Obama’s Budget Proposal to Tax Unrepatriated Foreign Earnings

By:
LISA S. GOLDMAN, CPA, AND THOMAS V. RUTA, CPA
Published Date:
Mar 1, 2015

President Obama’s 2016 Budget contains a proposal to end "deferral” of tax on income earned in Controlled Foreign Corporations (CFC). Under current law, foreign income that is not considered "Subpart F" is generally only taxed when it is repatriated to the U.S.  The administration feels that this "opportunity” for U.S. multinationals to defer U.S. tax on foreign earnings has enabled a staggering amount of earnings to accumulate outside the U.S., subject only to low effective foreign tax rates. 

The President’s proposal includes:

  • imposing a one-time, immediate, 14-percent tax on CFC’s accumulated earnings, with a reduced credit for associated foreign taxes paid, and
  • imposing a 19-percent “minimum” tax on U.S. corporation future foreign profits, with generally an 85% credit for associated foreign taxes paid.

Prior Repatriation Tax Holiday and IRC Section 965

Congress and prior Administrations have often debated taxation of unrepatriated foreign earnings.  As part of the American Jobs Creation Act of 2004, Congress and President George W. Bush enacted IRC Sec. 965 which provided a one-year tax holiday for repatriating corporate earnings.  It permitted U.S. corporations to repatriate their CFC profits into the U.S. at a reduced tax rate by providing a dividends received deduction equal to 85 percent of the qualifying cash dividends received by the US shareholder. This deduction resulted in a federal effective tax rate of 5.25% on this income. The benefits of this tax holiday were only available for a single taxable year and only to the extent that dividends received exceeded the average dividends received by the taxpayer from its CFCs during a specified base period. To qualify, Congress also required the repatriated dividends be paid in cash and be invested within the United States pursuant to a dividend reinvestment plan approved by the taxpayer’s management. President Obama’s proposal does not specifically impose these restrictions.

A 19-Percent Minimum Tax on Foreign Income

Generally, the President’s proposal limits deferral of CFC earnings.  It does not eliminate the Subpart F regime, which would operate concurrently. Consequently, income reported under the Subpart F regime would continue to be taxed at the full U.S. tax rate. The proposed 19% minimum tax is imposed on income not taxed under Subpart F and would apply to a U.S. corporation that (i) is a United States shareholder of a controlled foreign corporation (CFC), (ii) has foreign earnings from a foreign branch or (iii) what is referred to as "the performance of services outside the U.S."  Under this proposal, a foreign branch of a U.S. corporation would be treated as a CFC.

Under the proposal, foreign earnings of a CFC, branch or from the performance of services would be subject to current U.S. taxation at a rate (but not below zero) of 19 percent less 85 percent of the per-country foreign effective tax rate.  The foreign effective tax rate for a country would be computed on an aggregate basis with respect to all of the taxpayer’s earnings and associated taxes attributable to that country over a 60-month period that ends on the date on which the corporation’s current taxable year ends. The foreign effective tax rate would take into account only foreign taxes that, under current law, would be eligible to be claimed as a foreign tax credit for U.S. federal income tax purposes.

The minimum tax would be imposed on current foreign earnings regardless of whether the earnings are repatriated to the United States. All foreign earnings could later be repatriated without further U.S. tax. No tax would be imposed on the gain on the sale of CFC stock to the extent of earnings already subject to tax under the 14-percent, 19-percent or Subpart F regimes. Any gain from the sale of stock reflecting unrealized and thus previously untaxed gain would be subject to either (i) the minimum tax or (ii) tax at the full U.S. rate, depending on whether the underlying assets generated active or Subpart F income.

Under the proposal, foreign-source royalty and interest payments received by U.S. corporations would continue to be taxed at the full U.S. statutory rate, but in contrast with current law, could not be shielded by excess foreign tax credits associated with dividends from high-tax CFCs because the earnings of high-tax CFCs would be exempt from U.S. tax.

Current rules regarding CFC investments in United States property and previously taxed earnings would be repealed for United States shareholders that are U.S. corporations.

If enacted, the minimum tax proposal would be effective for taxable years beginning after December 31, 2015.  According to the White House Budget office, revenue raised by the minimum tax over a 10 year period of this tax would exceed $205 billion.

A 14-Percent One-Time Tax on Previously Untaxed Foreign Income

In addition to implementing the 19-percent minimum tax, the President’s proposal includes a one-time 14-percent tax on earnings previously accumulated in CFCs and had not been subject to U.S. tax.  A credit would be allowed for the amount of foreign taxes associated with such earnings multiplied by the ratio of the one-time tax rate (14%) to the maximum U.S. corporate tax rate for 2015, (currently 35%). Accumulated income subject to the one-time tax would not be subject to any further U.S. tax when repatriated.

The revenue raised by the one-time tax would be used to replenish the Highway Trust Fund to fund repairs and improvements to roads, bridges, transit systems and freight networks.

If enacted, the one-time tax would be effective on the date of enactment and would apply to earnings accumulated for taxable years beginning before January 1, 2016. The tax would be payable ratably over five years.  Per the White House Budget office, the one-time 14-percent minimum tax would raise in excess of $248 billion.

Unanswered Questions

The President’s budget proposal explicitly states that the 19-percent Minimum tax would apply to a U.S. corporation that is a United States shareholder of a CFC or that has foreign earnings from either a branch or the performance of services abroad.

In contrast, the budget proposal for the 14-percent minimum tax does not distinguish between the type of CFC shareholders and so it is unclear if it would be imposed on all CFC shareholders (including individuals), and whether a foreign tax credit would be available on the taxed income.  Currently, under IRC Sec. 902, only C Corporations owning 10 percent or more of voting stock are eligible to take a foreign tax credit for a proportion, based on dividends received, of the foreign taxes paid by the foreign corporation. This indirect credit allows a U.S. corporate shareholder to repatriate income from a foreign subsidiary without double taxation.

The 14-percent tax on accumulated foreign income and the 19-percent minimum tax on CFCs would represent a significant increase in tax to U.S. businesses. Some have described this change in the taxation of unrepatriated earnings as a transition to the long discussed “territorial” tax regime. Others criticize this “deemed repatriation tax” as retroactive taxation. The 2004 “repatriation holiday” lowered tax on foreign profits to 5.25%. The current proposal would tax accumulated foreign profits at 14% and future foreign profits at 19%, whether or not the earnings are repatriated.  Other proposals that have been discussed include a 5.25%, 6.5% or 8.75% tax on repatriated earnings. 

On February 5, Treasury Secretary Jack Lew announced the White House's willingness to work with lawmakers on some of the tax proposals in the President’s budget. Specifically he indicated that there was a "lot of room to work together” when comparing the President’s proposal to tax overseas profits with other foreign earnings tax proposals. The divide between these other proposals and the President’s plan is vast. Underlying the debate is the abiding economic issue of whether any of these alternative measures will benefit the economy or spur job growth.  


Goldman1
Lisa S. Goldman, CPA, is a partner at Raich, Ende, Malter & Co. LLP, with more than 20 years' experience serving Fortune 500 corporations and privately owned companies in the real estate, manufacturing and consumer products industries. She specializes in international taxation and in providing services for both high-net-worth individuals and their businesses. Ms. Goldman is a trust and estate practitioner (TEP) under the auspices of STEP and is a member of the NYSSCPA’s International Taxation Committee and the AICPA Tax Division.  She frequently writes and lectures on international tax topics.  She can be reached at 212-695-7003 or lgoldman@rem-co.com.

Ruta
Thomas V. Ruta, CPA, is a tax partner at Raich, Ende, Malter & Co. LLP, specializing in international taxation and in providing family office services for high-net-worth individuals and their businesses.  He is a member of the NYSSCPA International Taxation Committee and the AICPA Tax Division.  He is a trust and estate practitioner (TEP) under the auspices of STEP and holds the designation of Chartered Global Management Accountant.  He can be reached at 212-695-7003 or truta@rem-co.com.

 
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