My autumn has been enlivened by watching a slow-motion train wreck in progress, namely the provision of the Build Back Better

Act (H.R. 5376)¹  that would amend the foreign tax credit provisions to eliminate the one-year carryback of excess FTCs available under section 904(c).

Viewed in isolation, as it apparently has been by Congress, this amendment is a "revenue raiser.” On the other hand, viewed in context, the increased revenue is obtained only by imposing double taxation on those individuals who are affected, with combined rates potentially verging on or even exceeding 100 percent.

The classic form of double taxation relief by credit, as exemplified in the OECD model treaty, provides that when a resident of one country receives income from a source in another country, to prevent double taxation the country of residence will allow a credit against its tax for tax imposed in the source country. Crucially, this approach is effective even when the income is taxed in a different year in the source country than in the residence country.

The OECD approach of allowing credits on a source-by-source basis is cumbersome because it requires a separate claim of credit for each source of foreign-taxed income. The United States has always marched to a different drummer than most other OECD countries and has allowed credits on a pooled basis — foreign taxes on income from all foreign sources are offset against U.S. taxes on such income. However, while this approach recognizes the general principle of double taxation relief, unlike with a source-by-source approach it doesn’t ensure that effective relief will be available if income is recognized in different tax years in the two taxing jurisdictions.

To compensate for this, U.S. rules have always provided for FTC carrybacks and carryforwards. Until 2004 unused FTCs were carried back to the second and first preceding tax years and carried forward a further five years. In 2004, in a change intended to increase the utilization of FTCs, the carryback was reduced to a single year while the carryforward was extended to 10 years. The proposal to eliminate the carryback entirely (which would also cut back the carryforward to the pre-2004 period of five years) guarantees that when foreign-source income is taxed in the United States before it is taxed overseas, the taxpayer will suffer double taxation.

This is a horrendous result that, one trusts (the Toulouse² case notwithstanding), will be mitigated through double taxation treaties in which the United States has promised not to apply changes in its domestic FTC rules that adversely affect the ability of U.S. citizens resident in treaty countries to avoid double taxation in the United States — that is, unless Congress demonstrates that it actually knows what it is doing and specifically states that treaty overrides (and hence double taxation) are intended.

Yours faithfully, Jeffrey L. Gould Youngstein & Gould London

Dec. 6, 2021

FOOTNOTES

¹     James P. Fuller, Larissa Neumann, and Julia Ushakova-Stein, “U.S. Tax Review: The Build Back Better Act,” Tax Notes Int’l, Dec. 6, 2021, p. 1083.

²     Toulouse v. Commissioner, 157 T.C. No. 4 (2021). See also Jeffrey L. Gould, “The Tax Court’s Flawed Analysis in Toulouse Should Be Challenged,” Tax Notes Int’l, Sept. 27, 202J, p. 1695; and H. David Rosenbloom and Fadi Shaheen,”Toulouse: No Treaty-Based Credit?” Tax Notes Int’l, Oct. 25, 2021, p. 417.

END FOOTNOTES

DOCUMENT ATTRIBUTES

MAGAZINE CITATION           TAX NOTES INT'L, DEC. 13, 2021, P. 1211

                                            104 TAX NOTES INT'L 1211 (DEC. 13, 2021)  

TAX ANALYSTS DOCUMENT NUMBER                DOC 2021-45432