Edward Tanenbaum		Kevin Rowe

Under the mutual agreement provision of the United States-United Kingdom Income Tax Treaty, (the Treaty,) the US and the UK competent authorities have agreed to alleviate potential double taxation under the dual consolidated loss (DCL) regimes of both countries. This is the first bilateral agreement under section 1.1503-2(g)(1) of the regulations.

Use of losses

Under code section 1503(d), a DCL is a net operating loss (determined under US law) of a US corporation (a DRC) that is subject to income tax both in the US as well as in a foreign country on a residence basis, or on its income without regard to the source of its income. A DRC cannot use a DCL to reduce taxable income of any other member of its affiliated group although it is permitted to use the DCL to offset its own income from other sources.

A separate unit of a US corporation, including a permanent establishment (PE), as well as an LLC or partnership interest, is treated as a separate US corporation that is a DRC for purposes of the DCL regime whether or not it is taxed by the foreign country on its worldwide income. Consequently, any net operating loss of a separate unit cannot be used to offset other income of the US corporation that owns the separate unit but it can be used to offset other income of the separate unit.

The (g)(2) agreement

Under section 1.1503-2(g)(2)(i) of the regulations, the taxpayer may use a DCL against income of domestic affiliates provided it enters into an agreement (a (g)(2) agreement) to the effect that the taxpayer will not use the DCL under foreign income tax law to offset income of any foreign affiliate. The (g)(2) agreement requires the taxpayer to certify each year for the 15 years following the year in which the DCL was incurred that no portion of the DCL has been or will be used under the laws of a foreign country to offset income of any other person. If any part of the DCL is used to offset income of a foreign affiliate or made available for such use, or if other triggering events (including certain dispositions of the DCR or its assets) occur within the 15 year period, the US taxpayer must take into gross income an amount equal to the entire DCL plus interest.

Mirror legislation

Under the mirror legislation rule, a DRC is not permitted to use a DCL to offset income of domestic affiliates if a foreign jurisdiction has a regime that operates in a manner that is similar to the US DCL regime. More specifically, the rule provides that if foreign law bars use of a DCL against income of affiliates, then for purposes of the US DCL regime, the DRC is treated as if it used the DCL to offset income of a foreign affiliate. Consequently, the DCL is ineligible for a (g)(2) agreement and use of the loss in the US against income of an affiliate is barred. The mirror legislation rule is intended to prevent foreign countries from pushing DCLs into the US.

The United Kingdom generally allows its resident corporations to deduct losses realised in a PE except where the loss realised by the PE can be deducted against income that is not subject to the UK corporate income tax. In determining whether a PE loss can be utilised outside the UK, the UK disregards any rule in a foreign jurisdiction that limits the use of the loss derived by the PE. The US DCL regime is such a rule and, as a result, the PE loss cannot be utilised against the UK income.

The US-UK income tax treaty and the modified (g)(2) agreement

Generally speaking, if a DRC realises a DCL in the UK, it cannot use the DCL to offset income of affiliates in either country because of the interaction of the US and UK mirror legislation rules. Pursuant to the mutual agreement procedure in the Treaty, the US and the UK competent authorities have agreed to a procedure that allows taxpayers to elect to use certain DCLs that arise in a PE in one or the other country (the "Agreement").

The Agreement applies to a US company with a PE in the UK that has realised losses in UK accounting periods ending after April 1 2000. It applies only to a DCL of a US company that is attributable to a PE. It does not apply to a DCL of a US company that is a resident of the UK on account of being managed and controlled there (this rule does not treat a separate unit as a DRC). The Agreement is also inapplicable to a DCL realised by a hybrid entity (an entity taxed as a partnership in the US and as a corporation in the UK), or a separate unit owned through a hybrid entity.

Under the Agreement, a US company may make a section (g)(1) election to use a DCL either against income of affiliates in the US or the UK, but not both. If the US company opts to use the loss in the US it must enter a modified (g)(2) agreement, which is essentially the same as the regular (g)(2) (including the 15 year certification requirement). The modified (g)(2) agreement requires the taxpayer to notify both UK and US competent authorities if a triggering event occurs.

In general, a US company makes the election on its income tax return for the year in which the DCL was incurred. It may make the election for any open year for which the return is due on or before January 4 2007, (including extensions) by filing an amended federal income tax return for that year. The election is unavailable for a DCL incurred in a taxable year for which the statute of limitations for assessment of additional income tax has expired.

Sam Kaywood,(Sam.kaywood@alston.com), Atlanta
Kevin Rowe (kevin.rowe@alston.com), and
Edward Tanenbaum (edward.tanenbaum@alston.com), New York