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International Provisions of TIPRA
On May 17, 2006, President Bush signed into law the Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA). Among its provisions were several involving international taxes. Americans Living Overseas The TIPRA makes three changes to the $80,000 foreign earned income exclusion and housing allowance (i.e., the Sec. 911 exclusion). The most significant change is to cap the housing exclusion. This modification has the potential to increase dramatically the worldwide tax obligations of U.S. citizens and green card holders working in high-housing-cost cities (e.g., Tokyo, Hong Kong, London, etc.) or to increase the cost to their employers if they are tax-equalized. The act also indexes the exclusion for inflation, imposes a stacking rule and provides regulatory authority to allow for geographical differences. This provision is effective for tax years beginning after 2005. Sec. 911: Some of the details on the changes to the Sec. 911 exclusion are as follows. First, the income exclusion is indexed for inflation starting in 2006 (rather than 2008, as under current law), and is $82,400 for 2006. Second, the base housing amount used in calculating the foreign housing cost exclusion in a tax year is 16% of the amount of the foreign earned income exclusion limit (instead of the present-law 16% of the grade GS-14, step 1 amount). Reasonable foreign housing expenses in excess of the base housing amount remain excluded from gross income, but the exclusion is limited to 30% of the taxpayer’s foreign earned income exclusion. Treasury was given the authority to issue regulations or other guidance providing for the adjustment of the 30% housing cost limit based on geographic differences in housing costs relative to housing costs in the U.S. Third, income excluded as either foreign earned income or as a housing allowance is included for purposes of determining the marginal tax rates applicable to nonexcluded income. According to a Senate Finance Committee explanation of the provision, these changes are intended to provide an objective standard for determining the amount that taxpayers working abroad can exclude from income, and also to subject such individuals to the same tax rates applicable to those living and working in the U.S. who have the same amount of economic income. CPAs with clients living and working overseas may want to notify them of this change to the foreign earned income exclusion. Anti-Deferral of Subpart F Rules The TIPRA includes two provisions that extend expiring provisions under the anti-deferral rules of subpart F related to controlled foreign corporations (CFCs). One would extend for two years—through 2008—the subpart F exemption for active financing; the other would modify the lookthrough treatment of payments between related CFCs under foreign personal holding company (FPHC) income rules. Active financing and insurance income exception: Subpart F imposes immediate taxation on the income earned by foreign subsidiaries of U.S. companies, even if such income has not been brought back to the U.S. There is a temporary exception from subpart F for active financing and insurance income. The active financing exception generally applies to U.S.-based financial services and insurance industries and to domestic manufacturers that finance sales of large equipment to foreign customers. The subpart F exemption permits American financial services firms doing business abroad to continue to defer U.S. tax on their earnings from their foreign financial services operations until those earnings are returned to the U.S. parent. Regulated U.S. financial institutions with operations overseas need to retain earnings in foreign subsidiaries to meet expanding capital requirements. Without this provision, those earnings would be subject to current U.S. taxation, making it more costly for a growing overseas business to meet those capital requirements, and placing it at a competitive disadvantage in the global marketplace. The TIPRA extends the active financing exception for two years, until the end of 2008. Lookthrough treatment of payments between related CFCs under FPHC income rules: The TIPRA adds a new temporary exception from subpart F for dividends, interest, rents and royalties received by one CFC from a related CFC, to the extent attributable to the payer’s non-subpart F income. This provision is effective for tax years beginning after 2005 and before 2009. International Tax Revenue Raisers from the AJCA The TIPRA modifies two international tax provisions enacted as part of the American Jobs Creation Act of 2004 (AJCA). Repeal of FSC/ETI binding contract (grandfathered contracts) relief: When Congress repealed the foreign sales corporation (FSC) regime in 2000 and the extraterritorial income (ETI) regime in 2004, the repeal legislation included transition relief for transactions subject to binding contracts as of Sept. 30, 2000 (for FSC repeal) and Sept. 17, 2003 (for ETI repeal). To comply with a recent World Trade Organization Appellate Body ruling that the FSC and ETI binding contract relief provisions are prohibited export subsidies, the TIPRA repeals both the FSC and ETI binding-contract-relief grandfathering-rule provisions enacted under the AJCA, effective for tax years beginning after the enactment date; the general transition rule remains in effect. While that provision has received significant criticism from the manufacturing industry and other members of Congress, House Ways and Means Chairman Bill Thomas (R-CA) said enactment of the provision would end any further retaliation from the European Union (EU) regarding the extra-territorial income regime. In fact, on May 12, 2006, the EU announced that due to this provision repealing transitional ETI binding contract relief, it would withdraw reintroduction of sanctions. Sec. 199 wage limit: Under present law, the Sec. 199 manufacturing deduction is limited to 50% of a taxpayer’s Form W-2 wages. The TIPRA modifies the wage limit so that taxpayers may only include wages properly allocable to domestic production gross receipts. In addition, the act repeals the special limit on wages treated as allocated to partners or shareholders of passthrough entities. The provision is effective for tax years beginning after May 17, 2006. Other International Provisions Application of earnings-stripping rules to partners that are C corporations: This provision codifies proposed regulations attributing partnership interest income, interest expense and liabilities to corporate partners for the purposes of applying earnings-stripping rules to the corporation. It is effective for tax years beginning on or after May 17, 2006. Treatment of distributions attributable to FIRPTA gains: The TIPRA modifies the scope of the application of the Foreign Investment in Real Property Tax Act of 1980 (FIRPTA) regime by targeting those qualified investment entities with significant interests in U.S. real property and modifies the application of the FIRPTA for investors that own no more than 5% of certain qualified investment entities. The provision also restricts a foreign investor’s ability to avoid the FIRPTA regime by investing in a tiered qualified investment entity. Finally, the provision also imposes a FIRPTA obligation on foreign investors that engage in sale and repurchase transactions to avoid capital gain distributions that would otherwise subject the foreign investor to FIRPTA withholding. International Tax Items Dropped in Conference Some international tax provisions that were in earlier versions of the TIPRA and various other proposed bills in the past (and that may appear in future bills) include:
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