Cash-basis taxpayer claims additional foreign tax credit when paid

Plain-English summary

Chief Counsel advised how section 905(c) applies when a cash-basis individual pays additional creditable foreign income tax for an earlier year. Because the taxpayer had not timely elected under section 905(a) to use the accrual basis for foreign tax credits, the additional tax was creditable only in the year it was actually paid. The payment did not create a foreign tax redetermination for the earlier year under section 905(c)(1)(A), even though accrual-basis rules would relate the liability back to that year. A refund of foreign tax previously paid and credited is different because section 905(c)(1)(C) requires the affected U.S. tax year to be redetermined. The advice also stated that the cash-to-accrual election cannot be made or changed on an amended return.

Ruling snapshot

• Question: When may a cash-basis taxpayer credit additional foreign income tax paid for a prior taxable year?
• Outcome: Advice given
• Key authorities: IRC §§ 461, 904(c), 905(a), 905(c), 6511(d)(3)(A); Treas. Reg. §§ 1.446-1(c)(1)(ii), 1.461-4(g)(6)(iii)(B)

Full text (IRS public release)

ID: CCA_2015073118010399
UILC: 9413.04-00

Number: 201534013
Release Date: 8/21/2015
From:
Sent: Friday, July 31, 2015 6:01:04 PM
To:
Cc:
Bcc:
Subject: Application of section 905(c) to additional creditable tax paid by cash basis taxpayer

This confirms our oral advice as to the proper application of section 905(c) when an
individual taxpayer that claims foreign tax credits on the cash basis is assessed and
pays additional foreign income tax with respect to a prior taxable year. As explained in
more detail below, for a cash basis taxpayer the additional foreign tax is creditable only
in the taxable year in which the tax is actually paid, and not in the prior taxable year to
which the foreign tax relates. The relation-back year would be the proper year to claim
the credit only if the taxpayer had made a timely election under section 905(a) to claim
foreign tax credits in the year the tax accrued, rather than in the later year in which the
tax was paid. The law does not permit this election to be made or changed on an
amended return.

A number of special rules govern the accrual of creditable foreign income tax liabilities
and the year in which they may be claimed as a credit, owing to the special nature of
the foreign tax credit as a dollar-for-dollar offset to U.S. tax and its statutory purpose to
mitigate double taxation of foreign-source income. For example, under section 905(a),
a cash basis taxpayer may elect to claim foreign taxes as a credit in the year in which
the taxes accrue, rather than in the year in which they are paid; the statute provides that
once this election is made, credits for all subsequent years must be taken on the
accrual basis. In addition, creditable foreign taxes accrue in the year the “all-events”
test is met, that is, in the taxable year in which all the events have occurred that
establish the fact of the liability and permit the amount of the liability to be determined
with reasonable accuracy. In contrast to the accrual rules for other types of tax
liabilities, actual payment is not required in order for a creditable foreign tax liability to
accrue for U.S. tax purposes. Treas. Reg. §§1.446-1(c)(1)(ii) and 1.461-4(g)(6)(iii)(B);
see also section 461(f) (special rule permitting contested taxes to be deducted in the
year paid, rather than in the year in which the contest is resolved, does not apply to
creditable foreign income taxes). However, once the tax is properly accrued, it “relates
back” and is considered to accrue, for purposes of claiming the foreign tax credit on the
accrual basis, in the earlier tax year to which the foreign tax liability relates. See Cuba
Railroad Co. v. United States, 124 F. Supp. 182 (S.D.N.Y. 1954), aff’d, 254 F.2d 280
(2d Cir. 1958); Rev. Rul. 84-125, 1984-2 C.B. 125; Albemarle v. Commissioner, 118
Fed. Cl. 549 (2014).
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Section 905(c)(1)(A) provides that if accrued taxes when paid differ from the amounts
claimed as credits by the taxpayer, the U.S. tax due for the affected years or years must
be redetermined. Section 905(c)(1)(B) additionally provides that if accrued taxes are
not paid before the date two years after the close of the taxable year to which such
taxes relate, U.S. tax must be redetermined to reverse the credit for the accrued but
unpaid tax. Section 905(c)(2)(B) provides that any such accrued but unpaid taxes that
are subsequently paid shall be taken into account (other than in the case of taxes
deemed paid under section 902 or section 960) for the taxable year to which such taxes
relate, requiring a second redetermination of U.S. tax for the affected year or years.
Finally, section 905(c)(1)(C) requires a redetermination of U.S. tax for the affected year
or years if any tax paid is refunded, in whole or in part.

Sections 905(c)(1)(A), 905(c)(1)(B), and 905(c)(2)(B) address differences in the amount
of foreign tax accrued and claimed as credits and the amount of tax ultimately owed and
paid. For a cash basis taxpayer that has not made the election to claim foreign tax
credits in the year the tax accrues, foreign tax is creditable only in the year in which it is
paid, not in the year to which the tax relates and in which it is considered to accrue
under the “relation-back” doctrine. Accordingly, the payment of additional tax with
respect to a prior taxable year entitles the cash basis taxpayer to credit the tax only in
the year the additional tax is paid. It does not change, or constitute a redetermination
of, the cash basis foreign tax liability for the prior year to which the tax liability relates or
for any other year in which foreign tax was paid and claimed as a credit on the cash
basis. Accordingly, sections 905(c)(1)(A), 905(c)(1)(B), and 905(c)(2)(B) do not apply
when a cash basis taxpayer pays foreign tax in one year that relates to a different
taxable year.

In contrast, section 905(c)(1)(C) requires a redetermination of U.S. tax to reduce the
foreign tax credit claimed if foreign tax paid is refunded in whole or in part. Therefore, a
taxpayer claiming credits on the cash basis must file a U.S. amended return for affected
years and pay the resulting U.S. tax deficiency when foreign taxes previously paid and
claimed as a credit are refunded. This is because a refund, unlike an additional
payment, results in a change to the cash basis foreign tax liability, i.e., a foreign tax
redetermination, for the year in which the taxes were paid and claimed as a credit.

As noted above, a cash basis taxpayer may make a one-time election to claim credits
on the accrual basis, but this election is irrevocable, so the taxpayer may not elect again
to claim credits on the cash basis in a later year. Section 905(a). In addition, a change
in election from the cash basis to the accrual basis cannot be made on an amended
return. See Strong v. Commissioner, 36-1 USTC 9032; cf. Rev. Rul. 59-101, 1959-1 CB

189. For a taxpayer claiming credits on the cash basis, treating additional foreign tax
     payments as a redetermination of foreign tax that accrued in a prior year, and allowing
     the taxpayer to redetermine his or her U.S. tax by claiming additional credits in the prior
     year, would effectively permit the taxpayer to change his or her method of accounting
     for foreign taxes from the cash basis to the accrual basis on an amended return, which
     is not permitted by the case law and administrative rulings. Accordingly, for a taxpayer
     3

claiming foreign tax credits on the cash basis, the payment of additional foreign tax
does not constitute a foreign tax redetermination under section 905(c)(1)(A).
This rule accords with sound tax policy relating to the administration of the tax laws.
Section 905(c) extends the statute of limitations on assessment only in the event of a
change in a taxpayer’s liability for foreign tax previously claimed as a credit. Foreign
taxes claimed as a credit in the year paid often are allowable as a credit in a different
year than the year in which the tax accrued under the all-events test and the “relation-
back” doctrine. However, taxpayers are allowed a special 10-year period of limitations
to claim refunds of U.S. tax attributable to increased foreign tax credits, regardless of
whether the increased foreign tax credit results from choosing to claim a foreign tax
credit rather than a deduction for foreign tax paid, an increase in the taxpayer’s foreign
tax liability, or the correction of an error in computing the allowable credit originally
claimed. Section 6511(d)(3)(A); Rev. Rul. 68-150, 1968-1 C.B. 564; Rev. Rul. 77-54,
1977-1 C.B. 400. If an individual taxpayer was permitted to change his or her method of
accounting for foreign taxes from the cash to the accrual basis on an amended return,
duplicative claims for credit and, in some cases, time-barred U.S. tax deficiencies
potentially necessitating application of the mitigation provisions of sections 1311-1314
might result with respect to foreign tax that would be considered to accrue in one year
but that was originally claimed as a credit in the different year in which the tax was paid.

If the rules above result in economic double taxation not relieved by a relevant income
tax treaty or the excess credit carryover rules of section 904(c), the U.S. competent
authority might consider providing relief under the authority of an applicable treaty. See
Rev. Proc. 2006-54, 2006-49 IRB 1035.

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