Bloomberg Tax
Sept. 2, 2021, 8:01 AM

Foreign Tax Credit Proposed Jurisdictional Nexus Requirement: An International Tax Perspective

Nathalie Nguyen
Nathalie Nguyen
University of Florida

On Nov. 12, 2020, the IRS and Treasury released proposed regulations relating to the foreign tax credit, introducing under existing Treasury Regulation Section 1.901-2(c) a new jurisdictional nexus requirement (Proposed Treas. Reg. Section 1.901-2, 85 FR 72078). This new requirement has been criticized by numerous business groups and law firms, arguing it could lead to double taxation.

The measure has been proposed to respond to the proliferation of new unilateral taxes adopted by countries diverging from traditional taxing rules, such as digital services taxes. It explicitly targets rules such as consumer-based nexus of digital services taxes.

The jurisdictional nexus requirement would be added to the definition of an income tax under tax code Section 901. The proposed rule would require, for tax code Sections 901 and 903, that the foreign tax law provides a sufficient nexus between the foreign country and the taxpayer’s activities or investment in the foreign country giving rise to the taxable income for the foreign tax to be creditable against U.S. tax.

From an international tax perspective, the proposed jurisdiction nexus requirement is inconsistent with foreign tax credit principles and prejudicial to current discussions on the taxation of digital services.


History of Section 901
Existing Sections 901 and 903 allow a credit for income tax and taxes in lieu of income tax paid or accrued to any foreign country.

Under an original reading of Section 901, Congress did not require a jurisdictional nexus requirement for a foreign tax to be creditable. Current Section 901 provides that credit is allowed for any “income, war profits, and excess profits taxes paid or accrued during the taxable year to any foreign country or any possession of the United States.” Section 903 includes taxes paid “in lieu of an income tax” within the meaning of Section 901 income tax.

Congress enacted several modifications to the foreign tax credit regime. Among the most significant changes, Congress introduced in 1921 a first “overall limitation” limiting the creditability of the foreign tax to U.S. tax on foreign source income. In 1986, Congress modified the foreign tax credit limitations by requiring the foreign tax credit to be computed into different categories of income (baskets) (see article). Historically, Congress never provided a jurisdictional nexus requirement, limitations on the foreign tax creditability against U.S. tax being limited to source and amount considerations.

Principle of the Jurisdictional Nexus Requirement
The jurisdictional nexus requirement is intended to limit tax credit for these types of foreign taxes by excluding them from the income tax definition. Prop. Treas. Reg. Section 1.901-2 imposes the foreign tax to be consistent with current U.S. tax rules to be creditable. For a foreign tax to qualify as an income tax, “the tax must conform with established international norms, reflected in the Internal Revenue Code and related guidance, for allocating profit between associated enterprises, for allocating business profits of non-residents to a taxable presence in the foreign country, and for taxing cross-border income based on source or the situs of property (together, the ‘jurisdictional nexus requirement’)”.

For non-residents of the foreign country, the income subject to the foreign tax must satisfy a different nexus depending on the type of income. The first nexus is an income attribution based on activities nexus. The second nexus is based on the source of income, and the third nexus is based on the situs of property. The proposal expressly excludes any nexus that would be based on the location of customers, service recipients, or any destination-based criteria (Prop. Treas. Reg. Section 1.901-2).

Nexus Requirement Inconsistent With Avoidance of Double Taxation

When enacting the foreign tax credit, it was suggested that Congress sought to reduce double taxation and to promote U.S. business competitiveness (see article). Tax code Section 901 provides a tax credit for any income tax paid or accrued to any foreign country. The purpose of the foreign tax credit is to reduce double taxation. See American Chicle Co. v. United States.

Considering the original purpose of the tax credit is to provide relief for U.S. taxpayers with business in foreign countries, the Treasury’s intention to restrict the creditability of the foreign tax might seems unjustified from a policy perspective.

From a treaty perspective, Article 23 of the U.S. model income tax treaty provides relief from double taxation in the form of a tax credit against the U.S. for income tax paid or accrued in the other contracting state. However, the provision limits the tax credit available under U.S. law. Here, it must be determined whether a jurisdictional nexus requirement, limiting the availability of the tax credit, would change the general principle set by Section 901 as enacted by Congress and, if so, be contrary to the relief from double taxation offered by the U.S. model treaty.

Article 23B of the OECD model treaty grants a credit of tax paid on the income or capital, if the treaty provides the taxation of such income. One issue may arise in determining whether the unilateral taxes referred to in the proposed regulations are taxes in the sense of the convention. Since the OECD commentaries on the article recommend granting double taxation relief nonetheless qualification issues, the Treasury proposition to limit the creditability of specific foreign taxes in response to the recent taxes adopted may seem inadequate.

Issues Regarding Current Discussion on Taxation of Digital Economy

The proposed jurisdictional nexus requirement aims to dissuade the adoption of unilateral taxes such as digital services taxes. In contrast, proposals on the taxation of the digital economy are currently examined at the international level within the OECD under Pillar 1 and Pillar 2 and within the U.N.

OECD Pillar 1 intends to rewrite rules on nexus and allocation of profit of large multinational enterprises (MNEs) by taking into account new business models and expand the taxing rights of market jurisdictions (which, for some business models, is based on the location of the user).

According to an OECD Statement, “in a digital age, the allocation of taxing rights and taxable profits can no longer be exclusively circumscribed by reference to physical presence.” Therefore, a jurisdictional nexus requirement that would mainly rely on traditional physical activity and source nexus would be no longer solely relevant when considering new business models and go against the current efforts to address the taxation of the digital economy.

OECD Pillar 2 proposes to ensure that international businesses pay a minimum amount of tax regardless of their place of incorporation or where they operate. The U.S. has also pushed the idea of a global minimum tax. Pillar 2 proposals differ in that they are based on a revenue threshold and on an effective minimum tax rate to be determined. In the event Pillar 2’s proposals are adopted, those tax inclusions could lead to double taxation and, if so, raise the question of their creditability.

In contrast with current OECD discussions, the U.N. recently approved in April 2021 a new Article 12B for the U.N. model tax convention on the income from automated digital services that would allow a withholding tax for the state of source on the gross payments for automated digital services. Such a proposal would deviate from traditional international taxation rules. If countries implemented such withholding tax on income from automated digital services, it would have to be determined if, in the same way, it would be creditable under a jurisdictional nexus rule.


The proposed jurisdictional nexus requirement in Prop. Treas. Reg. Section 1.901-2 aims to limit the creditability of certain foreign taxes against the U.S. tax as a response to the proliferation of unilateral taxes, such as digital services taxes, adopted by several countries.

A jurisdictional nexus requirement limiting the creditability of a foreign tax might not dissuade the adoption of novel taxes and result more in harming U.S. taxpayers with business in foreign countries as it could raise several double taxation issues. It also does not anticipate current proposals on taxation of the digital economy and their future implications. As it stands today, this jurisdictional nexus requirement is fundamentally opposed to the very principle of the foreign tax credit’s original intent: the reduction of double taxation.

This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.

Author Information

Nathalie Nguyen ( is a student at the University of Florida Levin College of Law.

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