Changes in threshold in the high tax exception to subpart F income; exception no longer optional
A proposed provision (section 4201 of the draft legislation) would amend Code section 954 (and Code section 953) by changing the tax rate threshold that must be met in order for the high tax exception to subpart F income to apply.
Under the exception, an item of income is not treated as foreign base company income or insurance income for purposes of subpart F if it has been taxed at or above a threshold rate of foreign tax.
The proposal would change such threshold rate as follows:
- For foreign personal holding company income (FPHCI), foreign base company services income, and insurance income—from 90% to 100% of the maximum corporate U.S. tax rate (i.e., from a 31.5% to 25% tax rate)
- For foreign base company sales income (FBCSI)—from 90% to 50% of the maximum corporate U.S. tax rate (i.e., from 31.5% to 12.5% tax rate)
Changes proposed under this provision, in conjunction with the reduced maximum corporate rate, would result in lower thresholds for meeting the high tax exception, with the most favorable treatment provided for FBCSI (note also the favorable provisions for FBCSI introduced in section 4202 of the proposal and discussed below). The intent of these changes is to ensure that subpart F provisions apply only to low-taxed foreign base company income (and insurance income).
The provision (discussion draft section 4201) would also amend Code section 954 to establish the high tax exception threshold for foreign base company intangible income—a new category of subpart F income introduced in section 4211 of the proposal.
Subpart F income would generally not include the foreign percentage of foreign base company intangible income if such income (treated as a single item of income) is subject to a foreign effective tax which is at or above 60% of the maximum corporate U.S. tax rate.
This threshold would be phased in as follows: for tax years beginning in 2015—45%, 2016—48%, 2017—52%, 2018—56%, and 2019 and thereafter—60%.
Foreign base company intangible income other than the foreign percentage of such income (i.e., foreign base company intangible income generated from U.S. sources) generally would be excluded from subpart F income because it would meet the general 100% high-tax exception threshold. In the end, according to JCT, foreign base company intangible income would only be subpart F income under the proposal “to the extent that the income is subject to a foreign effective tax rate lower than the effective U.S. tax rate imposed after taking into account the deduction for foreign intangible income” discussed in discussion draft section 4211 (proposed Code section 250).
The changes would apply to tax years of foreign corporations beginning after December 31, 2014 and to taxable years of U.S. shareholders in which or with which such taxable years of foreign corporations end.
The proposal and the JCT commentary make it clear that the high tax exception is no longer an elective provision. Eliminating electivity for the exception presumably is intended to prevent cross-crediting of foreign taxes on income taxed at foreign rates higher than the applicable U.S. rates.
According to JCT, this provision, along with discussion draft sections 4211, 4103, 4202, and 4203, would increase revenues by $115.6 billion over 2014-2023.
Exclusion of 50% of FBCSI from subpart F and preservation of related foreign tax credits; exclusion of 100% of FBCSI earned by qualified residents of a U.S. tax treaty jurisdiction
A provision (section 4202 of the draft legislation) would amend Code section 954 to include only 50% of FBCSI in foreign base company income and consequently subpart F income.
This provision results in the exclusion from subpart F of 50% of low-taxed FBCSI, i.e., 50% of FBCSI that is not already excluded by virtue of meeting the modified 12.5% high tax exception threshold.
This proposal would amend Code section 960 so that all 100% (and not just 50%) of the low-taxed FBCSI is deemed to be included under section 951(a)(1) for purposes of calculating accompanying foreign tax credits.
The JCT expects that foreign taxes paid by the controlled foreign corporation (CFC) with respect to the excluded 50% of FBCSI would remain creditable as deemed paid taxes. This proposed amendment to section 960 may be particularly relevant in light of the other amendments to the FTC rules.
Finally, the proposal provides that all FBCSI of a CFC would be excluded from subpart F if the CFC is eligible as a qualified resident for all of the benefits provided under a comprehensive income tax treaty with the United States.
According to JCT, a “comprehensive income tax treaty" refers to any bilateral treaty for the elimination of double income taxation, and the scope of this provision is intended to be limited to those companies that satisfy the limitation on benefits provisions of income tax treaties.
The amendments would apply to tax years of foreign corporations beginning after December 31, 2014, and to tax years of U.S. shareholders in which or with which those taxable years of foreign corporations end.
According to JCT, this provision, along with discussion draft’s proposed sections 4211, 4103, 4201, and 4203, would increase revenues by $115.6 billion over 2014-2023.
Inflation adjustment of the de minimis exception for foreign base company income
A proposed provision (section 4203 of the draft legislation) would amend Code section 954 to require an inflation adjustment to the $1 million de minimis amount in the case of any tax year beginning after 2015, with all increases rounded to the nearest multiple of $50,000.
The proposal would be effective for tax years of foreign corporations beginning after December 31, 2014, and to taxable years of U.S. shareholders within which or with which such tax years of foreign corporations end.
According to JCT, this provision, along with discussion draft sections 4211, 4103, 4201, and 4202, would increase revenues by $115.6 billion over 2014-2023.
Extension of active financing exception, with a 50% limitation for low-taxed income and preservation of corresponding foreign tax credits
A provision (section 4204) of the proposal would, subject to modifications described below, extend for five years the exceptions from FPHCI, foreign base company services income, and insurance income, for certain income derived in the active conduct of a banking, financing, or similar business, or in the conduct of an insurance business.
The proposal would amend Code section 954(h) and (i) to provide that FPHCI (and consequently foreign base company services income per section 954(e)(2)) would not include any item of qualified banking or financing income of an eligible CFC or qualifying insurance income of a qualifying insurance company—if such income is subject to an effective foreign income tax rate of at least 50% of the maximum U.S. corporate rate (i.e., if it meets the 12.5% tax rate threshold). Further, the proposal would exclude from FPHCI (and foreign base company services income) 50% of any other item of qualified banking or financing income of an eligible CFC, or qualifying insurance income of a qualifying insurance company.
As a result, according to JCT, the high-taxed active financing income would be exempt, and low-taxed active financing income would be subject to a reduced U.S. tax rate of 12.5%, before the application of foreign tax credits.
The proposal would amend section 960 of the Code to ignore the exclusion of 50% of the low-taxed active financing and insurance income. Thus, the determination of taxes deemed paid under section 960(a) would be made as if no 50% exclusion were allowed.
The JCT expects that a U.S. shareholder would therefore be deemed to pay the pro rata share of the full amount of tax paid by the respective subsidiary on the qualifying banking, financing, or insurance income.
The amendments under discussion draft section 4203 would apply to tax years of foreign corporations beginning after December 31, 2013, and to tax years of U.S. shareholders in which or with which such tax years of foreign corporations end. The modified active financing and insurance exceptions in section 954(h), (i), and (e), and section 953(e) of the Code would be extended to years of the foreign corporation beginning before January 1, 2019, and to tax years of U.S. shareholders with or within which any such tax year of such foreign corporation ends.
According to JCT, this provision would reduce revenues by $18.4 billion over 2014-2023.
For more information, contact a tax professional with the International Corporate Services practice in KPMG’s Washington National Tax:
Section 4205. Repeal of section 955 of the Code—no inclusion based on withdrawal of previously excluded subpart F income from qualified investment
The proposal would repeal section 955 of the Code. As a result, there would no longer be current U.S. tax imposed on previously excluded foreign shipping income of a foreign subsidiary if there were a net decrease in qualified shipping investments.
The amendments under section 4205 (i.e., the repeal of section 955) would apply to taxable years of foreign corporations beginning after December 31, 2014, and to taxable years of U.S. shareholders in which or with which such taxable years of foreign corporations end.
According to JCT, this provision would increase revenues by less than $50 million over 2014-2023.