U.S. Tax Reform update: amid looming budget showdown, drafting of U.S. International Tax Reform Legislation continues
With the August recess now well in the rearview mirror, Congress is already deep into grappling with the imminent expiration of the U.S. Government’s funding authority on September 30. Amid the debates over the “Continuing Resolution” and related funding issues, the Iran deal, and other high-profile issues, the work on drafting international tax reform legislation continues, largely behind the scenes.
While skepticism as to the chances of Congress passing any significant tax legislation this year abounds, we believe that there is still an outside chance that Congress could pass international tax reform legislation – along with a Highway Bill and ‘tax extenders’ items – this year. Moreover, (and relevant to the more likely scenario of tax legislation being passed after 2015), legislation that is being drafted behind the scenes now will likely form the base of a tax bill to be considered next year or even in 2017, even if nothing significant passes in 2015.
For many business taxpayers, both those based in the U.S. and foreign based businesses with operations in the U.S., there is a risk that the international tax reform legislation, whenever it is passed by Congress, could eliminate or modify existing U.S. tax preferences important to the company’s bottom line, and raise taxes, without providing enough offsetting benefit. As always, the outcome of this legislation when it does pass will in significant part depend on the efforts of industries and companies to educate Congress as to the potential consequences of various proposals.
The template for international tax reform legislation being considered and drafted, mostly by the staff of House Ways and Means Chairman Paul Ryan (R-WI), continues to be the legislation introduced more than a year ago by former Ways and Means Chairman Dave Camp (R-MI). Other proposals that will influence the ultimate international tax reform legislation include: the bipartisan Ways and Means ‘innovation box’ proposal issued July 29, 2015, by Representatives Charles Boustany (R-LA) and Richard Neal (D-MA); the bipartisan Senate Finance Committee International Tax Reform Working Group proposal issued July 8, 2015, by Senators Rob Portman (R-OH) and Chuck Schumer (D-NY); and President Obama’s general international tax reform proposals issued in his FY 2016 Budget Proposal.
The following are key elements of these proposals:
Former House Ways and Means Chairman Camp international tax reform proposal:
- New territorial tax system – 95 percent exemption for dividends received by the U.S. parent from its foreign subsidiaries’ active business income. Foreign intangible income would be taxed currently as earned at a concessional rate of 15 percent once the proposal is fully phased-in.
- One-time tax for all US taxpayers owning 10 percent or more of foreign subsidiaries with unrepatriated foreign earnings – Assessed on accrued E&P since 1986, at a rate of 8.75 percent on cash E&P and 3.5 percent on remaining (reinvested in plant & equipment) E&P. Foreign tax credits could partially offset tax. Tax could be spread over back-loaded 8 year period.
- CFC look-through rule for payments between foreign subsidiaries – Made permanent.
Boustany-Neal Innovation Box Proposal:
- A corporation would be taxed at an effective tax rate of 10.15 percent on all innovation box profits. Benefits effectively limited to companies with significant R&D spending.
- Innovation box profit would equal tentative innovation profit (qualified gross receipts minus cost of goods sold and other allocable expenses) multiplied by the corporation’s research and development (R&D) ratio.
- The R&D ratio would equal the corporation’s domestic R&D expenditures over the preceding five years divided by the corporation’s total costs (not including cost of goods sold, taxes or interest) over the preceding five years.
- Qualified gross receipts would consist of gross receipts derived from the sale, lease, license or other disposition of “qualified property” in the ordinary course of a U.S. trade or business. Qualified property would include patents, inventions, formulas, processes, knowhow, computer software, and other similar IP, as well as property produced using such IP.
- Tax relief for a “repatriating” transfer of qualifying intangible property from a controlled foreign corporation to its US parent.
Portman-Schumer International Working Group Proposal:
- Mirrors key elements of the Camp proposal, including:
- Dividend exemption regime for dividends received by a U.S. parent from its foreign subsidiaries.
- A “one-time” tax on deemed repatriation of accumulated existing foreign earnings.
- “Robust” base erosion protections, including a possible new minimum tax.
- New limits on interest deduction for borrowings by U.S.-based multinationals..
- Tightened interest deduction limits for related party loans used by foreign-based multinationals to repatriate U.S. earnings to their home countries.
- In addition, the Working Group Proposal calls for a patent box regime, with a lower U.S. tax rate on income derived from intellectual property developed and owned in the U.S.
- CFC look-through rule would be made permanent.
Obama Administration international tax proposal:
- One-time repatriation tax of 14 percent on accumulated existing foreign earnings.
- New minimum tax of 19 percent on foreign earnings going forward.
- Limit on interest deduction attributable to unrepatriated foreign earnings — previously released proposal to defer the deduction of U.S. interest expense attributable to unrepatriated foreign earnings until such earnings are brought back to the U.S.
- A new form of limit on the deductibility of U.S. interest expense of the U.S. parent. The U.S. parent’s interest expense deduction would be limited based on its relative share of the total earnings of the corporate group as determined for consolidated financial statement reporting purposes under GAAP. More specifically, the U.S. parent’s interest expense deduction would be limited to the same proportionate share of total group interest expense as the U.S. parent’s proportionate share of the group’s total earnings (as computed by adding back net interest expense, taxes, depreciation, and amortization) as reflected in the corporate group’s consolidated financial statements.
- A new subpart F income category created for income of a foreign subsidiary from transactions involving “digital “goods” or services. The proposal would create a new category of subpart F income, for, which generally would include income of a CFC from the lease or sale of a digital copyrighted article or from the provision of a digital service, in cases where the CFC uses intangible property developed by a related party (including property developed pursuant to 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.
For any business seeking to better understand, and/or to influence the potential consequences of a tax reform bill, it is critical to become engaged now, beginning with the task of scrutinizing the details of the emerging tax reform plans and assessing the potential impact on their businesses, including running numbers regarding tax and financial statement impacts, and responding to the Hill.