On March 17, 2010, the House Ways & Means Committee approved The Small Business and Infrastructure Jobs Tax Act of 2010 (H.R. 4849), which is effective upon enactment and, among other things, limits tax treaty benefits for multinational firms based in third-party countries. The bill was sponsored by Rep. Sander M. Levin (D-MI) and is characterized as legislation that seeks to strengthen the American economy, assist small businesses and create jobs.
H.R. 4849 includes international measures that would raise $11.15 billion in revenue. Under current law, a foreign person who earns non-business U.S. source income in the nature of interest, dividends, rents, royalties and certain similar types of income is subject to a flat 30 percent U.S. withholding tax. However, the withholding tax can be reduced or eliminated under the provisions of a tax treaty between the United States and the country of residence of the foreign person. H.R. 4849 would place severe limitations on how tax treaties can reduce or eliminate taxation in the United States.
Specifically, H.R. 4849 will require 30 percent withholding if an entity makes a “deductible payment” to a foreign entity that is part of the same foreign controlled group of entities as the payor corporation and that is located in a U.S. tax treaty partner country, if the parent of the foreign controlled group is located in a third country that has not signed a tax treaty with the United States. If the parent of the foreign controlled group, however, is located in a U.S. tax treaty partner country, an applicable lower withholding rate could be relied upon. Deductible payments include interest on loans made to the payor or royalties charged the payor for the use of intellectual property—e.g., patents, trademarks and copyrights.
The proposed anti-treaty shopping measure contained in H.R. 4849 was originally set forth in H.R. 3160, introduced on July 24, 2007, by Rep. Lloyd Doggett (D-TX), which provided that deductible payments made to certain related foreign entities would be subject to withholding tax at the higher of the withholding rate applicable to payments made directly to the foreign parent and those made to a foreign affiliate in a treaty country. However, opponents of the Doggett bill argued that it violated U.S. international agreements. On July 14, 2009, in response to critics of the Doggett bill, House Democratic leadership including Rep. John Dingell (D-MI) and Rep. Charles Rangel (D-NY) introduced the America’s Affordable Health Choices Act of 2009 (H.R. 3200). H.R. 3200 proposed to limit tax treaty benefits with respect to U.S. withholding tax imposed on deductible related-party payments in a manner identical to H.R. 4849.
Nevertheless, critics of the legislation still believed that H.R. 3200 was too broad and unfairly overrode U.S. tax treaties.
This same critique now extends to H.R. 4849, given its similar treatment of the issue. If H.R. 4849 is enacted, foreign corporations with U.S. branch operations or U.S. affiliates that make deductible related-party payments would face an estimated $7.7 billion in tax hikes. Opponents argue that these tax hikes would have an adverse economic effect in that additional costs may incentivize foreign corporations to not do business in the United States, or to pass along the cost of doing business in the United States to U.S. persons.