Feature of the Week—International Tax Reform: Foreign Tax Credit “Reform”.
The plea for substantive international tax reform has been heard from Congress, Treasury, MNEs, and commentators across a wide spectrum of fiscal views for many years. The effective tax rate on U.S.-based MNEs is the second highest in the world after Japan, though Japan is in the process of lowering its own rates to a level competitive with other countries.
The Obama Administration and the current Congress, however, seem hell-bent on making the situation ever worse for U.S.-based MNEs, not only ignoring the fiscal realities of the competitive landscape but lambasting MNEs as shirking their fiscal responsibilities to the United States. The President’s words in his most recent revenue message are stunning. The essence of his views is that MNEs are “shirking” their responsibilities and that the Internal Revenue Code is “a broken system, written by well-connected lobbyists on behalf of well-heeled interests and individuals” [ Lowell, Briger & Martin: U.S. International Transfer Pricing ¶ 2.02[23] ].
The agenda for a responsible effort to provide competitive equilibrium for U.S.-based MNEs is familiar [ Lowell, Briger & Martin: U.S. International Transfer Pricing ¶ 2.02[22] ]. Is there any reason to hope that such an approach will be forthcoming from the present Administration and Congress? No. Rather, it can be anticipated that there will be stream of revenue-raising projects taken off the proverbial “shelf” to pay for the various stimulus packages that the Administration and Congress seem to throw at the wall, hoping that the economic slide somehow reverses course. Much of this effort is voiced in the rhetoric of creating or saving jobs. The likely impact is to simply continue, perhaps even accelerate, MNE investment in other places to try to cope with the disadvantage of the U.S. system.
This negative anticipation is certainly reflected in the international tax provisions (read revenue-raisers) in the Education Jobs and Medicaid Assistance Act of 2010 (H.R. 1586; P.L. 111-226 ), which the President signed into law on August 10, 2010 [BNA Daily Tax Report, August 11, 2010, page GG-1]. The temporary increase in funding for Medicaid and education will be paid for by a series of changes to the foreign tax credit and other international tax provisions relating to U.S.-based MNEs. President Obama described the provisions as “tax loopholes that encourage corporations that ship jobs overseas.”
The revenue raisers include:
(1.) Prohibition of splitting foreign tax credits from the underlying income.
(2.) Restricting the ability to claim deemed paid taxes under Code Sec. 956 relating to distributions of U.S. property where there is no underlying U.S. income inclusion.
(3.) Limitations on certain covered asset acquisitions, such as under Code Sec. 338(g) .
(4.) Separate foreign tax credit treatment for income re-sourced under treaties.
(5.) Restriction of foreign subsidiary redemptions under Section 304.
(6.) Modification of the affiliation rules for purposes of interest expense allocation.
(7.) Repeal of the 80/20 foreign business provision for U.S. withholding purposes.
(8.) Modification of the exception to the three-year period of limitations for failure to provide information about cross-border transactions or foreign assets in Code Sec. 6501(c)(8) , as amended in the Hiring Incentives to Restore Employment (HIRE) Act ( P.L. 111-147 , March 18, 2010) to include a reasonable cause standard. This, at least, rationalizes a draconian provision.
The proposed sourcing of foreign paid guarantee fees as U.S.-source income was not included in the final package.
Needless to say, the Administration and Congress ignored the persistent pleas of U.S.-based MNEs that their competitive posture vs. foreign-based competitors continues to erode. Thus, it is hard to muster any enthusiasm for the prospect of actual reform that will address the serious issues facing these MNEs. At the very least, a reasonable person might anticipate that Congress would realistically handle this situation. If there is a public policy need to raise revenue to deal with the bulging national debt, it might be responsible to address this via appropriate rate increases as a comprehensive international tax reform package is also prepared. Such an approach would require something beyond simple political grandstanding.