As you may be aware, the House Ways and Means Committee recently approved a multitrillion-dollar tax package (the “Proposal”) that has significant tax impact on both individuals and corporations. The obvious targets of the Proposal, of which many of you may be aware, include: individual tax rates (with a new proposed maximum rate of 39.6%), capital gains tax rates (with a new proposed maximum rate of 25%), corporate tax rates (with a new maximum rate of 26.5%), estate and gift tax Unified Credit reduction (reducing the exemption for U.S. citizens and U.S. domiciliaries back to $5,000,000, indexed for inflation), and grantor trusts (new rules that include grantor trust assets in the taxable estate of the grantor at death and limit the effectiveness of sales to intentionally defective grantor trusts). None of these topics will be discussed herein; instead, the discussion will focus on some of the international tax provisions.
As discussed previously in “The Draft of the International Tax Overhaul: Where is Captain America” (the “Overhaul Article”), the Senate Finance Committee released draft legislation, and a related summary, applicable to the U.S. international tax regime (the “Draft Legislation”). The Proposal addresses many of the questions left unanswered by the Draft Legislation and also puts forward modification to several of the concepts addressed therein.
As a reminder, the 2017 Tax Cuts and Jobs Act’s international tax changes were substantial, particularly as it relates to controlled foreign corporations ("CFCs").1 The following non-exclusive list of changes were implemented:
Please see the Overhaul Article for a more detailed discussion of the proposals in the Draft Legislation. This said, some of the more important aspects of the Proposal in relation to the Draft Legislation include:
GILTI is proposed to be modified to:
Section 250 is proposed to be modified to:
The practical effect of the modifications to GILTI and Section 250, in light of the increased corporate tax rate, will be an overall increase to what is considered to be “high tax” for purposes of avoiding U.S. income tax under the CxC GILTI rules (and therefore a presumed increase to the U.S. tax base). Similarly, the benefits of FDII are reduced. This appears to be drafted with the OECD concepts of a global minimum tax in mind.
Nevertheless, and as we learned in a certain movie involving Captain America, when you think that S.H.I.E.L.D. is there to help, you are surprised by H.Y.D.R.A. (the House Yields Decisive Reconciliation Action). By no means is there to be an implication (or an inference) that the Proposal is insidious in some manner (like the Helicarriers were); however, there are some surprises nonetheless. The two main surprises are:
Reinstatement of Section 958(b)(4).
The repeal of Section 958(b)(4), which allowed for “downward attribution,” has created confusion as to what constitutes a CFC in the context of the high net worth U.S. taxpayer operating a significant closely held business outside of the United States. It further raised questions relating to the Portfolio Interest Exemption (the “PIE”, which is discussed further herein) and how to plan for a U.S. person inheriting structures from non-U.S. persons. In this regard, a hidden gem in the Proposal (which is found in a portion of the Proposal limiting the deduction under section 245A to dividends received from a CFC) would amend the CFC rules by reinstating Section 958(b)(4) and adding Section 951B. In this regard, this is a welcomed change that would avoid the uncertainty that exists as to the application of repeal of the Section 958(b)(4) in other situations and otherwise allows clarification with respect to the perceived abuses that Congress intended to prohibit.
Changes to the Portfolio Debt Interest Exemption.
A non-U.S. taxpayer (i.e., individuals that are nonresident aliens and foreign corporations) is generally only subject to U.S. tax on their U.S.-source income.2 In this regard, one such category of U.S. source income for a non-U.S. taxpayer is “fixed or determinable annual or periodical gains, profits, and income” (“FDAPI”). FDAPI is generally subject to a 30 percent gross-basis tax, which is withheld at its source (unless this rate is subject to a reduced rate of, or entirely exempt from, U.S. tax under another provision of U.S. tax law or under an income tax treaty). This said, FDAPI includes U.S. source portfolio interest; however, such interest is exempt from the 30 percent gross-basis tax (known as the PIE) if certain condition are satisfied. In short, the PIE rules have several requirements, including:
The Proposal provides that, in the case of an obligation issued by a corporation, the definition of a 10 percent shareholder would be modified to be:
The Proposal applies to obligations issued after the date of enactment (and presumably, for now, any obligations that are substantially modified under Section 1001 after the date of enactment).
Wait, What? Bucky is the Winter Soldier? THIS IS A GAME CHANGER! In many situations, especially in private equity deals, the PIE is an essential tool utilized in attracting foreign investors who do not have voting control of the investment vehicle (but who may have an equity interest that equals or exceed 10%). Thus, what the Proposal purports to give with the reenactment of Section 958(b)(4) it takes away with the proposed changes to the PIE.
Other Proposed International Tax Related Changes.
Some other proposed changes include:
The Proposal is generally a welcomed addition to the Draft Legislation; however, the Proposal has presented some interesting surprises. Because the potential impact of the Proposal and the Draft Legislation may be far reaching and have a significant impact on how U.S. corporations and U.S. individual taxpayers do business internationally, it is important to monitor the progress of this proposed legislation. As noted above, one especially concerning aspect of the Proposal is the potential limitation placed on the availability of the PIE (particularly as it applies to private equity investment structures).
Please contact us if you want to discuss the Draft Legislation and/or the Proposal as applicable to your situation.
 A CFC is, generally, any foreign corporation in which more than 50 percent of the total combined voting power of all classes of stock entitled to vote is owned directly, indirectly, or constructively by U.S. shareholders on any day during the taxable year of such foreign corporation or more than 50% of the total value of the stock is owned directly, indirectly or constructively by U.S. shareholders [as defined in Section 951(b)] on any day during the taxable year of the corporation. The rules of attribution applicable for this purpose can have very broad application (including through family, business entities, and trusts and estates) and need to be reviewed under each set of facts.
 Consider, generally, Sections 861 – 865, 871 – 875, 879, 881-885, 897, 1441, 1442, 1445 and 1446.