This past August, President Obama signed into law several provisions which revised the foreign tax credit provisions. Most noteworthy, of course, is the new rule which requires a "matching" of foreign tax credits with the related foreign source income which is contained in new 909. The Treasury had lobbied for this type of provision given the government’s loss in Guardian Industries v. United States, 477 F.3d 1368 (Fed. Cir. 2007). See also Prop. Reg. §1.901-2(f). The proposed regulations provided that, in general, the person entitled to claim a credit for foreign taxes is the person who owns (under foreign tax law) the income that is subject to the foreign tax, i.e., the matching concept. The rationale for having a "matching" rule for foreign tax credits is that double taxation on foreign source income is ameliorated only where the person generating the foreign course income is the same person who is allowed to claim the credit for the taxes paid or accrued.

A strict "matching" approach is compromised where there is a so-called "splitter transaction" when the income (or earnings or profits under §§902 or 960 credit provisions) allocable to the foreign taxes is taken into account by a U.S. person related to the payor of the foreign taxes or by another person. The foreign source income goes to one taxpayer and the foreign taxes (and credits) are paid by a related taxpayer, i.e., the "covered person". A covered person is a person who directly or indirectly owns at least 10% of vote or value, or a person related to the taxpayer within §267(b), §707(b) or any person specified by the regulations.

New §909(a) provides that "if there is a foreign tax credit splitting event with respect to a foreign income tax paid or accrued by the taxpayer, such tax (credit) shall not be taken into account for purposes of this title before the taxable year in which the related income is taken into account under this chapter by the taxpayer."

The matching rule of §909 gives the foreign tax credit who reports the related income for U.S. tax purposes. The new anti-splitting (or matching) rule of s909 attempts to give the FTC (in the case of a splitter transaction) to the person who takes the related income into account for U.S. tax purposes, not foreign tax purposes. For purposes of a §902 or §960 foreign tax credit, such credits are not taken into account until the related income is taken into account by the same corporation that paid or accrued the taxes. For partnerships, §909 is applied at the partner level.

If the requirements of §909(a) are left unsatisfied, the foreign tax credit is not allowable until the year in which the related income is taken into account. §909(c)(2). Deferred foreign taxes do not affect §904(c) carryovers, §6511(d)(3)(A) extended periods for claiming a credit or refund, or for other purposes until §909(a)’s requirements are made. Moreover, the deferred foreign taxes can not be deducted before such year. See also §986(a). other calculations under the code until the year in which they are taken into account under section 909, nor can they be claimed as deductions before that year.

Section 909 applies to foreign taxes paid or accrued in tax years beginning after December 31, 2010. With respect to §902, it applies to taxes paid or accrued prior to 2011 for purposes of determining taxes deemed paid under sections 902 or 960 in tax years beginning after December 31, 2010 but not for other purposes. See §§909(b)(2), 964(a). (However, section 909 does not apply to those pre-2011 taxes for purposes of determining a section 902 corporation's earnings and profits under sections 909(b)(2) and 964(a). So despite its forward looking effective date, §909 will affect prior foreign taxes paid where the related income has not been reported in income for U.S. tax purposes by the same taxpayer. Prior to §909, the Service’s approach was to match foreign tax credits with the person owing the income for foreign purposes and not always the proper party for reporting the income for U.S. tax purposes. The new law changes the focus to looking at who is the proper party for reporting the income for U.S. tax purposes. See Treas. Reg. §1.901-2(f)(1). What will be difficult in applying §909 is identifying the related income on which the foreign taxes were paid. Section 909 applies only when there is an foreign tax credit splitting event, as defined within the statute. Therefore, it is not of unlimited scope. Still the provision requires analyzing complex sets of facts and rules under both foreign and domestic law.

To provide an example, consider a U.S. corporation which owns 100% of the stock of a foreign holding company, which in turn owns one or more foreign operating entities. The foreign holding company is a hybrid and is disregarded under the CTB regulations to §7701. The foreign holding company and the foreign operating entities, however, are treated as a group of companies for foreign income tax purposes under foreign law. The party liable to pay the foreign tax is the foreign holding company ("legal liability" standard). Under §909, the U.S. parent corporation could not claim the §901 foreign tax credit for the foreign taxes paid until it takes that income into account for U.S. income tax purposes. The splitting transaction falls within the provision because "covered persons", i.e., the operating companies, take the related income to account for U.S. tax purposes. See also CCA 200920051.

In short, unless forthcoming regulations provide otherwise, which is possible, it may be reasonable to assume that the Service’s position will be, after §909 becomes applicable, that the only persons eligible to claim a foreign tax credit with respect to a "splitting transaction" are those who have both legal liability under foreign law for payment of the foreign tax and also take the related income into account under U.S. tax law.