United States Alert - 14 February 2012
Administration FY2013 Budget and Treasury descriptions of international tax proposals (Greenbook) released
By Gretchen Sierra, Phil Morrison, Mark Wanek, Timothy Messenger and Oshan James
On 13 February 2012, the Obama Administration released its FY2013 Budget and the Treasury Department released the General Explanations of the Administration’s Fiscal Year 2013 Revenue Proposals (the “Greenbook”). When compared to the FY2012 Budget, the FY2013 Budget contains several carryover international tax proposals from the FY2012 Budget (“carryover proposals”). It also includes four new proposals.
Unless otherwise indicated, all international tax proposals are proposed to be effective for taxable years beginning after 31 December 2012.
Tax gain from the sale of a partnership interest on look-through basis
Proposal description: Gain or loss from the sale or exchange of a partnership interest would be effectively connected with the conduct of a trade or business in the United States to the extent attributable to the transferor partner’s distributive share of the partnership’s unrealized gain or loss that is attributable to effectively connected income (ECI) property.1 In addition, the transferee of a partnership interest would be required to withhold 10% of the amount realized on the sale or exchange of the interest unless the transferor certifies that it is neither a nonresident alien individual nor a foreign corporation. Reduced withholding would apply if the transferor obtains a withholding certificate from the Internal Revenue Service (IRS) establishing that the transferor’s ultimate tax liability is less than the amount otherwise required to be withheld. If the transferee fails to withhold the correct amount, the partnership would be liable for any underwithholding.2
The proposal would be effective for sales or exchanges after 31 December 2012.
Observations: The proposal essentially codifies Rev. Rul. 91-323 and extends FIRPTA-type withholding4 to sales or exchanges of partnership interests. The Administration is concerned that foreign taxpayers may be taking a position contrary to Rev. Rul. 91-32 because no Code provision explicitly treats gain from the sale or exchange of a partnership interest as ECI. The Administration appears to think it inappropriate for inside gain with respect to ECI assets to escape taxation where, without partner-level tax on gain, that inside gain will disappear where the partnership elects under §754 to adjust the basis of its assets upon the transfer of a partnership interest to reflect the transferee partner’s outside basis.
While the policy for the rule may be supportable, the adoption of a FIRPTA-like withholding regime in the partnership context would create several administrative difficulties for taxpayers and the IRS. First, it is unclear how the transferor would obtain the information required to compute its tax liability as the gain or loss “attributable to” ECI property is a partnership-level determination, which would presumably require a valuation of all of the partnership’s assets on the date of any transfer of a partnership interest. Second, there could be overwithholding in many circumstances, which would either require the processing of withholding certificates or refund claims by the IRS. Obtaining a withholding certificate from the IRS to reduce withholding would presumably require the partnership to produce a detailed computation of the unrealized gain or loss in each of its assets, which may not be possible prior to the transfer in many cases. FIRPTA has similar issues in the partnership context that create significant uncertainty for taxpayers and with respect to which regulations have never been issued.
Prevent use of leveraged distributions from related foreign corporations to avoid dividend treatment
Proposal description: Section 301(c) provides that a distribution of property to a shareholder is characterized first as a dividend to the extent of the distributing corporation’s earnings and profits (E&P), then as a return of basis and last as gain from the sale or exchange of property. The proposal would prevent return of basis treatment under §301 to the extent a foreign corporation (the “funding corporation”) funds a second, related foreign corporation (the “foreign distributing corporation”) in a transaction with a principal purpose of avoiding dividend treatment on distributions to a U.S. shareholder. 5 Funding transactions would include capital contributions, loans or distributions to the foreign distributing corporation, whether the funding transaction occurs before or after the distribution.
The proposal would apply to distributions after 31 December 2012.
Observations: The proposal appears to be modeled on the anti-abuse rules of §304 and §956.6 However, the instances in which these existing rules apply are far more limited than the proposal. Given the potential frequency of repatriating distributions by foreign corporations to their U.S. shareholders and the potential scope of this proposal to encompass ordinary financing structures, this proposal would seem to raise significant issues regarding its administrative burden.
Extend §338(h)(16) to certain asset acquisitions
Proposal description: A “section 338 election” allows a corporation that makes a “qualified stock purchase” of another corporation’s stock to step up the tax basis of the target corporation’s assets to fair market value.7 Section 338(h)(16) prevents use of this election to increase allowable foreign tax credits by providing that the deemed sale is ignored when sourcing and characterizing items for purposes of computing the foreign tax credit limitation.
Recently enacted §901(m) denies certain foreign taxes paid or accrued after a “covered asset acquisition.”8 A covered asset acquisition includes transactions that are treated as asset acquisitions for U.S. tax purposes but as the acquisition of an interest in an entity for foreign tax purposes.
The proposal would extend the application of §338(h)(16) to any covered asset acquisition occurring after 31 December 2012.
Observations: The Administration believes that covered asset acquisitions not currently subject to §338(h)(16) pose the same ability to increase inappropriately the foreign tax credit limitation as qualified stock purchases for which a §338 election is made. However, sourcing additional transactions under the §865 rules for sourcing stock gains may result in double taxation as §865 often sources stock gains as U.S. source under the assumption that stock gains are not taxed in foreign countries. This assumption can frequently be incorrect.
This proposal may also be viewed as being targeted at the check the box regulations. Although the Administration abandoned its check-the-box proposal in the FY2010 Budget, it may be using a targeted proposal to address the application of the check-the-box regulations in the international context.
Remove foreign taxes from a §902 corporation’s foreign tax pool when earnings are eliminated
Proposal description: Certain transactions result in a reduction, allocation or elimination of a corporation’s E&P other than by reason of a dividend or deemed dividend or a §381 transaction, such that there is not a corresponding reduction in the associated foreign taxes paid, e.g. a redemption of a corporation’s stock that is treated as a sale or exchange under §302(a) where there is a reduction of the company’s E&P under §312(n)(7).
The proposal would reduce a foreign corporation’s tax pool to the extent foreign taxes are associated with a reduction in such corporation’s E&P other than by reason of a dividend, deemed dividend or a §381 transaction.
The proposal would be effective for transactions occurring after 31 December 2012.
Observations: This proposal is consistent with the policy of the 1997 final regulations under §902, which removed from the tax pool any foreign taxes attributable to distributions to ineligible shareholders and eligible shareholders that chose to deduct foreign taxes.9
The descriptions of the carryover proposals in the Greenbook are nearly identical to those in last year's Greenbook with limited exceptions. Generally, where there are changes relative to last year’s Greenbook, the changes appear to be consistent with the President’s Plan for Economic Growth and Deficit Reduction submitted to the Joint Select Committee on Deficit Reduction (informally known as the “supercommittee”) and the American Jobs Act of 2011.
With respect to the reinsurance proposal (i.e. disallow the deduction for excess non-taxed reinsurance premiums paid to affiliates), the proposal differs only very slightly from the FY2012 Budget proposal and closely mirrors the language in the bill introduced late last year by Congressman Richard E. Neal (D-Mass).10 The FY2013 Budget proposal disallows a deduction for both premiums and “other amounts” paid to non-taxed affiliated foreign reinsurers. These “other amounts” would include items that are related to the reinsurance transaction giving rise to the premiums for which a deduction was disallowed.
Additionally, the FY2013 Budget contains a proposal to extend expiring provisions including an extension of §954(c)(6) and §954(h) (controlled foreign corporation look-through and active financing exceptions, respectively) through 31 December 2013.
|FY2013/2012 Treasury Budget comparison (in billions)|
|Carryover proposals||Revenue estimate|
|Defer deduction for interest expense related to deferred income||37.3||37.7|
|Determine foreign tax credit on a pooling basis||60.8||51.4|
|Tax currently excess returns associated with transfers of intellectual property offshore||23.0||20.8|
|Limit shifting of income through intangible property transfers||1.6||1.7|
|Disallow deductions for excess non-taxed reinsurance premiums paid to affiliates||2.4||2.6|
|Limit earnings stripping by expatriated entities||4.4||4.2|
|Modify tax rules for dual capacity taxpayers||10.7||10.8|
|Repeal gain limitation for dividends received in reorganization exchanges11||0.9||0.8|
|Carryover proposals total||141.1||130.0|
|Tax gain from the sale of a partnership interest on look-through basis||2.6||N/A|
|Prevent use of leveraged distributions from related foreign corporations to avoid dividend treatment||3.3||N/A|
|Extend §338(h)(16) to certain asset acquisitions||1.0||N/A|
|Remove foreign taxes from a §902 corporation’s foreign tax pool when earnings are eliminated||0.4||N/A|
|New proposals total||7.3||0.0|
|Total for all international proposals||148.4||130.0|
1The proposal would grant authority to the Treasury Secretary to determine the extent to which a distribution from the partnership would be treated as a sale or exchange of an interest in the partnership and to coordinate the new provision with the nonrecognition provisions of the Internal Revenue Code (“Code”).
2The partnership would satisfy the withholding obligation by withholding on future distributions to the transferee partner.
31991-1 C.B. 107. In Rev. Rul. 91-32, the IRS took the position that gain on the sale of a foreign partner’s interest in a partnership was ECI to the extent attributable to ECI property of the partnership.
5For this purpose, the funding corporation and the foreign distributing corporation are related if they are members of a control group within the meaning of §1563(a), but replacing the reference to “at least 80 percent” with “more than 50 percent.”
6See Treas. Reg. §1.304-4T; Treas. Reg. §1.956-1T(b)(4); Rev. Rul. 76-192, 1976-1 C.B. 206.
7For this purpose, a “qualified stock purchase” is any transaction or series of transactions in which the purchasing corporation acquires 80% of the stock of the target corporation.
8Section 901(m) provides “the term “covered asset acquisition” means:
(A) A qualified stock purchase (as defined in §338(d)(3)) to which §338(a) applies,
(B) Any transaction which – i. is treated as an acquisition of assets for purposes of this chapter, and ii. is treated as the acquisition of stock of a corporation (or is disregarded) for purposes of the foreign income taxes of the relevant jurisdiction,
(C) Any acquisition of an interest in a partnership which has an election in effect under §754, and
(D) To the extent provided by the Secretary, any other similar transaction.
9See Treas. Reg. §1.902-1(a)(8)(i), T.D. 8708.
10See H.R. 3157, 112th Cong. 1st Session, 12 October 2011.
11Listed as an “Other revenue changes and loophole closers” item and not specifically as an international tax reform item.