On May 31, the US House of Representatives passed its latest extender’s Bill, the American Jobs and Closing Tax Loopholes Act, which true to its name extends unemployment benefits and certain jobs stimulating tax provisions (e.g., the R&D credit and CFC look through rule) along with further tax changes to pay for them. The Senate will take up the Bill when it returns from its Memorial Day recess on June 7.
While provisions to tax carried interest as ordinary income have stolen the headlines, other provisions aim to further tax US MNC’s foreign earnings by significantly tightening the foreign tax credit (FTC) rules.
Adverse changes to the FTC regime have been widely anticipated. The Obama administration has not been shy about saying that it sees the current FTC regime as subject to abuse, and thus an easy mark in seeking revenue.
FTC regime critics’ chief targets were thought to be splitter transactions, used to optimizing FTC reallocations, and pooling all subs practices, which help maximize net credits.
The House bill does indeed target splitter transactions and pooling:
- No splitting to exploit recognition and timing differences. The bill would suspend the recognition of foreign tax credits until the related foreign income is taken into account for US tax purposes. The objective is to eliminate planning that exploits the timing differences between income recognition under foreign and US tax accounting.
- Limit credit to equivalent of dividend paid. On the pooling front, deemed-paid taxes from lower-tier foreign corporations (using section 956) would be limited, and hence the FTCs claimed, to the amount equivalent to an actual dividend paid by the CFC. Under the current “pooling” regime for deemed-paid foreign tax credits, FTCs can be claimed based on a “blend” or pooling of the deemed paid taxes of the dividend payor and dividend recipient, resulting in a higher tax credit.
- Further curbs on allocation of interest expense to foreign subs. The billl would also modify affiliation rules for purposes of rules allocating interest expense. Usable FTCs are limited to foreign-source taxable income, which is determined by allocating and apportioning interest expense for each affiliate, as if all were a single corporation. It would further strengthen existing rules designed to prevent taxpayers from excluding interest expense via allocation to a foreign sub.
Also targeted in the bill is the separate application of FTC limitation to items resourced under tax treaties, FTC benefits from covered asset acquisitions treated as stock purchases in the foreign jurisdiction (i.e., that result in a step-up of US but not foreign tax basis),
All together, these provisions are estimated to result in another $14+bn for the US Treasury over the next ten years. As this is a just a drop in the bucket, treasury-tax planners should expect more change to come.