While House Republicans could use the budget reconciliation process to pass tax reform without the need for Democratic support, leaders in the Senate have indicated a desire for bipartisan reform. White House press secretary Sean Spicer’s statement earlier this week on the tax reform process also suggests that input from the Democrats may be relevant.
With that in mind, we thought it would be useful to highlight a bill introduced in the Senate by Senators Bernie Sanders (I-VT) and Brian Schatz (D-HI) – the “Corporate Tax Dodging Prevention Act of 2017.” A companion bill was introduced in the House of Representatives by Representative Jan Schakowsky (D-IL). Prior iterations of the bill were introduced in 2013 and 2015; both died in committee. While we do not think that this bill is representative of the broader Democratic position as a whole, we do think that it is a useful data point from the more liberal wing of the caucus.
Here is a summary of what the bill does:
Ends Deferral. The bill generally proposes to tax all income earned by a U.S. taxpayer’s offshore subsidiaries on a current basis by redefining “subpart F income” to include all foreign-source income, such that “U.S. shareholders” of controlled foreign corporations (“CFCs”) are taxed on their pro rata share of the CFC’s earnings, regardless of whether or when the earnings are repatriated to the U.S.
President Trump’s tax reform proposals put forward during the campaign also called for an end to deferral. The House Blueprint, by contrast, limits the taxation of offshore earnings to a narrow subset of passive income.
Deems Repatriation. Unlike the House Blueprint and Trump’s proposals, both of which propose a deemed repatriation at materially lower rates, this bill would tax U.S. Shareholders on profits deemed repatriated from CFCs at tax rates generally applicable to subpart F income under current law (at a maximum rate of 35% for corporations and 39.6% for individuals).
The bill would permit taxpayers to pay the tax on the deemed repatriation in installments (no fewer than 2 or more than 8), but unpaid amounts would be accelerated in certain circumstances (e.g., liquidation, bankruptcy, sale of substantially all of the assets of the taxpayer, failure to make a prior installment payment).
For comparison, the House Blueprint proposes a split rate of 8.75% for earnings held in cash or cash equivalents and a 3.5% rate for other earnings, payable in installments over 8 years. Trump’s campaign proposals called for a 10% rate.
Modifies the Foreign Tax Credit Rules. The bill also makes changes to the foreign tax credit provisions of the Code, reinstating the pre-1976 “per country limitation” system.
Current law allows U.S. taxpayers to offset their U.S. tax liability for foreign-source earnings with a credit for income taxes paid to foreign governments, thereby avoiding double taxation of the same earnings. Generally foreign tax credits fall into one of two baskets. Credits arising from foreign taxes paid on passive income may only be used to offset tax paid by the U.S. taxpayer on passive foreign-source income, while credits arising from foreign taxes paid on income other than passive income (“general category income”) may only be used to offset the tax paid by a U.S. taxpayer on foreign-source income that is not passive. Before 1976, U.S. taxpayers were only allowed to use credits arising from foreign taxes paid in a particular country to offset the tax paid by a U.S. taxpayer on foreign-source income earned in the same country. The bill proposes to adopt this “per country” limitation once again, applying such limitation in addition to the existing passive versus general category income limitation.
Trump’s campaign proposals stated that foreign tax credits will remain in place to prevent double taxation. The House Blueprint is silent as to foreign tax credits.
Deems Offshore Entities to be U.S. Persons if Managed or Controlled in the U.S. Under current law, a corporation is a U.S. person for federal income tax purposes only if it is organized in the U.S. The bill proposes to expand the definition of a U.S. person to include a corporation organized outside the U.S. if the management or control of the corporation occurs primarily within the U.S.
Although the bill leaves it to Treasury to write regulations implementing the management and control test, it does specify two categories of regulations that are to be included in whatever Treasury writes – (1) regulations targeting corporations where the individuals who exercise day-to-day responsibility for the corporation are located in the U.S. (whether or not these individuals are officially named as executive officers or senior management), and (2) regulations targeting offshore investment vehicles where the investment decisions are made in the U.S.
Retroactively Tightens the Anti-Inversion Rules. The bill also tightens the existing anti-inversion rules by reducing the percentage of ownership overlap necessary for a foreign buyer to be taxed as a U.S. corporation after buying a U.S. target. Under existing law, very generally, if 80% of the foreign buyer is owned by former owners of the U.S. target after the transaction, the foreign buyer will be taxed as a U.S. corporation. The bill reduces this threshold to 50%, applicable retroactively to transactions occurring after May 8, 2014.
While President Trump and many House Republicans have generally advocated that the right way to deter inversions is to reduce corporate tax rates (or otherwise modify the corporate tax system) to make moving offshore less attractive, it is possible that tax reform will adopt a hybrid approach that makes inversions less attractive through modifications to the corporate tax system while also tightening existing anti-inversion rules to make inversions more difficult to accomplish.
Adds A New Earnings Stripping Rule. The bill also adds a new rule that would limit the amount of interest deductions that a U.S. member of a foreign-headed group of corporations could take against its U.S. taxable income. Specifically, the U.S. member’s interest deductions would be capped at the greater of 10% of the U.S. subsidiary’s adjusted taxable income or its allocable share of the group’s worldwide net interest expense (determined based on the percentage of the group’s earnings generated by the U.S. subsidiary). Excess interest deductions could be carried forward for use in future years. In a departure from the existing earnings stripping rules in Section163(j) and the regulations promulgated under Section 385, the cap would apply to deductions for net interest paid on both third party and intercompany debt.