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House-Passed Build Back Better Act - International Tax Perspective

Client Updates

On November 19, 2021, the House of Representatives passed the Build Back Better Act (the “Act”). The Act includes funding for various programs as well as significant new tax provisions intended to help offset the cost. The Act now heads to the Senate, where its passage faces significant obstacles.

While it remains uncertain whether the Act will ultimately become law (and, if so, in what form), the enactment of the Act in its current form would have substantial effects on the international provisions of the U.S. Internal Revenue Code and on taxpayers with cross-border structures and activities. Some aspects of the Act that may be of particular interest to such taxpayers are discussed below. For additional information regarding other tax provisions of the Act, please see our client updates regarding corporate tax (available here), and tax administration (available here).

Changes to the taxation of global intangible low-taxed income (“GILTI”) and foreign-derived intangible income (“FDII”)

  • The Act would reduce the Section 250 deduction for GILTI to 28.5% (from 50% under current law), resulting in a minimum GILTI tax rate of 15.015% (assuming a 21% corporate tax rate). The Act also would reduce the Section 250 deduction for FDII to 24.8% (from 37.5% under current law), resulting in an effective tax rate on FDII of 15.792% (also assuming a 21% corporate tax rate). These changes would be effective for tax years beginning after December 31, 2022.

  • The Act would raise the cap on foreign tax credits allowable to offset GILTI to 95% (from 80% under current law), meaning that there generally would be no residual U.S. tax on GILTI that is subject to an effective foreign income tax rate of at least 15.806% (15.015% divided by 95%). This change would be effective for tax years beginning after December 31, 2022.

  • The Act would remove the taxable income limitation on the Section 250 deduction for GILTI and FDII and allow such deduction to be taken into account in determining a domestic corporation’s net operating losses. This change would be effective for tax years beginning after December 31, 2022.

  • The Act would amend current law to require country-by-country application of the GILTI regime. This change would be effective for tax years of foreign corporations beginning after December 31, 2022 and for tax years of U.S. shareholders in which or with which such tax years of foreign corporations end.

  • The Act would expand the GILTI tax base by reducing to 5% (from 10% under current law) the net deemed tangible income return on qualified business asset investments (which amount is excluded from tested income). This change would be effective for tax years of foreign corporations beginning after December 31, 2022 and for tax years of U.S. shareholders in which or with which such tax years of foreign corporations end.

  • The Act would expand the definition of tested income by eliminating the exception for foreign oil and gas extraction income. This change would be effective for tax years beginning after December 31, 2022.

Changes to foreign base company sales and services income rules

  • The Act would limit foreign base company sales and services income to situations in which the related person is a “taxable unit” which is a “tax resident” of the U.S. For this purpose, the term “tax resident” of a country includes a person or arrangement subject to tax under the tax law of a country as a resident, or a person or arrangement that gives rise to a taxable presence by reason of its activities in such country. Although such income would no longer be foreign base company sales or services income, it could nevertheless be subject to U.S. tax under the GILTI regime. This provision would be effective for tax years beginning after December 31, 2021.

Other changes that are relevant to controlled foreign corporations (“CFCs”) and their shareholders

  • The Act would amend Section 245A to allow a 100% dividend received deduction only in cases in which a domestic corporation receives a dividend from a CFC (rather than any specified 10% owned foreign corporation, as under current law). The Act would also allow for certain foreign corporations to make an election to be treated as a CFC. This provision would be effective for distributions made after the date of enactment.

  • The Act would generally reinstate Section 958(b)(4), which prevents downward attribution of stock ownership from a foreign person to a U.S. person for the purposes of determining whether the U.S. person is a U.S. shareholder and whether the foreign corporation is a CFC. The policy considerations that prompted the repeal of Section 958(b)(4) as part of the Tax Cuts and Jobs Act (i.e., that taxpayers may engineer “de-control” transactions to avoid CFC treatment) are addressed by adding new Section 951B, which generally would apply the Subpart F rules to foreign controlled U.S. shareholders of foreign controlled CFCs. This provision would be effective for tax years of foreign corporations beginning after enactment and tax years of U.S. persons in which or with which such tax years of foreign corporations end.

  • The Act would eliminate the election available for a CFC that qualifies as a “specified foreign corporation” (generally, a CFC that is majority owned by a single U.S. shareholder) to use a tax year beginning one month after the tax year of its majority shareholder. This provision would be effective for tax years of CFCs beginning after November 30, 2022.

Changes to the foreign tax credit rules

  • The Act would require the foreign tax credit limitation rules to be applied on a country-by-country basis. This provision would be effective for tax years beginning after December 31, 2022.

  • The Act would repeal the foreign branch income basket under Section 904(d). This provision would be effective for tax years beginning after December 31, 2022.

  • The Act would limit the creditability of amounts paid or accrued by a “dual capacity taxpayer” (i.e., a taxpayer that is subject to a levy of any foreign country or possession of the U.S. and receives (or will receive) directly or indirectly a specific economic benefit from such country or possession). Under this proposal, a dual capacity taxpayer would not be permitted to claim a foreign tax credit for amounts paid to a foreign country that does not impose a generally applicable income tax on its residents. If the foreign country does have a generally applicable income tax, then the foreign tax credit would be limited to the amount that would be paid by the dual capacity taxpayer under such generally applicable income tax. This proposal would eliminate a dual capacity taxpayer’s ability to apply the “facts and circumstances method” under the current Section 901 regulations. This provision would be effective for taxes paid or accrued after December 31, 2021.

  • The Act would eliminate the carryback for excess foreign tax credits and would modify the carryforward period for foreign tax credits from the current 10 years to five years. The Act would repeal the current rule which precludes foreign tax credit carryforwards for GILTI category income. These changes would apply to taxes paid or accrued in taxable years beginning after December 31, 2021.

  • The Act would extend the principles of Section 338(h)(16) (which generally provides that the deemed asset sale that results from a Section 338 election is ignored for purposes of determining the source or character of any item in applying the foreign tax credit rules) to “covered asset dispositions” (generally, any transaction that is treated as a disposition of assets for U.S. tax purposes and that is treated as a disposition of stock of a corporation (or is disregarded) for foreign tax purposes). This provision would be effective for dispositions made after the date of enactment, subject to a binding contract exception.

Changes to the base erosion and anti-abuse tax (“BEAT”)

  • The Act would create a new schedule for increasing the BEAT rate:

    • 10% for tax years beginning after December 31, 2021 and before January 1, 2023;

    • 12.5% for tax years beginning after December 31, 2022 and before January 1, 2024;

    • 15% for tax years beginning after December 31, 2023 and before January 1, 2025; and

    • 18% for tax years beginning after December 31, 2024.

    Under current law, the BEAT rate is 10%, increasing to 12.5% for tax years beginning after December 31, 2025.

  • Under current law, the BEAT applies only to certain taxpayers that meet a base erosion percentage test for the tax year. The Act would expand the applicability of the BEAT by eliminating this requirement for tax years beginning before January 1, 2024.

  • The Act would provide that, if a taxpayer is an applicable taxpayer subject to the BEAT with respect to any taxable year beginning after December 31, 2021, then such taxpayer shall continue to be an applicable taxpayer with respect to each of the 10 succeeding taxable years.

  • The Act would modify the definition of base erosion payments by including new categories of expense and by excluding payments subject to U.S. tax (as GILTI, Subpart F income, or effectively connected income) or to a sufficient rate of foreign tax.

    The proposed changes to the BEAT would apply to tax years beginning after December 31, 2021.

Limitation on interest deductions for international financial reporting groups

  • The Act would enact new Section 163(n), which would limit the net interest expense which is allowed as a deduction by a “specified domestic corporation” that is a member of an international financial reporting group to an “allowable percentage” of 110% of such domestic corporation’s net interest expense. A “specified domestic corporation” generally refers to a domestic. corporation (excluding any exempted small business, S corporation, real estate investment trust, or regulated investment company, but including a foreign corporation engaged in a U.S. trade or business with respect to its items that are effectively connected with such business) if its average annual interest expense over its average annual interest income during the 3-taxable-year period ending with the taxable year in question exceeds $12 million. A specified domestic corporation’s “allowable percentage” is the corporation’s “allocable share” of the international financial reporting group’s reported net interest expense divided by the corporation’s reported net interest expense. A specified domestic corporation’s “allocable share” of the international financial reporting group’s reported net interest expense, in turn, is determined based upon the relative EBITDAs of such corporation and of the international financial reporting group. The proposal would also enact new Section 163(o), which would allow for indefinite carryforwards of interest expense disallowed under Section 163(j) or Section 163(n), whichever imposes the lower limitation. The amendments made by this section apply to taxable years beginning after December 31, 2022.

Narrowing of the portfolio interest exemption

  • The Act proposes to narrow the portfolio interest exemption applicable to interest paid by a corporation by providing that a “10-percent shareholder” who is ineligible for the exemption includes a shareholder who owns either 10% of the corporation’s voting stock (which is the rule under current law) or 10% of the total value of the corporation’s stock. This provision would apply to obligations issued after date of enactment.

We continue to monitor the progress of the Act and expect to provide further updates as developments unfold. If you have any questions about the Act, please contact any of the authors of this update.

 

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