Foreign Tax Credit Issues – Coca Cola
The IRS examined Coca Cola’s consolidated tax returns and it determined that royalty payments made by Coca Cola’s licensee corporations were not at arm’s length and should have been much higher. They increased Coca Cola’s royalty payments from its Mexican licensee considerably. The IRS then ruled that because of the adjustments Coca Cola had now overpaid their corporate taxes in Mexico, and that the foreign tax credits taken were no longer compulsory and therefore no longer creditable taxes in the U.S.
Sec. 901(b) allows for a credit for “the amount of any income….taxes paid or accrued during the taxable year to any foreign country”. Also, under Regs. Sec. 1.901-2(a)(2)(i), in order to be a creditable, a foreign tax must be a “compulsory payment pursuant to the authority of a foreign country to levy taxes.” Under Regs. Sec. 1.901-2(a)(5)(i), a tax payment is not considered compulsory to the extent “the amount paid exceeds the amount of liability under foreign law for tax.” The two requirements that must be satisfied for a foreign tax payment to be considered “compulsory”:
- The tax payment must be “determined by the taxpayer in a manner that is consistent with a reasonable interpretation and application of the….provisions of foreign law (including applicable tax treaties) in such a way as to reduce, over time, the taxpayer’s reasonably expected liability under foreign law for tax.”
- The “taxpayer must exhaust all effective and practical remedies, including invocation of competent authority procedures available under applicable tax treaties, to reduce, over time, the taxpayer’s liability for foreign tax.”
Under Sec. 905(c), a taxpayer is allowed to take a foreign tax credit for the amount of foreign tax paid, and, if it is later determined that foreign tax was overpaid, then the taxpayer must file an amended return with information sufficient to allow a redetermination of tax owed. The Tax Courts rule that the procedure under Sec. 905(c) should be followed, and therefore Coca Cola would be allowed to claim the foreign tax credits.