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The U.S. Tax Court held in Panagiota Pam Sotiropoulos, TCM 2017-75, that a U.K. income tax refund that the taxpayer had received, but that the U.K. tax authority challenged subsequently, must nevertheless be treated as a refund under Section 905(c).2 Accordingly, the IRS could reduce the taxpayer's claimed foreign tax credits (FTCs) for the year in which the U.K. tax had originally been paid.
This opinion may color future Tax Court decisions regarding the treatment of foreign tax refunds that have not yet been ultimately adjudicated. The decision applies Section 905(c) to cash-basis taxpayers using principles similar to Rev. Rul. 84-125, 1984-2 CB 125, which means that the decision will have an impact on both corporate and individual taxpayers. The case may also be of broader interest because it arose from information that the IRS received under a tax information exchange agreement with the United Kingdom. Tax information exchanges continue to expand globally and are increasingly likely to affect U.S. taxpayers going forward.
Background. The taxpayer, a U.S. citizen and cash-basis taxpayer, lived and worked in the United Kingdom. On her U.S. federal income tax returns for 2003-2005, she claimed FTCs based on the amounts of U.K. income tax that her employer withheld from her wages.
Sotiropoulos' U.K. income tax returns for the relevant periods included large deductions that resulted in substantial overpayments. She applied to have those overpayments returned, and the U.K. government (HMRC) duly repaid substantially all of the withheld tax. However, HMRC later challenged the deductions that gave rise to the overpayments.
The taxpayer contended that, for U.S. FTC purposes, the rebated amounts had not been "refunded" yet because the United Kingdom had not made a final decision as to her ultimate entitlement to refunds. According to her tax advisors,...