Taxpayer’s change to foreign tax deduction is ruled untimely

Extended limitation period of 10 years for refund claims applies only to foreign tax credit, Second Circuit affirms.
By Charles J. Reichert, CPA

The Court of Appeals for the Second Circuit upheld a lower court's ruling that a taxpayer's refund claim due to a change from the foreign tax credit to the foreign tax deduction was not timely. According to the court, the taxpayer could not use the special 10-year statute-of-limitation period of Sec. 6511(d)(3)(A) because that period applies only to refund claims related to the foreign tax credit, and not the foreign tax deduction.

Facts: For tax years ended June 30, 1995, 1997, and 2002, Trusted Media Brands Inc. elected to claim a foreign tax credit for taxes paid to foreign countries. In tax year 2002, the company had a net operating loss (NOL) of about $61 million, which it carried back to its 1997 return using the then-available carryback period of five years. In December 2011, Trusted Media filed an amended return for 2002 and changed its election from the foreign tax credit to a deduction for foreign taxes paid, resulting in a revised 2002 NOL of approximately $74.4 million. Trusted Media carried the increased NOL back to 1997, reducing its 1997 tax liability, which in turn reduced its allowable foreign tax credit. The company then carried back the disallowed portion of its 1997 foreign tax credit to tax year 1995 and claimed a $2.1 million refund.

The IRS disallowed the refund claim, and later, the company filed suit for a refund in the U.S. District Court for the Southern District of New York. The district court held that the taxpayer's claim was untimely because the 10-year limitation period applies only to refunds based on the use of the foreign tax credit, and the company's 1995 refund claim was not attributable to taxes paid in its 2002 tax year. The taxpayer appealed the decision to the Second Circuit.

Issues: When taxes are paid to a foreign country, taxpayers may claim either a tax credit or a tax deduction (but not both) based on the amount of the foreign taxes paid or accrued. The proportion of the U.S. tax that can be offset by the foreign tax credit is limited to the proportion of the taxpayer's income from foreign sources for that year. Unused amounts of the foreign tax credit can be carried back and forward to other tax years. Generally, refund claims by taxpayers must be made within three years from the date the original return was filed; however, Sec. 6511(d)(3)(A) extends the three-year period to 10 years for refund claims related to foreign tax credits. The taxpayer argued that the 10-year period also applies to the refund claims related to the foreign tax deduction.

Holding: The Second Circuit rejected the taxpayer's argument, holding that the plain language of Sec. 6511(d)(3)(A) states that the 10-year limitation period applies only to refund claims when a foreign tax credit had been allowed. Because the options to deduct or credit foreign taxes are mutually exclusive, the 10-year period could not apply to foreign tax deductions. Furthermore, according to the court, Regs. Sec. 301.6511(d)-3(a) states the 10-year period applies "in the case of an overpayment of income tax resulting from a credit," and it describes the only way for the 10-year period to be available, rather than one of multiple ways.

The court also stated that the application of the extended period to only the foreign tax credit makes sense when the taxpayer contests foreign taxes. In the case of a deduction, the contested taxes would be deductible in the year of final resolution. However, while the foreign tax credit is allowed for the year to which the tax relates, because the amount of a contested tax is often not determined until more than three years after the year to which the tax relates, the longer 10-year period for refund claims enables taxpayers to take a credit for those taxes, according to the court.

Finally, the court stated that Sec. 901 and its related regulation specify the time limit for choosing between the credit and the deduction, while Sec. 6511 and its related regulation specify the time limit for refund claims, and that these separate rules should not be conflated.

  • Trusted Media Brands, Inc., No. 17-3733-cv (2d Cir. 8/10/18)

— By Charles J. Reichert, CPA, instructor of accounting, University of Minnesota—Duluth.

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