Chairman Camp’s Discussion Draft of Tax Reform Act of 2014 and President Obama’s Fiscal Year 2015 Revenue Proposals: Proposals Relating to International Taxation

Sullivan & Cromwell LLP - March 25, 2014

On February 26, 2014, Ways and Means Committee Chairman Dave Camp released a discussion draft of tax reform legislation entitled the “Tax Reform Act of 2014” (the “Discussion Draft”).  Although the Discussion Draft is unlikely to be enacted in its current form, some or all of the proposals may serve as a template for future legislation.  In addition, on March 4, 2014, the Obama Administration (the “Administration”) released the General Explanations of the Administration’s Fiscal Year 2015 Revenue Proposals (commonly known as the “Green Book”).  Although the Green Book does not include proposed statutory language, the Green Book contains significant detail about the fiscal year 2015 revenue proposals.  Many of these proposals were made previously by the Administration but were not enacted into law.

This memorandum discusses key aspects of the Discussion Draft and the Green Book relating to international taxation that we anticipate may be of interest to our clients.  We will be distributing separate memoranda addressing the Discussion Draft and Green Book proposals relating to (i) domestic business taxation, and (ii) individuals, retirement plans and estate and gift taxation, both of which may be obtained by following the instructions at the end of this memorandum.

The Discussion Draft proposes comprehensive changes to the existing international taxation regime, and includes the following specific proposals:

  • shifting toward a territorial tax system by establishing a 95 percent deduction for the foreign-source portion of dividends received by domestic corporations from “specified 10 percent owned foreign corporations,” but requiring that shareholders of such corporations include as income (with up to a 90 percent deduction) their share of the corporations’ accumulated untaxed income;
  • making the look-through rule for related controlled foreign corporations permanent;
  • taxing foreign intangible income at the reduced rate of 15 percent but subjecting such income to Subpart F (i.e., taxing a U.S. shareholder of a controlled foreign corporation earning such income on a current basis whether such income is distributed or not) unless such income qualifies for the high taxed exclusion);
  • extending the exemption from Subpart F of qualified banking or finance income and qualified insurance income, but limiting the exemption to only 50 percent of the income earned if the income is not subject to tax at a rate that is at least 50 percent of the U.S. maximum rate of corporate tax;
  • denying interest deduction for members of worldwide affiliated groups with excess domestic indebtedness;
  • making the high-tax exception to Subpart F non-elective and creating an exception to foreign base company sales income for income earned by a foreign subsidiary incorporated in a country that has a comprehensive income tax treaty with the United States;
  • restricting the insurance business exception to passive foreign investment company rules;
  • tightening limitations on earnings stripping; and
  • limiting treaty benefits for certain deductible related party payments.
The Green Book proposals relating to international taxation include:
  • providing for reciprocal reporting of information in connection with the implementation of the Foreign Account Tax Compliance Act (“FATCA”);
  • creating a new category of Subpart F income for transactions involving digital goods or services;
  • preventing avoidance of foreign base company sales income through manufacturing services arrangements;
  • restricting the use of hybrid and reverse hybrid arrangements that create stateless income;
  • imposing additional limitations on “inversion” transactions;
  • exempting foreign pension funds from the application of the Foreign Investment in Real Property Tax Act (“FIRPTA”);
  • deferring interest deductions related to deferred foreign income;
  • determining foreign tax credit pools on an aggregate basis;
  • currently taxing some types of income from intangible property transferred to offshore related parties and clarifying (or broadening) the definition of intangible property;
  • modifying the foreign tax credit rules for dual capacity taxpayers;
  • taxing some gain from the sale of a partnership interest as effectively connected to a U.S. trade or business and requiring withholding in certain circumstances;
  • taxing certain leveraged distributions from related foreign corporations;
  • placing additional limits on the use of foreign tax credits in the case of certain asset acquisitions; and
  • removing foreign taxes from the foreign tax pool in the case of certain domestic shareholder corporations when earnings are eliminated from a foreign subsidiary.
Finally, both the Green Book and the Discussion Draft propose disallowing deductions for non-taxed reinsurance premiums paid to offshore affiliates.