U.S. Tax Reform Legislative Updates Fred Gander 12 May 2014
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Agenda 1
U.S. business tax reform drivers
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Tax reform proposals – Past and present
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Recent legislative proposals
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How BEPs relates to U.S. international tax reform
5
Wrap-up
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U.S. Business Tax Reform drivers
Business Tax Reform drivers ■ The United States has the highest nominal corporate tax rate – Current corporate income tax rate is 35% – 35% corporate tax rate discourages direct foreign investment and encourages off-shoring – But - average effective rate is 27% - roughly the same as the OECD ■ Many U.S. multinationals have effective tax rates below 25%; many U.S. companies that are purely domestic pay the 35% nominal rate ■ Efficiency goal should be to have income taxed at same effective rate no matter the industry or the source
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Business Tax Reform drivers Competitiveness ■ System for taxing non-U.S source income is out of step with the rest of the developed world. No question that U.S. companies may be at a competitive disadvantage in countries with tax rates lower than the U.S. – Trade competitors have moved to territorial systems – Taxes as a percentage of GDP are 3rd from the bottom in the OECD ■ No question that current system provides an incentive to keep money off-shore – Lock-out effect can be cured by taxing off-shore income at U.S. rate currently ■ The Obama Administration believes “territoriality” leads to domestic job loss and base erosion – The Obama Administration concludes that domestic detriment offsets whatever benefit U.S. multinationals could get from territoriality
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U.S. Tax Reform proposals: Past and present
U.S. Tax Reform proposals – Past and present Overview
Chairman Camp’s 2011 Proposals (10/11)
President Obama’s Framework Proposals (2/12)
25% corporate tax rate
28% corporate tax rate
Territorial System, 95% exemption
Enhance Sec. 199
Min Tax on foreign earnings
Follows budget proposals
Tax passive & mobile earnings
Sen. Enzi Proposals (2/12)
35% corporate tax rate
Territorial taxation, 95% exemption
CFC reforms
Tax foreign IP profits
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U.S. Tax Reform proposals – Past and present Overview
Obama Administrations 2015 Budget Proposals (_/14)
Senator Baucus’s Proposals (11/13)
Tax rate not specified
Tax rate not specified
Territorial system (Option Y) or current taxation with 40% exemption (Option Z)
Pooled foreign tax credits
Defer interest deductions
Tax excess IP profits
CFC reforms
Chairman Camp’s 2014 Proposals (2/14)
Phased tax rate reduction: 25% rate starting 2019
95% exemption
CFC reforms
Thin cap rule for excess U.S. debt.
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U.S. Tax Reform proposals – Past and present Common themes
Many of the U.S. tax reform proposals released: ■ Anticipate a reduction in the U.S. corporate rate (Camp 25%, Administration Framework 28% (25% for manufacturing), Baucus unspecified) ■ Contemplate a mandatory tax on unrepatriated foreign earnings (Administration has not specifically stated that but has said it would be on the table in the context of overall reform). ■ Contemplate some form of limitation of interest deductions at the corporate level ■ Include significant base erosion provisions (e.g., modify reach of U.S. CFC rules). This should put U.S. based multinationals on notice. ■ Include changing cost recovery to economic depreciation ■ Require capitalization of R&E expenses and part of advertising (Baucus and Camp)
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U.S. Tax Reform proposals – Past and present Why consensus is hard of find?
Obstacles to revenue-neutral Corporate tax reform ■ Redistribution of tax burden creates winners and losers ■ Revenue-neutrality constraints – U.S. vs. foreign – Individual vs. business – Individual income levels ■ Effect on U.S. manufacturing and small business ■ Absence of agreement on taxation of foreign income: territorial vs. modified worldwide ■ Coordination with individual rates – partnerships ■ Transition costs ■ Long-term revenue impact (most tax expenditures are timing provisions)
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Recent U.S. legislative proposals
The Administration’s FY2015 budget International tax proposals
FY2014 budget proposals included in FY2015 budget ■ Defer deduction for interest related to deferred income of foreign subsidiaries ■ Determine foreign tax credit on a pooling basis ■ Tax currently excess returns on intangible property transferred offshore ■ Limit shifting of income through intangible property transfers ■ Disallow deduction for untaxed reinsurance premiums paid to affiliates ■ Modify tax rules for dual capacity taxpayers ■ Tax gain from sale of partnership interests on look-through basis ■ Prevent use of leveraged distributions from related foreign corporations to avoid dividend treatment ■ Extend section 338(h)(16) to asset acquisitions ■ Remove foreign taxes from section 902 corporation’s foreign tax pool when earnings are eliminated
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The Administration’s FY2015 budget International tax proposals
New proposals in FY2015 budget ■ Restrict deductions for excessive interest of members of financial reporting groups ■ New Subpart F category for transactions involving digital goods and services ■ Prevent avoidance of foreign base company sales income through manufacturing service arrangements ■ Restrict use of hybrid arrangements that create stateless income ■ Limit application of Subpart F exceptions to reverse hybrid transactions that create stateless income ■ Limit the ability of domestic entities to expatriate
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Current proposal comparisons 2014 Camp territorial proposal
Top marginal tax rate reduced to 25% by 2019, with phased approach: 33% in 2015, 31% in 2016, 29% in 2017, 27% in 2018.
Territorial System: 95% DRD against foreign-source portion of a dividend received from a foreign corporation.
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In case of foreign corporation stock dispositions, basis reduction by amount of DRD, but only for purposes of calculating loss on such stock disposition.
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Permanently extend section 954(c)(6) look-through rule for related CFCs. 954(h) active finance exception extended for 5 years for active financing income that is subject to a foreign effective tax rate of 12.5% or higher.
FTC Considerations: -
Repeal of section 902;
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Section 960 credit must be determined on a current-year basis (thus, section 902 pooling approach no longer permissible).
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FTC limitation applied by allocating only directly allocable deductions to foreign source income.
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Expand passive category to include other mobile income. (Proposed change appears to adopt a lowtax / high-tax approach). Mobile category income would include current-law passive income, foreign base company sales income, and foreign base company intangible income.
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Current proposal comparisons 2014 Camp territorial proposal
Thin cap rules: -
Denial of interest expense deductions of U.S. shareholders that are members of worldwide affiliated groups with excess domestic indebtedness. Reduces threshold for excess interest expense to 40% of adjusted taxable income. No carryforward for excess limitation.
Base Erosion: -
Amend section 894 to deny treaty benefits with respect to certain deductible payments made to a related party.
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Treat intangible income as Subpart F income.
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New U.S. tax deduction incentive for a percentage of foreign intangible income earned directly by U.S. corporation. (When fully phased in, deduction expected to result in a 15% tax rate on income from the foreign exploitation of IP.
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New limitations on interest expense deductibility
Transition Rules: Subpart F income increased by amount of deferred foreign income for taxable year beginning prior to 1/1/2015. DRDs of 70% and/or 90% calculated based on cash position.
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Current proposal comparisons 2014 Camp territorial proposal
Other provisions: -
All of a CFC’s FBCSI is excluded from Subpart F if the CFC is eligible as a “qualified resident” for all benefits provided under a comprehensive U.S. income tax treaty.
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Subpart F high-tax kick out revised to be mandatory and with significant modifications. FBCI is not Subpart F income unless income subject to less than 25% foreign tax rate (assuming reduction in corporate tax rate fully phased in). FBCSI is not foreign base company income unless income subject to less than a 12.5% foreign tax (assuming reduction in corporate tax fully phased in). FBCII not FBCI unless income subject less than a specified rate calculated on a phased approach.
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Current proposal comparisons Baucus proposal Senate Finance Committee discussion draft
Tax rate not specified
Option Y proposes territorial system (100% DRD for 10% shareholders); Option Z proposes complete elimination of deferral and provides for a 40% exemption for “active foreign market income”. - Neither Option Y’s DRD nor Option Z’s 40% exemption available for 10/50 company dividends.
Repeal of section 902 and section 909 “splitter” rules.
Permanent disallowance for interest expense allocated to exempt foreign active income.
Base Erosion: Both Option Y and Option Z retain Subpart F regime for certain income types. If enacted, both Options Y and Z would significantly revise application of Subpart F. For example, Baucus’ Option Y imposes no residual tax on foreign earnings but creates a new category of Subpart F income for low-taxed income.
Partial repeal of check-the-box rules
Repeal of section 956
Repeal of DCL rules
Transition Rules – Specifics to be determined.
Option Z would repeal current administrative position that positive section 316 E&P is necessary for PTI distributions (i.e., PTI can be distributed even if there is an overall E&P deficit.)
Option Z would repeal section 1248 ordinary treatment for CFC stock sales.
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How BEPS relates to U.S. tax reform
OECD BEPS action plan How does it relate to U.S. tax reform?
■ The OECD BEPS Action Plan adds weight to the push for legislation as it validates and reinforces the concerns expressed by the Obama Administration, Camp and various others regarding tax planning involving base erosion / profit shifting. – U.S. legislators are aware of the OECD BEPS Action Plan. ■ A number of recent U.S. tax reform proposals propose new rules to curtail base erosion and profit shifting to low-tax jurisdictions. – Some of these proposals were introduced before publication of the OECD BEPS Action Plan (published on July 19, 2013) while other proposals were introduced after publication. ■ The United States is a very active OECD member.
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Wrap-Up
How likely is U.S. international tax reform? ■ International tax changes can still happen even if the U.S. Congress takes no action. This is because: – Much of the international tax regime is regulatory; – The United States can incorporate new standards / rules into its tax treaty negotiations (e.g., rules concerning hybrid mismatches and conduit financing). – Interpretations of rules could change.
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Preparing for U.S. tax reform What should companies do now?
■ Understand the direction of proposed law changes in order to:
Illustrative best practices
– Assess the impact to the company’s ETR and cash tax position
E&P deficit/management planning
FTC planning
– Assess the impact of common themes among proposals on existing or potential structures
Repatriation planning (for example through PTI or internal reorgs)
Same country planning
■ Update key U.S. (e.g., FTC, E&P, and basis) and non-U.S. tax and legal attributes (distributable reserves) ■ Adopt, refresh or continue baseline best practices by focusing on tax planning that: – Is sensible under current law in light of business objectives; – Allows for flexibility in reacting to international tax reform; and – Mitigates the taxpayer’s transition cost to a new international tax regime ■ Understand how the OECD BEPS initiative relates to U.S. tax reform.
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Contact
FRED R. GANDER
Washington National Tax, Principal-in-Charge, Europe and Middle East KPMG LLP 15 Canada Square London E14 5GL Tel 44 (0) 20 7311 2046 Fax 44 (0) 20 7311 6440 Cell 44 (0) 78 7847 8453
[email protected]
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