“It Depends”—Knowledge and Overpayment Interest Accrual on International Withholding Refund Claims

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TL Fahring

TL Fahring

Attorney

512.672.8920
tfahring@freemanlaw.com

TL Fahring focuses on helping individuals and businesses with a wide variety of matters involving state, federal, and international taxation. He has represented clients in all stages of federal and state tax disputes, including audits, administrative appeals, litigation, and collection matters. Mr. Fahring also has used his tax knowledge to assist clients in planning complex domestic and international transactions, including advising as to potential reporting and withholding requirements.

Mr. Fahring received his J.D. from the University of Texas School of Law, where he graduated with high honors and was inducted into the Order of the Coif and Chancellors honors societies. After clerking for a year at the Texas Eleventh Court of Appeals, he attended New York University School of Law, where he received an LL.M. (Master of Laws) in Taxation and served as a student editor on the Tax Law Review.

When does overpayment interest begin to accrue on a foreign corporation’s refund claim for taxes withheld at source?  In CCA 202144027 (Nov 5, 2021), IRS Chief Counsel shrugs. “It depends.”

Facts

CCA 202144027 involves a refund claim filed in Year 2 by Corporation X, a foreign corporation, for chapter 3 withholding taxes on interest that a related U.S. corporation paid to Corporation X in Year 1.  The last date prescribed for Corporation X to file its Form 1120-F was June 15, Year 2.  The IRS did not receive the Form 1120-F until later in Year 2.  The IRS issued the claimed refund in Year 6 with overpayment interest calculated beginning on the date on which the Form 1120-F was received in Year 2.

The question is whether overpayment interest should have begun accruing beginning on the due date for the Form 1120-F of June 15, Year 2.

Relevant Statutory and Regulatory Provisions

Chapters 3 and 4 of the Internal Revenue Code contain various withholding provisions regarding payments or income attributable to foreign corporations.

For example, a person with custody or control of any item of U.S. source fixed or determinable annual or periodical gains, profits, or income of a foreign corporation generally is required to withhold at a rate of 30% on such item. See I.R.C. §§ 1441, 1442(a).  A partnership with a foreign corporation as a partner must withhold at a rate of 21% on the partnership’s effectively connected taxable income that is allocable under section 704 to the foreign corporation.  See I.R.C. §§ 11(b), 1446(a), (b)(2)(B).  The Foreign Accounts Tax Compliance Act also may require a person with custody or control of a so-called “withholdable payment” to a foreign financial institution or nonfinancial foreign entity to withhold at a rate of 30%, unless the recipient meets certain information reporting requirements. See I.R.C. §§ 1471, 1472.

Tax withheld on an item of income under chapter 3 or 4 is credited against the income tax liability of the item’s recipient.  SeeI.R.C. §§ 33, 1462, 1474(b); Treas. Reg. § 1.1474-3(a).  If the amount withheld at source results in an overpayment of tax in a given taxable year, the recipient may be entitled to a refund. See Treas. Reg. §§ 1.1464-1(a), 1.1474-5(a).  A foreign corporation with such an overpayment may claim a refund by filing a Form 1120-F for that year.  Treas. Reg. § 1.6012-2(g).

Generally, interest on any overpayment of tax resulting in a refund is paid from the date of overpayment to a date preceding the date of the refund check by not more than 30 days.  I.R.C. § 6611(a), (b)(2).  Amounts withheld under chapter 3 or 4 are considered to have been paid on the last day for filing a return for the taxable year with respect to which such tax is allowable as a credit under section 1462 or 1474(b) without regard to any exemption from the requirement for filing a return under section 6012.  See I.R.C. §§ 6611(d), 6513(b)(3).  Generally, a foreign corporation that does not have an office or other place of business in the United States must file a Form 1120-F by June 15th following the close of the calendar year or on or before the 15th day of the 6th month following the close of its fiscal year.  See I.R.C. § 6072(c); Treas. Reg. § 1.6012-2(g).  However, an exemption from the requirement to file a Form 1120-F applies if a foreign corporation is not engaged in a U.S. trade or business during a taxable year and if its tax liability for that year is fully satisfied by withholding at source. Treas. Reg. § 1.6012-2(g)(2)(i).  An exception to this exemption applies if the foreign corporation will be seeking a refund for an overpayment of tax.  Treas. Reg. § 1.6012-2(g)(2)(i)(b)(2).

If a required return is filed after the last date prescribed for filing the return, interest generally is paid beginning on the date the return is filed.  I.R.C. § 6611(b)(3).

IRS Chief Counsel’s Analysis

IRS Chief Counsel observed that an apparent disconnect exists between the start dates for interest accrual under section 6611(b)(3) and (d), the exemption (and exception to the exemption) from filing a Form 1120-F under Treasury Regulation § 1.6012-2(g)(2)(i), and the requirement to file a Form 1120-F to obtain a refund for over-withheld amounts under Treas. Reg. § 1.6012-2(g).

Again, section 6611(d) says that for purposes of calculating overpayment interest, amounts withheld under chapter 3 or 4 are considered to have been paid on the last day for filing a return for the relevant taxable year regardless of any exemptions from filing requirements.  One such exemption applies regarding a Form 1120-F for foreign corporations that are not engaged in a U.S. trade or business whose tax liability is fully satisfied by such withholding and that are not seeking a refund.  Treasury Regulation § 1.6012-2(g)(2)(i). Section 6611(b)(3) says that overpayment interest begins to accrue on the date a late-filed returns is actually filed.

All of which raises the question—would a Form 1120-F that a foreign corporation files to obtain a refund after the last date prescribed for a filing a Form 1120-F be considered late for purposes of determining when interest begins to accrue?

According to IRS Chief Counsel, the answer is yes, at least if the foreign corporation knows as of the prescribed date for filing a Form 1120-F that amounts withheld during the taxable year exceeded its tax liability for that year.

As support for this position, IRS Chief Counsel leans heavily on the decision from the U.S. Court of Federal Claims in Overseas Thread Industries, Ltd. v. U.S., 48 Fed. Cl. 221 (2000).  This case involved a similar fact pattern.  The Court found that if a taxpayer “knows that its full withholding, at the time it occurs, will result in the overpayment for which it will seek a refund, then the taxpayer would be required to file an income tax return for that taxable year.”  But “if the foreign corporation meets the exceptional circumstances and does not file an income tax return for that taxable year, but later discovers the existence of an overpayment after the close of the applicable income tax return filing period, the foreign corporation would be required to file a return to claim the refund. . ..  Yet, this return should not be considered to be a late-filed income tax return because at the time the income tax return would have been due, the foreign corporation qualified for the filing exception.”  The Court thus appeared to distinguish between a foreign corporation that knew it had made an overpayment at the time prescribed for filing a Form 1120-F (in which case, any return filed after that date would be considered late) and a foreign corporation that discovered the overpayment only after that date (in which case, any return filed after that date would not be considered late).

IRS Chief Counsel applied this reasoning to the facts presented, observing that it was unclear when Corporation X knew that its withholding would result in an overpayment.  If Corporation X knew about it on or before June 15th, then it was required to file a return by that date, and if it filed the return by that date, then section 6611(b)(3) would not apply.  On the other hand, if Corporation X discovered that its withholding resulted in an overpayment after that date, then interest would begin to accrue as of June 15th regardless of whether it had filed a Form 1120-F by that date.

Observations

Regardless of whether it is correct, CCA 202144027 shines a light on the confusion that can arise at the intersection between international withholding and refund procedures.  It also illustrates the importance of proper documentation and record-keeping.  Because it is apparently the IRS’s position that the point at which a foreign corporation knows that its withholding results in an overpayment dictates whether a Form 1120-F filed to obtain a refund is timely, it is important for taxpayers potentially in this position to document precisely when the overpayment was discovered.

 

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