Executive summary: Deadline extended
The IRS and Treasury have given taxpayers an extended deadline to benefit from the single-country exception’s documentation requirement. Notice 2023-31, issued April 3, 2023, now gives taxpayers 180 days after the proposed foreign tax credit (FTC) regulations (the 2022 Proposed Regulations) are finalized to amend their license agreements or execute new ones to qualify for the single-country exception. This is a change from the original May 17, 2023 due date.
Treasury extends documentation deadline for single-country exception
The 2022 Proposed Regulations provide a new, and narrow, exception (the single-country exception) to the source-based attribution requirement where a taxpayer can substantiate that a withholding tax is imposed on royalties received in exchange for the right to use intellectual property (IP) solely within the territory of the taxing jurisdiction. To qualify for this limited exception, a taxpayer must have proper documentation in place in the form of a written license agreement. The single-country exception applies where:
I. The income subject to the tested foreign tax is characterized as gross royalty income; and
II. The payment giving rise to such income is made pursuant to a single-country license.
This exception is one of Treasury’s attempts to calm taxpayer fears that once historically creditable foreign income taxes paid (or accrued) may become non-creditable in tax years beginning on or after Dec. 28, 2021 (e.g., 2022 calendar year taxpayers).
The 2022 final FTC regulations (T.D. 9959) (the 2022 Final Regulations) stipulate that a foreign tax on gross income from royalties must be sourced based on the place of use of, or the right to use, the IP. This U.S. source rule for royalties is highly unusual compared to the rest of the world since most countries impose a tax based on the residence of the payor. This mismatch between U.S. and foreign tax law presents an issue to many taxpayers absent an exception (e.g., the single-country exception).
Treasury has extended the transition period for the documentation requirement to allow for an orderly implementation of the requirements of the single-country exception. Taxpayers now have 180 days after the date the regulations are finalized to satisfy the single-country exception requirements. This is a change from the original May 17, 2023 due date. The notice intends to address concerns surrounding the short timeframe to amend (or renegotiate) existing agreements with third parties.
Consistent with the 2022 Proposed Regulations, taxpayers may rely on this notice for foreign taxes paid (or accrued) in taxable years beginning on or after Dec. 28, 2021 and ending before the regulations are finalized.
The provisions described in this alert are subject to change in any finally enacted regulation package. Nonetheless, taxpayers should contact their advisors now to better understand how Notice 2023-31 may affect their tax obligations.
Taxpayers looking for additional information on the new FTC rules can view RSM's previous tax alerts (Treasury releases technical corrections to final FTC regulations, Treasury releases much anticipated proposed FTC regulations and Ten quick reminders for FTC). These alerts provide detailed insights on how taxpayers can satisfy the revamped cost recovery requirement, along with the new attribution requirement, which are two key steps in determining whether a foreign income tax is creditable under the new framework.