International Tax Reform
One focal point for tax legislation in 2010 will be on preventing “international tax avoidance.” The president’s FY 2011 budget proposes to increase U.S. tax revenues from foreign-based income. It also takes aim at reducing the tax incentives for U.S. companies to shift investments, earnings and jobs overseas.
IMPACT: Many proposals on the international front mirror recommendations made in last year’s budget. One major difference, however, is that, a year later, the Treasury Department has completed a year-long hiring blitz of a substantial number of experts in international taxation. With that structure in place, the administration is now prepared to work with Congress, as well as within its existing regulatory authority, on a vigorous international agenda. Major changes are expected in 2010 and 2011.
Deferred Interest Expense
U.S. taxpayers have been able to deduct interest expenses allocable to foreign source income, even if the expenses exceed the income or there is no foreign source income. The president proposes to defer the deduction of interest expense apportioned to foreign-source income that is not currently subject to U.S. tax. The deferred expense would be deductible only in a subsequent year when the foreign source income is subject to U.S. tax.
IMPACT: The Obama administration indicates that the current tax benefits may encourage U.S. businesses to shift investments and jobs overseas, “harming our domestic economy.”
Foreign Tax Credit
The foreign tax credit limitation is applied separately to foreign income in the passive category and the general category. A domestic corporation is deemed to pay the foreign taxes paid by a foreign subsidiary that pays it a dividend. The president would take a dual approach to prevent manipulation of the foreign tax credit. One proposal would determine the deemed-paid foreign tax credit based on the amount of consolidated earnings and profits repatriated to the U.S. taxpayer. Another proposal would adopt a matching rule to prevent the separation of creditable foreign taxes from the associated foreign income.
IMPACT: These foreign tax credit reforms would prevent inappropriate separation of creditable foreign taxes in cases such as hybrid arrangements.
Transfer Pricing
Companies are shifting income through transfers of intangible assets to low-taxed affiliates, resulting in a significant erosion of the U.S. tax base, according to the administration. One proposal would attack excessive income shifting by treating “excessive returns” as subpart F income in a separate foreign tax credit limitation.
Another proposal would clarify that intangible property includes workforce in place, goodwill, and going concern value. In addition, the IRS may value intangible property by considering profits or prices from a “realistic alternative” to the controlled transaction.
IMPACT: American know-how, reputation, and trained personnel are assets that the administration does not want shipped overseas without a higher return on those assets from tax revenues. The transfer-pricing proposal takes special aim at preventing inappropriate avoidance of taxes under Code Sections 367(d) and 482.
Reinsurance Transactions
Reinsurance transactions with foreign affiliates not taxed in the U.S. on insurance income can provide substantial tax advantages over similar transactions with entities taxed in the U.S. The president proposes to deny a deduction for reinsurance premiums paid to affiliated foreign reinsurance companies on U.S. risks. Alternatively, the foreign corporation could elect to treat the premium received as effectively connected income.
Earnings Stripping
Code Sec. 163(j) limits the deductibility of certain related-party interest. However, under current law, companies can reduce U.S. taxes through the use of a foreign entity holding related-party debt. A Treasury study found strong evidence of the use of such techniques by expatriated entities (a U.S. entity that is replaced with a foreign parent). The president proposes to tighten the statutory limitations on the deduction of interest by an expatriated entity to related persons.
Withholding Tax
The president proposes to repeal the 80/20 company provisions. These provisions have provided a limited exception to the rules requiring withholding on dividends and interest paid by a U.S. corporation to a foreign person. International investment companies have found inventive ways lately to significantly broaden this “limited” exception.
IMPACT: While U.S.-source income and gains paid on U.S. stock may be subject to 30 percent U.S. withholding, similar earnings from an equity swap are treated as foreign-source income and are not subject to withholding. The proposal would ensure that economically equivalent transactions are taxed in the same manner.
Taxes on Foreign Oil and Gas
Taxpayers that pay taxes on foreign oil and gas income are not subject to double taxation when they are receiving a specific economic benefit for the payment. The administration believes that existing law fails to achieve an appropriate split when a single payment is made to a foreign country. For example, where the country imposes a levy only on oil and gas income or imposes a higher levy on oil and gas income. The president proposes to limit the application of the foreign tax credit for amounts paid by “dual-capacity” taxpayers.
Foreign Accounts and Trusts – Reporting and Withholding
According to the administration, some Americans have evaded their tax responsibilities by hiding income in a foreign bank account, trust or corporation. The FY 2011 budget would strengthen the information reporting and withholding requirements for income earned abroad.
IMPACT: Hidden foreign assets have been a major target of the IRS and Congress, which see growing evidence of tax evasion in this area … as well as the opportunity to bring significant revenues into the Treasury. The IRS Commissioner has estimated revenues “in the billions” from the agency’s recent pursuit of Swiss account holders alone.
Withholding. One FY 2011 budget proposal would require a withholding agent to withhold tax of 30 percent on payments (of U.S. source income) to foreign financial institutions (FFIs). The FFI would have to report the name, address and taxpayer identification number (TIN) of the U.S. account holder, the account balance, and receipts, withdrawals and payments from the account.
Another proposal would require a withholding agent making a payment of interest or dividends to a foreign entity, or of proceeds from property that can generate interest or dividends, to withhold tax of 30 percent, unless the foreign entity certifies that no U.S. person owns an interest greater than 10 percent, or unless the entity provides the name, address, and TIN of each substantial U.S. owner.
COMMENT: Use of technology is also being called upon in the government’s mission to prevent foreign tax evasion. Along with withholding requirements, the administration would require electronic filing of returns by a financial institution that withholds taxes, effective for returns due after the date of enactment.
Registered bonds. Taxpayers can deduct interest on debt. A deduction for interest is allowed for certain bonds if they are in registered form. The administration would eliminate the foreign-targeted exceptions to the registration requirements, to ensure that owners are properly identified and that the income is properly reported. The provision would apply to obligations issued two years after the law’s date of enactment.
Reporting of bank accounts. Another proposal would supplement but not replace the reporting of foreign bank accounts on Form TD F 90-22.1 (FBAR). Any U.S. individual holding an interest in a foreign financial account, foreign entity, or instrument issued by a foreign person, would have to file an information return if the total assets of all accounts exceed $50,000. The IRS could impose reporting for domestic entities formed to hold foreign financial assets. Penalties for non-reporting would be at least $10,000. The proposal would take effect for tax years beginning after the date of enactment.
IMPACT: A rebuttable presumption would be allowed for the IRS in civil actions. If it is established that the individual had an undisclosed foreign account/asset, the aggregate value of the undisclosed account/asset would be presumed to exceed $50,000.
IMPACT: Penalties of 20 and 40 percent would be imposed on any understatement of tax attributable to undisclosed foreign financial assets. Moreover, the statute of limitations would be extended to six years for omissions from gross income exceeding $5,000 attributable to the nondisclosure of foreign financial assets. The extended statute of limitations would apply to returns for which the three-year statute has not expired.
COMMENT: Reporting would not be required where the U.S. financial institution determines that, among other things, the entity making or receiving the transfer is a publicly-traded corporation.
Trust reporting. A foreign trust that receives property from a U.S. person would be presumed to have a U.S. beneficiary under the president’s overall plan. This presumption will improve the ability of the IRS to enforce U.S. tax rules applicable to foreign trusts. The U.S. transferor can overcome the presumption by filing an information return indicating that neither the trust income nor its corpus benefits any U.S. person. This proposal would apply to transfers of property after date of enactment.
Penalties would also be increased for certain foreign trusts that fail to report transfers to and distributions from the trust.
Source: CCH, a Wolters Kluwer business