US FY2025 Budget contains international tax proposals, mainly stemming from prior budgets

In its FY 2025 explanation of the Biden Administration's revenue proposals issued on March 11, 2024 (Green Book), the United States (US) Treasury explains several international tax proposals in the administration's FY 2025 budget (Budget). Most proposals presented in this year's Budget appeared in the FY 2024 budget. The international tax proposals would:

• Raise the corporate income tax rate to 28% and limit the IRC Section 250 deduction to 25%, thereby raising the effective rate on global intangible low-taxed income (GILTI) to 21%
• Modify the GILTI regime to align with the global minimum tax rules under Pillar Two of the Base Erosion and Profit Shifting initiative of the Organisation for Economic Co-operation and Development (OECD)
  
  
• Replace the Base Erosion Anti-abuse Tax (BEAT) with an "undertaxed profits rule" (UTPR) that is consistent with the UTPR in the Pillar Two rules
  
  
• Repeal the deduction for foreign-derived intangible income (FDII)
  
  
• Create a new general business credit equal to 10% of eligible expenses incurred when onshoring a trade or business to the United States
  
  
• Disallow deductions for expenses incurred when moving a US trade or business offshore
  
  
• Create a second type of US shareholder to include in income amounts determined with respect to non-taxed dividends distributed by a controlled foreign corporation (CFC)
  
  
• Eliminate the "one-month deferral election" for CFCs, mandating the use of the same tax year for the CFC and its majority US shareholder
  
  
• Limit foreign tax credits (FTCs) on sales of hybrid entities
  
  
• Restrict deductions of excess interest expenses of members of a financial reporting group
  
  
• Revise the scope of the portfolio interest exclusion for 10% shareholders
  
  
• Modify the treatment of certain derivative transactions for foreign investors
  
  
• Permit taxpayers to retroactively elect, in certain circumstances, to treat a passive foreign investment company (PFIC) as a qualified electing fund (QEF) without IRS consent
  
  
• Require IRC Section 6038 reporting for each foreign "taxable unit"

The proposals have various effective dates. Even though the likelihood of these proposals being enacted this year is low, taxpayers should familiarize themselves with these proposals in case they appear as revenue offsets in future legislation.

Increasing corporate and GILTI rates

The Budget would raise the corporate tax rate to 28% from 21%, thereby increasing the effective GILTI rate. Other changes to the IRC Section 250 deduction for GILTI (as described later) would increase the effective GILTI rate to 21%.

The proposal would apply to tax years beginning after December 31, 2023. For tax years beginning before January 1, 2024, and ending after December 31, 2023, the corporate tax rate would equal 21% plus 7% times the portion of the tax year occurring in 2024 (for a tax year ending June 30, 2024, for instance, the tax rate would be approximately 24.5%, i.e., 21% + [7% * (182 days / 366 days)]).

Revising the GILTI regime, international dividend received deductions, and inversion rules

The Budget would change the GILTI regime and certain other provisions to eliminate perceived incentives to move US operations offshore and to comply with the global minimum tax rules under Pillar Two. These changes include:

• Taxing a US shareholder's entire net CFC tested income by eliminating the exemption for qualified business asset investments (effective for tax years beginning after December 31, 2024)
  
  
• Decreasing the deduction for a global minimum tax inclusion under IRC Section 250 to 25%, which would increase the GILTI rate to 21% when combined with the proposed corporate rate of 28% (effective for tax years beginning after December 31, 2023)
  
  
• Requiring US shareholders to effectively calculate their global minimum tax separately for each foreign jurisdiction in which their CFC operates, eliminating the ability to reduce US tax on income from low-taxed jurisdictions with foreign taxes paid in higher-taxed jurisdictions (effective for tax years beginning after December 31, 2024)
  • The Green Book clarifies that Pillar Two qualified domestic top-up taxes paid in a jurisdiction may be creditable against GILTI liability if they satisfy the requirements in IRC Section 901 or 903.
• Disallowing only 5%, rather than 20%, of a shareholder's FTCs with respect to the global minimum tax (effective for tax years beginning after December 31, 2024)
  
  
• Permitting US shareholders to carry forward net operating losses (within a single jurisdiction) and to carry FTCs forward 10 years (within a single jurisdiction) with respect to the global minimum tax (effective for tax years beginning after December 31, 2024)
  
  
• Accounting for foreign tax paid under a Pillar Two income inclusion rule (IIR) by a foreign parent on CFC income that would otherwise be part of the domestic corporation's global minimum tax inclusion (effective for tax years beginning after December 31, 2024)
  
  
• Limiting a US shareholder's dividends-received deduction (DRD) to either 50% or 65% of foreign-sourced dividends from a "qualified foreign corporation" that is not a CFC, depending on whether the shareholder owns at least 20% of the corporation's stock (effective for distributions after the date of enactment)
  
  
• Broadening IRC Section 265 to prohibit deductions allocable to foreign gross income that is either exempt from tax or effectively taxed at a lower rate through other deductions (effective for tax years beginning after December 31, 2024)
  
  
• Expanding the reach of the inversion rules in IRC Section 7874, both by redefining the circumstances in which a foreign acquiring corporation is treated as a US corporation (including reducing the relevant ownership threshold from 80% to merely more than 50%) and by adding new scenarios in which the requisite domestic entity acquisition can be found (effective for transactions completed after the date of enactment)
  
  
• Requiring US shareholders, for purposes of calculating stock losses on the disposition of foreign stock, to reduce their basis in a foreign corporation's stock by the sum of any stock-related (i) IRC Section 245A DRDs, (ii) IRC Section 250 deductions for GILTI inclusions, and (iii) deductions for IRC Section 965 transition tax inclusions (effective for dispositions occurring on or after the date of enactment (regardless of whether the deductions under IRC Section 250 or 965(c) were claimed in tax years preceding that date)

Replacing BEAT with UTPR

The Budget would repeal the BEAT and replace it with a UTPR that is consistent with the Pillar Two Model Rules. The UTPR would not apply to income subject to an IIR that is consistent with the Pillar Two Model Rules, which would include income that is subject to GILTI, reformed as proposed in the Budget. Thus, the UTPR would generally not apply to US-parented multinationals.

Under the Budget, both domestic corporations and domestic branches of foreign corporations would be denied US tax deductions (subject to certain de minimis exclusions) to the extent necessary to collect the hypothetical top-up tax required for the financial reporting group (generally, a group of business entities that prepare consolidated financial statements) to pay an effective tax rate of at least 15% in each foreign jurisdiction in which the group has profits. The Budget also includes a domestic minimum top-up tax that would preclude the imposition of a UTPR by other countries. This top-up tax would equal the excess of (i) 15% of the financial reporting group's US profit (determined using the same rules as under the UTPR to determine the group's profit for a jurisdiction), over (ii) all the group's income tax paid or accrued with respect to US profits (including federal and state incomes taxes, corporate alternative minimum taxes, and creditable foreign income taxes incurred on US profits). A coordination rule would reduce the UTPR disallowance imposed by the US to reflect any top-up tax collected by members of the group under a qualified UTPR in one or more jurisdictions. Whether a foreign jurisdiction has in effect a UTPR or an IIR that is consistent with Pillar Two Model Rules would be determined by Treasury under the standard specified in the Pillar Two Model Rules.

The Green Book provides, without further detail, that the Budget would ensure that taxpayers would continue to benefit from tax credits and other tax incentives when a UTPR in another jurisdiction comes into effect, "including clean energy tax provisions enacted in the IRA [i.e., the Inflation Reduction Act of 2022]." The reference to IRA clean energy tax provisions was not specifically included in the FY 2024 budget.

The proposal would be effective for tax years beginning after December 31, 2024. For additional details on this proposal, see EY Global Tax Alert, US | FY2024 Budget includes few new international tax proposals, largely reprising proposals from prior budgets, dated March 20, 2023.

Repealing and replacing the FDII tax benefit

The Budget would repeal the tax benefit for FDII and use the revenue to provide other unspecified incentives to encourage R&D, effective for tax years after December 31, 2024. See EY Global Tax Alert, US Treasury Green Book offers new details on international tax proposals, dated June 1, 2021.

Introducing onshoring and offshoring rules

The Budget would create a new general business credit equal to 10% of eligible expenses paid or incurred when onshoring a trade or business to the United States. The Budget would also disallow deductions for expenses paid or incurred in connection with offshoring a trade or business from the United States.

These rules would apply to expenses paid or incurred after the date of enactment. For more details on this proposal, see Global Tax Alert, US | FY2023 Budget includes new details on international tax proposals, dated April 1, 2022.

Creating a second type of US shareholder to include in income amounts determined with respect to non-taxed dividends

During a CFC's tax year, certain US shareholders of that CFC must include in gross income under IRC Sections 951(a) and 951A their pro rata share (a term of art) of the CFC's subpart F income and GILTI tested items in that tax year. The relevant US shareholders (inclusion shareholders) are those that own CFC stock on the last day of the CFC's tax year on which it constitutes a CFC (the last CFC day and inclusion stock). In general, an inclusion shareholder's pro rata share for a tax year is reduced if the CFC distributed a dividend in the tax year, on the inclusion shareholder's inclusion stock, to a person other than the inclusion shareholder. Under current law, a dividend can reduce an inclusion shareholder's pro rata share even if the recipient of the dividend was eligible for an offsetting deduction under IRC Section 245A or an exception applied that allowed the dividend to be excluded from the CFC recipient's subpart F income.

According to the Green Book, the proposal is intended to reduce the effect of such "non-taxed dividends." It generally would create a second type of inclusion shareholder: a US shareholder that owned stock of the relevant CFC during the CFC's tax year but not on the last CFC day of that tax year. This new type of inclusion shareholder with respect to a CFC generally would be required to include in gross income an amount determined with reference to any non-taxed dividend distributed by the CFC during the tax year.

The proposal would apply to tax years of foreign corporations beginning after the date of the enactment (and to US shareholders' tax years in which or with which those tax years end). For more details on the proposal, see EY Tax Alert, House Ways and Means Committee Chair proposes comprehensive international tax changes for reconciliation bill, dated September 17, 2021.

Requiring conformity in the tax year of a CFC and its majority US shareholder

Under IRC Section 898(c), a CFC must use the same tax year as its majority US shareholder but may elect to use a tax year that ends one month earlier than the majority US shareholder's tax year. The Budget proposes to eliminate this one-month deferral election.

The proposal would be effective as of the date of enactment. CFCs with an existing one-month deferral election would have a short tax year as of the first tax year end of their majority US shareholder, which would be at least 60 days after the date of enactment.

Limiting FTCs on sales of hybrid entities

IRC Section 338(h)(16) currently prevents the E&P generated from the deemed asset sale resulting from an IRC Section 338 election from changing the source or character of the gain on the stock sale. For FTC purposes, the Budget would apply the principles of that provision to sales of a specified hybrid entity (an entity that is treated as a corporation for foreign tax purposes but as a partnership or disregarded entity for US tax purposes) or taxable changes in the classification of an entity for US tax purposes.

The proposal would be effective for transactions occurring after the date of enactment. For more details on this proposal, see EY Global Tax Alert, US | FY2024 Budget includes few new international tax proposals, largely reprising proposals from prior budgets, dated March 20, 2023.

Limiting deductions of excess interest expense

The Budget would generally limit interest expense of a member of a multinational group that prepares consolidated financial statements (financial reporting group) if the member's net interest expense for financial reporting purposes (on a separate-company basis) is greater than the member's proportionate share of the financial reporting group's net interest expense on the group's consolidated financial statement, with proportionate share being determined on an EBITDA ratio.

The proposal would be effective for tax years beginning after December 31, 2024. For more details on this proposal, see EY Global Tax Alert, US | FY2024 Budget includes few new international tax proposals, largely reprising proposals from prior budgets, dated March 20, 2023.

Modifying the scope of portfolio interest exclusion for 10-percent shareholders

US federal income tax generally does not apply to portfolio interest received by a foreign person (i.e., US-source, non-effectively connected interest paid on an obligation that is in registered form and that would otherwise be taxable). Interest does not qualify as portfolio interest if, among others, it is received by a "10[%] shareholder" of the issuer of the obligation. In the context of an obligation issued by a corporation, a 10% shareholder is any person who owns "10% or more of the total combined voting power of all classes of stock of such corporation entitled to vote."

The Budget proposes to modify the definition of a 10% shareholder to take into account the 10% voting power previously described or "10[%]of the total value of shares of all classes of stock of such corporation." Under the proposal, shareholders that retain substantial interest in the total value of shares but have limited voting power would be within scope of the "10[%] shareholder" definition.

The proposal would be effective for US-source interest payments made on obligations issued (or deemed to be issued) on or after the date that is 60 days after enactment.

Modifying the treatment of certain derivative transactions for foreign investors

The proposal would tax certain income of foreign investors that enter into derivative transactions with respect to investments in particular partnerships. In particular, the proposal would "treat the portion of a payment on a derivative financial instrument (including a securities loan or sale-and-repurchase agreement) that is contingent on income or gain from a publicly traded partnership or other partnership specified by the Secretary … as a dividend equivalent, to the extent that the related income or gain would have been treated as ECI [income effectively connected to the conduct of a US trade or business] if the [investor directly] held the underlying partnership interest."

The proposal would be effective for tax years beginning December 31, 2024. For more details on this proposal, see EY Global Tax Alert, US | FY2024 Budget includes few new international tax proposals, largely reprising proposals from prior budgets, dated March 20, 2023.

Permitting retroactive QEF elections

The Budget would permit a taxpayer to retroactively elect to treat a PFIC as a QEF without IRS consent, in certain circumstances. This proposal would be effective on the date of enactment. Further, Treasury intends to issue regulations or guidance permitting taxpayers to amend previously filed returns for open years. For more details on this proposal, see EY Global Tax Alert, US | FY2023 Budget includes new details on international tax proposals, dated April 1, 2022.

IRC Section 6038 reporting for foreign taxable units

The Budget would expand the scope of IRC Section 6038 to require information reporting on a "taxable unit" basis and would impose penalties for failure to report. The Budget would also authorize Treasury to treat a US person that is a resident in a foreign jurisdiction as a resident of the United States for purposes of identifying taxable units subject to IRC Section 6038 reporting.

These proposals would apply to tax years of a controlling US person beginning after December 31, 2024, and to annual accounting periods of foreign business entities ending with or within those tax years. For more details on this proposal, see EY Global Tax Alert, US | FY2023 Budget includes new details on international tax proposals, dated April 1, 2022.

Implications

Most of the international tax proposals outlined in the FY 2025 Budget aim to generate tax revenues to support the Biden Administration's priorities in a manner consistent with the tax policies described in prior Budgets. If enacted, these proposals would notably increase taxes for most US multinational companies. Politically, however, the likelihood of their passage in the near term is low with a divided Congress and the forthcoming 2024 presidential and congressional elections. Taxpayers should nevertheless evaluate the potential impact of these proposals as they might resurface as revenue generators in future tax legislation.

Contact Information

For additional information concerning this Alert, please contact:

Ernst & Young LLP (United States), International Tax and Transaction Services

• Craig Hillier, Boston
  
  
• Colleen O’Neill, Washington, DC
  
  
• Martin Milner, Washington, DC
  
  
• Arlene Fitzpatrick, Washington, DC
  
  
• Bona Chung, Washington, DC
  
  
• Shivani Mehra, Washington, DC

Published by NTD’s Tax Technical Knowledge Services group; Maureen Sanelli, legal editor

For a full listing of contacts and email addresses, please click on the Tax News Update: Global Edition (GTNU) version of this Alert.