House Ways and Means Committee Chairman Sander Levin, D-Mich., has introduced a bill that would close tax loopholes blamed for encouraging multinational companies to ship jobs overseas.
H.R. 5893, the Investing in American Jobs and Closing Tax Loopholes Act of 2010, also includes provisions for extending the Build America Bonds program for one year to fund domestic infrastructure improvements and to extend the Emergency Fund for Job Creation and Assistance program for another year to help states support job programs.
The bill includes a package of provisions developed jointly by the Treasury Department, the Committee on Ways and Means and the Senate Finance Committee to curtail abuses of the U.S. foreign tax credit system. The bill would eliminate an estimated $11.6 billion of foreign tax credit loopholes.
The bill includes rules to prevent splitting of foreign tax credits from income. The bill would adopt an Obama administration budget proposal by implementing a matching rule that would suspend the recognition of foreign tax credits until the related foreign income is taken into account for U.S. tax purposes. The bill would not affect timing differences that result from normal tax accounting differences between foreign and U.S. tax rules. The provision would apply to all split foreign taxes claimed by taxpayers after Dec. 31, 2010.
Another provision would prevent taxpayers from claiming the foreign tax credit with respect to foreign income that is never subject to U.S. taxation because of a covered asset acquisition. The provision would generally apply to transactions occurring after Dec. 31, 2010, with special transition rules for certain transactions between unrelated parties.
Another provision would crack down on the separate application of foreign tax credit limitation to items resourced under tax treaties. To prevent double taxation, taxpayers are permitted to claim foreign tax credits with respect to foreign taxes paid on income earned offshore. To appropriately limit use of the foreign tax credit system to avoidance of double taxation, foreign tax credits are limited to the maximum amount of U.S. tax that could be imposed on the taxpayers foreign source income (i.e., 35 percent of the taxpayers foreign source income). Some taxpayers have devised a technique to use the U.S. treaty network to enhance foreign tax credit utilization well beyond what is needed to avoid double taxation by artificially inflating foreign source income. With this technique, ownership of income-producing assets that would ordinarily be held by U.S.-based multinational companies in the United States (e.g., investments in U.S. securities) is shifted to foreign branches and disregarded entities. This income is often lightly taxed on a net basis by the foreign country, but the treaty prevails in categorizing the entire gross amount of the income generated by the U.S. assets as foreign source. This artificially inflates the taxpayers foreign source income and allows the taxpayer to use foreign tax credits to reduce taxes on foreign source income beyond the maximum amount of U.S. tax that could be imposed on such income. This unintended tax planning technique has nothing to do with relieving double taxation. The bill respects the treaty commitment to treating such income as foreign source, but segregates the income so that it is not the basis for claiming foreign tax credits that have nothing to do with double taxation. In doing so, the bill conforms the foreign tax credit treatment of taxpayers operating abroad through foreign branches and disregarded entities to the treatment already afforded to taxpayers operating through foreign corporations. The provision would apply to taxable years beginning after the date of enactment.
Another provision would place a limitation on the use of Section 956 for foreign tax credit planning (i.e., the hopscotch rule). U.S.-based multinational companies typically have complex foreign structures designed to mitigate their worldwide tax expense. In many cases, these structures include companies located in low-tax jurisdictions (e.g., tax havens such as Bermuda and the Cayman Islands) in a multi-tier chain of subsidiaries. If a foreign subsidiary with a relative high tax expense distributes a dividend up through a chain of companies, the foreign tax credit on the dividend ultimately received by the U.S. shareholder is a blend of the tax rates of each foreign subsidiary in that chain. If there is a tax-haven company in that chain, the U.S. tax due on the dividend may be significantly higher than the tax would have been if the foreign subsidiarys dividend could have simply hopscotched over the chain as a direct distribution to the U.S. shareholder. Affirmative use of section 956, which was originally enacted as an anti-abuse provision, readily accomplishes this hopscotch by deeming a dividend from a foreign subsidiary directly to the U.S. shareholder. By taking advantage of this hopscotch rule, the foreign tax credit on this deemed dividend can be greater than the foreign tax credit would be on an actual dividend. The bill would limit the amount of foreign tax credits that may be claimed with respect to a deemed dividend under Section 956 to the amount that would have been allowed with respect to an actual dividend. The provision would apply to the affirmative use of section 956 after the date of Dec. 31, 2010.
The bill also includes a special rule with respect to certain redemptions by foreign subsidiaries. Where a foreign-based multinational company owns a U.S. company, and that U.S. company owns a foreign subsidiary, the earnings of the foreign subsidiary are generally subject to U.S. tax when they are distributed to the U.S. shareholder. When those earnings are then distributed by the U.S. company to its foreign shareholder, a 30 percent withholding tax applies, unless reduced by treaty or some other provision of the tax code.
Foreign-based multinational companies have devised a technique for avoiding U.S. taxation of such foreign subsidiary earnings. This technique involves a provision of the tax code that was originally enacted as an anti-abuse rule that treats certain sales of stock between related parties as a dividend. For example, under this provision, where a foreign-based multinational corporation sells stock in the U.S. company to its foreign subsidiary, the cash received from the foreign subsidiary in this sale is treated as a dividend from that foreign subsidiary. This deemed dividend allows the foreign subsidiarys earnings to completely and permanently bypass the U.S. tax system. The bill would eliminate this type of tax planning by preventing the foreign subsidiarys earnings from being reduced and, as a result, the earnings would remain subject to U.S. tax (including withholding tax) when repatriated to the foreign parent corporation as a dividend. The provision would apply to acquisitions after Dec. 31, 2010.
Another provision would modify the affiliation rules for purposes of rules allocating interest expense. To prevent double taxation (i.e., full taxation by both a foreign country and by the United States on the same item of income), taxpayers are permitted to claim foreign tax credits with respect to foreign taxes paid on income earned offshore. To appropriately limit use of the foreign tax credit system to avoidance of double taxation, foreign tax credits are limited to the maximum amount of U.S. tax that could be imposed on the taxpayers foreign source income (i.e., 35 percent of the taxpayers foreign source income). Taxpayers have used various techniques to minimize the amount of foreign source interest expense, which has the effect of artificially boosting foreign source income. In turn, this permits taxpayers to utilize more foreign tax credits than would otherwise be possible, and the use of such additional foreign tax credits has nothing to do with relieving double taxation. To prevent taxpayers from avoiding these rules, Treasury regulations prevent taxpayers from excluding foreign interest expense from the foreign tax credit limitation by placing it in foreign subsidiaries. The regulations achieve this result by including certain subsidiaries in the U.S. affiliated group. As a result, foreign source interest expense will be taken into account in the determination of the foreign tax credit limitation. The bill would modify the affiliation rules to strengthen these anti-abuse rules. The provision would apply to taxable years beginning after the date of enactment.
The bill also includes a repeal of the 80/20 rules. Under current law, dividends and interest paid by a domestic corporation are generally considered U.S.-source income to the recipient and are generally subject to gross basis withholding if paid to a foreign person. If at least 80 percent of a corporations gross income during a three-year period is foreign source income and is attributable to the active conduct of a foreign trade or business (a so-called 80/20 company), dividends and interest paid by the corporation will generally not be subject to the gross basis withholding rules. Furthermore, interest received from an 80/20 company can increase the foreign source income of, and therefore the amount of foreign tax credits that may be claimed by, a U.S. multinational company. The Treasury has become aware that some companies have abused the 80/20 company rules. As a result, the Presidents 2011 Budget proposes to repeal these rules. The bill would adopt the Presidents budget proposal to repeal the 80/20 company rules. The bill would also repeal the 80/20 rules for interest paid by resident alien individuals. The bill would include relief for existing 80/20 companies that meet specific requirements and are not abusing the 80/20 company rules. Subject to the relief for these existing 80/20 companies, the provision would apply to taxable years beginning after Dec. 31, 2010.
Another provision covers the source rules on guarantees. Under current law, the treatment of guarantee fees under the source rules is unclear. If guarantee fees are sourced like services, they are sourced according to the location in which the services were performed. If the guarantee fees are sourced like interest, they are sourced by reference to the country of residence of the payor. A recent court case determined that guarantee fees should be sourced like services. Sourcing guarantee fees in a manner similar to services would permit U.S. subsidiaries of foreign corporations to engage in earning stripping transactions by making deductible payments to foreign affiliates (thereby reducing their U.S. income tax liability) without the imposition of U.S. withholding tax on the payment. The bill would provide that guarantees on indebtedness issued after the date of enactment will be sourced like interest and, as a result, if paid by U.S. taxpayers to foreign persons will generally be subject to withholding tax. No inference is intended with respect to the treatment of guarantees on indebtedness issued before the date of enactment.
In addition, the bill contains a technical correction to statute of limitations provision in the HIRE Act. The bill would make a technical correction to the foreign compliance provisions of the Hiring Incentives to Restore Employment (HIRE) Act that would clarify the circumstances under which the statute of limitations will be tolled for corporations that fail to provide certain information on cross-border transactions or foreign assets. Under the technical correction, the statute of limitations period will not be tolled if the failure to provide such information is shown to be due to reasonable cause and not willful neglect.