United States:
Tax Court In Brief | AptarGroup, Inc. v. Comm’r | Foreign Tax Credits And Interest Expense Allocation And Apportionment
23 March 2022
Freeman Law
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Tax Litigation: The Week of March 14,
2022, through March 18, 2022
AptarGroup, Inc. v. Comm’r, 158 T.C. No. 4 | March 16,
2022 |Goeke, J. | Dkt. No. 7218-2
Opinion
Short Summary: AptarGroup, Inc.
(“Aptar”), a U.S. corporation, owned 100% of AptarGroup
Holdings, an entity organized under the laws of France (“AGH
France”). Aptar owned, directly or indirectly—through
AGH France or a later-formed foreign holding company—
controlled foreign corporations (“CFC”). The
CFCs held assets that generated
foreign source income, and some also held assets that generated
U.S. source income. Aptar paid or accrued interest expense, and
claimed a
foreign tax credit of $3,539,543 with respect to similar
taxes paid by the CFCs. The IRS disallowed the
foreign tax credit. The issue presented to the Tax Court
regards the apportionment of interest expense with respect to
AptarGroup’s stock in CFCs for purposes of computation of
foreign tax credit.
Primary Holdings:
- AptarGroup’s method of allocation of interest expense was
inconsistent with the method for allocation election made by the
CFC with respect to the interest expense in issue. Thus,
AptarGroup’s position was an improper application of Reg.
§ 1.861-9T. - For the apportionment of interest, two methods are available:
the asset method and the modified gross income method. Generally,
domestic corporations must use the asset method, and CFCs are
permitted to choose either method subject to certain consistency
requirements. See id. 1.861-9T(g). However,
under section Treas. Reg. § 1.861-9T(f), a CFC’s election
of the modified gross income method binds the U.S. shareholder to
that method. This is a consistency requirement that is a condition
of the CFC’s election, and AptarGroup did not use the modified
gross income method.
Key Points of Law:
- The U.S. taxes its citizens and domestic corporations on
worldwide income. To avoid double taxation, the Code allows U.S.
citizens and domestic corporations a credit for income tax paid to
a foreign country. See 26 U.S.C. § 901(a).
A domestic corporation may also claim a credit for tax that it is
deemed to have paid or accrued. at § 960. - The extent to which a taxpayer is entitled to a foreign tax
credit is determined by applying U.S. tax law; thus, the source of
income depends on how U.S. tax law categorizes such income. The
Code limits the amount of a foreign tax credit to prevent taxpayers
from using foreign tax to reduce U.S. tax on their U.S. source
income. - The allowable foreign tax credit for a taxable year is the
lesser of foreign tax paid or accrued or the foreign tax credit
limitation (“FTC limitation”) calculated pursuant to
§ 904(a). - In the case of an affiliated group of corporations, the foreign
tax credit is determined on a consolidated basis. Treas. Reg.
§ 1.1502-4(c). Where a taxpayer has more than one category of
income as listed in section 904(d) (a “limitation
category”), the FTC limitation must be computed separately for
each limitation category. at § 904(d)(1). The FTC limitation
is computed and totaled for the affiliated group. Treas. Reg.
§ 1.1502-4(d). - To compute the FTC limitation, the taxpayer must determine the
source for its gross income. After determining the source of the
gross income, the taxpayer must allocate each loss, expense, and
other deduction to a class of gross income and then, if necessary,
apportion that determined amount within the class of gross income
between a statutory grouping and a residual
grouping. See
Reg. § 1.861-8(a)(2). For purposes of the foreign tax
credit, each limitation category is a statutory grouping, and a
taxpayer claiming the credit must determine the foreign source
taxable income in each limitation category in which it has
income. - In general, expenses are allocated and apportioned on the basis
of the factual relationship of the expense to gross income in
accordance with Treas. Reg. § 1.861-8. Expenses are allocated
to the class of gross income to which they definitely relate. Some
expenses are not definitely related to a class of gross income or
are related to all gross income and thus must be ratably allocated
to all gross income. Then, if necessary, expenses are apportioned
between the statutory and residual groupings. at §
1.861-8(c)(3). - Special rules exist for allocation and apportionment of
interest expense in
Temporary Treasury Regulation § 1.861-9T. - For the allocation, interest expense is treated as related to
all income-producing activities and assets regardless of the
specific purpose for the borrowing. § 1.861-9T(a). For this
reason, interest expense must be ratably allocated to all gross
income. - For the apportionment of interest, two methods exist: the asset
method and the modified gross income method. Domestic corporations
must use the asset method, and CFCs are permitted to choose either
method subject to certain consistency requirements. See
id. 1.861-9T(g). The asset method requires taxpayers to
apportion interest expense to the various statutory groupings on
the basis of the average total value of assets assigned to each
grouping for the year. Id. To apply the asset
method, the taxpayer divides the value of its assets among the
relevant statutory groupings, a process the regulations define as
“characterizing” the
assets. See id. §
1.861-9T(g)(1)(i), (3)-(3)(iii). - The regulations provide a special consistency rule regarding
the characterization of CFC stock owned by a U.S. shareholder.
Specifically, section § 1.861-9T(f)(3)(iv) provides:
“Pursuant to (Treas.
Reg. § 1.861-12T(c)(2)), the stock of a controlled
foreign corporation shall be characterized in the hands of any
United States shareholder using the same method that the controlled
foreign corporation uses to apportion its interest
expense.” - Reg. § 1.861-12T(c)(3) describes two methods for
characterizing CFC stock—the asset method and the modified
gross income method—and imposes the same consistency rule:
“Stock in a controlled foreign corporation whose interest
expense is apportioned on the basis of assets shall be
characterized in the hands of its United States shareholders under
the asset method described in paragraph (c)(3)(ii). Stock in a
controlled foreign corporation whose interest expense is
apportioned on the basis of gross income shall be characterized in
the hands of its United States shareholders under the gross income
method described in paragraph (c)(3)(iii).” Treas. Reg. §
1.861-12T(c)(3)(i) (flush text). - Under section Reg. § 1.861-9T(f), a CFC’s election of
the modified gross income method binds the U.S. shareholder to that
method—the consistency requirement is a condition of the
election. Id. at § 1.861-9T(f)(3)(iv)
(imposing the consistency requirement), 1.861-12T (supplementing
§ 1.861-9T and its consistency requirement).
Insights: This case illustrates the
careful attention that a U.S. corporation taxpayer should put forth
when allocating and apportioning interest expense for purposes of a
foreign tax credits associated with ownership of shares in a CFC.
Treas. Reg. § 1.861-9T, as supplemented by Treas. Reg. §
1.861-12T, should be closely evaluated and applied so that the
consistency requirements applicable to elections for the foreign
tax credit are met between or among the U.S. taxpayer and the
CFCs.
The content of this article is intended to provide a general
guide to the subject matter. Specialist advice should be sought
about your specific circumstances.
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