Foreign tax credit refund cannot preserve deductions for the same taxes in closed years

Plain-English summary

A corporation timely changed several years from deducting foreign taxes to claiming foreign tax credits under the special ten-year refund period. The change created deficiencies in earlier years whose ordinary three-year assessment periods had expired, while also producing a later refund through foreign tax credit carryovers. Chief Counsel advised that the taxpayer could not retain deductions for the same taxes used to claim credits because Section 275(a)(4) forbids that double benefit. If the IRS allows the later refund, the mitigation provisions can permit assessment and collection of the otherwise time-barred earlier deficiencies. The IRS could alternatively use a closing agreement that conditions the refund on eliminating the earlier deductions and paying the resulting deficiencies.

Ruling snapshot

• Question: How should the IRS handle amended returns that switch foreign taxes from deductions to credits when the switch creates deficiencies in otherwise closed years?
• Outcome: Advice given: do not allow a double benefit; use mitigation or a closing agreement if the refund is allowed.
• Key authorities: IRC §§ 275(a)(4), 901, 904, 1311-1314, 6501, 6511(d)(3), 7121

Full text (IRS public release)

       Office of Chief Counsel
       Internal Revenue Service
       memorandum
       Number: 202133013
       Release Date: 8/20/2021
       CC:INTL:B03
       POSTU-119848-20

UILC: 6511.03-03

date: May 11, 2021

 to:   Tina Cleveland, Tax Analyst, DC LTA
       (National Taxpayer Advocate)

from: Corina Braun, Attorney
(International)

subject: Assessment Statute for Prior Years Following Election to Claim Foreign Tax Credits

       This Chief Counsel Advice responds to your request for assistance. This advice may
       not be used or cited as precedent.

       ISSUES

       Can the Service process the Taxpayer’s amended corporate tax returns for the ------- and
       ------- taxable years, which were filed in -------?


       FACTS

       Taxpayer Advocate Services requested advice concerning the Service’s refusal to
       process amended corporate tax returns filed by Taxpayer in ------- that show U.S. tax
       deficiencies for the ------- and ------- taxable years. In -------, Taxpayer filed amended
       returns for its ------- through ------- taxable years that reflect changes in its election to
       deduct foreign tax paid and instead to claim a foreign tax credit in each year under section
       901(a). The Service accepted and processed the amended returns for the -------, -------,
       ------------------------, and ------- taxable years. However, the Service did not accept and
       process the amended returns for the ------- and ------- taxable years, which reflected U.S.
       tax deficiencies attributable to reversing out deductions for foreign taxes taken on the
       original returns, on the grounds that the three-year period of limitations under section
       6501(a) on the assessment and collection of the tax due for those years, as shown on the
       amended returns, had expired. The Taxpayer subsequently filed an amended return to
       claim a refund for the ------- tax year attributable to the carryover under section 904(c) of
       creditable foreign taxes from the ------- through --taxable years, including foreign taxes
       deducted in ------- and ------- with respect to which the deficiencies attributable to

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eliminating those deductions appear time-barred. The amended ------- return was not
processed by the Service.

LAW AND ANALYSIS

Section 901(a) of the Internal Revenue Code provides that a taxpayer has the option, for
each taxable year, to claim a credit for foreign income taxes paid or accrued to a foreign
country in such taxable year, subject to the limitations under section 904. Alternatively,
a taxpayer may deduct the foreign income taxes under section 164(a)(3). The deduction
and credit for foreign income taxes are mutually exclusive; section 275(a)(4) provides that
no deduction shall be allowed for foreign income taxes if the taxpayer chooses to take to
any extent the benefits of section 901. Section 901(a) further provides that the choice to
claim the foreign tax credit for any taxable year “may be made or changed at any time
before the expiration of the period prescribed for making a claim for credit or refund of the
tax imposed by this chapter for such taxable year.”

Section 6511(a) of the Internal Revenue Code provides that a claim for credit or refund
of an overpayment shall be filed within three years from the time the return was filed or
two years from when the tax is paid, whichever is later. However, under section
6511(d)(3), if the refund relates to an overpayment attributable to any taxes paid or
accrued to any foreign country for which credit is allowed under section 901, the taxpayer
has ten years from the un-extended due date of the return for the taxable year in which
the foreign taxes are paid or accrued to file the claim. See §301.6511(d)-3. Treasury
regulation §1.901-1(d) provides that a taxpayer can claim the benefits of section 901 at
any time before the expiration of the period prescribed by section 6511(d)(3)(A).
Accordingly, Taxpayer’s ------- election to claim foreign tax credits under section 901(a) in
lieu of foreign tax deductions for each of the ------- through ------- taxable years was timely
made under the applicable section 901 regulation. However, the election change that
gave rise to the foreign tax credit carryforward resulting in the ------- overpayment also
gave rise to underpayments in both ------- and -------, as the result of eliminating the
deductions Taxpayer originally claimed for those same foreign tax payments. If
assessment and collection of the tax due in those years as the result of the election
change is time-barred, then Taxpayer would retain the benefit of both a deduction and a
credit for a single payment of foreign tax, in contravention of section 275(a)(4). The law
does not permit this result.

Equitable recoupment is an equitable remedy that precludes a taxpayer from treating one
transaction differently from year to year. Equitable recoupment allows the Service to
reduce a refund due a taxpayer for one year by an underpayment from a different year,
but only of a “related, and inconsistent, but now time-barred tax claim relating to the same
transaction.” IES Indus., Inc. v. United States, 349 F.3d 574, 581 (8th Cir. 2003) (quoting
United States v. Dalm, 494 U.S. 596, 608 (1990)). “The defense does not permit ‘one
transaction to be offset against another,’ but will allow a single ‘transaction which is made
the subject of suit by a plaintiff to be examined in all its aspects, and judgment to be
rendered that does justice in view of the one transaction as a whole.’” Id. at 582 (quoting
Rothensies v. Elec. Storage Battery Co., 329 U.S. 296, 299 (1946)). Equitable

POSTU-119848-20 3

recoupment focuses on the “single transaction, item, or taxable event.” Id at 581; see
also Bull v. United States, 295 U.S. 247, 261 (1935) (holding that equitable recoupment
applied when single transaction applying to both the income tax deficiency claim and the
time-barred estate tax overpayment claim arose out of the estate’s receipt of money from
a partnership); Stone v. White, 301 U.S. 532, 533 (1937) (holding that the government
could apply equitable recoupment to a refund claim where the single transaction was the
receipt of income for a period by an estate.); IES Indus., Inc. v. United States, 349 F.3d
574 (8th Cir. 2003) (holding that refunds attributable to capital losses and credits for
foreign taxes withheld from dividends on foreign stock purchased cum dividend and sold
ex-dividend and treated as an economic sham by the Service related to a “single
transaction” sufficient to apply equitable recoupment to reduce refund claim by including
dividends in taxable income); cf. Rothensies v. Elec. Storage Battery Co., 329 U.S. 296,
301 (1946) (holding that equitable recoupment did not apply where a deficiency claim for
excise taxes was sought to be offset by an overpayment of the excise tax for different
years).

Sections 1311 through 1314 of the Internal Revenue Code provide that the Service may
apply mitigation provisions to make adjustments to tax items that would otherwise be
prohibited. The following conditions must be met: 1) an error must have occurred in a
taxable year which cannot otherwise be corrected by operation of law; 2) there was a
determination for another year with respect to the item giving rise to the error; 3) the
determination was within one of the categories enumerated in section 1312 as a
circumstance of adjustment; and 4) the party who prevailed in the determination
maintained a position that was adopted there and that was inconsistent with the
erroneous treatment. Here, the circumstance of adjustment would be a double allowance
of a deduction or credit under section 1312(2). The Taxpayer obtained a deduction for
the foreign taxes in the initial filing. The Taxpayer would receive a credit for the same
foreign tax on the amended returns. Whether the foreign taxes are a deduction or a credit
for the same year is an inconsistent position under section 1311(b)(1). A determination
for mitigation purposes include a closing agreement under section 7121 or a final
disposition by the Secretary of a claim for refund. I.R.C. § 1313(a). The adjustment shall
be made as if it were a deficiency determined by the Secretary as if on the date of the
determination one year remained before the expiration of the periods of limitation upon
assessment for the taxable year being adjusted. I.R.C. § 1314(b). As the Taxpayer is
pursuing a refund, once the Secretary determines whether to allow or disallow the refund,
there is a determination which can be used to apply the mitigation provisions.

The purpose of section 275(a)(4) is to prevent taxpayers from claiming the benefits of
both a credit and a deduction with respect to the same taxes. However, the law is
currently unclear how section 275(a)(4), equitable doctrines such as equitable
recoupment, or the mitigation provisions under sections 1311 through 1314, operate to
prevent taxpayers from obtaining a double benefit (through both a deduction and a credit)
for a single amount of foreign income tax paid. These uncertainties have led taxpayers
to request guidance from the Service to clarify the effect of a timely change in election on
their U.S. tax liabilities.

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Proposed regulations (85 FR 72078) address this uncertainty and would amend §1.905-
3 to provide that a foreign tax redetermination includes a change by a taxpayer in its
decision to claim a credit or a deduction for foreign income taxes that may affect a
taxpayer's U.S. tax liability. The effect of treating a change in a taxpayer’s decision to
claim a credit or a deduction for foreign income taxes as a foreign tax redetermination is
that the Service may assess and collect any U.S. tax deficiencies in intervening years
that result from the taxpayer’s change in election, even if the generally-applicable three-
year assessment period under section 6501(a) has expired.

Section 7121(a) of the Internal Revenue Code authorizes the Treasury Secretary or their
delegate to enter into binding agreements with a taxpayer relating to the liability of such
person in respect of any internal revenue tax for any taxable period. These agreements
are referred to as “closing agreements.” Closing agreements are intended to dispose of
debatable matters. IRM 8.13.1.2.1(4). Section 7121(b) provides that a closing agreement
is “final and conclusive . . . [and] except upon a showing of fraud or malfeasance, or
misrepresentation of a material fact . . . the case shall not be reopened as to the matters
agreed upon or the agreement modified . . . .”

CONCLUSIONS

On its tax returns as originally filed, Taxpayer claimed deductions for the ------- through -
------- tax years. Taxpayer was entitled to change its election and to claim credits for the
------- through ------- taxable years within the 10-year period referenced in §1.901-1(d).
However, because the Code prohibits taxpayers from claiming both a deduction and a
credit for the same foreign tax, the Taxpayer cannot both retain the foreign tax deduction
on its originally filed returns and claim a credit for the same taxes on its amended -------
tax return. Thus, the Taxpayer should not be entitled to claim the foreign tax credits for
the amounts at issue on its ------- tax return without also amending its earlier returns on
which deductions for those taxes were claimed and paying any associated tax deficiency.
If, however, the ------- request for a refund is allowed, there will be a determination under
section 1313 and a double-allowance of a deduction or credit as described in section
1312(2). Mitigation would thus apply, and the Service would be entitled to assess and
collect the deficiencies for ------- and ------- in connection with allowance of the refund for
------- in accordance with section 1314. Alternatively, the Service may enter into a closing
agreement with the Taxpayer in which the Service agrees to allow the refund for -------
subject to the elimination of the deductions for the same taxes on the earlier year returns
and the payment of any resulting deficiencies. If you need assistance in drafting an
appropriate closing agreement to ensure that the impact of the deductions is reversed,
please let us know.

This writing may contain privileged information. Any unauthorized disclosure of this
writing may undermine our ability to protect the privileged information. If disclosure is
determined to be necessary, please contact this office for our views.

POSTU-119848-20 5

Please call (202) 317-5004 if you have any further questions.