A Foreign Tax Credit
Guardian Industries is a US company that makes glass products. Guardian owns three glass manufacturing plants and employs 1,200 people in Luxembourg. Guardian owns several companies in Luxembourg through which it runs this business. The companies are organized with a parent company that Guardian treats as a “disregarded entity” for US tax purposes, meaning that Guardian reports its tax results in the US as if the Luxembourg parent company does not exist. The next-tier subsidiaries of the Luxembourg parent are treated as corporations for US tax purposes. They block any income belonging to them from hitting the US return.
The Luxembourg companies file a group income tax return in Luxembourg.
Guardian takes the position that all the taxes paid on the group return to Luxembourg are taxes solely of the Luxembourg parent company. That’s because the subsidiaries do not have any “joint or several” liability for the taxes under Luxembourg law. That means that Guardian can claim the taxes paid as a foreign tax credit without waiting for its Luxembourg earnings, which are parked in the subsidiaries, to be distributed back to the United States. That’s because the taxes are treated as if paid by Guardian directly since the Luxembourg parent does not exist for US tax purposes.
The IRS disputed this result. It argued that the taxes should be considered paid by each of the subsidiaries in relation to the income it contributed to the group return. That way, no foreign tax credits could be claimed until the related income is repatriated to the US.
After soliciting input from the Luxembourg tax authorities, the US claims court agreed with Guardian.
It may be too soon for others to adopt the same strategy since the decision will probably be appealed. There is also a risk of being overturned by Congress. In May, the Senate tax-writing committee stuck language in a highway bill that would give the IRS broader authority to attack transactions where foreign tax credits are separated from the related foreign income.
Some Benelux lawyers also warn that the court may have overlooked two other legal principles. In some Benelux countries, when a subsidiary leaves the group return, it may have retrospective liability up to five years for its share of taxes while it was included in the return. In addition, many countries have a civil law principle that when one company pays a liability for another company, the second company may be required to contribute.