TAX NEWS - FEBRuary 2010
U.S. Treasury Department releases Greenbook
The following provides a short summary of the new international tax proposals in the FY2011 Budget and highlights changes to the international tax proposals in the FY2010 Budget. Except as otherwise noted, all proposed changes would be effective for taxable years beginning after 31 December 2010.
Transfers of intangible property
Proposal - The definition of subpart F income would be expanded to include "excess returns" from the transfer by a U.S. person to a related controlled foreign corporation (CFC) of intangibles in certain circumstances. The proposal would apply if the transferee CFC is subject to a low foreign effective tax rate. In addition, any such income would be placed in a separate foreign tax credit limitation basket. The proposal raises $15.5 billion over 10 years.
Observation - The proposal could be interpreted as a possible legislative response to the government's loss in the Veritas case. However, the exact scope of the proposal is unclear. For example, does the provision apply only to cost sharing arrangements, sales of intellectual property, and transfers of intangibles described in §367(d), or is the provision so broad as to cover routine licenses of intellectual property? How does one determine if a CFC is subject to a low effective tax rate? How is an excess return determined? According to reports, Administration officials have said they would regard a CFC as low-taxed if it pays an effective tax rate of less than 10percent and that a rate of return is excessive if it exceeds 30 percent.
Deductibility of reinsurance premiums
Proposal - U.S. insurance companies would be denied a deduction for reinsurance premiums paid to affiliated foreign reinsurance companies with respect to U.S. risks insured by the insurance company or its U.S. affiliates to the extent: (1) the foreign reinsurers are not subject to U.S. income tax with respect to premiums received and (2) the amount of reinsurance premiums (net of ceding commissions) paid to foreign reinsurers exceeds 50 percent of the total direct insurance premiums received by the U.S. insurance company and its U.S. affiliates for a line of business. Alternatively, a foreign corporation that is paid a premium from an affiliate that would otherwise be denied a deduction under this provision may elect to treat those premiums and the associated investment income as income effectively connected with the conduct of a trade or business in the U.S. The proposal raises $0.5 billion over 10 years.
Observations - The 50 percent threshold for application of the limitation in the proposal is a change from the original proposal made by Rep. Neal, which focused on the amount of unrelated party reinsurance purchased by line of business by U.S. insurance companies. In addition, unlike the original proposal by Rep. Neal, reinsurance purchased from domestic insurance companies (and possibly from unrelated foreign insurance companies, as well) would not eat into the threshold for application of the limitation under the proposal by the Administration. The proposal is silent concerning whether it is intended to override conflicting tax treaties if, as some contend, it is held to violate treaty non-discrimination provisions.
Proposal - The FY2011 Budget extends certain expiring provisions through 2011. In particular, the active financing and look-through exceptions of §954(h) and (c)(6), respectively, are extended for an additional two years.
Observation - The FY2010 Budget only allowed for an extension of these provisions through 31 December 2010.
Entity classification ("check-the-box")
Proposal - The FY2010 Budget provided for significant reform of the "check-the-box" rules for determining entity classification. However, the FY2011 Budget does not contain such a proposal.
Observation - Government officials have indicated that "engagement" with business leaders has caused the Administration to "focus their efforts elsewhere." We understand that the Administration has stated that the FY2010 Budget proposal will not be re-proposed and that the Administration supports leaving the existing rules in place.
Deferral of deductions
Proposal - The FY2010 Budget deferred certain deductions (other than R&D expense) of U.S. persons that are allocable to deferred foreign source income. However, the FY2011 Budget limits the deductions subject to the proposal to only interest expense. Thus, sales, general, and administrative expenses are excluded from the expenses that may be deferred if allocated and apportioned to deferred foreign source income. In addition, the Greenbook states that income earned through foreign branches of a U.S. person would be foreign source and related interest expense would not be subject to deferral. The FY2010 Budget proposal was estimated to raise $52.9 billion over 10 years. The FY2011 proposal is estimated to raise $25.6 billion over 10 years.
Observations - The revenue reduction is significant, particularly given that the FY2011 Budget appears to take into account that the worldwide interest expense apportionment rules of §864(f) are not effective until 2018.
Foreign tax credit pooling
Proposal - The proposal is the same as the proposal included in the FY2010 Budget. However, the revenue raised from this proposal has increased from $24.5 billion to $32.0 billion over 10 years.
Observation - The underlying cause for the revenue increase is unclear. This provision will continue to generate debate concerning the ability to claim a foreign tax credit on the repatriation of high-taxed earnings.
Foreign tax credit income matching
Proposal - The revenue estimate for the proposal to match foreign tax credits with foreign earnings has increased by $9.0 billion over 10 years. The proposal may extend the matching proposal to restrict the use of foreign tax credits with respect to earnings and profits against which foreign tax is imposed with respect to a specific taxpayer. The FY2011 Budget proposal is estimated to raise $27.4 billion over 10 years.
Observation - This proposal continues to have an abbreviated explanation. Given the revenue estimate has increased by 50percent, it may be a broader proposal than the recently proposed regulations under §901 addressing the technical taxpayer rule.
Dual capacity taxpayers
Proposal - The restrictions added to the dual capacity taxpayer rules of §901 are similar to the FY2010 Budget proposal. However, it may be broader because it does not focus solely on countries that do not impose a generally applicable income tax. The proposal is estimated to raise $8.5 billion over 10 years. The FY2010 Budget was estimated to raise $4.9 billion over 10 years.
Limit earnings stripping by expatriated entities
Proposal - The proposal is the same as the FY2010 Budget with one significant exception. The 50percent "adjusted taxable income" threshold would be reduced to 25 percent even in the case of unrelated party debt guaranteed by a related party. The proposal is estimated to raise $3.6 billion over 10 years.
Observations - The proposal raises compliance issues as applied to entities that expatriated (as described in §7874) in taxable years beginning after 1 July 1989, but prior to the date that governs the application of §7874. Such entities would have to determine, for the first time in 2011, whether they expatriated up to 21 years ago, under a standard that was first set forth in the U.S. Internal Revenue Code in 2004. Potentially effected companies may have undergone significant restructurings since the transaction to be tested was completed, making application of the standard even more difficult.
Finally, the extension of the provision to guaranteed debt will impact transactions where the related party guarantee is not intended to facilitate the erosion of the U.S. base, so much as to reduce the cost of borrowing.
Transfers of intangibles under §§367(d) and 482
Proposal - This proposal is substantially similar to the FY2010 Budget proposal. It would add "workforce in place," "goodwill" and "going concern value" in the definition of "intangible property" for purposes §§367(d) and the 482. However, the proposal would also provide that "the Commissioner may value an intangible taking into consideration the prices or profits that the controlled taxpayer could have realized by choosing a realistic alternative to the controlled transaction." (Emphasis added.)
Observation - The "realistic alternative" valuation language likely achieves a similar result to what was intended in the FY2010 Budget proposal, which would result in a value based on the "highest and best use" of the intangible. Since the FY2010 Budget was released, Administration officials have also confirmed that the "clarified" definition of intangibles was not meant to override the exclusion in the §367(d) regulations for foreign goodwill and going concern value.
Avoidance of withholding
Proposal - The proposal is substantially similar to the FY2010 Budget proposal. We understand from Administration officials that the proposal should be read as consistent with the Foreign Account Tax Compliance Act of 2009, H.R. 3933.
Proposal - There are a series of proposals in the FY2011 Budget that address international enforcement. These proposals are similar to the related FY2010 proposals; however, the FY2011 Budget excludes many rebuttable presumptions to U.S. source income. The revenue estimates from this proposal have dropped from $8.7 billion to $5.4 billion over 10 years.