MoFo Tax Talk - Volume 8, No. 4

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IRS PROVIDES RICS ALTERNATIVES TO ACCOUNT FOR FOREIGN TAX REFUNDS -

Generally, when a U.S. taxpayer pays foreign tax, the U.S. taxpayer is entitled to take a credit (a “Foreign Tax Credit”) against the taxpayer’s U.S. tax liability. The purpose is to avoid double taxation. When a RIC pays foreign tax, it has two options: it can either claim the foreign tax credit itself to offset any tax liability, or under certain circumstances, it can make a “Section 853 Election” that allows the RIC to pass through the foreign tax credit to its shareholders. In other words, the RICs shareholders are entitled to claim the foreign tax credit directly on their tax returns. Under existing rules (the “Default Method”), a taxpayer that receives a refund of foreign taxes is required to notify the IRS, which redetermines the taxpayer’s U.S. tax liability in the year in which the credit was taken. Due to a recent ruling by the EU Court of Justice, many RICs have received refunds of foreign taxes paid by the RIC in prior years. These refunds have caused RICs to question whether the existing rules regarding foreign tax credit refunds are administrable when applied to RICs that have made Section 853 Elections.

Notice 2016-10 (the “Notice”), released on January 15, 2016, by the IRS, gives RICs additional options when faced with refunds of foreign taxes paid in prior years. Generally, the Notice allows RICs to treat foreign tax credit refunds under two methods. The first method, the “Netting Method,” applies to a RIC that, in the same year in which it receives a refund of foreign taxes (the “Refund Year”), also pays an amount of foreign taxes equal to or greater than the refund (including interest received from the foreign taxing jurisdiction). Essentially, the RIC is permitted to use the foreign tax refund received to offset the foreign tax paid in the Refund Year. As a result, the RIC is not required to separately include the tax refund in its gross income, and shareholders are able to take advantage of foreign taxes paid by the RIC that are not offset by the refund. The Netting Method is available to RICs if (1) the economic benefit of the refund inures to the RIC’s Refund Year shareholders, (2) the RIC was not held predominantly by insurance companies or fund managers in connection with the creation or management of the RIC, (3) the RIC makes a Section 853 Election in the Refund Year, and (4) (as discussed above) foreign taxes paid by the RIC in the Refund Year equal or exceed the amount of the foreign tax refund (including interest received from the foreign taxing jurisdiction). If a RIC takes advantage of the Netting Method, the RIC is required to file an information statement with the IRS.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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