United States Tax: Ways & Means Releases Extenders Bill
The Bill includes 10 additional international tax provisions, some of which would fundamentally reform our current foreign tax credit (FTC) rules. Many of these new provisions are proposed to be effective as of May 21 2010; these provisions, however, may restrict the use of credits attributable to a post-effective date distribution of prior years' earnings. The international tax revenue raisers are estimated to raise over $15 billion over 10 years.
We understand that Congress continues to work toward passing the Bill prior to the Memorial Day recess. The House is expected to take up the Bill early next week. The Senate is expected to do so quickly thereafter, following House passage. We understand that the Joint Committee on Taxation will release a technical explanation of the Bill next week. The contents of the Bill could be subject to further revision.
Over the coming days we will continue to provide updates as information becomes available. A more detailed discussion of each of the Bill's international tax provisions follows.
I. Extenders
For calendar year-end foreign corporations, the expiring subpart F provisions lapsed on December 31, 2009. The Bill provides an extension of both provisions for an additional taxable year.
II. International Revenue Raising Proposals
FTC Modifications
Denial of foreign tax credits related to asset basis step-up transactions
The Bill would change the foreign tax credit rules for "covered asset acquisitions" after May 20, 2010, if the transferor and transferee are related (within the meaning of §267(b) or 707(b)), or after the date of enactment in any other case (unless pursuant to a contract binding on May 20, 2010, and at all times thereafter, or described in a ruling request submitted to the Internal Revenue Service (IRS), or a public announcement or filing with the Securities and Exchange Commission (SEC) made before that date).
Covered asset acquisitions include:
- Qualified stock purchase to which §338(a) applies;
- Acquisitions of hybrid entities;
- Acquisitions that are disregarded for foreign tax purposes;
- Acquisitions of partnership interests where the partnership has a §754 election in effect; and
- Any other similar transaction to the extent provided by the Treasury Secretary.
These are generally cases in which a transaction is treated differently for U.S. and foreign tax purposes - as an asset acquisition for U.S. tax purposes and as a stock acquisition for foreign tax purposes.
Under the provision, a covered asset acquisition (CAA) would give rise to a "disqualified portion" of any foreign income tax with respect to the income or gain attributable to the relevant foreign assets. This disqualified portion would be non-creditable.
The disqualified portion of the tax is generally computed as the ratio of (1) the aggregate step up in tax basis allocable to a tax year to (2) the foreign taxable income on which the foreign tax is determined. This provision is estimated to raise $4.03 billion over 10 years.
Separate application of FTC limitation to items resourced under tax treaties
Similar to the approach of §904(h)(10), which applies a separate foreign tax credit limitation "basket" to income of a foreign corporation that is U.S. source under internal U.S. law, but is sourced foreign under a treaty resourcing rule, the Bill would impose a separate foreign tax credit limitation "basket" on income that is U.S. source under internal U.S. law, is sourced foreign under a treaty source rule and is earned by a U.S. taxpayer through a branch or a disregarded entity. The provision would be effective for taxable years beginning after date of enactment.
The provision is estimated to raise $253 million over 10 years.
Denial of use of §956 "hopscotch" rule for foreign tax credit purposes
In the case of a U.S. corporation that owns multiple tiers of controlled foreign corporations, the Bill would limit the amount of foreign taxes deemed paid with respect to a §951(a)(1)(B) income inclusion from a lower-tier CFC attributable to acquisitions of U.S. property (within the meaning of §956(c)) by the CFC after May 20, 2010.
The limit would be the amount that would have been deemed paid if there had been actual cash distributions equal to the §951(a)(1)(B) inclusion up the chain from the controlled foreign corporation to the U.S. shareholder. Under the "pooling" regime for deemed paid foreign tax credits, the effect of an actual dividend is to "blend" the pools of the dividend payor controlled foreign corporation and dividend recipient CFC, and thus the proposal could significantly reduce the deemed paid taxes otherwise available under present law on an unblended §956 income inclusion directly from the lower-tier CFC.
The provision is estimated to raise slightly more than $1 billion over 10 years.
Modifications to the interest allocation rules concerning U.S. activities conducted by foreign subsidiaries
For purposes of computing the foreign tax credit limitation, foreign source taxable income is determined by allocating and apportioning interest expense of each member of an affiliated group as if all members of such group (generally, domestic corporations) were a single corporation. Existing regulations contain rules that expand the term "affiliated group" for this purpose to include any foreign corporation if its stock is owned at least 80% (by vote or value) by members of the affiliated group, and more than 50% of its gross income is "effectively connected income" (ECI). The regulations apply special limitations if less than 80% of such foreign corporation's gross income is ECI.
Effective for taxable years beginning after the date of enactment, the Bill would codify the treatment of an 80%-owned foreign corporation with at least 50% ECI as an affiliated group member, but without reference to the limitations now in the regulations. Presumably, this amendment is intended to provide additional authority supporting future modification of the interest allocation regulations.
The provision is estimated to raise $405 million over 10 years.
Prevent splitting foreign taxes from foreign income
Generally effective for foreign income taxes paid or accrued after May 20, 2010 (see below for further effective date details), the Bill would add a new §909 to the Code.
Section 909 would suspend the taking of a foreign income tax into account for purposes of the Code if there is a "foreign tax credit splitting event" (FTCSE) with respect to a foreign income tax paid or accrued by a taxpayer. The suspension for any portion of such tax would last until the taxable year in which "the related income" (i.e. the income to which the portion of the foreign income tax relates) is taken into account by the taxpayer under the income tax provisions of the Code. In the latter taxable year, the suspended foreign income tax is taken into account as a foreign income tax paid or accrued in such year.
There is an FTCSE with respect to a foreign income tax if the related income is (or will be) taken into account under the income tax provisions of the Code by a "covered person." With respect to any person who pays or accrues a foreign income tax, a covered person is any entity in which the payor holds, directly or indirectly, at least a 10% ownership interest (by vote or value); any person that holds, directly or indirectly, at least a 10% ownership interest (by vote or value) in the payor; any person that bears a relationship to the payor described in §267(b) or §707(b); and any other person specified by the Treasury Secretary.
Under a separate suspension rule for taxes paid or accrued by §902 corporations, an FTCSE suspends the taking of the tax into account for purposes of §§902, 960 and 964(a) (determination of earnings and profits) until the taxable year in which the related income is taken into account under the income tax provisions of the Code by the §902 corporation or by a domestic corporation meeting the 10% ownership requirements of §902(a) or (b) with respect to the §902 corporation. In the case of a partnership, §909 is applied at the partner level.
Treasury is authorized to provide such guidance as is necessary or appropriate to carry out the purpose of §909, including exceptions and guidance for the proper application of §909 with respect to hybrid instruments.
The provision would apply to foreign income taxes paid or accrued after May 20, 2010 (e.g. regular foreign corporate income taxes with respect a foreign taxable year ending after May 20, 2010), and foreign income taxes paid or accrued by a §902 corporation on or before May 20, 2010 (and not deemed paid on or before that date), but only for purposes of applying §§902 and 960 with respect to "periods after" May 20, 2010 (e.g. foreign income taxes paid or accrued by a foreign corporation before May 21, 2010, but deemed paid by a U.S. shareholder with
respect to a distribution in a period after May 20, 2010).
The provision is estimated to raise approximately $6 billion over 10 years.
Commentary on FTC provisions: These foreign tax credit proposals would fundamentally alter the taxation of cross-border investments and impede the ability to repatriate prior years' and future earnings to the U.S. affiliated group.
The §956 proposal results in a calculation of the foreign tax credit as if there was a combination of earnings and taxes of foreign subsidiaries in the same chain of ownership. As noted above, the effect of a series of deemed dividends up the chain of ownership is to "blend" the pools of the dividend payor and dividend recipient, and thus could significantly reduce the deemed paid taxes otherwise available under present law on an unblended §956 income inclusion directly from the lower-tier CFC. This provision can result in the double taxation of high taxed foreign income, absent a complete repatriation of the combined earnings and taxes up a chain of companies. Moreover, it is very difficult to determine the amount of foreign tax credits attributable to a 2010 §956 inclusion, where the U.S. property is acquired before and after the date of enactment. Further questions remain regarding allocations of previously taxed income and other §956 attributes.
Moreover, the effective date of the foreign tax credit splitter proposal applies with respect to foreign taxes that were already paid or accrued if they have not yet been brought back to the United States.
This proposal may substantially increase the cost of repatriating prior years' earnings. Moreover, the application of these provisions to preeffective date foreign taxes paid or accrued by controlled foreign corporations will likely have significant financial statement ramifications related to taxes reported on earnings in prior taxable years.
Other Proposals
Restrictions on redemption transactions executed by CFCs indirectly owned by foreign parent corporations
In a stock acquisition after May 20, 2010, described in §304 the Bill would prevent earnings of an acquiring foreign corporation from being deemed distributed as a dividend under §304 if more than half the dividends otherwise triggered by §304 would neither be (a) subject to U.S. income tax for the year in which the dividends arise, or (b) included in the E&P of a controlled foreign corporation.
In the case of a U.S. corporation with a foreign parent and a foreign subsidiary (a CFC), the proposal would prevent the application of §304 in the case of a related party redemption where earnings would be deemed distributed from the CFC to the foreign parent without U.S. taxation.
Under the Bill, such earnings would be preserved for potential U.S. taxation in the hands of the U.S. corporation (if distributed by the CFC), and ultimately, in the hands of the foreign parent via the U.S. withholding tax when repatriated to such foreign parent.
The provision is estimated to raise $255 million over 10 years.
Source rules for guarantee fees
In the recently decided case of Container Corp. v. Commissioner, the IRS argued that guarantee fees received by a foreign parent corporation from a U.S. subsidiary should be sourced like interest, but the Tax Court held that they should be sourced like compensation for services (i.e. based on where the services are performed). Under the Bill, fees for guarantees issued after the date of enactment will be sourced like interest and, as a result, if paid by U.S. taxpayers to foreign persons would generally be U.S. source payments subject to U.S. withholding tax. The summary of the Bill (released Thursday morning) says that no inference is intended with respect to the treatment of guarantees issued before the date of enactment.
The provision is estimated to raise $2.025 billion over 10 years.
Repeal of 80/20 rules
Dividends and interest paid by a domestic corporation or noncorporate resident are generally considered U.S.-source income and are subject to U.S. withholding tax if paid to a foreign person. An exception to these rules applies when at least 80% of the gross income of the domestic corporate or individual resident alien payor during a testing period (generally, the prior three years) was active foreign business income. Interest paid by a corporation meeting this test (an "80/20 company"), or by an individual meeting this test, is at least 80% foreign source. Dividends paid by an 80/20 company are at least 80% exempt from U.S. withholding tax.
The Bill would generally repeal the 80/20 rules for companies, as well as for interest paid by resident alien individuals, generally effective for taxable years beginning after December 31, 2010. However, corporations that were 80/20 companies in their last taxable year beginning before 2011, which meet a new enhanced 80% foreign business requirement with respect to each taxable year after that last pre-2011 year, and with respect to which there has not been an addition of a substantial line of business after the date of enactment of the Bill, will continue to pay dividends and interest at least 80% exempt from withholding tax in the hands of a foreign payee. The interest paid in such a case will no longer be foreign source income, however. Moreover, in applying the 80% foreign business requirements, the corporation and its controlled subsidiaries (determined on a greater-than-50% ownership basis) will be treated as one corporation.
The proposal would grandfather payments of interest on obligations issued before date of enactment, except where payable to a related person. The proposal is estimated to raise $153 million over 10 years.
Of note, the 80/20 repeal proposal in the Bill appears to be significantly narrower than prior versions. For example, the revenue estimate for the President's FY2011 Budget Proposal (as contained in the Greenbook) was approximately $1.15 billion over 10 years, while the version contained in the Small Business and Infrastructure Jobs Tax Act of 2010 (H.R. 4849) was $950 million. One possible alternative to the full repeal of the 80/20 company provisions would be a provision limiting the amount of interest and dividends exempt from U.S. withholding tax to the amount of foreign active business income received by the U.S. corporation during the three-year testing period.
This alternative was first proposed by the Clinton Administration in the Administration's FY2001 Budget and explained in the Department of Treasury General Explanations of the Administration's FY2001 Revenue Proposals.
Elimination of §356(a)(2) "boot within gain" limit to dividends received in reorganizations
Under current law, if a taxpayer exchanges stock in a reorganization where the exchange would be a nonrecognition event except that the exchanging shareholder receives boot (e.g. cash), the transferor may be required to recognize dividend income under §356(a)(2) if the exchange has the effect of the distribution of a dividend. However, the amount of the dividend is currently limited to the amount of gain (if any) in the stock that was exchanged.
The proposal, which was also contained in the President's FY2011 Budget, would repeal this "boot within gain" limitation, generally effective for exchanges after the date of enactment, in the case of any reorganization where the exchange has the effect of the distribution of a dividend. The boot would be treated as a dividend to the extent of the E&P of the corporation. Moreover, in the case of a §368(a)(1)(D) reorganization to which §354(b)(1) applies, the E&P of each corporation that is a party to the reorganization will be taken into account, and the amount that is a dividend, and the source thereof, will be determined under rules similar to the rules of §304(b)(2) and (5). Under a transition rule, the provision would not apply to exchanges between unrelated persons either (a) pursuant to a binding agreement in effect on May 20, 2010, and at all times thereafter, (b) described in a ruling request submitted to the IRS on or before such date, or (c) described in a public announcement or SEC filing on or before such date.
The proposal is estimated to raise $460 million over 10 years.
III. Technical Correction
Reasonable cause exception to §6501(c)(8) statute of limitations provision contained in the HIRE Act The Bill would make a technical correction to the amendment to Code §6501(c)(8) in the Hiring Incentives to Restore Employment (HIRE) Act, to clarify the circumstances under which the statute of limitations will be tolled for tax returns of corporations that fail to provide certain information on cross-border transactions or foreign assets. Under the technical correction, the tolling will apply only to the item or items related to the failure (and not to the entire tax return) if such failure is due to reasonable cause and not willful neglect. The proposal is effective as if it was passed as part of the HIRE Act (effective for returns for which the assessment statute of limitations is open after March 18, 2010).
The proposal is estimated to not have any revenue effect over 10 years.
TAX NEWS - may 2010
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