11 February 2016 International tax provisions in the Administration's fiscal year 2017 budget substantially similar to 2016 proposals On February 9, 2016, the Obama administration (the Administration) released its fiscal year 2017 budget proposals (the FY2017 Budget or Budget). At the same time, the Treasury Department released its General Explanations of the Administration's Fiscal Year 2017 Revenue Proposals (the Green Book). The international proposals in the FY2017 Budget and the Green Book are substantially similar to last year's proposals except that the proposals relating to i) active financing, and ii) the exemption of foreign pension funds from application of the Foreign Investment in Real Property Act (FIRPTA) have been removed, as those provisions were the subject of the Protecting Americans from Tax Hikes (PATH) Act of 2015 that was enacted on December 18, 2015. — Impose a 19% minimum tax on foreign income Detailed discussion In general, and subject to the rules of subpart F, US multinational companies generally defer US tax on the profits earned by their foreign subsidiaries until these profits are repatriated to the United States. According to the Green Book, the ability to defer US tax on CFC earnings until the profits are repatriated provides an incentive for US multinationals to shift profits abroad and thereby erode the US tax base. The Green Book asserts that the current system also discourages US multinationals from repatriating foreign earnings (due to the significant residual US tax payable). Additionally, the Green Book states that the current foreign tax credit system allows companies to reduce US tax on low-tax foreign-source income. The Administration proposes to supplement the existing subpart F regime with a per-country minimum tax on the foreign earnings of US corporations and their CFCs (the proposed minimum tax regime). The minimum tax would apply to a US corporation that either: (i) is a United States shareholder of a CFC or (ii) has foreign earnings from a branch or from the performance of services abroad. The foreign earnings of the CFC or branch or from such services would be subject to current US taxation at a rate (not below zero) of 19% less 85% of the per-country foreign effective tax rate (the residual minimum tax rate). The country to which foreign earnings and associated foreign taxes are assigned would be based on tax residence under foreign law. Earnings and taxes of a particular CFC may be allocated to multiple countries if the CFC has earnings subject to tax in different countries. If the same earnings of a CFC are subject to tax in multiple countries, the earnings (and all of the foreign taxes associated with those earnings) would be assigned to the highest-tax country. The minimum tax for a particular country would be computed by multiplying the applicable residual minimum tax rate by the minimum tax base for that country. A US corporation's tentative minimum tax base for a country for a tax year would be the total amount of foreign earnings for the tax year assigned to that country for purposes of determining the effective tax rate for the country. In assigning earnings to countries, both for purposes of determining the foreign tax rate as well as for determining the tentative minimum tax base for a particular year, rules would be implemented to restrict the use of hybrid arrangements to shift earnings from a low to a high-tax country for US tax purposes without triggering tax in the high-tax country. The tentative minimum tax base would be reduced by an allowance for corporate equity (ACE). Active assets generally would include assets that do not generate "foreign personal holding company income" under subpart F, determined without regard to either the "look-through rule" of Section 954(c)(6) or an election to disregard an entity as separate from its owner. According to the Green Book, the ACE allowance is intended to exempt from the minimum tax a return on the actual activities undertaken in a foreign country. The minimum tax would be imposed on current foreign earnings, regardless of whether they are repatriated to the United States, and all foreign earnings could be repatriated without further US tax. No US tax would be imposed on the sale by a United States shareholder of stock of a CFC to the extent any gain reflects the undistributed earnings of the CFC, which generally would have already been subject to tax under the proposed minimum tax, subpart F, or the one-time 14% tax (described in the next section) on previously untaxed income. Any stock gain that is attributable to unrealized (and therefore untaxed) gain in the CFC's assets would be subject to US tax in the same manner as would apply to the future earnings from those assets. Foreign-source royalty and interest payments received by US corporations would be subject to US tax at the full statutory rate. Under the proposal, a foreign branch of a US corporation would be treated like a CFC. Interest expense incurred by a US corporation that is allocated and apportioned to foreign earnings on which the minimum tax is paid would be deductible at the residual minimum tax rate applicable to those earnings. No deduction would be permitted for interest expense allocated and apportioned to foreign earnings on which no US income tax is paid. Finally, current-law rules regarding CFC investments in US property and previously taxed earnings would be repealed for US shareholders that are US corporations. One component of subpart F income is "foreign personal holding company income," which generally includes dividends, interest, rents and royalties. There are several exceptions to the definition of foreign personal holding company income. One temporary exception (the CFC look-through rule) applies to dividends, interest, rents, and royalties received or accrued by a CFC from a related CFC, to the extent the payments are attributable or properly allocable to income of the related CFC that is neither subpart F income nor income treated as effectively connected with the conduct of a trade or business in the United States. The CFC look-through rule applies to tax years of foreign corporations beginning after December 31, 2005, and before January 1, 2020, and to tax years of U.S shareholders with or within which such tax years of the foreign corporations end. The Administration proposes to make the CFC look-through rule permanent and income qualifying for the look-through exception would be subject to the 19% minimum tax. The proposal is estimated to raise $350 billion over 10 years and is proposed to be effective for tax years beginning after December 31, 2016. Under the proposed minimum tax regime, no US tax would be imposed on dividend payments from a CFC to a US shareholder. As a transition measure, the Administration is proposing a one-time 14% tax on accumulated earnings of CFCs that were not previously subject to US tax. A credit would be allowed for the amount of foreign taxes associated with such accumulated earnings, multiplied by the ratio of the one-time tax rate to the maximum US corporate tax rate for 2016. The one-time tax would be payable ratably over five years. The accumulated income would not be subject to further US tax on repatriation. The proposal is estimated to raise $299.4 billion over 10 years and is proposed to be effective on the date of enactment for earnings accumulated for tax years beginning no later than December 31, 2016. The American Jobs Creation Act of 2004 enacted a one-time election (the worldwide interest allocation election) under which members of an affiliated group of US corporations could, in certain circumstances, allocate interest on a worldwide group basis for foreign tax credit limitation purposes. The availability of this election has been deferred by subsequent legislation until tax years beginning after December 31, 2020. The Administration proposes to accelerate the availability of the worldwide interest allocation election. Under the Administration's proposed minimum tax regime, a taxpayer would be required to allocate and apportion interest expense among foreign-source gross income: (i) subject to tax at the full US statutory rate, (ii) subject to tax at various rates of US tax under the minimum tax, and (iii) not subject to US tax. According to the Green Book, absent the worldwide interest allocation election, certain taxpayers would be required to allocate more of their interest expense to these various categories of foreign-source gross income than is appropriate. The proposal is estimated to reduce revenue by $9.9 billion over 10 years and is proposed to be effective for tax years beginning after December 31, 2016. Under current law, a corporation may receive cash or other property without recognizing income in exchange for issuing its stock. The Green Book states that corporations are avoiding dividend treatment by causing a subsidiary to issue property to its corporate shareholder in exchange for stock (so-called hook stock). The Administration's proposal would disregard a subsidiary's purchase of hook stock for property so that the property used to purchase the hook stock would give rise to a deemed distribution from the purchasing subsidiary (through any intervening entities) to the issuing corporation. The hook stock would be treated as being contributed by the issuer (through any intervening entities) to the subsidiary. The proposal would grant the IRS authority to prescribe regulations to treat purchases of interests in shareholder entities other than corporations in a similar manner and to provide rules related to hook stock within a consolidated group. The proposal is estimated to raise $60 million over 10 years and would be effective for transactions occurring after December 31, 2016. 2. Prevent use of leveraged distributions from related foreign corporations to avoid dividend treatment Generally, property distributed by a corporation with respect to its stock is first treated as a dividend under Section 301(c)(1) to the extent of the distributing corporation's applicable E&P. Outside of the corporate reorganization and spin-off contexts, all of a corporation's current and accumulated E&P are taken into account in determining the extent to which a distribution of property made by the corporation is taxed as a dividend. The portion of the distribution received by a shareholder that is not a dividend applies against and reduces the shareholder's adjusted basis of the corporation's stock, and any amount distributed in excess of the shareholder's basis that is not a dividend is treated as gain from the sale or exchange of property. The shareholder takes a basis in the distributed property equal to its fair market value. The Green Book contends that corporations are entering into "leveraged distribution" transactions as a means to avoid dividend treatment under current law. As an example, it describes a corporation with E&P that would provide funds (e.g., through a loan) to a related corporation with little or no E&P, but in which the distributee shareholder has a relatively high adjusted stock basis. The Administration's proposal would treat a leveraged distribution from a corporation (distributing corporation) to its shareholder that is treated as a recovery of basis as the receipt of a dividend directly from a related corporation (funding corporation) to the extent the funding corporation funded the distribution "with a principal purpose of not treating the distribution as a dividend from the funding corporation." The Green Book notes that this proposal is revised from last year's proposal, which would have disregarded a shareholder's basis in the stock of a distributing corporation for purposes of recovering such basis without tax under Section 301(c)(2). The proposal is estimated to raise $260 million over 10 years and would be effective for transactions occurring after December 31, 2016. Under current law, if a target shareholder receives boot in exchange for target stock in a Section 368(a) reorganization, the shareholder generally must recognize gain equal to the lesser of the gain realized in the exchange or the amount of the boot received (the boot-within-gain limitation). If the exchange results in the distribution of a dividend, any gain recognized by the shareholder is treated as a dividend to the extent of the shareholder's share of the corporation's E&P, and the balance of the gain is treated as gain from the exchange of property. Furthermore, when the exchange has the effect of the distribution of a dividend, then all or part of the gain recognized by the exchanging shareholder is treated as a dividend to the extent of the shareholder's ratable share of the corporation's E&P. Outside the reorganization context, the amount treated as a dividend is by reference to all of a corporation's current and accumulated E&P. The Green Book states that there is no significant policy reason to vary the tax treatment of a distribution received in a reorganization (and currently subject to the boot-within-gain limitation) with the treatment afforded ordinary distributions under Section 301. The proposal would repeal the boot-within-gain limitation. Moreover, the proposal would "align the available pool of earnings and profits to test for dividend treatment" with the rules governing ordinary distributions. The proposal is estimated to raise $628 million over 10 years and is proposed to be effective for transactions occurring after December 31, 2016. The Administration again proposes to restrict deductions for interest expense for certain members of financial reporting groups. The formula for calculating the restriction in this year's proposal differs slightly from last year's formula. Moreover, this year's proposal should be evaluated in the context of the proposed minimum tax regime, under which the deduction for interest expense could be reduced or eliminated altogether, as discussed earlier, depending on the income against which it is allocated and apportioned. Section 163(j) disallows a deduction for a specified portion of interest expense paid by a domestic corporation to a related person when, inter alia, the corporation's debt-to-equity ratio is greater than 1.5:1. The Green Book states that Section 163(j) does not consider the leverage of a multinational group's US operations relative to the leverage of the group's worldwide operations in limiting deductions. According to the Green Book, this allows foreign-parented multinational groups to inappropriately reduce US tax on income from US operations by over-leveraging US operations relative to those located in lower tax jurisdictions. The Administration proposes to restrict deductions for "excessive" interest of members of a "financial reporting group," which is any group that prepares consolidated financial statements in accordance with US Generally Accepted Accounting Principles, International Financial Reporting Standards, or another method authorized by regulations. The interest expense limitation would be determined under a new relative leverage rule. In general, a financial reporting group member's interest expense deduction would be limited if: (i) the member has net interest expense for tax purposes (computed on a separate-company basis); and (ii) the member's net interest expense for financial reporting purposes (computed on a separate-company basis) exceeds the member's proportionate share of the net interest expense reported on the financial reporting group's consolidated financial statements. A member's proportionate share of the financial reporting group's net interest expense would be determined based on the member's proportionate share of the group's earnings (computed by adding back net interest expense, taxes, depreciation, and amortization) reflected in the group's financial statements. Alternatively, under the proposal, if a member fails to substantiate its proportionate share of a group's net interest expense, or if a member so elects, the member's interest deduction would be limited to the sum of the member's interest income and 10% of the member's adjusted taxable income, as defined in Section 163(j). The proposal, which would be subject to a number of important exceptions, would permit disallowed interest to be carried forward indefinitely and excess limitation for three years. If a member of a financial reporting group is subject to the rules under this new limitation provision, the member would not be subject to the application of Section 163(j). The proposal is estimated to raise $70.5 billion over 10 years and is proposed to be effective for tax years beginning after December 31, 2016. The Administration proposes again to tighten the rules under Section 7874 that apply to expatriation or inversion transactions. This year's proposal includes modifications limiting the proposal's scope. Section 7874 generally applies to expatriation or inversion transactions, including the direct or indirect acquisition by a foreign corporation of substantially all of the trade or business properties of a domestic partnership by a foreign corporation. Under current law, if the former owners of an inverted US entity own at least 60% but less than 80% of the foreign acquiring corporation, the acquired US entity will be denied certain tax attributes for 10 years after the acquisition. If the former owners of the US entity own 80% or more of the foreign acquiring corporation, the foreign acquiring corporation will be treated as a US corporation for all US federal income tax purposes. These rules do not apply, however, if, after the acquisition, the expanded affiliated group (EAG) that includes the foreign acquiring corporation has substantial business activities in the foreign country where the foreign acquiring corporation is created or organized, when compared to the total business activities of such group. The Green Book states that there is no policy reason to respect an inverted structure when the owners of a US entity retain a controlling interest in the EAG, only minimal operational changes are expected, and there is potential for substantial erosion of the US tax base. The Green Book also contends that the inverted structure resulting from the combination of a larger US group with a smaller foreign entity or group should not be respected if, after the combination, the EAG is primarily managed and controlled in the United States and does not have substantial business activities in the country in which the foreign entity was organized — even if the shareholders of the US entity do not maintain control of the resulting multinational group. The Administration's proposal would broaden the definition of an inversion transaction by replacing the 80% test in Section 7874 with a greater-than-50% test and eliminating the 60% test. The proposal also would add a "special rule" that would deem an inversion to occur (regardless of the level of shareholder continuity immediately after the acquisition) if: (i) immediately prior to the acquisition, the fair market value of the stock of the US entity is greater than the fair market value of the stock of the foreign acquiring corporation; (ii) the EAG is primarily managed and controlled in the United States; and (iii) the EAG does not conduct substantial business activities in the country in which the foreign acquiring corporation is created or organized. The proposal would expand the acquisitions subject to Section 7874 to include a direct or indirect acquisition of substantially all of the assets of a US partnership, substantially all of the trade or business assets of a US corporation, or substantially all of the US trade or business assets of a foreign partnership. Finally, the proposal would provide the IRS with authority to share tax return information with Federal agencies for the purpose of administering an agency's anti-inversion rules. The proposal is estimated to raise $13.4 billion over 10 years and is generally proposed to be effective for transactions completed after December 31, 2016. The proposal providing the IRS with the authority to share tax return information would be effective after December 31, 2016, without regard to when the inversion transaction occurred. Provide incentives for locating jobs and business activity in the United Sates and deny tax deductions for activity considered to involve "shipping jobs overseas" According to the Green Book, there are limited tax incentives for US employers to bring offshore jobs and investments into the United States under current law. The Green Book further provides that costs incurred to outsource US jobs generally are deductible for US income tax purposes. The Green Book notes that, despite the recent progress on "insourcing" of US businesses, the Administration's goal is to create tax incentives to bring offshore jobs and investments back into the United States and to reduce the tax benefits that exist under current law for expenses incurred to move US jobs offshore. The Administration's proposal would create a new general business credit against income tax equal to 20% of the eligible expenses paid or incurred in connection with insourcing a US trade or business. The Green Book provides that "insourcing a US trade or business" means reducing or eliminating a trade or business (or line of business) currently conducted outside the US and starting up, expanding or otherwise moving the same trade or business within the United States, to the extent that this action results in an increase in US jobs. It further provides that, while the creditable costs may be incurred by the foreign subsidiary of the US-based multinational company, the tax credit would be claimed by the US parent company. A similar benefit would be extended to non-mirror code possessions (Puerto Rico and American Samoa) through compensating payments from the US Treasury. Additionally, the Administration's proposal would disallow deductions for expenses paid or incurred in connection with outsourcing a US trade or business. For purposes of this proposal, "outsourcing a US trade or business" means reducing or eliminating a trade or business or line of business currently conducted inside the United States and starting up, expanding or otherwise moving the same trade or business outside the United States, to the extent that this action results in a loss of US jobs. It further adds that, in determining the subpart F income of a controlled foreign corporation, no reduction would be allowed for any expenses associated with moving a US trade or business outside the United States. Expenses paid or incurred in connection with insourcing or outsourcing a US trade or business are limited solely to expenses associated with the relocation of the trade or business and do not include capital expenditures or costs for severance pay and other assistance to displaced workers. The proposal would allow the Secretary to prescribe rules to implement the provision, including rules to determine covered expenses. The proposal is estimated to reduce revenue by $211 million over 10 years and is proposed to be effective for expenses paid or incurred after the date of enactment. Under current law, the transfer (or license) of intangible property to a related party is addressed by Section 482, and the transfer of such property in an outbound nonrecognition transaction is addressed by Section 367(d). Section 482 provides that the income generated from a transfer of intangible property must be commensurate with the income attributable to such property. Section 367(d) generally provides that the US transferor of such property is treated as selling the property for payments contingent on the productivity, use or disposition of the property commensurate with the transferee's income from the property. Both sections refer to Section 936(h)(3)(B) to define intangible property. The Green Book states that, in both the Section 482 and Section 367(d) contexts, controversy often arises as to whether certain items are considered intangible property. The Administration's proposal would provide that the definition of intangible property under Section 936(h)(3)(B), and therefore Sections 482 and 367(d), includes workforce in place, goodwill and going concern value. The proposal would further provide that intangible property also includes "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." As in prior years, it is not clear if the proposal is intended to include just US goodwill and going concern value and continue the existing exclusions for foreign goodwill and going concern value. The proposal would permit the IRS to value the transfer of multiple intangible properties on an aggregate basis to achieve a more reliable result. It also provides that the IRS may value intangible property taking into consideration the prices or profits that the controlled taxpayer could have realized by choosing a realistic alternative to the controlled transaction undertaken. The proposal is estimated to raise $3.07 billion over 10 years and is proposed to be effective for tax years beginning after December 31, 2016. The Administration's proposal would deny an insurance company a deduction for reinsurance premiums paid to affiliated foreign reinsurance companies to the extent that the foreign reinsurer (or its parent company) is not subject to US income tax on the premiums received. The proposal also would exclude from the insurance company's income (in the same proportion that the premium deduction was denied) any return premiums, ceding commissions, reinsurance recovered, or other amounts received for reinsurance policies for which a premium deduction is wholly or partially denied. The proposal provides that a foreign corporation that is paid a premium from an affiliate that would otherwise be denied a deduction under this provision could instead elect to treat those premiums and the associated investment income as effectively connected with a US trade or business. Such income would be treated as attributable to a permanent establishment for tax treaty purposes. The proposal further provides that the reinsurance income treated as effectively connected under this elective rule would be treated as foreign-source income and would be put in a separate basket for foreign tax credit purposes. The proposal is estimated to raise $7.7 billion over 10 years and is proposed to be effective for policies issued in tax years beginning after December 31, 2016. The Administration's proposal would tighten the foreign tax credit rules that apply to taxpayers that are subject to a foreign levy and also receive (directly or indirectly) a specific economic benefit from the levying country (dual-capacity taxpayers). Under current Treasury regulations, dual-capacity taxpayers are not permitted a foreign tax credit for the portion of the foreign levy paid for the economic benefit. If a foreign country has a generally imposed income tax, the dual-capacity taxpayer may treat that portion of the foreign levy considered a generally imposed income tax as a creditable tax. The balance of the foreign levy is considered compensation for the economic benefit. If the foreign country does not generally impose an income tax, the portion of the payment that does not exceed the applicable federal tax rate applied to net income is treated as a creditable tax. Under Section 907, the amount of creditable foreign taxes imposed on foreign oil and gas income is limited in any year to the applicable US tax on that income. The proposal would allow the taxpayer to treat as a creditable tax only the portion of a foreign levy that does not exceed the foreign levy that the taxpayer would pay if it were not a dual-capacity taxpayer. Additionally, the proposal would replace the current regulatory provisions, including the safe harbor, that apply to determine the amount of a foreign levy paid by a dual-capacity taxpayer that qualifies as a creditable tax. The proposal would convert the special foreign tax credit limitation rules of Section 907 into a separate category within Section 904 for foreign oil and gas income. The proposal would not override any US treaty obligations that allow a credit for tax paid or accrued on certain oil or gas income. The Green Book provides that the aspect of the proposal that would determine the amount of a foreign levy paid by a dual-capacity taxpayer that qualifies as a creditable tax is proposed to be effective for amounts that, if such amounts were an amount of tax paid or accrued, would be considered paid or accrued in tax years beginning after December 31, 2016. The Green Book further states that the aspect of the proposal that would convert the special foreign tax credit limitation rules of Section 907 into a separate category within Section 904 is proposed to be effective for tax years beginning after December 31, 2016. Under current law, the sale or exchange of a partnership interest is treated as the sale or exchange of a capital asset, and gain on the sale of a capital asset by a nonresident alien individual or foreign corporation is subject to US tax only if such gain constitutes US effectively connected income (ECI). The IRS has taken the position in Revenue Ruling 91-32 (1991-1 C.B. 107) that a foreign partner's gain or loss from the disposition of an interest in a partnership that is engaged in a trade or business through a fixed place of business in the United States is ECI gain or loss to the extent attributable to ECI property of the partnership and such amount is therefore subject to US tax. There is no explicit rule, however, in the Internal Revenue Code that expressly supports this position. According to the Green Book, taxpayers may take a position contrary to Revenue Ruling 91-32 because of the absence of an explicit code provision treating gain from the sale of a partnership interest as US ECI. The proposal would provide that gain or loss from the sale or exchange of a partnership interest is effectively connected with the conduct of a trade or business in the United States to the extent attributable to the transferor partner's distributive share of the partnership's unrealized gain or loss that is attributable to ECI property. Thus, a nonresident individual or foreign corporate partner in a partnership engaged in a US trade or business would be required to look through to its share of the partnership's assets in determining whether any gain on the disposition of its partnership interest is subject to US tax. As a means of enforcement, the proposal would require the transferee of a partnership interest to withhold 10% of the amount realized on the sale or exchange unless the transferor certified that it was not a nonresident alien individual or foreign corporation. If a transferor provided a certificate from the IRS establishing that the transferor's federal income tax liability for the transfer was less than 10% of the amount realized, the transferee would withhold such lesser amount. The partnership would be liable for the amount of any under-withholding and would satisfy the withholding obligation by withholding on future distributions that otherwise would go to the transferee partner. The proposal is estimated to raise $2.9 billion over 10 years and is proposed to be effective for sales or exchanges after December 31, 2016. The Green Book notes that certain transactions result in the reduction, allocation or elimination of a corporation's E&P other than by reason of a dividend or deemed dividend or by reason of the Section 381 carryover rules in a tax-free restructuring transaction. As examples, the Green Book refers to redemptions and certain Section 355 distributions that each can result in the reduction of the redeeming or distributing corporation's E&P, respectively. According to the Green Book, the reduction, allocation or elimination of E&P without a corresponding reduction in the associated foreign taxes paid results in a taxpayer claiming an indirect credit under Section 902 for foreign taxes paid on earnings that will no longer fund a dividend distribution for US income tax purposes. The Administration's proposal would reduce the amount of foreign taxes paid by a foreign corporation in the event a transaction results in the reduction, allocation or elimination of a foreign corporation's E&P other than a reduction of E&P by reason of a dividend or deemed dividend or by reason of a Section 381 transaction. The amount of foreign income taxes that would be reduced in such a transaction would equal the amount of foreign taxes associated with the eliminated E&P. The proposal is estimated to raise $333 million and is proposed to be effective for transactions occurring after December 31, 2016. Section 338(h)(16) generally provides that the deemed asset sale resulting from a Section 338 election is disregarded in determining the source or character of any item for purposes of the foreign tax credit rules to the seller. Thus, the deemed asset sale resulting from a Section 338 election made for a qualified stock purchase is not treated as occurring for this purpose and, instead, the gain is generally treated by the seller as gain from the sale of the stock. A covered asset acquisition, as defined in Section 901(m)(2), includes a transaction for which a Section 338 election has been made, but also includes other transactions that are treated as asset acquisitions for US tax purposes and acquisitions of an entity interest for foreign tax purposes. Under current law, transactions that constitute covered asset acquisitions by virtue of a Section 338 election are subject to Section 338(h)(16), but other covered asset acquisitions are not subject to the rule. According to the Green Book, the other types of covered asset acquisitions present the same foreign tax credit concerns as those addressed by Section 338(h)(16) in the case of a Section 338 election transaction. Accordingly, the Administration's proposal would extend the application of Section 338(h)(16) to any covered asset acquisition within the meaning of Section 901(m)(2). The proposal is estimated to raise $672 million over 10 years and is proposed to apply to covered asset acquisitions occurring after December 31, 2016. According to the Green Book, there has been a "proliferation of tax avoidance techniques" involving cross-border hybrid arrangements that result in deductions in one jurisdiction without any corresponding income inclusions in the other jurisdiction (so-called stateless income) or multiple deductions for the same payment in different jurisdictions. The Administration thus proposes to deny deductions for interest and royalties paid to related persons in certain circumstances involving a "hybrid arrangement." For this purpose, hybrid arrangements include hybrid entities, hybrid instruments and hybrid transfers (such as a sales-repurchase or "repo" transaction, in which the parties take inconsistent positions regarding the ownership of the same property). For example, the proposal would disallow a deduction in the United States when a taxpayer makes an interest or royalty payment to a related party and either: (i) as a result of the hybrid arrangement there is no income inclusion to the recipient in the foreign country, or (ii) the hybrid arrangement would allow the taxpayer to claim an additional deduction for the same payment in another country. The Administration's proposal would also grant the Secretary of the Treasury the authority to issue regulations necessary to carry out the purposes of the proposal, including provisions that would deny deductions from certain conduit arrangements involving a hybrid arrangement between at least two of the parties, deny interest and royalty deductions arising from transactions such as structured transactions involving unrelated parties, as appropriate, and deny deductions when such payment is subject to inclusion in the recipient's jurisdiction under a preferential regime that reduces otherwise generally applicable statutory rates by 25% or more. The proposal is estimated to raise $1.13 billion over 10 years and is proposed to be effective for tax years beginning after December 31, 2016. Limit the application of exceptions under subpart F for certain transactions that use reverse hybrids to create stateless income Under current law, foreign personal holding company income of a CFC does not include: (i) dividends and interest received from a related person organized under the laws of the same foreign country as the CFC if such related person has more than 50% of its assets used in a trade or business in such country (and, with respect to dividends, is paid out of income accrued while the CFC owned stock in the related person); and (ii) rents and royalties received from a related person for the use of, or privilege of using, property in the country where the CFC is organized (the same-country exception, found in Section 954(c)(3)). According to the Green Book, stateless income can arise when a reverse hybrid (an entity that is treated as a corporation for US tax purposes but is fiscally transparent under the laws of a foreign jurisdiction) earns dividends, interest, rents or royalties that are not subpart F income because of the same country exception or look-through rule (discussed supra). In addition, the income is not subject to tax in the foreign jurisdiction in which the reverse hybrid is created or organized because such jurisdiction views the reverse hybrid as fiscally transparent and therefore treats the income as derived by its owners, including its US owners. The proposal would deny the same country exception and the look-through rule (proposed to be extended permanently) to payments made to foreign reverse hybrids held directly by a US owner when such amounts are considered as deductible payments received from foreign related persons. The proposal is estimated to raise $1.4 billion over 10 years and is proposed to be effective for tax years beginning after December 31, 2016. The Green Book asserts that the existing categories of subpart F income are not adequate to tax properly the mobile income generated from digital goods and services. The Administration proposes to create a new category of subpart F income, foreign base company digital income, that would generally consist of income from the lease or sale of a digital copyrighted article or from the provision of a digital service. Specifically, income from the lease or sale of a digital copyrighted article, or from the provision of a digital service, would be foreign base company digital income if the CFC uses intangible property developed by a related person (including property developed under a cost-sharing arrangement) to produce the income and the CFC does not, through its own employees, make a substantial contribution to the development of the property or services that give rise to the income. An exception would be provided for income earned by the CFC from customers that are located in the country in which the CFC is created or organized and that use the digital articles or services in that country. The proposal is estimated to raise $9.14 billion over 10 years and is proposed to be effective for tax years beginning after December 31, 2016. 2. Prevent avoidance of foreign base company sales income through manufacturing services arrangements Another component of subpart F income is "foreign base company sales income," which generally consists of income earned by a CFC from buying or selling personal property from or to, or on behalf of, related persons if the personal property is both manufactured, produced, grown or extracted outside of the CFC's country of organization and used, consumed or disposed of outside of that country. Income derived by a CFC from the sale of products that it manufactures is excluded from the de?nition of foreign base company sales income. A CFC is treated as manufacturing the property it sells if the CFC makes a substantial contribution to the physical manufacturing of the product by a contract manufacturer. The Green Book suggests that the current definition of foreign base company sales income relies on technical distinctions that taxpayers can manipulate or circumvent. Consequently, the Administration proposes to expand the definition of foreign base company sales income to include income of a CFC from the sale of property manufactured on behalf of the CFC by a related party under a manufacturing service arrangement. The Administration's proposal provides that the existing exceptions to foreign base company sales income would continue to apply. The proposal is estimated to raise $19.2 billion over 10 years and is proposed to be effective for tax years beginning after December 31, 2016. Certain US shareholders of foreign corporation must include in income on a current basis the shareholders' proportionate shares of the foreign corporation's subpart F income only if the foreign corporation constituted a CFC for an uninterrupted period of 30 days or more during a tax year (the 30-day rule). The Green Book contends that taxpayers exploit the 30-day rule by causing foreign corporations to generate significant subpart F income during tax years of less than 30 days (e.g., through a Section 338(g) election structured to occur within fewer than 30 days of the start of a CFC's tax year). The Administration proposes to eliminate the requirement that the 30-day rule must be satisfied in order for US shareholders to have a subpart F inclusion. The proposal is estimated to raise $1.2 billion over 10 years and is proposed to be effective for tax years beginning after December 31, 2016. For purposes of determining whether a US person may be considered to be a US shareholder of a foreign corporation and, therefore, whether the foreign corporation is a CFC, Section 958(b) applies the constructive ownership rules of Section 318, with certain modifications. One of these modifications turns off downward attribution of stock ownership from a foreign person to a US person. For example, if a US corporation is a wholly owned subsidiary of a foreign parent corporation, and the US corporation and the foreign parent corporation each directly own 50% (by vote and value) of the stock of another foreign corporation, the US corporation is considered to own only 50% (by vote and value) of the stock of such other foreign corporation and is not considered to own the stock that is owned by the foreign parent corporation for purposes of determining whether the US corporation is a US shareholder of the foreign corporation. The Green Book states that the modified constructive ownership rules under Section 958(b) may allow a foreign acquirer of a US-parented group that also acquires a sufficient amount of the stock of one or more foreign subsidiaries of the former US-parented group to cause the foreign subsidiaries to cease to be CFCs for US tax purposes, thereby avoiding the application of subpart F to the continued ownership interest of the US shareholders. The Administration's proposal would amend the ownership attribution rules of Section 958(b) to allow downward attribution of stock ownership in a foreign corporation owned by a foreign parent to a related US person for purposes of determining whether the foreign corporation is a CFC. The proposal would raise an estimated $3.4 billion over 10 year and be effective for tax years beginning after December 31, 2016. Provide for reciprocal reporting of information in connection with the implementation of FATCA provisions Under current law, the FATCA provisions require foreign financial institutions to report to the IRS certain information about foreign financial accounts of US persons, in order to avoid the imposition of a new US withholding tax. The Green Book states that the broad information exchange network relationships that the Treasury Department has established contributes to the recent success of the IRS enforcement efforts against offshore tax evasion and the success of those information exchange relationships depends on cooperation and reciprocity. The Green Book notes that intergovernmental agreements under which a foreign government agrees to provide the information required by FATCA to the IRS are necessary to overcome the obstacles to such information exchange imposed by the laws of some foreign jurisdictions. Furthermore, it notes that requiring US financial institutions to report similar information to the IRS about nonresident accounts would facilitate such intergovernmental cooperation by enabling the IRS to reciprocate in appropriate circumstances by exchanging similar information with cooperative foreign governments to support their efforts to address tax evasion by their residents. The Administration proposes that certain financial institutions would be required to report the account balance for all financial accounts maintained at a US office and held by foreign persons. The proposal also would expand the current reporting required for US-source income paid to accounts held by foreign persons to include similar non-US source payments. Authority to issue regulations would be granted that would require financial institutions to report the gross proceeds from the sale or redemption of property held in, or with respect to, a financial account, information on financial accounts held by certain passive entities with substantial foreign owners, and such other information that the Secretary or his delegate determines is necessary to carry out the purposes of the proposal. The proposal would also require financial institutions that are required under FATCA or under the proposal to report to the IRS information on financial accounts also to furnish a copy of the information to the account holders. The proposal would not extend to financial institutions in jurisdictions that have an intergovernmental agreement with the United States when the jurisdiction reports FATCA information directly to the IRS. This proposal is not estimated to affect the US fisc and is proposed to be effective for returns required to be filed after December 31, 2017. Prevent the elimination of E&P through distributions of certain stock with basis attributable to dividend equivalent redemptions Generally, when a corporation distributes property with respect to its stock, the distributing corporation must recognize any gain realized on the distribution, and its E&P are increased by such gain. Although the distributing corporation generally does not recognize a loss, its E&P are decreased by the sum of the amount of money, the principal amount or issue price of any obligations (as the case may be), and the adjusted basis of any other property, so distributed. The Green Book states that corporations have devised many ways to avoid dividend treatment under current law by, for example, entering into preparatory transactions to eliminate a corporation's E&P, or shifting the corporation's E&P to a prior or subsequent year. Unlike this year's Green Book, last year's Green Book asserted that taxpayers were engaging in certain transactions that artificially increase the basis in stock of a subsidiary, and then distributing the subsidiary's stock to eliminate an amount of E&P of the distributing corporation equal to the increased stock basis. The proposal would amend Section 312(a)(3) to provide that a corporation's E&P are reduced by the basis in any distributed high-basis stock determined without regard to basis adjustments resulting "from actual or deemed dividend equivalent redemptions or any series of distributions or transaction undertaken with a view to create and distribute high-basis stock of any corporation." The proposal is estimated to have a negligible effect on revenue and would be effective upon enactment. The FY2017 Budget includes proposals introduced in FY2016 that would represent a substantial change to the US international tax regime. In particular, the proposal to impose a new 19% minimum tax on foreign earnings, as well as the companion proposal to impose a one-time 14% tax on previously untaxed foreign earnings, would have significant implications for US multinational companies. Similar to the FY2016 Budget, several of the international tax proposals are aimed at addressing concerns similar to those that are the target of the Organization for Economic Cooperation and Development's (OECD) base erosion and profit shifting (BEPS) project. In particular, the proposals addressing hybrid entities and arrangements, digital goods and services, and excessive interest expense would address BEPS-related concerns. Other proposals in the Budget that are not categorized as international tax proposals, such as the proposal relating to the treatment of the purchase of hook stock by a subsidiary as giving rise to deemed distributions, would have implications for cross-border transactions. The release of the Administration's proposals is just the start of the process and at this stage represents only an indication of the Administration's tax priorities. Although some have expressed interest in international tax reform this year, this may prove difficult given the 2016 Presidential election. Nevertheless, as lawmakers continue to work on the development of legislative approaches to tax reform, the international tax proposals contained in the Budget, which are scored as raising significant revenue in the aggregate, would likely be part of the dialogue.
Document ID: 2016-0307 | |||||||||||
