A Couple of Comments on the Compulsory Payment Rule and Foreign Corporate Groups

by David R. Tillinghast, Esq.
Baker & McKenzie LLP
New York, New York


We all know that Regs. §1.901-2(e)(5) imposes the so-called “compulsory payment” rule, under which a taxpayer may be denied a foreign tax credit to the extent that it has not taken appropriate steps to minimize the foreign taxes for which it seeks a credit. The author just stumbled across TAM 200807015 (2/15/08), which applied this rule to taxes paid by a U.K. group wholly owned by a U.S. group. (The TAM is lengthy and somewhat confusing, as it addresses a number of complicated issues not relevant to the discussion here.) What I want to comment on briefly is that it reached its conclusion by applying the rule “on a taxpayer-by-taxpayer basis” and considering the taxpayer to be the particular U.K. subsidiary which is deemed for U.S. tax purposes to have paid a U.K. tax.

The problems that may arise from this approach are well-known. They prompted the IRS to issue Prop. Regs. §1.901-2(e)(5)(iii), which treats all members of an 80%-owned foreign group as a single taxpayer for purposes of applying the compulsory payment rule. The TAM took no account of this proposed regulation. While the regulation will be effective only for taxable years beginning after it is published in final form, Notice 2007-95, 2007-49 I.R.B. 1091, allows a taxpayer to apply it for any taxable year ending on or after March 29, 2007. Since what the IRS put out was a TAM and the taxpayer did not refer to Notice 2007-95, we may presume that the years involved were earlier years. So the TAM is in effect obsolete.

Meanwhile, a potential new application of the compulsory payment rule may be in the making. Some time ago, the European Commission created a working party to develop what is known as the Common Consolidated Corporate Tax Base (CCCTB) proposal. This would allow a group of companies taxable in EU countries to elect to pay tax on a consolidated basis. Intra-group transactions would be eliminated as in the U.S. consolidated return rules. Consolidated taxable income of the group would be apportioned among the EU countries in which the group operates based on a formula still in development, but including as factors sales (on a destination basis) and probably the relative size of the group's payrolls in relevant countries. A group of EU companies (and PEs) could elect the CCCTB approach even if owned by a U.S. or other non-EU parent. See European Commission, CCCTB: Possible Elements of a Technical Outline, CCCTB/WP057 doc/en (July 26, 2007), also available on Tax Analysts' Document Service, Document 2007-22569.

The CCCTB proposal is so far just that. It has a long way to go before it can become EU law. There are a daunting number of policy and technical issues that remain to be resolved. (I understand that some American companies have concluded that the technical problems faced by a U.S.-owned group are so difficult that making the election would be impracticable.) Moreover, the difficulties of getting it approved are hardly negligible.

Nevertheless, there is some substantial momentum behind the proposal. In a recent lecture (which will be published as a paper in the Tax Law Review in the Spring), Michel Aujean, who, until he recently left his position at the European Commission, was in charge of the CCCTB project, noted that the Commission would strongly push for the adoption of the proposal. Moreover, he noted that many EU-based companies are also strongly for it. The reason on both sides is the same: transfer pricing has become so complex and burdensome to European tax authorities and European companies that something has to give. The system is rapidly becoming dysfunctional.

Assuming that CCCTB will one day see the light of day, the drafters of Prop. Regs. §1.901-2(e)(5)(iii) should take notice. Obviously, whether a group does or does not elect CCCTB will likely affect the amount of tax that it pays, not only in the aggregate but to each of the EU countries in which it is taxed. The compulsory payment rule should not be applied to deny credits in this context. (Indeed, it is difficult to see how, in the case of a group that made the election, the IRS could determine that by doing so foreign taxes were increased; this would require an EU-wide reconstruction of transfer prices that the group never paid any attention to.)

The drafters of the existing proposed regulation obviously did not take this eventuality into account. It could be read to encompass only national law rules. It refers to “a foreign law group relief or similar regime,” and the examples refer to national law provisions. There is no evident reason, of either a policy or technical nature, however, to exclude the regulation's application to groups electing the CCCTB approach. But there's no hurry. Even given the pace at which the IRS goes forward, the proposed regulation will probably be finalized before the CCCTB is actually born.