Significant and Immediate Impact on U.S Companies with International Operations
On August 10, 2010, the House passed, without change, the
Senate's version of H.R. 1586, sending the bill to President
Obama. The President signed the legislation later that day.
The bill generally provides aid to State and local governments. As
offsets for its spending provisions, however, the bill has several
revenue raisers, including significant limitations on the foreign
tax credit, aimed squarely at U.S. multinational
corporations.
The Statement of Administration Position called the international
revenue raisers "proposals to close international tax
loopholes that currently allow multinational corporations to
inappropriately lower their U.S. taxes." Although these
changes were billed as "loophole closers" by the
Administration and the proposal's sponsors, that moniker belies
their complexity and the fact that several of the provisions
reflect significant changes in the underlying policy of taxation of
foreign source income.
Moreover, the new international revenue raisers were developed
without public input and have not received much technical scrutiny
prior to enactment. Several of the proposals, especially the
foreign tax credit "matching" provision, raise a host of
technical issues. Because neither the Ways and Means Committee nor
the Finance Committee ever formally considered the revenue raisers
and no conference was held, there is almost no legislative history
other than Joint Committee on Taxation technical
explanations.
Several of the provisions are effective upon enactment, which is
August 10, 2010. Others become generally effective on January 1,
2011, or in the first taxable year beginning after December 31,
2010. There will therefore be significant and immediate pressure on
the Treasury Department and the IRS to publish interpretive
guidance regarding these new provisions.
International Tax Provisions in the Bill
Changes to the Foreign Tax Credit
The bill makes changes to the foreign tax credit rules that will
require U.S multinational groups to reconsider their current
operations and organizational structure.
"Matching" Rule to Prevent Separation of
Creditable Foreign Taxes from Associated Foreign Income (raises
$4.25 billion over 10 years)
Although the foreign tax credit is intended to relieve the double
taxation that would otherwise occur on foreign source income, the
foreign tax credit rules and income recognition rules do not always
match up for foreign and U.S. tax purposes. The foreign country may
tax the income before or after the United States, and the two
countries may see different entities as the taxpayer. The foreign
tax credit carryback and carryforward are intended to address these
timing differences.
The bill, however, addresses this potential timing problem, but
only in the government's favor. New section 909 of the Internal
Revenue Code provides that if there is a foreign tax credit
splitting event, the taxpayer cannot take a foreign tax credit
until the taxable year in which the related income is recognized
for U.S. tax purposes by the taxpayer. This is simple in concept
but very complicated in practice.
A foreign tax credit splitting event occurs if the income to which
the foreign income tax relates is taken into account by a covered
person (any entity in which the payor of the foreign tax holds at
least a 10 percent ownership interest, any person which holds at
least a 10 percent ownership interest in the payor, any person that
is related to the payor, and anyone else added by
regulation).
The new rules apply whether one directly pays the foreign tax
(i.e., as the partner in a partnership or as the owner of a
disregarded entity) or whether one is eligible for deemed paid
credits from a subsidiary corporation (i.e., taxes of a
"section 902 corporation" are not eligible for the deemed
paid credit until the related income is distributed to the person
eligible for the deemed paid credit).
New section 909 applies generally to foreign income taxes paid or
accrued in taxable years beginning after December 31, 2010.
Limitation on Foreign Tax Credit in Covered Asset
Acquisitions (raises $3.645 billion over 10 years)
This provision denies a foreign tax credit for the disqualified
portion of any foreign income tax paid or accrued in connection
with a covered asset acquisition. A covered asset acquisition
is
- a qualified stock purchase that is treated under section 338(a)
as an acquisition of assets,
- any transaction which is treated as an acquisition of assets
for U.S. tax purposes but which is treated as the acquisition of
stock of a corporation (or is disregarded) for foreign tax
purposes,
- any acquisition of an interest in a partnership which has an
election in effect under section 754, or
- to the extent provided by the Secretary, any other similar transaction.
The provision is generally effective for covered asset
acquisitions after December 31, 2010, with "binding
contract" relief.
Separate Foreign Tax Credit Basket for Income Resourced
under a Tax Treaty (raises $250 million over 10
years)
The provision applies a separate foreign tax credit limitation for
each item that (a) would be treated as U.S. source under U.S.
domestic law, (b) would be treated as foreign source under a treaty
obligation of the United States, and (c) the taxpayer chooses the
benefits of such treaty. The provision is effective for taxable
years beginning after the date of enactment (August 10,
2010).
Limitation on Amount of Foreign Taxes Paid in Section 956
Inclusions ("Hopscotch Rule") (raises $704 million over
10 years)
The provision limits the amount of foreign taxes creditable when
section 956 of the Internal Revenue Code requires an inclusion of
income. For section 956 inclusions attributable to U.S. property
acquired by a controlled foreign corporation ("CFC")
after December 31, 2010, the amount of foreign taxes deemed paid is
determined by comparing the foreign taxes deemed paid with respect
to the U.S. Shareholder's section 956 inclusion (the
"tentative credit") to a hypothetical credit.
- The hypothetical credit is the amount of foreign taxes the U.S.
shareholder would have been deemed to have paid if a dividend had
been distributed up through the chain (ignoring any withholding
taxes that would have been incurred in an actual
distribution).
- If the hypothetical credit is less than the tentative credit, then the amount of foreign taxes deemed paid with respect to the section 956 inclusion is limited to the hypothetical credit.
Other International Tax Provisions
Special Rule regarding Redemptions by Foreign
Subsidiaries (raises $250 million over 10 years)
The provision generally imposes an additional limitation on the
earnings and profits ("E&P") of a foreign corporation
that is taken into account in determining the amount (and source)
of a distribution that is treated as a dividend. If more than 50
percent of the dividends arising from an acquisition (before taking
into account the provision) would not be (1) subject to U.S. tax in
the year in which the dividend arises or (2) includible in the
E&P of a CFC, then the E&P of the foreign acquiring
corporation is not taken into account.
The special rule is intended to prevent a foreign acquiring
corporation's E&P from permanently escaping U.S. taxation.
It applies to acquisitions after the date of enactment (August 10,
2010).
Change to Interest Expense Allocation Rules for Certain
Foreign Subsidiaries (raises $390 million over 10 years)
For interest expense allocation purposes, the provision treats a
foreign corporation as a member of a U.S. affiliated group, if (a)
more than 50 percent of its gross income is effectively connected
income, and (b) at least 80 percent of its stock is owned directly
or indirectly by members of the affiliated group. If so, all of the
foreign corporation's assets and interest expense are taken
into account for the purposes of allocating and apportioning the
interest expense of the affiliated group. The provision applies to
taxable years beginning after date of enactment (August 10,
2010).
Repeal of 80/20 Company Rules (raises $153 million over 10
years)
The provision repeals the present law rule that (a) treats as
foreign source all or a portion of any interest paid by a resident
alien individual or domestic corporation that meets the 80/20 test
and (b) exempts from U.S. withholding tax all or a portion of any
dividends paid by a domestic corporation that meets the 80/20 test.
The provision generally applies to taxable years beginning after
December 31, 2010. It provides, however, a grandfather rule for
existing 80/20 companies that meet a new 80/20 test for each
taxable year beginning after December 31, 2010, as long as the
grandfathered company does not add a substantial line of
business.
Modification to Recently-Enacted Extension of Statute of
Limitations for Undisclosed Transactions (no revenue effect)
The bill does include one item of good news for taxpayers. The
Hiring Incentives to Restore Employment (HIRE) Act, enacted March
18, 2010, modified Internal Revenue Code section 6501(c)(8) to
extend the statute of limitations for taxpayers who fail to provide
information about certain cross-border transactions or foreign
assets. If the taxpayer fails to provide the required information,
the taxpayer's entire tax return remains open until three years
after the required information is provided. The provision provides
a reasonable cause exception, retroactive to enactment of the HIRE
Act.
Conclusion
These changes, especially those to the foreign tax credit, will
have a significant impact on international businesses. Taxpayers
need to reconsider current cross-border structures and contemplate
restructuring or, in some cases, accelerating planned
transactions.
Because of the stealth in which many of these proposals were
developed and the speed in which all of them were passed by
Congress, they have not received much detailed scrutiny. Some of
them, especially the foreign tax credit "matching"
provision, will require significant administrative guidance as to
details. In light of the effective dates, it is important for
affected companies to analyze quickly but thoroughly the impact of
these provisions to identify where guidance is needed and where
regulatory relief should be sought.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.