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Finally, respondent alleges that petitioners’ improper
attempts to manipulate the Internal Revenue Code, inconsistent
reporting and statements, and failure to review their returns
render them liable for the section 6662(a) accuracy-related
penalty.
II. Proper Tax Treatment of Payments
A. General Rules
1. Foreign Taxes and Sources of Income
Payment of taxes to a foreign Government may give rise to
either a deduction or a credit. See secs. 164, 901. Section
164(a)(3) provides that a deduction is allowed for foreign income
taxes. In lieu of this deduction, section 901(a) and (b)(1)
permits a taxpayer to elect a credit for foreign income taxes
which meet the requirements set forth in the statute and the
regulations promulgated thereunder. Section 904(a), however,
places the following limitation on the amount of the foreign tax
credit:
The total amount of the credit taken under section
901(a) shall not exceed the same proportion of the tax
against which such credit is taken which the taxpayer’s
taxable income from sources without the United States
(but not in excess of the taxpayer’s entire taxable
income) bears to his entire taxable income for the same
taxable year.
To determine the source of income, reference must be made to
the source rules enumerated in sections 861 and 862. Section
861(a)(2)(A) and (3) states that, in general, dividends from a
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