Overview

H.R. 3160, introduced on July 24, 2007, by Rep. Lloyd Doggett (D-TX) as an offset to a farm reauthorization bill, would amend Section 894 of the Code by providing that U.S. corporations making deductible payments to certain related foreign entities be required to withhold tax at the higher of the withholding rate applicable to payments made directly to the foreign parent and payments made to a foreign affiliate in a treaty country.

Background

Citing a 2002 U.S. Treasury Department report regarding loopholes in the treaty network, Rep. Doggett introduced the “Fairness in International Tax” bill designed to curb abuses in the U.S. international tax treaty network. The bill is intended to prevent foreign multinationals from enabling their U.S. affiliates to make deductible payments to foreign affiliates located in low or no tax countries at reduced withholding rates.

The bill, which would add a new Section 894(d), would provide that if a U.S. entity makes a deductible payment to a foreign entity that is part of the same foreign controlled group of entities as the U.S. corporation, then the withholding tax rate to be applied to the payment shall be the higher of the rate applicable in the case of a payment to the foreign parent corporation (taking into account any relevant tax treaty between the U.S. and the country in which the foreign parent corporation is present) or the rate applicable on the payment to the controlled foreign entity in the treaty country.

Deductible payments include interest on loans made to the U.S. affiliate or royalties charged the U.S. affiliate for the use of intellectual property, e.g., patents, trademarks, copyrights. U.S. corporations will be considered part of the same foreign controlled group (the common parent of which is a foreign corporation) if 50 percent or more of the stock is held by other corporations within the same group. Observations Taxpayers potentially affected by this bill have already weighed in arguing that the bill runs counter to U.S. treaty policy, effectively abrogating various provisions of our tax treaties, and that the “limitation on benefits” provisions contained in most U.S. tax treaties are already designed to curb the cited abuses. In addition, taxpayers have argued that the bill ignores the commercial and business reasons for why corporations establish separate subsidiaries in different jurisdictions to hold intellectual property. Taxpayers also argue that this bill will further render the United States as an uncompetitive environment in which to do business that will have an adverse affect on employment and business growth in the United States. Finally, fear of retaliation by treaty partners has been cited as a concern.

Whether or not this bill survives remains to be seen. It has already been attached to a farm reauthorization bill, H.R. 2419, which passed the House on July 27, 2007. While there is significant opposition to it, including from the White House, the congressional search for revenue offsets can’t be underscored enough and it is not clear how this will play out.