On February 9, 2016, the Obama Administration (Administration) released its Budget of the United States Government, Fiscal Year 2017. In conjunction with the release of the Administration’s budget proposal, the US Department of the Treasury also issued its General Explanations of the Administration’s FY2017 Revenue Proposals (the Greenbook).
In sum, the Administration’s international tax proposals do not break new ground. In fact, all of the proposals appeared in the Administration’s budget for FY 2016 (2016 budget). The only differences are revised proposed effective dates, revenue expectations, and changes to reflect the permanent extension of the exception under subpart F for active financing income and the temporary extension of the look-through treatment of payments between related controlled foreign corporations (CFCs). Although the proposals have generally not been embraced by members of Congress, they remain relevant as markers in fundamental tax reform discussions and as potential revenue raisers outside of tax reform.
This alert summarizes the Administration’s international tax proposals and considers the potential impact of such proposals.
Description of Proposals
The Administration proposes the following:
- Impose a 19% minimum tax on foreign income. To discourage US multinationals from locating production overseas and shifting profits abroad, the Administration generally proposes imposing a minimum tax on foreign income of US multinationals at a rate of 19% reduced (but not below zero) by 85% of the effective foreign tax rate imposed on that income. The minimum tax would be imposed on foreign earnings regardless of whether they are repatriated to the US, and all foreign earnings of a CFC could be repatriated without further US tax. The proposal would be effective for taxable years beginning after December 31, 2016.
- Impose a one-time 14% tax on previously untaxed foreign income. The Administration recommends imposing a one-time 14% tax on the accumulated earnings of CFCs that were not previously subject to US tax. The accumulated earnings subject to the one-time tax could then be repatriated without incurring further US tax. The proposal would be effective as of the date of enactment and would apply to earnings accumulated for taxable years beginning no later than December 31, 2016. (The 19% minimum tax described above would apply to all subsequent taxable years.) The tax would be payable ratably over five years.
- Restrict deductions for excessive interest of members of financial reporting groups. The Administration proposes limiting the interest expense deduction of each entity that is a member of a group that prepares consolidated financial statements if the member’s net interest expense for financial statement purposes exceeds the member’s proportionate share of the group’s financial statement net interest expense (“excess financial statement net interest expense”). A member’s proportionate share of the financial reporting group’s net interest expense would be determined based on the member’s proportionate share of the group’s earnings reflected in the group’s financial statements. The proposal would not apply to financial reporting groups that would otherwise report less than $5 million of net interest expense, in the aggregate, on one or more US income tax returns for a taxable year and would be effective for taxable years beginning after December 31, 2016. The Administration’s proposal is similar to the group ratio rule described in the final report on Action 4 (“Limiting Base Erosion Involving Interest Deductions and Other Financial Payments”) of the OECD/G20 Base Erosion and Profit Shifting (BEPS) Project.
- Limit the ability of domestic entities to expatriate. To limit the ability of domestic entities to expatriate, the Administration proposes broadening the definition of an inversion transaction by reducing the current 80% shareholder continuity threshold for continuing to be treated as a US entity to a greater-than-50% threshold and eliminating the 60% test for treatment as a surrogate foreign corporation. In addition, the proposal would add a special rule whereby, regardless of the level of shareholder continuity, an inversion transaction will be treated as occurring if (i) the fair market value of the stock of the US corporation is greater than the fair market value of the stock of the foreign acquiring corporation; (ii) the affiliated group is primarily managed and controlled in the US; and (iii) the affiliated group does not conduct substantial business activities in the relevant foreign country. The proposal would also provide the IRS with authority to share tax return information with federal agencies that are required not to contract with inverted companies. The proposal generally would be effective for transactions that are completed after December 31, 2016, except that, effective January 1, 2017, the proposal would provide the IRS with the authority to share with other federal agencies the specified information without regard to when the inversion transaction occurred. The proposal on inversions is consistent with the Administration’s continued focus on limiting the ability of US entities to expatriate. Treasury and the IRS have indicated that they intend to issue regulations implementing Notices 2015-79 and 2014-52, which provide guidance aimed at making it more difficult for US companies to invert without triggering negative consequences under section 7874, as well as reducing the tax benefits of corporate inversions.
- Limit shifting of income through intangible property transfers. To address the current controversy regarding the scope of the definition of intangible property under section 936(h)(3)(B), the Administration proposes that such definition also include workforce in place, goodwill and going concern value, and any other item owned or controlled by a taxpayer that is not a tangible or financial asset and that has substantial value independent of the services of any individual. The Administration also proposes to clarify that transfers involving intangibles may be valued on an aggregate basis where doing so achieves a more reliable result, as well as to clarify that the IRS may value intangible property taking into consideration the taxpayer’s realistic alternatives to the controlled transaction. The proposal would be effective for taxable years beginning after December 31, 2016. In September 2015, Treasury and the IRS issued proposed regulations (REG-139483-13) under sections 367(a) and (d) that were intended to address certain transactions involving the transfer of foreign goodwill and going concern value. The proposed regulations, however, do not address whether goodwill and going concern value are section 936(h)(3)(B) intangibles. Also in September, Treasury and the IRS issued temporary regulations addressing certain valuation issues under section 482 (T.D. 9738), including providing that an aggregate evaluation may be a more reliable measure of an arm’s-length result in certain cases. Despite the fact that the proposed regulations are generally proposed to apply to transfers occurring on or after September 14, 2015, and the temporary regulations are currently effective, the Administration’s budget estimate for this proposal has not changed from that in the 2016 budget.
- Tax gain from the sale of a partnership interest on look-through basis. Under the Administration’s proposal, gain or loss from the sale or exchange of a partnership interest would be treated as effectively connected with the conduct of a trade or business in the United States to the extent attributable to the transferor partner’s distributive share of the partnership’s unrealized gain or loss that is attributable to property used or held for use in the partnership’s trade or business within the United States. This would generally codify Revenue Ruling 91-32, which has been criticized as inconsistent with section 741’s characterization of gain from the sale of an interest in a partnership as gain from the sale of a capital asset (which is generally sourced to the residence of the seller). The proposal would also require the transferee of a partnership to withhold 10 percent of the amount realized on the sale or exchange of a partnership interest unless the transferor certified that the transferor was not a nonresident alien individual or foreign corporation. The proposal would be effective for sales or exchanges after December 31, 2016.
- Close so-called “loopholes” under subpart F. The Administration proposes expanding categories of subpart F income by (i) creating a new category of subpart F income for income of a CFC from the lease or sale of a digital copyrighted article or from the provision of a digital service that would apply in cases where the CFC uses intangible property developed by a related party (including property developed pursuant to a cost sharing arrangement) to produce the income and the CFC does not, through its own employees, make a substantial contribution to the development of the property or services that give rise to the income; and (ii) expanding foreign base company sales income to include income of a CFC from the sale of property manufactured on behalf of the CFC by a related person. In addition, the proposal would modify the thresholds for applying subpart F by (i) amending the ownership attribution rules of section 958(b) so that certain stock directly owned by a foreign person is attributed to a related US person for purposes of determining whether a foreign corporation is a CFC or a US person is a US shareholder; and (ii) eliminating the requirement that a foreign corporation must be a CFC for an uninterrupted period of at least 30 days in order for a US shareholder to have a subpart F income inclusion with respect to the corporation. The proposal would be effective for taxable years beginning after December 31, 2016.
- Restrict the use of hybrid arrangements that create stateless income. The Administration proposes denying deductions for interest and royalty payments made to related parties under certain circumstances involving a hybrid arrangement and limiting the application of exceptions under subpart F for certain transactions that use reverse hybrids to create income that is not taxed in any jurisdiction (i.e., “stateless” income). The proposal would be effective for taxable years beginning after December 31, 2016.
- Provide for reciprocal reporting of information in connection with the implementation of the Foreign Account Tax Compliance Act (FATCA). To permit the United States to provide equivalent levels of information to foreign governments that have entered into reciprocal intergovernmental agreements (IGAs) with the United States, the proposal would (i) require certain financial institutions to report the account balance for all financial accounts maintained at a US office and held by foreign persons; (ii) expand the current reporting required with respect to US source income paid to accounts held by foreign persons to include similar non-US-source payments; (iii) grant the Secretary of the Treasury authority to prescribe regulations that would require reporting of such other information as is necessary to enable the IRS to facilitate FATCA implementation by exchanging similar information with cooperative foreign governments in appropriate circumstances; and (iv) require financial institutions that are required under FATCA or this proposal to report to the IRS information with respect to financial accounts to furnish a copy of the information to the account holders in order to encourage voluntary tax compliance. The proposal would be effective for (information reporting) returns required to be filed after December 31, 2017.
- Disallow the deduction for excess non-taxed reinsurance premiums paid to affiliates. The Administration makes two recommendations to address what it views as tax advantages created by an inappropriate incentive for foreign-owned domestic insurance companies to reinsure US risks with foreign affiliates. First, the Administration proposes denying an insurance company a deduction for premiums and other amounts paid to affiliated foreign companies with respect to reinsurance of property and casualty risks to the extent that the foreign reinsurer (or its parent company) is not subject to US income tax with respect to the premiums received. Second, the Administration recommends excluding from the insurance company’s income (in the same proportion in which the premium deduction was denied) any return premiums, ceding commissions, reinsurance recovered or other amounts received with respect to reinsurance policies for which a premium deduction is wholly or partially denied. The provision would be effective for policies issued in taxable years beginning after December 31, 2016.
- Modify tax rules for dual-capacity taxpayers. The Administration’s proposal would allow a dual-capacity taxpayer (i.e., a taxpayer subject to a foreign levy that also receives a specific economic benefit from the levying country) to treat as a creditable tax the portion of a foreign levy that does not exceed the foreign levy that the taxpayer would pay if it were not a dual-capacity taxpayer. In addition, the proposal would convert the special foreign tax credit limitation rules of section 907 into a separate category within section 904 for foreign oil and gas income. Both of these rules would be effective for taxable years beginning after December 31, 2016.
- Modify sections 338(h)(16) and 902 to limit credits when non-double taxation exists. The Administration proposes amending the foreign tax credit rules to reduce the availability of foreign tax credits in circumstances where no double taxation would otherwise exist. More specifically, the Administration recommends extending the application of section 338(h)(16) to any covered asset acquisition within the meaning of section 901(m). The proposal would also reduce the amount of foreign taxes treated as paid by a foreign corporation in the event a transaction results in the reduction, allocation, or elimination of a foreign corporation’s earnings and profits other than a reduction by reason of a dividend or a section 381 transaction. These changes would be effective for transactions occurring after December 31, 2016.
- Provide tax incentives for locating jobs and business activity in the United States and remove tax deductions for shipping jobs overseas. To make the US more competitive in attracting businesses, the Administration proposes creating a new general business credit (to be claimed by the US parent company of a US-based multinational company) against income tax equal to 20% of the eligible expenses paid or incurred in connection with insourcing a US trade or business. For this purpose, insourcing a US trade or business means reducing or eliminating a trade or business (or line of business) currently conducted outside the US and starting up, expanding, or otherwise moving the same trade or business within the US, to the extent that this action results in an increase in US jobs. Conversely, to reduce tax benefits associated with US companies moving jobs offshore, the Administration proposes disallowing deductions for expenses paid or incurred in connection with outsourcing a US trade or business. For this purpose, outsourcing a US trade or business means reducing or eliminating a trade or business or line of business currently conducted inside the US and starting up, expanding, or otherwise moving the same trade or business outside the US, to the extent that this action results in a loss of US jobs. The proposal would be effective for expenses paid or incurred after the date of enactment.
- Repeal delay in the implementation of worldwide interest allocation. The Administration proposes moving up the date of implementation of worldwide interest allocation so that the worldwide affiliated group election would be available for taxable years beginning after December 31, 2016.
- Provide relief for certain accidental dual citizens. To provide relief to so-called “accidental Americans” from the section 877A “exit tax” on expatriation, the Administration proposes that an individual will not be subject to tax as a US citizen and will not be a covered expatriate subject to the mark-to-market exit tax under section 877A if the individual: (i) became a citizen of the United States and a citizen of another country at birth; (ii) at all times, up to and including the individual’s expatriation date, has been a citizen of a country other than the United States; (iii) has not been a resident of the United States (as defined in section 7701(b)) since attaining age 18½; (iv) has never held a US passport or has held a US passport for the sole purpose of departing from the United States in compliance with 22 CFR §53.1; (v) relinquishes his or her US citizenship within two years after the later of January 1, 2017, or the date on which the individual learns that he or she is a US citizen; and (vi) certifies under penalty of perjury his or her compliance with all US federal tax obligations that would have applied during the five years preceding the year of expatriation if the individual had been a nonresident alien during that period. The proposal would be effective after December 31, 2016.
As stated above, although the Administration’s international tax proposals have generally been met with a cool reception from Congress, the proposals remain relevant as markers in the debate over fundamental tax reform and as potential revenue raisers outside of tax reform. As Congress continues to consider international tax reform, it will need to tackle the same issues that the Administration’s proposals seek to address, including taxation of offshore profits, transition rules, base erosion, and whether and how to address inversions.