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A Senate Bill for tax reform would provide substantial changes from the House Bill in international financial reporting, and other tax provisions.

Comparison of House Bill vs. Senate Bill: International Tax Provisions

On Thursday, November 9, Senate Republicans unveiled their own version of a tax reform bill that would cut billions in taxes for individuals and corporations – while delaying a corporate rate cut for a year to lower the cost of the bill. EisnerAmper has provided below a summary comparing some of the more substantial international tax provisions of the House and Senate bills.

Establishment of Participation Exemption System for Taxation of Foreign Income

House

Senate

1. Deduction for Foreign-Source Portion of Dividends Received by Domestic Corporations for Specified 10%-Owned Foreign Corporations
  • Creates a participation exemption/dividend-exemption system for 100% of the foreign-source portion of dividends paid by a foreign corporation to a U.S. corporate shareholder that owns 10% or more of the foreign corporation
  • No foreign tax credit or deduction would be allowed for any foreign taxes paid or accrued with respect to any exempt dividend under this system. 
  • The proposed participation exemption system would be established and in effect for tax years after 2017.
  • No significant deviation from the House bill. 
  • Utilizes the concept of a “dividend received deduction (“DRD”) for dividends that qualify for the participation exemption (the same 10% ownership applies).
  • The participation exemption is not available for hybrid dividends which are defined as an amount received from a controlled foreign corporation (“CFC”) which would be eligible for the participation exemption and for which the specified 10% owned foreign corporation has also received a tax benefit from taxes imposed in the foreign country.
  • The Senate version includes a one-year holding period requirement of the CFC stock.
  • Recapture rule imposing 35% tax rate on mandatory inclusions of a U.S. shareholder that becomes an expatriated entity with 10 years of bill’s enactment. 

 

2. Application of Participation Exemption to Investments in United States property – current tax law under IRC Sec. 956 generally results in a taxable deemed dividend in the U.S. (without actual cash repatriation) in situations where foreign subsidiaries invest undistributed earnings and profits (“E&P”) in U.S. property.
  • Generally repeals the provisions provided under IRC Sec. 956 as applied to U.S. corporations. 
  • Generally repeals the provisions provided under IRC Sec. 956 as applied to U.S. corporations.
3. Limitation on Losses with Respect to Specified 10%-Owned Foreign Corporations. The proposed legislation intends to impact gain that is recognized by a U.S. parent when it sells or exchanges stock of a foreign subsidiary. As the law currently stands, the result of such a transaction is treated as a dividend distribution by the foreign subsidiary to the extent of E&P. Any gain in excess of such normally constitutes capital gain for the U.S. parent.
  • A U.S. parent would be required to reduce its basis in the foreign subsidiary’s stock by the amount of any exempt dividends paid to the U.S. parent – only for calculating a loss (not gain) on any sale or exchange of the foreign stock by its U.S. parent. 
  • This rule would be effective for distributions subsequent to 2017.  
  • The Senate proposal is essentially similar to House bill.      

4. Treatment of Deferred Foreign Income upon Transition to Participation Exemption System of Taxation.  The proposed legislation would impose a repatriation on E&P not previously taxed abroad. In general, current law does not tax foreign earnings and profits of subsidiaries until such funds are repatriated to the U.S. The rules will apply to S corporations as well.

  • Proposes U.S. shareholders owning at least 10% of a foreign subsidiary would be taxed in its last tax year beginning before 2018, post-1986 E&P that has not been subject to U.S. tax (there are proposed rules for determining E&P for this purpose).  
  • Cash or cash equivalents would be taxed at a reduced rate of 12% (subsequently increased to a proposed 14% by the House.)
  • Any remaining (illiquid) E&P would be taxed at a rate of 5% (subsequently increased to a proposed to 7% by the House). 
  • Elect to pay this particular tax liability over eight years in equal installments. 
  • If the U.S. shareholder is an S corporation, an election is permitted so that the liability would not become due until a triggering event.  Triggering events are when the S corporation ceases to be an S corporation, the S corporation ceases to exist or conduct business or the stock is transferred.
  • The Senate provision is similar with different taxation rates for untaxed E&P abroad. 
  • Taxpayers may deduct a portion of the mandatory inclusion in an amount necessary to result in a tax of rate 10% for cash and cash equivalents, and 5% for the remainder of E&P.  71.5% of the foreign tax paid on the cash portion would be disallowed for foreign income tax credit purposes and 85.7% of foreign income tax paid on the remainder would be disallowed.
  • If installment payment option is elected, the payments are scheduled as follows:
    • The payments for each of the first five years equals 8% of the net tax liability;
    • The amount of the sixth installment is 15% of the net tax liability, increasing to 20% for the seventh installment; and
    • The remaining balance of 25% in the eighth year.
  • There is a special rule for shareholders that are S corporations.
  • If the U.S. shareholder is an S corporation, an election is permitted so that the liability would not become due until a triggering event.  Triggering events are when the S corporation ceases to be an S corporation, the S corporation ceases to exist or conduct business or the stock is transferred.

 

Modification to Foreign Tax Credit System.

5. Modifications Related to Foreign Tax Credit System. As the legislation suggests a move toward a participation exemption system (described above), certain rules pertaining to foreign tax credits will require change. Section 902 would be repealed for dividends that fall within the purview of the participation exemption.  Section 960 would permit a foreign tax credit on a current year basis. 

  • Section 902: Repealed. No deemed-paid credit with respect to any income inclusion under subpart F.
  • Section 960: A foreign tax credit would be allowed for any subpart F income includible in the income of a U.S. shareholder on a current-year basis.  This provision would be effective for tax years of foreign corporations beginning after 2017 and for tax years of U.S. shareholders in which or with which such tax years of foreign subsidiaries end. 
  • Section 902: Repealed.
  • Section 960: Modified, but no specific proposal provided.  

 

  • Addition of a separate foreign tax credit limitation basket for foreign branch income. Foreign branch income would be allocated to a specific foreign tax credit basket

6. Sourcing of Inventory.  The rules would alter current rules for the sourcing of inventory as either foreign-source or domestic-source. A maximum of 50% of the income derived from the sale of inventory property that is produced in the U.S. and sold outside of the U.S. (or vice versa) may be treated as foreign-source income. 

  • The income would be allocated and apportioned between domestic and foreign sources solely based on the production activities with respect to the inventory.
  • The income would be allocated and apportioned between domestic and foreign sources solely based on the production activities with respect to the inventory.

Modification of Subpart F

7. Modification of Subpart F Provisions.  Foreign shipping income earned since 1986 is subject to subpart F inclusion in a subsequent year to the extent there is a net decrease in qualified shipping investments during that subsequent year.

  • This rule for inclusion would be eliminated under the proposed legislation and would be effective for tax years of foreign corporations beginning after 2017 and for tax years of U.S. shareholders in which or with which such tax years of foreign subsidiaries end. 
  • This rule would remain under the Senate version of the bill.

8. Foreign Oil Related Income Under Subpart F. Certain foreign oil related income is currently taxed under Subpart F.  Tax reform would attempt to repeal this exclusion.     

  • Under the proposal, the imposition of current U.S. tax on foreign-base company oil related income would be repealed.
  • Effective for tax years of foreign corporations beginning after 2017 and for tax years of U.S. shareholders in which or with which such tax years of foreign subsidiaries end.
  • The Senate proposal eliminates foreign-base company oil related income from Subpart F income, but does not provide extensive detail.

9. Inflation adjustment for De Minimis Exception Under Subpart F. The $1 million subpart F de minimis exception would be adjusted for inflation.  The existing de minimis subpart F inclusion rule states that if the gross amount of such income is less than the lesser of 5% of the foreign subsidiary’s gross income or $1 million, then the U.S. parent is not subject to current U.S. tax on any of the income.  Historically, the $1 million threshold was not adjusted for inflation.        

  • The provision would be effective for tax years of foreign corporations beginning after 2017 and for tax years of U.S. shareholders in which or with which such tax years of foreign subsidiaries end.
  • The Senate version closely mirrors the House bill, but all increases will be rounded to the nearest multiple of $50,000.

 

10. IRC Sec. 954(c)(6). Certain types of payments made between CFCs are not Subpart F due to the exclusion under IRC Sec. 954(c)(6), a temporary provision in the Code. This legislation would be made permanent under either version of the bill.     

  • The House version of the bill would make IRC. Sec. 954(c)(6) permanent.
  • The Senate version of the bill would make IRC. Sec. 954(c)(6) permanent.

11. Stock Attribution Rules. Both versions of the bill would alter the attribution rules to determine ownership of a CFC.  Under current rules, a U.S. person is constructively the owner of shares owned by related persons, affiliates and shareholders, but a U.S. corporation generally cannot be treated as constructively owning stock held by its foreign shareholder(s).       

  • Per the House proposal, a U.S. corporation would be treated as constructively owning stock of its foreign shareholder (i.e., downward attribution).
  • Per the Senate proposal, there would also be downward attribution from a foreign shareholder to a U.S. corporation to determine CFC ownership.

12. 30-Day Rule for Ownership of CFC. Current rule states a U.S. parent of a CFC is subject to the subpart F regime if it owns stock of a foreign subsidiary for an uninterrupted period of 30 days or more during the year. 

  • 30-day rule would be eliminated.  
  • 30-day rule would be eliminated.  

Rules Related to Passive and Mobile Income

13. Current Inclusion of Foreign Passive and Mobile Income

Foreign High Returns

  • The provision calls for current U.S. tax on 50% of the U.S. parent’s foreign high returns.
  • Foreign high returns is defined as the aggregate income of foreign subsidiaries that exceeds a routine return of 7% plus the federal short-term applicable federal rate (“AFR”) on the subsidiaries’ aggregate basis in depreciable tangible property, adjusted downward for interest expense. 
  • Foreign high returns exclude effectively connected income (“ECI”), subpart F income, any gross income excluded from Subpart F foreign personal holding company income or foreign base company income by reason of meeting the high tax exception of IRC Sec. 954(b)(4), insurance and financing income that satisfied the “active financing exemption” under subpart F and income from the disposition of commodities produced or extracted by the taxpayer or certain related-party payments.
  • The U.S. parent would be taxed on foreign high returns each year, regardless of whether or not earnings were repatriated. Foreign tax credits allowed for foreign taxes paid with respect to foreign high returns would be limited to 80% of the foreign taxes paid, would not be allowed against U.S. tax imposed on other foreign-source income and would not be allowed to be carried back or forward.

Global Intangible Low-Taxed Income (“GILTI”)

  • Under the Finance bill, a U.S. shareholder of a CFC is currently taxed on its CFC GILTI (without the 50% reduction per the House bill).
  • GILTI operates similar to the current subpart F provisions. The Finance bill does not have the 50% exclusion provided in the House bill.
  • GILTI is defined as the excess (if any) of a U.S. shareholder’s net CFC tested income over the U.S. shareholder’s net deemed tangible income return.
  • CFC tested net income of the shareholder is the aggregate of its pro rata share of the tested income of each CFC over its pro rata share of the tested losses of each CFC.
  • Aggregate CFC net-tested income for the purpose of computing GILTI does not include income of the CFC currently taxed pursuant to other sections of the code such as ECI, and Subpart F income, any gross income excluded from Subpart F foreign personal holding company or foreign-base company income by reason of meeting the high tax exception pursuant to IRC. Sec. 954(b)(4), and any oil and gas extraction income and foreign oil related income.
  • Net deemed tangible income return is 10% of the aggregate shareholder’s pro-rata share of the qualified business asset investment (“QBAI”).
  • QBAI of a CFC is the quarterly average of the U.S. shareholder’s pro rata share of the aggregate tangible depreciable asset basis.
  • For domestic parents of a CFC, a partial deemed paid foreign tax credit is allowed to offset U.S. taxes imposed under this section. The amount of foreign tax credit allowed is 80% of the GILTI inclusion over the domestic parent’s aggregate amount of its pro rata share of the tested income of each CFC.

Deduction for Foreign-Derived Intangible Income

  • A domestic parent of a CFC is allowed a deduction of 37.5% on the lesser of:
    1. The sum of its foreign-derived intangible income, plus the amount of GILTI in gross income, or
    2. Its taxable income.
  • The House bill does not have a deduction provision; rather, it excludes 50% of the foreign high return amount.
  • Foreign-derived intangible income is the domestic parent’s deemed intangible income multiplied by a fraction of the parent’s foreign deduction eligible income over its total deduction eligible income.
  • Deduction eligible income is the gross income of the domestic parent excluding:
    1. Subpart F income under Section 951;
    2. GILTI of the corporation;
    3. Dividend received from a CFC;
    4. Any domestic oil and gas income of the corporation; and
    5. Any foreign branch income, over allocable deductions to such income.
  • Foreign-derived deduction eligible income means deduction eligible income of the taxpayer that is derived in connection with:
    1. Property that is sold to a person who is not a US person for foreign use, or
    2. Services provided outside of the U.S. Property sold for further manufacture in the U.S. is not treated as sold for foreign use.
  • Further, a related party foreign sale is not treated as sold for foreign use unless the property is ultimately sold to a foreign third party.

14. Transfers of Intangible Property from CFCs to U.S. Shareholders

 

 

  • The proposal provides that a CFC that owns intangible property on the date of the enactment will be able to the distribute the intangible property to its U.S. shareholder without incurring a gain on the transaction by treating the fair market value of the property on the date of distribution as not exceeding its adjusted basis.
  • The stock basis in the CFC is adjusted to reflect any deferred gain.
  • The shareholder’s adjusted basis in the property is the adjusted basis in the property immediately before the distribution reduced by the amount of the increase.
  • For this section to be applicable, the distribution should be made by the CFC before the last day of the third taxable year of the CFC beginning after the end of this year.

Base Erosion Proposals

15. Limitation on Interest Deductibility

  • A provision under the House bill would limit interest deductions of U.S. corporations that are members of an international financial reporting group to the extent the U.S. corporation’s share of global net interest expense exceeds 110% of its share of the group’s global EBITDA. 
  • Any disallowed interest expense would be carried forward for up to five tax years, with the carryforward utilized on a first in, first out basis. 
  • For purposes of this provision, an international financial reporting group is a group of entities that includes at least one foreign corporation engaged in a trade or business in the U.S. or at least one domestic corporation and one foreign corporation, prepares consolidated financial statements, and has annual global gross receipts of more than $100 million.
  • The Finance bill limits the interest deductions of U.S. corporations that are members of the worldwide affiliated group. The worldwide affiliated group means a group of one or more chains of corporations (including foreign corporations) connected through a 50% stock ownership with a common parent.
  • Unlike the House version, there is no dollar threshold for the size of the group which is subject to this rule.
  • The amount disallowed is the product of net interest expense of the domestic corporation multiplied by the debt-to-equity differential percentage.
  • The debt-to-equity differential percentage computes the amount of domestic debt that is considered excessive over the total domestic indebtedness.
  • The amount that is considered excessive is the amount of indebtedness in excess of 110% of the debt that the domestic members would hold if the domestic debt was proportionate to the affiliate group’s worldwide debt-to-equity ratio.
  • The amount disallowed because of this provision can be carried forward indefinitely.

16. Limitations on Income Shifting Through Intangible Property Transfers

 

  • The Finance bill expands the statutory definition of intangible property pursuant to IRC Section 936(h)(3)(B) to include:
    • Workforce in place,
    • Goodwill (both foreign and domestic).
    • Going concern value, and
    • The residual category of “any similar item” the value of which is not attributable to tangible property or the services of an individual
  • The proposal clarifies the authority of the Commissioner to specify the method to value intangibles; including permitting valuation of intangibles on an aggregate basis if it’s determined that the aggregate basis achieves a more reliable result than an asset-by-asset approach. 
  • The Finance bill also codifies the realistic alternative principle with respect to intangible property, allowing the IRS to determine an arms-length price by reference to a transaction that was different than the transaction actually concluded.

17. Certain Related Party Amounts Paid or Accrued in Hybrid Transactions or with Hybrid Entities

 

  • Under the Finance bill, a U.S. shareholder may not deduct any interest or royalty payments made pursuant to a hybrid transaction or to a hybrid entity.
  • The amount denied is any interest or payment made to a related party to the extent that the related party is not required to include such income under the tax law of the country of which the related party is a resident, or if the related party is allowed a deduction with respect to such amount.

18. Other Taxes

Excise Tax

  • The House bill contemplates excise taxes on certain payments from domestic corporations to related foreign corporations, unless the foreign corporation elects to treat such payments as effectively connected income.
  • The provision applies to international financial reporting groups (defined in Section 15 above) with payments from the U.S. corporations to their foreign affiliates totaling at least $100 million on average annually over three years.
  • Under the proposal, payments (other than interest) made by a U.S. corporation to a related foreign corporation that are deductible, includible in costs of goods sold, or includible in the basis of a depreciable or amortizable asset, would be subject to a 20% excise tax – unless the related foreign corporation elected to treat the payments as ECI. 
  • As a result, the foreign corporation’s net profits (or gross receipts if no election is made) with respect to those payments would be subject to full U.S. tax, effectively eliminating any potential U.S. tax benefit otherwise achieved.
  • Exceptions would apply for intercompany services which a U.S. company elects to pay for at cost (i.e., no markup) and certain commodities transactions.
  • To determine the net taxable income that is to be deemed ECI, the foreign corporation’s deductions attributable to these payments would be determined by reference to the profit margins reported on the group’s consolidated financial statements for the relevant product line.
  • No credit would be allowed for foreign taxes paid with respect to the profits subject to U.S. tax. Further, in the event no election is made, no deduction would be allowed for the U.S. corporation’s excise tax liability.

Minimum Tax

  • Instead of an excise tax, the Finance bill proposes a base erosion minimum tax on excess base erosion payments made. The minimum tax is a surrogate for the House proposed excise tax.
  • The rule applies to domestic corporations and specifically excludes a RIC, REIT, or S corporation.
  • The application of the rule is limited to domestic corporations who generate average annual gross receipts of at least $500m million for the three-taxable-year period ending with the preceding taxable year, and which has a base erosion percentage of 4% or higher.

19. Repeal of Special Rules for Domestic International Sales Corporations

N/A

  • The Finance bill repeals the special Code rules for DISCs and IC-DISCs.
  • Corporations will no longer be exempt from corporate level tax allowed under these rules, and individual shareholders will be subject to shareholder-level taxation on distributions out of the corporation’s earnings.

Miscellaneous

20. Additional Deduction with Respect to Domestic Production Activities in Puerto Rico

  • The House bill provides that eligibility of domestic gross receipts from Puerto Rico for the domestic production deduction would apply retroactively to tax years beginning after December 31, 2016 and before January 1, 2018.

N/A

21. Extension of Temporary Increase in Limit on Cover-Over of Rum Excise Taxes

  • The House bill provides that the $13.25 per proof gallon excise tax cover-over amount paid to the treasuries of Puerto Rico and the U.S. Virgin Islands would apply retroactively to include imports after December 31, 2016, and be extended to rum imported into the United States before January 1, 2023.

N/A

22. Extension of American Samoa Economic Development Credit

  • The House bill provides that the credit for taxpayers currently operating in American Samoa would retroactively apply to tax years beginning after December 31, 2016 and be extended to tax years beginning before January 1, 2023.

N/A

23. Restriction on the Insurance Business Exception to PFIC rules

  • The House bill proposes to amend the passive foreign investment company (“PFIC”) rules as applied to insurance companies. 
  • Under current law, U.S. shareholders of PFICs are taxed currently on a PFIC’s earnings, but there is an exception for PFIC income that is derived in the active conduct of an insurance business if the PFIC is predominantly engaged in an insurance business and would be taxed as an insurance company were it a U.S. corporation. 
  • The House bill would alter the PFIC exception in that it would apply only if the foreign corporation would be taxed as an insurance company were it a U.S. corporation and if loss and loss adjustment, unearned premiums, and certain reserves constitute more than 25% of the foreign corporation’s total assets (or 10% if the corporation is predominantly engaged in an insurance business and the reason for the percentage falling below 25 is solely due to temporary circumstances). 
  • The Finance bill would alter the PFIC exception in that it would apply only if the foreign corporation would be taxed as an insurance company were it a U.S. corporation and the applicable insurance liabilities constitutes more than 25% of the foreign corporation’s total assets.
  • “Applicable insurances liabilities” means (1) loss and loss adjustment expenses, (2) certain reserves for insurance risk and claims. Applicable insurance liabilities exclude unearned premiums reserves.

24. Source of Gain on the Sale or Transfer of a U.S. Partnership Interest by a Foreign Person

N/A

  • The gain or loss from the sale or exchange of U.S. partnership interest by a foreign person is treated as effectively connected income with a U.S. trade or business to the extent that the transferor would have effectively connected gain or loss had the partnership sold all of its assets at fair market value.
  • The proposal also imposes a withholding tax of 10% of the amount realized on the sale or exchange of the partnership interest unless the transferor certifies that is not a foreign individual or corporation.
  • If the transferee failed to withhold properly, the proposal imposes an obligation by the partnership to withhold distributions to the transferee partner an amount equal to the amount that should have been withheld.

25. Repeal of Fair Market Value of Interest Expense Allocation

 

  • The proposal prohibit taxpayers from allocating interest expense on the basis of fair market value of assets
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Charles Brezak is an International Tax Services Group Director with over 30 years experience advising clients on cross-border tax planning.

Aninda Dhar is a Senior Tax Manager with extensive experience in federal and international tax matters. Aninda provides tax consulting services to entities in numerous industries and serves a diverse roster of clients.

Charles Schneider is a Partner in the International Tax Services Group. He has advised U.S. and foreign-based multinational publicly and privately held enterprises on domestic and international tax issues for more than 25 years.