On May 4, 2009, President Obama unveiled several major international tax proposals that are intended to correct perceived loopholes in current law. On May 11, 2009, the administration issued the Treasury Greenbook, which provided a more detailed description of the tax proposals.
Significant new limits on deferral under Subpart F
Currently, businesses that invest overseas can take immediate deductions on their U.S. tax returns for expenses supporting their overseas investments, and can defer paying U.S. taxes on the profits they make from those investments. The administration believes this preferential treatment uses U.S. taxpayer dollars to provide companies with an incentive to invest overseas, giving them a tax advantage over competitors who make the same investments to create jobs in the United States. The administration’s proposal on deferral, similar to an earlier measure proposed by House Ways and Means Chairman Charles Rangel (D-NY), would prohibit companies from taking such deductions, with the exception of research and development expenses, until they repatriate their earnings. Deferred amounts in a particular year would be carried forward to subsequent years, and then combined with a taxpayer’s current year expenses before determining the impact of the limit on deferral in that year.
Tighten use of the foreign tax credit
Currently, U.S. businesses can credit their foreign taxes against their U.S. tax liability on foreign income that is taxable in the United States. However, the administration argues that some U.S. businesses artificially inflate or accelerate these credits, providing them with a competitive advantage over companies that invest in the United States. In addition, the administration argues that current law permits the separation of creditable foreign taxes from the associated foreign income in certain cases, such as those involving hybrid arrangements. The proposal would make two major changes: (1) the credit would be based on the consolidated foreign tax the taxpayer actually pays on its total foreign earnings of all the foreign subsidiaries including lower-tier subsidiaries and (2) the credit would no longer be allowed for foreign taxes paid on income not subject to U.S. taxes. Require U.S. companies to treat certain foreign affiliates and subsidiaries as corporations Currently, U.S. businesses can “check the box” on foreign subsidiary corporations and treat them as disregarded entities. Taxpayers can move money between these disregarded entities, thereby shifting income from high-tax to low-tax jurisdictions without incurring U.S. tax on that income. The administration proposes to reform these rules to require foreign subsidiaries to be considered as separate corporations for U.S. tax purposes by repealing the availability of the check-the-box election for controlled foreign corporations in cases where the foreign owner and disregarded subsidiary are not organized or created in the same country. A first-tier foreign entity wholly owned by a U.S. person would not be affected unless a tax avoidance motive is discerned.
Strengthen the qualified intermediary program
The administration believes the Qualified Intermediary (QI) program has become subject to abuse. Under the proposal, no foreign financial institution would qualify as a QI unless it identifies all of its account holders that are U.S. persons. A QI would be required to report all reportable payments received on behalf of all U.S. account holders, as well as file Form 1099s with respect to such payments. Withholding agents would be required to withhold 30 percent of U.S. fixed or determinable annual or periodical gain payments to individuals who use non-QIs, and to withhold 20 percent of gross proceeds from the sale of any security that would be reported to a U.S. non-exempt payee when paid to a non-QI located in a jurisdiction without a satisfactory exchange of information program with the United States. Taxpayers would be required to disclose their identities to the IRS and demonstrate compliance to obtain a refund, and would create a legal presumption against users of non-QIs. In addition, the Treasury Department would be given the authority to provide 1) for certain exceptions for the 20-30 percent withholding on payments made to certain foreign investors, as well as certain low-risk payments; 2) that a financial institution can be a QI only if the financial institutions it commonly controls are also QIs; and 3) that for any financial institution to be a QI, it must collect information indicating the beneficial owners of the foreign entity account holder, especially if it is a U.S. person that is a beneficial owner. The proposal also would require a list of QIs to be made publicly available. Lastly, any U.S. person or any QI that forms or acquires a foreign entity on behalf of a U.S. individual or his/her controlled entity would be required to file an information return with the IRS regarding such foreign entity.
Cracking Down on the Abuse of Tax Havens by Individuals
The administration has proposed a comprehensive package of disclosure and enforcement measures to make it more difficult for financial institutions and wealthy individuals to evade taxes. The proposal would increase penalties, as well as extend the statute of limitations for enforcement. U.S. individuals would be required to report on their income tax return any transfers or receipts of money or property with a value of more than $10,000 from any foreign financial account owned by them or by their controlled entities. U.S. financial intermediaries or QIs that make such transfers would have to meet certain reporting requirements as well. Taxpayers required to file a Report of Foreign Bank and Financial Accounts (FBAR) would have to disclose certain information on their tax returns in addition to their obligation to file the FBAR. Making R&E Tax Credit Permanent To Encourage Investment in Innovation in the United States Currently companies are eligible for a tax credit equal to 20 percent of qualified research expenses above a base amount. The R&E tax credit, however, has never been made permanent, and is set to expire on December 31, 2009. The administration believes that uncertainty about whether the R&E credit will be extended reduces its effectiveness in stimulating investments in new innovation because taxpayers find it difficult to factor the credit into decisions about research projects that will not be initiated or completed prior the credit’s expiration. The plan would make the R&E tax credit permanent to provide businesses with the certainty they need to make long-term investments in research and innovation.
Additional Proposals Made
The administration has proposed various other reforms, including:
- limiting the shifting of income through intangible property transfers by clarifying that intangible property a) includes workforce in place, goodwill and going concern value; b) may be valued on an aggregate basis to achieve a more reliable result; and c) must be valued at its highest and best use;
- tightening the limitation on the deductibility of interest paid by an expatriated entity to related persons by a) eliminating the current debt-to-equity safe harbor; b) reducing the threshold for the limitation, from 50 percent to 25 percent of adjusted taxable income with respect to certain disqualified interest; and c) limiting the carry-forward for disallowed interest to 10 years and eliminating the carry-forward of excess limitation;
- repealing the boot-within-gain limitation in cross-border reorganizations in which the acquiring corporation is foreign and the exchange is effectively a dividend distribution;
- repealing the 80/20 company provisions that exempts dividends and interest paid by 80/20 domestic corporations to foreign persons as U.S. source income; and
- issuing new guidance on dividend substitutes, e.g., equity swaps, which would trigger U.S. source income and withholding obligations.
Critique of the Proposals
Business interests argue that, given the current economic downturn, the plans would reduce the ability of U.S. companies (that currently pay the highest corporate tax rates worldwide) to compete in foreign markets and cripple economic growth in the United States. They also view the plans as ill-conceived and ill-timed policies that fail to recognize the global economic pressures faced by U.S. corporations, increases the cost of doing business overseas and risks job losses or higher prices as companies try to compensate for a greater tax burden. Most pointedly, critics argue that the plan wrongly assumes that business conducted abroad would occur in the United States as a result of the proposed tax reforms.
If passed, the tax proposals would not take effect until 2011. There is likely to be a lively congressional debate on the more substantive tax provisions, and it is not clear what provisions will make it through. On the other hand, procedural provisions dealing with offshore abuses by U.S. persons, including those relating to the QI regime, will certainly see the light of day.