Dual-Capacity Taxpayer Must Use Facts-and-Circumstances or Safe-Harbor Method

In Field Service Advice (FSA) 200032037, the IRS National Office concluded that a dual-capacity taxpayer must use the safe-harbor or facts-and-circumstances method in determining the amount of its creditable taxes, because the U.S.-Indonesia tax treaty does not specify that the Indonesian levy is an "income tax."

In FSA 200032037, a U.S. corporation conducted operations in Indonesia with a controlled entity of the Indonesian government. Under an agreement with that government, the corporation agreed to pay Indonesian taxes as indicated in the agreement, regardless of subsequent changes to Indonesian tax law or changes under the U.S.-Indonesian tax treaty. The corporation was treated as a dual-capacity taxpayer with regard to Indonesia, as defined in Regs. Sec. 1.901-2(a)(2)(ii).

Even though it was a dual-capacity taxpayer, the corporation argued that all of the taxes paid to Indonesia should be creditable for U.S. purposes. It based its argument on Regs. Sec. 1.901-2A(b)(2), which provides that, when a treaty with a foreign country treats a foreign levy as an income tax for foreign tax credit (FTC) purposes, all of the levy is treated as a creditable tax if the credit is claimed under the treaty and not under Sec. 901 or 903.

The IRS National Office disagreed with the taxpayer and concluded that the treaty did not treat the levy as an income tax. It pointed to language in the 1977 U.S. Model Treaty, which specifically provides that a levy is treated as an income tax. Because the language in the Model Treaty was absent from the U.S.-Indonesia treaty, and because the Technical Explanation states that "[e]ach Contracting State will apply its domestic law to determine what is a creditable tax," the National Office ruled that the Regs. Sec. 1.901-2A(b)(2) exception did not apply.

The National Office also allowed the taxpayer to switch from claiming a deduction for foreign taxes to claiming a credit for foreign taxes during the 10-year period prescribed in Sec. 6511(d)(3)(A), regardless of whether the taxpayer claimed the FTC under the Code or the treaty.

From Thomas D. Fuller, J.D., Washington, DC