As you may be aware, the House Ways and Means Committee recently approved a multitrillion-dollar tax package (the “Proposal”) that has significant tax impact on both individuals and corporations. The obvious targets of the Proposal, of which many of you may be aware, include: individual tax rates (with a new proposed maximum rate of 39.6%), capital gains tax rates (with a new proposed maximum rate of 25%), corporate tax rates (with a new maximum rate of 26.5%), estate and gift tax Unified Credit reduction (reducing the exemption for U.S. citizens and U.S. domiciliaries back to $5,000,000, indexed for inflation), and grantor trusts (new rules that include grantor trust assets in the taxable estate of the grantor at death and limit the effectiveness of sales to intentionally defective grantor trusts). None of these topics will be discussed herein; instead, the discussion will focus on some of the international tax provisions.
As discussed previously in “The Draft of the International Tax Overhaul: Where is Captain America” (the “Overhaul Article”), the Senate Finance Committee released draft legislation, and a related summary, applicable to the U.S. international tax regime (the “Draft Legislation”). The Proposal addresses many of the questions left unanswered by the Draft Legislation and also puts forward modification to several of the concepts addressed therein.
As a reminder, the 2017 Tax Cuts and Jobs Act’s international tax changes were substantial, particularly as it relates to controlled foreign corporations ("CFCs").1 The following non-exclusive list of changes were implemented:
- The so-called "transition tax" of Sec. 965 and the related changes to the Foreign Tax Credit system (especially Sec. 902) and to the Dividends Received Deduction (Sec. 245A);
- Global Intangible Low Tax Income ("GILTI");
- Foreign Derived Intangible Income ("FDII");
- The special rules of Sec. 250;
- The Base Erosion and Anti-Abuse tax ("BEAT"); and
- The reduction of the U.S. corporate tax rate to 21%.
Please see the Overhaul Article for a more detailed discussion of the proposals in the Draft Legislation. This said, some of the more important aspects of the Proposal in relation to the Draft Legislation include:
GILTI is proposed to be modified to:
- use a “country by country” calculation (“CxC GILTI”). Related changes are made in the foreign tax credit rules;
- use a 5% deemed return on qualified business asset investment (i.e., the amount that can be deferred under GILTI);
- allow for carryover of country-specific net CFC tested loss to the succeeding taxable year; and
- have a reduced foreign tax credit “haircut” (being reduced from 80% to 95%, in most cases).
Section 250 is proposed to be modified to:
- change the percentages with respect to FDII and GILTI. The percentage for FDII is changed to 21.875 percent (from 37.5 percent), and the percentage for GILTI is changed to 37.5 percent (from 50 percent); and
- repeal the taxable income limitation and allow for the Section 250 deduction to be taken into account for purposes of determining the Net Operating Loss of a taxpayer.
The practical effect of the modifications to GILTI and Section 250, in light of the increased corporate tax rate, will be an overall increase to what is considered to be “high tax” for purposes of avoiding U.S. income tax under the CxC GILTI rules (and therefore a presumed increase to the U.S. tax base). Similarly, the benefits of FDII are reduced. This appears to be drafted with the OECD concepts of a global minimum tax in mind.
Nevertheless, and as we learned in a certain movie involving Captain America, when you think that S.H.I.E.L.D. is there to help, you are surprised by H.Y.D.R.A. (the House Yields Decisive Reconciliation Action). By no means is there to be an implication (or an inference) that the Proposal is insidious in some manner (like the Helicarriers were); however, there are some surprises nonetheless. The two main surprises are:
Reinstatement of Section 958(b)(4).
The repeal of Section 958(b)(4), which allowed for “downward attribution,” has created confusion as to what constitutes a CFC in the context of the high net worth U.S. taxpayer operating a significant closely held business outside of the United States. It further raised questions relating to the Portfolio Interest Exemption (the “PIE”, which is discussed further herein) and how to plan for a U.S. person inheriting structures from non-U.S. persons. In this regard, a hidden gem in the Proposal (which is found in a portion of the Proposal limiting the deduction under section 245A to dividends received from a CFC) would amend the CFC rules by reinstating Section 958(b)(4) and adding Section 951B. In this regard, this is a welcomed change that would avoid the uncertainty that exists as to the application of repeal of the Section 958(b)(4) in other situations and otherwise allows clarification with respect to the perceived abuses that Congress intended to prohibit.
Changes to the Portfolio Debt Interest Exemption.
A non-U.S. taxpayer (i.e., individuals that are nonresident aliens and foreign corporations) is generally only subject to U.S. tax on their U.S.-source income.2 In this regard, one such category of U.S. source income for a non-U.S. taxpayer is “fixed or determinable annual or periodical gains, profits, and income” (“FDAPI”). FDAPI is generally subject to a 30 percent gross-basis tax, which is withheld at its source (unless this rate is subject to a reduced rate of, or entirely exempt from, U.S. tax under another provision of U.S. tax law or under an income tax treaty). This said, FDAPI includes U.S. source portfolio interest; however, such interest is exempt from the 30 percent gross-basis tax (known as the PIE) if certain condition are satisfied. In short, the PIE rules have several requirements, including:
- the debt obligation must be in registered form;
- the interest cannot be contingent;
- the debt cannot be payable to a bank or otherwise effectively connected to a U.S. trade or business;
- the beneficial owner must provide to the U.S. withholding agent a statement certifying that the beneficial owner is not a U.S. person (generally done on Form W-8 BEN-E); and
- the interest cannot be received by “a 10 percent shareholder”. For this purpose, a 10 percent shareholder is, in the case of an obligation issued by a corporation, any person who owns 10 percent or more of the total combined voting power of all classes of stock of such corporation entitled to vote, or, in the case of an obligation issued by a partnership, any person who owns 10 percent or more of the capital or profits interest in such partnership.
The Proposal provides that, in the case of an obligation issued by a corporation, the definition of a 10 percent shareholder would be modified to be:
- any person who owns 10 percent or more of the total combined voting power of all classes of stock of such corporation entitled to vote ; and
- any person who owns more than 10 percent of the total value of the stock of such corporation.
The Proposal applies to obligations issued after the date of enactment (and presumably, for now, any obligations that are substantially modified under Section 1001 after the date of enactment).
Wait, What? Bucky is the Winter Soldier? THIS IS A GAME CHANGER! In many situations, especially in private equity deals, the PIE is an essential tool utilized in attracting foreign investors who do not have voting control of the investment vehicle (but who may have an equity interest that equals or exceed 10%). Thus, what the Proposal purports to give with the reenactment of Section 958(b)(4) it takes away with the proposed changes to the PIE.
Other Proposed International Tax Related Changes.
Some other proposed changes include:
- Modification of Foreign Base Company Sales and Service Income. Under existing CFC rules, Foreign Base Company Sales and Service Income are a type of Subpart F income that can result in a deemed distribution to a U.S. taxpayer. Under current law, the rules can apply where there are transactions between a CFC and certain related parties not in the same country as the CFC. In effect, the U.S. tax law was monitoring not only shifts of income from the U.S. tax base to a non-U.S. jurisdiction but was also catching perceived abuses whereby there were shifts from one foreign jurisdiction to another. The Proposal would limit the application of Foreign Base Company Sales and Service Income to situations that involve U.S. residents. Although this should reduce the impact of the Foreign Base Company Sales and Service Income rules, this income would then be potentially subject to the CxC GILTI rules. Thus, it is uncertain at this point the extent to which this is a beneficial change;
- Repeal of the election for a one month deferral in determining the taxable year of a Specified Foreign Corporation. This rule allowed the choice of a taxable year beginning 1 month earlier than the majority U.S. shareholder year;
- Foreign oil related income would be amended to include oil shale and tar sands;
- Certain adjustments to the calculation of Earnings and Profits of a CFC;
- Expansion of the extraordinary dividend rule in certain CFC contexts; and
- Creation of a new limitation on the deduction of interest by certain domestic corporations that are in an international financial reporting group.
The Proposal is generally a welcomed addition to the Draft Legislation; however, the Proposal has presented some interesting surprises. Because the potential impact of the Proposal and the Draft Legislation may be far reaching and have a significant impact on how U.S. corporations and U.S. individual taxpayers do business internationally, it is important to monitor the progress of this proposed legislation. As noted above, one especially concerning aspect of the Proposal is the potential limitation placed on the availability of the PIE (particularly as it applies to private equity investment structures).
 A CFC is, generally, any foreign corporation in which more than 50 percent of the total combined voting power of all classes of stock entitled to vote is owned directly, indirectly, or constructively by U.S. shareholders on any day during the taxable year of such foreign corporation or more than 50% of the total value of the stock is owned directly, indirectly or constructively by U.S. shareholders [as defined in Section 951(b)] on any day during the taxable year of the corporation. The rules of attribution applicable for this purpose can have very broad application (including through family, business entities, and trusts and estates) and need to be reviewed under each set of facts.
 Consider, generally, Sections 861 – 865, 871 – 875, 879, 881-885, 897, 1441, 1442, 1445 and 1446.