Competent authority and FTCs.

In a recent revenue ruling, the IRS revisited the issue of claiming deemed paid foreign tax credits (FTCs) after income had been allocated by the Service from a foreign subsidiary to its U.S. parent under Sec. 482. Rev. Rul. 92-75 held that the amount of foreign tax paid that would otherwise be available in computing the deemed paid tax credit was reduced as a result of an allocation of income from a foreign subsidiary to its U.S. parent corporation if the corporations did not attempt to obtain an actual reduction in the foreign taxes, including competent authority consideration in a country with which the United States has an income tax convention.

In the ruling, a domestic parent, P, owned all of the outstanding stock of S, a corporation organized in F, a foreign country that had an income tax convention with the United States. The IRS reallocated income under Sec. 482 from S to P on sales of products during calendar years 1986 and 1987.

In both 1986 and 1987, P received dividends from S and claimed deemed paid FTC under Sec. 902, based on the amount of F tax paid by S in 1986 and 1987 before the Sec. 482 allocations. The 1986 dividend was paid out of 1986 earnings and profits (E&P), and the 1987 dividend was paid out of E&P accumulated subsequent to Dec. 31, 1986.

S did not seek a refund of F tax attributable to the income allocated to P in 1986 and 1987, although a refund might have been obtained if F accepted the Sec. 482 allocation.

The U.S. tax treaty with F provides for consideration by the Competent Authority of the two countries. Neither P nor S requested the assistance of the respective Competent Authority to coordinate the amount of tax due in F resulting from the Sec. 482 adjustments made by the Service.

The procedures for obtaining Competent Authority consideration are set forth in Rev. Proc. 91-23, which indicates that failure to request Competent Authority assistance may cause the denial of part or all of any FTC claimed. In support of the loss of FTC, the revenue procedure cites Regs. Sec. 1.901-2(e)(5)(i), which states, in general, that an amount paid to a foreign government is not a tax paid, to the extent it exceeds the amount of liability for tax under foreign law.

The regulation goes on to state that a foreign tax paid does not exceed the liability if calculated by the taxpayer using a reasonable and consistent interpretation of foreign tax law to reduce, over time, the taxpayer's reasonably expected liability under foreign law, and if the taxpayer exhausts all effective and practical remedies, including any applicable competent authority procedures, to reduce, over time, the taxpayer's liability for tax. A remedy is effective and practical only if its cost is reasonable in light of the amount at issue, taken on an aggregate basis.

Rev. Proc. 91-23 further states that the taxpayer is obligated to take protective measures so that the resolution of the matter through Competent Authority is not jeopardized or barred by administrative, legal or procedural barriers. Protective measures include, for example, filing amended tax returns or claims for refund in the foreign jurisdiction, waiving an expiring statute of limitations, avoiding the lapse of the right to appeal any tax determination, complying with the applicable procedures for obtaining Competent Authority consideration, and seeking a correlative adjustment in the foreign country. These measures should be undertaken regardless of any treaty terms concerning the waiving of procedural barriers.

When the adjustment is one proposed by the United States, a written request for Competent Authority assistance should be submitted as soon as practical after the amount of the proposed adjustment is determined and communicated to the taxpayer in writing; a copy of the request is also forwarded to the IRS office where the case is pending. Rev. Proc. 91-23 specifies the information required and the form that the request should follow. The U.S. Competent Authority will notify the taxpayer whether the facts provide a basis for assistance. A request may be denied if the Competent Authority concludes that the taxpayer, for example, (1) is not entitled to the treaty benefits, (2) is agreeing to terms with the foreign government that are unacceptable to the United States, (3) does not agree that the proceedings should include his participation, (4) fails to provide sufficient information or (5) fails to comply with the revenue procedure or to cooperate so that the negotiations are impeded.

Under the facts of Rev. Rul. 92-75, the Service held that, because they failed to seek Competent Authority assistance to negotiate an adjustment to S's tax in F, P and S had failed to exhaust their effective and practical remedies to reduce the liability to F tax. Therefore, the reductions in S's income resulting from the Sec. 482 allocation were treated as resulting in a reduction in F tax paid by S for 1986 and 1987.

In the computation of the deemed paid FTC, the years 1986 and 1987 were treated differently. Dividends paid after 1986 were considered as being paid from a pool of E&P accumulated since 1986. Prior to 1987, the E&P determination was on a year by year basis. In recomputing the deemed paid tax credit, the IRS removed the appropriate amount of noncompulsory foreign tax from the formula. If the amount of foreign tax reduction can be calculated by the Service, that amount may be used. The U.S. Competent Authority may, at its option, consult with its foreign counterpart to make this determination; otherwise, some other method of allocation may be used. The effect of the reduction on the post-1986 E&P and taxes paid pools are to be determined pursuant to Secs. 902, 905(c) and 964.