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The Elusive Basis Problem of the Foreign Tax Credit Limitation Under 26 USC § 901(m)

Author(s): Rufus Rhoades and Alexey Manasuev
Date: April 2011

The Background.

As we know, Congress tinkered with the foreign tax credit (FTC) rules in 2010 in a number of ways. One of those changes was to add Section 901(m) (“Denial of foreign tax credit with respect to foreign income not subject to United States taxation by reason of covered asset acquisitions”) to the Code.1 The problem that Congress had in mind resolving can best be shown through an example.

The Problem.

Rhoco, Inc., a NY corporation, acquires all of the stock of Peterco, SA, a French corporation. Rhoco makes the 26 USC § 338 election2 and allocates that purchase price amongst Peterco’s assets. Assume that Peterco has three assets that have a value of $100 each but a basis in Peterco’s hands of $40 each. As a result of the election, the basis of each of those assets for U.S. purposes is $100, but for French tax law purposes, since the election is meaningless under French law, the basis remains $40 each. For 2011, Peterco’s net income, for French tax purposes, was $500,000. For U.S. purposes, however, Peterco’s income was only $300,000 because, under French law, Peterco’s depreciation deduction on the lower basis assets was a good deal less than the depreciation on the higher basis assets calculated under U.S. tax accounting rules. That difference means that (1) Peterco’s income for U.S. purposes is lower than it will be for French purposes, and (2) the French income tax is higher (and, hence, the foreign tax credit is greater) than it would have been had the basis calculations been the same under both sets of tax rules. In other words, the FTC will be higher than it would be, relative to French source income, had the bases of the assets been the same for both French and U.S. law purposes.

Congressional Solution.

Congress’s response to the issue presented by …

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