No credit for tax paid to US Virgin Islands
Credit claim denied for Virgin Islands taxes paid by U.S. citizens
TAX ALERT |
In a Sept. 7, 2016, division opinion (Vento v. Commissioner), the Tax Court ruled that three sisters claiming to be bona fide residents of the U.S. Virgin Islands for the tax year in question, but who later admitted they were not, could not claim a foreign tax credit for the Virgin Islands income taxes they paid that year. Siding with the IRS, the Tax Court stated that because the sisters were not bona fide residents of the U.S. Virgin Islands at the time, the taxes they paid were not ‘compulsory’ and, thus, not creditable.
The three sisters, all United States residents, did not file U.S. federal income tax returns for the 2001 tax year. Instead, each sister filed an individual territorial income tax return with the Virgin Islands Bureau of Internal Revenue (BIR), and included a tax payment with each return. As a result of the BIR filings, the U.S. Treasury transferred the estimated tax payments made by each sister during 2001, along with any credits to their respective accounts from prior years, to the BIR. It was subsequently determined that none of the three sisters were bona fide Virgin Islands residents during 2001, resulting in the IRS issuing notices of deficiency in 2005. The sisters sought to credit the payments made with their U.S. Virgin Islands returns along with U.S. estimated tax payments transferred to the BIR, against their 2001 U.S. tax liabilities.
To mitigate double taxation, the Internal Revenue Code generally allows U.S. persons a credit for any foreign income tax paid on their foreign-source income. In order for a foreign income tax to be creditable, it must be compulsory (paid in satisfaction of a legal obligation) and actually paid (not reasonably certain to be refunded). In addition to being compulsory and actually paid, the amount of any potential credit is limited to ensure the credit cannot be used to reduce a taxpayer’s U.S. tax on their U.S.-source income. This is accomplished by limiting a taxpayer’s potential foreign tax credit to the amount of U.S. tax attributed to a taxpayer’s foreign-source income.
In Vento, the IRS argued, and the Tax Court agreed, that since the sisters were not bona fide residents of the U.S. Virgin Islands during 2001, they were not legally liable for the U.S. Virgin Islands income taxes they paid. Consequently, these taxes were not compulsory, and thus, not creditable. Moreover, the tax was not ‘actually paid’ because the sisters could have obtained a refund had they filed a timely request with the BIR (they had not). The case illustrates that taxpayers should ensure that they have exhausted all remedies available to reduce or refund a foreign tax on a timely basis because failure to do so may result in double tax.