Executive Order May Reduce U.S. International Tax Burdens (article)
This article was updated on October 6 to reflect new information.
In April 2017, President Trump signed an Executive Order (EO) directing the Department of the Treasury to examine recent tax regulations to determine whether any (1) imposed an undue financial burden on U.S. taxpayers; (2) added undue complexity to the federal tax laws; or (3) exceeded the statutory authority of the Internal Revenue Service.
The Treasury subsequently issued a Notice identifying eight significant regulations as meeting one of the first two criteria. (The Treasury declined to state that any of the identified regulations exceeded the statutory authority of the IRS – the third potential criterion of the EO.) Three of the eight have particular significance for international transactions. Comments were requested by early August about whether these regulations should be rescinded or modified and, if modified, how this would be done to reduce burdens and complexity. The Treasury report recommending action on all eight regulations was delivered to the President and published on Oct. 2, 2017.
Multinational companies should take note of the identified regulations and the Treasury's recommended actions. Many of the regulations may be simplified or postponed as a result of the EO.
Debt or Equity
Final and temporary regulations under Internal Revenue Code Section 385 modify the treatment of interests in corporations as stock or indebtedness for U.S. federal tax purposes. One way these regulations reclassify certain related-party debt as equity is by treating as stock certain debt that is issued by a corporation to a controlling shareholder in a distribution or other related-party transaction that achieves an economically similar result.
The regulations were issued in part to reduce tax benefits from a so-called international inversion. During an international inversion, a U.S. corporation engages in a reorganization after which its foreign operations are owned by a foreign corporation whose foreign income is largely untaxed by the U.S. Frequently in such an inversion, the U.S. corporation ends up with debt owed to a foreign related party. The regulations deny interest deductions on such debt under certain circumstances. If they only applied where a foreign party is involved, they might violate U.S. treaty provisions; as a result, the regulations apply broadly to treat wholly domestically issued debt as equity. Comprehensive tax reform may change the incentives and tax treatment of international inversions. Recent conversations about tax reform have included provisions to eliminate base erosion and profit shifting, and so the Treasury report recommends putting regulations on distributions on hold until it’s clear if base erosion will be addressed more collectively.
Minimum documentation requirements are also established by the regulations in order for related party debt to be respected as such. The documentation requirements have been viewed as creating a significant burden for issuers, and the Treasury recently postponed implementation for one year to permit timely compliance. Upon further review of the requirements, the IRS and the Treasury are considering how to rework the requirements. One option, according to the Treasury report, would be to eliminate them. Another would be to significantly modify the requirements related to the reasonable expectation to pay indebtedness, one of the sticking points in the new rules.
Foreign Currency Gains and Losses
Final regulations under Section 987 establish rules on foreign currency gain or loss with respect to a so-called qualified business unit. The regulations provide for translating income from branch operations conducted in a foreign functional currency; calculating foreign currency gain or loss with respect to the branch’s financial assets and liabilities; and recognizing foreign currency gain or loss when the branch makes transfers of property to its owner. Recently, the Treasury announced a deferral of these rules for most taxpayers to Jan. 1, 2019. Taxpayers may choose to apply them to taxable years beginning after Dec. 7, 2016.
Additionally, the Treasury report indicates that more modifications may be coming that would allow entities to elect a more simplified method for calculating Section 987 gain or loss. There are also discussions around alternative loss recognition timing limitations and alternative transition rules.
Transfers to a Foreign Corporation
Final regulations under Section 367 eliminate the ability of taxpayers to transfer foreign goodwill and going concern value to a foreign corporation without immediate or future U.S. income taxation. The Treasury and the IRS are evaluating a proposal to include an active trade or business exception for foreign goodwill and going concern transfers that would include outbound transfers of foreign goodwill and going concern value.
How Multinational Companies Can Prepare
Many of the recommendations included in the Treasury report do not have deadlines, so pending further action by the Treasury, companies should approach these regulations with care. Taxpayers should continue to apply the regulations in their current form but keep an eye out for additional modifications from the IRS and the Treasury.
President Trump, working with a group of six administration officials and Republican leaders from Congress, announced a framework for tax reductions on Sept. 27, 2017. Among other steps, the tax reform plan outlines a territorial tax system:
- The previous border adjustment tax included in the House of Representatives’ proposals is eliminated, but broad income tax exemption for dividends from foreign subsidiaries in which the U.S. parent owns at least a 10 percent stake would be implemented.
- Existing profits held overseas would be subject to a one-time tax, to be paid over time. Rates for this tax are not specified.
- Ongoing future foreign profits of U.S. multinationals would also be subject to tax at a lower rate from the one-time tax on existing profits. The tax is designed to reduce “shipping jobs and capital overseas” and appears to be a significant exception to proposed territoriality.
Our professionals will continue to monitor international tax developments closely. For comments, questions or concerns about these and other International Tax developments, please contact your local CBIZ tax professional.
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