On September 23, as a follow-up to the Administration’s job creation and infrastructure bill, the American Jobs Act of 2011, President Obama released draft legislation for the “President’s Plan for Economic Growth and Deficit Reduction” (the “Plan”), which had been submitted to Congress and the Joint Select Committee on Deficit Reduction a few days before. Provisions that would increase taxes on multinational corporations are an important part of the Plan. Also included are several proposals from the Administration’s previous fiscal year budget proposals from 2001 and 2012. The Plan includes the following international tax proposals:
Deferring deductions for interest expense related to deferred income
The Plan includes a matching rule that would limit the ability of companies to take interest expense deductions allocable and apportioned to the taxpayer’s foreign-source income that is not currently subject to U.S. tax until such income is subject to U.S. tax. The interest expense deduction would be allowed in later years in proportion to the amount of the taxpayer’s previously deferred foreign-source income that is repatriated and becomes subject to U.S. tax.
Determining the foreign tax credit on a pooled basis
The Plan would require a taxpayer to determine its deemed paid foreign tax credit on a consolidated basis. The proposal would limit the credit allowed based on the average of the foreign effective tax rates across all of the taxpayers controlled foreign corporations (CFC) and Section 902 corporations (i.e., a 10-percent-owned foreign subsidiary). Any deemed-paid taxes that exceed the credit limit (the product of the current inclusion ratio and the sum of the domestic corporation’s aggregate post-1986 foreign income taxes and its suspended aggregate post-1986 foreign income taxes) would be suspended for potential use in a later year. The rule would allow taxpayers to claim deemed paid credits from foreign corporations below the sixth tier in a chain of foreign corporations. The proposed rule differs from the recent Obama budget proposal by limiting the credit for deemed paid taxes instead of actually changing the method for calculating deemed paid taxes.
Taxing currently excessive returns associated with transfers of intangibles offshore
The proposal would change the rules governing intangible property transfers in order to prevent erosion of the U.S. tax base from income shifting to low-tax affiliates. If a U.S. parent transfers an intangible to its CFC in circumstances that demonstrate excessive income shifting from the United States, an amount equal to the excessive return would be treated as subpart F income. The Plan would essentially expand the definition of subpart F income to include “foreign base company excess intangible income,” which covers income that is derived from the use of any “covered intangible” and includes a same-country exception and a tax rate exception from the definition.
Modifying the definition of intangible property
The Plan would change the definition of intangible property for purposes of outbound transfers and the allocation of income and deduction rules to prevent the perceived shifting of income outside the United States. The provision would add goodwill, goingconcern value and workforce-in-place to the list of items included in the definition of intangible property. The proposed rule states that transfers of intangible property between related parties would be valued in the aggregate if a more reliable result would be achieved and consideration would be given, in determining the true taxable income from the transfer of intangibles, to the price or profits that could have been realized by the taxpayer if a realistic alternative transaction had been chosen. It appears that this proposal would not override the Section 367(d) regulation exclusion for foreign goodwill and going-concern value.
Limiting earnings stripping by expatriated entities
The Plan would tighten the Section 163(j) earnings stripping rules to prevent a “specified expatriated entity” (reference is made to Section 7874 surrogate foreign corporations that are not treated as domestic corporations under those rules) from using foreignrelated parties and certain guaranteed debt to inappropriately reduce the U.S. tax on income earned from their U.S. operations. Specifically, the proposal eliminates a debtto- equity safe harbor and the threshold for the amount of excess limitation is reduced to 25 percent (instead of 50 percent) of adjusted taxable income over the corporation’s net interest expense. Further, disallowed deductions would be carried forward for 10 years and the carry-forward of excess limitation would be eliminated.
Additional international tax proposals
The Plan would also prevent a taxpayer that pays a foreign tax in exchange for a specific economic benefit (a “dual capacity taxpayer”) from claiming a foreign tax credit for the portion of the foreign tax paid for the economic benefit, and would create a separate foreign tax credit limitation category for foreign oil and gas income.
Taxpayers should be aware that the Administration’s plan has not been well received by Congress or the business community, and its likelihood of passage is small, at least in the short term. Nevertheless, many recognize that this legislation gives taxpayers further insight into the Administration’s ideas for how it will frame future discussions on modifying the corporate tax system.