Cal. Code Regs. Tit. 18, §§ 24345-7

Current through Register 2024 Notice Reg. No. 40, October 4, 2024

Section 24345-7 - Foreign Taxes

(a) Definitions, as used in this regulation;

(1) "Income tax" means a tax on or according to or measured by gross or net income or profits paid or accrued within the income year imposed by the authority of any foreign country.

(2) "Foreign tax" means a compulsory payment imposed by and pursuant to the authority of a foreign country to levy taxes. A penalty, fine, interest or customs duty is not a tax. Whether a foreign tax requires a compulsory payment pursuant to a foreign country's authority to levy taxes is determined by principles of United States law and not by principles of law of the foreign country.

(3) "Foreign country" means any jurisdiction other than one embraced within the United States, including a political subdivision of such jurisdiction.

(4) "Dual capacity tax" means a tax which is paid to a foreign country or to an agency or instrumentality of a foreign country which is all or in part an income tax and which is also for receipt of or future receipt of, directly or indirectly, a specific economic benefit from a foreign country or from an agency or instrumentality of a foreign country.

(5) "Specific economic benefit" means an economic benefit that is not made available on substantially the same terms to substantially all persons who are subject to an income tax that is generally imposed by the foreign country, or, if there is no such generally imposed income tax, an economic benefit that is not made available on substantially the same terms to the population of the country in general.

(6) "Paid" means "paid or accrued"; the term "payment" means "payment or accrual"; and the term "paid by" means "paid or accrued by or on behalf of."

(7) "Entity" means a corporation, partnership, bank, association, business trust or organization of any kind.

(b) Income tax.

(1) In general. Section 24345(b) of the Revenue and Taxation Code allows, in part, a deduction for taxes paid or accrued during the income year except taxes on or according to or measured by income or profits paid or accrued within the income year imposed by the authority of the government of any foreign country. Whether a foreign tax is an income tax is determined independently for each separate foreign tax. If the initial amount of one foreign tax is reduced or satisfied by credit or otherwise by the amount of another foreign tax, the amount of the first tax that is paid or accrued is the excess of the initial tax over the other tax. No deduction shall be allowed under section 24345(b) of the Revenue and Taxation Code for payments of foreign taxes which are refunded, credited, rebated, abated or forgiven by a foreign government.

(2) Realization. An "income" tax can only be imposed upon realized income, and to the extent a foreign tax is not imposed on realized income, it is not an income tax. Although the technical concept of realization does not require the receipt of money or property by the taxpayer, it does require the taxpayer to obtain the fruition of the economic gain which has accrued to it or it requires some identifiable event whereby the taxpayer obtains the final enjoyment of whatever economic gain or benefit has accrued to it.

(3) Burden of Proof.

(A) In general. The burden of proof rests upon the taxpayer to prove entitlement to a deduction under section 24345(b) of the Revenue and Taxation Code. Whether a foreign tax is properly characterized as an income tax will be decided on its own facts by reference to the specific activity taxed. Thenature of a foreign tax is determined by its operation, not by labels placed upon it, and a determination must be made as to how a foreign tax is actually imposed on the tax payer for the given income year for which a deduction is claimed under section 24345(b) of the Revenue and Taxation Code. A single foreign tax may be deductible in part, based upon the manner in which the tax is actually imposed upon the taxpayer for the given year for which the deduction is claimed. A taxpayer shall be entitled to a deduction for only that portion of the tax actually imposed upon the taxpayer for the given income year for which the deduction is claimed which the taxpayer can establish is not an income tax.

EXAMPLE:

Corporation B is engaged in foreign country Y in the business of extracting petroleum. B pays to Y a foreign tax based upon a tax base comprised of two elements:

(1) gross income of B from activities within Y, and

(2) the value of B's end of year inventory in Y. B had gross income of 100, and inventory in Y of 10 at the end of the year. B is entitled to a deduction of the tax paid to Y on the value of B's end of year inventory of 10 which is a non-income tax element of the foreign tax, but is not entitled to a deduction on the tax paid to Y on its 100 of gross income which is an income tax. These conclusions are determined without regard to how Y's foreign tax law is applied to other taxpayers.

(B) Presumption. It shall be presumed, subject to rebuttal, that a payment to a foreign country is an income tax if the foreign country asserts that the payment is all or in part pursuant to the foreign country's authority to levy taxes.

(4) Nonapplicability of federal provisions. Sections 901 and 903 of the Internal Revenue Code, and the federal regulations promulgated thereunder, shall not be used to determine the character or deductibility of a foreign tax under section 24345 of the Revenue and Taxation Code.

(c) Dual capacity taxes.

(1) In general. The deductibility of a foreign tax, or a portion of it, is determined under this subsection if the tax paid is a dual capacity tax. Otherwise, the deductibility of a foreign tax is to be determined under subsection (b). If in applying the principles of California law, a foreign tax requires a compulsory payment in exchange for a specific economic benefit, the tax is considered to have two distinct elements; an income tax, and a tax in exchange for the specific economic benefit. In such a situation, these two distinct elements of the foreign tax (and the amount paid pursuant to each such element) shall be separated.

(2) Burden of proof for dual capacity taxes.

(A) In order for a taxpayer to deduct all or a portion of a dual capacity tax, the burden is upon the taxpayer claiming a deduction to prove that the imposition of the foreign tax is directly related to the receipt or future receipt of, directly or indirectly, a specific economic benefit from the foreign country and the amount, if any, that is not an income tax, by use of one of two alternative methods. Those methods are the facts and circumstances method (described in subsection (c)(3)(A)) and the safe harbor method (described in subsection (c)(3)(B)).

(3) Satisfaction of burden of proof.

(A) Facts and circumstances method. If the taxpayer claiming a deduction establishes, based on all the relevant facts and circumstances, the specific amount, if any, of the dual capacity tax that is not an income tax within the meaning of subsection (b), such amount is deductible. In determining the deductible amount under the facts and circumstances method, neither the methodology nor the results that would be obtained if a taxpayer elected to apply the safe harbor method is a relevant fact or circumstance.

(B) Safe harbor method. Under the safe harbor method, the taxpayer claiming a deduction for a dual capacity tax makes an election on its California return with respect to the foreign country which asserted that tax upon an entity included in its combined report as provided in subsection (c)(4) and, pursuant to such election, applies the safe harbor method formula described in subsection (c)(5).

(4) Election to use the safe harbor method.

(A) Scope of election. An election to use the safe harbor method is made on a country-by-country basis. If an election is made to use the safe harbor method for dual capacity taxes paid to a particular foreign country, the election applies to all entities included in a taxpayer's combined report which paid dual capacity taxes to that foreign country and to all dual capacity taxes paid to that foreign country. The election applies to the first income year for which the election is made and to all subsequent income years of the electing taxpayer, unless the election is revoked in accordance with subsection (c)(4)(D). The election to use the safe harbor method is made in the time and manner set forth in subsection (c)(4)(C).

(B) Effect of election. An election to use the safe harbor method constitutes a specific waiver by the taxpayer of the right to use the facts and circumstances method for any dual capacity taxes for the elected foreign country for the years to which the election applies. An election to use the safe harbor method also constitutes a specific waiver by the taxpayer to pursue any additional deduction for any dual capacity taxes for the elected foreign country for the years to which the election applies through any litigation pursuant to sections 26101 through 26107 of the Revenue and Taxation Code, or by protest pursuant to section 25664 of the Revenue and Taxation Code, or by appeal pursuant to sections 25666(b) and 25667 of the Revenue and Taxation Code or by refund or credit pursuant to sections 26071 through 26081 of the Revenue and Taxation Code.

(C) Time and manner of making the election to use the safe harbor method.

1. In general. An electing taxpayer shall attach a statement, for each foreign country for which the election is made which asserted a dual capacity tax upon an entity included in its combined report, to its California Franchise or Income Tax Return for the first income year for which the election is made and shall file such return by the due date (including extensions), pursuant to sections 25401 through 25406 of the Revenue and Taxation Code, for the filing thereof. The statement shall provide that the electing taxpayer elects to use the safe harbor method for each such foreign country.

2. Certain retroactive elections. Notwithstanding the requirements of subsection (c)(4)(C)1. an election may be made for any years ended on or before December 31, 1990 for which returns have previously been filed by timely filing (including extensions), pursuant to sections 26073 and 26073.2 Of the Revenue and Taxation Code, an amended California Franchise or Income Tax Return setting forth the calculation(s) of the safe harbor method deduction(s) for the first of the election income years and applying the safe harbor method in such amended return; by attaching to such first election year return a statement containing the statement and information set forth in subsection (c)(4)(C)1. and by timely filing (including extensions) amended returns setting forth the calculation(s) of the safe harbor method deduction(s) for all other election years for which returns have previously been filed and applying the safe harbor method in such amended returns. All such amended returns must be filed on or before June 30, 1991, unless the Franchise Tax Board agrees in writing to a later filing and the applicable statutes of limitations on deficiency assessments or refund claims have not expired by the time of such later filing.

(D) Revocation of election. An election to use the safe harbor method can only be revoked with the written consent of the Franchise Tax Board. Request for consent to revoke an election shall be made by filing a statement providing that the taxpayer revokes the safe harbor election with the Franchise Tax Board, Post Office Box 1468, Sacramento, CA 95812-1468. Such statement shall be mailed to the Franchise Tax Board no later than the 90th day before the due date (including extensions), pursuant to sections 25401 through 25406 of the Revenue and Taxation Code, for the filing of the return for the first income year for which the revocation is sought to be effective. The Franchise Tax Board shall make its consent to any revocation conditioned upon necessary adjustments being made in one or more income years so as to prevent the revocation from resulting in amounts being duplicated or omitted.

(5) Safe harbor method formula.

(A) In general. The elective safe harbor method formula applies to determine the portion, if any, of a dual capacity tax that is not an income tax. The safe harbor method formula addresses two possible parts of a dual capacity tax payment. The first part is the "posted price differential" payment, which is defined as an actual payment of a foreign tax imposed on the differential between the market and posted price of crude oil (hereinafter "PPD" payment). A PPD payment is generally computed by subtracting from the actual tax paid to a foreign country the tax that would have been payable had gross receipts been calculated based on the market price, not the posted price, of crude oil. The second part of the payment, is the NONPPD payment which is defined as an actual payment of dual capacity tax which is not a PPD payment. Unless otherwise provided, both PPD and NONPPD payments exclude those payments which are refunded, credited, rebated, abated or forgiven by a foreign country. In no case shall payments representing withholding of taxes imposed on interest, dividends, rent, salaries, wages, premiums, annuities, remunerations, emoluments and other fixed or determinable annual or periodic gains, profits and income ("withholding taxes") payable by the payee of such amounts be included in the elective safe harbor method formula computation or components.

(B) Under the safe harbor method formula the amount paid in an income year which is not an income tax is determined by two part computation:

PART ONE:	A-X(B-C)=D
PART TWO:	A-X[B-(C+D)]+E=F

The components of the safe harbor method formula are defined asfollows:

A =The aggregate amount of NONPPD payments plus amounts of liability actually paid during the income year for taxes which are not dual capacity taxes and which are not separately deductible under subsection (b), excluding any withholding tax.

B = The amount of total gross receipts which relate to all activity taxed in the foreign country as determined under subsection (c)(5)(C).

C = The amount of cost of goods sold and operating expenses incurred in the income year to which the election pertains that related to the gross receipts included in component B, above, as determined under subsection (c)(5)(C), excluding NONPPD payments, but including PPD payments, if any.

D = The result of the PART ONE computation, but not less than zero.

E = PPD payments, if any.

F = The safe harbor deduction.

X = Fifty-five percent (.55) for all income years ended on or before December 31, 1986. Fifty two percent (.52) for all income years beginning on or after January 1, 1987.

In no case shall the deductible amount exceed the actual payment amount; and the deductible amount is zero if the safe harbor method formula yields a deductible amount less than zero. In no case shall the deductible amount be less than the PPD payments. In no case shall more than a single deduction be allowed for any payment of a foreign tax.

(C) Determination of gross receipts, cost of goods sold and operating expenses. For purposes of safe harbor formula, gross receipts, cost of goods sold and operating expenses are those same items as determined under accounting methods set forth in subsections (b)(3) and (d) of section of title 1825137-6 of title 18 of the California Code of Regulations. Gross receipts exclude the difference between the posted price and market price of crude oil.

(D) Combined operations. If the operations in a foreign country were carried on by more than one entity combinable in a taxpayer's California report, those operations are to be combined in computing the deduction under the safe harbor method.

(E) Examples of application of the safe harbor formula method.

EXAMPLE 1:

The Petroleum Profits Tax Law (PPTL) of foreign country A provides, in part, that all underground oil and gas in that country is the property of the government of country A and that no person shall mine or produce petroleum unless authorized by a concession agreement issued under that law. The PPTL imposes a tax on the profits of all companies engaged in "petroleum operations" which are defined as activities involved in and incidental to obtaining petroleum and natural gas. The General Income Tax Law (GITL) of country A subjects all income generated in that country to taxation. However, income from petroleum operations is exempted by the GITL. The tax imposed under the PPTL is based on net income and the amount of the tax is set at a flat rate of 70 percent, a rate higher than the GITL tax rate which is set at a flat 55 percent. For purposes of calculating net income under the PPTL, profits are calculated based on the posted price of crude oil, which is higher in amount than the actual market price. In 1985 S is a concession holder whose income generated within country A is solely from its petroleum extraction operations therein. S is a wholly owned subsidiary of, and includible in the combined group of, a California taxpayer.

The PPTL tax is a dual capacity tax. Pursuant to procedures of computing tax liability and the methods of accounting set forth in the PPTL (which are different than the methods of accounting that pertain to the safe harbor method formula set forth in subsection (c)(5)(C)), S had 165 in grossreceipts, 45 in cost of goods sold and operating expenses, and a net income of 120 (165 less 45). A tax liability of 84 (120 net income multiplied by the 70 percent tax rate) is imposed on and paid by S under the PPTL.

For purposes of the safe harbor method formula, of the 84 imposed and paid under the PPTL, 10 is determined to be a PPD payment within the meaning of component E because that is the amount by which the actual tax paid under the PPTL exceeded the tax that would have been payable had profits been calculated based on the market price of crude oil. Component A, the NONPPD payment, is 74 (84 less 10). S received 150 in gross receipts within the meaning of component B and the methods of accounting attendant thereto. S also incurred 50 in cost of goods sold and operating expenses (including the PPD payment of 10) within the meaning of component C and the methods of accounting attendant thereto. Component X is .55 because the income year in issue is prior to 1987.

The deduction allowed by the safe harbor method formula is determined as follows: A=74, B=150, C=50, E=10 and X=.55.

PART ONE: A-X(B-C)=D

74-.55(150-50)=D

74-.55(100)=D

74-55 =D

D=19

PART TWO: A-X[B-(C+D)]+E=F

74-.55[150-(50+19)]+10=F

74-.55[150-69]+10=F

74-.55[81]+10=F

74-44.55 +10=F

F=39.45

Thus, of the 84 imposed on and paid by S to country A, 39.45 is deductible. The remaining 44.55 is not deductible.

EXAMPLE 2:

The Petroleum Tax Law (PTL) of foreign country B provides, in part, that all underground oil and gas in that country is the property of the government of country B and that no person shall mine or produce petroleum unless authorized by a concession agreement issued under that law. Furthermore, the PTL specifies that an oil company or other concession holder under the PTL shall pay such income tax and other taxes as are payable under the laws of country B. The PTL requires that if the total annual amount of income tax and other direct taxes falls short of 70 percent of a concession holder's profits from all its country B concessions, such concession holder must pay such sum by way of a "surtax" as will make the total of its payments equal 70 percent of its profits. Credit is allowed for the payment of income tax and other direct taxes of country B against the PTL liability.

Under the PTL, "profits" are defined as the income resulting from the operations of the concession holder after deducting certain expenses. No deduction is allowed for income taxes and other direct taxes paid to country B. For purposes of calculating "income resulting from the operations of the concession holder," profits are calculated based on the posted price of crude oil, which is higher in amount than the actual market price. In 1985 S is a concession holder whose income generated within country B is solely from its petroleum extraction operations therein. S is a wholly owned subsidiary of, and includible in the combined group of, a California taxpayer.

All companies engaged in business activities in country B must pay an income tax imposed under the Corporation Income Tax Law (CITL). The CITL is the general income tax law of country B and is imposed at a flat rate of 55 percent.

The PTL tax is a dual capacity tax. Pursuant to procedures of computing tax liability and the methods of accounting set forth in the PTL (which are different than the methods of accounting that pertain to the safe harbor method formula set forth in subsection (c)(5)(C) and the methods of accounting set forth in the CITL), S had 165 in gross receipts, 45 in cost of goods sold and operating expenses and a net income of 120 (165 less 45). A tax liability of 84 (120 net income multiplied by the 70 percent tax rate) is imposed on S under the PTL.

The CITL tax is determined not to be deductible under subsection (b). Pursuant to procedures of computing tax liability and the methods of accounting set forth in the CITL (which are different than the methods of accounting that pertain to the safe harbor method formula set forth in subsection (c)(5)(C) and the methods of accounting set forth in the PTL), S had 150 in gross receipts, 50 in cost of goods sold and operating expenses and a net income of 100 (150 less 50). A tax liability of 55 (100 net income multiplied by the 55 percent tax rate) is imposed on and paid by S under that law. However, S is allowed a credit of the amount paid under the CITL against its PTL tax liability. Therefore, the net amount of tax S actually pays under the PTL is 29 (84 less 55).

For purposes of the safe harbor method formula, of the 29 paid under the PTL, 10 is determined to be a PPD payment within the meaning of component E because that is the amount by which the actual tax paid under the PTL exceeded the tax that would have been payable had profits been calculated based on the market price of crude oil. No portion of the CITL is a PPD payment. Component A, the NONPPD payment, is 19 (29 less 10) plus 55 paid under the CITL which was credited against S's liability under the PTL, for a total value of 74. S received 150 in gross receipts within the meaning of component B and the methods of accounting attendant thereto. S also incurred 50 in cost of goods sold and operating expenses (including the PPD payment of 10) within the meaning of component C and the methods of accounting attendant thereto. Component X is .55 because the income year in issue is prior to 1987.

The deduction allowed under the safe harbor method formula is determined as follows:

A=74, B=150, C=50, E=10 and X=.55.

PART ONE: A-X(B-C)=D

74-.55(150-50)=D

74-.55(100)=D

74-55 =D

D=19

PART TW O: A-X[B-(C+D)]+E=F

74-.55[150-(50+19)]+10=F

74-.55[150-69]+10=F

74-.55[81]+10=F

74-44.55 +10=F

F=39.45

Thus, of the 84 imposed on and paid by S to country B, 39.45 is deductible. The remaining 44.55 is not deductible.

EXAMPLE 3:

The Petroleum Revenue Law (PRL) of foreign country C provides, in part, that all underground oil and gas in country C, its territorial waters and its continental shelf is the property of country C and that no person shall extract such oil and gas except under license from the government of country C. Securing such a license to extract oil and gas in country C subjects a taxpayer to the tax imposed under the PRL. The PRL imposes a tax on all profits from oil extraction at a flat rate of 60 percent. Gross receipts for purposes of the PRL are calculated based on the current market value of oil and gas. The PRL tax is generally based on net income and is imposed in addition to the tax imposed by the Corporation Income Tax Law (CITL), the general income tax law of country C. The tax liability paid under the PRL is allowed as a deduction in computing a taxpayer's liability under the CITL. In 1985 S is a license holder under the PRL whose income generated within country C is solely from its petroleum extraction operations therein. S is a wholly owned subsidiary of, and includible in the combined group of, a California tax payer.

The CITL imposes a tax on the aggregate of net income of a corporation and its rate is set at a flat 50 percent.

The PRL tax is a dual capacity tax. Pursuant to procedures of computing tax liability and the methods of accounting set forth in the PRL (which are different than the methods of accounting that pertain to the safe harbor method formula set forth in subsection (c)(5)(C) and the methods of accounting set forth in the CITL), S had 150 in gross receipts, 40 in cost of goods sold and operating expenses and a net income of 110 (150 less 40). A tax liability of 66 (110 net income multiplied by the 60 percent tax rate) is imposed on and paid by S under the PRL. The CITL tax is determined to not be deductible under subsection (b). Pursuant to the procedures of computing tax liability and the methods of accounting set forth in the CITL (which are different than the methods of accounting that pertain to the safe harbor method formula set forth in subsection (c)(5)(C) and the methods of accounting set forth in the PRL), S had 150 in gross receipts, 52 in cost of goods sold and operating expenses, a deduction for the payment of its PRL liability of 66, and a net income of 32 (150 less 52 and 66). A tax liability of 16 (32 net income multiplied by the 50 percent tax rate) is imposed on and paid by S under the CITL.

For purposes of the safe harbor method formula, the value of component A is 82 (66 paid under the PRL plus 16 paid under the CITL). S received 150 in gross receipts within the meaning of component B and the methods of accounting attendant thereto. S also incurred 40 in cost of goods sold and operating expenses within the meaning of component C and the methods of accounting attendant thereto. The value of component E is zero because there were no PPD payments. Component X is .55 because the income year in issue is prior to 1987.

The deduction allowed under the safe harbor method formula is determined as follows: A=82, B=150, C=40, E=O and X=.55.

PART ONE: A-X(B-C)=D

82-.55(150-40)=D

82-.55(110)=D

82-60.5

D=21.5

PART TWO:

82-.55[150-(40+21.5)]+0=F

82-.55[150-61.5]+0=F

82-.55[88.5]+0=F

82-48.675 +0=F

F=33.325

Thus of the 82 imposed on and paid by S to country C, 33.325 is deductible. The remaining 48.675 is not deductible.

Cal. Code Regs. Tit. 18, §§ 24345-7

1. New section filed 3-1-91; operative 3-31-91 (Register 91, No. 15).

Note: Authority cited: Section 26422, Revenue and Taxation Code. Reference: Section 24345, Revenue and Taxation Code.

1. New section filed 3-1-91; operative 3-31-91 (Register 91, No. 15).]