[Code of Federal Regulations]
[Title 26, Volume 9]
[Revised as of April 1, 2002]
From the U.S. Government Printing Office via GPO Access
[CITE: 26CFR1.903-1]

[Page 633-635]
 
                       TITLE 26--INTERNAL REVENUE
 
    CHAPTER I--INTERNAL REVENUE SERVICE, DEPARTMENT OF THE TREASURY 
                               (CONTINUED)
 
PART 1--INCOME TAXES--Table of Contents
 
Sec. 1.903-1  Taxes in lieu of income taxes.

    (a) In general. Section 903 provides that the term ``income, war 
profits, and excess profits taxes'' shall include a tax paid in lieu of 
a tax on income, war profits, or excess profits (``income tax'') 
otherwise generally imposed by any foreign country. For purposes of this 
section and Secs. [hairsp][hairsp]1.901-2 and 1.901-2A, such a tax is 
referred to as a ``tax in lieu of an income tax''; and the terms 
``paid'' and ``foreign country'' are defined in 
Sec. [hairsp][hairsp]1.901-2(g). A foreign levy (within the meaning of 
Sec. 1.901-2(g)(3)) is a tax in lieu of an income tax if and only if--
    (1) It is a tax within the meaning of Sec. 1.901-2(a)(2); and
    (2) It meets the substitution requirement as set forth in paragraph 
(b) of this section.

The foreign country's purpose in imposing the foreign tax (e.g., whether 
it imposes the foreign tax because of administrative difficulty in 
determining the base of the income tax otherwise generally imposed) is 
immaterial. It is also immaterial whether the base of the foreign tax 
bears any relation to realized net income. The base of the tax may, for 
example, be gross income, gross receipts or sales, or the number of 
units produced or exported. Determinations of the amount of a tax in 
lieu of an income tax that is paid by a person and determinations of the 
person by whom such tax is paid are made under Sec. 1.901-2 (e) and (f), 
respectively, substituting the phrase ``tax in lieu of an income tax'' 
for the phrase ``income tax'' wherever the latter appears in those 
sections. Section 1.901-2A contains additional rules applicable to dual 
capacity taxpayers (as defined in Sec. 1.901-2(a)(2)(ii) (A)). The rules 
of this section are applied independently to each separate levy (within 
the meaning of Secs. 1.901-2(d) and 1.901-2A (a)) imposed by the foreign 
country. Except as otherwise provided in paragraph (b)(2) of this 
section, a foreign tax either is or is not a tax in lieu of an income 
tax in its entirety for all persons subject to the tax.
    (b) Substitution--(1) In general. A foreign tax satisfies the 
substitution requirement if the tax in fact operates as a tax imposed in 
substitution for, and not in addition to, an income tax or a series of 
income taxes otherwise generally imposed. However, not all income 
derived by persons subject to the foreign tax need be exempt from the 
income tax. If, for example, a taxpayer is subject to a generally 
imposed income tax except that, pursuant to an agreement with the 
foreign country, the taxpayer's income from insurance is subject to a 
gross receipts tax and not to the income tax, then the gross receipts 
tax meets the substitution requirement notwithstanding the fact that the 
taxpayer's income from other activities, such as the operation of a 
hotel, is subject to the generally imposed income tax. A comparison 
between the tax burden of this insurance gross receipts tax and the tax 
burden that would have obtained under the generally imposed income tax 
is irrelevant to this determination.

[[Page 634]]

    (2) Soak-up taxes. A foreign tax satisfies the substitution 
requirement only to the extent that liability for the foreign tax is not 
dependent (by its terms or otherwise) on the availability of a credit 
for the foreign tax against income tax liability to another country. If, 
without regard to this paragraph (b)(2), a foreign tax satisfies the 
requirement of paragraph (b)(1) of this section (including for this 
purpose any foreign tax that both satisfies such requirement and also is 
an income tax within the meaning of Sec. 1.901-2(a)(1)), liability for 
the foreign tax is dependent on the availability of a credit for the 
foreign tax against income tax liability to another country only to the 
extent of the lesser of--
    (i) The amount of foreign tax that would not be imposed on the 
taxpayer but for the availability of such a credit to the taxpayer 
(within the meaning of Sec. 1.901-2(c)), or
    (ii) The amount, if any, by which the foreign tax paid by the 
taxpayer exceeds the amount of foreign income tax that would have been 
paid by the taxpayer if it had instead been subject to the generally 
imposed income tax of the foreign country.
    (3) Examples. The provisions of this paragraph (b) may be 
illustrated by the following examples:

    Example 1. Country X has a tax on realized net income that is 
generally imposed except that nonresidents are not subject to that tax. 
Nonresidents are subject to a gross income tax on income from country X 
that is not attributable to a trade or business carried on in country X. 
The gross income tax imposed on nonresidents satisfies the substitution 
requirement set forth in this paragraph (b). See also examples 1 and 2 
of Sec. 1.901-2(b)(4)(iv).
    Example 2. The facts are the same as in example 1, with the 
additional fact that payors located in country X are required by country 
X law to withhold the gross income tax from payments they make to 
nonresidents, and to remit such withheld tax to the government of 
country X. The result is the same as in example 1.
    Example 3. The facts are the same as in example 2, with the 
additional fact that the gross income tax on nonresidents applies to 
payments for technical services performed by them outside of country X. 
The result is the same as in example 2.
    Example 4. Country X has a tax that is generally imposed on the 
realized net income of nonresident corporations that is attributable to 
a trade or business carried on in country X. The tax applies to all 
nonresident corporations that engage in business in country X except for 
such corporations that engage in contracting activities, each of which 
is instead subject to two different taxes. The taxes applicable to 
nonresident corporations that engage in contracting activities satisfy 
the substitution requirement set forth in this paragraph (b).
    Example 5. Country X imposes both an excise tax and an income tax. 
The excise tax, which is payable independently of the income tax,is 
allowed as a credit against the income tax. For 1984 A has a tentative 
income tax liability of 100u (units of country X currency) but is 
allowed a credit for 30u of excise tax that it has paid. Pursuant to 
paragraph (e)(4)(i) of Sec. 1.901-2, the amount of excise tax A has paid 
to country X is 30u and the amount of income tax A has paid to country X 
is 70u. The excise tax paid by A does not satisfy the substitution 
requirement set forth in this paragraph (b) because the excise tax is 
imposed on A in addition to, and not in substitution for, the generally 
imposed income tax.
    Example 6. Pursuant to a contract with country X, A, a domestic 
corporation engaged in manufacturing activities in country X, must pay 
tax to country X equal to the greater of (i) 5u (units of country X 
currency) per item produced, or (ii) the maximum amount creditable by A 
against its U.S. income tax liability for that year with respect to 
income from its country X operations. Also pursuant to the contract, A 
is exempted from country X's otherwise generally imposed income tax. A 
produces 16 items in 1984 and the maximum amount creditable by A against 
its U.S. income tax liability for 1984 is 125u. If A had been subject to 
country X's otherwise generally imposed income tax it would have paid a 
tax of 150u. Pursuant to paragraph (b)(2) of this section, the amount of 
tax paid by A that is dependent on the availability of a credit against 
income tax of another country is 0 (lesser of (i) 45u, the amount that 
would not be imposed but for the availability of a credit (125u-80u), or 
(ii) 0, the amount by which the contractual tax (125u) exceeds the 
generally imposed income tax (150u)).
    Example 7. The facts are the same as in example 6 except that, of 
the 150u A would have paid if it had been subject to the otherwise 
generally imposed income tax, 60u is dependent on the availability of a 
credit against income tax of another country. The amount of tax actually 
paid by A (i.e., 125u) that is dependent on the availability of a credit 
against income tax of another country is 35u (lesser of (i) 45u, 
computed as in example , Sec. 6, or (ii) 35u, the amount by which the 
contractual tax (125u) exceeds the amount A would have paid as income 
tax if it had been

[[Page 635]]

subject to the otherwise generally imposed income tax (90u, i.e., 150u-
60u).

    (c) Effective date. The effective date of this section is as 
provided in Sec. 1.901-2(h).

[T.D. 7918, 48 FR 46295, Oct. 12, 1983; 48 FR 52033, Nov. 16, 1983]