More often that I would like to admit when reviewing developments for the update to Saltzman and Book IRS Practice & Procedure I come across an issue that I had not thought about at all. In this round, with my colleague Marilyn Ames taking the lead we have been working on discussing a number of challenging and technical issues relating to interest, the subject of an entire chapter in the treatise. One issue that jumped out at me was an IRS legal memo’s discussion of when interest on an overpayment accrues when a foreign corporation may have no obligation to file a US income tax return but eventually does so to claim a refund relating to withholding taxes. The issue centers on whether interest accrues from the due date of the return or the later date when the corporation filed a processable return. The legal memo focuses on whether the taxpayer knew it was entitled to a refund on the due date of the return and hence had to file a return to alert the IRS of the corporation’s claimed overpayment.
As with almost all interest issues, the matter is a bit technical so I will review the applicable provisions and briefly discuss the memo’s analysis.
The facts in question in the legal memo involved the foreign corporation filing a tax return claiming a refund of the withheld tax after the due date of the 1120-F, the income tax return for foreign corporations. The corporation was not engaged in a US trade or business.
Generally under Section 6611 interest is paid on any overpayment of tax from the date of overpayment to a date that precedes the refund date by not more than 30 days. Withholding taxes are generally deemed as being paid on the due date of the return. Section 6611(b)(3) provides an exception to the general rule that interest accrues from the date of overpayment and provides when a return is filed after its due date “no interest shall be allowed or paid for any day before the date on which the return is filed.”
Regulation Section 1.6012-2(g) provides that a foreign corporation that is not engaged in a US trade or business is not required to file a return if its tax liability for the taxable year is fully satisfied by withholding. But the regulations also provide that if that foreign corporation believes it has overpaid its tax, it must file a return claiming the overpayment.
Is a return considered filed after the due date for interest purposes if the foreign corporate taxpayer did not have an obligation to file the return but for the claimed overpayment attributable to excess withholding?
The legal memo discusses a few cases that considered the issue, including Overseas Thread Industries (OTI), 48 Fed. Cl. 221, 230 (2000). In discussing Overseas Thread the memo notes that the “Court of Federal Claims reasoned that the proper interpretation of § 1.6012-2(g) is that the foreign corporation must file a return when claiming a refund, but that the return will not be considered late for purposes of section 6611(b)(3) if the foreign corporation did not know that it was owed a refund when the return was due.”
In applying that standard to the facts in the memo, the memo notes that it was unclear when the foreign corporation knew that the withholding would result in an overpayment of its US tax. If the taxpayer knew that the withholding exceeded its tax due before the due date (plus extension) then interest would accrue only upon the later filing of a processable return. If the taxpayer did not know that it was entitled to a refund of excess withholding at or before the due date, then the interest would accrue from the earlier due date.
While the difference between the due date and the date of actual filing might not be that long of a time, when the dollars are large enough the difference may be meaningful. There are some lurking issues, including what kind of proof will the IRS be looking for in evaluating when the interest begins to accrue.
The knowledge standard raises significant challenges for tax administrators who may not be able to determine that knowledge on the face of a return. Also lurking if the parties disagree is the jurisdictional basis for standalone interest overpayment suits, an issue we and guest poster Bob Probasco have discussed many time in the context of the Pfizer case (see for example Pfizer Again – On to the Substantive Issue).
For what it is worth, I would prefer that the law reflect a bright line rule going in either direction. The approach reflected in the memo at least allows some compensation to taxpayers for the government’s use of the money, and also provides some incentive for non-US taxpayers to timely file returns. It does, however, open the door to disputes and suggests that non US corporate taxpayers engaged in a trade or business may wish to state when they knew that they had overpaid their US tax obligation.