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Surprise! Your Foreign Tax Credit Is Not Allowed Under Section 901(I)

January 14, 2014, Tax Notes International

In their article for Tax Notes International, Caplin & Drysdale member H. David Rosenbloom, former associate Michael R. Lloyd, and former summer associate Sae Jin Yoon describe some of the uncertainties raised by section 901(l) and suggest possible interpretations and solutions for an overly broad statute. For the complete article, please visit Tax Notes International's website (subscription required).
 
Excerpt taken from the article "Surprise! Your Foreign Tax Credit Is Not Allowed Under Section 901(l)," Tax Notes International, Jan. 13, 2014, p. 171.
 
The cross-referencing of rules of one section of the IRC for application in another section occurs so frequently that it is easy to forget the risks of legislating in this manner. Section 901(l) presents a cautionary tale.
 
The section says that "in no event shall a credit be allowed" for any foreign withholding tax on any item of income or gain other than a dividend if the holder of the property that gave rise to the income or gain either: 

  • does not meet a minimum holding period requirement; or
  • is under an obligation to make "related payments with respect to positions in substantially similar or related property."

In determining what is a "withholding tax" and whether the above-described eligibility requirements are satisfied, section 901(l) cross-references the rules of section 901(k), a code section that denies the foreign tax credit for foreign withholding taxes on certain dividends. Section 901(k) itself cross-references the rules of section 246(c), which denies the dividends received deduction in certain circumstances. The result is a statute that, in its plain language, extends well beyond what could ever have been anticipated or reasonably intended. As one observer has dryly noted, this is a "trap for the wary."
 
Thus, section 901(l) clearly embraces a variety of legitimate, non-abusive, and thoroughly innocuous transactions. Taxpayers face genuine confusion regarding the section's reach, and this appears to have given rise to both administrative uncertainty and inconsistent application. Congress was aware that it had not crafted a nuanced piece of legislation, and it specifically authorized the Treasury Department to issue regulations to carry out the statute's purposes.2 Treasury has exercised that authority only to announce two narrow exceptions to the expansive statutory coverage.
 
This article describes some of the uncertainties raised by section 901(l) and suggests some possible interpretations and solutions for an overly broad statute. With Congress at a seemingly indefinite standstill, the problems of the section are not likely to be resolved through legislative action. It is therefore time for Treasury to act under its delegated authority to eliminate at least some of the glaring anomalies.

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