Global Tax Alert | 8 August 2014

US Congressman Levin releases discussion draft of legislative proposal to tighten earnings stripping rules and expand Section 956 rules

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Executive summary

On 31 July 2014, Congressman Sander Levin, Ranking Member of the House Ways and Means Committee, released a discussion draft of legislation (the discussion draft) that would tighten the earnings stripping rules of Section 163(j) and expand the rules under Section 956 that require current US tax on certain earnings of controlled foreign corporations (CFCs). According to documents accompanying the discussion draft, these provisions are intended to address certain perceived tax benefits that might be obtained by US companies that engage in so-called “inversion” transactions. However, the provisions in the discussion draft are not limited to companies that have engaged in inversion transactions. The discussion draft’s proposals would affect foreign-owned US companies more generally and, thus, would have potential implications for all foreign companies investing into the United States.

The discussion draft provisions would:

  • Broaden the scope of Section 956 to take into account a CFC’s investment in “foreign group property” if the ultimate parent of the CFC is a foreign corporation
  • Tighten Section 163(j) by repealing the debt-to-equity safe harbor provision, reducing the percentage of adjusted taxable income threshold for determining excess interest expense to 25%, repealing the carryforward of excess limitation and reducing the carryforward period for disallowed interest expense to five years

In addition, the accompanying documents note the intention that the proposed legislation also address the ability to “de-control” CFCs to avoid the application of the Subpart F rules.

Detailed discussion

The discussion draft released by Congressman Levin consists of a proposed bill entitled the Stop Corporate Earnings Stripping Act of 2014. Documents containing background information and a summary of the proposed provisions were released with the discussion draft.

The background document describes the discussion draft as limiting “two key tax incentives” for corporate inversion transactions. The document further describes the discussion draft as complementing anti-inversion legislation recently introduced by Congressman Levin, the “Stop Corporate Inversions Act of 2014” (H.R. 4679), which would significantly expand the scope of transactions subject to the anti-inversion rule of Section 7874. For more details, see EY Global Tax Alert, US Senator Levin introduces bill to tighten inversion rules under Section 7874, dated 2 June 2014.

However, the scope of the discussion draft is not limited to companies that have completed an inversion transaction. The proposals in the discussion draft would apply generally to any foreign-owned US company.

Congressman Levin has invited public comment on the discussion draft, with submissions to be made by 5 September 2014.

Proposed changes to Section 956

The discussion draft would expand the scope of the Section 956 investment in United States property rules to take into account “foreign group property” held by certain CFCs. This expansion would apply only in the case of a CFC that is a member of an expanded affiliated group the common parent of which is not a US person.

For purposes of this provision, “foreign group property” is defined as any stock or obligation of any foreign person that is not a CFC. An exception would be provided for the stock or obligation of any entity if less than 25% of the total combined voting power of the entity (immediately after the acquisition of any stock in the entity by the CFC) is owned directly or indirectly by the common foreign parent. In addition, foreign group property would be determined by extending the application of the exceptions to the definition of United States property that are provided for certain obligations in connection with sales or processing of property and for certain positions, deposits, and obligations of dealers in securities or commodities.

An expanded affiliated group would be an affiliated group as defined in Section 1504(a), determined by substituting “more than 50%” for “at least 80%” and without regard to the Section 1504(b)(2) and (3) exclusions for certain insurance companies and foreign corporations. A partnership or other non-corporate entity would be treated as a member of an expanded affiliated group if the entity controls, or is controlled by, members of such group.

The discussion draft also provides for the inclusion of non-corporate entities in the definitions of, and application of the rules regarding, “foreign group property” and “expanded affiliated group.”

In addition, the discussion draft provides that, under regulations to be prescribed, a CFC would be considered as holding an obligation of a US person if the CFC is a pledgor or guarantor of the obligation. It further provides that, under regulations to be prescribed, a CFC would be considered as holding an obligation of a foreign person if the CFC or, to the extent provided under such regulations, any US shareholder of the CFC, is a pledgor or guarantor of the obligation.

Finally, the discussion draft provides that Section 960(c), which was enacted in 2010 to limit the amount of foreign taxes considered deemed paid with respect to Section 956 inclusions in connection with investments in United States property, would apply also to acquisitions of foreign group property after 31 December 2010.

The discussion draft provides that these proposed provisions would apply to tax years of CFCs ending after the date of enactment and to tax years of US shareholders in which or with which such tax years of CFCs end.

Proposed changes to Section 163(j)

The discussion draft would repeal the 1.5-to-1 debt-to-equity safe harbor under Section 163(j)(2)(A). It would reduce the percentage of adjusted taxable income threshold for determining excess interest expense under Section 163(j)(2)(B) from 50% to 25%. The discussion draft also would repeal the three-year carryforward of excess limitation under Section 163(j)(2)(B) and would reduce to five years the carryforward period for disallowed interest expense under Section 163(j)(1)(B).

The discussion draft provides that these proposed provisions would apply to tax years ending after the date of enactment.

Place holder regarding de-control of CFCs

The discussion draft includes a placeholder for to-be-developed provisions related to de-control of CFCs. The summary of the discussion draft indicates that these provisions are intended to address the ability of foreign-controlled US multinational groups to “de-control” CFCs in order to avoid application of the Subpart F rules (including application of the proposed changes to Section 956 in the discussion draft).

Implications

While the discussion draft has been released in connection with Congressman Levin’s focus on corporate inversion transactions, it is important to note that the provisions included in the discussion draft are not limited to inverted companies. The proposed changes would apply to foreign-controlled US multinational groups more generally and, therefore, could potentially affect any foreign company investing inbound into the United States.

The earnings stripping rules have attracted attention from several lawmakers in Washington, DC recently. The potential reform of these rules was the subject of discussion during the Senate Finance Committee hearing on international tax issues on 22 July 2014. The Administration’s budget proposals have also included proposed reforms in this area.

Foreign companies with US subsidiaries should review the discussion draft to evaluate the potential effects on their business. Consideration also should be given to the opportunity to participate in the international tax policy dialogue by providing comments on the discussion draft.

For additional information with respect to this Alert, please contact the following:

Ernst & Young LLP, International Tax Services, Washington, DC
  • Barbara Angus
    +1 202 327 5824
    barbara.angus@ey.com
  • Eric Oman
    +1 202 327 6559
    eric.oman@ey.com
  • Yuelin Lee
    +1 202 327 6378
    yuelin.lee@ey.com
  • Andreia Leite Verissimo
    +1 202 327 6034
    andreia.leiteverissimo@ey.com

EYG no. CM4643