William H. Green, Attorney

On March 31, 2005, the U.S. Court of Federal Claims permitted Guardian Industries to claim a direct foreign tax credit for taxes paid by its Fiscal Unity Group (FUG) in Luxembourg. Although the group consists of separate foreign corporate entities, the Group Parent company elected to be treated as a check-the-box (CTB) entity for U.S. tax purposes. In addition, under local Luxembourg law, the Group Parent was solely liable for the FUG tax liability. As a result, Guardian was eligible to claim the full amount of the taxes paid by the Luxembourg Group Parent as a foreign tax credit.
After a brief statement of facts, this article contains an example on the use of tax planning for separating and accelerating the foreign tax credit benefits from the underlying associated earnings. The immediate cash flow benefits of this strategy, however, may be negated by the subsequent U.S. tax on foreign deferred earnings.

Statement of Facts

The Taxpayer, Guardian Industries, is involved in the manufacture of glass products for commercial and home applications throughout the world. GIE, a Luxembourg S.a.r.l., holds a controlling interest in nine separate Luxembourg corporations (S.A.s), which comprise the Guardian Luxembourg Group. This Group files a consolidated tax return as a fiscal unity group (FUG) under Article 164bis of the Luxembourg tax law. During 2001, GIE paid about 3.5 million Euros in Luxembourg taxes.

In January, 2001, the Group Parent, or GIE, filed a Form 8832 with the IRS and elected to be a disregarded foreign entity for U.S. tax purposes. The IRS approved this election in March, 2001.

In its initial 2001 return, filed June 4, 2002, Guardian treated the Luxembourg tax as prorated between the various members of the Guardian Luxembourg Group. Two weeks later, Guardian submitted an amended return, claiming a refund of over $2.8 million. In its refund claim, Guardian took the position that the Group Parent, or GIE was the true taxpayer liable for the entire FUG tax liability in 2001. Thus, the entire amount of the 2001 Luxembourg taxes, which were paid by GIE, qualified as foreign tax credits under Sec. 901. There is no indication in the opinion that GIE received dividends or reported taxable income attributable to the other members of the Guardian Luxembourg Group in 2001.

Conclusions of the Court

In a brief opinion, the Claims Court granted Guardian's motion for a Summary Judgement on its refund claim. In its analysis, the Court considered the U.S. regulations under Sec. 901, involving direct foreign tax credits, and the testimony of foreign tax experts on the effect of the Luxembourg fiscal unity group (FUG) tax liability under Article 164bis of the Luxembourg tax law.

Under Reg. Secs. 1.901-2(f)(3) and -2(f)(1), a direct foreign tax credit can be claimed only by the person on whom foreign law imposes legal liability. The Court cited relevant portions of the Biddle decision but did not comment. See U.S. 573, 580-581 (1938). The IRS claimed that the FUG members were jointly and severally liable for the tax, so the Luxembourg tax must be prorated amongst its members

In order to verify the merits of Guardian's claim that GIE alone was responsible or legally liable for the 2001 Luxembourg tax, the Court considered the expert opinion of foreign tax practitioners. Based on the opinion of foreign counsel and the testimony of the Luxembourg tax authorities, the Court found that the manner in which Article 164bis was administered is consistent with the conclusion that the parent company (GIE) has sole liability for the FUG income tax. Thus, the Court ruled in favor of Guardian and permitted the refund claim.

Impact on Foreign Tax Planning for U.S. Multinationals

The Guardian decision appears limited to an advantageous set of facts. Although many countries have fiscal unity or tax consolidation provisions, their statutes may not allocate full legal liability to the parent. For example, in the United States, affiliated group members are jointly and severally liabile for income taxes attributable to each member of the group.

The Guardian decision produces favorable cash flow benefits upfront, since it accelerates foreign tax credits. However, as illustrated below, this result may have an onerous effect on Guardian in subsequent years.

Assume the following fact pattern for 2001 with no distributions from SUBs to GIE:

	GIE	SUB1	SUB2	SUB3	TOTAL
Taxable Income	100	100	100	100	400
Tax (20%)	20	20	20	20	80
Earnings	80	80	80	80	320

Under the IRS position, Guardian would report 100 of income and 20 of foreign tax credits, which results in a net $15 ($100 x 35%, less 20 FTC) U.S. tax on GIE's earnings. If all the FUG earnings were remitted, the U.S. tax would be $60 ($400 x 35%, less 80 FTC).

Based on the Court's analysis, for 2001 GIE would have to report 160 of taxable income, which includes 80 of foreign taxes to be claimed as a credit in its 2001 Form 1118. This would result in excess credits in 2001 of $24 ($160 x 35%, less 80 FTC). Excess credits produced by the decision could be applied in 2001 or carried back to prior years if the taxpayer has excess limitation under Sec. 904.

For 2002, GIE would have the following beginning foreign earnings for U.S. tax purposes:

	GIE	SUB1	SUB2	SUB3	TOTAL
Current Income	0	0	0	0	0
Tax (20%)
Earnings	0	80	80	80	240

For U.S. tax purposes, this strategy produces a mismatching between the foreign taxes paid and the U.S. tax on the underlying income. The acceleration of the foreign tax credits in 2001 creates a pool of Luxembourg earnings without any underlying tax credits to offset the U.S. tax on subsequent remittances of earnings from the Luxembourg companies owned by GIE. Thus, if Guardian remits its remaining Luxembourg earnings, it will be liable for an additional U.S. tax of $84 ($240 x 35%, less 0 FTC).

For tax accounting purposes, the income and taxes of the Luxembourg Group are included in Guardian's 2001 financial statements. As a result, there is a matching of financial income and taxes in 2001. Presumably, Guardian can claim that these funds are permanently reinvested under APB #23, so the U.S. tax cost on remitting the funds is eliminated. In the year of remittance, however, the additional U.S. tax will be a tax provision cost.