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By Edward Tanenbaum, Esq.
Alston & Bird LLP, New York, NY
There's an old rule of thumb that if you see tax proposals repeating themselves in the legislative process often enough, the proposals will eventually become law. All of us can surely point to any number of provisions that have gone through this process.
The latest iteration of this can be found in H.R. 4213 (the American Jobs and Closing Tax Loopholes Act of 2010), offered jointly on May 20, 2010, by Senate Finance Committee Chairman Max Baucus and House Ways and Means Committee Chairman Sander Levin, as well as in H.R. 5328 (the International Tax Competitiveness Act of 2010), introduced in the House on May 18, 2010, by Representative Lloyd Doggett.
This commentary will focus on H.R. 5328. You'll remember that Rep. Doggett and Rep. Levin had been sponsors of a number of earlier familiar bills, such as the Stop Tax Haven Abuse Act whose provisions, together with various provisions contained in the May 2009 and February 2010 Obama Green Book proposals, are now finding their way into both H.R. 4213 and H.R. 5328.
The centerpiece of H.R. 5328 is the "managed and controlled" provision relating to certain foreign corporations. This provision is similar to that contained in the earlier Stop Tax Haven Abuse Act and is an indication that §367 and §7874 (inversions) are regarded by Congress as not doing enough to prevent abuse. In particular, new §7701(p) would provide that, notwithstanding the usual definition of a domestic corporation, a corporation that would otherwise be regarded as foreign would be treated as domestic if its management and control occurred, directly or indirectly, primarily within the United States.
The provision would apply to any qualifying foreign corporation if its stock is regularly traded on an established securities market or if the aggregate gross assets of the corporation (including assets under management for investors), whether held directly or indirectly, at any time during the taxable year (or preceding taxable year), is $50,000,000 or more. (Carved out of the gross asset test is a corporation that is a controlled foreign corporation and is a member of an affiliated group, the common parent of which is a domestic corporation that has substantial assets (other than cash, cash equivalents, and stock of foreign subsidiaries) held for use in an active trade or business in the United States.)
Management and control (primarily occurring in the United States) is left to regulations to be prescribed. However, the regulations are directed to provide that management and control of the corporation will be treated as occurring primarily in the United States if substantially all of the executive officers and senior management who exercise day-to-day responsibility for making decisions involving strategic, financial, and operational policies of the corporation are located in the United States. However, the regulations are also directed to provide that individuals who are not executive officers and senior management will, nonetheless, be treated as such if they exercise the day-to-day responsibilities involving strategic, financial, and operational policy decisions. A special rule would also provide that management and control will be treated as occurring primarily within the United States if the assets of the corporation (directly or indirectly) consist primarily of assets being managed on behalf of investors and the decisions about how to invest are made in the United States.
Among the other more significant provisions contained in H.R. 5328 is a trio of amendments that attack head-on Congress' concerns about the use (or misuse) of intellectual property in the international context.
The first prong of the trio would repeal the current look-through rule under §954(c)(6) for royalties received from related-party controlled foreign corporations (CFCs). Thus, any royalty payments from a related-party CFC would no longer benefit from the exclusion under §954(c)(6) from treatment as foreign personal holding company income (an element of Subpart F income).
Second, in determining foreign personal holding company income in connection with royalties, the determination of such classification would be made without regard to any election treating any entity as a disregarded entity.
Third, in connection with making a determination of the existence of foreign base company sales income in connection with the purchase/sale of personal property, property would be treated as having been purchased from a related party (creating Subpart F income) if any intangible property made available to a CFC (directly or indirectly) by a related U.S. person contributed (directly or indirectly) to the production of such personal property by the CFC. However, the foregoing would not apply to any personal property produced directly by the CFC (without regard to an election to disregard any entity).
Finally, no good revenue-raising international tax bill these days can be devoid of the other two proposals that seem to have made their way into most other tax bills, Green Books, etc. The first would repeal the 80/20 rule under which dividends and interest paid by a domestic corporation are free of U.S. withholding tax if at least 80% of the domestic corporation's gross income during the preceding three-year period is foreign-source income attributable to the active conduct of a foreign trade or business.
Second, the "boot-within-gain" rule would be amended so that any boot received in connection with a tax-free reorganization would be taxable as a dividend (to the extent it would have been so treated if the boot were distributed by the corporation immediately after the exchange in redemption of stock having a fair market value equal to the boot) without regard to the gain recognized (limitation) in the transaction.
The "managed and controlled" portion of H.R. 5328 was initially targeted (back in the Stop Tax Haven Abuse Act days) at offshore hedge funds and private equity funds. However, it is by no means so limited. The general concept is not a novel one, at least by other countries' standards. Many countries establish residency for taxpayers on an effective management basis and, to that extent, are far less formalistic than is the United States. Indeed, the concept is not unknown in the United States either, as can be seen from our treaty negotiations. For example, in setting forth the requirements for a taxpayer to meet the "limitation on benefits" provisions of the U.S.-Netherlands Income Tax Treaty under the "publicly traded" exception, there is the ability for the taxpayer to demonstrate that it is managed and controlled in the particular Contracting State of residency. The test in the treaty for determining whether an entity is managed and controlled in a particular country is similar, but not identical, to that proposed in H.R. 5328, although the two have somewhat different underlying purposes.
Nonetheless, this is a worrisome provision that could have the effect of bringing many foreign corporations into the U.S. taxing jurisdiction on a worldwide basis if the various tests are met. Taxpayers are likely to plan around the somewhat vague and ambiguous tests in an attempt to manage the situation but surprises are inevitable.
The trio of intellectual property provisions also raises some significant issues. They represent a continuing frontal attack on transfer pricing generally, and on the use of intellectual property in the cross-border context in particular.
The February 2010 Green Book already contained a number of proposals addressing income shifting/transfer pricing issues with respect to intangible property transferred abroad. The proposals contained in H.R. 5328 build off of the Green Book proposals but they are quite targeted and specific and would have a significant adverse impact on planning for the use of intangible property abroad.
The second of the trio of provisions, for example, would certainly put a dent in traditional offshore check-the-box election tax planning pursuant to which royalty payments from one disregarded entity to another disregarded entity of a common CFC would be disregarded or ignored in the Subpart F determination.
What strikes me (again) after reading all of these proposals (whether contained in this or other bills, Green Books, etc.) is that Congress is looking for all sorts of revenue raisers to offset (as much as possible) the tax extenders, the costs involved in subsidizing major health care reform, job promotion, and economic recovery—but in a seemingly hodge-podge manner.
For example, the "managed and controlled" provision relies on the theory that if the foreign entity has a significant management nexus with the United States, it ought to be taxed here as a domestic entity. On the other hand, in proposing the elimination of the 80/20 rule, H.R. 5328 itself takes the opposite approach by not recognizing the degree of foreign income and foreign activity as a means to avoid the U.S. withholding tax.
Second, the proposed elimination of the royalty look-through rule is the opposite of what is being proposed in the extenders bill, H.R. 4213, at least with respect to royalties. Finally, although the February 2010 Green Book proposals dropped the check-the-box proposals contained in the May 2009 Green Book proposals, the attack on the use of check-the-box international planning techniques apparently still continues.
It would appear that Congress is beginning to run out of a coherent set of revenue raisers and, as a result, is resorting to a piecemeal approach rather than what should reflect a cohesive tax policy approach.
This commentary also will appear in the August 2010 issue of the Tax Management International Journal. For more information, in the Tax Management Portfolios, see Isenbergh, 900 T.M., Foundations of U.S. International Taxation, and in Tax Practice Series, see ¶7110, U.S. International Taxation — General Principles.
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