Glimpse of Obama Administration's Changes in Taxation of U.S. Based Multinationals
The Obama Administration set forth certain changes it will seek to have Congress adopt next year or beginning in 2011 as part of the 2010 budget proposals in the area of international taxation, particularly with respect to U.S. based multinational companies. See U.S. Dept. of Treasury, "General Explanations of the Administration's Fiscal Year 2010 Revenue Proposals" (May 2009). Under U.S. federal income tax law principles, U.S. companies can generally defer paying U.S. tax on earnings of their foreign subsidiaries engaged in business operations outside of the United States until such earnings are repatriated. This results in a deferral of U.S. tax on such foreign earnings which is particularly attractive where the foreign based subsidiary is operating in a lower tax country or perhaps a tax haven jurisdiction. Under the controlled foreign corporation rules, such desired deferral of foreign earnings can be blocked by the required inclusion of a corporation’s Subpart F income of a controlled foreign corporation. While such rules have been in place for some time, allocation of expenses, interest and other items have been used to reduce Subpart F income or otherwise create timing differences to either reduce the pass through of Subpart F income or broaden the deferral. The Administration’s controversial budget proposals would effectively reduce the scope of deferral, increasing taxes on U.S. companies conducting foreign operations through foreign subsidiaries. The proponent of such legislation has been Chairman Charles Rangel (D-NY) of the House Ways and Means Committee. See H.R. 3970, "Tax Reduction and Reform Act of 2007," section 3201.
Deferral of Current Use of Foreign Related Deductions. The first major reform under the Obama Administration’s proposals would be to allow certain "foreign-related deductions" only to the extent that expenses (other than research and development expenditures) and losses are allocable or apportionable to currently taxed foreign income. The largest categories of foreign-related expenses likely to be deferred in some degree would be interest and stewardship/headquarters costs. Deferred expenses would be carried forward to subsequent years and would be combined with foreign-source expenses for that year before applying the proposal in that year.
Blended Deemed-Paid Foreign Tax Credits. The second major reform would be to adjust or blend the amount of deemed paid foreign tax credits under section to no more than the average rate of total foreign tax actually paid on total foreign earnings by the company's foreign subsidiaries (presumably earned after the effective date). This change is designed to eliminate the ability to manage high- and low-tax foreign income pools separately.
A third and still important change would be to treat a "defective entity" formed in a foreign jurisdiction to be treated as a separate corporation for U.S. tax purposes, except for foreign defective entities owned directly by: (i) companies incorporated in the same country; or (ii) U.S. entities (except in cases where U.S. tax avoidance is present). This reform will have the likely result of subjecting many U.S. companies to current taxation on Subpart F income.
