One of tax life's significant attractions for U.S. multinationals is the capacity to claim a foreign tax credit (FTC) for taxes paid in foreign jurisdictions. Much like many attractions, however, the opportunity to avoid double taxation by having recourse to that unilateral U.S. credit mechanism comes with its own obstacles and hurdles to cross before one can avail oneself of that benefit. One of those hurdles, Treasury's requirement that the foreign tax be compulsory, took the spotlight in Procter & Gamble v. United States, 2010 U.S. Dist. LEXIS 83747 (S.D. Ohio 2010).
Only certain taxes that are paid in foreign countries are creditable. As relevant herein, to be considered as a "tax" and be creditable, the payment must be compulsory. [Treas. Reg. 1.901-2(e)(5)(i)] An amount paid is considered to be noncompulsory (i.e., voluntary) if it exceeds the amount of the taxpayer's liability for the tax under applicable foreign country law. The regulations provide that 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 liability for the foreign tax.
Generally, the taxpayer must contest the tax liability under local law and, if available, request competent authority assistance when the taxpayer believes that a foreign tax assessment is incorrect, in order to satisfy the "compulsory" requirement of the regulations. In lieu of contesting the tax, a taxpayer may establish that it has exhausted all effective and practical remedies under the foreign law by obtaining an opinion from legal counsel in the relevant foreign jurisdiction to the effect that the taxpayer would probably not be successful if it contested the liability under local law or an applicable treaty and the costs that would be involved would be significant compared to the likelihood of success. P&G Singapore discharged that obligation in Korea, which the court recognized.
P&G Singapore did not, however, follow that procedure in Japan, and therein lay the problem. Since Japan, in effect, imposed its withholding tax on Korean source royalties, contrary to Japanese law and the U.S.-Japan Income Tax Treaty, P&G Singapore should have at least attempted to obtain a refund of those taxes from Japan. Indeed, the court found that P&G Singapore had an obligation to seek a refund and possibly file a request for competent authority assistance if the claim for refund from Japan had been rejected.SignificanceThe case suggests a number of points about the FTC. First, although FTCs may be allowed where two countries tax the same stream of income, the taxpayer should be on notice that one of the assessments may be incorrect when both countries tax the same income. Taxpayers might be wise to review their international transactions to determine, among other things, whether foreign-to-foreign transactions may contain some impediment to claiming the full amount of foreign taxes paid as an FTC...
Alexey Manasuev is a Senior Manager in U.S. Corporate Tax Group of Ernst & Young LLP in Toronto, Canada. He can be reached at: firstname.lastname@example.org. The views and opinions in this publication are those of the author and do not necessarily represent the views and opinions of Ernst & Young LLP. This publication contains information in summary form, current as of the date of publication, and is intended for general guidance only. It should not be regarded as comprehensive or a substitute for professional advice. Before taking any particular course of action, contact Ernst & Young or another professional advisor to discuss these matters in the context of your particular circumstances. We accept no responsibility for any loss or damage occasioned by your reliance on information contained in this publication.
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RELATED LINKS: For further insights, see:
1-12 Rhoades & Langer U.S. Int'l Taxation & Tax Treaties -- § 12.02 - Foreign Tax Credit: Direct Credit - Preliminary Considerations
1-15 Rhoades & Langer U.S. Int'l Taxation & Tax Treaties -- § 15.02 – Foreign Tax Credit: Miscellaneous Accounting Problems
1-15 Rhoades & Langer U.S. Int'l Taxation & Tax Treaties -- § 15.04 – Foreign Tax Credit: Miscellaneous Issues – Other Foreign Tax Credit Related Sections
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