modify the 1983 voluntary tax regulations. The Proposed Regulations address the operation of the voluntary tax rule with respect to commonly controlled entities and expand the traditional definition of a voluntary tax so that the voluntary tax rule denies foreign tax credits in certain structured transactions that the IRS finds objectionable in their foreign tax credit impact. The traditional purpose of the voluntary tax rule has been to compel taxpayers to exhaust reasonable administrative and judicial remedies overseas to reduce their foreign tax liabilities. Rules like the new single-taxpayer proposed rule are helpful in permitting taxpayers to reduce their aggregate foreign tax burden without running afoul of the voluntary tax rule, but the rule is too narrowly drawn to fully achieve this result. The anti-arbitrage proposed rules and the recent FSA regarding the UK relevant withholding tax expand the voluntary tax rule's scope beyond its traditional boundaries. The Service's effort to broaden the meaning of a voluntary tax will likely make it harder in the future to determine with confidence when a voluntary tax issue exists. The IRS should leave the voluntary tax rule essentially as is to avoid muddying the foreign tax credit waters, and should develop different means of addressing new foreign tax credit issues recently challenged under a voluntary tax analysis.
Full text
The U.S. foreign tax credit is intended to grant a U.S. taxpayer an offset for foreign income tax paid or accrued against its U.S. federal income tax liability under appropriate circumstances. For this purpose, to be a foreign "tax," a payment must be compulsory and pursuant to the authority of a foreign country to levy taxes.1 The voluntary tax rule is that an amount paid is not compulsory, and thus is not an amount of tax paid, to the extent that it exceeds the liability for tax under foreign law (Reg. 1.901-2(e)(5)(i)). * Many laypersons would say that 'Voluntary tax" is an oxymoron. Used as a verb, "levy" has been defined as "an imposing or collecting, as of a tax, by authority or force."2 However, U.S. foreign tax credit provisions have their own special logic. 1RS policy is that a foreign tax credit should be denied unless the taxpayer has taken reasonable measures to mitigate its foreign tax liability. The foreign tax credit is designed to reduce the possibility of double taxation when a taxpayer is subject to income tax in the U.S. and a foreign country, not to permit a taxpayer to be indifferent to its potential foreign income tax liability so long as the foreign tax can be offset against its U.S. tax liability.
A voluntary tax rule is not necessary to protect the fisc when foreign taxes are deducted because a deduction (as opposed to a credit) does not allow the taxpayer to recoup fully the cost of the foreign tax against its U.S. tax liability. Since the taxpayer necessarily bears some of the burden of the foreign tax paid when a deduction is claimed, it has an incentive to ensure that its foreign tax liability is as low as possible. The situation is different when foreign taxes are credited and, as is becoming increasingly common, the foreign tax rate is lower than the U.S. tax rate.
The appropriate foreign tax credit rules for requiring taxpayer diligence in reducing foreign tax are not intuitively obvious. The current Regulations defining a voluntary tax have remained unchanged since 1983.3 Reductions in foreign tax rates, ambiguities in the current Regulations, the advent of checkthe-box planning, and, perhaps most importantly, the Service's continuing search for new tools to police the foreign tax credit, have put increasing pressure on rules that the 1RS began developing during the Carter Administration.
In 2007, Proposed Regulations were issued that would modify the 1983 voluntary tax Regulations ("Proposed Regulations").4 The Proposed Regulations address the operation of the voluntary tax rule with respect to commonly controlled entities5 and expand the traditional definition of a voluntary tax so that the voluntary tax rule denies foreign tax credits in certain structured transactions that the IRS finds objectionable in their foreign tax credit impact (this second set of Proposed Regulations will be referred to as the "anti-arbitrage rule").6
This article discusses the traditional, relatively modest scope of the voluntary tax rule and the Service's expanding attempts to broaden its reach in ways that make the rule's moorings and applications less clear than they were in 1983. The Proposed Regulations are the latest example of IRS efforts to make the voluntary tax rule do more duty than was originally intended or that, we believe, is appropriate. The article also looks at longstanding and more recent interpretative issues arising under the voluntary tax Regulations.
History
Voluntary tax Regulations were first proposed in 1979,7 but their origins trace back further. For some time before then, the IRS took the position that foreign taxes paid on amounts reallocated from a foreign subsidiary to its U.S. parent in a U.S.-initiated transfer pricing adjustment were subject to disallowance unless the taxpayer exhausted its effective and practical remedies to get a refund of these foreign taxes.8 Because the U.S. parent's increased U.S. tax liability attributable to the reallocation of income that should never have been subject to foreign tax could potentially be offset by indirect foreign tax credits, it was thought necessary to require taxpayers to take reasonable efforts to reduce their foreign tax at issue.9
There were three different versions of foreign tax credit Regulations containing the voluntary tax rule before they were finalized in 1983. The multiple sets of Regulations reflect the Service's struggle to distinguish taxes from royalties paid by oil and gas companies; difficulties with the voluntary tax Regulation were not a driving force behind the issuance of so many versions of the foreign tax credit Regulations. The Preambles to the last three sets of voluntary tax Regulations shed little light on the reasons for their revisions to the voluntary tax rule.10
1979 Proposed Regulations
The 1979 voluntary tax Proposed Regulations provided, in their entirety:
(i) In general. A payment is compulsory only if made pursuant to a legal liability to a foreign government.
(ii) Overstatement of liability. A payment is not compulsory to the extent that it exceeds legal liability. A payment may [emphasis in original] exceed legal liability, for example, if all effective and practical remedies (including remedies under applicable tax conventions) are not exhausted in seeking a reduction of liability. A payment exceeds legal liability, for example, if advantage is not taken of all available provisions of foreign law which would permanently reduce, with reasonable certainty, the legal liability to the foreign government, a [sic] provision of foreign law is not considered to reduce permanently legal liability if, as a result of taking advantage of the provision, legal liability in other periods will be commensurately greater. For example, a deduction for depreciation over a reasonable asset life permitted by foreign law is not considered to result a payment in excess of legal liability. (For the Treatment [sic] of refunds of foreign taxes which have been credited, see § 1.905-3.)
(iii) Contested charges. A payment does not cease being compulsory during an action disputing legal liability to pay the charge or the appropriate amount of the pay ment. A compulsory payment includes a payment in bona fide settlement of a dispute with the foreign government as to the appropriate amount of the payment.
(iv) Optional charges. A payment of a charge is not compulsory to the extent that there is an option either to make some other payment for which consideration of more than nominal value is received or to pay the charge and receive no consideration. For example, the payment of a charge is not compulsory to the extent that it is possible, in lieu of making the payment, to purchase a bond or other security which has more than nominal value.
(v) Payment to third parties. A payment to a person other than a foreign government is considered to be a compulsory payment to a foreign government to the extent that the payment reduces a legal liability to the government.11
Although the Service's voluntary tax positions that pre-dated the 1979 Proposed Regulations originated in the context of transfer pricing adjustments, these Proposed Regulations surprisingly had no examples dealing with transfer pricing adjustments and the impact of a taxpayer's action or inaction in seeking correlative adjustments overseas. Examples addressing these issues were included in Temporary Regulations issued in 198012 and similar examples are in the current Regulations (Reg. 1.9012(e)(5)(ii), Examples 1-4).
1980 Temporary Regulations
The IRS issued Temporary Regulations in 1980 that improved, but embraced substantially the same principles as, the 1979 Proposed Regulations.13 The most notable changes in the 1980 Temporary Regulations were:
* The addition of examples regarding transfer pricing adjustments, as noted.14
* The introduction of a test resembling a cost/benefit test, i.e., that "[a] remedy is effective and practical only if it is reasonable to believe that the potential reduction in liability would justify the expenses of pursuing the remedy."15
* The addition of the important rule that "[a] person need not alter its form of doing business or its business conduct to reduce its liability under foreign law for income tax."16
* The inclusion of an example showing that a taxpayer may use a depreciable life for an asset that is longer than the shortest permissible under foreign law without running afoul of the voluntary tax rule.17
The 1980 Temporary Regulations also added the following examples:
* Taxpayer C pays a foreign tax that, at the time, was based on a reasonable interpretation of foreign law. Subsequent to the payment of the tax, but while C still has time to file for a refund, a court in the foreign jurisdiction rules that certain deductions are allowable to taxpayers like C. C had not originally claimed these deductions. C does not file for a foreign tax refund, although the expenses of filing are small in relation to the potential refund. The example concludes that C's refundable foreign tax was voluntary.18 This example is notable because it required taxpayers to keep abreast of foreign tax law changes subsequent to the payment of foreign taxes, even if the original determination of their liabilities was reasonable at the time.
* Foreign country ("Country X") permits its residents to calculate income under one of two methods. U.S. citizens resident in Country X chose the method that resulted in the most tax due to Country X. The example does not explain the reason for the U.S. citizens' choice of one method over the other. The example concluded that the amount by which the Country X tax imposed under the method selected by the U.S. citizens exceeded the amount that would have been imposed if the U.S. citizens had chosen the other method was voluntary.19 This example is significant because it treated a foreign tax as voluntary when the tax was in fact legally due.
* U.S. citizen A goes to a foreign country that imposes a 10% charge on gains from investment property with no significant purpose other than altering the source of the gain from a U.S. tax perspective. (Under the source rules at the time, a U.S. persons gain from the sale of certain personal property was U.S.-source unless the gain was subject to a 10% foreign tax.) The example concluded that the resultant foreign tax was voluntary.20 Normally, the voluntary tax rule compels a taxpayer to use all reasonable, effective, and practical measures to properly determine its foreign tax liability and to defend its determination in the foreign country. In contrast, this example stood for the proposition that, even if the foreign tax liability is correctly determined, the tax can still be voluntary if the taxpayer voluntarily subjected itself to the tax for U.S. tax-avoidance purposes.
1983 Proposed Regulations
In 1983, new voluntary tax Proposed Regulations were issued.21 Highlights from the 1983 Proposed Regulations include:
* For the first time, an express statement that effective and practical remedies may include Competent Authority.
* Reworking of the cost/benefit-type test to state, as it does now, that "[a] remedy is effective and practical only if the cost thereof is reasonable in light of the amount at issue and the likelihood of success."22
* Inclusion of an example showing that taxpayers may choose a longer depreciable life under foreign law without creating a voluntary tax problem similar to the example in the 1980 Temporary Regulations.23
* Elimination of certain examples from the 1980 Regulations, including the three notable examples discussed above.
1983 Final
(and Current) Regulations
The voluntary tax final Regulations were intended to provide greater guidance than earlier versions on how far a taxpayer has to go to reduce its foreign tax liability to avoid a voluntary tax problem.24 Significant changes from the 1983 Proposed Regulations include:
* Reintroduction of an express statement that shifting tax liabilities from one period to another does not create voluntary tax issues (Reg. 1.901-2(e)(5)(i)) (and the retention of the depreciable life example in the 1983 Proposed Regulations (see Reg. 1.901-2(e)(5)(ii), Example 5).
* Inclusion for the first time of an express statement allowing taxpayers to rely on advice interpreting foreign tax law obtained in good faith from competent foreign tax advisors to whom the taxpayer has disclosed the relevant facts (Reg. 1.901-2(e)(5)(i)).
* Statement that a "settlement by a taxpayer on two or more issues will be evaluated on an overall basis, not on an issue-by-issue basis, in determining whether an amount is a compulsory amount" (Reg. 1.901 -2(e)(5)(i)).
* Addition of an example in which the taxpayer had no actual or constructive knowledge that its pricing of a transaction was likely to be erroneous until the 1RS initiated a transfer pricing adjustment, which occurred after the relevant foreign statute of limitations had expired. The example concludes that the taxpayer had no effective and practical remedies, so the tax was not voluntary (Reg. 1.901 - 2(e)(5)(ii), Example 4). This new example is the first (and only) instance in the voluntary tax Regulations in which the expiration of a foreign statute of limitations does not cause a foreign tax to be voluntary.
Operation and framework of the final Regulations. The final Regulations provide (Reg. 1.901-2(e)(5)(i)):
* "An amount paid is not a compulsory payment, and thus is not an amount of tax paid, to the extent that the amount paid exceeds the amount of liability under foreign law for tax."
* "An amount paid does not exceed the amount of such liability if the amount paid is determined by the taxpayer in a manner that is consistent with a reasonable interpretation and application of the substantive and procedural provisions of foreign law (including applicable tax treaties) in such a way as to reduce, over time, the taxpayer's reasonably expected liability under foreign law for tax, and if the taxpayer exhausts all effective and practical remedies, including invocation of Competent Authority procedures available under applicable tax treaties, to reduce, over time, the taxpayer's liability for foreign tax (including liability pursuant to a foreign tax audit adjustment)"
* "Where foreign tax law includes options or elections whereby a taxpayer's tax liability may be shifted, in whole or part, to a different year or years, the taxpayer's use or failure to use such options or elections does not result in a payment in excess of the taxpayer's liability for foreign tax."
* "In interpreting foreign tax law, a taxpayer may generally rely on advice obtained in good faith from competent foreign tax advisors to whom the taxpayer has disclosed the relevant facts."
* "An interpretation or application of foreign law is not reasonable if there is actual notice or constructive notice (e.g., a published court decision) to the taxpayer that the interpretation or application is likely to be erroneous."
* "A remedy is effective and practical only if the cost thereof (including the risk of offsetting or additional tax liability) is reasonable in light of the amount at issue and the likelihood of success."
* "A settlement by a taxpayer of two or more issues will be evaluated on an overall basis, not on an issue-by-issue basis, in determining whether an amount is a compulsory amount."
* "A taxpayer is not required to alter its form of doing business, its business conduct, or the form of any business transaction in order to reduce its liability under foreign law for tax."
The provisions regarding options or elections and the taxpayer's business form and conduct above are particularly important. In practice, they protect taxpayers from some voluntary tax arguments that IRS agents might otherwise advance.
The Section 902 rules, which provide for an indirect credit, and the section 903 rules, which provide for an "in-lieu of" credit, adopt the definition of "tax" from the portion of the foreign tax credit Regulations that includes the voluntary tax rule, thereby, not surprisingly, incorporating the rule by reference.25
Examples in the 1983 final Regulations. The voluntary tax final Regulations contain six examples. Like the examples in many tax Regulations, these address fairly easy situations. The majority of the examples deal with transfer pricing-related overpayments to a foreign tax authority.
Example 1 involves taxpayers with actual knowledge that the allocation of profits between two related entities is not consistent with a reasonable interpretation and application of foreign law. It concludes that the resulting overpayments are voluntary.
In Example 2, a foreign law is not clear and a taxpayer lacking actual or constructive knowledge that the allocation of profits is likely to be erroneous until the 1RS initiates a transfer pricing adjustment. The taxpayer in Example 2 does not exhaust its effective and practical remedies under foreign law to obtain a refund and, as a result, the taxes attributable to the amounts reallocated to the U.S. are voluntary.
In Example 3, the taxpayer is in the same situation as in Example 2, but it does exhaust the remedies reasonably available to it, so its taxes are compulsory. In Example 4, the IRS does not initiate an adjustment until after the foreign statute of limitations for refund has expired and the taxpayer has no remedies to obtain a refund. In this situation, the taxes are compulsory.
Two examples do not involve transfer pricing. Example 5 illustrates that a taxpayer's choice of a depreciable life longer than the shortest permissible under foreign tax law did not run afoul of the voluntary tax rule because the choice was consistent with the requirement that the taxpayer reduce over time its reasonably expected foreign tax. It notes that, because the voluntary tax standard refers to reasonably expected tax liability, actual events occurring in subsequent years, such as changes in the taxpayer's profitability or to the relevant foreign tax rates, are "immaterial." Example 6 involves a taxpayer that fails to claim a refund to which it is entitled under an applicable treaty and concludes that the resulting overpayment is voluntary.
The balance of this article discusses recent IRS efforts to broaden the meaning of a voluntary tax and recurring interpretative issues under the voluntary tax Regulations.
1988 NSAR 8261
There is some limited, additional IRS guidance on what taxpayers must do to exhaust their remedies to avoid the loss of foreign tax credits. Although it interpreted the 1980 Temporary Regulations, a 1988 non-docketed service advice review (NSAR)26 still represents a useful summary of the facts and circumstances that can affect a taxpayer's duties to exhaust its effective and practical remedies under the current voluntary tax rule. The NSAR remains useful because it establishes a simple, cohesive framework for analyzing taxpayers' duties under different fact patterns. It divides taxpayers into three categories and describes the types of measures that taxpayers in each category must take.
Taxpayers in "Category 1 " are those who have clearly made an error in calculating their liabilities or applying foreign law.27 The NSAR indicates that it would require such a taxpayer to show that it had exhausted all effective and practical remedies and further that "if the taxpayer fails to gain a reduction in foreign tax liability for procedural, as opposed to substantive reasons, where foreign law becomes clear, after payment of the tax, that a reduction in tax liability is obtainable, the excess foreign tax paid is not creditable."28 This example illustrates the consequences of a taxpayer's failure to satisfy the current voluntary tax rule's requirement that a taxpayer must make a reasonable determination of its foreign tax liability under the voluntary tax rule. Presumably, the NSAR's conclusion that a Category 1 taxpayer must obtain a refund or the tax paid will be voluntary remains correct under the current voluntary tax rules.
Taxpayers in "Category 2" are those facing an area in which foreign law was uncertain or unclear, but subsequently were put on notice by the Service of a possible overpayment of foreign tax when the IRS reallocated income away from a related party in the foreign country at issue under section 482. In that situation, the NSAR states that the taxpayer must exhaust its effective and practical remedies to get a refund from the foreign government (see Reg. 1.901-2(e)(5)(ii), Example 3). The NSAR's summary of the voluntary tax rule's application to Category 2 taxpayers remains true under the current rules, as reflected in Example 2 of the final Regulations. Pursuant to Example 4 of the final Regulations, if a taxpayer in Category 2 first receives notice that it may have overpaid its foreign taxes at a time when it has no remedies remaining under foreign law to seek a refund, the amounts overpaid should not be voluntary.
"Category 3" is confined to those taxpayers who have reasonably interpreted foreign law in determining their tax liabilities. Taxpayers in "Category 3" generally do not need to do anything more to obtain a foreign tax credit, even if the taxpayers are actually disputing their foreign tax liabilities.
Competent Authority
There is some question as to whether taxpayers must invoke Competent Authority, to the extent available, under all circumstances regardless of the likelihood of prevailing. The NSAR discussed above, for example, notes its disagreement with the Tax Court's decision in Schering Corp., 69 TC 579 (1978), acq. in result only, 1981-2 CB 1, to the extent that the Tax Court sustained the foreign tax credits of a taxpayer that did not resort to Competent Authority and deemed such administrative steps to be "futile."29 The NSAR states that Competent Authority procedures, to the extent available, were per se reasonable and effective under the 1980 Temporary Regulations:
[W]e think that seeking competent authority assistance, where available, is an effective and practical remedy within the meaning of the Temporary Regulation and that, therefore, a taxpayer must go to competent authority where such a procedure is available.
Similarly, the final Regulations state, somewhat ambiguously, that the taxpayer must pursue "all effective and practical remedies, including invocation of Competent Authority procedures." In a Chief Counsel Advisory, the 1RS recently denied credits as voluntary where the taxpayer had deliberately caused itself to be treated as a resident in both a foreign jurisdiction and the United States, stating that the taxpayer was required to invoke Competent Authority procedures to determine residency in one or the other country.30 The CCA says that it was "reasonable to expect" that the Competent Authorities would agree that the one appropriate place for the taxpayer's residence was the United States, though it does not say (at least in its redacted text) why it reaches this conclusion.
The Service's most recent Revenue Procedure on Competent Authority assistance, however, does not state that failure to invoke Competent Authority will necessarily constitute a failure to exhaust administrative remedies. Rev. Proc. 2006-54, 2006-49 IRB 1035, section 11, indicates that:
Acts or omissions by the taxpayer that preclude effective competent authority assistance, including failure to take protective measures as described in section 9 of this revenue procedure or failure to seek competent authority assistance, may constitute a failure to exhaust all effective and practical remedies as may be required to claim a credit. see Treas. Reg. § 1.9012(e)(5)(i). (Emphasis added.)
The Revenue Procedure's approach is proper. The portion of the Regulations stating the need for a cost/benefit-type analysis applies to Competent Authority no less than it does to other potential remedies. Also, the recital of facts in Example 3 in the Regulations notes that the taxpayer had invoked Competent Authority "the cost of which [was] reasonable in view of the amount at issue and the likelihood of success" (Reg. 1.901-2(e)(5)(ii), Example 3). Therefore, the proper reading of the Regulations is that Competent Authority relief is not a "super remedy" but rather that the taxpayer is compelled to pursue Competent Authority (like any remedy) only if it would be effective and practical in light of the potential costs and benefits thereof.
A difficulty in evaluating a Competent Authority remedy under the cost/benefit-type test is that the Competent Authorities have broad discretion and, therefore, handicapping one's likelihood of success in individual cases submitted to Competent Authority can be challenging. This is probably one reason why questions have arisen regarding the nature of a taxpayer's obligations to pursue Competent Authority relief under the voluntary tax rule.
The mere act of invoking Competent Authority may not be enough once it is determined that Competent Authority relief needs to be pursued. In Rev. RuI. 2006-23,2006-20 IRB 900, dealing with tax coordination agreements with various U.S. possessions, the IRS stated that seeking Competent Authority assistance and obtaining no relief, either because the Competent Authorities failed to reach an agreement or because the taxpayer rejected an agreement reached by the Competent Authorities, generally would not, in and of itself, establish that the taxpayer has exhausted all effective and practical remedies.31
Not all issues are within the scope of the Competent Authority provision of a treaty and, in some instances, it may not be entirely clear whether a particular issue is covered.32 For example, while the appropriate withholding tax rate on a royalty paid between a U.S. company and a company resident in the treaty partner is clearly within the scope of Competent Authority, the correct depreciation rate under foreign law for a controlled foreign corporation (CFC) incorporated under the laws of the treaty partner probably is not. What about the correct foreign law depreciation rate for a treaty partner-based permanent establishment of a U.S. company? Occasional uncertainties about the precise scope of Competent Authority are another reason that the Competent Authority remedy can prove troublesome in a voluntary tax analysis. If a taxpayer reasonably believes that an issue is not within the scope of Competent Authority and does not request Competent Authority assistance, it would seem unfair for the IRS to take the position, at a time when the taxpayer can no longer seek Competent Authority assistance, that this assistance was previously available and, therefore, the voluntary tax rule applies.
Cost/Benefit-Type Analysis
A longstanding uncertainty under a test resembling a cost/benefit test in the voluntary tax Regulations is: When the foreign tax at issue is large, but the prospects for eliminating liability for it are small, is the taxpayer nonetheless obligated to pursue a remedy because the cost of doing so is less than the foreign tax that can be saved based on a discounted probability? For example, if the foreign tax at issue is 1 billion euros, the fees involved in pursuing its elimination are expected to total 5 million euros, and the likelihood of taxpayer success is estimated by foreign experts to be 5%, must the taxpayer pursue elimination of the tax because the expected fees of 5 million euros are less than the 50 million euros (5% of 1 billion) of tax that the taxpayer stands to avoid based on a discounted probability? If interest accrues on the tax at a rate of 10% and foreign tax experts estimate that the resolution of the controversy will take no less than a year, does this potential cost (100 million euros or more) factor into the cost/benefit-type analysis?33
IBM, 38 Fed. Cl. 661,80 AFTR2d 97-5848 (Fed. Cl. Ct., 1997), arguably stands for the proposition that remedies that have a very small possibility of success may not be considered effective or practical.34 In that case, before the taxpayer paid an Italian tax, an Italian tax expert advised the taxpayer that its only argument against the application of the tax was "a near certain loser" and that its chances of successfully recovering the tax in court were remote. The taxpayer thereafter filed for a refund and was in the process of litigating its claim in an Italian court when it accrued a foreign tax credit for the tax, claiming that it had exhausted all of its effective and practical remedies given the expert's advice that the litigation was unlikely to succeed. The IRS argued that the taxpayer could not treat the levy as a compulsory foreign tax until the litigation concluded unsuccessfully. The court agreed with the taxpayer, stating that the voluntary tax Regulations do not require taxpayers to exhaust all remedies-just those that are effective and practical-and granted summary judgment in favor of the taxpayer on this issue.
One useful way to identify an effective and practical remedy under the test resembling a cost/benefit test is to ask: If the United States provided no foreign tax credit, would a reasonable business person choose to pursue the remedy to reduce his foreign tax? Unfortunately, however, this question is not always simple to answer or maybe susceptible to different answers because it is essentially an empirical question. Even taxpayers anxious to comply with the voluntary tax rule will sometimes have difficulty collecting all relevant information regarding the effectiveness of a remedy and the likelihood of prevailing in a foreign tax dispute. The Regulations allow taxpayers to rely on qualified foreign tax counsel, but three qualified foreign tax lawyers may sometimes hold three different opinions on the efficacy of a remedy. These realities create opportunities for the 1RS to aggressively press voluntary tax challenges and anecdotal evidence suggests that these challenges are on the rise.
Marks & Spencer pic. v. Halsey, C446/03 (December 13,2005), »provides an example of how the voluntary tax rule compels U.S. tax experts to make cost/benefit-type determinations based on unsettled foreign tax law. The issue in Marks & Spencer was whether a U.K. resident corporation could use the losses of its French affiliate. Although the U.K. tax authorities determined that the U.K. resident corporation could not use its French affiliate's losses, at the time many foreign tax experts predicted that the taxpayer would prevail in the European Court of Justice (ECJ). The foreign tax experts' conclusion was bolstered by language in the opinion of the ECJ Advocate General regarding the case, rendered prior to the ECJ's decision, which suggested that the taxpayer was likely to prevail in the ECJ.36
Although many foreign legal experts were of the opinion that similarly situated U.K. taxpayers were entitled to refunds based on a theory similar to the taxpayer's in Marks 6- Spencer, many refund claims were expected to expire under the relevant statutes of limitations prior to the ECJ's decision. To further complicate the situation, U.K. Inland Revenue refused to process claims for refund based on a Marks 6- Spencer-type theory at the time. However, under a cost/benefit-type analysis, many U.S. tax experts concluded that UK subsidiaries of U.S taxpayers must file protective claims for refunds or else risk a voluntary tax challenge in light of the foreign experts' predictions, the relatively low cost of filing a protective claim for a refund to prevent the statute of limitations from expiring, and the potential amount of the refunds. Although ultimately the ECJ's decision was far more limited than many expected, the Marks & Spencer saga shows that the voluntary tax rule often requires U.S. tax experts to make cost/benefit-type determinations regarding issues based on foreign law about which they do not have expertise.
Apart from those instances in which the probability of successfully reducing the taxpayer's foreign tax liability or receiving a refund is "remote" and those at the other extreme in which the foreign tax is reasonably certain to be refunded (see Reg. 1.901-2(e)(2)), the cost/benefit-type test is not especially easy to apply and there is limited guidance regarding its application.
Nontax "costs." Another point on which there is uncertainty is the kinds of costs and benefits that may be considered under the cost/benefit-type analysis called for by the voluntary tax rule. As noted, the Regulations state that a "settlement by a taxpayer of two or more issues will be evaluated on an overall basis, not on an issue-by-issue basis, in determining whether an amount is a compulsory amount." They further provide that a "remedy is effective and practical only if the cost thereof (including the risk of offsetting or additional tax liability) is reasonable in light of the amount at issue and the likelihood of success."
Are taxpayers limited to considering the costs of litigation and potential counterclaims and offsets, as one might read the Regulations to say? Such an approach seems too restrictive. For example, what if pursuing a tax reduction or abatement in a foreign country might reasonably be expected to jeopardize the taxpayer's business relationship with the foreign sovereign and lead to a significantly greater loss of business revenue than the foreign taxes at issue?37 May the taxpayer make additional foreign tax payments to stave off an "audit from hell" involving armed government officials and the threat of incarceration if the taxpayer has little or no foreign tax exposure as a strict legal matter?38 Also, may the taxpayer's financial condition be considered? For example, what if the taxpayer does not have the funds to pursue remedies that might otherwise be reasonable in light of the foreign tax amount at issue?
Tax amnesty. Tax amnesty offered by foreign governments can be difficult to analyze under the Regulations' cost/benefit-typetest. For example, how does a taxpayer prove that paying a certain, somewhat arbitrary tax amount, upfront in exchange for amnesty is the way to minimize foreign tax? In Ltr. RuI. 8339036, involving amnesty, the 1RS sensibly permitted the taxpayer to dispense with Competent Authority procedures in light of repeated and protracted litigation with the foreign government over its liability. Additional facts that guided the Service's decision included the foreign government's offer to abate the penalties and interest that it had asserted, and the deadline that it provided for acceptance, which would come to pass before the litigation or the Competent Authority process could conclude. In Ltr. RuI. 8323094, the 1RS considered a foreign government's offer of amnesty to a taxpayer that was arguably liable for a tax but that had not filed foreign tax returns or been assessed or paid the tax. The amnesty in this ruling was a 30% reduction in the disputed tax during the periods at issue, as well as the elimination of most interest and penalties. The IRS examined the taxpayer's substantive foreign tax exposure, discussed the risk that the taxpayer's position might not be upheld, and concluded that the taxpayer's downside risk if it was audited and assessed could be quite substantial. Accordingly, the IRS ruled that credits for taxes paid pursuant to the amnesty program would be allowed.
Both of these private letter rulings interpreted the 1980 Temporary Regulations even though they did not expressly include a cost/benefit-type test. The same conclusions probably would have been reached under the final Regulations. In both rulings, it appears that the IRS considered potential penalties and interest costs in its cost/benefit-type analysis.
Time-Barred Claims
Not surprisingly, merely because the statute of limitations has run on a refund in a foreign jurisdiction will not alone convince the IRS that a taxpayer has exhausted all effective and practical remedies. On the other hand, an overpayment of foreign tax based on a taxpayer's unreasonable determination of its foreign tax liability will be a voluntary tax even if the taxpayer subsequently exhausts all of its effective and practical remedies to obtain a refund.39 In that situation, expiration of the statute of limitations is irrelevant. The tax was voluntary at the time of payment; expiry of the statute of limitations merely makes its voluntary status permanent. For example, in a 1998 field service advice,40 the 1RS indicated that a taxpayer that had been subject to a reallocation of income under Section 482 would have to show that its foreign tax payments were based on a reasonable interpretation of foreign law and either that the foreign statute of limitations was closed at the time that the Section 482 adjustment was proposed (see Reg. 1.9012(e)(5)(ii), Example 4) or, if the statute of limitations was open, the taxpayer had no way to reserve its right to a refund under foreign law if the IRS-initiated adjustment was sustained at a later date.
Timing Options and Elections
As noted above, the Regulations state that the use or failure to use an option or election to shift the taxpayer's liability to a different year or years does not cause the taxpayer's resulting payments to exceed its liability under the voluntary tax rule. Reg. 1.901-2(e)(5)(ii), Example 5, includes an election to use a depreciable life of two, four, six, or ten years. The taxpayer elected ten years. The example concludes that the election merely shifts the taxpayer's liability to different years, so the voluntary tax rule does not apply to deny credits. The example also notes that because the taxpayer's "reasonably expected" liability is what must be taken into account, its ultimate actual liability and unforeseeable events occurring in subsequent years are immaterial (e.g., whether the taxpayer has sufficient profit in the years that deferred depreciation deductions actually reduce the taxpayer's foreign tax liability or whether the foreign tax rate falls). However, to the extent that making a tax option or election increases foreign taxes, the additional foreign tax may be voluntary.41
The rule on options and elections does not allow aggregate foreign tax liability over the years to which the option or election relates to increase if the liability increase is "reasonably expected." But when is a foreign tax liability increase reasonably expected vs. not reasonably expected? Choosing a longer useful life for depreciation purposes when a foreign tax rate reduction has just been enacted reduces the value of depreciation deductions and, therefore, increases foreign tax liability over time in violation of the voluntary tax rule. However, what if a foreign tax rate reduction is merely under consideration by the foreign government when a longer useful life is chosen? Presumably, in this situation, it is incumbent on the taxpayer to get expert advice regarding the prospect that the rate reduction will be adopted or risk voluntary tax treatment of the additional tax paid due to the reduced value of the depreciation deductions.
Given the diverse legislative processes in countries around the world, requiring taxpayers to determine the foreseeability of foreign rule changes seems inherently unfair. A taxpayer generally should be able to make a reasonable interpretation and application of foreign law without considering potential foreign law change. Consideration of pending rules should be required only if the taxpayer has actual or constructive notice that their passage is highly likely.42
The voluntary tax Regulations imply, but do not state, that the time value of money is irrelevant in applying them. That is, making an election that accelerates foreign tax generally is permitted even though this increases the tax paid in discounted present value terms. Because ignoring the time value of money is somewhat old-fashioned in the tax law, can the IRS be relied on to disregard it in applying the voluntary tax rule?
Other Options and Elections
Another issue presented by the Regulations is whether elections to shift foreign tax liability between or among years are (1) merely an example of the foreign tax law elections that taxpayers may freely make without a voluntary tax problem, or (2) the only foreign tax law elections permitted without voluntary tax scrutiny. The Regulations can reasonably be read to permit foreign tax law elections of various types without voluntary tax scrutiny. However, a recent Chief Counsel Advisory makes plain that the IRS is now interpreting the Regulations more restrictively.
In the Advisory,43 a special U.K. tax (referred to under U.K. law as the "relevant withholding tax" (RWT)) was imposed on substitute payments44 made by borrowers to lenders of stock equal to the excess of (1) any amount of source-country withholding tax (e.g., French withholding tax) that would have been imposed on dividends paid on the borrowed stock had the dividends been paid to the owner rather than the borrower, over (2) the sourcecountry withholding tax actually levied when the dividends were paid to the borrower. Under U.K. law, the stock borrower (a CFC in this case) could choose to credit the French withholding tax, for example, actually withheld from the dividends that it received against the RWT or instead against the CFC's mainstream U.K. corporate tax liability. The IRS concluded that the RWT was a separate levy and not a creditable tax. More importantly for purposes of this discussion, the IRS held that the CFC's choice to credit the French withholding tax against noncreditable RWT rather than creditable U.K. mainstream tax transformed an equal amount of its U.K. mainstream tax into a voluntary tax.45
The voluntary tax Regulations require a taxpayer to reduce, over time, its reasonably anticipated liability for "foreign tax," not "foreign income tax" or other creditable foreign tax (see Reg. 1.901-2(e)(5)(i)). The CFC in the CCA fully complied with this mandate in crediting the source-country withholding tax against RWT tax -indisputably a "foreign tax"-but nonetheless was treated as paying a voluntary tax. Because the Regulations elsewhere define a "tax" (Reg. 1.901-2(a)(2)) and carefully distinguish between taxes that are and are not "income" taxes (see Regs. 1.901-2(a)(3) and (b)), it is appropriate to read the required reduction in "foreign tax" as it is written rather than as a required reduction in foreign income tax or other creditable foreign tax.
Permitting a taxpayer to choose to offset a noncreditable tax liability rather than a creditable one with a third-country withholding tax is arguably inappropriate as a policy matter, but the Regulations as written nonetheless permit it. The CCA, therefore, flouts the language of the Regulations in treating a portion of the U.K. mainstream tax as voluntary. More importantly, the CCA signals that, in the Chief Counsel's view, taxpayers are no longer free to use foreign tax law options and elections (other than those that shift foreign tax liability among or between years) without fear of violating the voluntary tax rule.46 This 1RS approach seems at odds with principles of international tax comity. It also seems to violate the spirit, if not the letter, of U.S. income tax treaty provisions that treat covered taxes as creditable income taxes.47
Business Conduct and Business Purpose
The last sentence of the voluntary tax Regulations states that "[a] taxpayer is not required to alter its form of doing business, its business conduct, or the form of any business transaction in order to reduce its liability under foreign law for tax."48 This limitation on the voluntary tax rule permits taxpayers to enter into the business transactions that they want even though they increase foreign tax liabilities.
Entering into a business transaction that increases foreign tax obviously does not give the taxpayer license to ignore reasonable administrative remedies that may limit foreign tax. For example, suppose that a U.S. corporation is managed and controlled in a country that treats management and control as grounds to tax the company as a resident. The corporation enters in a business transaction that increases that residence country tax. Whether or not the corporation entered into this transaction, it is required to use Competent Authority procedures to avoid being taxed as a resident in the foreign country to the extent that the procedures are available and their use is reasonable under the circumstances.49
Coordinating the application of existing Code rules with the check-the-box rules is a cottage industry for tax lawyers. The voluntary tax rule's coordination with the check-the-box rules is no exception.
Example. Disregarded entity DE2 buys DEl in a taxable transaction overseas that provides a basis step-up under foreign tax law. Amortization of the increased basis, however, is at a special, reduced tax rate. See Exhibit 1.
The choice of a taxable sale increases foreign tax; DE1 and DE2 could have merged tax free under the laws of their jurisdiction but chose not to do so. Because DE1 and DE2 are disregarded as separate from CFC, either a merger or sale would be disregarded from a U.S. tax perspective. Had the sale been regarded for U.S. tax purposes, the last sentence of the voluntary tax Regulation would have shielded the sale from voluntary tax scrutiny. Arguably, the answer should not differ simply because the sale is disregarded under the checkthe-box Regulations. In the real world, the sale is a business transaction. Therefore, any additional tax resulting from the choice to sell rather than to merge should not be voluntary, consistent with the last sentence of the voluntary tax Regulations.
Whether or not the check-the-box Regulations cause a transaction to be disregarded, another issue is whether the last sentence of the Regulations protects a taxpayer from voluntary tax scrutiny if the taxpayer lacks a non-U.S. tax business reason for "its form of doing business, its business conduct, or the form of a business transaction." In the example above, if DEl and DE2 lack a non-U.S. tax business reason for choosing a taxable sale over a tax-free merger, Example 14 in the 1980 Temporary Regulations seemed to read a business purpose requirement into the last sentence of the Regulations. This example concluded that an increase in foreign tax that resulted from the form of business transaction chosen (subjecting the sale of an asset to foreign tax in a particular foreign country) was voluntary because the taxpayer had "no significant purpose" for choosing the form of transaction other than U.S. tax avoidance. While neither this nor a similar example appears in the final Regulations, a taxpayer lacking a non-U.S. tax business purpose for a transaction for which it seeks protection under the last sentence of the Regulations may encounter resistance from the IRS or a court.
Single-Taxpayer Proposed Rule
As noted above, the Proposed Regulations would amend the voluntary tax Regulations in two ways. They would treat (1) certain entities as a single taxpayer for purposes of applying the voluntary tax rule ("single-taxpayer rule");50 and (2) foreign taxes paid in certain structured transactions as voluntary per se ("anti-arbitrage rules").51
If finalized in its present form, the single-taxpayer rule would treat all foreign entities that are at least 80% owned,52 directly or indirectly,53 by a U.S. person as a single taxpayer for purposes of applying the voluntary tax rule:
If a U.S. person described in section 901(b) directly or indirectly owns stock possessing 80 percent or more of the total voting power and total value of one or more foreign corporations (or, in the case of a non-corporate foreign entity, directly or indirectly owns an interest in 80 percent or more of the income of one or more such foreign entities), the group comprising such foreign corporations and entities (the "U.S.-owned group") shall be treated as a single taxpayer for purposes of paragraph (e)(5) of this section.54
Similarly, the single-taxpayer rule would treat all domestic corporations that are members of the same consolidated group as a single domestic corporation in applying the voluntary tax rule:
All domestic corporations that are members of a consolidated group (as that term is defined in § 1.1502-1 (h)) shall be treated as one domestic corporation for purposes of this paragraph (e)(5)(iii). For purposes of this paragraph (e)(5)(iii), indirect ownership of stock of another equity interest (such as an interest in a partnership) shall be determined in accordance with the principles of section 958(a)(2), whether the interest is owned by a U.S. or foreign person.55
"Non-corporate foreign entity" seems intended to pick up foreign partnerships and foreign check-the-box DEs. While some have suggested that foreign DEs may not be covered because a DE is ipso facto not an entity, it is hard to see why the IRS would distinguish for voluntary tax purposes between, for example, a 99%-owned and a 100%-owned foreign corporation that has been "checked" to be a flow-through entity.
Treating foreign DEs and related CFCs as a single taxpayer appropriately permits taxpayers to use the U.K. group relief rules in many instances as they want without worrying about losing foreign tax credits under the voluntary tax rule. Consider the structure in Exhibit 2. Treating the U.K. DEs and the U.K. CFC as a single taxpayer allows the U.S. parent to choose to surrender U.K. DE2's 100 loss either to U.K. CFC or to U.K. DEl-as permitted under U.K. lawwithout voluntary tax concerns because the choice will not alter the aggregate U.K. tax collected from the U.K. group pictured.58 Surrender of the loss to U.K. CFC will increase current section 901 credits at the expense of U.K. CFC's section 902 tax pool; surrender of the loss to U.K. DEl will have the opposite effect. It is hard to see why allowing a U.S. company a choice provided by U.K. tax rules should result in a denial of foreign tax credits. Further, total U.S. foreign tax credits over time are likely to be unaffected by the choice in this example because, ultimately, the U.K. taxes in the U.K. CFC's section 902 pool would come home on repatriations from, or the liquidation of, the CFC. However, as discussed above, in a recent CCA involving a different U.K. tax law election, the IRS crossed the threshold of finding a tax to be voluntary based on a taxpayer's exercise of a U.K. tax law-provided election in one manner rather than another.
In the Exhibit 3 structure, in contrast to the Exhibit 2 structure, the single-taxpayer rule apparently does dictate that a U.K. loss be surrendered to one U.K. entity rather than another to avoid a voluntary tax problem. If B surrenders its 100 loss to C instead of retaining that loss, under the single-taxpayer rule any additional U.K. tax that B paid later as a result should not be voluntary. However, if B chose instead to surrender the loss to A, because A cannot be treated as a single taxpayer with B, the additional tax that B paid later as a result apparently would be voluntary. Because A is not a U.S. taxpayer, requiring B to surrender its loss to C or to retain the loss for its own use does reduce the U.S. group's overall creditable foreign taxes over time. This requirement might be defended then as an appropriate application of the voluntary tax rule, although it does take the rule beyond its traditional realm of requiring exhaustion of administrative and judicial remedies.
EXHIBIT 1Coordination of the Voluntary Tax Rule and the Check-the-Box RulesEXHIBIT 2Single-Taxpayer Rule: Example 1EXHIBIT 3Single-Taxpayer Rule: Example 2
There are situations in which a more expansive version of the single-taxpayer rule would be appropriate. For example, if a U.S. corporation incorporates a business that had previously operated as an actual foreign branch, the U.S. corporation might rationally elect to pay a foreign tax on the business's appreciation on its incorporation if the foreign tax due would be less than the present value of the foreign tax saved in the future from the increased amortizable asset basis created by the election. However, under the Proposed Regulations, the CFC is regarded as an entity separate from the U.S. corporation. Because the future amortization deductions will directly benefit only the CFC, the U.S. corporation's tax due as a result of the election would seemingly be voluntary under the Proposed Regulations. Prior to the publication of the Proposed Regulations, few advisors probably would have reached this conclusion, but the Proposed Regulations essentially provide that the voluntary tax rule applies entity by entity regardless of whether entities are related, unless the single-taxpayer rule says otherwise.57
Some commenters have suggested that the single-taxpayer rule might force taxpayers to choose between foreign tax credits and the use of a dual consolidated loss (DCL) of one entity to offset the income of a related entity under a domestic use election.58 The DCL rules are generally designed to prevent the sharing of a loss with a related entity in both the United States and a foreign jurisdiction.59 Permitting a foreign entity other than the foreign entity that incurs a DCL (the "loss entity") to use the loss is a"foreign use" (Reg. 1.1503(d)3). If the single-taxpayer rule treats the loss entity as part of a single taxpayer that includes related foreign entities, under applicable foreign law the loss entity can share the loss with the related foreign entities,60 and it is reasonably foreseeable that the loss entity will not be able to use the loss in a stand-alone manner in the foreign country,61 the loss entity will seemingly be required to share the loss with the related foreign entities or the foreign tax imposed on the related entities resulting from the loss entity's failure to share the loss will be voluntary.
However, if the loss is shared this way, a domestic use election to use the loss currently within the consolidated group under the DCL Regulations will not be permitted or the terms of a previously made domestic use election will be violated.62 In some instances, this dilemma may be averted by organizing the loss entity under U.S. domestic law in addition to the foreign law under which it was originally organized. For an entity organized in the United States and in a foreign jurisdiction, it should be treated as a domestic entity (Reg. 301.7701-5). Therefore, the tension between the voluntary tax and DCL rules might be avoided by organizing a foreign entity under U.S. law as well, so that it will be treated as a domestic entity. In that situation, however, the entity may be required to seek Competent Authority assistance to determine its residency. Otherwise, the foreign taxes incurred as a result of its failure to do so may be treated as voluntary.63 If a loss entity generally does not pay significant foreign tax, the potential loss of credit under the voluntary tax rule for failing to seek Competent Authority relief may not be of concern. In any event, it seems doubtful that the drafters of the Proposed Regulations or the DCL Regulations were aware of this interaction between the voluntary tax and DCL rules.
Anti-Arbitrage Proposed Rules
The anti-arbitrage rules are intended to address certain structured transactions that the IRS and Treasury view as inappropriately generating foreign tax credits.64 Under the Proposed Regulations, an amount paid to a foreign country "is not a compulsory payment, and thus is not an amount of tax paid," if the foreign payment is attributable to an arrangement that meets a six-condition test.65 The anti-arbitrage rules are the latest and boldest step by the Service to push the voluntary tax rule beyond its traditional boundaries, and they have essentially nothing to do with exhausting administrative or judicial remedies. The 1RS would concede that the structured transactions at issue do not implicate the current voluntary tax rule. Calling the foreign taxes imposed in these transactions "voluntary" is similar to the technical taxpayer Proposed Regulations calling a reverse hybrid legally liable under foreign law for the tax imposed on its income.66 Saying it does not make it so, at least not in reality, but tax Regulations inhabit their own special universe. One wonders whether the courts ultimately will accept the Service's selfasserted authority to push certain concepts substantially beyond their real world meaning to police foreign tax credit claims.
Notwithstanding how a payment would be treated otherwise under the general voluntary tax rule, the anti-arbitrage rules would deny a foreign tax credit for any payments that result from an arrangement meeting the six conditions spelled out in the Proposed Regulations.67 The anti-arbitrage rules would apply only if, among other requirements, the arrangement is structured in a manner that will result in a foreign tax benefit (e.g., a credit, deduction, loss, exemption, or a disregarded payment) to the foreign counterparty68 and the foreign counterparty is unrelated69 to the U.S. person that otherwise would be ultimately entitled to claim a credit for the foreign payments.70
Conclusion
The traditional purpose of the voluntary tax rule has been to compel taxpayers to exhaust reasonable administrative and judicial remedies overseas to reduce their foreign tax liabilities. Rules like the new single-taxpayer proposed rule are helpful in permitting taxpayers to reduce their aggregate foreign tax burden without running afoul of the voluntary tax rule, but the rule is too narrowly drawn to fully achieve this result. The anti-arbitrage proposed rules and the recent FSA regarding the U.K. RWT expand the voluntary tax rule's scope beyond its traditional boundaries. The Service's effort to broaden the meaning of a voluntary tax will likely make it harder in the future to determine with confidence when a voluntary tax issue exists. We believe that the IRS should leave the voluntary tax rule essentially as is to avoid muddying the foreign tax credit waters, and should develop different means of addressing new foreign tax credit issues recently challenged under a voluntary tax analysis.
1 Reg. 1.901-2(a)(2)(i). see Calianno. "Loss Sharing Among Foreign Group Members-The 'Compulsory' Requirement and Related Issues," 18 JOIT 22 (June 2007).
2 Dictionary.com Unabridged (v 1.1). Random House, Inc. (October 21, 2007), http://dictionary. reference.com/browse/levy.
3 Reg. 1.901-2Ie)(S), TD 7918 (October 6, 1983).
4 REG-156779-06, March 29, 2007, as modified by Notice 2007-95, 2007^19 IRB 1091 (modifying the effective date) ("Current Prop. Regs."). See Ocasal and Lubkin, "Section 901 Proposed Regs, on Structured Transactions: A 'Strict Liability' Approach to Foreign Tax Credit Anti-Abuse Rules," 18 JOIT 20 (September 2007).
5 Current Prop. Reg. 1.901-2(e)(5)(iii).
6 Current Prop. Reg. 1.901-2(e)(5)(iv).
7 LR-100-78, 44 Fed. Reg. 36071 (June 20, 1979).
8 See, e.g., Rev. RuI. 72-370, 1972-2 CB 437; Rev. RuI. 76-508, 1976-2 CB 225, superseded by Rev. RuI. 92-75, 1992-38 IRB 10 (which is now itself superseded; see note 28, Infra).
9 See, e.g., GCM 34565, July 28, 1971 (considering proposed Rev. RuI. 72-370 and Rev. RuI. 72371); GCM 36722, May 7, 1976 (considering proposed and now superseded Rev. RuI. 76-508).
10 See TD 7739,45 Fed. Reg. 75647 (November 17, 1980); LR-100-78, 48 Fed. Reg. 14641 (April 5, 1983); TD 7918, 48 Fed. Reg. 46272 (October 12, 1983).
11 Former Prop. Reg. 1.901-2(a)(2), 44 Fed. Reg. 36071, 36072 (June 20, 1979) ("Former Prop. Regs.").
12 Temp. Reg. 4.901 -2(f)(9), Examples 9-10, TD 7739, 45 Fed. Reg. 75647, 75656 (November 17, 1980) ("Former Temp. Regs.").
13 See Former Temp. Reg. 4.901-2(f)(5).
14 Former Temp. Reg. 4.901 -2(f)(9), Examples 9-10.
15 Former Temp. Reg. 4.901-2(f)(5).
16 Id.
17 Former Temp. Reg. 4.901-2(f 1(9). Example 13.
18 Id.. Example 11.
19 Id.. Example 15.
20 Id.. Example 14.
21 LR-100-78, 48 Fed. Reg. 14641 (April 5, 1983).
22 1983 Prop. Reg. 1.901-2(e)(5)(i).
23 1983 Prop. Reg. 1.90l-2(e)(5)(ii), Example 4.
24 See TD 7918, 48 Fed. Reg. 46272 (October 12, 1983).
25 Temp. Reg. 1.902-1 T(a)(7); Reg. 1.903-Ka).
26 1988 NSAR 8261, 1988 WL 1092574 (September 2, 1988).
27 See Reg. 1.901-2(e)(5)(ii), Example 1 (amounts knowingly overpaid to a foreign affiliate in disregard of the foreign country's transfer pricing rules are voluntary).
28 See also Rev. RuI. 80-231, 1980-2 CB 219 (when it is clear that the taxpayer knew or should have known it was overpaying its taxes, the taxes are voluntary even if the taxpayer exhausts all of its administrative and procedural remedies and loses on procedural grounds), as modified by Rev. Rul. 92-75 (which was modified and superseded on another point in Rev. Proc. 2006-54, 2006-49 IRB 1035).
29 1988 NSAR 8261 (quoting Schering at 602).
30 CCA 200532044. see also note 63, infra.
31 See also Rev. Proc. 2006-54, 2006-49 IRB 1035, Section 11.
32 See generally Rev. Proc. 2006-54, Section 2.01 ("Taxpayers are urged to examine the specific provisions of the treaty under which they seek relief, in order to determine whether relief may be available in their particular case. If, after examining the applicable treaty, a taxpayer is unsure whether relief is available, the taxpayer should contact competent authority.")
33 Consider the last sentence in the discussion of "Tax Amnesty" below.
34 The court also rejected an inference from the refund portion of the section 901 Regulations that a tax must be "reasonably certain" to be refunded or abated before its payment will be deemed voluntary. The refund Regulation provides, in pertinent part, that "an amount is not tax paid to a foreign country to the extent that it is reasonably certain that the amount will be refunded, credited, abated, or forgiven." Reg. 1.901-2(c)(2)(i). The court rejected the taxpayer's argument that this Regulation is relevant to the "effective and practical" requirement. Id. atfn. 12.
35 See "U.K. Legislation Wrap-Up," PwC In & Out, 17 JOIT 10 (July 2006) 0719; "U.K. Tax Authorities Announce Group Relief Changes in Finance Bill 2006 Following Marks & Spencer," PwC In & Out, 17 JOIT 9 (May 2006) 0519; and "ECJ Releases Judgment in Marks & Spencer case, " PwC In & Out, 17 JOIT 14 (February 2006) 0214.
36 Reprinted at 2005 WTD 67-8 (April 7, 2005). See generally Sheppard, "News Analysis: Dowdy Retailer Set to Destroy European Corporate Tax, Part 3, " 2005 WTD 110-4 (June 9, 2005) (describing this situation).
37 When a taxpayer forgoes a reduction or abatement to preserve a business relationship with a sovereign, could the amount subject to reduction or abatement be equated with a payment in exchange for a specific economic benefit? Cf. Regs. 1.901-2Ia)(Z), 1.901-2A (separate regime applies to taxpayers that receive a specific economic benefit for the taxes that they pay).
38 If the additional payments demanded as a "tax" by the foreign government are clearly not authorized under foreign law, the payments might not fall within the definition of a "tax" in the Regulations. see Reg. 1.901-2(a)(2)(i). If the payment is not a tax for this reason, it would not be creditable in any event.
39 Note 28, supra.
40 1998 WL 1984349 (March 8, 1998).
41 See FSA 200049010 (increased foreign tax due resulting from an election to postpone the payment of a foreign tax was voluntary).
42 As Example 5 points out, a taxpayer is required to consider its reasonably anticipated tax liability in future years only in assessing the foreign tax impact of its current year options and elections. The voluntary tax Regulations also indicate that a taxpayer's interpretation of foreign tax law is not reasonable if the taxpayer has actual or constructive notice that the interpretation is likely to be erroneous. Thus, a taxpayer should have to consider potential changes to foreign tax law only if it has actual or constructive notice of the changes and if the changes, when enacted, are likely to make its current projection of its future foreign tax liabilities erroneous. Example 5 concludes that whether rates change in the future is "immaterial." This statement might be construed to mean that a reasonable assessment of future liabilities based on the current foreign tax law is all that is required. However, the facts of this example stipulate that, at the time of its projections of its future foreign tax liabilities, the taxpayer's interpretation of foreign law was consistent with reducing its reasonably expected foreign tax liability. Thus, the better reading of the example is that no foreign tax law changes that would be likely to increase the taxpayer's future liabilities were reasonably expected at the time.
43 CCA 200622044.
44 A "substitute payment" is a payment made by the borrower of a share of stock or security to compensate the lender for the dividends or interest paid on the borrowed stock or security. Cf. Regs. 1.8612(a)(7), 1.861-3(a)(6) (defining substitute interest payments and substitute dividend payments, respectively, for purposes of source rules).
45 Although not discussed in the CCA, there may be an issue as to whether legal liability for the RWT was truly that of the securities borrower as the IRS assumed. see Stevens, "IRS Says U.K. Tax not Compulsory, but Taxpayers Need not Agree, "112 Tax Notes 1157 (September 25, 2006).
46 Former Temp. Reg. 4.901 -2(0(9), Example 15 (1980) treats an increase in foreign tax that results from a foreign tax law election as voluntary. This example shows that a taxpayer's election to calculate its taxable income under one method that results in more foreign tax than another permissible method gives rise to voluntary tax. However, neither this example nor a similar example was included in the 1983 Proposed or final Regulations. Thus, from 1983 until 2006, the law could reasonably be read to permit foreign law elections of various types without running afoul of the voluntary tax rule.
47 See, e.g., 2001 U.S.-U.K. tax treaty, which entered into force on March 31, 2003, Articles 2(3)(b)(iii) and 24(1 Mb) (U.K. mainstream corporate tax will be treated as income tax for purposes of deemed paid credit); Xerox Corp., 41 F.3d 647,74 AFTR2d 94-7097 (CA-F.C., 1994), cert. den. 516 U.S. 817 (1995), nonacq. 1997-1 CB 1 (rejecting IRS argument that setoff of U.K. tax paid by one company ("first company") against its subsidiary's tax liability causes first company's tax to be noncreditable); Compaq Computer Corp., 113 TC 363 (1999), at 375 (same).
48 Reg. 1.901-2(e)(5)(i).
49 see note 29, supra.
50 Current Prop. Reg. 1.901-2(e)(5)(iii).
51 Current Prop. Reg. 1.9010 -2
52 By total voting power and total value for a foreign corporation and, fora non-corporate foreign entity, by interest in the entity's income. Current Prop. Reg. 1.901-2(e)(5)(iii)(A).
53 Indirect ownership of an equity interest is to be determined in accordance with section 958(a)(2). Current Prop. Reg. 1.901-2(e)(5)(iii)(B).
54 Current Prop. Reg. 1.901-2(e)(5)(iii).
55 Id.
56 If the U.K. DEs are not treated as a single taxpayer with the affiliated U.K. CFC, in this example, a failure to surrender U.K. DE2's loss to U.K. CFC might cause a voluntary tax in U.K. CFC equal to the U.K. tax rate multiplied by the loss. Worse, the taxpayer would face a Catch-22 seemingly because if the loss is surrendered to U.K. CFC, this would increase the U.K. taxes of USP, U.K. DE1, and U.K. DE2 combined so that they may be considered to pay voluntary tax.
57 There is strong technical logic, even under current law, for applying the voluntary payment rule entity by entity since even consolidated group members technically are separate taxpayers. see, e.g., First Chicago Corp., 96 TC 421 (1991), affd 135 F.3d 457,81 AFTR2d 98-545 (CA-7,1998) (consolidated group members may not aggregate shareholdings for purposes of meeting ownership requirements for deemed-paid foreign tax credits). This is an instance, however (not rare in the tax law), where technical logic produces results that make little sense.
58 Letter from James Peaslee, reprinted at 2007 Tax Notes Today 69-14 (April 9, 2007); Sheppard, "News Analysis: New U.S. Policy-Use That Loss Somewhere Else, " 2007 Tax Notes Today 79-8 (April 24, 2007).
59 See TD 9315, March 16, 2007 (discussing prohibition of foreign use of DCL for domestic use election to be permissible).
60 This assumes that what the United States regards as a loss is also treated as a loss for foreign tax purposes. Often, a loss entity has a loss for both purposes as it has interest expense in excess of its income. Sometimes, however, differences between U.S. and foreign law cause the loss entity to have a loss for U.S. purposes and not under foreign law. For example, an entity may not be able to deduct the cost of options to acquire its parent's stock under foreign law unless it reimburses the parent for those options, but the same expense may leave the entity in a loss position from a U.S. tax perspective. In the latter situation, there is no tension between the DCL rules and the voluntary tax rule because there is no loss to share under foreign law.
61 This might happen, for example, when the loss entity is a holding company with a significant amount of debt that only receives dividends from members of its U.S. consolidated group.
62 id.
63 See CCA 200532044 (discussed in the text at fn. 30 above, arguing that taxpayer's failure to invoke Competent Authority to determine single residency for dually incorporated entity was failure to exhaust its reasonable administrative remedies).
64 Preamble to Current Prop. Regs., 72 Fed. Reg. 15081.
65 Current Prop. Reg. 1.901-2(e)(5)(iv)(A). Briefly, the six conditions are: (Da foreign tax payment is attributable to the income of an entity and substantially all of that entity's gross income is passive income and substantially all if its assets produce passive income; (2) a U.S. person would be eligible to claim a credit under section 901, 902, or 960 for all of this tax payment; (3) the tax payment is substantially greater than the amount of credits that the U.S. person would have reasonably expected to be able to claim had it directly owned its proportionate share of the entity's assets; (4) the arrangement is structured so that it results in a foreign tax benefit for a counterparty or a person related to the counterparty; (5) the counterparty is unrelated to the U.S. person and is considered to own a specified amount of the equity or the assets of the entity under applicable tax law in relevant foreign jurisdictions; and (6) certain specified types of tax arbitrage are determined to exist. See Current Prop. Reg. 1.901-2(e)(5)(iv)(B).
66 REG-124152-06, August 3, 2006. See Rubinger and Greenwald, "Section 901 Proposed Regulations Shut Down Guardian and Reverse-Hybrid Structures," 18 JOIT22 (January 2007).
67 id.
68 Current Prop. Reg. 1.901-2(e)(5)(iv)(B)(4).
69 For this purpose, two persons are related if either (1) one person directly or indirectly owns stock (or an equity interest) possessing more than 50% of the total value of the other person, or (2) the same person directly or indirectly owns stock (or an equity interest) possessing more than 50% of the total value of both persons. Current Prop. Reg. 1.901-2(e)(5)(iv)(C)(5).
70 Current Prop. Reg. 1.901-2(e)(5)(iv)(B)(5).
ALAN FISCHL is a partner and MICHAEL HARPER is a director in the Washington, D.C. office ofPricewaterhouseCoopers LLP. Mr. Fischl is a member of the Board of Advisors of the Journal. An earlier draft of this article was presented at a meeting of the Washington International Tax Study Group. The authors thank the members ofthat group for their insightful comments and suggestions and for granting permission to publish this article. Any errors are the authors' alone. The views expressed in this article are the personal views of the authors and are not necessarily shared by PricewaterhouseCoopers LLP, its clients, or members of the Washington International Tax Study Group.
Copyright Thomson Professional and Regulatory Services, Inc. May 2008