IRS and Treasury Provide Needed Clarity to FTC Cost-Recovery Requirement

The IRS and Treasury have issued technical corrections to the January 4, 2022 foreign tax credit (“FTC”) Final Regulations to ease some taxpayers’ tensions regarding the cost-recovery requirement. The Final Regulations modified the net gain requirement by limiting the predominant character analysis in determining whether a foreign levy meets each of the components of the net gain requirement—the realization requirement, the gross receipts requirement, and the cost recovery requirement (formerly called the net income requirement). 

The Final Regulations provided that whether a tax satisfies each of the realization, gross receipts, and cost recovery requirements is based on the terms of the foreign tax law governing the computation of the tax base. More specifically, there must be substantial conformity in the principles used to calculate the foreign tax base and the U.S. tax base.

Cost Recovery

Under the Final Regulations, the cost-recovery requirement is satisfied when the foreign tax law allows for the recovery of significant costs and expenses attributable to gross receipts in the foreign tax base or provided a comparable allowance that at least equaled those significant costs and expenses.

Many taxpayers found issue with these changes because they were concerned that it might require the foreign cost recovery system to mirror the U.S.’s system to satisfy the requirement.  However, the IRS and Treasury maintain that the focus is and has always been on the principles used by the foreign taxing authority rather than the form of the actual cost-recovery system.

The IRS and Treasury attempted to ease tensions by reiterating that the Final Regulations were meant to provide flexibility in what satisfies the net gain requirements while allowing the determination to be based on more objective and readily available information for the sake of sound tax administration. 

In doing so, the IRS and Treasury added, by way of its technical corrections, “public policy concerns” to the regulation’s list of ways in which a foreign disallowance can correspond with U.S. tax law.  This list already included disallowances intended to limit base erosion or profit shifting.

While this change is not groundbreaking, it provides the taxpayer needed clarity in what can satisfy the cost recovery requirement.

We Can Help

Please reach out to our international tax team if you have any questions regarding the FTC Final Regulations or the recent technical corrections.

The information provided in this communication is of a general nature and should not be considered professional advice. You should not act upon the information provided without obtaining specific professional advice. The information above is subject to change.