As discussed in a previous article, the Foreign Tax Credit (FTC) is a bedrock of the U.S. tax system to reduce the impact of double taxation. In general terms, income that is derived from a foreign jurisdiction by a U.S. taxpayer, which is subject to an “income, war profits, and excess profits taxes paid or accrued during a tax year to any foreign country” will give rise to a tax credit for the U.S. taxpayer. I.R.C. § 901. Such credit is commonly known as the FTC.
Until the publication of the final regulations concerning the FTC last January 4, 2022, the FTC was generally predicated upon the existence of an “income tax”. Under previous regulations. (Prior Treasury Regulations or Prior. Treas. Reg.), an “income tax” was considered as such if such levy was a tax and the predominant character of the tax was that of an “income tax” in the U.S. sense. See Prior. Treas. Reg § 1.901-2(a)(1). A foreign levy was considered as having a predominant character of an income tax in the U.S. sense if the levy was designed to reach “net gain” in the normal circumstances of its calculation. See Prior. Treas. Reg § 1.901-2(b).
Whether the foreign tax was imposed upon “net gain” was dependent upon three requirements: (i) that the tax was imposed on the occurrence of the taxable event (realization test), (ii) that the tax was based on the gross receipts of the taxpayer (gross receipts test) and (iii) that the base of the tax allowed for the respective deductions associated to earning of the income, such as recovery of expenditures (net income test). See Prior. Treas. Reg § 1.901-2(b)(2), (3), (4).
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