Procedure Grab Bag – Foreign Tax Credits

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Two cases dealing with foreign tax credits, with very different litigation records; one being denied cert by SCOTUS (Albemarle, which we’ve covered before) and one tossed on summary judgement in the District Court (Estate of Herrick) with the taxpayer prevailing on making a late election where no late election was permissible.  The second case has pretty interesting regulatory interpretation.

No SCOTUS

The first has been covered here on PT before on at least two occasions.  SCOTUS has denied cert in Albemarle Corp. v. US.  When the Federal Circuit reviewed the case, I wrote the following in a SumOp:

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Hopping in the not-so-wayback-machine, in October of 2014, SumOp covered Albemarle Corp. v. US, where the Court of Federal Claims held that tax accruals related back to the original refund year under the “relation back doctrine” in a case dealing with the special statute of limitations for foreign tax credit cases.   As is often the case in SumOp, we did not delve too deeply into the issue, but I did link to a more robust write up.  It seems the taxpayers were not thrilled with the Court of Federal Claims and sought relief from the Federal Circuit.  Unfortunately for the taxpayer, the Fed Circuit sided with its robed brothers/sisters, and affirmed that the court lacked subject matter jurisdiction because the refund claim had not been made within the ten year limitations period under Section 6511(d)(3)(A).   This case deserves a few more lines.  The language in question states,  “the period shall be 10 years from the date prescribed  by law for filing the return for the year in which such taxes were actually paid or accrued.”   When the tax was paid or accrued is what generated the debate.

In the case, a Belgium subsidiary and its parent company, Albemarle entered into a transaction, which they erroneously thought was exempt from tax, so no Belgian tax was paid.  Years in question were ’97 through ‘01.  In 2002, Albemarle was assessed tax on aspects of the transaction in Belgium, and paid the tax that was due.   In 2009, Albemarle filed amended US returns seeking about $1.5MM in refunds due to the foreign tax credit for the Belgian tax.  Service granted for ’99 to ’01, but not ’97 or ’98 because those were outside the ten year statute for claims related to the foreign tax credit under Section 6511(d)(3)(A).  Albemarle claimed that the language “from the date…such taxes were actually…accrued” means the year in which the foreign tax liability was finalized, which would be 2002 instead of the year the tax originated.  Both the lower court and the Circuit Court found that the statute ran from the year of origin.  The Circuit Court came to this conclusion after a fairly lengthy discussion of what “accrue” and “actually” mean, plus a trip through the legislative history and various doctrines, including the “all events test”, the “contested tax doctrine”, and the “relation back” doctrine.  The Court found the “relation back” doctrine was key for this issue, which states the tax “is accruable for the taxable year to which it relates even though the taxpayer contests the liability therefor and such tax is not paid until a later year.” See Rev. Rul. 58-55.  This can result in a different accrual date for crediting the tax against US taxes under the “relation back” test and when the right to claim the credit arises, which is governed by the “contested tax” doctrine.

At that time, McDermott, Will and Emery posted some “Thought Leadership” (I’ve hated that term for a long time, but the summary is extensive and helpful), which can be found here.  The final paragraph of their advice is right on the mark, indicating there is no circuit split, so there likely would be no SCOTUS review.  It also provides great additional parting advice, stating:

Taxpayers in similar situations wishing to take positions contrary to the Federal Circuit’s decision, and without any option other than litigation, may want to file suits in local district court to avoid the negative precedent. Taxpayers may also want to consider filing protective refund claims in situations where it does not appear that a tax payment to a foreign jurisdiction will actually be made (and there will be enough time to file a formal refund claim with the IRS) within 10 years from the date the U.S. federal income tax return was filed to avoid the situation in Albemarle.

Not so late election

The second foreign tax credit case is the Estate of Herrick v. United States from the District Court for the Central District of Utah, where an estate filed late income tax returns seeking a refund for a decedent who had resided and worked in the Philippines for a number of years.  The taxpayer failed to file income tax returns during that period, under the mistaken belief that no income tax would be due because of credits for the foreign tax he was paying (not how that works).  The Service created SFRs, and assessed and collected over a $1MM in tax for the years in question.  The taxpayer sought summary judgement on its refund claim, which the IRS was contesting, arguing the taxpayer was not entitled to the credit or exclusion for foreign income taxes or that there were insufficient facts to establish that he was entitled to the same.

Under Section 911, some taxpayers living and working abroad in some circumstances can exclude a portion of the foreign earned income, and under Section 901, there is a credit for foreign tax that is paid, which can be applied against US income tax (as most of our readers know, under Section 61, the United States generally treats all income of its citizens, wherever earned, as being taxable income—these provisions help to reduce the potential for double taxation with the other jurisdictions).

As to the second claim, that insufficient evidence was available regarding the credits, the IRS position largely applied to one year.  For all other years, the taxpayer had showed copies of its returns, copies of his employer’s information related to him for the years in question, and the taxing authority in the Philippines verified all the information, including payment.  For one year, only a copy of the return and the employer’s information was available.  The Court found this was sufficient evidence to show proof of payment.

The second argument the Service made was that the taxpayer could not obtain the foreign earned income exclusion under Section 911 because the taxpayer had not made the election on a timely filed return or within one year of a timely filed return.  See Treas. Reg. 1.911-7(a)(2)(i).  Seems damning.

The Court, however, stated that the Service was only looking to subsections (A) through (C), and not giving consideration to subsection (D) in the Regulations allowing for elections to made when:

(D) With an income tax return filed after the period described in paragraphs (a)(2)(I) (A), (B), or (C) of this section provided –

(1)  The taxpayer owes no federal income tax after taking into account the exclusion and files Form 1040 with Form 2555 or a comparable form attached either before or after the Internal Revenue Service discovers that the taxpayer failed to elect the exclusion; or

(2)  The taxpayer owes federal income tax after taking into account the exclusion and files Form 1040 with Form 2555 or a comparable form attached before the Internal Revenue Service discovers that the taxpayer failed to elect the exclusion.

The Court found the first prong under (D) did not apply.  The taxpayer claimed that it did not owe any federal income tax, because the IRS had already assessed and collected an amount over the total amount outstanding.  The Court stated, however, the fact that no tax was due at the time of filing was not the question, and the determination was whether any tax was due for the year, which had been the case but the Service had already collected that amount via levy.

The Court, however, held that the second prong did apply.  The Court found the Service had not discovered the failed election.  The Court found the Service had determined the taxpayer failed to file returns for the years in question, but that was not the same as discovering the taxpayer failed to make the election (would anyone be surprised if the Service doesn’t concede this point in other jurisdictions?).  This allowed the taxpayer to make the election on the late filed returns.

Stephen Olsen About Stephen Olsen

Stephen J. Olsen’s practice includes tax planning and controversy matters for individuals, businesses and exempt entities for the law firm Gawthrop Greenwood, PC.

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Comments

  1. John R. Dundon II, EA says:

    In Estate of Herrick v. United States the distinction between failing to file a tax return and failing to make a required election on a tax return is good to know. Thank you!

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