Washington Tax Insight July 2015

 
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Background—Budget

When Congress returns from recess on July 7th, they will face some key issues that need to be addressed prior to the month-long August recess including a long-term highway bill and appropriations legislation. Behind the scenes work on comprehensive tax reform continues at an active pace in the tax-writing committees focused on international tax and business tax issues.

The movement of appropriations bills has slowed primarily because the Senate is unable to take up consideration of legislation absent the 60 votes needed to move forward. Senate Democrats do not support the allocations that were approved in the Budget Resolution and will not support Republican-drafted bills.  The leadership is also hampered by the periodic loss of votes from 5 Republican Senators running for President who are spending increasing amounts of time campaigning for the nomination.  Current expectations are that, as in past years, Congress will be forced to approve a Continuing Resolution at the end of the current fiscal year on September 30th, which would fund the government at current levels.

The deadline for raising the US debt limit will likely not come until November or December of this year. This could defer consideration of other key legislation for 2015 until then while the Republican-controlled Congress assesses what issues should be packaged together to help gain approval of the debt legislation.  Issues that are likely to be addressed in the fall include tax extenders, the highway bill and international tax reform.

Congressional Activity

The Highway Trust Fund

The House and Senate tax-writing committees both held recent hearings to examine funding proposals for the highway bill, which is currently authorized through July 31st.  There is consensus in Congress that a six-year highway bill should be the goal, but a long-term bill will require a funding source for an additional $85-90 billion, and there is no agreement on the source of that funding.  The Ways & Means Committee has focused on deemed repatriation proposals as described below, and the Senate Finance Committee has focused on reviewing the ways states have worked with the private sector to finance infrastructure projects including through public-private partnerships and the issuance of tax-preferred bonds.  As the end of July deadline approaches, Congress could opt to approve another short-term highway bill without a funding source, in which case this issue could be  considered in the package of year-end legislation.

Miscellaneous Tax Legislation Issues

  • Affordable Care Act (ACA)

After the Supreme Court decision in King v. Burwell upholding tax-credit subsidies under the Affordable Care Act (ACA), Congressional Republicans will turn their focus to a future repeal of the ACA, but they were recently informed by the Congressional Budget Office (CBO) that repeal would increase the budget deficit by $353 billion.

  • Internet Access Tax Moratorium

The House approved legislation that would permanently extend the current-law moratorium on state and local Internet access taxes.  A Senate companion bill has been introduced but the Senate Finance Committee has not yet moved to markup this legislation.  The issue will likely continue to be linked to legislation that would make it easier for a state to capture sales and use tax revenue from transactions involving online and other remote vendors that do not have an in-state physical presence.  The current moratorium has been in effect since 1998 and is due to expire on October 1, 2015.

  • Tax-related Trade Legislation

Congress has passed, and the President has signed into law, two bills that will help rewrite the rules for US trade policy, specifically the Trade Promotion Authority and the Trade Preferences Extension Act. The latter Act included several miscellaneous tax provisions including an increase in estimated tax payments by large corporations (assets over $1 billion) due in July, August or September of 2020 by 8% of the amount otherwise due  (reducing the next estimated tax payment by the same amount).

Tax Reform Update

Senate Finance Committee Working Groups

The Senate Finance Committee Working Groups on tax reform sent reports to Chair Hatch (R-UT) and Ranking Member Wyden (D-OR) on July 8th, and the reports were released publicly.  The report of the International Tax working group, which is chaired by Senators Portman (R-OH) and Schumer (D-NY), includes a series of options which could be considered independently for consideration in legislation later this year, e.g. as a funding source for the highway bill.  The list of options includes an “innovation box” providing for a reduced rate of tax on certain intellectual property and intangibles, and the inclusion of a tax on repatriated earnings as part of a “hybrid territorial” system for taxing foreign-source income of US multinationals. A detailed description of these reports will be included in our next issue.

House Ways & Means Committee

The W&M Subcommittee on Select Revenue Measures held a hearing on deemed repatriation proposals which are being considered as a funding source for the highway funding bill.  The Joint Tax Committee issued a report for this hearing describing the current tax laws covering the repatriation of foreign earnings, the financial accounting treatment of undistributed earnings of foreign subsidiaries under US GAAP, and two specific repatriation proposals that were included in the Camp discussion draft of 2014 and the Administration’s revenue proposals in the FY 2016 budget.  W&M Committee Chair Ryan has stated publicly that he opposes the use of a stand-alone deemed repatriation tax as a revenue source for the highway bill but he would consider linking such a proposal to other international tax reforms as part of a long-term highway bill.  SFC Committee Chair Hatch has not expressed support for this approach but neither has he has expressed opposition to it.

At the direction of Chair Ryan, Cong. Boustany (R-LA) is working on an international tax draft that is also expected to include an “innovation box” proposal as well as other international tax reforms.  Cong. Boustany has stated that he is working with staff from the Joint Tax Committee, Treasury and the Ways & Means Majority staff in developing his discussion draft.  The “innovation box” appears to be emerging as the key proposal for an international tax reform bill since it is viewed as an incentive to locate research jobs and profits in the US, and it is expected to raise significant revenue.  But some in the business community. including The Business Roundtable, the National Retail Federation and the National Association of Manufacturers, have expressed doubts about it especially if the proposal is not packaged with corporate rate cuts. 

OECD Base Erosion and Profit Shifting (BEPS) Project

In anticipation of the 2-day OECD conference in Washington, D.C., in early June focusing on the OECD’s BEPS project (addressing “double non-taxation”), SFC Chair Hatch and W&M Committee Chair Ryan sent a letter to Treasury Secretary Lew asking him to keep Congress informed on the details of the BEPS project, to continue engagement with the tax-writing committees, and to solicit input from them. The letter raises questions about some of the decisions made relating to country-by-country reporting, and also cites significant concerns about provisions in other proposals of the BEPS project including modifying the permanent establishment (PE) rules, the use of subjective general anti-abuse rules (GAAR) in tax treaties and the collection of sensitive data from US companies for purposes of measuring base erosion and profit shifting.

Treasury and the IRS

Circular Basis Regulations

The IRS released proposed regulations aimed at addressing tax accounting problems that arise for corporate taxpayers that file consolidated income tax returns by eliminating the so-called “circular adjustments to basis problem” in a broader range of transactions.

Tax Reform in Detail: Camp International Tax Proposals

Senate Majority Leader McConnell (R-KY) has now joined SFC Chair Hatch (R-UT) and W&M Committee Chair Ryan (R-Wisc.) in stating that comprehensive tax reform is unlikely to happen in 2015, but the House and Senate leadership have not ruled out the possibility of individual pieces of tax reform moving this year, such as the international tax reform proposals.  For this reason, we believe that taxpayers should be analyzing and understanding current proposals and ideas so that they can engage directly with government officials and consider such proposals in the course of their tax planning.  In this issue, we review the international tax proposals that were included in the February 2014 comprehensive tax reform discussion draft proposal released by former W&M Committee Chair Camp.  

As part of the discussion about tax reform, one key issue is whether the United States will transition from its current worldwide system for taxing international income, which generally taxes a domestic company on its worldwide income, to a territorial system, which generally exempts foreign-source income from domestic taxation.  The Camp discussion draft proposes a number of significant changes to the current US system that would move the US toward a territorial system.

  • Participation exemption for foreign dividends.  The draft would change the way US law prevents double taxation of the foreign income of US corporations by adopting a participation exemption for certain foreign dividends.  The draft proposes a 95% dividends received deduction (DRD) for the foreign-source portion of dividends received by a domestic corporation from a foreign corporation the voting stock of which is at least 10% owned by the domestic corporation for a 6-month holding period.  Neither credits nor deductions would be allowed for any foreign taxes paid with respect to dividends eligible for the new DRD.
  • Interest expense deductions.  The draft includes a provision that would deny interest expense deductions for corporate US shareholders of worldwide affiliated groups that have “excess domestic indebtedness.”  Thus, if the US shareholders (as a group) fail both a relative leverage test and a percentage-of-adjusted-taxable-income test, their interest expense deductions would be reduced.
  • Foreign intangible income.  The draft would create a new category of subpart F income for “foreign base company intangible income,” which would be the excess of the gross income of a foreign subsidiary over 10% of the subsidiary’s adjusted basis in depreciable tangible property (but not including income or property from commodity extraction). 
  • Repatriation rule.  The draft would require any 10% US shareholder (whether or not corporate) of a controlled foreign corporation (CFC) or other 10%-owned foreign corporation to include in income the shareholder’s pro rata share of the undistributed and previously untaxed post-1986 foreign earnings of the corporation.  This inclusion would occur in the last taxable year before the exemption system begins and would be taxed at present law rates.  Pre-1987 earnings would generally be excluded from this deemed repatriation, but would still be eligible for the new DRD upon actual repatriation after the participation exemption system takes effect.  The draft would impose multiple tax rates on the deemed repatriation depending on the types of assets that the deferred earnings had funded, specifically a 90% deduction for the deferred earnings in noncash assets and 75% for cash or liquid assets.
  • Inbound provisions/earnings stripping.  The draft would amend the 163(j) “earnings stripping” rule by lowering to 40% (from 50%) the percentage of the taxpayer’s adjusted taxable income that serves as the general benchmark for determining whether its net interest expense is “excess interest expense”.  The draft would also eliminate recourse to the taxpayer’s prior three years of “excess limitation” to increase the threshold.

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For further information, please contact:

Robert M. Gordon, Managing Director
Robert.Gordon@tpctax.com
312-235-3321

 

 

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