United States

Taxpayer denied 10-year refund period on foreign tax credit

TAX ALERT  | 

In a recent case, (see Trusted Media Brands, Inc. v. U.S. 120 AFTR 2d 2017-5298), the District Court for the Southern District of New York concluded, among other things, that the 10-year period of limitations applicable to a claim for refund related to a foreign tax credit was not available for a taxpayer that had originally claimed a foreign tax credit, but subsequently amended its return to claim a deduction for the foreign taxes paid.

In Trusted Media Brands, Inc. the taxpayer (Trusted Media), for tax years 1995, 1997 and 2002, paid foreign income taxes and claimed a foreign tax credit for those taxes on its income tax returns. In addition, Trusted Media incurred a net operating loss (NOL) for its 2002 tax year which, pursuant to the provisions of the Code at that time, it carried back to its 1997 tax year.

During December of 2011, Trusted Media filed an amended income tax return for 2002, in which it elected to take a deduction, instead of a credit, for the foreign income taxes it had paid during 2002, which resulted in an increase to Trusted Media’s NOL for 2002. Trusted Media then filed an amended income tax return for 1997 reflecting this larger NOL carryback. After these amended returns, Trusted Media was left with excess foreign tax credits, which it contended could be carried forward or back based on provisions of the Code existing at that time. As a result, Trusted Media filed an amended income tax return for 1995, which it claimed a refund of approximately $2 million.

The main issue in this case was whether the claims for the tax years in question, 1995, 1997 and 2002, were made within the required time periods.

Generally, a U.S. person who pays foreign income taxes is allowed one of two options with respect to those amounts for any given tax year. A taxpayer may elect to either deduct those taxes from their gross income, or, subject to certain limitations, credit those taxes dollar for dollar against their U.S. income tax liability on foreign source income. Generally, the limitation for claiming a credit or a refund is either three years from the date the return is filed, or two years from the date the tax was paid, whichever is later. However, if the credit or refund relates to an overpayment attributable to foreign taxes paid for which a credit is allowed, the period is extended to 10 years from the due date, including extensions, of the return for the tax year the foreign taxes were paid.

In this case the IRS argued, and the court agreed, that the 10-year limitation period on claiming refunds attributable to foreign taxes paid relates only to amounts for which a credit is actually taken, and not to amounts that are claimed as a deduction. In coming to their conclusion, the courts placed particular emphasis on the language, specifically one word, used in the applicable provisions of the Code.

The court found that the 10-year limitation period applied solely to claims based on foreign tax credits “allowed,” which they defined as those credits actually taken, as opposed to foreign tax credits “allowable,” which they defined as credits for foreign taxes that the code permits, but which the taxpayer does not take. Accordingly, the court concluded that the 10-year limitation period only applies to overpayments attributable to foreign taxes paid for which a credit is actually taken, one that is “allowed,” and not to overpayments attributable to foreign taxes claimed as a deduction.

Taxpayers considering whether to amend their tax returns in order to change from taking a deduction for foreign taxes paid to claiming a credit, or vice versa, should make sure to consult their tax advisors regarding this decision because the 10-year limitations may not apply.

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