U.S. Legislative Outlook Tom Patten 2 March 2011
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1 U.S. Legislative Outlook Tom Patten 2
2 Agenda Understanding the U.S. legislative process. Recent legislative developments. Proposals. 2
3 Understanding the U.S. Legislative Process The Long Road from Bill to Law Why are so few bills ever enacted? Why are new tax provisions embedded in seemingly unrelated pieces of legislation? 3
4 The Three Branches of Government Legislative Congress (Senate and the House of Representatives ( H.R. )) Both houses must pass an agreed bill for the President to sign. Executive President and his administration Cannot introduce legislation into Congress. The president signs legislation into law. May veto laws (subject to override by 2/3 majority in both houses). Judicial Interprets the law no law-making function. 4
5 The U.S. Legislative Process Draft Bills from members of Congress, the Administration or others Introduction, House H.R. #### TBG sent to committee or desk or calendar Committee action /inaction Hearings / Mark-up Vote to report bill writing report Introduction, Senate S.. #### sent to committee or desk or calendar Committee action /inaction Hearings / Mark-up Vote to report bill writing report Floor Activity Refer to Rules Committee Debate Floor Activity Debate Votes Conference resolving differences (if necessary) Vote President signs or vetoes Law printed, codified Regulatory activity 5
6 Obstacles to Lawmaking Proposing is easier than enactment. - Proposals may come from any member of Congress or the Administration. Both houses must pass the identical bill. - Currently, the Senate and HR are controlled by different parties. Risk of Senate filibuster. - The Democrats control the Senate, but do not have the 60% majority required to break a filibuster. Possibility of Presidential veto. - Neither house has the 2/3 majority required to override the veto. 6
7 Pay-as-you-go All federal legislation must be revenue neutral. - Spending measures and tax relief must be offset by revenue raisers. - Subject to certain exemptions, e.g., Social Security. Individual tax relief likely to be offset by raisers affecting business. No necessary connection between spending/relief and revenue raisers. Therefore, important tax laws may be embedded in unrelated bills. - Healthcare reform was offset by codification of the economic substance doctrine. - State aid under the Education Jobs and Medicaid Assistance Act of 2010 was offset by the foreign tax credit ( FTC ) splitter rules and other crossborder provisions. 7
8 Recent Legislation Codification of the Economic Substance doctrine. The Foreign Account Tax Compliance Act of 2009 ( FATCA ). Revenue Raisers under the Education Jobs and Medicaid Assistance Act of Reinstatement of exemptions from the controlled foreign corporation ( CFC ) rules. - CFC look-through rule. - The active financing income exception. 8
9 Codification of the Economic Substance Doctrine Applies to transactions entered into after 30 March New laws codify a longstanding judicial doctrine. If a transaction lacks economic substance, strict liability penalties apply to underpayments and understatements of income. - Penalties of up to 40% of underpayment. For a transaction to have economic substance : - It must change in a meaningful way the taxpayer s economic position. - The taxpayer must have a substantial purpose for entering into it. 9
10 FACTA Enacted 18 March 2010 as part of the Hiring Incentives to Restore Employment ( HIRE ) Act. Generally effective for payments made after Strengthens information reporting and withholding compliance with respect to U.S. persons who invest through non-u.s. entities. Information reporting burdens are imposed on certain non-u.s. entities -- foreign financial institutions ( FFIs ) and non-financial foreign entities ( NFEs ). Reporting requirements are enforced through a withholding backstop. Withholdable payments to FFIs and NFEs include: - U.S.-source FDAP-type income, e.g., portfolio interest. - Gross proceeds from the sale or other disposition of property that can produce U.S.-source interest or dividends. 10
11 Information Reporting and Withholding under FATCA 30% withholding to be imposed on U.S. source withholdable payments made either to a FFI or a NFE unless they comply with new reporting disclosures and related requirements: - They must obtain certain information from U.S. shareholders and/or U.S. account holders. - No specific form or format has been issued or identified in obtaining and reporting the required information. - FFIs are subject more extensive requirements than NFEs. - In general, to avoid withholding: - FFIs are required to enter into, and comply with an information sharing agreement with the Internal Revenue Service ( IRS ). - NFEs must either certify as to no substantial U.S. ownership or provide certain identifying information about their U.S. owners. 11
12 Foreign Financial Institutions and Non-Financial Foreign Entities FFI is broadly defined. Certain entities should be excluded from the scope of the FFI requirements, e.g., certain foreign insurance companies and retirement plans. NFE is any foreign entity that is not a FFI. Certain categories of NFEs are generally exempt from FACTA withholding, e.g., publicly traded corporations & foreign governments. It is hoped that forthcoming Treasury guidance will help clarify the scope of these categories. 12
13 Education Jobs and Medicaid Assistance Act of 2010 ( Education Act ) Enacted 10 August 2010 to provide state aid for education and Medicaid. Aid is offset by significant revenue raisers, generally effective for transactions/tax years beginning after 12/31/2010, including: - Foreign tax credit splitter rules. - Limit on section 956 inclusions. - Covered asset acquisition rules. - Cross-border share sale rules. 13
14 Education Act - Foreign Tax Credit Splitter Rules Address transactions that separate creditable foreign taxes from the income to which they relate ( FTC splitting events ). A FTC splitting event occurs with respect to foreign tax if the related income is (or will be) taken into account by a covered person, i.e., generally, a person that owns a 10% interest in the foreign taxpayer (or vice versa), or is related to the taxpayer under the applicable rules. The rules defer the FTC generated by such events until the taxable year in which the taxpayer takes the related income into account. The rules address both direct and indirect FTCs. 14
15 FTC Splitting Events Example TBG Reverse Hybrid Structure USP RHFS Foreign Tax: $50 E&P $100 (assume US tax deferred) Facts 1. US parent ( USP ) with reverse hybrid foreign sub ( RHFS ). 2. RHFS acts as a blocker in income not subject to immediate US tax. 3. As RHFS is a flow-through for foreign law purposes, USP is liable for the foreign tax under foreign law. Under FTC splitter rules The income related to USP s $50 of foreign taxes is RHFS s $100 of E&P. The FTC for the $50 is deferred. 15
16 FTC Splitting Events Group Relief Loss-surrender Structure USP IrCo1 According to IRS guidance, loss-sharing gives rise to an FTC splitting event when the following conditions are met: 1. There is an instrument that is treated as indebtedness in the issuer s tax jurisdiction and that is disregarded for U.S. tax purposes, e.g., a loan between two disregarded entities with the same owner. 2. The owner of the disregarded debt instrument pays a foreign income tax attributable to a payment or accrual on the instrument. IrCo 2 Disregarded loan IrCo3 IrCo4 Surrender of Losses 3. The payment or accrual on the instrument gives rise to a deduction for foreign tax purposes, and the issuer of the instrument incurs a shared loss that is taken into account under foreign law by an entity or entities that are covered persons with respect to the owner of the instrument. 16
17 Education Act - Limit on Section 956 Inclusions ( Anti-Hopscotch Rule ) Response to the use of section 956 to selectively repatriate high-tax pools of E&P from certain CFC s, while avoiding rate blending that would occur on an actual dividend distribution up through multiple tiers of CFCs. - CFCs are certain majority-u.s. owned foreign corporations subject to special rules due to the potential for income-shifting. The anti-hopscotch rule limits a deemed paid credit for any section 956 inclusion to the lesser of: - The FTC amount that would result if the amount included had been distributed as a dividend up through the ownership chain separating a CFC from its U.S. shareholder, or - The amount of the FTC that would result under the hopscotch rule. 17
18 Section 956 prior and new rule Prior (Hopscotch) Rule New Rule USP USP 956 Loan: $1,000 CFC1 CFC2 E&P = $4,000 Taxes = $0 E&P = $1,000 Tax Pool = $1,000 E&P = $4,000 Dividend = $1,000 Total E&P = $5,000 Post-Div Tax Pool = $1,000 ETR = 20% E&P = $1,000 Tax Pool = $1,000 CFC1 CFC2 Hypothetical Distribution $1, Loan: $1,000 Hypothetical Distribution $1,000 U.S. tax calculation Dividend $1,000 Section 78 Gross-up $1,000 Taxable Income $2,000 US Tax $ 700 FTC ($700) Residual US Tax $ 0 FTC C/F $ 300 Difference $520 U.S. tax calculation Dividend $1,000 Section 78 Gross-up $ 200 Taxable Income $ 1,200 US Tax $ 420 FTC ($200) Residual US Tax $ 220 FTC C/F $ 0 18
19 Education Act Covered Asset Acquisitions Certain U.S. tax elections or transactions can result in the creation of additional asset basis eligible for amortization or depreciation for U.S. tax purposes without a corresponding increase in the basis of such assets for foreign tax purposes. Examples include: - Qualified stock purchase where a section 338 election is made. - Acquisition of a partnership interest holding foreign assets where a section 754 election is made. - Acquisitions of stock of disregarded entities. New rule limits a taxpayer's ability to credit foreign taxes paid following a covered asset acquisition. 19
20 Education Act Covered Asset Acquisitions Applies to covered asset acquisitions after 31 December Grandfather rule: new rule does not apply to unrelated party covered asset acquisitions if - Made pursuant to a written agreement which was binding on 1 January 2011; - Described in a ruling request to the IRS on or before 29 July 2010; or - Described in a public announcement or SEC filing on or before 1 January
21 Education Act Changes to Cross-Border Share Sale Rules Example 1 Note US CFC UK F1 F1 shares Old rule: Dividend to UK that is not subject to US tax and reduces first CFC s E&P, then F1 s E&P. New rule: Dividend only reduces F1 s E&P. F1 21
22 Education Act Changes to Cross-Border Share Sale Rules Example 2 Property (e.g., cash, debt or assets) UK US CFC US shares Old rule: Dividend to UK that reduces first CFC s E&P, then US E&P. Not subject to US tax except to the extent of US withholding tax on dividend, if any. New rule: Only redeems CFC s E&P if more than 50% of the total dividend is subject to US tax (e.g., withholding tax). - Thus, old rule still applies if CFC s E&P is less than 50% of purchase price, assuming US dividend subject to tax. - Treaty exemption? - What about a pre-sale dividend from CFC? 22
23 Reinstatement of the CFC Look-Through Rule and Active Financing Income Exception Both exceptions expired on 31 December Both reinstated and extended through 2011 by the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 (signed December 17, 2010). Exceptions from the subpart F anti-deferral rules applicable to certain significant U.S. shareholders of CFCs. CFC rules generally require certain U.S. shareholders to include in taxable income on a current basis certain subpart F income of a CFC. The look-through rule excludes from subpart F income dividends, interest, rent, and royalties received or accrued from a related CFC. The active financing income exception excludes from subpart F income certain banking and financing income of banks and financial institutions. 23
24 Legislative Proposals Proposals from President Obama s 2012 Budget. Anti-treaty shopping rules. Corporate residency rules Management and control override. 24
25 Proposals from the 2012 Budget Determine FTCs on a pooled basis. Introduce a new subpart F category of income reflecting an excess return associated with transfers of intangibles offshore. Expand the deemed royalty regime relating to intangible transfers from the United States by clarifying the definition of intangible property. Tighten the earnings stripping rules for inverted U.S. companies. Defer interest deductions relating to deferred income. Deny deductions on reinsurance premiums paid to affiliates that are not subject to tax 25
26 Anti-Treaty Shopping Bill Denies treaty benefits for U.S. withholding tax imposed on deductible related-party payments unless the foreign parent of the group would be entitled to reduction under the treaty. Applicable to intra-group deductible payments (e.g., interest and royalties) but not dividends. 26
27 Corporate Residency - Management & Control Overrides Provisions have been included in previous bills in both houses. Treats certain foreign corporations managed and controlled primarily in the United States as U.S. corporations for federal tax purposes Triggered where substantially all executive officers and senior management who exercise day to day responsibility for strategic/financial/operational decisions of foreign company are located primarily in the United States. 27
28 Contact details Tom Patten +44 (0) This publication has been prepared for general guidance on matters of interest only, and does not constitute professional advice. You should not act upon the information contained in this publication without obtaining specific professional advice. No republication or warranty (express or implied) is given as to the accuracy or completeness of the information contained in this publication, and, to the extent permitted by law, PricewaterhouseCoopers LLP, its members, employees and agents do not accept or assume any liability, responsibility or duty of care for any consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it PricewaterhouseCoopers LLP. All rights reserved. 'PricewaterhouseCoopers' refers to PricewaterhouseCoopers LLP (a limited liability partnership in the United Kingdom) or, as the context requires, the PricewaterhouseCoopers global network or other member firms of the network, each of which is a separate and independent legal entity.
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