On September 19, 2011 the President submitted to the Joint Select Committee on Deficit Reduction a limited number of international tax reform proposals which the Administration “scored” for budgetary purposes as reducing the deficit by approximately $112 billion over a 10 year period. The changes proposed were essentially the same ones that were part of the President’s 2012 budget proposal announced last February. Some tax commentators were disappointed that there is no real comprehensive reform, such as shifting from a worldwide system of taxation to a territorial or sourcing based system as some had advocated.
The idea of enacting wide ranging reforms in this area would first require a consensus of what such new or revised system would look like, perhaps with or without a value added tax being part of the mix as many treaty partners have added. Then, the conceptual reforms or policy reforms reflected in such new or revised system would undoubtedly require a rethinking of many rules contained in or otherwise directly linked with the foreign tax provisions in the Code, including the subpart F rules for current inclusion of such income to U.S. shareholders of controlled foreign corporations, the passive foreign investment company or PFIC provisions, reorganization provisions, dividend treatment from foreign based subsidiaries would be just several of a host of provisions that would have to be addressed. Such reforms would undoubtedly have treaty impacts which treaties might require revision or at least negotiations as to whether revisions were necessary.
So perhaps massive reforms in this area are not appropriate at this time given the uncertain economic times we are living through. Reshuffling the deck chairs of the "ship" of our international tax system might add to the uncertainties we currently face. Still, a simple reduction in the corporate tax rate to a rate competitive in the worldwide market might be quite attractive to inspire increased investment and employment in the U.S. by both multinationals and U.S. based companies. For the “reformers” the President’s proposals have been criticized as unattractive and simply broadening the base of (foreign source) income that is subject to current taxation.
The International Tax Reforms Being Proposed by the Obama Administration At This Time
Defer deduction of interest expense related to deferred income. Under current law, a taxpayer that incurs interest expense properly allocable and apportioned to foreign-source income may be able to deduct that expense even if some or all of the foreign source income is not subject to current U.S. taxation. To provide greater matching of the timing of interest expense deductions and recognition of associated income,the proposal would defer the deduction of interest expense properly allocable and apportioned to foreign-source income to the extent the U.S. taxation of such income is deferred. This would reduce the deficit by $36 billion over 10 years.
Determine the foreign tax credit on a pooling basis. Under the proposal, a taxpayer would be required to determine foreign tax credits from the receipt of a dividend from a foreign subsidiary on a consolidated basis for all its foreign subsidiaries. Foreign tax credits from the receipt of a dividend from a foreign subsidiary would be based on the consolidated earnings and profits and foreign taxes of all the taxpayer's foreign subsidiaries. This would reduce the deficit by $53 billion over 10 years.
Tax excess returns associated with transfers of intangibles offshore currently. The IRS has broad authority to allocate income among commonly controlled businesses under section 482 of the Internal Revenue Code. Notwithstanding the transfer pricing rules, there is evidence of income shifting offshore,including through transfers of intangible rights to subsidiaries that bear little or no foreign income tax. Under the proposal, if a U.S parent transfers an intangible to a controlled foreign corporation (CFC) in circumstances that demonstrate excessive income shifting from the United States, then an amount equal to the excessive return would be treated as subpart F income. This would reduce the deficit by $19 billion over 10 years.
Limit shifting of income through intangible property transfers. The definition of intangible property for purposes of the special rules relating to transfers of intangibles by a U.S. person to a foreign corporation (section 367(d) of the Internal Revenue Code) and the allocation of income and deductions among taxpayers (section 482) would be clarified to prevent inappropriate shifting of income outside the United States. This would reduce the deficit by $1 billion over 10 years.
Limit earnings stripping by expatriated entities. Under the proposal, the rules that limit the deductibility of interest paid to related persons subject to low or no U.S. tax on that interest would be amended to prevent inverted companies from using foreign-related party and certain guaranteed debt to reduce inappropriately the U.S. tax on income earned from their U.S. operations. This would reduce the deficit by $4 billion over 10 years.