Foreign tax credit relief is possible | Norton Rose Fulbright
The United States taxes US companies on worldwide income. It allows credit – in theory – for taxes that were paid on the same income to other countries. However, the foreign tax credit rules are so full of fine print that many US companies are unable to claim such credits in practice. The biggest problem is something called the “interest allocation” rules.
Up to 35¢ in credit is allowed for each $1 that a US corporation earns from foreign sources. The problem is US tax rules treat borrowed money as fungible. Thus, if a US parent company borrows large sums in the United States, part of the interest paid is considered a cost of its foreign operations in the same ratio as the company has its assets deployed in the US and abroad. Thus, a US company might earn $X million from its plants in Spain, but it will be treated as having earned much less after a share of its domestic borrowing costs is allocated to the Spanish operations. Many US companies have large overhangs of allocated interest expense that they must burn off – called “overall foreign losses” – before they will be considered to have earned even one dollar abroad.
Congress passed new rules – called “worldwide fungibility” – in 1999. The idea was the principle that borrowed money is fungible ought to apply both ways so that some foreign borrowing costs should be charged partly to US operations. However, the measure failed to become law. Congress seems unlikely to revisit the issue any time soon.
In the meantime, the US Treasury is receiving letters from US companies urging it to take steps on its own to help. Domestic interest expense is allocated currently in the same ratio as a company’s assets are deployed at home and abroad by looking either at the relative fair market values of the assets or their “tax bases.” Most companies use tax bases because they do not want the hassle of having to have their assets appraised every year. The problem with tax basis is US assets are depreciated more rapidly for tax purposes than foreign assets. This creates distortion: over time, the company looks like it has more foreign assets. The letter writers want Treasury to allow the same slower depreciation to be used for US assets solely for purposes of allocating interest expense.
Michael Caballero, a Treasury lawyer, said the government is studying the suggestion, but no decision has been made yet. The fact that the issue is not on the IRS business plan for this year would not prevent the government from acting.
Meanwhile, the Treasury is also being pressed to adopt worldwide fungibility on its own – without waiting for Congress to act. Ken Kies, a former staff director of the Congressional Joint Tax Committee, argued in an article in the influential Tax Notes magazine in late March that the Treasury has authority on its own to ignore the interest allocation rules that Congress wrote into the US tax code. Treasury is not convinced.
Kies cites a statement in section 864(e)(7) of the US tax code granting the IRS authority to flesh in details of the interest allocation rules and even to decide that they “shall not apply for purposes of any provision of this subchapter to the extent the [IRS] determines that [their] application . . . for such purposes would not be appropriate.”