The increasing globalization of the economy has made international tax issues more commonplace, even for smaller practitioners, since any transaction that goes across an international border has tax implications.
Significant pieces of legislation enacted during the past year, as well as proposals in the Obama administration's budget, will affect the international tax landscape in the months ahead, say experts.
"It was a huge year for developments on the international scene," said Harold Pskowski, managing editor for U.S. international tax publications at BNA. "[The Foreign Account Tax Compliance Act] in March, the foreign tax credit 'splitter' legislation in August, and now the Green Book proposals [the explanation by the Treasury of the Obama administration budget proposals] are extremely significant."
FATCA, originally enacted as a "pay-for" in last year's HIRE Act, is meant to prevent offshore tax abuses. It imposes a 30 percent withholding tax on foreign entities that won't disclose the identities of U.S. account holders, and has extensive reporting requirements.
"U.S. persons have been setting up foreign entities to siphon U.S.-sourced income overseas, and disguising themselves as foreign persons," explained Pskowski. "This legislation is designed to cure this. Now the payor will have to verify the status of the payee to make sure they are, in fact, foreign."
"FATCA is a huge issue, but it doesn't go into effect until Jan. 1, 2013," noted Remy Farag, international tax analyst at the Tax & Accounting business of Thomson Reuters. "The regulations are still in the development stage. A lot of the larger foreign financial institutions are lobbying for 'carve-outs,' for classes and sections that might not fall under the purview of the reporting requirements."
The effect of the foreign tax credit "splitter" rules is that U.S. corporations will be able to use fewer foreign tax credits than in the past, he observed. The new rules are in Code Section 909, which came into effect for transactions that begin after Dec. 31, 2010.
"The new law provides that a taxpayer can't claim a foreign tax credit until it recognizes the related income for the Section 901 credit, or an appropriate level of foreign income for U.S. tax purposes," said Farag. "It's trying to remedy situations where a U.S. entity pays foreign tax abroad but doesn't repatriate income back to the U.S. The general rule prior to this was that if you pay income tax to a foreign government, you would get a foreign tax credit under Section 901. People were trying to amass as much foreign tax credit as they could. Under this provision, the credits are not disallowed, but they are suspended until the income is brought back to the U.S." If there is an FTC splitting event, the FTC will not be taken into account before the related year, he said. "So it is suspending the credits, not disallowing them. In some instances, though, it appears that these FTCs can be suspended indefinitely. In effect, what good is a tax credit that is suspended indefinitely?"
TODAY, NOT TOMORROW
Although recent congressional hearings on tax reform addressed the possibility of lowering corporate rates and moving from the current worldwide system to a more territorial system, the president's recent budget proposals dealt mainly with the way the current system works, according to Joe Calianno of Grant Thornton's National Tax Office. "A lot were hoping for a broader reform in the international tax area," he said. "But what we have in the budget this year is designed to address the way the current system works."
Most of the proposals, he added, were designed to raise taxes by targeting U.S.-based multinationals. "If these were to be enacted, they would be harmful to U.S.-based companies, since the proposals would put them at a competitive disadvantage to foreign-based multinationals."
One of the proposals would defer the deduction-of-interest expense for foreign-source income, according to Jon Davies, international tax partner at the Silicon Valley office of Armanino McKenna. Deferred interest expense would be deductible in a subsequent tax year in proportion to the amount of the previously deferred foreign-source income that is subject to U.S. tax during that subsequent tax year.
"The main thrust is that there are situations where you can deduct the entire amount of a foreign expense, even though there is no foreign-source income, because it's in a foreign subsidiary, and the U.S. parent is able to deduct that currently," said Davies. "The administration concern is that we're funding overseas investment, rather than expansion in the U.S. The proposal would defer the interest-expense deduction until the foreign-source income that it relates to is brought back to the U.S."
Another proposal, which would affect transfers of technology out of the U.S., has met with greater resistance, according to Davies. It would provide that if a U.S. person transfers, directly or indirectly, an intangible from the U.S. to a related controlled foreign corporation, then "excess income" from transactions connected with or benefiting from the intangible would be treated as Subpart F income (which is deemed to be brought back into the U.S., and taxable in the U.S.) if the income is subject to a low foreign effective tax rate.
SEEKING MORE GUIDANCE
The codification of the economic substance doctrine and the enactment of the FTC splitter rules are both important legislation, but so far there has been little guidance, observed Rodney Lawrence, principal-in-charge of KPMG's international corporate services practice. "The economic substance legislation put new rules in the Tax Code that are supposed to codify old court decisions and the common law," he said. "So far, there's no real guidance on it. It basically says that it only applies when it's relevant, but no one can be sure when it's relevant. It's estimated to raise $6 billion, and that's all in penalties."
The FTC splitter rule is designed so that a taxpayer can claim a foreign tax credit for foreign taxes paid only when the related income has been brought into the U.S. "A lot of international tax-planning structures split off taxes from income," explained Lawrence. "If you're a multinational and can get credit now without bringing the related income into the U.S. tax base, it's a winner, because you're getting the credit without having to pay tax on the income."
Although the splitter rules came into effect at the beginning of the year, the guidance on the rules is primarily on their retroactivity, Lawrence observed. "There's no real guidance on how to employ the rules going forward," he said.
Cross-border corporate actions generate particularly difficult tax issues, with even simple corporate actions resulting in unexpected consequences, according to Richard Ryndak, senior product manager of capital changes at Wolters Kluwer Financial Services. "U.S. investors in foreign companies need to be aware if a company was or might become a [passive foreign investment company] during the holding period," he said. "If it was a PFIC at any point, it has to continue to be treated as a PFIC for the investor's purposes."
As an example, Ryndak pointed out that international hotel conglomerate Accor SA split its hotels and prepaid services businesses during 2010 into two separately listed companies. "The hidden issue is that the company stated that it expected to become a PFIC," he said. "To prevent the sheltering of investments abroad, there is a rule that says that if a company is a PFIC, any excess distribution or any gain on the distribution is subject to an extremely onerous tax, allocated over the entire holding period it was a PFIC. Income may have to be restated for prior years of the holding period if it became a PFIC."
INERTIA ON BUDGET PROPOSALS
The administration budget proposals that put U.S.-based multinationals at a competitive disadvantage are less likely to be enacted now that there is a split in party control of the Senate and the House, said Grant Thornton's Calianno: "I doubt that there will be a lot of support in the House for these proposals."
Marc Gerson, former majority tax counsel to the House Ways & Means Committee and tax partner at Miller & Chevalier, agreed. "Although the budget doesn't include any big reform proposals, it does contain some significant changes to the international tax regime," he said. "However, given the change in control of the House, and the fact that offsets are not required for legislation, there is now an environment that makes it less likely that proposals contained in the budget will get serious traction."
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