February 9, 2010
Will You Get the Credit You Deserve?
The U.S. Internal Revenue Code permits U.S. taxpayers, who pay income tax to foreign countries, to take that tax as a credit to reduce U.S. tax on foreign source income. While the rules are complex in determining the exact amount of the credit, one fundamental principle shines through and is the subject of this International Tidbit – documenting the amount of the foreign tax paid.
Income taxes paid to foreign governments through the mechanism of tax withheld by the foreign payor are common, particularly with respect to payments of royalties, services, and rents to a U.S. taxpayer. To make sure the tax is paid, the foreign payor is required by its government to withhold tax and, if it fails to do so, is liable for the unpaid tax. Such taxes are typically in the range of 5% to 30% of gross income and can be important for U.S. taxpayers in reducing U.S. tax on foreign source income – the foreign tax credit.
Pursuant to Treasury Regulations, a U.S. taxpayer must provide a receipt evidencing each such foreign tax payment, if requested by the IRS. Evidence of tax paid must be in the form of an original, a duplicate original, or a duly certified or authenticated copy. If the receipt is in a foreign language, the taxpayer must furnish a certified translation. At one time, the Treasury proposed requiring such evidence to be attached to the taxpayer’s tax return in order to take the foreign tax credit, but this proposal has never been finalized.
If the taxpayer cannot produce this information, the IRS, at its discretion, may accept secondary evidence such as records of payments to the taxpayer, taking into account the prevailing tax in the foreign country at the time of the payment.
It is not uncommon for U.S. taxpayers to have difficulties obtaining tax receipts from foreign payors who are expected to retain the original receipts pursuant to rules in the country of payment. As a result, U.S. taxpayers may want to include a provision in their agreement with the foreign payor that a duplicate receipt must be provided within a certain period after the payor has withheld and paid the tax to the foreign government. Otherwise, the U.S. taxpayer may have to scramble to come up with the evidence during an IRS audit years after the payments were made and the contract with the foreign payor may have ended. The alternatives are to risk losing the foreign tax credit for the unsubstantiated payment or face an uphill battle with the IRS to get the credit the U.S. taxpayer deserves.
The statements contained herein are provided for information purposes only, are not intended to constitute tax advice which may be relied upon to avoid penalties under any federal, state, local or other tax statutes or regulations, and do not resolve any tax issues in your favor. Furthermore, such statements are not presented or intended as, and should not be taken or assumed to constitute, legal advice of any nature, for which advice it is recommended that you consult your own legal counselors and professionals.