FTC carryback eliminates interest on earlier underpayment of tax.

In Fluor Corp., 5/24/96, the Court of Federal Claims held that if a foreign tax credit (FTC) from one year is carried back to an earlier year and eliminates an underpayment in that year, it also eliminates the interest on the underpayment. The carryback is treated as an actual payment of the tax in the prior year.

The IRS audited Fluor Corp.'s 1982-1984 tax returns and found an underpayment for 1982. However, an FTC carryback generated in 1984 eliminated the 1982 underpayment.

The Service assessed interest on the underpayment from Jan. 15, 1983 (due date of the 1982 return) until Jan. 15, 1985 (due date of the 1984 return). The IRS reasoned that had the taxpayer paid the proper tax in 1982, the government would have had use of the money until the carryback was generated two years later. The taxpayer argued that the carryback was retroactive, extinguishing the deficiency and eliminating the interest charge on the deficiency.

Interest - in General

Sec. 6601 (a) provides generally that interest is due on any tax deficiency not timely paid. Interest accrues between the date on which the tax should have been paid and the date of actual payment.

Sec. 6601(d) provides "restricted interest" when deficiencies are subsequently reduced by a net operating loss (NOL) carryback, a net capital loss carryback or a Sec. 39 business credit carryback. In these cases, interest accrues only until the filing date for the tax year giving rise to the carryback. FTC carrybacks are not mentioned.

Sec. 6611(a) provides generally that interest is paid on any tax overpayment not refunded within a certain time. Interest accrues between the date of the overpayment and the date the tax is credited or refunded (with a 30-day window for refund checks).

Sec. 661 (f) provides that if an overpayment results from the carryback of an NOL, net capital loss or business credit, interest is not paid for the period between the date of payment and the filing date for the tax year giving rise to the carryback. Sec. 6611(g) provides the same rule for overpayments resulting from FTC carrybacks.

Supreme Court Precedent

In Manning v. Seeley Tube & Box Co., 338 US 561 (1950), the Supreme Court held that when a deficiency is eliminated by an NOL carryback, interest on the deficiency accrues until the date the carryback arises, absent a clear expression of congressional intent to the contrary. The subsequent cancellation of the duty to pay the tax does not cancel the duty to pay interest:

[T]he taxpayer, by its failure to pay the taxes owed, had the use of funds which rightfully should have been in the possession of the United States. The fact that the statute permits the taxpayer subsequently to avoid the payment of that debt in no way indicates that the taxpayer is to derive the benefits of the funds for the intervening period. In the absence of a clear legislative expression to the contrary, the question of who properly should possess the right of use of the money owed the government for the period it is owed must be answered in favor of the government. (338 US at 566.)

Federal Circuit Precedent

In Shriners Hospital for Crippled Children, 862 F2d 1561 (Fed. Cir. 1988), the IRS disallowed a deduction for a charitable contribution made by an estate. The estate paid the resulting tax deficiency and interest thereon.

Congress subsequently amended the Code to allow the deduction, and the amendment was retroactive to the tax year at issue. The legislative history provided that the amendment applied "not merely for deduction purposes but for all purposes," although the amendment specifically prohibited the payment of interest on refunds of overpayments resulting therefrom.

The Service refunded the tax attributable to the deducted amount, but refused to refund the interest the taxpayer had paid.

The Federal Circuit held for the taxpayer. The legislative history was a clear expression of intent that the tax liability for the prior year was changed, so that no deficiency arose and no interest could be due. The court was unmoved by the resulting disparity of treatment between taxpayers who properly refrained from taking the deduction (and were prohibited by the statute from receiving interest on their subsequently refunded overpayments) and those who improperly took the deduction (and could recover interest on the deficiency assessed by the IRS).

Fluor

In Fluor, the Court of Federal Claims analyzed the statutes and cases described above and addressed whether there was a clear expression of congressional intent that interest not be imposed on underpayments later extinguished by an FTC carryback. The court found it unnecessary to look to the legislative history, as had been done in Shriners Hospital, because "[t]he intent of Congress can be discerned from the plain language of the statute." The foreign taxes "shall be deemed paid or accrued" in the earlier year. Had they been paid then, no deficiency would have arisen, so the taxpayer was entitled to a refund of the interest.

The court acknowledged that its holding, taken in conjunction with Sec. 6511(g), creates a disparity in treatment between taxpayers who paid the correct amount of tax in the earlier year (and were not entitled to interest on the refund resulting from the carryback) and those who underpaid in the earlier year (and were relieved of the obligation to pay interest on their underpayment). As in Shriners Hospital, the court found this result flowed from the specific provisions enacted by Congress.