Administrative Proposal Would Tax Excess Returns from OutBound IP Transfers
On February 14, 2011, the Obama Administration released its Fiscal Year 2012 Budget, containing many of the international tax proposals that were included (but not adopted by Congress) in previous years' budgets.One of the most significant and far reaching proposals, which was included in the FY 2011 budget and slightly modified and clarified in the current budget, would treat certain excess returns associated with the offshore transfer of intangibles (IP) as currently taxable under Subpart F.More specifically, under the proposal, if a U.S. person transfers (either directly or indirectly) an intangible(IP) from the United States to a related controlled foreign corporation (CFC), certain excess income from transactions connected with, or benefitting from, the IP would be treated as Subpart F income if such income is subject to a low foreign effective tax rate.Moreover, this Subpart F would be treated as income in a separate foreign tax credit limitation basket, effectively preventing the U.S. taxpayer from cross crediting high-taxed foreign income generated in the active or passive baskets against the U.S. tax on this low taxed Subpart F income.The proposal would be effective for transactions in taxable years beginning after December 31, 2011.
For purposes of this proposal, excess income from the outbound transfer of IP is defined as the excess of gross income from transactions connected with or benefitting from the IP over the costs (excluding interest and taxes) properly allocated and apportioned to this income, increased by a percentage mark-up. Although the proposal does not state what percentage mark-up would be appropriate, Treasury officials have indicated that a 50% mark-up over costs would be used as the relevant benchmark. Thus, in many cases a substantial portion of the income generated from the offshore use of U.S. transferred IP by a related CFC would be effectively recaptured and subject to current U.S. taxation to the 10% or more U.S. shareholders of the CFC under Subpart F. In this regard, because the "transfer” of an intangible is defined to include a transfer by sale, lease, license, or through any shared risk or development agreement (e.g., a cost sharing arrangement), the potential scope of this proposal is exceedingly broad.
As indicated, the proposal would apply if the related CFC is subject to a low foreign effective tax rate on the associated income from the transferred IP.No guidance is provided, however, as to what constitutes a low foreign effective tax rate (or even whether U.S. or foreign tax principles would be applied in making this determination).Treasury officials have informally indicated, however, that a sliding scale from 5% to 15% would be used for this purpose.Thus, for example, 100% of the excess income would be treated as Subpart F income if such income were taxed at a foreign effective rate of less than 5%, whereas only a portion of that income (as yet undetermined) would be captured as Subpart F income if taxed at a rate between 5% and 15%. Significantly, because the FY 2011 version of this proposal utilized a flat 10% rate as the threshold, it would not have applied to Irish subsidiaries subject to a 12.5% tax rate. By contrast, the current proposal could sweep a substantial portion of the intangible income earned by Irish companies (often used by U.S. companies to hold and commercially exploit IP).
This proposal, together with another budget proposal that would "clarify” the definition of IP (for purposes of sections 367(d) and 482) to include workforce in place, goodwill and going concern value, represents a coordinated approach by the Administration to address a perceived significant (and inappropriate) erosion of the U.S. tax base through outbound IP transfers, notwithstanding the application of transfer pricing rules designed to achieve arm's length results.