Green Book Offers Proposed Tax Changes
Big Changes Could be in Store for Multinational Companies
By Frank Landreneau, CPA, and Edward N. Goldsberry, CPA

In 2008 when the nation elected a new president, we knew the Obama administration’s proposed changes to international tax rules would be discussed and debated by the tax community. Now that the president has been in office for several months, the release of the administration's budget is only the start for what could be a long legislative process for the many tax proposals included in the proposed budget.

Of course, there are other issues, including healthcare reform. However, there is strength in numbers; the substantial revenue figures associated with the international tax proposals will keep them front and center.

On May 11, 2009, the Treasury Department released the highly anticipated Treasury Green Book, General Explanations of the Administration's Fiscal Year 2010 Revenue Proposals. In addition to other tax proposals, the Green Book provides details on the international tax proposals, estimated to raise approximately $210 billion over 10 years (FY2010-FY2019). Although, the proposals are pretty far-reaching, several commentators noted that they could have been even more substantive.

The proposals are intended to principally operate by eliminating or reducing deferral of U.S. tax on multinationals’ overseas income and by strengthening reporting requirements and enforcement targeted at capturing additional tax dollars from unreported offshore income, primarily from foreign bank and investment accounts.

The four key points in the summary of the proposals include:

1. Limitations on the use of the entity classification election, known as the “'check-the-box” election. The focus here is for the United States to be able to tax foreign income earlier. This is tax that U.S. multinationals ordinarily defer primarily through the use of various offshore finance companies. There are two problems with this proposal. First, many U.S. trading partners may view this as income that should be appropriately taxed by them first, and therefore enact legislation to counter the U.S. move. Second, the proposed approach may inadvertently raise taxes on many U.S. small- and medium-sized companies that are currently operating internationally, but not using deferral structures for the purpose of avoiding U.S. taxation.

2. Deferral of deductions, other than research and experimentation expenses, related to foreign-source income that is not currently subject to U.S. income tax. The idea here is that timing of deductions should match the timing of income reporting. For example, if a U.S.-based company borrows funds related to starting operations conducted by a foreign subsidiary corporation, the company can deduct the interest expense related to the debt as incurred, while deferring taxation on the earnings of the foreign subsidiary. This will have implications for how certain financing arrangements will be structured.

3. Changes to the U.S. foreign tax credit system by first, requiring deemed paid foreign tax credits to be determined on a consolidated basis, and second, implementing a matching rule to prevent the splitting of foreign income taxes from the underlying income. In order to minimize its overall U.S. tax liability on such earnings in a given year, taxpayers currently can repatriate high- and low-taxed foreign earnings in such a way to achieve a “blended” effective foreign tax rate. Under the new proposals, all foreign undistributed earnings, along with associated foreign taxes, would be combined in one pool, reducing the opportunity to minimize the effective U.S. tax rate by cherry picking which set of foreign earnings to repatriate in a particular year based on the rate of tax in a particular foreign jurisdiction.

4. Bolstering of the information reporting and withholding systems that support U.S. taxation of income earned or held by U.S. persons through offshore accounts or entities. The proposed rules are an extension of the enforcement efforts already underway regarding reporting by U.S. persons who have foreign bank or investments accounts.

There are additional international tax proposals that target more narrowly defined transactions. Three of them target transfer pricing for intangibles, further limitations on potential U.S. tax benefits for former U.S. companies that moved to other tax jurisdictions and reducing current U.S. tax benefits for foreign-owned US-based companies that earn the majority of their income from operations outside the United States.

The Obama administration's proposals also include a provision for codifying the economic substance doctrine. This would require that all transactions have potential economic benefit – exclusive of tax benefits – in order to be valid for tax purposes. Other proposals would extend provisions that currently provide relief for taxpayers in allowing them to redeploy earnings overseas without immediate taxation in the U.S. tax base.

Executives need to become familiar with these international tax proposals and assess how they could affect their companies, and should speak to their tax advisors as to what impact the proposals may have on their current operating structures. In addition, preliminary discussions should begin with respect to identifying alternatives and restructuring initiatives should these proposals become law.

Frank Landreneau, CPA, and Edward N. Goldsberry, CPA, are both directors in PKF Texas’ Tax Department.