10-year refund statute applies only to foreign tax credits

Aug 13, 2018
Aug 13, 2018
0 min. read

The Second Circuit Court of Appeals has affirmed a district court’s ruling that the special 10 year statute of limitations period on refund claims applies only to overpayments attributable to foreign taxes for which the taxpayer has elected to claim a credit, and not to foreign taxes for which the taxpayer has elected to take a deduction– even if the taxpayer was otherwise eligible to claim a credit for the foreign taxes.

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, on which it claimed a refund of approximately $2 million.

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 of the return for the tax year the foreign taxes were paid.

Trusted Media argued, as they had previously, that because the regulations set forth a single timeframe during which a taxpayer may elect to switch between claiming a foreign tax credit or taking a deduction for foreign taxes paid or accrued, there is also a single timeframe in which a taxpayer may claim a refund based on a foreign tax credit or deduction – the 10 year statute of limitations period.  The Second Circuit, reviewing the case de novo, disagreed.

The court enumerated several reasons that led them to reach their conclusion.  First, the court stated, quite simply, that the plain language of the relevant statute “compels it.”  Echoing the district court’s analysis, the Second Circuit found that under the relevant statute, the option to deduct or credit foreign taxes is mutually exclusive. Accordingly, because Trusted Media elected to deduct the foreign taxes it had paid or accrued on its 2002 tax return, the option to claim a foreign tax credit would be unavailable to them.  As a result, the 10-year statute of limitations applicable to foreign tax credits would likewise be unavailable.

The court also noted that the relevant Treasury regulations support this position, stating that the regulations confirm, “that the special 10‐year limitations is applicable to overpayments ‘resulting from a credit.’”  The court went on to state that thus, “by [their] express terms, the regulations [provide] only one condition under which the special ten-year limitations period applies, which is if the overpayment ‘result[s] from a credit.’” 

This affirmation by the Second Circuit serves as a reminder for taxpayers to carefully consider the decision of whether to amend a tax return to change the election to credit or deduct foreign taxes in a prior year. 

RSM contributors

Subscribe to RSM tax newsletters

Tax news and insights that are important to you—delivered weekly to your inbox