Daily Tax Update - August 3, 2006

The IRS today proposed regulations addressing the "technical taxpayer" rule, which helps determine the proper claimant of foreign tax credits. The regulations were issued in response to a series of developments, perhaps most notably the recent decision in Guardian Industries v. U.S. 65 Fed. Cl. 50 (2005), in which the parent of a Luxembourg consolidated group claimed credits for taxes on income of its subsidiaries. The court held that the parent was solely liable for the taxes under Luxembourg law, so was entitled to the credits under regulations providing that the credits are those of the person legally liable for the taxes under foreign law. Today's proposed regulations apportion the taxes among all the members of the group pro rata based on the relative amounts of net income of each member as computed under foreign law. The regulations focus on who is required to take the income into account, rather than who has the obligation to remit the tax.

  • The regulations also provide rules for determining who is entitled to credits in the case of a reverse hybrid whose owner bears liability for the foreign tax under foreign law. In that case, the reverse hybrid is considered to have legal liability based on the portion of the owner's taxable income that is attributable to the owner's share of the income of the reverse hybrid. In addition, the regulations clarify a technical ambiguity in the current regulations by providing that hybrid entities that are treated as partnerships under U.S. law have legal liability for foreign tax imposed on the income of the entity, and the owner of a disregarded entity is considered to have legal liability for such tax.
  • The regulations contain few surprises and take a practical approach to the problems the government has had with taxpayers applying the technical taxpayer rule according to its literal terms, as in Guardian. One question is whether the modifications proposed in the regulations, which are proposed to be effective for foreign taxes paid or accrued during taxable years beginning on or after January 1, 2007, will adversely affect the government's appeal in Guardian. Courts may view the issuance of regulations like these as an effective concession that the prior rule did not support the government's litigating position.
  • For additional information, contact Philip R. West.

Today, the Senate Finance Committee held a hearing titled, "Kick-off for Tax Reform: Tackling the Tax Code" featuring members of the President's Advisory Panel on Federal Tax Reform and various private sector witnesses. In Committee Chairman's Charles Grassley's (R-IA) opening statement, he said that he was "open minded" which direction to go toward tax simplification. Grassley said, "Let me say that I have no pre-conceived notion of which direction we should go, whether we’re talking about a flat tax, national retail sales tax, value-added tax or substantial modification of the current system. Let me also note that I instructed the Finance Committee tax staff to develop simplification proposals in all income tax areas."

  • Grassley added, "On a preliminary note, we did invite Treasury Department officials to today’s hearing. Treasury officials told us that, at this time, they did not wish to participate in the hearing so that they could have a chance to review tax reform proposals with Secretary Paulson. Treasury officials informed my staff that Treasury would be happy to participate in future hearings on this topic. We hope to have hearings this Fall on tax reform. We will look forward to Treasury’s participation at that time. In addition, I still expect Treasury and the Administration’s official response to the President’s Advisory Panel on Federal Tax Reform that is the focus of today’s hearing. In other words, we’re kicking off tax reform, but we’ll be waiting to hear from one of the key coaches, Secretary Paulson, as he draws up the Treasury’s playbook."
  • Additional testimony will be available here.

As provided for in Treasury regulations, advice (if any) relating to federal taxes that is contained in this communication (including attachments) is not intended or written to be used, and cannot be used, for the purpose of (1) avoiding penalties under the Internal Revenue Code or (2) promoting, marketing or recommending to another party any plan or arrangement addressed herein.

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