On December 18, 2015 President Obama signed into law H.R. 2029,
which incorporated both the "Protecting Americans from Tax
Hikes Act of 2015" (PATH) and the Consolidated Appropriations
Act, 2016. In what has been unusual fashion of late, the measures
passed the House and Senate and were signed into law relatively
quickly. From an international corporate tax perspective, the new
law finally gives taxpayers some certainty with respect to the US
tax impact on their international operations.
The new law makes a number of tax extenders permanent, while
extending others for 5 years and some for two years. Specifically,
US taxpayers who are owners of controlled foreign corporations
("CFC") have faced uncertainty over the past several
years with respect to certain exceptions under the Subpart F
regime. The Subpart F regime deals with the US taxation of certain
income earned by CFCs.
In general, US taxpayers who are 10 percent or greater shareholders
in a CFC must include in their annual income their pro rata share
of the CFC's Subpart F income. This results in current US
taxation on certain income of a non-US corporation regardless of
whether the income is actually repatriated to the US. This
anti-deferral regime is intended to prevent US taxpayers from
artificially shifting portfolio/passive income offshore to lower
tax jurisdictions in order to avoid or delay the US tax cost. There
are several categories of Subpart F income and the definitions
contain a number of exceptions. Two of these exceptions are the
so-called CFC look-through exception of IRC §954(c)(6) and the
active finance exception of IRC §954(h).
The CFC look-through exception excludes from Subpart F income
dividends, interest, rents, or royalties received by one CFC from a
related CFC to the extent the dividends, interest, rents, or
royalties are attributable or properly allocable to non-Subpart-F
income (or income effectively connected with a US trade or
business, "ECI"). This exception takes into account the
movement of cash predicated by business needs, as opposed to
shifting for perceived tax reasons. The imposition of current US
tax movements would inhibit US multi-national corporations
("MNCs") from redeploying active revenue to continue
business growth in other jurisdictions. This important exception
has applied for tax years beginning after December 31, 2005, and
when originally enacted, was set to expire at the end of 2008.
However, Congress has passed several extensions with the most
recent one expiring at the end of 2014. Congress has not always
acted timely and has let the extension expire only to revive it
with retroactive effect, which has led to tremendous uncertainty
for taxpayers from both a planning and reporting perspective. US
MNCs often employ complex and multi-layered global structures and
constant uncertainty around this exception has led some to delay
intercompany cash movements and required others to borrow from
third parties to satisfy cash needs. Furthermore, US reporting
rules require corporations to calculate earnings using the law in
force at the time, resulting in a Subpart F inclusion that must
then be reversed when Congress retroactively extended the
exception.
The new law extends the CFC look-through exception to tax years of
foreign corporations beginning before January 1, 2020 (i.e.,
through 2019 for calendar year corporations). This will give US
MNCs a longer window within which to plan their business operations
and has been welcome news to CFOs, VPs of tax, tax directors and
tax professionals alike. However, further extension of items not
made permanent may prove more difficult for permanent planning in
the long run.
The active finance exception excludes from Subpart F income certain
qualified banking or financing income of an eligible CFC. This
exception has a complex history; in its prior form it was abolished
and reinstated by President Clinton and the Supreme Court,
respectively. In 1998, Congress re-wrote the rules in the current
form and provided an extension for one year. Since then, IRC
§954(h) has been extended for various terms with intermittent
proposals for permanent enactment, the last of which has now
finally been adopted.
The active finance exception is vitally important for US MNCs
predominantly involved in the banking or financing business. As
taxpayers have been uncomfortable with the state of flux of the
active finance exception over the past several years, less has been
done in the planning context as compared with CFC look-through
planning. The primary reason for this is that the active finance
exception is more focused on unrelated customer dealings, leaving
less opportunity for intercompany planning unlike the CFC
look-through exception. Nevertheless, US MNCs in these qualifying
businesses can now manage their multinational structure with a
longer term plan and greater certainty regarding their US tax
costs.
Finally, in an unrelated and unexpected development, the new law
increases the US withholding tax on disposition of US real property
interests from 10 percent to 15 percent. While this change does not
alter the substantive tax rules related to dispositions of US real
property, it will impact the economics both when non-US investors
consider exiting their current US real estate investments and as
they consider investing in the US real estate market in the
future.
Overall, H.R. 2029 is a significant win for taxpayers compared to
legislative tax actions over the previous few years. While overall
tax reform is still a major goal for Congress, the new rules at
least give taxpayers several years of stability with respect to
previously uncertain areas.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.