On July 21, 2023, the Internal Revenue Service (IRS) unveiled Notice 2023-55. This document offers temporary relief to taxpayers, aiding them in determining the credibility of a foreign tax under sections 901 and 903. The Notice applies for tax years from December 28, 2021, to December 31, 2023.
The Evolution of Foreign Tax Credit Regulations
The Treasury Department introduced proposed regulations on November 12, 2020, significantly altering the existing rules under sections 901 and 903. These changes primarily affected the definition of a creditable foreign tax. Section 901 allows a foreign tax credit (FTC) for foreign taxes paid on foreign income. In contrast, section 903 provides an FTC for foreign taxes paid “instead of” a generally imposed foreign income tax.
The proposed regulations of 2020 were met with apprehension from taxpayers and commentators, as they feared that foreign taxes, previously considered creditable, would not meet the new criteria for claiming an FTC, leading to double taxation.
Despite these concerns, the Treasury finalized the FTC regulations on January 4, 2022, mainly maintaining the form of the 2020 proposed regulations. In response to further public criticism, the Treasury released new proposed rules on November 22, 2022, which eased the cost-recovery and source-based attribution requirements for withholding taxes on royalties. The IRS subsequently issued guidance (Notice 2023-31) clarifying the single-country exception on April 3, 2023.
The Impact of the Former FTC Regulations
Under the previous FTC regulations, a foreign tax had to be treated as a tax imposed on “net gain” to be a creditable tax. The 2022 final regulations modified the net gain requirement by including an “attribution” requirement. This requirement is satisfied when the foreign tax is imposed based on the taxpayer’s activities or property ownership in the foreign country or when the tax is imposed under sourcing rules similar to those of the US.
The Role of Notice 2023-55
Notice 2023-55 allows taxpayers to apply certain aspects of the former FTC regulations instead of those imposed under the January 2022 final regulations. Firstly, taxpayers can use the former rules under prior Treas. Reg. §§ 1.901-2(a) and (b) generally contain the definition of a foreign income tax and the net gain requirement.
Secondly, taxpayers can apply for Treas. Reg. § 1.903-1 without using the attribution requirement. This change has been welcomed as it removes the overly restrictive and detrimental source-based attribution requirements, allowing taxpayers to obtain FTCs on such withholding taxes.
Limitations and Consistency Requirements
However, Notice 2023-55 clarifies that a gross-basis tax on providing digital services does not meet the net income requirement under the former rules and remains non-creditable as a tax in place of an income tax. Therefore, digital service taxes stay outside the scope of FTC creditability.
The Notice also includes a rule that requires taxpayers to apply the rules consistently concerning all foreign taxes paid in the relief year. All members of a consolidated group must always apply for temporary relief. A taxpayer may not involve in the temporary relief to claim an FTC for any amount of foreign tax allowable as a deduction.
The Future Implications of Notice 2023-55
Notice 2023-55 provides much-needed relief to taxpayers with foreign taxes that were creditable under the previous regime but may have been subject to doubt due to the 2022 final regulations. As the relief period applies retroactively to tax years beginning on or after December 28, 2021, electing taxpayers must amend tax returns and consider the election’s impact on their financial statements.