Swiss-American Chamber of Commerce Corporate Tax Reform - Impacts on Swiss and Other European Companies

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1 Swiss-American Chamber of Commerce Corporate Tax Reform - Impacts on Swiss and Other European Companies Marc J. Gerson Rocco V. Femia May 25-26, 2011

2 U.S. Tax Reform Recognized Need for Fundamental U.S. Tax Reform Last major overhaul of the Internal Revenue Code was in 1986 Increasingly complex for taxpayers to comply with (and the IRS to administer) the Code Temporary nature of significant portions of the Code Increased revenue pressure associated with the budget deficit and projected spending increases in federal retirement and health care programs (Social Security, Medicare and Medicaid) Competitive pressure to lower the U.S. statutory corporate tax rate (35%, among the highest in OECD) 2

3 Prospects for U.S. Tax Reform in the Short Term Unlikely that tax reform will be completed in Budget deficit concerns 2011 estimate = $1.5 trillion (9.8% of GDP) Divided government Administration - Democratic U.S. Senate 53 Democrats / 47 Republicans U.S. House of Representatives 242 Republicans / 193 Democrats Pending 2012 Presidential Election At a minimum, significant tax reform discussions will continue in 2011 and extend into 2012 Congressional hearings Groundwork for

4 Tax Reform Proposals Numerous Tax Reform Proposals The Bipartisan Tax Fairness and Simplification Act (Senators Wyden and Coats) President s Economic Recovery Advisory Board Report on Tax Reform Options The Debt Reduction Task Force (Former Senator Domenici) The National Commission on Fiscal Responsibility and Reform Report (Former Senator Simpson) House Republicans (Ways and Means Chairman Camp / Budget Chairman Ryan) Varying levels of detail, but all proposals generally finance a reduction in the corporate tax rate by base broadening through an elimination of tax expenditures (i.e., deductions, credits and other preferences) Proposed rates ranged from the mid-20s to the high-20s Proposals vary from eliminating all tax expenditures to eliminating selected tax expenditures Obama Administration FY2012 Budget Proposals 4

5 Threshold Scope Issues for U.S. Tax Reform Is tax reform addressed on a stand-alone basis or as part of a deficit reduction effort? Is corporate tax reform addressed on a stand-alone basis or in combination with individual tax reform? Administration has suggested support for corporate tax reform on a stand-alone basis whereas Congressional tax-writers have suggested support for overall reform of the Code The potential impact of corporate tax reform base broadening on flow-through taxpayers (e.g., partnerships and LLCs) needs to be considered Is corporate tax reform revenue neutral? Does it result in a reduction of net revenues from the corporate tax? Revenues from the corporate tax are at historic lows as a percentage of GDP and total revenue Does it raise revenue used to finance individual tax reform or deficit reduction? 5

6 U.S. International Tax Reform Existing proposals generally focus on the taxation of the international operations of U.S.-based multinational corporations Potential shift from a worldwide system to a territorial system exempting active foreign-source income from U.S. taxation Numerous Issues To Address Level of exemption for foreign dividends Treatment of royalties or other returns from IP Importance of expense allocation rules Increased pressure on transfer pricing and sourcing rules Subpart F / foreign tax credit rules applicable to passive or mobile foreign income Need for transition rules Repeal of (or limitations on) deferral of U.S. taxation on foreignsource income 6

7 U.S. International Tax Reform The taxation of the U.S. operations of foreign-based multinational corporations has not received significant attention in the tax reform debate to date This likely will change as the debate develops, particularly as additional revenue sources are need to fund any significant reduction in the U.S. corporate tax rate Pending U.S. House of Representatives Committee on Ways and Means hearing on inbound issues of foreign-based multinational corporations 7

8 Proposals of Interest to Foreign-Based Multinational Corporations Managed and Controlled Corporate Residency Test Limitation on Tax Treaty Benefits Earnings Stripping Offshore Reinsurance Financial Crisis Responsibility Fee (Bank Tax) 8

9 Managed and Controlled Corporate Residency Test Under longstanding law, a corporation is treated as domestic or foreign for U.S. tax purposes based on its place of incorporation The standard has been eroded to some extent by the 2004 anti-inversion rules The proposal would treat publicly-traded foreign corporations and corporations with gross assets of more than $50 million as domestic corporations for U.S. tax purposes if they are managed and controlled primarily in the United States if substantially all of the executive officers and senior management of the corporation [as well as certain other individuals] who exercise day-to-day responsibility for making decisions involving strategic, financial and operational policies of the corporation are primarily located in the United States Application potentially subjects corporations with significant U.S. management functions to U.S. taxation on their worldwide income 9

10 Managed and Controlled Corporate Residency Test Originally proposed by the Congressional Joint Committee on Taxation in 2005; the proposal has consistently been introduced in both the U.S. Senate and the U.S. House of Representatives since that time Earlier managed and controlled bills included a so-called treaty exception whereby the managed and controlled test would not apply to corporations organized in jurisdictions with a U.S. tax treaty prior to enactment of the bill If the managed and controlled test were enacted it is uncertain whether it would include a treaty exception The treaty exception has not been included in more recently introduced bills, including the pending bill before the U.S. House of Representatives Highly publicized redomestications from non-treaty jurisdictions (Bermuda, Cayman Islands) to treaty jurisdictions (Switzerland, Ireland) 10

11 Limitation on Tax Treaty Benefits Under current law, a 30% gross-basis withholding tax is imposed on payments of U.S.-source interest, dividends, rents and royalties to foreign corporations Under an applicable tax treaty, U.S. withholding tax may be reduced or eliminated on payments to an affiliate resident in the treaty country, regardless of the residency of the ultimate parent corporation of the multinational group For example, assume a foreign multinational group with its parent corporation in Brazil has a U.S. subsidiary and a U.K. subsidiary An interest payment made by the U.S. subsidiary to the U.K. subsidiary generally would be exempt from withholding tax under the U.S.-U.K. tax treaty Anti-treaty shopping rules would be met as long as the U.K. subsidiary conducts a significant trade or business in the U.K. to which the interest income relates 11

12 Limitation on Tax Treaty Benefits Under the proposal, the U.S. withholding tax may not be reduced under a tax treaty unless the withholding tax would be reduced under a tax treaty if the payment at issue were made directly to the ultimate foreign parent corporation of the payee The proposal would treat the interest payment in our example as a hypothetical payment from the U.S. subsidiary to the Brazil parent corporation and, because there is no U.S.-Brazil tax treaty, the payment would be subject to the general 30% withholding tax rate As a result, foreign parent corporations in non-treaty jurisdictions (e.g., Brazil, Singapore, Taiwan, Hong Kong, Argentina, Malaysia) would be subject to 30% withholding tax on payments made between their subsidiaries that otherwise qualify for treaty benefits Foreign parent corporations in treaty jurisdictions would not be impacted by the legislation 12

13 Limitation on Tax Treaty Benefits A broader proposal was passed by the U.S. House of Representatives in 2007 The proposal would have applied not only to foreign parent corporations in non-treaty jurisdictions but also to foreign parent corporations in certain jurisdictions with older, less favorable treaties The proposal has not gained traction in the U.S. Senate Override of existing tax treaty obligations/concerns regarding potential retaliation Treaty override is problematic as an institutional matter for the Administration and the U.S. Senate Considered by the U.S. Senate as recently as December 2010 but continues to be rejected 13

14 Earnings Stripping Current law (Section 163(j)) limits the deductibility of certain interest paid by certain thinly capitalized corporations to related persons (i.e., interest on related-party debt paid by a U.S. subsidiary to its foreign parent corporation) Applies to corporations that have a debt-to-equity ratio greater than 1.5 to 1 and net interest expense in excess of 50 percent of adjusted taxable income Disallowed interest expense may be carried forward indefinitely for deduction in a subsequent year Excess limitation (the amount by which adjusted taxable income exceeds net interest expense) may be carried forward for three years 14

15 Earnings Stripping 2007 U.S. Treasury Department Report concluded that expatriated entities (i.e., former U.S.-based multinational corporations that inverted) used foreign-related party debt to inappropriately reduce the U.S. tax on income from U.S. operations Report stated that it could not quantify earnings stripping abuse by non-expatriated entities Reporting instituted to better develop data Based on the 2007 report, the Bush Administration and the Obama Administration have proposed to tighten the earnings stripping rules for certain expatriated entities 15

16 Earnings Stripping Obama Administration FY2012 Budget Proposal Eliminates 1.5 to 1 debt-to-equity safe harbor 50% adjusted taxable income threshold reduced to 25% 10-year carryforward for disallowed interest No carryforward of excess limitation Applies to entities that expatriated in taxable years beginning after July 10, 1989 (rather than the March 3, 2004 effective date of the anti-inversion rules) Potential that proposal may be expanded beyond expatriated entities Need for additional revenue Further Treasury data on earnings stripping by such entities 16

17 Offshore Reinsurance Under current law, insurance companies are allowed a deduction for reinsurance premiums, regardless of whether such premiums are paid to an affiliated or an unaffiliated company or to a domestic or foreign company There are a number of proposals that would deny or limit the deduction for reinsurance premiums paid to certain affiliated reinsurance companies 17

18 Financial Crisis Responsibility Fee (Bank Tax) The Obama Administration has proposed a financial crisis responsibility fee to recoup the costs of the Troubled Asset Relief Program (TARP) and discourage excessive risk-taking by financial institutions FY2011 Proposal - $90 billion FY2012 Proposal - $50 billion Proposal would apply not only to U.S.-based companies, but also to U.S. subsidiaries of foreign firms 18

19 Financial Crisis Responsibility Fee (Bank Tax) Although the proposal has received significant Congressional consideration (i.e. hearings), it has not gained traction Dispute regarding scope of tax Dispute regarding appropriate mechanism/tax base Recoupment of TARP costs no longer valid purpose Desire to be consistent with international standards 19

20 Potential Standards for Punitive Tax Legislation Impacting Foreign-Based Multinational Corporations Black List Corporate Residency Current place of incorporation test Managed and controlled test Expatriated Entities vs. Non-Expatriated Entities March 4, 2003 effective date (2004 legislation) Earlier effective date (Grassley Press Release March 21, 2002; July 10, 1989 effective date in Administration earnings stripping proposal) Tax Treaty Jurisdiction vs. Non-Tax Treaty Jurisdiction Whether or Not Entity is Subject to a Comprehensive Foreign Income Tax 20

21 Developing A Strategy for U.S. Tax Reform Consider priority of U.S. tax reform in the context of other U.S. legislative priorities Consider public relations implications Determine priorities based on tax profile Determine U.S. tax deductions, credits and preferences of greatest value Leverage use of trade associations/coalitions where appropriate Determine desired level of engagement (if any) Determine appropriate timing based on legislative environment and agenda 21

22 Contact Information For more information, please contact: Marc J. Gerson Rocco V. Femia