Tax Alert: White House Reveals FY 2010 Budget Proposal Details
5/12/2009
On May 4, 2009, the Obama administration provided new details to the proposals contained in the FY 2010 budget outline released on February 26, 2009. These proposals would substantially change the U.S. international tax regime largely by (i) limiting U.S. deductions for expenses related to foreign income that is not repatriated back to the U.S. and (ii) modifying the foreign tax credit and "check-the-box" rules.
The projected overall impact of these proposals (combined with other international tax reforms) would be to increase the U.S. tax burden for corporations with foreign operations by $210 billion over the next ten years. If Congress approves these proposals and they are enacted into law, they will become effective in 2011. A portion of the revenue generated would be used to make the research and development credit set to expire on January 1, 2010 permanent.
As these are merely proposals, the Obama administration has yet to release all of the details regarding these changes.
There are multiple other recent tax reform proposals that have similar themes including among others, House Ways & Means Committee Chairman Rangel's 2007 International Tax Reform Bill, Senator Dorgan's "Imported Property" Bill introduced in January 2009, and the Stop Tax Haven Abuse Act introduced by Senators Dorgan and Levin.
President Obama's Proposals
(1) Deferral Provisions
Presently, U.S. corporations can deduct expenses related to foreign subsidiaries and defer paying U.S. taxes on the profits earned by the foreign subsidiaries until those profits are repatriated back to the U.S., typically in the form of dividends. The proposal would prohibit a U.S. company from claiming a deduction supporting its foreign subsidiaries until the U.S. parent actually pays U.S. tax on its offshore profits. Research and development expenses however, would still be permitted to be deducted even without repatriation of foreign source earnings.
The example provided in the Treasury summary states that if a U.S. parent borrows funds that are then contributed to a foreign subsidiary, the interest expense on the loan would not be deductible until such funds are repatriated back to the U.S. Presumably, any headquarters' costs that are attributable to services provided to foreign subsidiaries would also be subject to a similar limitation.
(2) Foreign Tax Credit
Another Obama proposal would prevent artificially inflating or accelerating foreign tax credits claimed for foreign tax payments. This proposal would require a taxpayer's foreign tax credit to be determined based on the amount of total foreign tax the taxpayer actually paid on its total foreign earnings. This could prevent companies from taking credits on high taxed earnings at a rate above the average rate of foreign taxes paid by all foreign subsidiaries. In addition, a foreign tax credit would be disallowed for foreign taxes paid on income not subject to a U.S. tax.
(3) Revisions to the "Check-the-box" Rules
U.S. firms that have foreign subsidiaries in low tax jurisdictions are generally required to currently include into taxable income passive income, such as dividends, interest, rents and royalties, received by a foreign subsidiary even when the foreign subsidiary does not distribute any of such earnings. The check-the-box rules permit U.S. firms to make their subsidiaries essentially "disappear" for U.S. tax purposes. If a U.S. firm's foreign subsidiaries are disregarded, the firm could shift income amongst the subsidiaries without reporting any passive income or paying any U.S. tax. Another Obama proposal would require U.S. firms to report certain foreign subsidiaries as corporations. As a result, U.S. firms would no longer be able to make certain foreign subsidiaries "disappear" and passive income shifted amongst these subsidiaries would be currently included into taxable income by the U.S. parent even where no actual amount had been distributed.
In addition, the Administration's proposals would crackdown on offshore tax havens by individuals and would add 800 new IRS employees to strengthen the IRS's international tax enforcement efforts. These new proposals would make it harder for individuals to illegally hide money overseas in tax havens. These proposals would include:
(a) requiring foreign financial institutions that have dealings with U.S. customers to sign an agreement with the IRS to become a Qualified Intermediary and share information about their U.S. customers with the IRS;
(b) tightening the reporting standards for overseas investments;
(c) increasing penalties and imposing negative presumptions on individuals who fail to report foreign accounts in which they hold a financial interest in or have signature authority over; and
(d) extending the statute of limitations for enforcement.
For more information regarding the foregoing, please contact any of the following: James Wall, Director of International Tax (646-254-7460 or via email), Howard Berger (646-254-7457 or via email), or Sean Dokko (212-297-0400 or via email).
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