Proposed Rule2022-25337
Guidance Related to the Foreign Tax Credit
Primary source
Metadata and text below are from the Federal Register, a public-domain U.S. government work. Always verify the official published version before relying on it for any legal matter.
Published
November 22, 2022
Issuing agencies
Treasury DepartmentInternal Revenue Service
Abstract
This document contains proposed regulations relating to the foreign tax credit, including guidance with respect to the reattribution asset rule for purposes of allocating and apportioning foreign taxes, the cost recovery requirement, and the attribution rule for withholding tax on royalty payments.
Full Text
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<title>Federal Register, Volume 87 Issue 224 (Tuesday, November 22, 2022)</title>
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[Federal Register Volume 87, Number 224 (Tuesday, November 22, 2022)]
[Proposed Rules]
[Pages 71271-71286]
From the Federal Register Online via the Government Publishing Office [<a href="http://www.gpo.gov">www.gpo.gov</a>]
[FR Doc No: 2022-25337]
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DEPARTMENT OF THE TREASURY
Internal Revenue Service
26 CFR Part 1
[REG-112096-22]
RIN 1545-BQ46
Guidance Related to the Foreign Tax Credit
AGENCY: Internal Revenue Service (IRS), Treasury.
ACTION: Notice of proposed rulemaking.
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SUMMARY: This document contains proposed regulations relating to the
foreign tax credit, including guidance with respect to the
reattribution asset rule for purposes of allocating and apportioning
foreign taxes, the cost recovery requirement, and the attribution rule
for withholding tax on royalty payments.
DATES: Written or electronic comments and requests for a public hearing
must be received by January 23, 2023.
ADDRESSES: Commenters are strongly encouraged to submit public comments
electronically. Submit electronic submissions via the Federal
eRulemaking Portal at <a href="http://www.regulations.gov">www.regulations.gov</a> (indicate IRS and REG-112096-
22) by following the online instructions for submitting
[[Page 71272]]
comments. Once submitted to the Federal eRulemaking Portal, comments
cannot be edited or withdrawn. The Department of the Treasury (the
``Treasury Department'') and the Internal Revenue Service (the ``IRS'')
will publish for public availability any comment submitted
electronically, and on paper, to its public docket. Send hard copy
submissions to: CC:PA:LPD:PR (REG-112096-22), Room 5203, Internal
Revenue Service, P.O. Box 7604, Ben Franklin Station, Washington, DC
20044. Submissions may be hand delivered Monday through Friday between
the hours of 8 a.m. and 4 p.m. to CC:PA:LPD:PR (REG-112096-22),
Courier's Desk, Internal Revenue Service, 1111 Constitution Avenue NW,
Washington, DC 20224.
FOR FURTHER INFORMATION CONTACT: Concerning Sec. Sec. 1.901-2 and
1.903-1, Teisha Ruggiero, (646) 259-8116; concerning Sec. 1.861-20,
Suzanne Walsh, (202) 317-4908; concerning submissions of comments and
requests for a public hearing, Regina Johnson, (202) 317-6901 (not
toll-free numbers) or by sending an email to <a href="/cdn-cgi/l/email-protection#24545146484d474c4145564d4a4357644d56570a434b52"><span class="__cf_email__" data-cfemail="b3c3c6d1dfdad0dbd6d2c1daddd4c0f3dac1c09dd4dcc5">[email protected]</span></a>
(preferred).
SUPPLEMENTARY INFORMATION:
Background
On December 17, 2019, the Treasury Department and the IRS published
proposed regulations (REG-105495-19) addressing changes made by the Tax
Cuts and Jobs Act (Pub. L. 115-97, 131 Stat. 2054 (2017)) (the
``TCJA'') and other related foreign tax credit rules in the Federal
Register (84 FR 69124) (the ``2019 Foreign Tax Credit (``FTC'')
proposed regulations''). Correcting amendments to the 2019 FTC proposed
regulations were published in the Federal Register on May 15, 2020 (85
FR 29368). The 2019 FTC proposed regulations were finalized as part of
TD 9922, published in the Federal Register (85 FR 71998) on November
12, 2020 (the ``2020 FTC final regulations''). On the same date, the
Treasury Department and the IRS published proposed regulations (REG-
101657-20) in the Federal Register (85 FR 72078) (the ``2020 FTC
proposed regulations''). The 2020 FTC proposed regulations addressed
changes made by the TCJA and other foreign tax credit issues.
Correcting amendments to the 2020 FTC final regulations were published
in the Federal Register on October 1, 2021 (86 FR 54367). A public
hearing on the 2020 FTC proposed regulations was held on April 7, 2021.
The 2020 FTC proposed regulations were finalized in TD 9959, published
in the Federal Register (87 FR 276) on January 4, 2022 (the ``2022 FTC
final regulations''). Correcting amendments to the 2022 FTC final
regulations were published in the Federal Register on July 27, 2022 (87
FR 45018 and 87 FR 45021).
This document contains proposed regulations (the ``proposed
regulations'') addressing the following issues: (1) the definition of a
reattribution asset for purposes of allocating and apportioning foreign
income taxes; (2) the application of the cost recovery requirement; and
(3) the application of the source-based attribution requirement to
withholding taxes on certain royalty payments.
Explanation of Provisions
I. Allocation and Apportionment of Foreign Income Taxes
A. In General
Section 1.861-20 provides rules for allocating and apportioning
foreign income taxes to the statutory and residual groupings, including
the categories described in section 904 that apply for purposes of
calculating a taxpayer's foreign tax credit limitation. In general,
Sec. 1.861-20 operates by first assigning the foreign gross income on
which the foreign income tax is imposed to statutory and residual
groupings based upon the character of the item of U.S. gross income
that corresponds to the foreign gross income (the ``corresponding U.S.
item''). Sec. 1.861-20(c) and (d). Foreign income tax expense is
allocated to the grouping to which the foreign gross income is
assigned, and if foreign gross income is assigned to more than one
grouping, deductions computed under foreign law are allocated and
apportioned to the groupings and foreign tax expense is apportioned
among the groupings based upon foreign taxable income in the groupings.
Sec. 1.861-20(e) and (f).
The 2022 FTC final regulations provide rules for allocating and
apportioning foreign income tax arising from a disregarded payment.
Foreign gross income included by reason of the receipt of a disregarded
payment has no corresponding U.S. item because Federal income tax law
does not give effect to the payment as a receipt of gross income.
Section 1.861-20(d)(3)(v) therefore characterizes the disregarded
payment under Federal income tax law for purposes of assigning this
foreign gross income to the statutory and residual groupings. These
rules treat the portion of a disregarded payment, if any, that causes
U.S. gross income of the payor taxable unit to be reattributed under
either Sec. 1.904-4(f)(2) (in the case of a taxpayer that is an
individual or domestic corporation) or Sec. 1.951A-2(c)(7)(ii)(B) (in
the case of a taxpayer that is a foreign corporation) to the recipient
taxable unit as a ``reattribution payment.'' Sec. 1.861-
20(d)(3)(v)(E)(7); see also part I.B of this Explanation of Provisions
for a description of the reattribution payment rules. The excess of a
disregarded payment over the portion that is a reattribution payment is
treated either as a contribution from one taxable unit to another
taxable unit owned by the first taxable unit, or as a remittance of a
taxable unit's current and accumulated earnings. Sec. 1.861-
20(d)(3)(v)(E)(2) and (8). Section 1.861-20(d)(3)(v)(D) provides a
special rule for characterizing disregarded payments that are made in
exchange for property and are not reattribution payments.
B. Reattribution Payments, Remittances, and the Reattribution of Assets
Section 1.861-20(d)(3)(v)(B) assigns foreign gross income from a
disregarded payment that is a reattribution payment to the same
statutory and residual grouping as the U.S. gross income that is
reattributed to the recipient taxable unit. This assignment occurs
before taking into account any reattribution payments made by the
recipient taxable unit.
Foreign gross income included by reason of a remittance is assigned
to the statutory and residual groupings by reference to the proportion
of the tax book value of the assets of the remitting taxable unit in
the groupings as assigned for purposes of apportioning interest
expense. Sec. 1.861-20(d)(3)(v)(C)(1)(i). In other words, the
character of the assets of the remitting taxable unit is a proxy for
the character of the current and accumulated earnings out of which the
remittance is made. To more accurately reflect the character of the
remitting taxable unit's earnings, the reattribution asset rule in
Sec. 1.861-20(d)(3)(v)(C)(1)(ii) requires that a reattribution of
income from one taxable unit (payor taxable unit) to another taxable
unit (recipient taxable unit) result in a concomitant reattribution of
the tax book value of the assets of the payor taxable unit that
generated the reattributed income (``reattribution assets'') from the
payor taxable unit to the recipient taxable unit.
After further study, the Treasury Department and the IRS have
concluded that the reattribution asset rule is not needed for
allocating and apportioning foreign tax on a remittance in the case of
disregarded property sales, and particularly with respect to
disregarded sales of inventory property. For example, consider a
domestic corporation that directly owns two taxable units that are
disregarded for U.S. Federal income tax purposes: DE1,
[[Page 71273]]
which manufactures inventory property, and DE2, which distributes
inventory property to unrelated customers. DE1 sells the manufactured
inventory to DE2 in exchange for a disregarded payment. The disregarded
payment that DE1 receives for the sale of inventory property to DE2
becomes a reattribution payment when DE2 on-sells the inventory
property and generates gain in a transaction that is regarded for U.S.
tax purposes. Accordingly, gain from the sale of the inventory is
reattributed from the distributing taxable unit to the manufacturing
taxable unit, and a portion of the distributing taxable unit's assets
is reattributed to the manufacturing taxable unit. Although the assets
of the manufacturing taxable unit contributed to the production of the
income of both taxable units, the tax book value of the manufacturing
taxable unit's assets is not reattributed to the distributing taxable
unit. As a result, the reattribution asset rule, by reattributing
assets only from the distributor taxable unit to the manufacturing
taxable unit, does not more accurately balance among the taxable units
all of the assets that produced the gain from the inventory sale. The
reattribution of assets instead changes the ratios of the assets
considered held by the taxable units such that a greater percentage of
the distributor taxable unit's assets consist of non-inventory assets
(for example, cash), and a greater percentage of the manufacturing
taxable unit's assets consist of inventory.
Accordingly, proposed Sec. 1.861-20(d)(3)(v)(E)(6) retains the
general definition of reattribution asset but excludes any portion of
the tax book value of property transferred in a disregarded sale from
being attributed back to the selling taxable unit. Comments are
requested on whether similar revisions should be made to the
reattribution asset rule in situations other than disregarded property
sales. Comments are further requested on other issues related to the
allocation and apportionment of foreign income taxes to disregarded
payments, which may be considered in future guidance projects.
II. Creditability of Foreign Taxes Under Sections 901 and 903
A. In General
Section 901 allows a credit for foreign income, war profits, and
excess profits taxes, and section 903 provides that such taxes include
a tax in lieu of a generally-imposed foreign income, war profits, or
excess profits tax (collectively, ``foreign income taxes''). Before its
amendment by the 2022 FTC final regulations, Sec. 1.901-2(a)(1)
provided that a foreign levy was an income tax if and only if (1) it
was a tax, and (2) the predominant character of that tax was that of an
income tax in the U.S. sense. Under former Sec. 1.901-2(a)(3), the
predominant character of a foreign tax was that of an income tax in the
U.S. sense if the tax (1) was likely to reach net gain in the normal
circumstances in which it applied (the ``net gain requirement''), and
(2) was not a ``soak-up'' tax. To satisfy the net gain requirement, a
foreign tax needed to meet the realization, gross receipts, and net
income requirements. See former Sec. 1.901-2(b).
The 2022 FTC final regulations revised the net gain requirement to
better align the regulatory tests with principles in the Internal
Revenue Code (``Code'') for determining the base of a U.S. income tax,
as well as to simplify and clarify the application of these tests. The
revisions made by the 2022 FTC final regulations ensure that a foreign
tax is a creditable net income tax only if the determination of the
foreign tax base conforms in essential respects to the determination of
taxable income under the Code. In particular, the 2022 FTC final
regulations limit the role of the predominant character analysis
generally required under the prior regulations, which often required
empirical analysis, in determining whether a foreign tax meets each of
the net gain requirements. Under the 2022 FTC final regulations, a
foreign tax satisfies the net gain requirement only if the tax
satisfies the realization requirement, the gross receipts requirement,
the cost recovery requirement (formerly the net income requirement),
and the attribution requirement. In addition, the 2022 FTC final
regulations provide that the determination of whether a foreign tax
satisfies each component of the net gain requirement is generally based
on the terms of the foreign tax law governing the computation of the
tax base and not based on empirical analysis. Sec. 1.901-2(b)(1). The
2022 FTC final regulations also maintained the long-standing all-or-
nothing rule; that is, a foreign tax either is or is not a foreign
income tax, in its entirety, for all persons subject to the foreign
tax. Sec. 1.901-2(a)(1)(i).
B. Cost Recovery Requirement
1. Application Under 2022 FTC Final Regulations
Consistent with the net income requirement in former Sec. 1.901-
2(b)(4), the 2022 FTC final regulations require, under the cost
recovery requirement, that the base of a foreign tax permits the
recovery of significant costs and expenses attributable, under
reasonable principles, to the gross receipts included in the tax base.
Sec. 1.901-2(b)(4)(i)(A). However, to ensure that a foreign tax is a
foreign income tax only if the foreign tax allows for the recovery of
costs and expenses in a manner that conforms in essential respects to
the determination of taxable income under the Code, and to limit the
empirical analysis that would otherwise be required, the 2022 FTC final
regulations modified the cost recovery requirement in several respects.
For example, the 2022 FTC final regulations provide a list of costs and
expenses that are always treated as significant (costs and expenses
related to capital expenditures, interest, rents, royalties, wages or
other payments for services, and research and experimentation). Sec.
1.901-2(b)(4)(i)(C)(1). Whether other costs and expenses are
significant continues to be determined under an empirical analysis;
that is, based on whether, for all taxpayers in the aggregate to which
the foreign tax applies, the item of cost or expense constitutes a
significant portion of the taxpayers' total costs and expenses. Id.
However, the 2022 FTC final regulations also recognized that,
similar to the United States, foreign countries limit the recovery of
certain significant costs and expenses. As a result, Sec. 1.901-
2(b)(4)(i)(C)(1) provides that foreign tax law is considered to permit
the recovery of significant costs and expenses, even if recovery of
certain significant costs and expenses is disallowed in whole or in
part, if such disallowance is consistent with any principle underlying
the disallowances required under the Code (``principles-based
exception'').
2. Response to the 2022 FTC Final Regulations
Following the publication of the 2022 FTC final regulations, the
Treasury Department and the IRS have received a number of questions
regarding the application of the cost recovery requirement as well as
requests to modify the requirement. In particular, taxpayers and other
stakeholders identified a number of foreign tax laws that impose
disallowances or other limitations on the recovery of costs and
expenses that are not clearly matched to a principle underlying a
similar disallowance under the Code, even though, in the view of these
stakeholders, the foreign tax as a whole is consistent with a net
income tax in the U.S. sense. Moreover, taxpayers noted that, in some
instances, it was difficult to determine the principle underlying the
foreign disallowance
[[Page 71274]]
because of a lack of information from the foreign country.
The Treasury Department and the IRS agree that, in certain
instances, the cost recovery requirement should be satisfied even if
the foreign tax law contains a disallowance or other limitation on the
recovery of a particular cost or expense that may not reflect a
specific principle underlying a particular disallowance in the Code.
The income tax provisions of the Code contain a number of disallowances
and other limitations on the deductibility of certain costs and
expenses. In some instances, the principle or principles behind the
limitation is clear, either because the motivation is articulated in
legislative history or because it is possible to determine the
principle from the terms of the limitation itself. However, the
principles underlying other limitations may be less apparent, making it
difficult to determine whether a foreign limitation on the
deductibility of certain costs and expenses is consistent with any
principle underlying the disallowances under the Code.
As explained in the preamble to the 2022 FTC final regulations,
section 901 allows credits for foreign taxes that are income taxes in
the U.S. sense, and this standard is met if there is substantial
conformity in the principles used to calculate the foreign tax base and
the U.S. tax base. Complete conformity between the rules for
determining the foreign tax base and the U.S. tax base is not required.
Accordingly, the proposed regulations provide additional guidance for
evaluating disallowances under foreign tax law that may not mirror the
expense disallowance rules in the Code, but that nonetheless do not
prevent the foreign tax from being a tax imposed on net income.
Proposed Sec. 1.901-2(b)(4)(i) retains the general cost recovery
requirement under the 2022 FTC final regulations, but provides that the
relevant foreign tax law need only permit recovery of substantially all
of each item of significant cost or expense. Consistent with the
general approach of the 2022 FTC final regulations, whether a foreign
tax permits recovery of substantially all of each item of significant
cost or expense is determined based solely on the terms of the foreign
tax law. Proposed Sec. 1.901-2(b)(4)(i)(C)(1).
Proposed Sec. 1.901-2(b)(4)(i)(C)(2) provides a safe harbor for
purposes of applying this requirement. Under the safe harbor, a
disallowance of a stated portion of an item (or multiple items) of
significant cost or expense does not prevent a foreign tax from
satisfying the cost recovery requirement if the portion of the item (or
items) that is disallowed does not exceed 25 percent. This safe harbor
also permits the foreign tax law to cap deductions of a single item of
significant cost or expense or multiple items that relate to a single
category of per se significant costs and expenses described in proposed
Sec. 1.901-2(b)(4)(i)(B)(2) so long as the cap, based solely on the
terms of the foreign tax law, is not less than 15 percent of gross
receipts, gross income, or a similar measure, or in the case of a cap
based on a percentage of taxable income, or a similar measure, the cap
is not less than 30 percent. A foreign law limitation that caps
deductions of multiple items that relate to different categories of per
se significant costs and expenses at a stated percentage (for example,
a cap on the deduction of all interest and royalties, combined, at 15
percent of gross receipts), or that caps deductions of multiple items
of significant costs or expense that are significant under proposed
Sec. 1.901-2(b)(4)(i)(B)(1) at a stated percentage, would not meet the
safe harbor. The safe harbor is intended to provide additional
certainty where a foreign tax law disallowance is in the form of a
stated portion or cap. Taxpayers will not need to identify a
corresponding principle underlying the disallowances required under the
Code for foreign tax law disallowances that meet the safe harbor. If
the foreign tax law contains a disallowance that is not within the safe
harbor, and that otherwise prevents the recovery of substantially all
of an item of significant cost or expense, then the limitation would be
examined under the principles-based exception from the 2022 FTC final
regulations, retained in proposed Sec. 1.901-2(b)(4)(i)(F)(1), which
permits more substantial disallowances (including complete
disallowances) of an item of significant cost or expense that are
consistent with any principle underlying the disallowances required
under the Code. The proposed regulations make additional clarifications
to this rule, to provide that the principle must be reflected in a
disallowance within the income tax provisions of the Code, and if the
disallowance addresses a non-tax public policy concern, then such
concern must be similar to the non-tax public policy concerns reflected
in the Code. In addition, the proposed regulations remove the example
of a limit on recovery of interest based upon a measure of taxable
income from this principles-based exception because such a limitation
would generally be covered by the safe harbor. See proposed Sec.
1.901-2(b)(4)(iv)(H) (Example 8). If the foreign law disallowance does
not meet the safe harbor or otherwise permit recovery of substantially
all of each item of significant cost or expense, the principles-based
exception would be relevant for determining whether the foreign tax
could satisfy the cost recovery requirement.
Additionally, proposed Sec. 1.901-2(b)(4)(iv)(F) through (J)
provide new examples illustrating the application of the cost recovery
requirement. The proposed regulations also reorganize the provisions of
the cost recovery requirement to accommodate the addition of these new
provisions, as well as to better reflect the structure of the
requirement.
C. Attribution Requirement for Royalty Payments
1. Application Under 2022 FTC Final Regulations
The 2022 FTC final regulations added an attribution requirement in
Sec. 1.901-2(b)(5) as an element of the net gain requirement to
require that a foreign tax conform to the concepts of taxing
jurisdiction reflected in the Code that define an income tax in the
U.S. sense. The purpose of the attribution requirement is to allow a
credit for a foreign tax only if the country imposing the tax has
sufficient nexus to the taxpayer's activities or investment of capital
that generates the income included in the tax base. This result is
consistent with the statutory purpose of the foreign tax credit to
relieve double taxation of income through the United States ceding its
own taxing rights only where the foreign country has the primary right
to tax the income.
With respect to a foreign levy imposed on nonresident taxpayers,
the attribution requirement limits the scope of gross receipts and
costs included in the base of a foreign tax to those that satisfy the
activities-based attribution, source-based attribution, or property-
based attribution tests. Sec. 1.901-2(b)(5)(i). These tests are
consistent with U.S. income tax principles reflected in the Code's
provisions that only tax foreign persons' income that is effectively
connected with a U.S. trade or business or attributable to U.S. real
property, or that is fixed or determinable annual or periodical (FDAP)
income sourced in the United States.
Under the source-based attribution requirement in Sec. 1.901-
2(b)(5)(i)(B), a foreign tax imposed on the nonresident's income on the
basis of source meets the attribution requirement only if the foreign
tax law's
[[Page 71275]]
sourcing rules are reasonably similar to the sourcing rules that apply
for Federal income tax purposes. In the case of gross income arising
from royalties, Sec. 1.901-2(b)(5)(i)(B)(2) provides that the foreign
tax law must source royalties based on the place of use of, or the
right to use, the intangible property, consistent with how the Code
sources royalty income.
For foreign taxes imposed in lieu of an income tax, the 2022 FTC
final regulations also modified the substitution requirement in Sec.
1.903-1, including by adding an attribution requirement. Under Sec.
1.903-1(c)(2)(iii), a foreign withholding tax must meet the source-
based attribution requirement in Sec. 1.901-2(b)(5)(i)(B) to qualify
as a ``covered withholding tax'' that may be creditable as a tax in
lieu of an income tax. Thus, a withholding tax on a royalty payment is
creditable only if the foreign tax law sources royalties based upon the
place of use of, or the right to use, the intangible property,
consistent with how the Code sources royalty income. The 2022 FTC final
regulations also maintained the all-or-nothing rule for the
substitution requirement; that is, a foreign tax either is or is not a
tax in lieu of an income tax, in its entirety, for all persons subject
to the foreign tax. Sec. 1.903-1(b)(1). Accordingly, a withholding tax
on royalties that is imposed on the basis of the residence of the payor
of the royalty is not creditable, whether or not the relevant
intangible property is in fact used within the territory of the taxing
jurisdiction. Sec. 1.903-1(d)(3) and (4) (Examples 3 and 4).
The determination of whether a foreign levy meets the requirements
under Sec. Sec. 1.901-2 and 1.903-1 is made on a levy-by-levy basis.
Section 1.901-2(d) provides rules for determining whether one foreign
levy is separate from another foreign levy. In general, Sec. 1.901-
2(d)(1)(ii) provides that separate levies are imposed on particular
classes of taxpayers if the tax base is different for those taxpayers.
The 2022 FTC final regulations added a special rule for withholding
taxes imposed on nonresidents that treats each such tax as a separate
levy with respect to each class of gross income (as listed in section
61) to which the tax applies. Sec. 1.901-2(d)(1)(iii). This rule
allows withholding taxes that are imposed on classes of income that are
subject to different sourcing rules of the taxing jurisdiction to be
analyzed as separate levies under the covered withholding tax
requirement in Sec. 1.903-1(c)(2). The 2022 FTC final regulations also
provided that if a foreign country imposes a withholding tax on two or
more subsets of a separate class of income and a different source rule
applies to each subset of income, then separate levies are considered
imposed on each subset of that separate class of income. Sec. 1.901-
2(d)(1)(iii). These special rules reflect the general principle in
Sec. 1.901-2(d)(1) that the separate levy determination is based upon
U.S. principles and not whether foreign tax law imposes the levy or
levies pursuant to a single or separate statutes. The rules also enable
testing the creditability of a withholding tax on a more granular
basis. This approach better reflects the purpose of the attribution
requirement to allow a foreign tax credit only where, in the U.S. view,
the taxing jurisdiction has the primary right to tax the income.
2. Response to the 2022 FTC Final Regulations
Following the publication of the 2022 FTC final regulations, the
Treasury Department and the IRS received questions regarding the
application of the source-based attribution requirement to certain
royalty withholding taxes. In addition, the Treasury Department and the
IRS received requests (including a petition for rulemaking) to change
the requirement, by allowing a credit even if a foreign country sources
royalties based on the residence of the payor or by applying a
different standard.\1\
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\1\ The Treasury Department and the IRS received a petition for
rulemaking with respect to the attribution requirement as applied to
a tax on a resident but declined to engage in rulemaking on that
subject. The Treasury Department and the IRS have determined that
the attribution requirement as contained in the 2022 FTC final
regulations, including as applied to residents, is appropriate to
ensure that a foreign tax is consistent with the general principles
of income taxation reflected in the Code. These principles include
not only those related to determining realization, gross receipts,
and cost recovery, but also principles for determining the scope of
the items of gross receipts and costs that may be properly taken
into account in computing the tax base on which the foreign tax is
imposed.
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As an initial matter, some taxpayers questioned whether the
sourcing rule for royalties was applied differently than that for
services because Sec. 1.901-2(b)(5)(i)(B)(1) includes a reference to
the use of ``reasonable principles'' for purposes of applying the
source-based attribution requirement to a payment for services, while
the equivalent rule in Sec. 1.901-2(b)(5)(i)(B)(2) for royalties does
not. Since the introductory text in Sec. 1.901-2(b)(5)(i)(B) states
that, in all instances, sourcing rules must be reasonably similar to
the sourcing rules under the Code, the same standard applies regardless
of whether the relevant payment is for services or for royalties.
However, to avoid further confusion, the proposed regulations conform
the language of Sec. 1.901-2(b)(5)(i)(B)(1) and (2).
Additionally, the Treasury Department and the IRS are aware that,
in some cases, a taxpayer may license intangible property for use
solely within the foreign country in which the licensee is resident,
but the foreign country sources royalties based on the residence of the
payor. In these cases, notwithstanding the actual use of the licensed
property in the taxing jurisdiction, a credit would not be allowed for
the royalty withholding tax under the source-based attribution
requirement for royalties in Sec. 1.901-2(b)(5)(i)(B). However, in
these cases, the foreign country imposing tax on the royalty income
should, from a U.S. perspective, have the primary taxing right over the
royalty income because the intangible property giving rise to the
royalty is in fact being used solely in that foreign country. That is,
notwithstanding the difference in sourcing rules for royalty income,
there is complete overlap between the jurisdiction with the primary
right to tax based on U.S. tax principles and the taxing rights
exercised by the taxing jurisdiction.
The Treasury Department and the IRS have concluded that it is
appropriate to provide a limited exception to the source-based
attribution requirement of the 2022 FTC final regulations where the
taxpayer can substantiate that a withholding tax is imposed on
royalties received in exchange for the right to use intangible property
solely within the territory of the taxing jurisdiction. The Treasury
Department and the IRS have concluded that it would be unduly
burdensome for both the taxpayer and the IRS to determine the place of
use of all intangible property on a country-by-country basis based on
each taxpayer's facts and circumstances. While taxpayers may need to
determine the place of use of certain intangible property to determine
whether the royalty income is U.S. or foreign source, or for other
purposes, those determinations generally do not require taxpayers or
the IRS to separately determine the use in a specific foreign country.
For this reason, this limited exception applies only if the taxpayer
has a written license agreement that provides for the payment of the
royalty and that limits the use of the intangible property giving rise
to the royalty payment to the territory of the foreign country imposing
the tax.
[[Page 71276]]
3. The Single-Country Exception
Reflecting this new limited exception, proposed Sec. 1.903-
1(c)(2)(iii) provides that a tested foreign tax satisfies the source-
based attribution requirement if the tax meets either the source-based
attribution requirement in Sec. 1.901-2(b)(5)(i)(B) or the exception
in proposed Sec. 1.903-1(c)(2)(iii)(B) (the ``single-country
exception'').
In general, the single-country exception applies where (1) the
income subject to the tested foreign tax is characterized as gross
royalty income, and (2) the payment giving rise to such income is made
pursuant to a single-country license. Proposed Sec. 1.903-
1(c)(2)(iii)(B). Consistent with Sec. 1.901-2(b)(5)(i)(B), proposed
Sec. 1.903-1(c)(2)(iii)(B) provides that foreign tax law generally
applies for purposes of determining whether the gross income or gross
receipts arising from a transaction are characterized as a royalty,
except in the case of a transaction that is considered the sale of a
copyrighted article under Sec. 1.861-18, which is not treated as a
license of intangible property but as a sale of tangible property.
A payment is made pursuant to a single-country license if the terms
of the written license agreement under which the payment is made
characterize the payment as a royalty and limit the territory of the
license to the foreign country imposing the tested foreign tax.
Proposed Sec. 1.903-1(c)(2)(iv)(A). However, a payment (or portion of
a payment) may be treated as made pursuant to a single-country license
even if the written agreement does not limit the territory of the
license to the foreign country imposing the tax or provides for
payments in addition to those for the use of intangible property (for
example, for related services), if the agreement separately states the
portion (whether as a specified amount or as a formula) of the payment
subject to the tested foreign tax that is characterized as a royalty
and that is with respect to the part of the territory of the license
that is solely within the foreign country imposing the tax. See
proposed Sec. Sec. 1.903-1(c)(2)(iv)(B) and (d)(9) (Example 9).
The Treasury Department and the IRS are aware that, to qualify for
the single-country exception, taxpayers may need to revise existing
license agreements. Additionally, because certain withholding taxes may
remain non-creditable, taxpayers may be incentivized to maximize the
portion of a payment that is made pursuant to a single-country license.
For example, a taxpayer that receives royalty payments pursuant to a
related-party license agreement that grants the licensee rights to
several different types of intangible property--some of which will be
exploited solely within the taxing jurisdiction and some outside of the
taxing jurisdiction--may be incentivized to amend the related-party
license agreement to separately state a royalty amount that purports to
qualify for the single-country exception but that may exceed an amount
that, under the arm's length principles of section 482 and sourcing
principles of section 861, is attributable to the exploitation of the
intangible property within the taxing jurisdiction. Additionally,
taxpayers may be disincentivized from revising existing agreements to
reflect changes in facts and circumstances if doing so would decrease
the amount of the royalty that is eligible for the single-country
exception.
To address these concerns, proposed Sec. 1.903-1(c)(2)(iv)(C)
provides that a payment is treated as not made pursuant to a single-
country license if the taxpayer knows, or has reason to know, that the
required agreement misstates the territory in which the intangible
property is used or overstates the amount of the royalty with respect
to the part of the territory of the license that is solely within the
foreign country imposing the tax. Thus, the required agreement must
reflect the relevant facts and circumstances, as known by the taxpayer
or as would be known by a reasonably prudent person in the position of
the taxpayer, regarding both the amount of the relevant royalty and the
territory in which the intellectual property is actually used.
In general, a taxpayer cannot qualify for the single-country
exception without satisfying the documentation requirement in proposed
Sec. 1.903-1(c)(2)(iv)(D). Under proposed Sec. 1.903-1(c)(2)(iv)(D),
the required agreement pursuant to which the qualifying royalty is paid
must be executed no later than the date on which the royalty is paid.
However, recognizing that the single-country exception is proposed to
be applicable to periods preceding the release of this notice of
proposed rulemaking, a special transition documentation rule is
provided for royalties paid on or before May 17, 2023. In that case, to
satisfy the documentation requirement, the required agreement must be
executed no later than May 17, 2023, and the agreement must state
(whether in the terms of the agreement or in recitals) that royalties
paid on or before the execution of the agreement are considered paid
pursuant to the terms of the agreement.
The required agreement must be maintained by the taxpayer and
provided to the IRS within 30 days of a request by the Commissioner or
another period as agreed between the Commissioner and the taxpayer. Id.
For purposes of the rule, the term taxpayer includes a partnership upon
which foreign law imposes a tax. See Sec. 1.901-2(f)(4) and (g)(7).
Therefore, if the royalty withholding tax is imposed at the partnership
level, the documentation required by the proposed regulations must be
maintained by the partnership, even though the party that claims the
credit is the partner and not the partnership. The Treasury Department
and the IRS request comments as to whether special rules may be
necessary to address the documentation requirement in the case of
partnerships.
Finally, proposed Sec. 1.903-1(d)(3) and (8) through (11) provide
new examples illustrating the application of the source-based
attribution rule and single-country exception for covered withholding
taxes on royalties.
4. Separate Levy
The proposed regulations also modify the separate levy rule in
Sec. 1.901-2(d)(1)(iii) for withholding taxes imposed on nonresidents.
Specifically, Sec. 1.901-2(d)(1)(iii)(B)(3) provides that a
withholding tax that is imposed on a royalty payment made to a
nonresident pursuant to a single-country license is treated as a
separate levy from a withholding tax that is imposed on other royalty
payments made to such nonresident and from any other withholding taxes
imposed on other nonresidents. As with the special separate levy rule
for withholding taxes on different classes of income or different
subsets of income within a class of income, this rule may result in a
foreign withholding tax being considered a separate levy in cases where
the foreign tax law considers only a single levy to be imposed. In
contrast to a net income tax, this separate levy rule can be applied to
withholding taxes because withholding taxes on royalties are imposed on
gross income and on a payment-by-payment basis. In addition, as with
the other special levy rules, this separate levy rule better aligns the
outcomes of the test with the purposes of the foreign tax credit rules,
including that of the attribution requirement. The proposed regulations
also reorder and reorganize the paragraphs of proposed Sec. 1.901-
2(d)(1)(iii) to accommodate the addition of this new provision, and to
reflect the structure of the rules more logically.
[[Page 71277]]
III. Applicability Dates
In general, except for proposed Sec. 1.861-20(d)(3)(v)(E)(6), the
proposed regulations are proposed to apply to taxable years ending on
or after November 18, 2022. However, once the proposed regulations are
finalized, taxpayers may choose to apply some or all of the final
regulations to earlier taxable years, subject to certain conditions.
Proposed Sec. 1.861-20(d)(3)(v)(E)(6) is proposed to apply to
taxable years ending on or after the date final regulations adopting
these rules are filed with the Federal Register. Taxpayers may choose
to apply the rules of Sec. 1.861-20(d)(3)(v)(E)(6), once finalized, to
taxable years that begin after December 31, 2019, and end before the
date final regulations adopting these rules are filed with the Federal
Register provided they apply Sec. 1.861-20(d)(3)(v)(E)(6) consistently
to their first taxable year beginning after December 31, 2019, and any
subsequent taxable year ending before the date final regulations
adopting these rules are filed with the Federal Register.
Proposed Sec. 1.901-2(b)(4)(i) and (iv), (b)(5)(i)(B)(2), and
(d)(1)(iii) and proposed Sec. 1.903-1(c)(2) and (d)(3), (4), and (8)
through (11) are proposed to apply to foreign taxes paid in taxable
years ending on or after November 18, 2022. Taxpayers may choose to
apply the rules of Sec. 1.901-2(b)(4)(i) and (iv), once finalized, for
foreign taxes paid in taxable years beginning on or after December 28,
2021, and ending before November 18, 2022, provided that they
consistently apply those rules to such taxable years. Taxpayers may
also choose to apply the rules of Sec. Sec. 1.901-2(b)(5)(i)(B)(2) and
(d)(1)(iii) and 1.903-1(c)(2) and (d)(3), (4), and (8) through (11),
once finalized, for foreign taxes paid in taxable years beginning on or
after December 28, 2021, and ending before November 18, 2022, provided
that they consistently apply those rules for such taxable years.
Finally, until the effective date of final regulations, a taxpayer
may rely on all or part of the proposed regulations, subject to certain
conditions. Specifically, a taxpayer may choose to rely on the
provisions addressing the reattribution asset rule (proposed Sec.
1.861-20(d)(3)(v)(E)(6)) for taxable years that begin after December
31, 2019, and end before the effective date of final regulations
adopting these rules. A taxpayer may also choose to rely on the
provisions addressing the cost recovery requirement (proposed Sec.
1.901-2(b)(4)(i) and (iv)) for foreign taxes paid in taxable years
beginning on or after December 28, 2021, and ending before the
effective date of final regulations adopting these rules. Finally, a
taxpayer may choose to rely on the provisions addressing the
attribution requirement for royalty payments (proposed Sec. 1.901-
2(b)(5)(i)(B)(2) and (d)(1)(iii) and proposed Sec. 1.903-1(c)(2) and
(d)(3), (4), and (8) through (11)) for foreign taxes paid in taxable
years beginning on or after December 28, 2021, and ending before the
effective date of final regulations adopting these rules.
If a taxpayer chooses to rely on any of the three portions of the
proposed regulations described in the preceding paragraph, the taxpayer
and its related parties, within the meaning of sections 267(b)
(determined without regard to section 267(c)(3)) and 707(b)(1), must
consistently follow all proposed regulations with respect to that
portion for all relevant years until the effective date of the final
regulations adopting the rules.
Conforming Amendments to Other Regulations and Guidance
The Treasury Department and the IRS intend to make conforming
amendments to other regulations, including the cost recovery rules that
are not being revised in these proposed regulations and the examples in
Sec. Sec. 1.901-2(b)(4)(iv) and 1.903-1(d), upon finalization of the
proposed regulations.
Special Analyses
I. Regulatory Planning and Review
The Administrator of the Office of Information and Regulatory
Affairs (``OIRA''), Office of Management and Budget, has determined
that this proposed rule is not a significant regulatory action, as that
term is defined in section 3(f) of Executive Order 12866. Therefore,
OIRA has not reviewed this proposed rule pursuant to section 6(a)(3)(A)
of Executive Order 12866 and the April 11, 2018, Memorandum of
Agreement between the Treasury Department and the Office of Management
and Budget (``OMB'').
II. Paperwork Reduction Act
The Paperwork Reduction Act of 1995 (44 U.S.C. 3501-3520) (``PRA'')
requires that a federal agency obtain the approval of the OMB before
collecting information from the public, whether such collection of
information is mandatory, voluntary, or required to obtain or retain a
benefit.
A. Overview
The collection of information in these proposed regulations is in
proposed Sec. 1.903-1(c)(2)(iv)(D). As discussed in part II.C.3 of the
Explanation of Provisions, proposed Sec. 1.903-1(c)(2)(iii)(B)
provides an exception (the ``single-country exception'') to the source-
based attribution requirement if a taxpayer can substantiate that the
payment on which the royalty withholding tax is imposed was made
pursuant to an agreement that limits the right to use intangible
property to the jurisdiction imposing the tested foreign tax. Proposed
Sec. 1.903-1(c)(2)(iv)(A). The exception applies only where the
taxpayer has a written license agreement that provides for the payment
of the royalty and that limits the use of the intangible property
giving rise to the royalty payment to the territory of the foreign
country imposing the tax. A payment may also qualify for the single-
country exception if the agreement separately states the portion
(whether as a specified amount or as a formula) of the payment subject
to the tested foreign tax that is characterized as a royalty and that
is with respect to the portion of the territory of the license that is
solely within the foreign country imposing the tax. Proposed Sec.
1.903-1(c)(2)(iv)(B).
Proposed Sec. 1.903-1(c)(2)(iv)(D) requires taxpayers who claim
eligibility for the exception to provide an agreement described in
proposed Sec. 1.903-1(c)(2)(iv)(A) or (B), as applicable, (the
``required agreement'') within 30 days of a request by the Commissioner
or another period as agreed between the Commissioner and the taxpayer.
Proposed Sec. 1.903-1(c)(2)(iv)(D) also provides a transition rule in
the case of a royalty paid on or before May 17, 2023, that requires the
required agreement to be executed no later than May 17, 2023.
B. Collection of Information--Proposed Sec. 1.903-1(c)(2)(iv)(D)
The Treasury Department and the IRS intend that the information
collection requirement in proposed Sec. 1.903-1(c)(2)(iv)(D) will be
set forth in the forms and instructions identified in Table 1.
[[Page 71278]]
Table 1--Tax Forms Impacted
------------------------------------------------------------------------
Number of Forms to which the
Collection of information respondents information may be
(estimated) attached
------------------------------------------------------------------------
Proposed Sec. 1.903- \2\ 42,030 Form 1116 and Form
1(c)(2)(iv)(D). 1118.
------------------------------------------------------------------------
Source: IRS's Compliance Data Warehouse.
The estimate for the number of impacted filers with respect to the
collection of information in proposed Sec. 1.903-1(c)(2)(iv)(D) is
based on the number of U.S. corporations that filed a return that had a
Form 1118 that reported an amount of withholding tax on rents,
royalties, and license fees on Schedule B, Part I, column e; U.S.
corporations that filed a return that had a Form 1118 that reported an
amount of deemed paid taxes and a Form 5471 that reported an amount of
gross royalties and license fees on Schedule C (and thus may have
incurred a withholding tax on those royalties); and U.S. individuals
that filed a return and had a Form 1116 that reported an amount of
withholding tax on rents and royalties on Part II, column n.\3\ This
represents an upper bound of potentially affected taxpayers: not all
taxpayers that have reported an amount of royalty withholding tax paid
to a foreign country or that have royalty income on which they may have
paid a withholding tax are expected to claim a credit for such tax, and
not all taxpayers who claim such a credit are expected to rely on the
single country exception in proposed Sec. 1.903-1(c)(2)(iii)(B).
---------------------------------------------------------------------------
\2\ The estimated number of respondents in this Table 1 is based
on the number of respondents from the 2020 tax year.
\3\ As explained in part II.C.3 of the Explanation of
Provisions, the collection of information in proposed Sec. 1.903-
1(c)(2)(iv)(D) also impacts partnerships and S corporations that pay
a withholding tax that is imposed at the partnership or S
corporation level under foreign law even though it is the partners
or S corporation shareholder that claims the credit for those taxes.
The Treasury Department and the IRS lack sufficient data to identify
the number of partnerships and S corporations that pay foreign
withholding taxes on royalty income. However, the IRS and Treasury
Department do not expect that this will impact the number of
affected taxpayers since the partners and shareholders that claim a
credit for the royalty withholding tax would be captured within the
Form 1116 and Form 1118 filers.
---------------------------------------------------------------------------
The Treasury Department and the IRS expect that taxpayers subject
to the collection of information in proposed Sec. 1.903-1(c)(2)(iv)(D)
will not have a significant increase in burden (if any) because some
taxpayers may already have existing license agreements that qualify for
the single-country exception in place for a variety of tax and non-tax
law reasons, and other taxpayers may not elect to take advantage of the
single-country exception. The reporting burden associated with this
collection of information will be reflected in future PRA submissions
associated with Form 1118 (OMB control number 1545-0123), Form 1065
(OMB control number 1545-0123), and Form 1116 (OMB control numbers
1545-0074 for individuals, and 1545-0121 for estates and trusts). The
collection of information in proposed Sec. 1.903-1(c)(2)(iv)(D) will
be reflected in future Paperwork Reduction Act submissions that the
Treasury Department and the IRS will submit to OMB for these forms. The
current status of the Paperwork Reduction Act submissions related to
these forms is summarized in Table 2.
Because the proposed regulations, including the collection of
information in proposed Sec. 1.903-1(c)(2)(iv)(D), are proposed to
apply to taxes paid in taxable years ending on or after the date the
proposed regulations are filed with the Federal Register, the Treasury
Department and the IRS have submitted the collection of information in
proposed Sec. 1.903-1(c)(2)(iv)(D) to the OMB for review in accordance
with the Paperwork Reduction Act and requested a new OMB control number
(the ``temporary OMB control number''). After the rulemaking is
finalized, the information collection contained within the regulations
will be incorporated into the OMB control numbers described in Table 2.
Table 2--Status of Current Paperwork Reduction Submissions
----------------------------------------------------------------------------------------------------------------
Incorporated into
Temporary OMB OMB control No.(s)
Form Type of filer control No. after final
rulemaking
----------------------------------------------------------------------------------------------------------------
Form 1116................................. Trusts & estates............ 1545-NEW 1545-0121
Individual.................. 1545-NEW 1545-0074
Form 1118................................. Business.................... 1545-NEW 1545-0123
----------------------------------------------------------------------------------------------------------------
Commenters are strongly encouraged to submit public comments
electronically. Comments and recommendations for the proposed
information collection should be sent to <a href="https://www.reginfo.gov/public/do/PRAMain">https://www.reginfo.gov/public/do/PRAMain</a>, with electronic copies emailed to the IRS at
<a href="/cdn-cgi/l/email-protection#1e6e6c7f307d7173737b706a6d5e776c6d30797168"><span class="__cf_email__" data-cfemail="d9a9abb8f7bab6b4b4bcb7adaa99b0abaaf7beb6af">[email protected]</span></a> (indicate REG-112096-22 on the subject line). This
particular information collection can be found by selecting ``Currently
under Review--Open for Public Comments'' then by using the search
function. Comments can also be mailed to OMB, Attn: Desk Officer for
the Department of the Treasury, Office of Information and Regulatory
Affairs, Washington, DC 20503, with copies mailed to the IRS, Attn: IRS
Reports Clearance Officer, SE:W:CAR:MP:T:T:SP, Washington, DC 20224.
Comments on the collections of information should be received by
January 23, 2023.
The likely respondents associated with the temporary OMB control
number are U.S. persons who pay or accrue foreign withholding taxes on
royalty income.
Estimated total annual reporting burden: 420,300 hours.
Estimated average annual burden per respondent: 10 hours.
Estimated number of respondents: 42,030.
Estimated frequency of responses: Annually.
The Treasury Department and the IRS expect to add the burden for
this
[[Page 71279]]
temporary OMB control number to OMB control numbers 1545-0123, 1545-
0074, and 1545-0121 after the final rulemaking. For 1545-0123 and 1545-
0074, the Treasury Department and the IRS estimate burdens on a
taxpayer-type basis rather than a provision-specific basis.
III. Regulatory Flexibility Act
Pursuant to the Regulatory Flexibility Act (5 U.S.C. chapter 6), it
is hereby certified that the proposed regulations will not have a
significant economic impact on a substantial number of small entities
within the meaning of section 601(6) of the Regulatory Flexibility Act.
The proposed regulations provide guidance affecting individuals and
corporations claiming foreign tax credits. The domestic small business
entities that are subject to the foreign tax credit rules in the Code
and in the proposed regulations are generally those that operate in a
foreign country or that have income from sources outside of the United
States and pay foreign taxes. The reattribution asset definition in
proposed Sec. 1.861-20(d)(3)(v)(E)(6) applies only to taxable units
that make or receive disregarded payments that are considered
reattribution payments which result in the reattribution of assets from
one taxable unit to another. Sec. 1.861-20(d)(3)(v)(C)(1)(ii). In
addition, some provisions of these proposed regulations, such as
proposed Sec. 1.903-1, apply only to entities that license
intellectual property for use in a foreign country and receive royalty
payments that are subject to foreign withholding tax. The Treasury
Department and the IRS do not expect that the proposed regulations will
likely affect a substantial number of domestic small business entities
because it is infrequent for domestic small entities to engage in
significant foreign operations or in the types of transactions giving
rise to the foreign taxes addressed by these proposed regulations.
However, the Treasury Department and the IRS do not have adequate data
readily available to assess the number of small entities potentially
affected by the final regulations.
The Treasury Department and the IRS have determined that the
proposed regulations will not have a significant economic impact on
domestic small business entities. To provide an upper bound estimate of
the impact these final regulations could have on business entities, the
Treasury Department and the IRS calculated, based on e-file data for
the 2020 tax year, foreign tax credits as a percentage of four
different tax-related measures of annual receipts (see Table 3 for
variables) by corporations. As demonstrated by the data in Table 3
below, foreign tax credits as a percentage of all four measures of
annual receipts are substantially less than the three to five percent
threshold for significant economic impact for corporations with
business receipts less than $250 million.
Table 3--FTCs as Percentage of Annual Receipts
--------------------------------------------------------------------------------------------------------------------------------------------------------
Under $500k to $1M to $5M to $10M to $50M to $100M to $250M or
Size (by business receipts) $500k $1M $5M $10M $50M $100M $250M more
--------------------------------------------------------------------------------------------------------------------------------------------------------
FTC/Gross Receipts (%).......................................... 0.00 0.00 0.00 0.01 0.01 0.02 0.03 0.05
FTC/Business Receipts (%)....................................... 0.00 0.00 0.00 0.00 0.01 0.02 0.03 0.05
FTC/Total Income (%)............................................ 0.00 0.00 0.00 0.01 0.02 0.04 0.07 0.57
FTC/(Total Income--Total Deductions) (%)........................ -0.02 0.03 0.05 0.11 0.16 0.41 0.72 3.33
--------------------------------------------------------------------------------------------------------------------------------------------------------
Source: RAAS:KDA (Tax Year 2020 CDW E-File Data 9-26-22).
Note: Business Receipts = Total Income + Cost of Goods Sold.
The Treasury Department and the IRS anticipate that only a small
fraction of existing foreign tax credits would be impacted by these
regulations, and thus, the economic impact of these regulations will be
considerably smaller than the effects shown in Table 3. A portion of
economic impact of these proposed regulations derive from the
collection of information requirement in proposed Sec. 1.903-
1(c)(2)(iv)(D). The Treasury Department and the IRS do not have readily
available data to determine the incremental burden that this collection
of information will have on small business entities. However, the
Treasury Department and the IRS believe this collection of information
will only marginally increase taxpayers' burdens because some taxpayers
may already have existing license agreements that qualify for the
single-country exception for a variety of tax and non-tax law reasons,
and other taxpayers may not elect to take advantage of the single-
country exception. Furthermore, as demonstrated in Table 3 in this Part
III of the Special Analyses, foreign tax credits do not have a
significant economic impact for any gross-receipts class of business
entities. Therefore, proposed Sec. 1.903-1(c)(2)(iv)(D) will not have
a significant economic impact on small business entities. Accordingly,
it is hereby certified that the proposed regulations will not have a
significant economic impact on a substantial number of small entities.
IV. Section 7805(f)
Pursuant to section 7805(f), these proposed regulations will be
submitted to the Chief Counsel for Advocacy of the Small Business
Administration for comment on its impact on small businesses. The
Treasury Department and the IRS also request comments from the public
on the certifications in this Part III of the Special Analyses.
V. Unfunded Mandates Reform Act
Section 202 of the Unfunded Mandates Reform Act of 1995 (UMRA)
requires that agencies assess anticipated costs and benefits and take
certain other actions before issuing a final rule that includes any
Federal mandate that may result in expenditures in any one year by a
state, local, or tribal government, in the aggregate, or by the private
sector, of $100 million in 1995 dollars, updated annually for
inflation. This proposed rule does not include any Federal mandate that
may result in expenditures by state, local, or tribal governments, or
by the private sector in excess of that threshold.
VI. Executive Order 13132: Federalism
Executive Order 13132 (entitled ``Federalism'') prohibits an agency
from publishing any rule that has federalism implications if the rule
either imposes substantial, direct compliance costs on State and local
governments, and is not required by statute, or preempts State law,
unless the agency meets the consultation and funding requirements of
section 6 of the Executive order. This proposed rule does not have
federalism implications and does not impose substantial direct
compliance costs on state and local governments or preempt State law
within the meaning of the Executive order.
[[Page 71280]]
Comments and Request for Public Hearing
Before these proposed regulations are adopted as final regulations,
consideration will be given to any comments that are submitted timely
to the IRS as prescribed in this preamble under the ADDRESSES heading.
The Treasury Department and the IRS request comments on all aspects of
the proposed rules, and specifically on the issues identified in Parts
I.B and II.C.3 of the Explanation of Provisions. All comments will be
available at <a href="http://www.regulations.gov">www.regulations.gov</a> or upon request.
A public hearing will be scheduled if requested in writing by any
person that timely submits written comments. Requests for a public
hearing are encouraged to be made electronically. If a public hearing
is scheduled, notice of the date and time for the public hearing will
be published in the Federal Register. Announcement 2020-4, 2020-17 IRB
1, provides that until further notice, public hearings conducted by the
IRS will be held telephonically. Any telephonic hearing will be made
accessible to people with disabilities.
Drafting Information
The principal authors of the proposed regulations are Jeffrey L.
Parry, Teisha M. Ruggiero, and Suzanne M. Walsh of the Office of
Associate Chief Counsel (International). However, other personnel from
the Treasury Department and the IRS participated in their development.
List of Subjects in 26 CFR Part 1
Income taxes, Reporting and recordkeeping requirements.
Proposed Amendments to the Regulations
Accordingly, the Treasury Department and IRS propose to amend 26
CFR part 1 as follows:
PART 1--INCOME TAXES
0
Paragraph 1. The authority citation for part 1 continues to read in
part as follows:
Authority: 26 U.S.C. 7805 * * *
0
Par. 2. Section 1.861-20 is amended by revising paragraphs
(d)(3)(v)(E)(6) and (i) to read as follows:
Sec. 1.861-20 Allocation and apportionment of foreign income taxes.
* * * * *
(d) * * *
(3) * * *
(v) * * *
(E) * * *
(6) Reattribution asset. The term reattribution asset means an
asset that produces one or more items of gross income, computed under
Federal income tax law, to which a disregarded payment, other than a
disregarded payment received in exchange for property, is allocated
under the rules of paragraph (d)(3)(v)(B)(2) of this section.
* * * * *
(i) Applicability dates. (1) Except as provided in paragraphs
(i)(2) through (4) of this section, this section applies to taxable
years beginning after December 31, 2019.
(2) Paragraphs (b)(19) and (23) and (d)(3)(i), (ii), and (v) of
this section apply to taxable years that begin after December 31, 2019,
and end on or after November 2, 2020.
(3) Paragraph (d)(3)(v)(E)(6) of this section applies to taxable
years that end on or after [date the final rule is filed with the
Federal Register]. Taxpayers may choose to apply the rules in paragraph
(d)(3)(v)(E)(6) of this section to taxable years beginning after
December 31, 2019, and ending before [date the final rule is filed with
the Federal Register], provided they apply paragraph (d)(3)(v)(E)(6) of
this section consistently to their first taxable year beginning after
December 31, 2019, and any subsequent taxable year beginning before
[date the final rule is filed with the Federal Register]. Otherwise,
for taxable years beginning after December 31, 2019, and ending before
[date the final rule is filed with the Federal Register], see Sec.
1.861-20(d)(3)(v)(E)(6) as contained in 26 CFR part 1 revised as of
July 27, 2022.
(4) Paragraph (h) of this section applies to taxable years
beginning after December 28, 2021.
0
Par 3. Section 1.901-2 is amended:
0
1. By revising paragraph (b)(4)(i)(A).
0
2. By redesignating paragraphs (b)(4)(i)(B), (b)(4)(i)(C)(3), and
(b)(4)(i)(D) as paragraph (b)(4)(i)(G), (b)(4)(i)(D), and (b)(4)(i)(E),
respectively.
0
3. By adding new paragraph (b)(4)(i)(B).
0
4. By revising paragraph (b)(4)(i)(C).
0
5. By revising the first sentence of newly redesignated paragraph
(b)(4)(i)(D).
0
6. By adding paragraph (b)(4)(i)(F).
0
7. In newly redesignated paragraph (b)(4)(i)(G)(1), by removing the
language ``one or more significant costs and expenses'' and adding the
language ``substantially all of each item of significant cost or
expense'' in its place.
0
8. In paragraph (b)(4)(iv)(A)(2), by removing the language
``significant costs and expenses'' and adding the language
``substantially all of each item of significant cost or expense'' in
its place.
0
9. In paragraph (b)(4)(iv)(B)(2), by removing the language
``(b)(4)(i)(B)(2)'' and adding the language ``(b)(4)(i)(G)(2)'' in its
place.
0
10. By removing and reserving paragraph (b)(4)(iv)(C).
0
11. In paragraphs (b)(4)(iv)(D)(2) and (b)(4)(iv)(E)(2), by removing
the language ``(b)(4)(i)(C)(2)'' and adding the language
``(b)(4)(i)(F)(2)'' in its place.
0
12. By adding paragraphs (b)(4)(iv)(F) through (J).
0
13. By revising paragraphs (b)(5)(i)(B)(2), (d)(1)(iii), and (h).
The revisions and additions read as follows:
Sec. 1.901-2 Income, war profits, or excess profits tax paid or
accrued.
* * * * *
(b) * * *
(4) * * *
(i) * * *
(A) In general. A foreign tax satisfies the cost recovery
requirement if the base of the tax is computed by reducing gross
receipts (as described in paragraph (b)(3) of this section) to permit
recovery of substantially all of each item of significant cost or
expense (including each item of cost or expense related to the
categories described in paragraph (b)(4)(i)(B)(2) of this section)
attributable, under reasonable principles, to such gross receipts. See
paragraph (b)(4)(i)(B) of this section for rules regarding the
determination of what is a significant cost or expense, paragraph
(b)(4)(i)(C) of this section for rules regarding the recovery of
substantially all of an item, paragraph (b)(4)(i)(E) of this section
for rules regarding principles for attributing costs and expenses to
gross receipts, and paragraph (b)(4)(i)(F) of this section for
exceptions to this rule. A foreign tax need not permit recovery of
significant costs and expenses, such as certain personal expenses, that
are not attributable, under reasonable principles, to gross receipts
included in the foreign tax base. A foreign tax whose base is gross
receipts, with no reduction for costs and expenses, satisfies the cost
recovery requirement only if there are no significant costs and
expenses described in paragraph (b)(4)(i)(B) of this section
attributable to the gross receipts included in the foreign tax base.
See paragraph (b)(4)(iv)(A) of this section (Example 1). A foreign tax
that provides an alternative cost allowance satisfies the cost recovery
requirement only as provided in paragraph (b)(4)(i)(G) of this section.
(B) Significant costs and expenses--(1) In general. Except as
provided in paragraph (b)(4)(i)(B)(2) of this section, whether an item
of cost or expense is significant for purposes of this paragraph
(b)(4)(i) is determined based
[[Page 71281]]
on whether, for all taxpayers in the aggregate to which the foreign tax
applies, the item of cost or expense constitutes a significant portion
of the taxpayers' total costs and expenses.
(2) Per se significant costs and expenses. An item of cost or
expense (as characterized under foreign law) related to capital
expenditures, interest, rents, royalties, wages or other payments for
services, and research and experimentation is always treated as an item
of significant cost or expense for purposes of this paragraph
(b)(4)(i).
(C) Recovery of substantially all of each item--(1) In general.
Whether a foreign tax permits recovery of substantially all of each
item of significant cost or expense is determined based solely on the
terms of the foreign tax law.
(2) Safe harbor. One or more disallowances of a stated portion of
an item (or multiple items) of significant cost or expense does not
prevent a foreign tax from being considered to permit recovery of
substantially all of each item of significant cost or expense if the
total portion of the item (or items) that is disallowed does not exceed
25 percent. A limitation that caps the recovery of an item of
significant cost or expense, or multiple items of cost or expense that
relate to a single category of significant costs and expenses described
in paragraph (b)(4)(i)(B)(2) of this section does not prevent a foreign
tax from being considered to permit recovery of substantially all of
each item of significant cost or expense if the limitation is a
qualifying cap. For such purpose, a limitation that caps the recovery
at a stated portion of gross receipts, gross income, or a similar
measure is a qualifying cap if the stated portion of such measure is
not less than 15 percent. A limitation that caps the recovery at a
stated portion of taxable income (determined without regard to the item
at issue) or a similar measure is a qualifying cap if the stated
portion of such measure is not less than 30 percent.
(3) Non-recovery of significant costs and expenses. Significant
costs and expenses (such as interest expense) are not considered to be
recovered by reason of the time value of money attributable to the
acceleration of a tax benefit or economic benefit attributable to the
timing of the recovery of other costs and expenses (such as the current
expensing of debt-financed capital expenditures).
(D) * * * A foreign tax law permits recovery of substantially all
of each item of significant cost or expense even if such item of cost
or expense is recovered earlier or later than it is recovered under the
Internal Revenue Code unless the time of recovery is so much later as
effectively to constitute a denial of such recovery. * * *
* * * * *
(F) Exceptions--(1) Disallowances consistent with U.S. principles.
Notwithstanding paragraph (b)(4)(i)(A) of this section, a disallowance
of all or a portion of an item of significant cost or expense does not
prevent a foreign tax from satisfying the cost recovery requirement if
such disallowance is consistent with any principle underlying the
disallowances required under the income tax provisions of the Internal
Revenue Code, including the principles of limiting base erosion or
profit shifting and addressing non-tax public policy concerns similar
to those reflected in the Internal Revenue Code. For example, a foreign
tax may satisfy the cost recovery requirement even if the foreign tax
law disallows deductions in connection with hybrid transactions,
disallows deductions attributable to gross receipts that in whole or in
part are excluded, exempt or eliminated from taxable income, or
disallows certain deductions consistent with non-tax public policy
considerations similar to those underlying the disallowances contained
in section 162. See paragraphs (b)(4)(iv)(I) and (J) of this section
(Examples 9 and 10).
(2) Amounts that need not be recovered. A foreign tax law may
satisfy the cost recovery requirement even if the foreign tax law does
not permit recovery of costs and expenses attributable to wage income
or to investment income that is not derived from a trade or business.
In addition, in determining whether a foreign tax (the ``tested foreign
tax'') meets the cost recovery requirement, it is immaterial whether
the tested foreign tax allows a deduction for other taxes that would
qualify as foreign income taxes (determined without regard to whether
such other tax allows a deduction for the tested foreign tax). See
paragraphs (b)(4)(iv)(D) and (E) of this section (Examples 4 and 5).
* * * * *
(iv) * * *
(F) Example 6: Substantially all; application of the safe
harbor--(1) Facts. Country X imposes a tax (``Country X tax'') on
the income of corporations that are resident in Country X. Under
Country X tax law, full deductions are allowed for each item of
significant cost or expense attributable under reasonable principles
to the gross receipts included in the Country X tax base, except
that Country X tax law disallows a deduction for 25 percent of a
taxpayer's costs and expenses for royalties related to patents.
(2) Analysis. Under paragraph (b)(4)(i)(B)(2) of this section,
an item of cost or expense related to royalties is always treated as
a significant cost or expense, and therefore, under paragraph
(b)(4)(i)(A) of this section, absent an exception, Country X tax law
must permit recovery of substantially all of each item of cost or
expense related to royalties, including the item of royalties
related to patents. The stated percentage of costs and expenses from
royalties related to patents (25 percent) that is disallowed under
Country X tax law does not exceed 25 percent. Accordingly, under the
safe harbor in paragraph (b)(4)(i)(C)(2) of this section, the
disallowance does not prevent the Country X tax from being
considered to permit recovery of substantially all of each item of
cost or expense related to royalties, and therefore the Country X
tax satisfies the cost recovery requirement.
(G) Example 7: Substantially all; application of the safe
harbor--(1) Facts. Country X imposes a tax (``Country X tax'') on
the income of corporations that are resident in Country X. Under
Country X tax law, full deductions are allowed for each item of
significant cost or expense attributable under reasonable principles
to the gross receipts included in the Country X tax base, except
that Country X tax law disallows a deduction for 15 percent of a
taxpayer's costs and expenses for rents and 25 percent of a
taxpayer's costs and expenses for interest.
(2) Analysis. Under paragraph (b)(4)(i)(B)(2) of this section,
an item of cost or expense related to rents or interest is always
treated as a significant cost or expense, and therefore, under
paragraph (b)(4)(i)(A) of this section, absent an exception, Country
X tax law must permit recovery of substantially all of each item of
cost or expense related to royalties and interest. The stated
percentage of the costs and expenses related to rents (15 percent)
that is disallowed under Country X tax law does not exceed 25
percent. Additionally, the stated percentage of the costs and
expenses related to interest (25 percent) that is disallowed under
Country X law does not exceed 25 percent. Accordingly, under the
safe harbor in paragraph (b)(4)(i)(C)(2) of this section, the
disallowances do not prevent the Country X tax from being considered
to permit recovery of substantially all of each item of cost or
expense related to rents and interest, and therefore the Country X
tax satisfies the cost recovery requirement.
(H) Example 8: Substantially all; application of the safe
harbor--(1) Facts. Country X imposes a tax (``Country X tax'') on
the income of corporations that are resident in Country X. Under
Country X tax law, full deductions are allowed for each item of
significant cost or expense attributable under reasonable principles
to the gross receipts included in the Country X tax base, except
that Country X tax law caps the recovery of the deduction of
interest at 30 percent of the taxpayer's taxable income determined
without regard to interest expense.
(2) Analysis. Under paragraph (b)(4)(i)(B)(2) of this section,
an item of cost or expense related to interest is always
[[Page 71282]]
treated as a significant cost or expense, and therefore, under
paragraph (b)(4)(i)(A) of this section, absent an exception, Country
X tax law must permit recovery of substantially all of each item of
cost or expense related to interest. The stated cap on recovery in
Country X tax law with respect to interest (30 percent of taxable
income determined without regard to interest expense) is not less
than 30 percent of taxable income determined without regard to
interest expense. Additionally, the cap on recovery relates to a
single category of significant costs and expenses described in
paragraph (b)(4)(i)(B)(2) of this section. Accordingly, under the
safe harbor in paragraph (b)(4)(i)(C)(2) of this section, the
disallowance does not prevent the Country X tax from being
considered to permit recovery of substantially all of each item of
cost or expense related to interest, and therefore the Country X tax
satisfies the cost recovery requirement.
(I) Example 9: Permissible disallowance based on U.S.
principles--(1) Facts. Country X imposes a tax on the income of
corporations that are resident in Country X. Under Country X tax
law, full deductions are allowed for each item of significant cost
or expense attributable under reasonable principles to the gross
receipts included in the Country X tax base, except that under
Country X's anti-hybrid rules, a deduction is disallowed for any
payment, including interest, royalties, rents, or payments for
services, made by a Country X resident to a related entity located
outside of Country X if the payment is not included in gross income
by the payee or the payee is not subject to tax.
(2) Analysis. Under paragraph (b)(4)(i)(B)(2) of this section,
each item of cost or expense related to interest, rents, royalties,
and payments for services is always treated as a significant cost or
expense, and therefore, under paragraph (b)(4)(i)(A) of this
section, absent an exception, Country X tax law must permit recovery
of substantially all of each item of cost or expense related to
interest, rents, royalties, and payments for services. Country X tax
law does not permit recovery of any portion of any item of
significant cost or expense that is subject to the anti-hybrid
rules. As a result, the safe harbor in paragraph (b)(4)(i)(C)(2) of
this section does not apply to such item. Further, because a
deduction is disallowed for any item of cost or expense that is
subject to the Country X anti-hybrid rules, the Country X tax law
completely disallows certain items of cost and expense related to
interest, rents, royalties, and payments for services and thus does
not permit recovery of substantially all of each item of significant
cost or expense related to interest, rents, royalties, and payments
for services. However, under paragraph (b)(4)(i)(F)(1) of this
section, a disallowance of all or a portion of an item of
significant cost or expense does not prevent a foreign tax from
satisfying the cost recovery requirement if the disallowance is
consistent with any principle underlying the disallowances required
under the income tax provisions of the Internal Revenue Code. The
income tax provisions of the Internal Revenue Code, specifically
section 267A, contain disallowances of deductions based on the
principle of limiting base erosion or profit shifting. Country X's
disallowance of deductions for any payment, including interest,
royalties, rents, or payments for services also reflects the
principle of limiting base erosion or profit shifting. Accordingly,
because Country X's anti-hybrid rules are consistent with the
principle of limiting base erosion or profit shifting, the Country X
tax satisfies the cost recovery requirement.
(J) Example 10: Permissible disallowance based on U.S.
principles--(1) Facts. Country X imposes a tax on the income of
corporations that are resident in Country X. Under Country X tax
law, full deductions are allowed for each item of significant cost
or expense attributable to the gross receipts included in the
Country X tax base, except that no deduction is permitted for any
stock-based payments for services.
(2) Analysis. Under paragraph (b)(4)(i)(B)(2) of this section,
each item of cost or expense related to wages or other payments for
services is always treated as a significant cost or expense, and
therefore, under paragraph (b)(4)(i)(A) of this section, absent an
exception, Country X tax law must permit recovery of substantially
all of each item of cost or expense related to wages or other
payments for services. Country X tax law denies a deduction for any
stock-based payments for services, and therefore the safe harbor in
paragraph (b)(4)(i)(C)(2) of this section is not satisfied. Further,
given that no deduction is allowed for stock-based payments for
services, the Country X tax law completely disallows an item of cost
or expense related to wages or other payments for services and thus
does not permit recovery of substantially all of each item of
significant cost or expense related to wages or other payments for
services. However, under paragraph (b)(4)(i)(F)(1) of this section,
a disallowance of all or a portion of an item of significant cost or
expense does not prevent a foreign tax from satisfying the cost
recovery requirement if such disallowance is consistent with any
principle underlying the disallowances required under the income tax
provisions of the Internal Revenue Code. The income tax provisions
of the Internal Revenue Code contain targeted disallowances or
limits on the deductibility of certain items of compensation in
particular circumstances based on non-tax public policy reasons,
including to influence the amount or use of a certain type of
compensation in the labor market. For example, section 162(m)
imposes limits on deductions for compensation of certain highly-paid
employees, and section 280G limits the deductibility of certain
``parachute payments'' provided to individuals when an entity
undergoes a change of control. Country X's targeted disallowance of
deductions for the portion of payments for services attributable to
stock-based compensation also reflects a principle of influencing
the amount or use of a certain type of compensation (stock-based
compensation) in the labor market. Accordingly, because the Country
X tax law's disallowance is consistent with a principle underlying
the disallowances required under the income tax provisions of the
Internal Revenue Code, the Country X tax satisfies the cost recovery
requirement.
(5) * * *
(i) * * *
(B) * * *
(2) Royalties. Under the foreign tax law, gross income from
royalties must be sourced based on the place of use of, or the right to
use, the intangible property, as determined under reasonable principles
(which do not include determining the place of use of, or the right to
use, the intangible property based on the location of the payor).
* * * * *
(d) * * *
(1) * * *
(iii) Tax imposed on nonresidents--(A) In general. A foreign levy
imposed on nonresidents is always treated as a separate levy from that
imposed on residents, even if the base of the tax as applied to
residents and nonresidents is the same, and even if the levies are
treated as a single levy under foreign tax law.
(B) Withholding tax--(1) In general. Except as otherwise provided
in this paragraph (d)(1)(iii)(B), a withholding tax (as defined in
section 901(k)(1)(B)) that is imposed on a payment giving rise to gross
income of nonresidents is treated as a separate levy as to each
separate class of income described in section 61 (for example,
interest, dividends, rents, or royalties) subject to the withholding
tax.
(2) Subsets of income. If two or more subsets of a separate class
of income are subject to a withholding tax based on different income
attribution rules (for example, if technical services are subject to
tax based on the residence of the payor and other services are subject
to tax based on where the services are performed), separate levies are
considered to be imposed with respect to each subset of that separate
class of income.
(3) Royalty income. A withholding tax that is imposed on a payment
giving rise to gross royalty income of a nonresident that is made
pursuant to a single-country license (as determined under Sec. 1.903-
1(c)(2)(iv)) is treated as a separate levy from a withholding tax that
is imposed on other gross royalty income of such nonresident and is
also treated as a separate levy from any withholding tax imposed on
other nonresidents.
* * * * *
(h) Applicability dates--(1) In general. Except as provided in
paragraphs (h)(2) and (3) of this section, this section applies to
foreign taxes paid (within the meaning of paragraph (g) of this
section) in taxable years beginning on or after December 28, 2021. For
foreign taxes
[[Page 71283]]
that relate to (and if creditable are considered to accrue in) taxable
years beginning before December 28, 2021, and that are remitted in
taxable years beginning on or after December 28, 2021, by a taxpayer
that accounts for foreign income taxes on the accrual basis, see Sec.
1.901-2 as contained in 26 CFR part 1 revised as of April 1, 2021.
(2) Certain foreign taxes paid to Puerto Rico. For foreign taxes
paid to Puerto Rico by reason of section 1035.05 of the Puerto Rico
Internal Revenue Code of 2011, as amended (13 L.P.R.A. 30155) (treating
certain income, gain or loss as effectively connected with the active
conduct of a trade or business with Puerto Rico), this section applies
to foreign taxes paid (within the meaning of paragraph (g) of this
section) in taxable years beginning on or after January 1, 2023. For
foreign taxes described in the preceding sentence that are paid in
taxable years beginning before January 1, 2023, see Sec. 1.901-2 as
contained in 26 CFR part 1 revised as of April 1, 2021.
(3) Modifications to cost recovery and royalty attribution rules.
Paragraphs (b)(4)(i) and (iv), (b)(5)(i)(B)(2), and (d)(1)(iii) of this
section apply to foreign taxes paid (within the meaning of paragraph
(g) of this section) in taxable years ending on or after November 18,
2022. For foreign taxes described in the preceding sentence that are
paid in taxable years ending before November 18, 2022, see Sec. 1.901-
2(b)(4)(i) and (iv), (b)(5)(i)(B)(2), and (d)(1)(iii) as contained in
26 CFR part 1 revised as of July 27, 2022. Taxpayers may choose to
apply the rules in paragraphs (b)(4)(i) and (iv) of this section to
foreign taxes paid in taxable years beginning on or after December 28,
2021, and ending before November 18, 2022 provided that they
consistently apply those rules to such taxable years. Additionally,
taxpayers may choose to apply the rules of paragraphs (b)(5)(i)(B)(2)
and (d)(1)(iii) of this section to foreign taxes paid in taxable years
beginning on or after December 28, 2021, and ending before November 18,
2022, provided that they consistently apply those rules and the rules
of Sec. 1.903-1(c)(2) and (d)(3), (4), and (8) through (11) to such
taxable years.
* * * * *
0
Par 4. Section 1.903-1 is amended:
0
1. By revising paragraphs (c)(2) introductory text and (c)(2)(iii).
0
2. By adding paragraph (c)(2)(iv).
0
3. By revising paragraph (d)(3).
0
4. By removing and reserving paragraph (d)(4).
0
5. By adding paragraphs (d)(8) through (11).
0
6. By revising paragraph (e).
The revisions and additions read as follows:
Sec. 1.903-1 Taxes in lieu of income taxes.
* * * * *
(c) * * *
(2) Covered withholding tax. A tested foreign tax is a covered
withholding tax if, based on the foreign tax law (except as provided in
paragraph (c)(2)(iii)(B) of this section), the requirements in
paragraphs (c)(1)(i) and (c)(2)(i) through (iii) of this section are
met with respect to the tested foreign tax. See also Sec. 1.901-
2(d)(1)(iii) for rules treating withholding taxes as separate levies
with respect to each class of income subject to the tax, with respect
to each subset of a class of income that is subject to different income
attribution rules, or with respect to withholding tax that is imposed
on a payment giving rise to gross royalty income of a nonresident that
is made pursuant to a single-country license (as determined under
paragraph (c)(2)(iv) of this section).
* * * * *
(iii) Source-based attribution requirement. The income subject to
the tested foreign tax satisfies the requirements in paragraph
(c)(2)(iii)(A) or (B) of this section.
(A) The income subject to the tested foreign tax satisfies the
attribution requirement described in Sec. 1.901-2(b)(5)(i)(B).
(B) The income subject to the tested foreign tax is characterized
as royalty income and the payment giving rise to such income is made
pursuant to a single-country license as determined under paragraph
(c)(2)(iv) of this section. For purposes of this paragraph
(c)(2)(iii)(B) and paragraph (c)(2)(iv) of this section, whether the
income is characterized as royalty income is determined under the
foreign tax law, except that income from the sale of a copyrighted
article (as determined under rules similar to Sec. 1.861-18) is not
characterized as royalty income regardless of the characterization of
the income under the foreign tax law.
(iv) Single-country license--(A) In general. Except as otherwise
provided in this paragraph (c)(2)(iv), for purposes of paragraph
(c)(2)(iii)(B) of this section, a payment is made pursuant to a single-
country license if the terms of the license agreement pursuant to which
the payment is made characterize the payment as a royalty and limit the
territory of the license to the foreign country imposing the tested
foreign tax.
(B) Separately stated portions. If a written agreement that is not
described in paragraph (c)(2)(iv)(A) of this section separately states
a portion (whether as a specified amount or as a formula) of the
payment subject to the tested foreign tax and such portion is both
characterized as a royalty under the terms of the agreement and is
attributable to the part of the territory of the license that is solely
within the foreign country imposing the tested foreign tax, then that
portion of the payment is treated as made pursuant to a single-country
license.
(C) Validity of agreement. A payment is considered not made
pursuant to a single-country license if the taxpayer knows, or has
reason to know, that the terms of the agreement pursuant to which the
payment is made misstate the territory in which the relevant intangible
property is used or overstate the amount of the royalty with respect to
the part of the territory of the license that is solely within the
foreign country imposing the tested foreign tax. A taxpayer is
considered to have reason to know if its knowledge of relevant of facts
or circumstances is such that a reasonably prudent person in the
position of the taxpayer would question whether the terms of the
agreement misstate the territory in which the relevant intangible
property is used or overstate the amount of a royalty. For purposes of
this section, the principles of sections 482 and 861 apply to determine
whether the terms of the agreement misstate the territory in which the
relevant intangible property is used or overstate the amount of a
royalty. See paragraph (d)(11) of this section (Example 11).
(D) Documentation. A taxpayer must provide the agreement described
in paragraph (c)(2)(iv)(A) or (B) of this section, as applicable (the
``required agreement''), within 30 days of a request by the
Commissioner or another period as agreed between the Commissioner and
the taxpayer. Except as provided in the next sentence, the required
agreement pursuant to which the royalty is paid must be executed no
later than the date of payment that gives rise to the gross royalty
income that is subject to the tested foreign tax. In the case of a
royalty that is paid before the date on which the required agreement is
executed, in order to meet the requirement of this paragraph
(c)(2)(iv)(D), the required agreement must be executed no later than
May 17, 2023, and the agreement must state that royalties paid on or
before the date of execution of the agreement are, for purposes of this
paragraph (c)(2)(iv), considered paid pursuant to the terms of the
agreement.
(d) * * *
[[Page 71284]]
(3) Example 3: Withholding tax on royalties; attribution
requirement--(i) Facts. YCo, a resident of Country Y, is a
controlled foreign corporation wholly owned by USP, a domestic
corporation. In Year 1, YCo enters into a written license agreement
(the ``Agreement'') with XCo, a resident of Country X unrelated to
YCo or USP, for the right to use YCo's intangible property (``IP'')
in a territory defined by the Agreement as the entire world,
including Country X, in exchange for payments that the terms of the
Agreement characterize as royalties. The payments made by XCo to YCo
under the Agreement are also characterized as royalties under the
laws of Country X. Under Country X's tax law, all gross royalty
payments made by a Country X resident to a nonresident are treated
as giving rise to Country X source income and are subject to a 20
percent withholding tax, regardless of whether the nonresident payee
has a taxable presence in Country X. Country X has a generally-
imposed net income tax within the meaning of paragraph (c)(1)(i) of
this section, and nonresidents subject to the withholding tax on
royalties are not also subject to a Country X net income tax on
their royalty income. In Year 1, XCo withholds 20u (units of Country
X currency) of tax on a 100u royalty paid to YCo under the
Agreement.
(ii) Analysis--(A) Separate levy. Under Sec. 1.901-
2(d)(1)(iii)(B)(1), Country X's withholding tax imposed on gross
royalty income of nonresidents is treated as a separate levy. Under
Sec. 1.901-2(d)(1)(iii)(B)(3), the 20u of Country X withholding tax
imposed on the 100u of royalties paid by XCo to YCo is treated as a
separate levy from the Country X withholding tax on royalties if the
Agreement pursuant to which the royalties are paid is a single-
country license under paragraph (c)(2)(iv) of this section. The
Agreement does not meet the requirements of paragraph (c)(2)(iv) of
this section because it neither limits the territory of the license
to Country X nor separately states the portion of the payment that
is with respect to the part of the territory of the license that is
solely within Country X. Thus, the 20u of Country X withholding tax
paid by YCo is not treated as a separate levy under Sec. 1.901-
2(d)(1)(iii)(B)(3).
(B) Covered withholding tax. Under paragraph (c)(2) of this
section, a tested foreign tax is a covered withholding tax if
paragraphs (c)(1)(i) and (c)(2)(i) through (iii) of this section are
met. Country X's withholding tax on royalties meets the requirements
of paragraphs (c)(1)(i) and (c)(2)(i) and (ii) of this section
because Country X has a generally-imposed net income tax, Country
X's withholding tax on the royalties paid pursuant to the Agreement
is imposed on the gross royalty income of persons who are
nonresidents of Country X, and nonresidents subject to the
withholding tax on royalties are not also subject to the Country X
generally-imposed net income tax on their royalty income. However,
the Country X withholding tax on royalties paid pursuant to the
Agreement does not meet the requirements of Sec. 1.901-
2(b)(5)(i)(B) and paragraph (c)(2)(iii)(A) of this section because
Country X's sourcing rule for royalties (based on residence of the
payor) is not based on the place of use of, or the right to use, the
intangible property. Additionally, the payment that is subject to
Country X's withholding tax is not made pursuant to a single-country
license under paragraph (c)(2)(iv) of this section for the reasons
described in paragraph (d)(3)(ii)(A) of this section (the separate
levy analysis of this paragraph (d)(3) (Example 3)). Therefore, the
requirement in paragraph (c)(2)(iii)(B) of this section is not met.
Accordingly, the Country X withholding tax paid by YCo is not a
covered withholding tax, and none of the 20u Country X withholding
tax paid by YCo with respect to the 100u royalty payment made to XCo
is a foreign income tax.
* * * * *
(8) Example 8: Withholding tax on royalties; single-country
license--(i) Facts. The facts are the same as in paragraph (d)(3)(i)
of this section (the facts of Example 3) except that in Year 1, YCo
enters into a written license agreement (the ``Agreement'') with XCo
for the right to use YCo's IP in a territory defined by the
Agreement as Country X, in exchange for payments that the terms of
the Agreement characterize as royalties, and XCo in fact only uses
the IP in Country X. In Year 1, XCo withholds 20u of tax from 100u
of royalties paid to YCo under the Agreement.
(ii) Analysis--(A) Separate levy. Under Sec. 1.901-
2(d)(1)(iii)(B)(1), Country X's withholding tax imposed on gross
royalty income of nonresidents is treated as a separate levy. Under
Sec. 1.901-2(d)(1)(iii)(B)(3), the 20u of Country X withholding tax
imposed on the 100u of royalties paid by XCo to YCo is treated as a
separate levy from the Country X withholding tax on royalties if the
Agreement pursuant to which the royalties are paid is a single-
country license under paragraph (c)(2)(iv) of this section. The
Agreement meets the requirements of paragraph (c)(2)(iv)(A) of this
section because it is a written license agreement that characterizes
the payment as a royalty and limits the territory of the license to
Country X. Thus, the 20u Country X withholding tax paid by YCo is
treated as a separate levy under Sec. 1.901-2(d)(1)(iii)(B)(3).
(B) Covered withholding tax. Under paragraph (c)(2) of this
section, a tested foreign tax is a covered withholding tax if
paragraphs (c)(1)(i) and (c)(2)(i) through (iii) of this section are
met. Country X has a generally-imposed net income tax, Country X's
withholding tax on the royalties paid pursuant to the Agreement is a
withholding tax that is imposed on the gross income of persons who
are nonresidents of Country X, and nonresidents subject to the
withholding tax on royalties paid pursuant to the Agreement are not
also subject to a net income tax on their royalty income. Thus, the
requirements of paragraphs (c)(1)(i) and (c)(2)(i) and (ii) of this
section are met. The withholding tax paid by YCo does not meet the
requirements of Sec. 1.901-2(b)(5)(i)(B) and paragraph
(c)(2)(iii)(A) of this section because Country X's source rule for
royalties (based on residence of the payor) is not based on the
place of use of, or the right to use, the intangible property.
However, the payment that is subject to Country X's withholding tax
is made pursuant to a single-country license under paragraph
(c)(2)(iv) of this section for the reasons described in paragraph
(d)(8)(ii)(A) of this section (the separate levy analysis of this
Example 8). Therefore, the requirement in paragraph (c)(2)(iii)(B)
of this section is met. Accordingly, the Country X withholding tax
on the payment made by XCo to YCo pursuant to the Agreement is a
covered withholding tax and all of the 20u of Country X withholding
tax paid by YCo with respect to the 100u of royalties under the
Agreement is a foreign income tax.
(9) Example 9: Withholding tax on royalties; separately stated
portion--(i) Facts. The facts are the same as in paragraph (d)(3)(i)
of this section (the facts of Example 3) except that in Year 1, YCo
enters into a written agreement (the ``Agreement'') with XCo for the
right to use YCo's IP in a territory defined by the Agreement as the
entire world, as well as for YCo to provide certain services to XCo
in Country Y, in exchange for a payment equal to 10 percent of XCo's
annual revenue. The Agreement provides a formula for determining the
amount of the payment that is characterized as a royalty and that is
with respect to the part of the territory that is within Country X
(the ``separately stated formula''). The separately stated formula
provides that the first 30u of the payment represents payment for
services provided by YCo, and that 40 percent of the remainder of
the payment represents payment of a royalty with respect to the part
of the territory of the license that is solely within Country X. The
portion of the payment by XCo to YCo that is characterized as
services income under the Agreement is also characterized as
services income under the laws of Country X. Additionally, all
payments by a resident of Country X for services provided by a
nonresident are treated as giving rise to Country X source income,
regardless of where the services are performed, and gross income
from services is subject to the same 20 percent withholding tax as
gross royalty income. In Year 1, XCo earns gross income of 1,800u
and pays YCo 180u under the Agreement. XCo withholds 12u of tax from
the 60u of royalties attributable to the part of the territory of
the license that is solely within Country X that are paid to YCo
under the separately stated formula in the Agreement. The portion of
the payment by XCo to YCo that is characterized as a royalty with
respect to the part of the territory of the license that is solely
within Country X under the separately stated formula in the
Agreement is also characterized as a royalty under the laws of
Country X. XCo withholds 24u of tax from the remaining 120u payment
paid to YCo under the Agreement, consisting of 6u of tax on the 30u
payment for services and 18u of tax on 90u of royalties. YCo does
not know, or have reason to know, that the terms of the Agreement
misstate the territory in which YCo's IP is used or overstate the
amount of the royalty with respect to the part of the territory of
the license that is solely within Country X.
(ii) Analysis--(A) Separately stated portion. The analysis is
the same as in paragraph (d)(8)(ii) of this section (the
[[Page 71285]]
analysis of Example 8), except that the portion of the payment that
is a royalty with respect to the part of the territory of the
license that is solely within Country X under the separately stated
formula in the Agreement is treated as made pursuant to a single-
country license under paragraph (c)(2)(iv) of this section because
the Agreement is a written agreement that separately states the
portion of the payment that is characterized as a royalty and that
is with respect to the part of the territory of the license that is
solely within Country X. Thus, the Country X withholding tax on the
portion of the payment from XCo to YCo that is a payment of a
royalty with respect to the part of the territory of the license
that is solely within Country X under the separately stated formula
under the Agreement is a separate levy and a covered withholding
tax. Accordingly, the 12u Country X withholding tax paid by YCo from
the 60u of royalties with respect to the part of the territory of
the license that is solely within Country X is a foreign income tax.
(B) Remaining portion of royalties. The analysis is the same as
paragraph (d)(3)(ii) of this section (the analysis of Example 3).
Specifically, the 18u Country X withholding tax on the 90u royalty
payment that is not with respect to the part of the territory that
is within Country X is neither a separate levy nor a covered
withholding tax. Accordingly, none of the 18u Country X withholding
tax paid by YCo with respect to the remaining 90u royalty payment
under the Agreement is a payment of foreign income tax.
(C) Services portion. Under Sec. 1.901-2(d)(1)(iii)(B)(1),
Country X's withholding tax imposed on gross services income of
nonresidents is a separate levy. The Country X withholding tax of 6u
on the 30u payment for services made by XCo to YCo under the
Agreement is not a covered withholding tax. The withholding tax paid
by YCo does not meet the requirements of Sec. 1.901-2(b)(5)(i)(B)
and paragraph (c)(2)(iii)(A) of this section because Country X's
sourcing rule for services (based on residence of the payor) is not
reasonably similar to the sourcing rule that applies under the
Internal Revenue Code (based on where the services are performed).
The special separate levy and covered withholding tax rules for
single-country licenses under Sec. 1.901-2(d)(1)(iii)(B)(3) and
paragraph (c)(2)(iii)(B) of this section do not apply to withholding
taxes on payments for services. Accordingly, none of the 6u of
Country X withholding tax paid by YCo with respect to the 30u
payment for services under the Agreement is a payment of foreign
income tax.
(10) Example 10: Characterization of payment--(i) Facts. The
facts are the same as in paragraph (d)(3)(i) of this section (the
facts of Example 3), except that in Year 1, YCo enters into a
written license agreement (the ``Agreement'') with XCo for the right
to use YCo's IP in a territory defined by the Agreement as Country
X, in exchange for a payment that the terms of the Agreement
characterize as a royalty, but that is characterized as a payment
for services under the laws of Country X, and all payments of
services paid by a resident of Country X to a nonresident are
treated as giving rise to Country X source income, regardless of
where the services are performed, and are subject to a 20 percent
withholding tax.
(ii) Analysis. Under Sec. 1.901-2(d)(1)(iii)(B)(1), Country X's
withholding tax imposed on gross services income of nonresidents is
a separate levy. The Country X withholding tax of 20u on the 100u
payment for services made by XCo to YCo under the Agreement is not a
covered withholding tax. The withholding tax paid by YCo does not
meet the requirements of Sec. 1.901-2(b)(5)(i)(B) and paragraph
(c)(2)(iii)(A) of this section because Country X's sourcing rule for
services (based on residence of the payor) is not reasonably similar
to the sourcing rule that applies under the Internal Revenue Code
(based on where the services are performed). The special separate
levy and covered withholding tax rules for single-country licenses
under Sec. 1.901-2(d)(1)(iii)(B)(3) and paragraph (c)(2)(iii)(B) of
this section do not apply to withholding taxes on income that is not
characterized as royalty income under the foreign tax law.
Accordingly, none of the 20u Country X withholding tax paid by YCo
with respect to the 100u paid under the Agreement is a payment of
foreign income tax.
(11) Example 11: Withholding tax on royalties, validity of
agreement--(i) Facts. The facts are the same as in paragraph
(d)(3)(i) of this section (the facts of Example 3), except that XCo
is a controlled foreign corporation wholly owned by USP.
Additionally, in Year 2, XCo and YCo cancel the written license
agreement entered into in Year 1 and YCo enters into two new written
license agreements with XCo, one agreement which grants XCo the
right to use certain YCo IP in a territory defined as Country X (the
``Country X Agreement''), and one of which grants XCo the right to
use the same YCo IP in a territory defined as the entire world
except for Country X (the ``Rest of World Agreement''). Both
agreements characterize the payments under the agreements as
royalties, and the payments are also characterized as royalties
under the laws of Country X. In Year 2, XCo withholds a total of 20u
of tax from a total of 100u of royalties paid to YCo under the
Country X Agreement and the Rest of World Agreement. Based on the
terms of each agreement, 18u of tax was withheld from 90u of
royalties paid to YCo under the Country X Agreement, and 2u of tax
from 10u of royalties paid to YCo under the Rest of World Agreement.
YCo knew or had reason to know that under the principles of sections
482 and 861, with respect to the 100u of royalties paid by XCo to
YCo, 40u is attributable to XCo's use of YCo IP in Country X and 60u
is attributable to use of YCo IP outside Country X.
(ii) Analysis--(A) Rest of World Agreement. The analysis is the
same as paragraph (d)(3)(ii) of this section (the analysis of
Example 3). Specifically, the 2u Country X withholding tax on the
10u royalty payment under the Rest of World Agreement is neither a
separate levy nor a covered withholding tax. Accordingly, none of
the 2u Country X withholding tax paid by YCo with respect to the 10u
royalty payment under the Rest of World Agreement is a payment of
foreign income tax.
(B) Country X Agreement. The analysis is the same as paragraph
(d)(3)(ii) of this section (the analysis of Example 3), except that
the reason that the Country X Agreement does not meet the
requirements of paragraph (c)(2)(iv) of this section is that YCo
knew or had reason to know that the terms of the Country X Agreement
overstate the amount of the royalty with respect to Country X. Thus,
the 18u Country X withholding tax on the 90u royalty payment under
the Country X Agreement is neither a separate levy nor a covered
withholding tax. Accordingly, none of the 18u Country X withholding
tax paid by YCo with respect to the 90u royalty payment under the
Country X Agreement is a payment of foreign income tax.
(e) Applicability dates--(1) In general. Except as provided in
paragraphs (e)(2) and (3) of this section, this section applies to
foreign taxes paid (within the meaning of Sec. 1.901-2(g)) in taxable
years beginning on or after December 28, 2021. For foreign taxes that
relate to (and if creditable are considered to accrue in) taxable years
beginning before December 28, 2021, and that are remitted in taxable
years beginning on or after December 28, 2021, by a taxpayer that
accounts for foreign income taxes on the accrual basis, see Sec.
1.903-1 as contained in 26 CFR part 1 revised as of April 1, 2021.
(2) Certain foreign taxes paid to Puerto Rico. For foreign taxes
paid to Puerto Rico under section 3070.01 of the Puerto Rico Internal
Revenue Code of 2011, as amended (13 L.P.R.A. 31771) (imposing an
excise tax on a controlled group member's acquisition from another
group member of certain personal property manufactured or produced in
Puerto Rico and certain services performed in Puerto Rico), this
section applies to foreign taxes paid (within the meaning of Sec.
1.901-2(g)) in taxable years beginning on or after January 1, 2023. For
foreign taxes described in the preceding sentence that are paid in
taxable years beginning before January 1, 2023, see Sec. 1.903-1 as
contained in 26 CFR part 1 revised as of April 1, 2021.
(3) Modifications to the covered withholding tax rules. Paragraphs
(c)(2) and (d)(3), (4), and (8) through (11) of this section apply to
foreign taxes paid (within the meaning of Sec. 1.901-2(g)) in taxable
years ending on or after November 18, 2022. For foreign taxes that are
paid in taxable years ending before November 18, 2022, see Sec. 1.903-
1(c)(2) and (d)(3) and (4) as contained in 26 CFR part 1 revised as of
July 27, 2022. Taxpayers may choose to apply the rules in paragraphs
(c)(2) and (d)(3), (4), and (8) through (11) of this section to foreign
taxes paid in taxable years beginning on or after December 28, 2021,
and ending before November 18,
[[Page 71286]]
2022, provided that they consistently apply those rules and the rules
of Sec. 1.901-2(b)(5)(i)(B)(2) and (d)(1)(iii) to such taxable years.
Melanie R. Krause,
Acting Deputy Commissioner for Services and Enforcement.
[FR Doc. 2022-25337 Filed 11-18-22; 11:15 am]
BILLING CODE 4830-01-P
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</html>Indexed from Federal Register on November 22, 2022.
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