Do as I Say, Not as I Do: The Foreign Tax Credit Regulations’ Focus on the Terms of Foreign Tax Law

The latest set of final regulations on foreign tax credits generally analyzes the creditability of foreign taxes by comparing U.S. regulatory requirements to the words of foreign tax laws, not to their application in practice or their economic effect. This approach essentially chooses increased administrability and reduced whipsaw potential at some cost to accuracy. It also represents a return to the position that the IRS advocated before the United States Supreme Court’s decision in PPL. The regulations’ preamble implies that taxpayers were not always following the post-PPL approach of examining a foreign tax’s economic effect.

If taxpayers were more likely to prove the application and economic impact of foreign law when it benefited them, and conversely to rely on the words of foreign law when that produced a more favorable result, the IRS may have been whipsawed. In addition, due to the costs of proving data-reliant tests, larger taxpayers may have been better able to gather the relevant information about the economic effects of foreign tax laws, as compared to smaller taxpayers with fewer resources. Although the shift to general reliance on the terms of foreign law entails acceptance of some inaccuracies, this may be an acceptable cost for stopping the potential whipsaw of the government by taxpayers. Reliance on the terms of foreign law may also reduce the relative incremental advantage of larger taxpayers over smaller taxpayers regarding their ability to apply the relevant creditability tests.