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Better systems for foreign tax credit substantiation
Foreign tax credits (FTCs) aim to alleviate double taxation by providing a dollar-for-dollar reduction of US tax liability. Taxand USA asks if your company is doing everything necessary to substantiate FTCs and maintain readiness for IRS audit.
The IRS requires that all receipts of foreign taxes be provided upon request for substantiation. Many companies however lack the operational functions or tools to manage this requirement. The result is poor or nonexistent record-keeping which can create a significant hidden tax liability when the IRS audits FTCs.
Receipt compliance gets very complicated very fast. In a best-case scenario a corporation is paying foreign income taxes directly to a foreign taxing authority and there is a system in place to collect and retain all returns and receipts of payment. At the outset of an IRS audit the receipts are either immediately available in a local file-drive or readily available at a foreign subsidiary.
As this is not always the case and the solution is to build a system for record keeping. This should align tax, finance and business goals to create a system of sustainable record-keeping. An ideal system will leverage your current accounting system. At a minimum building a substantiation system requires the following steps:
- review Form 1118 and supporting workpapers to analyze your current FTC position
- review supporting documentation currently on hand
- review and program your accounting systems to track foreign taxes accrued and paid
- develop a methodology and implement required new protocols and safety measures for taxes paid
- coordinate with foreign subsidiaries and withholding agents to obtain the appropriate documentation for both current and future FTCs
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Every company’s situation is different. To succeed you will need to build a custom tailored collection system that addresses your business’s specific challenges and risks. The system will need to align the goals of various groups with the goals of the tax group ultimately responsible for proper substantiation. The system should be scalable and user-friendly for all groups involved.