Ten-Year Statute Doesn't Apply to Refund Arising from Foreign Tax Deduction

(Parker Tax Publishing September 2018)

The Second Circuit held that a company that elected to deduct foreign taxes from its U.S. taxable income for a prior tax year was barred by the three-year statute of limitations from claiming a refund for an overpayment arising from the deduction. The Second Circuit rejected the taxpayer's argument that the special 10-year statute of limitations period under Code Sec. 6511(d)(3)(A) applied after concluding that Code Sec. 6511(d)(3)(A) applies only to refund claims relating to an overpayment attributable to a credit for foreign taxes paid, and does not apply where a taxpayer elects to deduct foreign taxes. Trust Media Brands, Inc. v. U.S., 2018 PTC 260 (2d Cir. 2018).

Background

Trusted Media Brands, Inc. paid taxes to foreign countries in 1995, 1997, and 2002 and opted to claim a foreign tax credit (FTC) on its returns for each year. For 2002, Trusted Media incurred a net operating loss (NOL) of approximately $61 million, unrelated to the payment of foreign taxes. Trusted Media had no U.S. tax liability to offset with its FTC for 2002, so it carried back its NOL to 1997.

In 2011, Trust Media filed an amended 2002 return in which it changed its election to take a FTC to a deduction for the foreign taxes it paid that year. This change increased Trusted Media's 2002 NOL to approximately $74.4 million. Trusted Media carried this larger NOL back to 1997, reducing its taxable income for that year. The decrease in taxable income resulted in a decrease in the limit on the FTC Trusted Media could claim for 1997. As a result, some of the FTC Trusted Media had claimed in 1997 could no longer be used for that year, but instead could be carried back to other years. Trusted Media carried the 1997 excess FTC back to 1995, resulting in an overpayment of taxes of approximately $2.1 million.

Trusted Media filed an amended 1995 return in 2011 to claim a refund of its alleged $2.1 million tax overpayment. The IRS disallowed the claim as untimely. After an administrative appeal, Trusted Media sued for the refund in a district court. Trusted Media argued that the 1995 overpayment was attributable to its election to deduct foreign taxes paid in 2002 and thus was timely under the special 10-year limitations period in Code Sec. 6511(d)(3).

The district court disagreed and held that Trusted Media's refund claim was untimely for two reasons. First, the district court concluded that the 10-year limitations period applies only to overpayments attributable to foreign taxes for which the taxpayer elects to claim a credit, not for foreign taxes for which a deduction is elected. Second, the district court found that Trusted Media's 1995 refund claim was not attributable to its 2002 foreign taxes within the meaning of Code Sec. 6511(d)(3). Trusted Media appealed to the Second Circuit.

Analysis

U.S. taxpayers are required to pay tax on their worldwide income. In order to prevent such income from being taxed both by the United States and a foreign country, taxpayers can either claim a credit under Code Sec. 901 for the foreign taxes paid or deduct the foreign taxes from taxable income under Code Sec. 164(a)(3). Under Reg. Sec. 1.901-1(d), the deadline by which a taxpayer must choose between claiming an FTC or a deduction for a particular year is generally the period prescribed by Code Sec. 6511(d)(3)(A), which is 10 years.

Under Code Sec. 6511(a), a refund for an overpayment of taxes generally must be filed within the later of three years from the filing of the return or two years from the payment of the tax. Additionally, Code Sec. 6511(b) contains a default rule limiting the amount of refund to which a taxpayer is entitled, which varies depending on when the taxpayer files the refund claim. However, under Code Sec. 6511(d)(3)(A), a special 10-year period applies to refund claims attributable to foreign tax credits, and Code Sec. 6511(d)(3)(B) provides an exception to the refund limit if the overpayment is attributable to a credit for foreign taxes.

On appeal, Trusted Media argued that the special 10-year period for overpayments resulting from a credit was simply one way, but not the only way, by which the longer period is available. The taxpayer also argued that because Reg. Sec. 1.901-1(d) sets a single period within which a taxpayer can elect to toggle between an FTC or a deduction, there is also a single period within which a taxpayer can claim a refund based on either an FTC or a deduction.

The Second Circuit rejected Trusted Media's arguments and held that the 10-year limitations period applies only to overpayments attributable to foreign taxes for which the taxpayer elects a credit, not for which the taxpayer chooses a deduction, but was otherwise eligible to claim a credit.

The Second Circuit said that its conclusion was compelled by the plain language of Code Sec. 6511(d)(3)(A), which provides that the 10-year period applies only to claims for which an FTC is allowed. The court reasoned that the options to deduct foreign taxes or take a credit are mutually exclusive. Having elected a deduction for 2002, Trusted Media was not eligible to elect an FTC. Thus, by its express terms, Code Sec. 6511(d)(3)(A) did not apply.

The court further found that Reg. Sec. 301.6511(d)-3(a) supported its conclusion by confirming that the extended limitations period applies to overpayments resulting from a credit. The court rejected Trusted Media's argument that this provision provided only one condition under which the 10-year period applies; in the court's view, the regulation sets forth the only way by which the special 10-year period is available.

Next, the court found that the exception in Code Sec. 6511(d)(3)(B) to the refund limit in Code Sec. 6511(b)(2) also supported its holding. The court explained that without Code Sec. 6511(d)(3)(B), many taxpayers would effectively be denied the benefit of the 10-year period because, although they would have 10 years to file for a refund, the refund amount would be limited to the portion of the tax paid within the prior two years. Code Sec. 6511(d)(3)(B) solves this problem by providing that the refund limit does not apply to the extent an overpayment is attributable to the allowance of an FTC. In the view of the Second Circuit, this provision unambiguously refers to credits, not deductions, further reinforcing the conclusion that Code Sec. 6511(d)(3)(A) is limited to refunds resulting from an FTC.

The court found that limiting the 10-year period to overpayments arising from an FTC made sense considering the timing problems that can arise when foreign taxes are contested. As the court explained, when a deduction is claimed for foreign taxes paid or accrued, the taxpayer takes the deduction in the year in which the foreign tax liability is conclusively determined. Conversely, an accrual method taxpayer must claim a credit for the year to which the foreign tax relates, even if the amount is not determined until a later year. Thus, in the court's view, the extended limitations period is necessary where a credit is claimed for a contested foreign tax liability, but not required for a taxpayer electing a deduction.

Finally, the Second Circuit disagreed with Trusted Media's argument that the single period for electing whether to claim an FTC or a deduction under Reg. Sec. 1.901-1(d) implies a single period within which taxpayers can claim refunds based on either FTCs or deductions. The court found that the requirements governing refund claims are found in Code Sec. 6511 and Reg. Sec. 301.6511(a)-1 to (g)-1, not Code Sec. 901, and that Trusted Media was asking it to conflate these separate time limitations.

For a discussion of the statute of limitations for refunds or credits of overpayments, see Parker Tax ¶261,180. For a discussion of deductions and credits for foreign taxes, see Parker Tax ¶83,140.

Disclaimer: This publication does not, and is not intended to, provide legal, tax or accounting advice, and readers should consult their tax advisors concerning the application of tax laws to their particular situations. This analysis is not tax advice and is not intended or written to be used, and cannot be used, for purposes of avoiding tax penalties that may be imposed on any taxpayer. The information contained herein is general in nature and based on authorities that are subject to change. Parker Tax Publishing guarantees neither the accuracy nor completeness of any information and is not responsible for any errors or omissions, or for results obtained by others as a result of reliance upon such information. Parker Tax Publishing assumes no obligation to inform the reader of any changes in tax laws or other factors that could affect information contained herein.

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