+44 (0)20 7833 3500  •  +1 212 465 7800  •  +64 4 499 6444  • 

Frank Hirth’s letter to the IRS on Proposed Regulation 105600-18

Private Clients - 05 Feb 2019

5 February 2019


CC:PA:LPD:PR (REG-105600-18)

Room 5203

Internal Revenue Service

PO Box 7604

Ben Franklin Station


DC 20224



Re: Regulation 105600-18 – Request for Comments on Proposed Transitional Rule §1.904-2(j)(1)(iii)


Dear Sirs

We write in response to the Treasury Department’s request for comments regarding specific provisions included in Proposed Regulation 105600-18 (the “Proposed Regulation”) and related to transitional rules for the carryover of foreign tax credits post-enactment of the 2017 Tax Cuts and Jobs Act (P.L. 115-97) (the “TCJA”).  We refer to our earlier submission on the same topic, dated 30 August 2018 and addressed to Messrs David J Kautter and William M Paul. 

This submission is made on behalf of a significant part of our client base generally, namely US citizens resident overseas.  We assist more than 2,000 such individuals annually with their US tax compliance.  Such individuals are exposed to worldwide double taxation by operation of local residency-based taxation combined with US citizenship-based taxation.  The principal mechanism for the mitigation of double taxation in these circumstances is the foreign tax credit. 

The TCJA introduced new rules impacting the operation of the foreign tax credit without including any transitional provisions.  The lack of transitional provisions has been addressed in Proposed Regulation 105600-18 which provides guidance in this area.  The Treasury and the IRS have requested comments specifically in relation to these transitional provisions.  We intend to demonstrate that the proposed provisions will be unworkable by many US citizens resident abroad and that a broader provision is necessary to address the problems faced by our client base and other US citizen taxpayers resident overseas.


Changes to the foreign tax credit rules enacted as part of the TCJA included the additional of two categories of income, namely (i) foreign branch income and (ii) income includible under new IRC §951A (GILTI), as categories for which the foreign tax credit limitation of IRC §904(a) must be determined separately under §904(d).  This is commonly known as the separate “basket” treatment.

IRC §904(c) provides for a one-year carryback and 10-year carryover of foreign tax credits that are not utilized in the year such taxes are paid or accrued.  Consistent with the other provisions of §904, carrybacks and carryovers are made on a basket-by-basket basis (with the exception of the new GILTI basket for which carrybacks and carryovers are specifically disallowed).  The provisions of §904(c) were introduced for the express purpose of preventing double taxation arising as a result of timing differences in the recognition of income for U.S. and foreign tax purposes.

The TCJA does not provide any transitional rules for assigning carryforwards of unused foreign taxes earned in pre-2018 years to the new post-2017 separate categories.  In the absence of transitional rules, proposed §1.904-2(j)(1)(ii) provides that if unused foreign taxes paid or accrued or deemed paid with respect to a separate category of income are carried forward to a taxable year beginning after December 31, 2017 those taxes are allocated to the same post-2017 separate category as the pre-2018 separate category from which the unused foreign taxes are carried.

In the preamble to the Proposed Regulation the Treasury and IRS acknowledge that such a transitional provision may give rise to double taxation where unused foreign taxes paid, accrued or deemed paid in a pre-2018 taxable year are not assigned to the separate category to which the taxes would have been assigned if the new post-2017 separate categories had existed in the pre-2018 taxable year.  Accordingly, proposed §1.904-2(j)(1)(ii) alone does not provide a sufficient mechanism for ensuring unused foreign taxes are matched to the separate category in which the corresponding foreign income is allocated.  As a consequence, absent any further provision, the success of §904(c) in mitigating double taxation arising as a result of timing differences is limited significantly.

To address this shortcoming proposed §1.904-2(j)(1)(iii) provides an exception from the general rule of proposed §1.904-2(j)(1)(ii).  The exception permits taxpayers to assign unused foreign tax credits in the pre-2018 separate general category to the post-2017 separate foreign branch category to the extent such foreign taxes would have been assigned to that separate category if the taxes had been paid or accrued in a post-2017 taxable year.  Any remaining unused taxes are to be assigned to the post-2017 general category. 

Due to the definition of post-2017 foreign branch category income and the fact that carryovers are not permitted in the GILTI basket, the exception in proposed §904-2(j)(2)(iii) applies only to unused foreign taxes paid or accrued in respect to pre-2018 general category income.  A taxpayer may choose whether to adopt the general allocation method of proposed §904-2(j)(2)(ii) or the exception in proposed §904-2(j)(2)(iii). 


Adopting the exception of proposed §904-2(j)(2)(iii) requires a taxpayer to analyse the extent to which income earned in prior years would have been foreign branch category income had such category of income existed in such year. 

In essence, general category income for each relevant pre-2018 year must be split between income that would constitute general category income in a post-2017 year and income that would be foreign branch category income.  Allocable deductions and expenses would need to be redetermined so as to calculate the appropriate apportionment of the old general category limitation to the new general and foreign branch categories for each of those years.  Corresponding foreign taxes must be allocated accordingly. To the extent such foreign taxes exceed the applicable limitation for the basket to which they are assigned such foreign taxes would be carried forward to future years within the applicable basket.

Whilst Section 904(c) permits a carry forward of foreign tax credits up to a maximum of 10 years only, practically speaking the analysis required to comply with proposed §904-2(j)(2)(iii) would in many cases cover a period of up to 20 years and in some cases more, as illustrated by the following example. 

Example 1

Assume, for instance, that a taxpayer had a general category limitation of $50,000 in the 2008 year.  The taxpayer accounts for foreign taxes on a paid basis and paid foreign taxes of $60,000 in the 2008 year.  In addition, the taxpayer had unused foreign tax credits of $10,000 carried forward from the 1999 year.  Assume also that the taxpayer pays no further foreign taxes in the intervening years from 2009 through 2018 inclusive but has foreign income in 2009 giving rise to a general category limitation of $5,000 in that year. 

After preparing the 2008 tax return, the taxpayer has $20,000 of unused foreign general category tax credits, $10,000 of which relate to foreign taxes paid in 2008 and $10,000 to foreign taxes paid in 1999.  As such, the taxpayer’s 2018 return should show $10,000 of unused general category foreign tax credits carried forward from the 2008 return.  Of the $10,000 of unused foreign taxes paid in 1999 $5,000 were used in the 2009 year with the balance then expiring.

In 2018 the taxpayer chooses to compute their foreign tax carryforwards in accordance with proposed §904-2(j)(2)(iii).  Accordingly, the taxpayer must undertake an analysis of their 2008 tax return in order to determine the extent to which the unused $10,000 carried forward to 2018 relates to foreign taxes that would be attributable to foreign branch category income had such taxes been paid in a post-2017 year.

Assume that this analysis shows that of the $50,000 general category limitation on the taxpayer’s 2008 return, $20,000 relates to income which would be foreign branch category income in a post-2017 year with the balance allocable to general category income.  Further, assume that of the $60,000 of foreign taxes paid in 2008, half relates to foreign taxes incurred on income which would be foreign branch category income post-2017.  Finally, assume the 2009 limitation applies wholly to foreign branch category income.

In these circumstances, the extent to which a carry forward on the taxpayer’s 2018 return relates to foreign branch category income requires not only an analysis of the 2008 year but also the 1999 year.  The impact of the 1999 year is illustrated in Fig 1:

Figure 1 Scenario 1 - unused 1999 foreign taxes relate to foreign branch category income Scenario 2 - unused 1999 foreign taxes relate to general category income
  Foreign Branch Category General Category Foreign Branch Category General Category
2008 Limitation 20,000 30,000 20,000 30,000
Taxes paid in 2008 30,000 30,000 30,000 30,000
Unused foreign taxes brought forward from 1999 10,000     10,000

Unused foreign taxes carried forward to 2009

of which from 1999 and expires in 2009

of which from 2008 and carries to 2018













2009 Limitation 5,000 - 5,000 -

Carry forward to 2010

of which from 1999 and expires in 2009

of which from 2008 and carries to 2018













Where the unused foreign taxes paid in 1999 relate to foreign branch category income, the taxpayer has $10,000 of credit available to be used in the 2018 year, all of which should be allocable to the foreign branch category.  On the other hand, where the unused foreign taxes paid in 1999 relate to general category income the taxpayer’s foreign branch credit available for use on their 2018 return is reduced to just $5,000, again all of which relates to foreign branch category income.  We understand the $5,000 of remaining credit is not lost but remains in the general category basket.

Thus, the analysis required to comply with proposed §904-2(j)(2)(iii) would cover a period stretching back to the 1999 year and, indeed, possibly further where foreign taxes paid in 1999 relate to income earned in earlier years.  Putting aside the complexity and costs involved in undertaking such an analysis, in the vast majority of cases sufficient records will simply be unavailable not least because the pre-TCJA rules did not make it necessary to maintain such records.

There is a further issue which comes to light when the rules above are affected by a separate limitation loss (SLL), overall foreign loss (OFL), or overall domestic loss (ODL).  The proposed regulations provide transition rules in this regard, but should there be any loss allocations affecting the various baskets this would need separate analysis and would impact the use of foreign tax credits across the various baskets. 

In such circumstances, taxpayers will have no choice but to adopt the general principal of proposed §904-2(j)(ii) for tax credit carryovers, which as discussed above, and as acknowledged in the preamble to the Proposed Regulations, does not provide a sufficient mechanism for the avoidance of double taxation arising from timing differences. It follows that proposed §904-2(j)(2)(iii) should be widened to provide a workable solution to the issue of timing differences arising from the introduction of the new foreign branch income category.

Alternative Solutions

The preamble to the Proposed Regulations provides an example of a simplified approach to the problem laid out above.  In lieu of a full analysis it is proposed that unused foreign tax credits carried forward to 2018 may be apportioned with reference only to the relative amounts of foreign branch category and general category income in the first post-2017 taxable year to which the credits are carried (the ‘Simplified Allocation’).

Clearly, the Simplified Allocation avoids any difficulties that might otherwise be presented by the lack of available historical records. Further, given the Simplified Allocation would be made purely with reference to the relative amounts of foreign branch category and general category income of the current year the proposal removes the need for any computation beyond that which would be required for the determination of a taxpayer’s current year US tax liability in any case.  In these respects, the proposal presents a more workable option than the current exception laid out at proposed

§904-2(j)(2)(iii) and would be the favoured option for many overseas taxpayers absent any alternative.

Nevertheless, the need for an any alternative approach to the general allocation of proposed

§904-2(j)(2)(ii) arises out of the failure of the general allocation method to provide sufficient protection from double taxation for taxpayers facing timing differences.  As such, any alternative must, by necessity, address this risk or otherwise fall short of its purpose.  The Simplified Allocation fails to properly guarantee this result given the allocation between income categories is made on essentially arbitrary grounds.  Indeed, such an arbitrary apportionment could, and likely would in many circumstances, produce an unreasonably favourable result for taxpayers, particularly where adoption is optional.

In our view, there are only two solutions that strike the right balance between the practical difficulties associated with the current proposed §904-2(j)(2)(iii) and the continued effectiveness of the 904(c) carryover provisions as a mechanism for eliminating timing differences:

  • As previously summarised in our letter to Messrs Kautter and Paul of 30 August 2018 taxpayers should be allowed to allocate pre-TCJA general category carryovers freely between the general basket and the new foreign branch basket.
  • Alternatively, if a free allocation is not acceptable, enable taxpayers to adopt an allocation on ‘any just and reasonable grounds’.

The ‘just and reasonable’ requirement would allow both the taxpayer and the IRS to take into account the extent to which historical records are available and the relative burden of undertaking the analysis otherwise required under proposed §904-2(j)(2)(iii).  In cases where the means for a full analysis are readily available and the exercise is not disproportionate to the amounts at stake, an accurate analysis (or as close to an accurate analysis as can be achieved) may be expected.  In other cases, taxpayers would be required to adopt the most reasonable apportionment achievable in the circumstances.

The ‘just and reasonable’ threshold minimises the scope for abuse whilst allowing the §904(c) provisions to achieve their purpose.  Thus, a balance is struck between the interests of the Treasury and taxpayers who might otherwise face a choice between double taxation or an unreasonably burdensome (or potentially impossible) deconstruction of their historic unused foreign tax position.


Thank you for this opportunity to provide our views on this vital issue for many Americans resident overseas.

If you have any questions please contact Jeffrey Gould, Carol Hipwell or Matthew Pannell on +4420 7833 3500.


Yours faithfully

Frank Hirth Plc

To print a copy of this article, click here.

Share this article:

Matthew Pannell

Matthew Pannell

Associate Director

T: +44 (0) 20 7833 3500
Email me
Office: London