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Firm Addresses Foreign Tax Credit Carryovers Under Proposed FTC Regs

APR. 11, 2019

Firm Addresses Foreign Tax Credit Carryovers Under Proposed FTC Regs

DATED APR. 11, 2019
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11 April 2019

CC:PA:LPD:PR (REG-105600-8)
Room 5203
Internal Revenue Service
PO Box 7604
Ben Franklin Station
Washington DC 20224
USA

Re: Regulations 105600-8 — Further Comments on Proposed Transitional Rule §1.904-2(j)(1) Concerning Foreign Tax Credit Carryovers from 2017 and Prior Years

Dear Sirs

We have written to you before on 30 August 2018 and 5 February 2019 recommending that for taxpayers having "general basket" foreign tax credit carryovers from 2017 and prior periods, such carryovers be freely offsettable against U.S. taxes on foreign source income in the two "new" baskets that replace the pre-2018 general basket, namely the post-2017 general basket and the foreign branch basket.1 We refer to this below as the "free allocation" method. We have noted previously that free allocation was available to taxpayers prior to enactment of the TCJA 2017.

As comments on the proposed regulations continue to be submitted, we are hopeful that this supplementary comment will be taken into consideration.

The proposed regulations provide that 2017 carryovers from the pre-2018 general basket are creditable against post-2017 taxes in the post-2017 general basket (i.e. equating the two "general" baskets despite their disparate compositions), subject to the ability of taxpayers having access to the necessary information and accountancy services to elect to allocate pre-2018 carryovers between post-2017 general and foreign branch baskets as if the foreign branch basket had existed under prior law.2 At the same time, in the preamble to the proposed regulations, Treasury solicits comments on whether the final regulations should include a "simplified rule" that would allow taxpayers to allocate carryovers between the general and branch basket with less of a compliance cost, and what that rule should provide.

None of the alternatives contemplated in the proposed regulations and preamble will be as beneficial to some taxpayers as the free allocation available to them under prior law. Particularly affected will be individuals having foreign branch basket income post-2017 but whose foreign tax credit carryovers are comprised of taxes that would be assigned to the post-2017 general basket under the new rules.3 The transitional rules reflected in the proposed regulations will not permit such individuals to take the benefit of their pre-2018 foreign tax credit carryovers as would have been the case under the pre-2018 rules. Yet such individuals will have planned their financial affairs based on the reasonable expectation that such credits would be available.

The preamble to the proposed regulations provides significant detail regarding Treasury's deliberations as to the appropriate transitional approach to adopt for pre-2018 foreign tax credit carryovers, but there is no acknowledgement that free allocation of carryovers is an available option. Yet it is inevitable that any solution other than free allocation will for some taxpayers result in a reduced utilization of foreign tax credit carryovers from 2017 and prior years as compared with that which was provided under prior law. In other words, under the approach taken in the proposed regulations the value of foreign tax credit carryovers to some U.S. taxpayers will have been retrospectively reduced as a result of the enactment of the TCJA.4 This can only be justified on the (unstated) assumption that Congress intended such a diminution.

Available evidence suggests that Congress did not intend TCJA changes to retrospectively diminish the value of tax carryovers. Specifically, the new limitation on the utilization of net operating losses to 80% of taxable income is expressly not applicable to net operating loss carryovers from 2017 and prior years. TCJA §13302(e). Thus the introduction of new limitations on the utilization of net operating losses was expressly not intended to reduce the value of taxpayers' existing net operating loss carryovers. Congress' failure to expressly provide in the TCJA for the same "grandfathering" of foreign tax credit carryovers is much more likely the result of a lack of time and the comparatively small number of taxpayers affected than a reflection of a different policy.

Regulations which provide for a diminution of the value of taxpayers' pre-TCJA carryovers, as presently contemplated, should require stronger evidence of Congressional intent than exists in this case. We therefore urge reconsideration of the option of allowing a free allocation of pre-TCJA general basket foreign tax credit carryovers to the post-TCJA general and foreign branch baskets. Such an approach would have the significant added advantage of eliminating the complexity and cost of the various alternatives that have been proposed for allocating pre-TCJA foreign tax credit carryovers to the post-TCJA foreign tax credit baskets, which would be a boon both to taxpayers and the IRS.

Tax returns covering the first post-TCJA year, 2018, are due now and although the due date may be extended the resolution of the treatment of foreign tax credit carryovers will significantly affect the amount of tax required to be paid with some extension requests. If publication of final foreign tax credit regulations is delayed, earlier guidance regarding the treatment to be given carryovers would be very helpful.

Thank you for this opportunity to provide our views on this vital issue for many Americans resident overseas. If you have any questions please contact Jeffrey Gould, Carol Hipwell or Matthew Pannell on +4420 7833 3500.

Yours faithfully

Frank Hirth Plc
London, UK

FOOTNOTES

1For reasons adverted to in the preamble to the proposed regulations, it is appropriate to disregard the new §951A basket in the analysis of the issue of foreign tax credit carryovers.

2Prop. regs. § 1.904-2(j)(1)(ii) and (iii). The practical difficulties of fulfilling the requirements of the elective alternative were illustrated in our letter of 5 February 2019.

3This is a problem not shared by the U.S.-based multinational corporations at which the proposed regulations appear to be principally addressed.

4Indeed, even if a taxpayer can achieve an efficient utilization of credits through the allocation option provided in the proposed regulations, Treasury acknowledge that this approach will be practicable only where "the benefits exceed the costs", i.e. that an efficient use of credits can only be obtained at the cost of an increased expenditure of tax return preparation fees. Inevitably, it is the individual taxpayers, most of them overseas residents, who will most often find that the benefits are insufficient to justify the accounting costs (assuming sufficient information is even obtainable).

END FOOTNOTES

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