Creditable Foreign Taxes as an Expense in Applying the Economic Substance Profit Test - Here We Go Again?
December 21, 2006
On December 21, 2006, James M. Peaslee, a tax partner in the New York office, authored an Alert entitled “Creditable Foreign Taxes as an Expense in Applying the Economic Substance Profit Test--Here We Go Again?” Notice 98-5 disallowed credits for foreign income taxes in certain transactions where the post-foreign tax economic profit was low compared with the credits claimed. In effect, the Notice took the view that foreign income taxes should be treated as an expense in applying the common law economic substance profit test. In 2001, that view took a beating in the IES and Compaq cases. Notice 98-5 was withdrawn in 2004. Despite this history, it is becoming increasingly clear that the IRS has not abandoned its position in IES and Compaq (at least for taxpayers not in those circuits such as those in New York). Also, the issue is likely to arise in connection with the economic substance codification proposal that is under consideration by Congress. The article discusses why foreign taxes should not be viewed as an expense.