U.S. taxpayers pay taxes on all of their income, regardless of where it is earned. Congress has recognized that this basic principle of the Internal Revenue Code may result in “double taxation” of income earned outside the United States. Thus, the Code provides a foreign tax credit, which equalizes the tax burden by “treat[ing] the taxes imposed by the foreign country as if they were imposed by the United States,”1 and providing a dollar-for-dollar credit on the taxpayer’s U.S. liabilities.
While the foreign tax credit regime seeks to eliminate the perceived unfairness of taxing income that was previously taxed by another country, as commerce has become increasingly international and complex, the Internal Revenue Service has become concerned that the foreign tax credit’s laudable goals are subject to abuse by sophisticated corporations engaging in transactions designed to create a tax arbitrage. In recent years, taxpayer claims for foreign tax credits have faced increasing government scrutiny,2 and the IRS has challenged several such claims under the common law “economic substance” doctrine.
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