May 6, 2009
On Monday, President Obama released the details of his Administration’s plan to reform the tax treatment of offshore earnings and combat tax havens. Crediting House Ways and Means Chairman Charles Rangel, Senate Finance Committee Chairman Max Baucus, Senator Carl Levin and Congressman Lloyd Doggett, the President announced a plan that would make several major substantive tax law changes, including reforming the deferral of income earned overseas, taxing certain foreign subsidiaries as corporations, and limiting the application of the foreign tax credit. The plan also includes several efforts to improve international tax compliance, such as strengthening certain information reporting requirements and increasing the IRS’ enforcement tools. The Administration anticipates that these reforms will generate approximately $198 billion in revenue from 2011 to 2019.
The Administration’s proposal generated immediate opposition from the business community. The criticism included charges that the proposal would disadvantage U.S. businesses relative to their foreign competitors and could make them attractive targets for takeovers by foreign firms. And though his name was invoked by the President, Senate Finance Committee Chairman Max Baucus issued a release stating that "further study is needed" of the proposal.
Prospects for the President’s proposal are uncertain. While the President still enjoys tremendous support among the public and on Capitol Hill, the chances of many of these proposals passing will depend on whether the savings are needed to fund priority legislative initiatives such as health care and education reform and tax cuts. Absent such a politically compelling need, it is unlikely that Congress will move such legislation on its own as a deficit-reduction measure.
Substantive Tax Law Changes
The substantive reforms are targeted towards U.S. multinational corporations, affecting their ability to defer foreign income, treat their subsidiaries as disregarded entities, and use foreign tax credits. The Administration has also proposed a tax cut in the form of making permanent the Research and Experimentation Tax Credit.
1. Require Deferral of Deductions Related to Deferred Income
Under current law, U.S. corporations can defer taxes indefinitely on certain profits they earn overseas until they "repatriate" that money back to the United States. Corporations are permitted to deduct currently certain expenses that relate to these deferred foreign-source earnings. The Administration’s proposal would disallow deductions associated with offshore earnings until the corresponding income was repatriated to the United States and subject to U.S. tax.
2. Classify Certain Foreign Subsidiaries as Corporations
Currently, U.S. multinational corporations may, under the "check-the-box" regulations, elect to treat certain foreign subsidiaries as disregarded entities. In certain circumstances, this treatment enables the U.S. corporations to avoid U.S. tax on the income earned by those subsidiaries. The proposal would require U.S. corporations to treat certain of those subsidiaries as corporations for U.S. tax purposes. The details of this proposal remain unclear.
3. Limit Foreign Tax Credit
Currently, U.S. businesses that pay taxes to foreign governments can claim a credit against their U.S. taxes based on the amount of foreign taxes paid. The Administration’s proposal would require that a U.S. corporation’s foreign tax credit be determined based on the amount of total foreign tax the taxpayer actually pays on its foreign earnings and would not allow a foreign tax credit for foreign taxes paid on income not subject to U.S. tax. Although the proposal does not contain any specifics, prior proposals addressing this issue suggest that the new legislation would require the corporation’s foreign taxes to be prorated over the taxpayer’s entire foreign income, including deferred income, thereby limiting the amount of foreign taxes eligible to be credited.
4. Permanently Extend the Research and Experimentation Tax Credit
The Research and Experimentation Tax Credit, which provides a credit equal to 20% of qualified research expenses, is set to expire at the end of 2009. The Administration proposes to make this tax credit permanent.
Other Proposed Changes
The remaining reform provisions are primarily targeted at increasing the tax compliance of wealthy individuals who attempt to evade U.S. taxes by hiding income earned in offshore accounts. The Administration’s proposals would require increased information reporting by non-U.S. financial institutions, impose additional withholding obligations on U.S. financial institutions, create a presumption against taxpayers in certain tax cases, increase penalties for failure to report certain foreign investment and extend the statute of limitations for international tax enforcement.
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