Guidance on Foreign Tax Credit Splitter Transactions (2023)

Editor: Frank J. O’Connell Jr., CPA, Esq.

Foreign Income & Taxpayers

On Feb. 14, 2012, Treasury published temporary regulations to provide guidance on the Sec. 909 foreign tax credit splitter event provisions that were enacted in August 2010 as part of the Education Jobs and Medicaid Assistance Act of 2010, P.L. 111-226. The temporary regulations expand on the rules outlined in Notice 2010-92 and identify certain fact patterns that give rise to a foreign tax credit splitting event. The effective date of the temporary regulations is for tax years beginning after Jan. 1, 2012.

General Overview of the U.S. Foreign Tax Credit Regime

U.S. individuals and corporations are generally subject to U.S. taxation on their worldwide income, without regard to where the income is sourced. As a result, U.S. persons with foreign income are subject to the risk of double taxation. To mitigate this risk, U.S. taxpayers are allowed a credit under Sec. 901 against their U.S. tax liability (subject to certain formulary limitations) for foreign taxes paid or accrued during the tax year. Specifically, foreign income taxes, war profits taxes, and excess profits taxes, or other foreign taxes that are imposed “in lieu” of such taxes, are eligible for credit against U.S. tax. Similarly, under Sec. 902, a domestic corporation that owns at least 10% of the voting stock of a foreign corporation is allowed a “deemed paid” credit for foreign taxes paid by the foreign corporation that the domestic shareholder is treated as having paid when the foreign corporation’s earnings are distributed or otherwise included in the U.S. shareholder corporation’s income.

Why the Foreign Tax Credit Splitter Rules Arose

One question that has historically weighed on U.S. tax authorities (and one that is critical in determining whether a U.S. taxpayer has the right to claim a foreign tax credit) is who, for U.S. tax purposes, is considered as actually having paid or accrued the foreign tax to be credited. The difficulty of this question, which had been debated in the courts for years, was brought to the forefront by the decision in Guardian Industries Corp., 477 F.3d 1368 (Fed. Cir. 2007). In this case, a U.S. corporation, Guardian, conducted business operations in Luxembourg through a wholly owned Luxembourg subsidiary, Guardian Industries Europe S.a.r.l. (GIE), which was treated for U.S. tax purposes as a disregarded entity. GIE was the parent of a Luxembourg consolidated group of operating companies, which were treated for U.S. tax purposes as corporations.

Under Luxembourg law, GIE was liable for paying the consolidated Luxembourg income tax liability on behalf of the group. Guardian took the position that because of GIE’s disregarded status, it had the right to claim as a foreign tax credit all taxes paid by GIE on behalf of the consolidated group in Luxembourg. Despite the IRS’s arguments that the Luxembourg tax, in fact, should have been treated as being owed jointly by all members of the consolidated group and not solely by GIE (a scenario that would have reduced the creditable taxes claimed by Guardian), the court held in favor of Guardian and allowed the full foreign tax credit.

In response to the Guardian decision, the IRS in 2006 issued Prop. Regs. Sec. 1.901-2(f)(1), which required foreign taxes to be considered paid by the person on whom foreign law is considered to impose legal liability for the tax. These rules were meant to apply regardless of (1) whether another person was obligated to remit the tax; (2) whether another person actually remitted the tax; or (3) whether foreign law permitted local tax authorities to proceed against another person to collect the tax in the event of nonpayment. In addition, these proposed regulations contained a set of rules governing treatment of taxes on combined income, providing that for foreign tax credit purposes, foreign taxes imposed on the combined income of two or more persons would be treated for U.S. tax purposes as being imposed on each person separately, on a pro rata basis.

The 2006 regulations were never finalized and have recently been updated by the new temporary regulations issued on Feb. 14, 2012 (T.D. 9577). In addition to updating the 2006 proposed regulations, the new temporary regulations provide a list of arrangements that constitute a foreign tax credit splitting event.

Overview of Sec. 909

Sec. 909 addresses the treatment of foreign tax credit splitter arrangements. A splitter arrangement is a situation in which, for U.S. tax purposes, the foreign taxes can be taken into account in a period when the related income is not taken into account. Under these circumstances, Sec. 909 requires that the foreign taxes not be taken into account by the taxpayer until the related income is taken into account. The Guardian case serves as an illustration. While the disregarded parent under Luxembourg law was treated as having sole liability for all taxes paid by the consolidated group, the income of the underlying operating entities was not “taken into account” by the disregarded Luxembourg parent (and consequently, by the U.S. taxpayer) for U.S. tax purposes due to its corporate classification. Thus, there existed a split between the foreign income and the related foreign taxes.

Sec. 909 provides that, where a splitter arrangement exists, foreign taxes that would otherwise be creditable under Sec. 901, 902, or 960 are suspended until the time that the foreign income that gave rise to the taxes is taken into account by the person claiming the credit for U.S. tax purposes (i.e., the taxpayer). Put another way, Sec. 909 disallows foreign tax credits arising from splitter arrangements until the foreign income and foreign taxes are matched in the hands of the taxpayer.

The crux of the new rules centers on what types of arrangements constitute a foreign tax credit splitting event. Sec. 909(d) defines a “foreign tax credit splitting event” as an event where the foreign income that gives rise to the foreign taxes (i.e., “related income”) is taken into account by a covered person. A covered person includes: (1) any entity in which the taxpayer holds a 10% ownership interest; (2)any person that holds a 10% ownership interest in the taxpayer; or (3) persons related to the taxpayer under Sec. 267(b) or 707(b). In the case of partnerships, Sec. 909(c)(1) provides that the anti­splitter rules are applied at the partner level, and except as otherwise provided by the IRS, similar rules are applied in the case of S corporations and trusts.

Both Sec. 909 and the Joint Committee on Taxation’s technical explanation (Technical Explanation of the Revenue Provisions of H.R. 1586 (JCX-46-10) (Aug. 10, 2010)) remain silent on some key aspects of the new provisions; neither provides a bright-line test for determining what, specifically, “related income” comprises (a question that is expected to challenge taxpayers that attempt to navigate these new rules), stating only in the technical explanation that the IRS has broad discretion and authority to provide guidance on the application of the rules with respect to treatment of losses, E&P deficits, and certain timing differences between U.S. and foreign tax law. The IRS also may provide guidance on the application of Sec. 909 in cases involving disregarded payments, group relief, or other similar arrangements.

Notice 2010-92

Sec. 909 and the accompanying regulations generally apply to foreign income taxes paid or accrued in tax years beginning after 2010. In Notice 2010-92, the IRS stated that Sec. 909 may also apply to taxes paid or accrued under splitter arrangements in tax years prior to 2011, but only for purposes of suspending credits under Secs. 902 and 960 that were claimed after 2010. The notice provides an exclusive list of four “pre-2011” splitter arrangements (which were later incorporated in Temp. Regs. Sec. 1.909-6T) that would apply to such taxes paid or accrued prior to 2011. The notice further stated that future guidance could potentially identify additional transactions and arrangements to which Sec. 909 may apply, while providing the caveat that any such guidance would apply only to foreign taxes paid or accrued in post-2010 tax years. The four pre-2011 splitter arrangements identified in Notice 2010-92 are:

  • Reverse-hybrid structures;
  • Certain foreign consolidated groups;
  • Group relief and other loss-sharing regimes involving disregarded debt; and
  • Hybrid instruments.

Splitter Arrangements: Temporary Regulations

As discussed below, the new temporary Sec. 909 regulations issued in February 2012 identify four types of arrangements that would explicitly be treated as splitter arrangements.

Reverse-hybrid splitter arrangements: The new rules expand Notice 2010-92 to include taxes paid (or accrued) by persons other than Sec. 902 corporations. The rules provide that a splitter arrangement arises when a taxpayer pays or accrues foreign income taxes with respect to the income earned by a reverse-hybrid entity (i.e., an entity that is a corporation for U.S. tax purposes, but is treated as a disregarded entity or branch for foreign tax purposes). Such an arrangement gives rise to a splitter even if the reverse-hybrid entity has a loss or a deficit in earnings and profits for a particular year for U.S. tax purposes (i.e., due to timing differences).

Loss-sharing splitter arrangements: Certain jurisdictions (the United Kingdom, for instance) offer under their tax laws certain “loss sharing” regimes (also known as “group relief”). A foreign loss-sharing arrangement exists when one entity in a foreign combined group surrenders its loss to one or more entities in the foreign combined group. The new rules further require that a shared loss in one “U.S. combined income group” that is taken to offset income in another U.S. combined income group not be taken into account.

Hybrid-instrument splitter arrangements: Certain hybrid instruments generally give rise to splitter arrangements. Specifically, a U.S. equity hybrid instrument (i.e., an instrument that is treated as equity for U.S. purposes and debt for foreign purposes) is treated as a splitter if payments with respect to the instrument give rise to foreign taxes and are deductible for foreign tax purposes, but do not give rise to income for U.S. tax purposes. Similarly, a U.S. debt hybrid instrument (one that is treated as equity for foreign tax purposes but debt for U.S. tax purposes) is a splitter arrangement if foreign income taxes are paid or accrued by the issuer of the instrument with respect to any “interest” income earned that would have been deductible for U.S. purposes, but is not deductible for foreign tax purposes.

Partnership interbranch payment splitter arrangements: An allocation of foreign income tax paid or accrued by a partnership with respect to an interbranch payment described in Regs. Sec. 1.704-1(b)(4)(viii)(d) is a splitter arrangement to the extent that the tax is not allocated to the partners in the same proportion as the distributive shares of income in the creditable foreign tax expenditure category to which the interbranch payment tax is assigned.


The precise effect that these new rules will have on taxpayers is difficult to determine. The restrictive nature of the rules is expected to encourage some taxpayers to reduce their foreign tax base, in anticipation that compliance with these rules will likely be cumbersome at best. As mentioned, no clear guidance has been provided on key aspects of the rules, specifically, the determination of related income, as well as the process by which foreign taxes can be “matched” with such income. These challenges dramatically increase in direct proportion to the complexity of taxpayers’ foreign structures, especially those with foreign operations that draw on various income streams and pools of foreign earnings.

One obvious step that could help mitigate the negative impact of these new rules is streamlining a taxpayer’s foreign structure in a manner that assists the taxpayer in efficiently tracking pools of foreign income and taxes. Simplifying foreign structures would also likely prove to be the best defense against creating “inadvertent” splitters, or splitters that are borne independent of the taxpayer’s planning objectives.

In addition, these new rules will have the effect of forcing taxpayers to become better versed in foreign law, as the statutory workings of foreign tax jurisdictions now more than ever will have a direct impact on their ability to claim foreign tax credits. Acquiring a deeper understanding of the nuances of various foreign tax regimes (particularly in jurisdictions that offer consolidation regimes and loss-sharing benefits) is critical to future planning endeavors.

Finally, the need for clear internal documentation of a taxpayer’s foreign activities has now garnered a new premium, as detailed documentation may be the best way to substantiate compliance with these new regulations.


Frank J. O’Connell Jr. is a partner in Crowe Horwath LLP in Oak Brook, Ill.

For additional information about these items, contact Mr. O’Connell at 630-574-1619 or .

Unless otherwise noted, contributors are members of or associated with Crowe Horwath LLP.

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