Foreign Tax Credit, Partnerships and Disregarded Entities: The Latest Rules

Foreign Tax Credit, Partnerships and Disregarded Entities: The Latest Rules

[Editor's Note:  This narrative is derived from Rhoades & Langer, U.S. International Taxation and Tax Treaties, § 12.02[3][a][ii][B] (Matthew Bender).] 

The foreign tax credit is the international taxpayer's chief defense against double taxation of the same items of income, once by the foreign jurisdiction and once by the United States.

A partnership is considered to pay whatever foreign tax is imposed on the partnership entity by the foreign country. [Treas. Reg. § 1.901-2(f)(4)(i).]  The partnership regulations [Treas. Reg. § 1.702-1(a)(6) and § 1.704-1(b)(4)(vii)] set forth the rules for allocating foreign tax paid by a partnership among partners.  Under those regulations, the partner is to take into consideration his distributive share of the taxes paid by the partnership.  The election to treat taxes as a deduction is made at the partner level. [Treas. Reg. § 1.702-1(a)(6).] 

Foreign law will apply the foreign tax at the entity level when the entity is recognized as a tax paying entity under foreign law, even if it is a disregarded entity (generally, a "DE") under U.S. law. [ Treas. Reg. § 301.7701-2(c)(2)(i).]  Under those circumstances, the person that is treated as owning the assets of the DE is considered as legally obligated to pay the foreign tax for U.S. tax purposes. [ Treas. Reg. § 1.901-2(f)(4)(ii).]

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