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On May 5, 2009, President Obama presented a first look at his international tax law reform proposals. This was followed by a more detailed explanation of the provisions in the “Green Book”. In general, the president's proposals aim to place limits on (1) The tax benefits from doing business in tax haven countries and low-tax offshore countries, and (2) The use of Controlled Foreign Corporations to defer offshore earnings from US tax.

These international tax reforms will be used to pay the cost of making the Research & Experimentation Tax Credit permanent. Currently, the R&E Credit is set to expire at the end of 2009.

The business proposals affect two types of offshore entities for US companies. The first is the Controlled Foreign Corporation or “CFC”. A CFC is a foreign corporation where US persons own more than 50% of the corporation on any day during the year.

The second is a Disregarded Entity. A Disregarded Entity is a foreign entity which is treated as a division of its tax owner. A US company can affirmatively elect to treat a qualified foreign entity (such as a foreign limited liability company) as a Disregarded Entity through what’s commonly called a “Check The Box” or CTB Election. The tax owner can be a US company or a CFC. The provisions aim to close the following perceived loopholes:

• Benefits of CFC’s owning Check The Box entities. Where a CFC can shift high-taxed income to a low-tax jurisdiction by using a Disregarded Entity, a CTB Election would not be permitted for US purposes.
• Limit US tax deductions for activities that support CFC’s:
  • US tax deductions such as interest expense that support earnings in CFC’s would not be allowed until the foreign earnings are repatriated and taxed in the US:
    • An exception would be made for US R&D expenditures
    • The limitation would be calculated based on the current expense apportionment rules for limiting the foreign tax credit
  • Interest paid to a related foreign entity would be subject to further limitations:
    • The debt to equity safe harbor would be eliminated
    • The 50% of taxable income limitation would be reduced to 25%
    • The carryforward of excess taxable income limitation would be repealed
• Certain foreign tax credit planning would be eliminated:
• No foreign tax credit would be allowed for taxes paid on foreign income until the foreign income is subject to US taxes
• The foreign tax credit would have a new limitation based on total foreign taxes compared to total foreign income:
  • The “deemed paid” foreign tax credit for CFC’s would be calculated on a consolidated basis. The limitation would be computed based on aggregate foreign taxes and aggregate earnings and profits for the foreign subsidiaries that repatriated funds.
• More foreign transfers and reorganizations involving CFC’s would have taxable consequences. Intangible property that is subject to gain when transferred offshore would now include workforce in place, goodwill and going concern value:
• Intangible assets could be valued on an aggregate basis versus separately
• Intangible property would be valued at its highest and best use and under the arms length standard
• Boot on transfers to foreign corporations would not be limited to the gain if the transfer had the effect of being a dividend

President Obama also proposes to increase the IRS funding for international auditing and enforcement.

On the positive side, the proposals include an extension of the Subpart F active financing and look-through exceptions. These provisions allow certain transactions between CFC’s to avoid characterization as a deemed dividend for US purposes.

If you have any questions, please contact your RubinBrown advisor, or contact:

  Linda Paradis, CPA
  Partner
  Tax Consulting Services Group
  314.290.3382
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  Steven J. Brown, CPA
  Partner-in-Charge
  Tax Consulting Services Group
  314.290.3326
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