Foreign intangible income subject to taxation at reduced rate; intangible income treated as subpart F income
A provision of the discussion draft (section 4211 of the draft legislation) would modify Code section 954 and create a new category of subpart F income—foreign base company intangible income (FBCII).
FBCII would be potentially taxable to a U.S. shareholder of a controlled foreign corporation (CFC).
In conjunction with proposed revisions to the subpart F rules elsewhere in the discussion draft proposal, this new category of subpart F income would include only amounts that are subject to a low foreign tax rate.
In addition, the proposal would provide a new, phased-in deduction by adding new section 250 to the Code to reduce U.S. taxation of a U.S. corporation on income from its exploitation of intangibles in a foreign market. When fully phased in, the deduction from the gross income of the domestic corporation would be expected to result in a reduced tax rate of 15% for income from the foreign exploitation of intangible property.
This provision of the proposal is described as a refinement of the international tax reform discussion draft released by the Ways and Means Committee in October 2011. It is intended to simplify the calculation of affected intangible income, and to exempt normal returns on investments in affected property, while removing the incentive to erode the U.S. tax base by locating intangible property in a low-tax jurisdiction outside the United States.
This new category of subpart F income, FBCII, would be equal to:
- The excess of a CFC’s adjusted gross income (excluding its commodities gross income) over 10% of the adjusted basis of the CFC’s qualified business asset investment (depreciable tangible property used in a trade or business (but excluding property used to produce commodities gross income)) for a tax year, reduced by
- The applicable percentage of the CFC’s foreign personal holding company income, foreign base company sales income, foreign base company services income, and foreign base company oil related income. The applicable percentage for this purpose is: (1) the excess of the CFC's adjusted gross income over 10% of the CFC's qualified business asset investment divided by (2) the adjusted gross income of the corporation.
The basis of any property under this proposal would be determined at the close of the year in accordance with the new rules provided elsewhere in the proposal, and without regard to any provisions enacted after the enactment of these rules.
The proposal would grant the Secretary authority to issue guidance to prevent avoidance of the application of the tangible property rules, including guidance on property that is transferred or held temporarily, and guidance when avoiding the purpose of the proposal is a factor in the transfer or holding of property.
The proposal also would add new Code section 250 to provide a new deduction for a U.S. corporation: (1) that is taxable on FBCII of a CFC; and (2) with respect to foreign intangible income earned directly (rather than through a CFC).
The amount of the allowable deduction for a year would be equal to the applicable percentage of the lesser of a domestic corporation’s: (1) FBCII allocable to property and services provided for ultimate use outside the United States and imputed intangible income allocable to property and services provided for ultimate use outside the United States; or (2) taxable income determined without regard to this new deduction. Intangible income would be allocated to property and services provided for ultimate use outside based upon the ratio of foreign-derived adjusted gross income to total adjusted gross income for the year.
Under the proposal, the applicable percentage would be 55% for tax years beginning in 2015, and would be reduced—in conjunction with the phase-in of the 25% corporate rate—to 52% in 2016, 48% in 2017, 44% in 2018, and 40% for tax years beginning in 2019 or thereafter.
The rules on taxation of FBCII to a U.S. shareholder of a CFC would be effective for tax years of a CFC beginning after 2014, and for tax years of a U.S. shareholder in which or with which such tax years of such CFC end. The rules allowing a deduction of a percentage of FBCII and of directly earned foreign intangible income would be effective for tax years beginning after 2014.
According to Joint Committee on Taxation, this provision—along with the foreign tax credit measures of the discussion draft—would increase revenues by $115.6 billion over the period from 2014-2023.
Denial of deduction for interest expense of U.S. shareholders that are members of worldwide affiliated groups with excess domestic indebtedness
A provision of the discussion draft (section 4212 of the draft legislation) would amend Code section 163 to add a new section 163(n), and potentially limit the amount of deductible interest expense of a U.S. corporation that is a U.S. shareholder (as defined in Code section 951(b)) with of one or more foreign corporations when the U.S. and foreign corporations are members of the same worldwide affiliated group.
The proposal would not apply to a group consisting only of domestic corporations.
The proposal would be intended to:
- Reduce the incentive for U.S. corporations to maintain excessive leverage
- Prevent U.S. corporations from generating excessive interest deductions and incurring disproportionate amounts of debt to produce exempt foreign income under the proposed dividend-exemption system
The proposal focuses on two indicia of excessive leverage: (1) indebtedness of a U.S. corporation that exceeds the level of the indebtedness of a worldwide affiliated group (comprised of related U.S. and foreign entities); and (2) net interest expense of a U.S. corporation that exceeds a prescribed percentage of the U.S. corporation’s adjusted taxable income. Affiliated corporations would be treated as one taxpayer for purposes of testing under this rule.
Very generally, a portion of otherwise deductible interest of a U.S. corporation would be disallowed by the lesser of: (1) the extent a U.S. group’s net interest expense is attributable to debt in excess of 110% of the debt-to-equity ratio of the worldwide affiliated group; or (2) the extent to which net interest expense exceeds 40% of adjusted taxable income of the U.S. corporation.
Disallowed interest expense in a tax year could be carried forward to a subsequent tax year.
The proposal would provide authority for appropriate regulations to carry out the purposes of this proposal, including prevention of avoidance, modification of affiliated group determinations, coordination with the branch profits tax under section 884, and reallocation of shares of partnership indebtedness, or distributive shares of a partnership’s interest income or interest expense.
This proposal also would provide coordination with section 163(j), and would provide generally that the amount disallowed under section 163(j)(1)(A) would be reduced by the amount of any reduction under this proposal.
This provision would be effective for tax years beginning after 2014.
The Joint Committee on Taxation estimates that this provision would increase revenues by $24.0 billion over the period from 2014-2023.
For more information, contact a tax professional with the International Corporate Services group in KPMG’s Washington National Tax: