On August 10, 2010, President Obama signed into law the Education Jobs and Medicaid Assistance Act of 2010 (the "Act"). The Act changes many sections of the federal tax laws, helping to pay for a temporary increase in funding for Medicaid and education. The most significant changes relate to the use of and limitations on the foreign tax credit, which are summarized below.
A taxpayer generally is able to receive a credit against its taxes for the amount of foreign taxes paid. Under prior law, the amount of the taxpayer's foreign tax credit generally was limited to the amount of the U.S. tax liability on its foreign source income, and the limitation was generally applied to income in two separate categories: passive income and general income. The limitation was generally calculated based on the taxpayer's total foreign source income, regardless of whether the foreign taxes paid by the taxpayer actually related to such foreign source income. In addition, a taxpayer was generally able to claim an indirect credit with respect to foreign taxes that were paid by a subsidiary in which the taxpayer owned a 10% or more interest when the taxpayer either (i) received dividend distributions from the subsidiary or (ii) was required to include a portion of the subsidiary's income in the taxpayer's income pursuant to the controlled foreign corporation rules.
The Act maintains these limitations, but adopts additional limitations on a taxpayer's use of foreign tax credits:
- The Act defers the creditability of a foreign tax paid by a
taxpayer until the income to which the foreign tax relates is taken
into account by the taxpayer.
- The Act denies a foreign tax credit for the disqualified
portion of any foreign income tax paid or accrued in connection
with a covered asset acquisition. A covered asset acquisition is a
transaction treated as asset acquisition for U.S. tax purposes but
treated as a stock acquisition (or is disregarded) for foreign tax
purposes. Examples of a covered asset acquisition include a
qualified stock purchase where the taxpayer has made an election
pursuant Section 338(g) or Section 338(h)(10) of the Internal
Revenue Code (the "Code") or an acquisition of an
interest in a partnership that has an election pursuant to Section
754 of the Code in effect . The disqualified portion of the foreign
income tax paid or accrued is the ratio of (i) the basis
differences allocable with respect to such assets (i.e., the
difference between the adjusted basis of the assets before the
transaction and the adjusted basis after the transaction) divided
by (ii) the income on which the foreign income tax is
determined.
- The Act limits the amount of foreign taxes that a taxpayer is
deemed to pay with respect to any Section 956 inclusion (relating
to income from investments by controlled foreign corporations in
U.S. property) to the lesser of the foreign taxes deemed paid
(without regard to the new provision) or the hypothetical foreign
taxes that the taxpayer would be deemed to have paid had cash in
the amount of the Section 956 inclusion been distributed from the
foreign corporation that holds the U.S. property through the chain
of ownership to the taxpayer.
- The Act imposes a separate foreign tax credit limitation to tax items that are resourced pursuant to a treaty obligation of the United States.
In addition to these changes to the foreign tax credit rules, the Act also made the following revisions:
- The Act limits the earnings and profits of a foreign acquiring
corporation that are taken into account in determining the amount
(and source) of a distribution that is treated as a dividend in
stock purchases that are recharacterized as redemptions pursuant to
Section 304 of the Code.
- The Act specifically includes as members of an affiliated group
for purposes of the interest allocation rules, those foreign
corporations with effectively connected income greater than 50% of
their gross income where at least 80% of the voting power, or the
value of which, is owned by other members of the affiliated
group.
- The Act repeals certain rules relating to interest and
dividends received from resident alien individuals or domestic
corporations whose active foreign business income represents at
least 80% of the gross income of such individual or corporation. A
grandfather rule is provided for corporations currently satisfying
the 80% foreign active business requirement.
- The Act limits the extension of the statute of limitations
period with respect to the failure to provide certain information
returns that are related to certain foreign transfers.
- The Act also eliminates an advance payment option that was previously available to certain taxpayers who are eligible to receive the earned income tax credit.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
