Translation date for indirect foreign income taxes.

Translation Date for Indirect Foreign Income Taxes

On September 19, 1990, Tax Executives Institute filed comments concerning the translation of indirect foreign income taxes under section 986 of the Internal Revenue Code. The comments took the form of a letter from Institute President Michael J. Bernard to Ronald A. Pearlman, Chief of Staff of the Joint Committee on Taxation. The letter, reprinted below, was prepared under the aegis of the Institute's International Tax Committee, whose chair is Raymond G. Rossi of Intel Corporation.

Background

This letter supplements our previous discussions with you and your staff with respect to the translation of foreign income taxes under section 986(a)(1) of the Internal Revenue Code. You have requested the Institute's suggestions for a workable solution to the compliance burdens imposed by section 986.

As we previously discussed, section 986(a)(1) provides that, for purposes of determining the foreign tax credit, foreign income taxes are translated into dollars using the exchange rate in effect when the taxes are paid. Prior to the enactment of section 986 in 1986, deemed-paid taxes were translated at the exchange rate in effect, on the date of distribution, in accordance with the decision in Bon Ami Co., 39 B.T.A. 825 (1939).

Section 986 places considerable administrative burdens on taxpayers to collect and analyze the information on foreign income tax payments necessary to compute the dollar value for each tax payment and refund using multiple rates. Multinational corporations may have hundreds of foreign subsidiaries and operate in countries (such as Japan) requiring multiple payments of separate creditable income taxes. In addition, the application of section 986 in respect of foreign income taxes paid after the end of the U.S. taxpayer's taxable year will retroactively affect the calculation of the U.S. pool of earnings and profits. For example, some jurisdictions provide that a corporation's taxes in respect of a given year are not due until the following year(s). Under section 986, the foreign income tax liability is to be translated using an unknown future rate (i.e., the rate in effect in the subsequent year). At a minimum, therefore, U.S. law requires the continual recalculation of the earnings and profits pool and the filing of amended returns. Multinational corporations find it difficult, if not literally impossible, to comply with the statutory requirements for translating their myriad foreign tax payments.

Proposal

You asked that the Institute propose an alternative to section 986 or the Bon Ami rule. We recommend that indirect foreign income taxes be translated at the rate in effect on the last day of the corporation's taxable year in respect of which the tax is paid. Such an approach is administratively simpler than the current statutory scheme, would not be subject to manipulation by taxpayers, and consequently would further the goal of tax simplication without frustrating the policy underlying the enactment of section 986. The use of a single rate is a reasonable administrative compromise between section 986 and the Bon Ami rule and would further the goal of tax simplication.

In addition, we recommend that, for those taxpayers operating in a hyperinflationary country, an election to use an average of the rates in effect on the first and last day of the corporation's taxable year should be provided.

If you have any questions, please do not hesitate to call Raymond G. Rossi, chaif of TEI's International Tax Committee, at [phone], or the Institute's professional staff (Timothy J. McCormally or Mary L. Fahey) at [phone].