U.S. International corporate tax update
Deloitte Belgium Tax Quarterly, Issue 43 - March 2011
Numerous recent U.S. legislative and administrative changes have dramatically altered the U.S. tax landscape. The recently passed legislation included significant U.S. tax increases and compliance requirements for multinational businesses.
The following is a brief highlight of some of the more important recent U.S. tax developments.
Uncertain Tax Positions (“UTP”)
On September 24, 2010, the IRS released Announcement 2010-75, announcing the release of the final Schedule UTP and related instructions for use by those taxpayers required to report uncertain tax positions (UTPs) on their U.S. tax returns. Schedule UTP requires the reporting of a corporation's federal income tax positions for which the corporation or a related party has recorded a reserve in an audited financial statement, beginning with the 2010 tax year. Schedule UTP also requires the reporting of a corporation's federal income tax positions for which the corporation or a related party has not recorded a reserve because the corporation expects to litigate the position. A corporation must file Schedule UTP with its income tax return for 2010 if:
- The corporation has total assets equal to or exceeding $100 million in 2010 tax years;
- The corporation makes a reserve under any accounting standard (U.S. GAAP, IFRS, etc);
- The corporation files U.S. tax Form 1120, Form 1120-F, Form 1120-L or Form 1120-PC;
- The corporation issued (or a related party issued) audited financial statements; and
- The corporation has one or more tax positions that must be reported on Schedule UTP.
The IRS will gradually decrease the asset threshold to $50 million starting with 2012 tax year and to $10 million starting with 2014 tax year.
A U.S. subsidiary of a foreign corporation is required to disclose its UTP’s if it records a reserve in its audited financial statements and it meets the asset threshold for the year. Additionally, a U.S. subsidiary of a foreign corporation is required to disclose a UTP if it has taken a position on its tax return and the foreign parent includes a reserve for the position on its financial statement.
Foreign Account Tax Compliance Act (“FATCA”)
Effective for years after December 31, 2012, one of the primary goals of FATCA is to combat the perceived problem of U.S. Taxpayers hiding assets outside the U.S. to avoid U.S. income tax.
FATCA requires non-U.S. financial institutions to provide the IRS with information on U.S. persons invested in accounts outside of the U.S. and for non-U.S. entities to provide information about any U.S. owners. To compel these non-U.S. entities to provide this information, FATCA will require the imposition of a 30 percent withholding tax on any “withholdable payment” made to non-U.S. financial institutions do not enter into an agreement with the IRS and non-U.S. entities that do not disclose substantial U.S. owners. Withholdable payments may include but are not limited to U.S. source interest, dividends, rents, salaries, wages, premiums, annuities, compensations, and remunerations that are not effectively connected with a U.S. trade or business. Additionally, withholdable payment includes gross proceeds from the sale or disposition of any property that can produce U.S. source interest or dividends.
Internal Revenue Code (“IRC”) Section 304 Changes
A foreign-based (foreign-parented) multinational group of companies may have U.S. subsidiaries which own controlled foreign corporations (“CFC”s). Without going into all of the technical aspects of IRC Section 304, prior to the legislative changes, if a foreign member of such a multinational group (see the structure chart below) sold stock of a member of the group to a related CFC (in the chart below sale of stock of US subsidiary by the non- U.S. parent to CFC), the amount received by the seller under IRC Section 304 before the changes, could be treated as a dividend received directly from the CFC that acquired the stock. Accordingly, the earnings and profits of the acquiring CFC could “hopscotch” any intermediary shareholders (and thus be permanently removed from the U.S. tax system).
The new Act prevents earnings of an acquiring foreign corporation from being deemed distributed as a dividend under IRC Section 304 if more than half the dividends otherwise triggered by Section 304 would neither be (a) subject to U.S. income tax for the year in which the dividends arise, or (b) included in the earnings and profits of a CFC. It is anticipated that regulations will provide a rule to prevent the avoidance of the provision, including through the use of partnerships, options, or other arrangements to cause a foreign corporation to be treated as a CFC.
This legislative change to IRC Section 304 limits the ability of foreign held multinationals to remove earnings subject to US tax efficiently in cases of sandwiched structures.
Provisions Affecting the Foreign Tax Credit (“FTC”) Rules
Income from assets acquired in “covered” asset acquisitions: New rules permanently deny foreign tax credits (FTCs) for a portion of the foreign taxes on income from assets acquired in a way that results in a basis step-up for US tax purposes but not foreign tax purposes (a so-called “covered asset acquisition”). The disqualified portion of the foreign tax for any post-acquisition taxable year is generally computed as the ratio of (1) the aggregate step up in tax basis allocable to that year to (2) the income from the assets on which the foreign tax is determined.
Foreign tax credit splitters: The new rules suspend, for FTC and other U.S. tax purposes, the foreign income taxes paid or deemed paid by a taxpayer with respect to which there is a “foreign tax credit splitting event” (FTCSE). There is an FTCSE with respect to a foreign income tax if the related income is (or will be) taken into account for U.S. income tax purposes by a “covered person.” With respect to the payor of the foreign income tax, a covered person is any entity in which the payor holds, directly or indirectly, at least a 10% ownership interest (by vote or value); any person that holds, directly or indirectly, at least a 10% ownership interest (by vote or value) in the payor; any person that bears a relationship to the payor described in attribution rules under IRC Sections 267(b) or 707(b); and any other person specified by the U.S. Treasury Secretary. These new rules inhibit the ability of US based multinationals to maximize their US FTC by splitting foreign tax credits from related income.
FTCs for U.S. tax on items sourced foreign under treaties: New rules apply to income derived from a U.S.-owned foreign corporation that is U.S. source under internal U.S. law, but is sourced foreign under a treaty resourcing rule—the new provision generally imposes a separate FTC limitation on any other income of a U.S. taxpayer that is U.S. source under internal U.S. law but sourced foreign under a treaty.
Economic Substance Doctrine
Healthcare Reform Legislation that was enacted on March 30, 2010 codified in IRC Section 7701(o) the common law economic substance doctrine that courts and the IRS have applied in the past to deny tax benefits in cases where transactions satisfy the technical requirement of the law but are nonetheless tax motivated. Under the new Section 7701(o), in the case of any transaction to which the economic substance doctrine is relevant, a transaction is treated as having economic substance only if:
- A meaningful change in the taxpayer’s economic position apart from tax effects and
- A substantial non-tax purpose for entering into the transaction.
Significant penalties (ranging from 20-40%) apply to transactions that do not meet this test. No exceptions to the penalty, including the reasonable cause exception, are available. Thus, outside opinions or in-house analysis would not protect the taxpayer from the penalty.
These and other enacted and proposed U.S. tax legislation may significantly impact the tax position of US based and foreign multinationals doing business with the U.S.
Therefore careful consideration should be given to the legislative changes and their impact on international transactions involving the U.S.