SERVICE HOLDS INCOME ALREADY CREDITED UNDER TAX LAW OF THE NETHERLANDS IS NOT ELIGIBLE FOR FOREIGN TAX CREDIT UNDER U.S. LAW

Rev. Rul. 86-134

ISSUE

Whether investment incentives ("WIR premiums") granted by the Kingdom of the Netherlands should be treated as reducing Netherlands income taxes paid or accrued for purposes of the U.S. foreign tax credit in the situation described below.

FACTS

X is an accrual method, calendar year domestic corporation actively engaged in a trade or business through a permanent establishment within the Netherlands. Income derived by X's permanent establishment is subject to the Netherlands Corporation Income Tax Act of 1969, as amended. X's 1986 Netherlands income tax liability computed without regard to credits is Df1. 50,000.

After May 1, 1986, X purchased and placed in service certain fixed assets for use in the Netherlands permanent establishment. The total cost of these assets was Df1. 100,000.

The assets qualify for a Netherlands investment incentive under the 1978 Investment Account Act, as amended (Wet Investeringsrekening, abbreviated WIR) in the amount of Dfl. 12,500. WIR allows tax-free premiums to encourage investment in qualifying business use assets located in the Netherlands. Currently the basic WIR premium is equal to 12.5 percent of the cost of a qualifying asset. The basic WIR premium may be increased by one or more supplemental premiums. The premiums are allowed to Netherlands residents subject to the Netherlands corporation or individual income tax and also to non-residents of the Netherlands who operate there through a permanent establishment.

The amount of the WIR premium is not included in Netherlands taxable income and the premium does not reduce the Netherlands depreciable basis of a qualified asset for which a premium is allowed. In general, the WIR premium is allowable in the taxable year in which a commitment (contract) to invest in a qualifying asset is entered into, but the amount of the premium is limited in that year to the portion of the premium allowable with respect to the amount actually expended in the year to acquire the asset, and the rest of the premium is allowable in the earlier of the taxable year the asset is placed in service or the year the balance of the purchase price is paid.

If an asset for which a WIR premium has been allowed is disposed of within 8 years, the premium is recaptured in the same proportion as the amount received for the asset bears to the original cost. Recaptured premiums are not deductible from Netherlands taxable income and do not affect the calculation of gain or loss on the disposition of the asset for Netherlands income tax purposes.

In general, with respect to commitments to invest in qualified assets entered into after April 30, 1986, payment of the allowable WIR premiums by the Netherlands government to the investor (and repayment of recaptured premiums to the government by the investor on the disposition of a qualified asset) is effected only through the Netherlands income tax assessment system. The investor, whether a resident or a non-resident of the Netherlands, claims a credit or offset against the Netherlands corporate or individual income tax assessment for the amount of WIR premiums due, and shows an addition to tax for recaptured premiums. If the net amount of premiums due the investor exceeds the tax assessment (or if there is no tax liability), the excess of current WIR premiums over the current year's Netherlands income tax assessment may be carried back 3 taxable years and then carried forward 8 taxable years (or carried forward 12 years in the case of start-up companies) until used against the investor's Netherlands income tax liability. These are the same periods over which Netherlands net operating losses may be carried.

LAW AND ANALYSIS

Section 901 of the Code allows a credit, subject to the limitations of section 904, for the amount of income, war profits and excess taxes paid or accrued, or deemed paid under sections 902 or 960, to any foreign country or possession of the United States. When analyzing a foreign levy to determine if it is a creditable tax, principles developed under U.S. law, not foreign law control. Biddle v. Commissioner, 302 U.S. 573 (1938); section 1.901-2(a)(2) of the Income Tax Regulations. Thus, U.S. principles also control in determining whether an amount of foreign income tax has been reduced by means of a refund or credit. The controlling U.S. principles regarding the treatment of an amount of foreign income tax subject to reduction by refund or credit for purposes of the U.S. foreign tax credit are contained in section 1.901-2(e)(2) of the Income Tax Regulations.

Section 1.901-2(e)(2)(i) of the Income Tax Regulations provides that an amount is not tax paid or accrued to a foreign country to the extent that it is reasonably certain that the amount will be refunded, credited, rebated, abated or forgiven. This rule is illustrated by Example (2) of section 1.901-2(e)(2)(ii), where an initial foreign income tax liability of 100u is reduced under foreign law by an investment credit of 15u and a charitable contributions credit of 5u. Example (2) holds that the amount of foreign income tax paid or accrued is 80u. Thus, the investment credit must be treated as reducing the amount of foreign income tax paid or accrued.

Because the only manner in which a taxpayer can receive WIR premiums is as a credit or offset against Netherlands income tax assessments, section 1.901-2(e)(2)(i) and the holding of Example (2) directly apply to the treatment of WIR premiums allowable with respect to commitments to invest in qualified assets entered into after April 30, 1986, under the 1978 Investment Account Act, as amended. Accordingly, the Dfl. 12,500 amount is not income tax paid or accrued to the Netherlands because it is reasonably certain that a WIR premium equal to that amount will be allowed as a credit against X's pre-credit Netherlands income tax liability within the meaning of section 1.901-2(e)(2)(i). X's 1986 pre-credit Netherlands income tax liability of Dfl. 50,000 must be reduced by Dfl. 12,500, the amount of the allowable WIR premium. The taxable year (or taxable years, if a carryback or carryover applies) in which the WIR premium is allowed as an offset against Netherlands income tax is the proper taxable year for which Netherlands income taxes are considered reduced. If a WIR premium that has been allowed with respect to commitments to invest in qualified assets entered into after April 30, 1986, is recaptured in a later taxable year, the amount of the recaptured premium shall be treated as an increase in Netherlands income tax for the taxable year in which the liability for the recaptured premium is paid or accrued.

HOLDING

Under the circumstances described above, for purposes of the U.S. foreign tax credit, WIR premiums allowable with respect to commitments to invest in qualified assets entered into after April 30, 1986, must be treated as reducing Netherlands income taxes paid or accrued for the taxable year or years in which the premium is allowed. WIR premiums described in the previous sentence that are recaptured in a later taxable year must be treated as an increase in Netherlands income taxes paid or accrued for the taxable year in which the liability for the recaptured premium is paid or accrued.

The holding of this revenue ruling does not apply to either the allowance or the recapture of a WIR premium allowable with respect to commitments to invest in qualified assets entered into before May 1, 1986.