Key insights from the 2021 final foreign tax credit regulations

In brief

Treasury and the IRS on December 28, 2021, released final regulations (the ‘2021 Final Regulations’) addressing various aspects of the foreign tax credit (FTC) regime. The 2021 Final Regulations were published in the Federal Register on January 4, 2022, and represent the third set of final regulations that have been issued with respect to the core provisions of the US foreign tax credit regime following the 2017 Tax Cut and Jobs Act. 

The 2021 Final Regulations finalize, among other provisions, certain of the proposed FTC regulations released on September 29, 2020 (the ‘2020 Proposed Regulations’). The 2021 Final Regulations provide guidance in the following areas: 

• the disallowance of a credit or deduction for foreign income taxes with respect to dividends eligible for a dividends-received deduction under Section 245A; 
• the allocation and apportionment of foreign income taxes, interest expense, and certain deductions of life insurance companies; 
• the definition of a foreign income tax and a tax in lieu of an income tax, including a new attribution requirement (previously the ‘jurisdictional nexus’ requirement); 
• the definition of foreign branch category income; and 
• the time at which foreign taxes accrue and can be claimed as a credit. 

The regulations also contain clarifying rules relating to foreign-derived intangible income (FDII). The 2021 Final Regulations affect taxpayers that claim credits or deductions for foreign income taxes or that claim a deduction for FDII. Certain provisions of the 2020 Proposed Regulations were not finalized in the 2021 Final Regulations, which Treasury and the IRS continue to study. 

While the 2021 Final Regulations are effective on March 7, 2022, certain provisions are applicable to periods beginning before that date. The various applicability dates are discussed further below and summarized in the table at the end of this document.

The takeaway: The 2021 Final Regulations are among the most significant developments in the US FTC regime during its 100+ year existence, as they fundamentally change the definition of what is a creditable foreign income tax under Sections 901 and 903. The regulations are expected to reduce significantly the amount of FTCs that taxpayers may claim. Taxpayers should immediately re-evaluate each of the foreign taxes historically claimed as a creditable tax under the new regulatory framework to determine whether such taxes may continue to be claimed as a credit under Sections 901 or 903.

For financial statement reporting purposes, under the income tax accounting standard, companies should assess the impact, if any, of all new information in the period. This includes any impact from the issuance of regulations by the US Treasury, such as the 2021 Final Regulations. Therefore, taxpayers who are affected by the 2021 Final Regulations will need to consider their impact, if any, beginning in the financial period that includes December 28, 2021, the date the Regulations were issued.