On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”) was signed into law. The CARES Act provides for roughly $2 trillion of economic relief to those impacted by the COVID-19 pandemic. The Act also includes certain modifications to the Internal Revenue Code (“IRC”). Subsequently, on April 17, 2020, the IRS released Revenue Ruling 2020-08 addressing the appropriate period for refund claims resulting from a foreign tax credit (“FTC”) carryback that was “released” by reason of a net operating loss (“NOL”) carryback from a subsequent year. This FGMK International Tax Alert provides an overview of the potential impact of these developments on tax planning.
CARES Act Modifications to NOL Rules
The CARES Act suspends on a temporary basis the 80 percent taxable income limitation on the use of net operating losses (“NOLs”) to offset taxable income, which was established under the Tax Cuts and Jobs Act of 2017 (the “TCJA”). The CARES Act also provides the ability to carry back NOLs, something that was previously eliminated under the TCJA. These changes apply for tax years beginning after December 31, 2017 and before January 1, 2021.
How taxpayers elect to utilize these new NOL rules may impact FTCs. Assuming NOLs are carried back to years where FTCs were used to offset taxes, elimination of income by NOLs could create excess FTCs in a given tax year. Those excess FTCs can then be carried back to previous tax years in refund claims. Consider the following example.
US1, a calendar year taxpayer, has a $100 NOL for 2019. Under the amended carryback rules of the CARES Act, US1 elects to carry the 2019 NOL back to its 2014 tax year. The 2019 NOL reduces US1’s 2014 taxable income to zero. In 2014, US1 claimed $50 of FTCs, which results now in excess FTCs that US1 elects to carry back to 2013. This FTC carryback results in a $25 overpayment/refund claim for 2013.
Please note that the ability to carryback FTC claims from a timing perspective may be impacted by recently issued Revenue Ruling 2020-08, detailed below.
Other Foreign Tax Credit Implications
Larger NOL deductions, while providing potential cash tax refunds, will generally reduce a taxpayer's FTC limitation, regardless of whether the NOL source is foreign or domestic. A taxpayer will likely have a greater FTC carryback or carryforward following an NOL carryback. Domestic-source NOLs may generate, or increase, an overall domestic loss (“ODL”) account. Foreign-source NOLs may generate, or increase, a separate limitation loss or an overall foreign loss (“OFL”) account, which could be detrimental in a subsequent tax year, including in the Section 965 transition tax year.
In addition, the tax rate differential between pre-TCJA and post-TCJA tax years should also be understood in contemplating the NOL carryback. Generally, FTCs carried to pre-TCJA years would be available to offset income taxed at 35 percent, while FTCs utilized in a post-TCJA year will only offset income taxed at a 21 percent rate (i.e., corporate tax rates).
Revenue Ruling 2020-08
Section 6511(d)(3)(A) provides for an extended 10-year limitation period (as opposed to the typical three-year limitation) for credit/refund claims associated with tax overpayment attributable to foreign tax credits. The extended limitation period begins when these taxes were actually paid or accrued.
Section 6511(d)(2)(A) provides a distinct time window for refund claims attributable to carrybacks of NOLs and net capital loss carrybacks: specifically, three years after the tax return due date for the tax year in which the NOL arose.
In Revenue Ruling 71-533, the IRS stated that a claim for refund or credit of an overpayment from an FTC carryback that was the result of an NOL carryback from a subsequent year was subject to the 10-year limitation period under Section 6511(d)(3)(A). The ruling used the example of a taxpayer that generated an NOL on its 1969 tax return and then carried that loss back to its 1966 tax return, resulting in no taxable income for 1966. However, because taxpayer had used FTCs to offset its tax liability on the original 1966 tax return, the NOL carryback created excess FTCs for that year that the taxpayer carried back to its 1964 tax year, resulting in an overpayment for the 1964 tax year.
The taxpayer filed a claim for refund of the overpayment for its 1964 tax year (from its 1969-generated NOL). The IRS held that the taxpayer’s claim properly fell within the 10-year limitation period pursuant to Section 6511(d)(3)(A), and thus was not subject to the three-year period under Section 6511(d)(2)(A).
The Service’s decision in Revenue Ruling 71-533 was based in part on its previous holding in Revenue Ruling 68-150. Rev. Rul. 68-150 provided that Section 6511(d)(3)(A) applies to “claims for credit or refund based on the correction of mathematical errors in the computation of taxes subject to the provisions of that section … or any other adjustments to the size of the foreign tax credit, including those due to the payment of additional foreign taxes.”
Impact of Revenue Ruling 2020-08
Revenue Ruling 2020-08 announces that Revenue Ruling 71-533 and the relevant portion of Revenue Ruling 68-150 noted above are currently being reconsidered and, accordingly, are suspended while the Service reconsiders the issues. Specifically, the IRS is contemplating whether the special three-year limitation period for claims for credit or refund that relate to overpayments attributable to NOL carrybacks provided by Section 6511(d)(2)(A) should have been applied to the facts of Revenue Ruling 71-533, as opposed to the 10-year limitation period of Section 6511(d)(3)(A).
Pursuant to the facts set forth in Revenue Ruling 71-533, the taxpayer would have had until 1974 to timely file a refund claim under Section 6511(d)(3)(A)’s 10-year limitation period. However, had the IRS applied Section 6511(d)(2)(A), the limitation period would have ended in 1972 (i.e., three years after the year in which the taxpayer generated the NOL). Revenue Ruling 71-533 does not specifically state when the refund claim for the 1964 tax year was filed, but it seems logical to deduce that it occurred in a reasonable time frame after the taxpayer filed the 1969 tax return in 1970 to provide that the 1969 NOL was eligible to be carried back to 1966.
Trusted Media Brands Case – Credits vs. Deductions
There is one final wrinkle in considering Section 6511(d)(3)(A)’s 10-year limitation period: whether the refund claim is the result of foreign taxes credited or deducted. Taxpayers have a choice on their tax return as to whether to use foreign taxes paid as a credit, dollar for dollar, against income tax due or as a deduction to offset taxable income. Unique attributes and circumstances dictate when one method is preferred over the other for a given taxpayer. However, a recent tax case (Trusted Media Brands, Inc. v. United States, 899 F.3d 175 (2d Cir. 2018)) suggests that foreign tax deductions are not entitled to the ten-year limitation period that foreign tax credits enjoy.
Taxpayer in Trusted Media Brands first claimed a credit for foreign taxes paid but, on an amended tax return for 2002 which was filed 2011, decided instead elected to claim foreign tax deductions against income. This caused a series of changes to various returns, which ultimately led to taxpayer claiming a tax refund for the 1995 tax year. Taxpayer asserted that the 10-year statute of limitations of Section 6511(d)(3)(A) should apply (with respect to the 2002 tax return up through the 2011 date of amended filing).
The IRS denied the claim and argued that the general three-year statute of limitations should apply. When taxpayer sued in District Court, the Court denied the taxpayer’s claim as untimely and held that the 10-year statute of limitations with respect to refund claims of foreign taxes applies only to credits and not deductions. The Second Circuit affirmed the District Court’s decision.
If you have clients that plan to carry back NOLs, please consult the FGMK international tax team to understand the potential impact to FTCs.
The summary information in this document is being provided for education purposes only. Recipients may not rely on this summary other than for the purpose intended, and the contents should not be construed as accounting, tax, investment, or legal advice. We encourage any recipients to contact the authors for any inquiries regarding the contents. FGMK (and its related entities and partners) shall not be responsible for any loss incurred by any person that relies on this publication.
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