Obama's 2016 budget contains sweeping international tax proposals
TAX ALERT |
On Feb. 2, 2015, President Obama presented to Congress his fiscal year 2016 budget. Within the budget, the Obama administration put forth many proposals, and chief among them were broad and sweeping international tax reform proposals that are sure to create some debate and controversy. Following is a summary of some of the Obama administration’s significant international tax reform proposals, which will act as the first offer in a discussion on broader overall tax reform and, more importantly, may signal the administration’s potential willingness to enter into serious discussions on the topic:
- Impose a 19 percent minimum tax on foreign income
In a fundamental shift to international taxation, this proposal would impose a minimum tax on the foreign income of U.S. corporations at a rate of 19 percent. The proposed minimum tax would be imposed on income as it is earned but would be reduced by 85 percent of the effective foreign tax rate imposed on that income. The proposal would be effective for tax years beginning after Dec. 31, 2015.
- Impose a 14 percent one-time tax on previously untaxed foreign income
In coordination with the 19 percent minimum tax on foreign income, this proposal would impose a one-time tax of 14 percent on previously untaxed foreign earnings of U.S. companies, subject to a reduced foreign tax credit. Such accumulated earnings could then be brought back to the U.S. without further taxation. This proposal is directed squarely at the almost $2 trillion of overseas profits that companies have stockpiled outside the United States. The proposal would be effective on the date of enactment (DOE) and apply to earnings accumulated for tax years beginning before Jan. 1, 2016. Any tax due would be payable over five years.
- Provide tax incentives for locating jobs and business activity in the United States and remove tax deductions for shipping jobs overseas
This proposal would create a new general business credit against income tax equal to 20 percent of the eligible expenses paid or incurred in connection with “insourcing” a U.S. trade or business (i.e., starting up, expanding or otherwise moving a business within the United States that is currently conducted outside of the United States). The proposal also would reduce tax benefits associated with a U.S. company moving jobs offshore by disallowing deductions for expenses paid or incurred in connection with outsourcing a U.S. trade or business. The proposal would be effective for expenses paid or incurred after the DOE.
- Restrict deductions for excessive interest of members of financial reporting groups
Section 163(j) currently limits the amount of interest expense a corporation may deduct, but it does not account for differences in the relative proportion of leverage between the U.S. group and the foreign operations. This proposal aims to limit allowable interest expense for members of affiliated groups to the amount not in excess of each member’s proportional share. Disallowed interest would carry forward indefinitely, while excess limitation (i.e., cushion in the annual calculation that could allow additional interest deductions) would expire after three tax years. The proposal would not apply to financial services entities or affiliated groups with less than $5 million in interest expense. The proposal would be effective for tax years beginning after Dec. 31, 2015.
- Repeal delay in the implementation of worldwide interest allocation
The American Jobs Creation Act of 2004 created a one-time election to enable domestic members of an affiliated group to allocate the interest expense of domestic members on a worldwide group basis. Subsequent legislation delayed the availability of the election until tax year 2021. In coordination with the proposal to impose a 19 percent minimum tax on foreign income, the availability of the election would be required to preserve the principles of expense allocation. This proposal would make the election available for tax years beginning after Dec. 31, 2015.
- Extend the exception under subpart F for active financing income
Generally, interest and dividends are considered passive income and subject to subpart F taxation (i.e., immediate U.S. taxation). The active financing exception operates by allowing corporations to exclude from passive income such amounts arising from active banking, financing, insurance, or similar business activities. This proposal would make permanent the active financing exception that has been extended on a temporary basis numerous times in the past but is currently expired for tax years starting after Dec. 31, 2014.
- Extend the look-through treatment of payments between related controlled foreign corporations (CFCs)
Generally, a domestic corporation must include the passive income of its foreign subsidiaries in its income for the current tax year under subpart F. Under the CFC look-through rule, interest, rents and royalties received by a foreign subsidiary from a related party can be considered active income if such payments are attributed to the related party’s active business. This proposal would make permanent the CFC look-through rule that has been extended on a temporary basis numerous times in the past but is currently expired for tax years starting after Dec. 31, 2014.
- Limit shifting of income through intangible property transfers
This proposal seeks to limit shifting of income to low- or no-tax jurisdictions through intangible property transfers. Under the proposal, the definition of intangible property for purposes of transfer pricing and outbound property transfers would include workforce in place, goodwill, going concern value, and any other item owned or controlled by a taxpayer that is not a tangible or financial asset and that has substantial value independent of the services of any individual. The proposal would be effective for tax years beginning after Dec. 31, 2015.
- Modify tax rules for dual capacity taxpayers
The current U.S. regulations allow dual capacity taxpayers to take a foreign tax credit on the portion of a foreign levy that constitutes an income tax and denies a foreign tax credit for payments made to a foreign country in exchange for an economic benefit. However, current law fails to provide guidelines for segregating a single net payment. This proposal would allow taxpayers to take as a credit the tax it would pay if it did not receive an economic benefit, even where the taxpayer makes a single payment of tax. In addition, the proposal would create a new separate limitation category within section 904 for foreign oil and gas income received in tax years beginning after Dec. 31, 2015.
- Tax gain from the sale of a partnership interest on a look-through basis
This proposal would provide that gain or loss from the sale or exchange of an interest in a partnership with a U.S. trade or business by a foreign seller is itself considered effectively connected income (ECI). The amount of ECI would be limited to the extent attributable to the transferor partner’s distributive share of the partnership’s unrealized gain or loss attributable to ECI property. In addition, a transfer of a partnership interest would be subject to a 10 percent withholding tax unless the transferor certifies that it is a domestic person. There has been some controversy over this position relating to foreign taxpayers, as it conceptually contradicts the treatment a U.S. taxpayer would receive upon the sale of a partnership interest. The proposal would be effective for sales or exchanges occurring after Dec. 31, 2015.
- Modify sections 338(h)(16) and 902 to limit credits when non-double taxation exists
Recent tax law changes were enacted to prevent potential “hyping” of foreign tax credits (i.e., increasing the effective rate of foreign tax pools from a U.S. tax perspective) in situations in which certain transactions are viewed differently between the United States and a foreign tax jurisdiction. Current law acts to reduce the available foreign tax credits in these situations to amounts consistent with the U.S. view of the transaction. The proposal would expand the scope of these rules to cover other transactions (e.g., stock redemptions) and provide for similar reductions of available foreign tax credits. The proposal would be effective for transactions occurring after Dec. 31, 2015.
- Close loopholes under subpart F
This proposal seeks to expand the categories of subpart F income by creating a new type of foreign base company income for digital goods and including income from manufacturing service arrangements in foreign base company sales income. Additionally, the proposal seeks to amend CFC attribution rules to include in a U.S. person’s ownership those shares held by a related foreign person. Finally, the proposal seeks to eliminate the CFC 30-day ownership requirement. The proposal would be effective for tax years beginning after Dec. 31, 2015.
- Restrict the use of hybrid arrangements that create stateless income
Through complex international structures involving entities that are viewed differently by U.S. versus foreign tax authorities, businesses have been able to generate income that is not subject to tax in any jurisdiction while allowing for deductions for those payments within a foreign jurisdiction (i.e., stateless income). This proposal would generally deny deductions for payments that either have no corresponding income inclusion to the recipient or would otherwise be deductible in multiple jurisdictions. The proposal would be effective for tax years beginning after Dec. 31, 2015.
- Limit the ability of domestic entities to expatriate
In a follow-up to proposed regulations issued by the Treasury in the fall of 2014, this proposal would broaden the definition of an inversion by considering a transaction an inversion if continuing U.S. ownership is at least 50 percent. Additionally, regardless of shareholder continuity or level of activity in the foreign jurisdiction, a transaction would be considered an inversion if the stock of the U.S. corporation is worth more than the foreign acquiring corporation if primary management and control remains in the United States. A transaction treated as an inversion would be ignored, and the company would remain subject to U.S. tax on its worldwide income. The proposal would be effective for transactions completed after Dec. 31, 2015.
These proposals, some previously suggested under the Obama administration and some significant new proposals, represent a broad range of revenue raisers and policy shifts in the taxation of international business activity. It is difficult to predict which, if any, of these proposals will make it through a Republican-controlled House and Senate, but arguably, the proposals demonstrate an interest in entering into serious debate on corporate tax reform and simplification, which both parties publicly support. As with anything this significant, the public theater portion of this debate may not represent the real negotiations going on behind the scenes.
In addition to the authors, the following people contributed to this article: Kristie Angle, Senior Manager; Jonathan Hobbs, Senior Manager; Andrew Petruzelli, Manager; Erika Stefanski, Manager; and Teresa Tran, Supervisor.