On 3 April 2023, the IRS released Notice 2023-31 notifying taxpayers of their intent to extend the transition period for an exception to pay foreign royalty withholding taxes once proposed Treasury Regulation (issued 21 November 2022) is finalized. The Internal Revenue Service (IRS) extension period - from 17 May 2023 to 180 days after the date the proposed regulations are finalized and filed with the Federal Register – would apply to the Foreign Tax Credit (FCT) proposed single-country exception, issued as part of the IRS's 21 November 2022 proposed regulations.
Under these proposed regulations, a royalty withholding tax would qualify as an FTC if the company has a licensing agreement in a given country to use the intellectual property that generates the royalty, and as long as the IP is used only in that country. To qualify for the proposed single-country exception, taxpayers may need to revise existing license agreements to satisfy the above documentation requirement. Rather than having to revise licensing agreements that will allow taxpayers to meet the single-country exception by 17 May 2023, the proposed Treasury Regulations would give taxpayers additional breathing room. They will now have at least 180 days after the date final regulations are filed with the Federal Register.
Otherwise, taxpayers may rely on Notice 2023-31 for foreign taxes paid in taxable years beginning on or after 28 December 2021 and ending before the effective date of the final single-country exception rule, provided the foreign tax is otherwise eligible for the exception.
Note: The Treasury and the IRS in 2021 issued FTC regulations providing that foreign withholding taxes on royalty payments are creditable only if the foreign law treats royalties as taxable income based upon the place of use, or the right to use, of the intangible property, consistent with how the Internal Revenue Code (IRC) imposes taxes on royalty income. Royalty withholding taxes were of particular concern to taxpayers, as many countries use rules to demand withholding taxes on royalty payments that are different from those that the US adopts. The result is that, absent a specific exception, many taxpayers would face ineligibility of foreign withholding taxes to qualify as FTCs. The above proposed regulations address this issue.