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).

In summary, if the foreign tax met the realization, gross receipts and the net income tests, such levy was considered be a tax with a predominant character of an income tax in the U.S. sense, and such tax was creditable for purposes of the FTC.

However, the final regulations concerning the FTC published on January 4, 2022, have dramatically changed the requirements to establish the existence of an income tax for purposes of the FTC. TD 9959. The new regulations impose a new requirement that, if not adequately planned for, will prevent U.S. taxpayers from crediting payment of foreign taxes.

Under the new regulations, to be creditable, a foreign tax will be considered a foreign income tax if it meets the traditional requirements provided in the prior regulations (i.e. realizations, gross receipt, net income and cost recovery tests) in addition to an “attribution” test. Treas. Reg. § 1.901-2(a)(3)(b).

The Attribution requirement

Beginning March 7, 2022, a foreign income tax will only be creditable for purposes of the FTC if it is attributable to the foreign jurisdiction that is imposing it. Satisfaction of the attribution requirement (which replaced the nexus requirement introduced by the proposed regulations) will depend upon whether the foreign income tax is imposed on a nonresident or a resident of such foreign jurisdiction. Treas. Reg. § 1.901-2(a)(3)(b)(5).

  • Attribution requirement for residents. In this case, the attribution requirement is met if the foreign tax provides that any allocation of income, gains, deductions or losses between the resident and its related parties are made at arm’s length. Treas. Reg. § 1.901-2(a)(3)(b)(5)(ii). In other words, the foreign country’s transfer pricing rules must be based upon the arm’s length principles.
  • Attribution requirement for nonresidents. In this case, the attribution requirement can be met under three different alternatives: (i) attribution based on activities, (ii) attribution based on source or (iii) attribution based on situs of property. Treas. Reg. § 1.901-2(a)(3)(b)(5)(i). Each of these alternatives envision certain types of income, and as discussed later, left other completely out of its scope preventing getting a credit for purposes of the FTC.


  • Attribution based on activities of a nonresident. Under this approach, the gross receipts and costs of the nonresident subject to the foreign income tax are attributable, under reasonable principles, to the activities of the nonresident in such country. The rules to establish this type of attribution are similar to the rules of determining the existence of effectively connected income (ECI) to the U.S. I.R.C. § 864(c). It must be noted that these reasonable principles do not include the rules of the foreign country that deem the existence of a trade or business or permanent establishment on activities of a person that is not an agent or a pass-through entity of the U.S. taxpayer. For example, if the legislation of the foreign jurisdiction establishes the existence of a permanent establishment for a nonresident on the activities of an independent agent such rules would not meet this attribution requirement.
  • Attribution based on the source of income. In this case, the foreign tax is based on the source of income of the nonresident, which is limited to the gross receipts obtained from sources within the foreign jurisdictions. Additionally, the sourcing rules of the foreign country must be reasonably similar to the sourcing rules of the U.S., although the foreign rues do not need to conform in all aspects to the rules of the IRC. Foreign law is determinative to establish the character of the gross income with the exception of the sale of property. This attribution alternative provides specific sourcing rules for services and royalties. In the case of sales of property, the regulations expressly provide that the attribution requirement must be met either on the activities of the nonresident or the situs of the property, which renders the attribution based on sourced inapplicable for such type of cases.
  • Attribution based on situs of property. This rule is based on the situs or location of the property and covers the tax on gains derived from the disposition of property, such as shares, or interest in a pass-through entity. However, this attribution rule is limited to the gross receipts attributable to the disposition of real property located in the foreign country, or a foreign entity that owns the real property, similarly to the FIRPTA See I.R.C. § 897. For property different from shares, the attribution will only include gross receipts from the disposition of business property under rules similar to determine ECI.

Impact of the attribution requirement

As seen, the attribution requirement is full of complex rules that will surely impact the international operations of U.S. taxpayers. For example, in the case of the attribution requirement in cases of foreign residents, the regulations clearly impact operations in foreign jurisdictions where the arm’s length principle is not followed. A quick review of the OECD Transfer Pricing Country Profiles reveals the alignment of the transfer pricing rules to the arm’s length principle around the world.

A clear example of a jurisdiction that is directly impacted by this new attribution requirement is Brazil. Although there is no formal reference or provision to the arm’s length principle in its legislation, Brazil has made substantial efforts to align with the OECD Transfer Pricing Guidelines. Under the textual language of the regulations, the “allocation of the made pursuant to the foreign country’s transfer pricing rules) is determined under arm’s length principles”. Accordingly, on a first impression basis, income taxes paid in Brazil would prevent a credit for purposes of the FTC.

More concerning is the application of the attribution requirement on foreign taxes imposed on nonresidents on disposition of property. Under the language of the regulations, the attribution requirement in these cases, can only be met by either the activities alternative or the situs of the property alternative. The regulations expressly prevented the application of the source alternative on the income derived from the disposition of property (e.g. capital gains). This is relevant, for example, in cases where the foreign jurisdiction imposes a tax on the disposition of stock of entities incorporated on such jurisdiction (capital gains on the sale of foreign stock). In these cases, the only possible alternative applicable is the situs of property, which only applies to cases similar to FIRPTA (i.e. when the foreign entity assets are predominantly real property).

The preamble of the regulations clearly determines that for the sale of property, there is no need for a foreign sourcing rule similar to the U.S. law, considering that under U.S. law a nonresident is only taxed on the disposition of property only if such income is connected to a trade or business or if the property being disposed is real property. Accordingly, the Treasury stated:

“Thus, the final regulations provide that, with respect to foreign tax imposed on income derived from the sale or other disposition of property, including copyrighted articles sold through an electronic medium, the tax meets the attribution requirement only if the inclusion of the income in the foreign tax base meets the activities based nexus requirement in § 1.901–2(b)(5)(i)(A) or the property-based nexus requirement in 1.901–2(b)(5)(i)(C).”

TD 9959, Summary of Comments and Explanation of Revisions to Final Regulations, p. 290. Under these comments of the Treasury, it would seem that in cases for which a foreign tax applies on the sale of disposition of property, such tax would not be creditable because the attribution requirement could not be met.

For example, in multiple jurisdictions, such as Mexico, that impose a tax on the sale of the shares of entities that are incorporated in such country by a nonresident, such tax would not be creditable under the new FTC regulations, considering that the attribution requirement would not be met, unless the situs or property alternative applies. It is true that the existence of a tax treaty would provide certain relief when the tax paid is considered as an income tax under the treaty and the levy is directly paid by the U.S. taxpayer. Treas. Reg. § 1.901-2(a)(1)(iii). However, the U.S. treaty network does not cover the majority of the jurisdictions around the world, and it is more probable than not that the attribution requirement certainly will prevent multiple foreign taxes on dispositions of property from being creditable.


The new FTC regulations, although intended to deny a credit for foreign taxes designed for digital providers, have opened the door to question the creditability of taxes that were creditable under the previous regulations. Taxpayers must analyze carefully the application of the new rules to prevent surprises and to plan accordingly. Planning is of the essence, considering that the effective date of these set of regulations is next March 3, 2022.

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