January Legislative Proposals Would Affect Inbound and Outbound Taxpayers
Legislation introduced into Congress in January included some previously proposed provisions that target certain perceived international tax abuses. As these international tax provisions are revenue raisers, there could be strong political support for their passage.
On January 5, legislation repealing the boot-within-gain limitation for certain domestic and cross-border reorganizations was introduced. The boot-within-gain rule is frequently used by foreign investors when restructuring their holdings in the U.S. The rule generally limits the taxable amount of boot (e.g., cash) received in a reorganization to the amount of unrecognized gain in the shares exchanged by a corporation that is a party to that reorganization. Thus, for example, where there is no built-in gain in the shares exchanged in the reorganization, the rule would permit a tax-free repatriation of the corporation’s earnings. Under HR 62, boot received in the reorganization would be taxed as dividend, subject to earnings and profits limitations (which are also expanded in the case of certain “D” reorganizations). HR 62 is proposed to be effective for transactions occurring after the date of enactment.
U.S. Managed or Controlled Publicly Traded Foreign Corporations
In another provision affecting inbound investors, HR 62 would treat certain publicly traded foreign corporations or foreign corporations that have gross assets of at least $50,000,000 as U.S. corporations if they are primarily “managed and controlled” in the U.S. For this purpose, a foreign corporation would be treated as primarily managed and controlled in the U.S. if substantially all of the corporation’s executive officers and senior management who exercise day-to-day decision making responsibilities regarding operational, strategic and financial policies are located primarily in the U.S. Thus, if this provision were enacted, a foreign corporation primarily managed and controlled in the U.S. would be subject to U.S. taxation on its worldwide income (with foreign tax credit relief, as appropriate) in the same manner as a U.S. corporation. This provision is proposed to be effective for taxable years beginning two years after enactment.
Royalty Income and the CFC Look-Through Rule
HR 62 also included a provision affecting outbound taxpayers and their CFCs. The legislation would amend the “CFC look-through rule” (previously discussed) with respect to royalty income received or accrued by a CFC from a related CFC. Thus, if enacted, HR 62 would cause royalty payments between CFCs to be treated as Subpart F income, subject to applicable exceptions. The proposed legislation would also extend the Subpart F rules to royalty payments between a CFC and a foreign entity that has made a check-the-box election to be disregarded for federal income tax purposes. In addition, HR 62 could treat sales of personal property by a CFC as giving rise to Subpart F income (even without an actual related party purchase) if an intangible belonging to a U.S. related party was utilized by the CFC in the manufacture of the property sold. This rule would not apply, however, if the CFC directly manufactured the property sold, without taking into account any manufacturing conducted by a disregarded entity of the CFC.
U.S. Withholding Taxes on Certain Related-Party Payments
HR 64, also introduced on January 5, 2011, would override treaty-based reductions for U.S. withholding taxes on certain related-party payments, effective for payments made after enactment. Under this bill, deductible payments (such as interest and royalties) made by a U.S. entity to a related foreign entity will not benefit from a reduced treaty withholding rate unless such payment would be eligible for a reduced treaty rate if made directly to the foreign parent of the related foreign entity. For example, interest paid by a U.S. corporation to a Dutch corporation owned by Hong Kong corporation would be subject to 30% U.S. withholding tax (rather than 0% under the U.S.-Netherlands treaty) because a direct payment of interest by the U.S. corporation to the Hong Kong parent would not benefit from any reduced withholding rate (i.e., there is no U.S. treaty with Hong Kong). It should be noted that unlike a similar anti-treaty-shopping bill several years ago, HR 64 would not limit treaty benefits if the foreign parent corporation had a treaty with the U.S. but such treaty contained a higher withholding rate.
HR 64 (and its predecessor bill) has been met with significant opposition from some of the U.S.’s closest treaty partners as well as many multinational companies who assert that the proposed law could strain existing taxpayer relationships and impact the ability of the U.S. to object to treaty violations by other countries. Moreover, most U.S. treaties already contain limitation on benefits provisions which are designed to prevent the kind of treaty-shopping abuses underlying the proposed legislation. Nonetheless, because this provision bears a whopping $7.7 billion revenue estimate, its progress deserves watching.