Legislative update - Foreign tax credit proposals in Ways and Means chairman’s tax reform “discussion draft”  

February 28:  The tax reform “discussion draft,” released this week by House Ways and Means Chairman Dave Camp, proposes changes to the rules for foreign tax credits—FTCs.

The following report examines the proposed discussion draft’s changes to the foreign tax credit rules.

Repeal section 902 and determination of section 960 credit on a current year basis

A provision of the discussion draft proposal (section 4101 of the draft legislation) would repeal Code section 902, which deems a U.S. corporate shareholder of a 10% owned foreign corporation to have paid a portion of the foreign corporation’s taxes when it receives or is deemed to receive a dividend from that foreign corporation.


The proposal would retain the deemed paid credit under section 960 for subpart F inclusions, but would compute the allowable credit based on current year taxes rather than under the section 902 “pooling” approach.


Under the Joint Committee on Taxation (JCT) report,  the IRS and Treasury would be directed to provide rules for allocating taxes to subpart F inclusions.  The JCT report anticipates that those rules would be similar to the rules in current Reg. section 1.904-6 for allocating taxes to separate section 904(d) categories of income. For example, if income treated as subpart F income for U.S. purposes is not subject to foreign tax, no taxes would be attributable and deemed paid with respect to a subpart F inclusion.


To the extent foreign taxes attributable to a subpart F inclusion are not claimed as credits in the year of the subpart F inclusion—for example because they arise on a distribution of previously taxed earnings (PTI) from a lower-tier to an upper-tier CFC—these foreign taxes would be allowed as credits under section 960 in the year the PTI is distributed. The section 960 credit, as under current law, would be computed separately for each separate category of income under section 904(d).


The proposal would make conforming amendments to other Code provisions to reflect the repeal of section 902, including:


  • Amending section 78 to treat the “gross-up” for deemed paid taxes as an additional section 951(a) inclusion rather than a dividend
  • Repealing section 1293(f), which allowed a deemed paid credit under section 960 for qualified electing fund inclusions
  • Amending section 909 to apply to direct foreign taxes and foreign taxes that would be deemed paid under section 960

The amendments are proposed to be effective for tax years of foreign corporations beginning after December 31, 2014, and to tax years of U.S. shareholders in which―or with which―such tax years of foreign corporations end.

KPMG observation

The repeal of section 902 would have significant consequences for section 902 corporations (referred to as “qualified 10 percent owned foreign corporations” in the discussion draft proposal) because no taxes paid or accrued by such corporations could be claimed as FTCs.


The Ways and Means chairman’s proposal appears to be substantively the same as the November 2013 then-Finance chairman’s draft proposal, with one exception. The Ways and Means chairman’s proposal would retain section 909 for direct foreign taxes, while the Finance chairman’s proposal would repeal section 909.

Foreign tax credit limitation applied by allocating only directly allocable deductions to foreign source income

A provision in the discussion draft (section 4102 of the draft legislation) would add a new section 904(b)(3) to the Code, providing that for purposes of computing the FTC limitation, only directly allocable deductions would be subtracted from foreign source gross income to arrive at foreign source taxable income.


Directly allocable expenses would include salaries of sales personnel, supplies, and shipping expenses directly related to producing foreign source income. Examples of expenses that would not be directly related to producing foreign source income and, thus, would not reduce foreign source gross income for FTC purposes include general and administrative expenses, stewardship expenses and interest expense.


The amendments are proposed to be effective for tax years of foreign corporations beginning after December 31, 2014, and to tax years of U.S. shareholders in which―or with which―such tax years of foreign corporations end.

KPMG observation

This proposal is viewed as “taxpayer favorable” because it would result in more foreign source taxable income and, thus, a higher FTC limitation than if indirect expenses were applied to reduce foreign income. Expenses that do not reduce foreign source income would not be disallowed and, thus, would reduce worldwide taxable income in the denominator of the FTC limitation fraction.

Passive category income expanded to include other mobile income

A provision in the discussion draft (section 4103 of the draft legislation) would retain the two separate categories of income under Code section 904(d), but would rename the passive category as the mobile income category and expand the former passive category to include foreign base company sales income and foreign base company intangible income (as defined in sections 4202 and 4211 of the draft legislation).


Mobile category income also would include financial services income.


Excess foreign taxes carried over from a pre-effective date year would be subject to the new rules, and regulatory authority would be provided for the IRS and Treasury to provide for the allocation of excess credit carry backs from post-effective to pre-effective date years.


These amendments are proposed to be effective for tax years of foreign corporations beginning after December 31, 2014, and to tax years of U.S. shareholders in which or with which such tax years of foreign corporations end.

KPMG observation

Under current law, the general category in most cases includes active business income, while the passive category includes investment type income. The proposal appears to move away from an active / passive approach and toward a low-tax / high-tax approach. The revised categories of subpart F income that would fall within the mobile category generally would be defined to include only income taxed at a rate less than 50% of the U.S. rate without regard to whether earned as part of an active trade or business. Financial services income, although derived as part of an active business, generally is low-taxed compared to other types of active business income.

Source of income from sales of inventory determined solely on basis of production activities

A provision of the discussion draft (section 4104 of the draft legislation) would revise the current general rule under current Code section 863(b), which sources income from inventory property produced in one jurisdiction and sold in another jurisdiction by allocating 50% of sales income to the place of production and 50% to the place of sale (determined based on title passage). Under the proposed change, income from inventory sales would be sourced entirely based on the place of production. Thus, if inventory property is produced in the United States and sold outside of the United States, sales income would be 100% U.S. source. If inventory property is produced partly within and partly outside of the United States, income from sales would be partly U.S. and partly foreign source.

KPMG observation

The proposed change would produce a more economically realistic result as compared to the current rule, which relies on the easily manipulable title passage rule. Query, though, whether it could have the unintended result of encouraging companies to expand foreign production.



For more information, contact a tax professional with the International Corporate Services group of KPMG’s Washington National Tax:


Caren Shein

(202) 533-4210




©2014 KPMG LLP, a Delaware limited liability partnership and the U.S. member firm of the KPMG network of independent member firms affiliated with KPMG International Cooperative ("KPMG International"), a Swiss entity. All rights reserved.


The KPMG logo and name are trademarks of KPMG International.


KPMG International is a Swiss cooperative that serves as a coordinating entity for a network of independent member firms. KPMG International provides no audit or other client services. Such services are provided solely by member firms in their respective geographic areas. KPMG International and its member firms are legally distinct and separate entities. They are not and nothing contained herein shall be construed to place these entities in the relationship of parents, subsidiaries, agents, partners, or joint venturers. No member firm has any authority (actual, apparent, implied or otherwise) to obligate or bind KPMG International or any member firm in any manner whatsoever.


The information contained in herein is of a general nature and is not intended to address the circumstances of any particular individual or entity. Although we endeavor to provide accurate and timely information, there can be no guarantee that such information is accurate as of the date it is received or that it will continue to be accurate in the future. No one should act on such information without appropriate professional advice after a thorough examination of the particular situation.


Direct comments, including requests for subscriptions, to us-kpmgwnt@kpmg.com.
For more information, contact KPMG's Federal Tax Legislative and Regulatory Services Group at:

+ 1 202 533 4366

1801 K Street NW
Washington, DC 20006.

Share this

Share this

Subscribe

Current and future KPMG clients may subscribe to TaxNewsFlash email alerts.


Email your contact information.

TaxNewsFlash-United States by year