Obama’s war on tax havens

Earlier this year, the US Government proposed a number of international tax reforms that are intended to close several perceived tax loopholes.

If enacted, the proposals - which are currently expected to affect accounting periods commencing after 31 December 2010 - could have a significant impact on non-US companies with US parents.

Some of the key proposals include:

1.Changes to tax deferral

At the moment, businesses that invest overseas can take immediate deductions on their US tax returns for expenses supporting their overseas investments, and can defer paying US taxes on the profits they make from those investments. The administration's proposals on deferral would prohibit companies from taking such deductions, with the exception of research and development expenses, until they repatriate their earnings.

If implemented, the changes are bound to add even more complexity to the reporting requirements for UK subsidiaries of US companies.

2.Changes to foreign tax relief

At the moment double tax relief is calculated on a corporation by corporation basis, allowing selective repatriation of certain pools of non-US earnings and cross-crediting.

Obama’s second proposal would require US taxpayers to calculate double tax relief with respect to foreign taxes paid by a subsidiary on a blended basis.  This would involve aggregating foreign taxes paid with earnings and profits of all non-US subsidiaries.

This could result in companies converting non-US subsidiaries in high tax jurisdictions into branches so that foreign taxes associated with those non-US earnings would be treated as taxes paid directly by the US taxpayer and therefore eligible for a direct foreign tax credit rather than being subject to the blending.

It is also thought that US multinationals may consider repatriating high taxed income prior to the enactment of this proposal.  Where there are UK subsidiaries in the group it is worth noting that the new UK dividend exemption could facilitate such repatriations.

3.Reform of “check the box” rules

US Groups have, for many years, been able to use so-called ‘check-the-box’ rules so that foreign subsidiary corporations are treated as ‘disregarded entities’. Taxpayers can move money between these disregarded entities, thereby shifting income from high-tax to low-tax jurisdictions without incurring US tax on that income.

There is speculation that the check the box rules may be repealed altogether, which would create huge uncertainty for many entities subject to US taxation.

4.Cracking down on the abuse of tax havens by individuals

A comprehensive package of disclosure and enforcement measures has been proposed to make it more difficult for financial institutions and wealthy individuals to evade taxes.

The proposals would increase penalties, as well as extend the statute of limitations for enforcement. US individuals would be required to report on their income tax return any transfers or receipts of money or property with a value of more than $10,000 from any foreign financial account owned by them. Furthermore, US financial intermediaries that make such transfers would have to meet certain reporting requirements as well.

5.General anti-avoidance provisions

The US courts have developed a common law doctrine that denies a taxpayer the benefits of certain tax-motivated transactions regardless of whether the transaction satisfies the literal requirements of a provision.  This is known as the economic substance doctrine.  In order to ensure a consistent approach, the Obama administration is considering including the doctrine on the statute book.

From a UK perspective, this is a worrying development as we know that HMRC regularly meet with the IRS to share best practice and, if enacted in the US, it might not be long before a similar provision was introduced in the UK

There is likely to be a lively congressional debate about the proposed changes to the US tax code and it is not clear what provisions will make it onto the statute book.  However, one thing is almost certain and that is that the changes will be sufficiently wide-reaching that very few UK clients with US tax-related affairs will be unaffected.

The message is therefore clear - anyone acting for US-related clients needs to keep abreast of the developments in case urgent steps have to be taken before the provisions are brought into force.

Elaine Durrant
Partner
Milsted Langdon
Part of the MGI association
www.mgi-uk.com