10 Year Period to Change Election to Deduct Rather Than Credit Foreign Taxes May Not Apply

Background

In lieu of the three-year period that normally applies to filing amended tax returns to claim a tax refund, taxpayers have generally had 10 years to decide whether to claim a deduction or credit for foreign taxes paid (or deemed paid). Since taxpayers may carryover unused foreign tax credits (FTCs) for 10 years, it seems logical to allow taxpayers 10 years (rather than three) to determine whether to deduct or credit these taxes. In fact, it is not unusual for taxpayers to amend their returns to switch between deducting or crediting foreign taxes because of unforeseen events that made one choice more beneficial than the other.

However, in a recent Chief Counsel Advice (CCA), Internal Revenue Service rejected as untimely a refund claim by a U.S. consolidated group resulting from an election to deduct rather than credit foreign taxes paid in a prior tax year. The refund claim was filed beyond the normal three-year statute of limitations (SOL) period but still within 10 years of the original filing date.

Salient Points of Chief Counsel Advice 201204008

The CCA stated that the 10-year SOL only applies if the claim for refund or credit relates to an overpayment attributable to any taxes paid or accrued for which credit is allowed against U.S. income tax. Under the facts of the CCA, the taxpayer had claimed a credit for its foreign taxes paid. However, as it turned out, claiming a credit for such taxes resulted in no benefit in the year the credit was claimed or in the credit carry-forward period. On the other hand, deducting the foreign tax created a loss that could be carried back to a prior year. This carryback would result in a refund of U.S. taxes previously paid. The CCA concluded that such a refund claim did not fall within the 10-year SOL that normally applies to refunds based on a foreign tax credit claim.

The CCA provided the following rationale: the 10-year SOL statute uses the word "allowed" rather than "allowable.” Based on this distinction, the CCA concluded that the 10-year SOL applies only where the taxpayer claims a credit rather than a deduction. This is because the statutory language governing the 10-year SOL states that it applies only where the claim for refund is based on foreign taxes “for which credit is allowed.” Thus, in order to apply the 10-year SOL, the refund must stem from an attempt to credit, not deduct, foreign taxes. 

Another way to read the statutory language would be to allow the extended SOL for claims based on foreign taxes of a type for which credit is allowed. Under this reading, the 10-year statute would apply if the underlying foreign tax is of a type “for which credit is [normally] allowed.” That reading might have prevailed if the statute had used the word “allowable” in lieu of “allowed.” However, it does not and because of this, IRS presumably concluded it was precluded from applying this interpretation even though such a reading would be consistent with the policy of allowing taxpayers more time to resolve matters involving foreign income taxes.

Observations

While the CCA is not binding authority, it may indicate how IRS will approach this issue in future cases. Thus, taxpayers should not be surprised if IRS denies a refund request based on a new decision to deduct, instead of credit, foreign taxes if the change is made after the normal three-year SOL expires but within the 10-year SOL. Taxpayers may find that they will have to undertake additional measures in order to obtain a refund, like taking the matter to appeals and/or considering litigation.

Taxpayers in an excess credit position who are concerned that the logic outlined in this CCA may apply to them have at least two options. One is for taxpayers to consider developing arguments to fortify their position that the extended SOL applies to a claim based on a deduction. In other words, taxpayers should develop a position based on legislative intent, court cases or other authority that the word “allowed” in the statute does not limit application of the extended SOL to credit claims, and then be prepared to fight IRS at appeals or in court. In the second option, taxpayers may adopt a policy of claiming a deduction in lieu of a credit in the first instance and then reverse that decision prior to the expiration of the 10-year SOL.  Presumably filing amended returns based on a decision to claim a credit in lieu of a previously claimed deduction would be allowed even under the logic of the CCA. In any event, it is clear that taxpayers should consider the impact of the CCA on their positions and develop a plan either to fall within or to refute its logic.