Chairman Camp’s Latest Tax Reform Proposal
On February 26, 2014, Representative Dave Camp (Rep. MI), the Chairman of the House Ways and Means Committee, released a bill to reform the Internal Revenue Code, entitled “The Tax Reform Act of 2014.” The bill, which is labeled a discussion draft, is a more comprehensive version of a discussion draft of a tax bill released in 2011.The bill, if it were to become law, would significantly change U.S. international tax rules. We discuss some highlights below.
Overview of the bill
The bill is divided into eight parts (or titles), which address (i) taxation of individuals, (ii) repeal of the alternative minimum tax, (iii) taxation of businesses, (iv) taxation of foreign income, (v) tax-exempt entities, (vi) tax administration and compliance, (vii) excise taxes and (viii) deadwood and technical provisions. Chairman Camp’s 2011 proposal did not specify many details, the same cannot be said of this version, which runs to nearly 1000 pages.
The bill is intended to be revenue neutral and to that end would eliminate or curtail numerous tax preferences (i.e., deductions and credits) for individuals and business. The bill also would repeal the alternative minimum tax for individuals and set the top individual rate at 35%. The corporate income tax rate would be reduced from 35% to 25%. This rate reduction would be phased in over a five-year period.
Participation exemption for foreign income
Under the bill, as with Chairman Camp’s 2011 proposal, the United States would no longer tax the worldwide income of U.S. multinationals. An exemption system would be implemented, providing U.S. corporations with a deduction for dividends received from certain foreign corporations. Similar to the laws of other exemption countries, the bill would allow a deduction for only 95% of the dividend, rather than 100%, in order to compensate for deductions attributable to tax-exempt income
Under a transition rule, income of U.S. multinationals that has been accumulated offshore would be subject to current tax under the U.S. subpart F rules in the year prior to the year that the exemption system took effect. Accumulated offshore income held in cash would be taxed at an 8.75% rate. Non-cash accumulated income would be taxed at a lower 3.5% rate. The tax on this income could be paid over an eight-year period.
Both the foreign tax credit and the subpart F rules would be retained, although with modifications. For example, the indirect foreign tax credit would be repealed, and in computing the foreign tax credit limitation only deductions directly allocable to foreign source income would be taken into account.
The subpart F rules would be modified to include only low-taxed foreign source income. The subpart F look-through rules also would be made permanent.
In order to address base erosion and income shifting (BEPS) concerns, a new category of subpart F income would be created, “foreign base company intangible income.” This amount is the excess of the foreign corporation’s adjusted gross income over 10% of the corporation’s qualified business asset investment, subject to certain adjustments. This category of subpart F income is not taxed at the full corporate tax rate, however. Domestic corporate shareholders are allowed a deduction, which is intended to reduce the effective tax rate on such income. BEPS issues would also be addressed by denying a deduction for interest expense of US shareholders which are members of a worldwide affiliated groups with excess domestic indebtedness.
Changes affecting foreign taxpayers
The bill includes five provisions aimed at foreign taxpayers. Two of the provisions target insurance companies and another targets cruise-ship companies. The remaining two provisions are of general interest, however.
The earnings stripping rules of section 163(j), which limits the deduction for interest paid to certain persons that are not subject to tax (or are taxed at a reduced rate) would be tightened. Under current law, interest that is not currently deductible, “excess interest expense,” may be carried forward indefinitely and allowed as a deduction to the extent of any available limitation in a future year. Also, any excess limitation under section 163(j) may be carried forward three years. The bill would not allow an excess limitation to be carried forward. Also, the bill would change the definition of excess interest expense from interest expense that exceeds 50% of adjusted taxable income, to interest expense that exceeds 40% of adjusted taxable income.
The bill also would deny treaty benefits for certain deductible payments made to related persons. The withholding tax on a related party deductible payment would not be reduced by treaty, unless the withholding tax would be reduced by the treaty if the deductible payments were made directly to the payee’s parent. This approach has been advocated in the past, with some success.KEYWORD: Corporate Tax Reform
Tax Insights Blog