TAX LAWYERS DISCUSSED STRATEGIES FOR STRIPPING FOREIGN TAX CREDITS at the American Bar Association meeting in May
“Stripping” foreign tax credits refers to the idea of bringing back credits for use in the United States before the earnings become subject to US tax. The IRS said two years ago in Notice 98-5 that it is considering requiring that use of foreign tax credits wait until the earnings become taxable in the US. However, it has been slow to act.
In one structure, a US company owns a foreign subsidiary, FC1, which owns FC2. FC2 owns the project. FC1 is transparent for US tax purposes, but it is treated as a corporation by the foreign country. FC2 is a corporation in the US, but transparent abroad. Therefore, the foreign country views its taxes as imposed on FC1. However, because FC1 is transparent for US tax purposes, the US treats the taxes as imposed on the US parent while the earnings from the project remain insulated from US taxes because they are in FC2.
In another structure, FC1 and FC2 are both corporations for US tax purposes. However, the foreign country views FC1 as a corporation and FC2 as transparent. Therefore, foreign taxes are imposed on FC1. Earnings remain trapped for US purposes in FC2. A small dividend by FC1 to the US releases all the foreign tax credits for use in the United States.