T he proposed regulations under section 905 strike us as a - - PDF document

Tax Notes International

May 5, 1997 .1479

Dear Commissioner Richardson:

T

he proposed regulations under section 905 strike us as a thoroughly disingenuous attempt to effect a substantial change in the regulations whjle purporting merely to "clarify" their meaning. There is nothing in the preamble to the proposed regulations that acknowledges what must be

• bvi-
• us to the Service
• that

the amendments will dramatically increase the burden on taxpayers, making it more difficult for them to establish entitle- ment to foreign tax credits. We would not object if there were good reason to stiffen the substantiation requirements in this manner, but there is not. The proposed amendments, as we understand them, reflect a blunderbuss ap- proach; to address a perceived problem of a specific nature, they raise the burden of substantiation in an unrealistic and unnecessary way for all tax- payers. We acknowledge some hesitation in expressing this view, in light of the fact that (as discussed below) the actual language

• f the proposed

amend- ments is so indirect that it could mean anything or nothing at all. At the outset, it should be noted that the regulations the Service proposes to "clarify" have been in place and pretty much the same for the last 75 years. Since 1918, when the foreign tax credit was adopted, Congress has re- quired that taxpayers furnish "evidence satisfactory to the Commissioner

• showing. ..[all] information necessary

for the computation

• f such

credit." Revenue Act of 1918 section 238(b). Treasury Regulations have implemented this requirement since 1919 by requiring, as they still do, that a corporation claiming foreign tax credits file a Form 1118 "carefully filled out with all the information there called for" and attach to the Form 1118 "the receipt for each such tax payment." Regulations 45, Articles 383 and 611 (1919). In 1920, Treasury stated that, in the case

• f foreign tax withheld at the

source, the U .S. person should substantiate the tax payment by attaching

The actual language

• f the proposed

amendments is so indirect that it could mean any- thing

• r nothing

at all.

1480 .May 5, 1997 Commentary

Tax Notes International

lThe explanation accompanying the 1941 amendments illustrated the type of secondary evidence envisioned. These illustrations, which were incorporated di- rectly into the regulations in 1957 and now appear as Treasury Regulation section 1.905-2(b)(1), (2), and (3), stated in part that "where evidence of withholding can- not be secured from those who have made the payments [a reference to the type of certified statement identified in the 1933 Treasury decision], the Commissioner may in his discretion accept secondary evidence of such withholding and of the amount of the tax so withheld, having due regard to the taxpayer's books of ac- count and to the rates of taxation prevailing in the particular foreign country during the period involved." I.R. Mim. 5219, 1941-2 C.B. 140.

to the Form 1118 an affidavit from the withholding agent confirming the amount of tax withheld and paid. Treasury stated: When credit is claimed by an American bank for the amount of tax withheld from interest on bank deposits and paid to a foreign Gov- ernment by a foreign bank, there should be attached to and filed with form 1118, an affidavit from the foreign withholding agent. The affidavit should set forth the title of the statute under which such withholding was required, the amount of interest accrued to the American bank, and the amount of tax withheld and paid to the foreign Government. O.D. 671, 3 C.B. 283 (1920). In 1933, Treasury reaffirmed that an affidavit from a foreign withholding agent would be treated as a "r~ceipt of payment" and would satisfy the substantiation requirements for claiming a foreign tax credit where the taxpayer could not otherwise obtain a receipt from the foreign government. Treasury stated: In general, by "receipt" is meant a receipt issued by a foreign gov- ernment to one of its taxpayers for taxes paid on the latter's own income or upon income of a distributee where such taxpayer is the

• distributor. However, in the case of taxes paid at the source upon

dividends, interest, or royalties distributed to a domestic share- holder or creditor. ..A certified statement by the foreign distribu-

• tor. ..showing

the gross distribution, the tax withheld, and the net amount credited to the domestic taxpayer, may be considered a re- ceipt for the purpose of credit allowances, provided that in these cases of taxes withheld at a foreign source the domestic taxpayer is unable to secure receipts issued by the foreign government, and provided further that such credits shall be subject to the usual veri- fication

• f income and application
• f known foreign tax rates

thereto. I.T. 2676, XII-I C.B. 48,49 (1933). Eight years later, Treasury amended the regulations to make the sub- stantiation requirements for foreign tax credits "more flexible" by authoriz- ing the receipt of secondary evidence "in support of credit for foreign taxes." I.R. Mim. 5219, 1941-2 C.B. 140. The 1920 and 1933 Treasury decisions had already established that "an affidavit" or "a certified statement" from a foreign withholding agent was acceptable proof of payment, so the 1941 amendments built upon this premise and provided that where a taxpayer could not "furnish { 1) a receipt for such foreign tax payment or (2) the foreign tax return or (3) direct evidence of the amount of tax withheld at the source," then the Commissioner could, in his discretion, accept secondary evidence "of the payment or accrual of the tax or of the withholding of the tax. ..." T.D. 5056,1941-2 C.B. 139.1 In Lederman v. Commissioner, 6 T.C. 991 (1946), the Tax Court reviewed the regulations and stated: "it is clear that withholding and payment are

Only in the last 10 years have concerns been raised that proof

• f withhold-

ing may, in some instances, not be satisfactory proof

• f payment.

Tax Notes International

Commentary considered to be the same for purposes of the credit," and further: "it seems clear from the regulation. ..that direct evidence of the fact that tax has been withheld at the source and of the amount withheld are satisfactory and sufficient proof to support a claim for credit. ..." 6 T.C. at 998. The Service acquiesced in the Lederman decision, 1946-2 C.B. 3. The text of Forms 1116 and 1118 further confirmed that proof of with- holding was acceptable proof of payment. The 1959 version of Form 1116, for instance, provided in two places that foreign taxes paid by individuals should be "evidenced by [an] attached receipt, return, or withholding state- ment." Form 1116, Part 1, line 17; Part II, line 6 (italics added). As of 1961, when Elisabeth Owens wrote The Foreign Tax Credit, the acceptance of a withholding statement as proof of payment was clear. Owens wrote: What constitutes an acceptable document or statement secured from a withholding agent is not specified in the Regulation, except that it shall show the amount of tax withheld. In O.D. 671, 3 CB 283 (1920), it is stated that an affidavit from a foreign withholding agent should set forth the title of the statute under which the with- holding was required, the amount of the income paid to the taxpay- er, and the amount of tax withheld. However, this rule was applied in a situation where the taxpayer was in a position to secure a special affidavit from the person withholding the foreign tax. It ap- pears that any official withholding statement would ordinarily be

• sufficient. Secondary evidence of a tax withheld, if required by the

district director where a withholding statement cannot be secured, would probably be of the same character as secondary evidence of a tax paid.

• E. Owens, The Foreign Tax Credit, section 8/4C4a, page 513 (1961).

And in 1985, the Service confirmed that direct evidence of withholding satisfied the substantiation requirements of Code section 905(b). In two private letter rulings, the Service stated: Bank raises the issue of whether section 905(b) of the Code requires that a taxpayer must substantiate that a withholding tax has been paid to the government imposing the tax before that tax is consid- ered paid under section 905 of the Code. Section 905(b) requires that before a withholding tax will be considered paid under section 905 the taxpayer must provide direct evidence of the fact that the tax has been withheld, or such secondary evidence as the district director may in his discretion accept. Section 1.905-2(b) of the regu-

• lations. Therefore, it is the view of the Service that section 905(b)

does not necessarily require a taxpayer to substantiate that a with- holding tax has been paid to the government imposing the tax be- fore that tax is considered paid under section 905. See Jules D. Lederman, 6 T.C. 991 (1946), acq. 1946-2 C.B. 3; see also Owens, The Foreign Tax Credit, 7/2C, at p. 451 (1961). However, as to what constitutes direct or acceptable secondary evidence of the fact that the tax has been withheld, that is a determination to be made by the district director . LTR 8531035 (May 7, 1985) and LTR 8534011 (May 21, 1985). Thus, all authorities consistently and repeatedly held in the 65 years from 1920 to 1985 that proof of withholding was proof of payment. Only in the last 10 years have concerns been raised that proof of with- holding may, in some instances, not be satisfactory proof of payment. In 1986, Congress struck a note of caution in cases

• f net loans and subsidies.

In the case of net loans, Congress stated that the Service should be careful to ensure that the taxes claimed to have been withheld were actually with- held.2 In the case

• f subsidies, Congress stated the Service should be careful

May 5, 1997 .1481

• I. The

Proposed Amendments Are Meaningless As stated at the outset, the proposed amendments are so obscure that they could mean anything

• r nothing

at all. The proposed amendments There is nothing in require that a taxpayer "prove that any taxes withheld at the source were the amendments paid to the foreign country, as required in paragraph (a) of this section." that says that the This has always been required. And, as the discussion above shows, since

f .d 1920 taxpayers have been allowed to prove that withheld taxes were paid type O evl ence to a foreign country by submitting "an affidavit from the foreign withholding that was acceptab!e

• agent. ..set[ting]

forth the title of the statute under which such withhold- to prove payment In ing was required, the amount of [income earned by the taxpayer], and the the past will be amount of tax withheld and paid to the foreign Government." O.D. 671, 3 acceptable no more. C.B. 283 (1920). This was reaffirmed in 1933, see I.T. 2676, XII-1 C.B. 48, 49 (1933), and repeatedly thereafter by the authorities cited above. Indeed, since 1941 the regulations themselves have incorporated these authorities by treating "direct evidence of the amount of tax withheld at the source" as proof of payment. Nothing in the language of the proposed amendments disavows this long line of authority; there is nothing in the amendments that says that the type

• f evidence that was acceptable to prove payment in 1920, 1933, 1941, 1946,

1959, 1961, or 1985 will be acceptable no more. Consequently, the proposed amendments, taken literally, do not actually say anything.

• 2. The 'Interim

Credit' Notion is Misapplied Putting aside issues of construction, we suspect the proposed amend- ments are meant to imply that the type of evidence that proved payment for the last 75 years will no longer be accepted -rather, such evidence will simply allow the taxpayer to "buy time" to obtain some other, less accessible proof of payment. This suspicion is based on the "interim credit" notion that 2"The conferees believe that the rule set forth in Lederman

• v. Commissioner,

6 T.C. 991 (1946), which suggests that payment is proved ipso facto by the act of withholding, is subject to abuse. Application of the Lederman rule is of particular concern in the context

• f a 'net loan,' under which the net amount paid to the U

.S. payee is unaffected by the amount of tax withheld. In such a case, it is impossible to determine prima facie whether a claimed amount withheld has actually been withheld, since the amount received by the payee remains unchanged. The logic of the Lederman rule simply does not apply in such circumstances, and external proof of withholding and payment over should be required." H.R. Rep. No.841, 99th Cong., 2d Sess. 11-594 (1986). 3"The conferees' concerns with respect to documentation

• f foreign taxes are

heightened by the problem of subsidized foreign tax payments. The conferees are informed that in some cases amounts withheld are retained by the withholding agent, in whole or in part, with the explicit or implicit approval of the foreign sovereign. ...Therefore, the conferees expect that a receipt or other positive proof

• f payment

will generally be required to establish the amount of foreign withhold- ing tax paid with respect to foreign source interest income received by U.S. tax- payers." H.R. Rep. No.841, 99th Cong., 2d Sess. 11-594 (1986). 1482 .May 5, 1997

Tax Notes International to ensure that foreign governments were not allowing withholding agents to keep the amounts withheld.3 The proposed amendments are the wrong way to deal with these concerns. Moreover, it is inexcusable

• because it is untrue -for

the Service to suggest that the proposed amendments simply "clarify" the longstanding regulations. In addressing these points, however, we must acknowledge that

• ur interpretation of the proposed

amendments is based

• n our perception
• f their intent -for

the language

• f the proposed

amendments, taken by itself, defies interpretation.

Commenta~

Commentary ~

• We suspect

that the proposed amend- ments are using the 'interim credit' concept in a way that has absolutely no support in the Code or regulations.

4See also The Steel Improvement and Forge Company v. Commissioner, 36 T. C. 265, 281-82 (1961) (foreign tax credit is provisional because it is subject to adjust- ment if tax is refunded); IRM, Handbook 4233 section 598.4 (if a taxpayer files a return and claims a foreign tax credit on the accrual basis, the amount of the foreign tax credit is allowed as "a provisional or interim credit, subject to adjust- ment based on the exchange rate when the tax is actually paid").

Tax Notes International

May 5, 1997 .1483

the Service advanced in the Continental Illinois litigation and now seeks to import into the regulations. The idea that a foreign tax credit is "a provisional or interim credit" has long been recognized and is not controversial. To our knowledge, it was first articulated by the Tax Court in Pacific Metals Corp.

• v. Commissioner,

1 T .C. 1028, 1030 (1943), where the court required a taxpayer to reduce the amount

• f a foreign tax credit claimed in Year 1 when a portion of the tax was

refunded to him in Year 3. The court explained that the foreign tax credit is "a provisional or interim credit" because the amount

• f the credit is subject

to adjustment based on certain events specified in Code section 905(c) (originally section 238(a)

• f the Revenue

Act of 1918, then section 131(c)

• f

the Revenue Act of 1932)

• namely,

the credit is subject to adjustment if the tax is refunded to the taxpayer or, in the case

• f a credit for accrued

tax, if the amount of tax ultimately paid differs from the amount of tax accrued. The "provisional or interim" quality of the credit arises from the fact that the amount of the credit is subject to adjustment upon the occurrence

• f

certain events. This applies equally to taxes paid directly, taxes accrued,

• r

taxes withheld at the source.4 We suspect, however, that the proposed amendments are using the "in- terim credit" concept in an entirely different way -a way that has abso- lutely no support in the Code

• r regulations. The proposed

amendments seem to imply that a credit claimed for taxes withheld at the source is an "interim credit" in a way different from taxes paid directly or accrued. They appear to suggest, in short, that satisfying the "secondary evidence" require- ments for taxes withheld at source, Treas. Reg. section 1.905-2(b)(3), entitles the taxpayer to claim the credit only on a temporary

• r "interim" basis

while the taxpayer obtains some

• ther type of substantiation

for the credit. Indeed, the proposed amendments seem to suggest that even satisfying the "direct evidence" requirement for taxes withheld at source, see Treas. Reg. section 1.905-2(b) ("direct evidence

• f the amount of tax withheld at the source")

entitles a taxpayer to claim the credit only on a temporary

• r "interim" basis,

pending the submission

• f some
• ther type of direct or secondary

evidence. To put it plainly, this "interim credit" concept, if we have understood it correctly, would constitute a complete repudiation of the current regulatory scheme. The language and structure of the regulations, as revised in 1941 and again in 1957, have reflected the view that a taxpayer can carry his substantiation burden by furnishing (i) a receipt for such foreign tax pay- ment, (ii) the foreign tax return, or (iii) direct evidence

• f the amount of tax

withheld at the source. If such evidence was impossible to obtain, the taxpayer could carry his burden by producing any of the three types of secondary evidence identified by the Service in the 1941 commentary , I.R.

• Mim. 5219,

1941-2 C.B. 140,

• r later in Treasury Regulation

section 1.905- 2(b)(1), (2), and (3). Nothing in the history of the Code or regulations supports the Service's new gloss on the "interim credit" concept,

• r the

subordination of direct evidence

• f withholding to secondary

evidence

• f

some

• ther type.

• 3. Conclusion

If the Service is going to jettison a regulatory structure that has been in place for over a half century , it should do so forthrightly and tailor the revisions sensibly to address the particular issue of concern rather than adopt the blunderbuss approach reflected in the proposed regulations. If the concern relates to net loans or hidden subsidies, the revisions should address those legitimate concerns. This should not be done by raising the substantiation requirements for all taxpayers in all situations involving foreign withholding taxes. In the vast majority of cases, after all, there is no reason to doubt that taxes withheld at source represent taxes owed to, and collected by, foreign authorities. The effect of the proposed amendments in these cases would simply be to impose a large, and largely pointless, additional burden on taxpayers to produce "better" evidence for a proposition that no one really has reason to doubt -but which nonetheless may be difficult or impossible to prove in this manner. ..

Sincerely,

• H. David Rosenbloom

Matthew

• W. Frank

Caplin & Drysdale Washington, D.C. April 11, 1997

Tax Notes International

1484 .May 5, 1997 Commentary This article first appeared in Tax Analysts (www.tax.org), and has been reproduced here with permission. Tax Notes International, May 5, 1997, p. 1479,