08.18.10

On August 10, 2010, the President signed the Education Jobs and Medicare Assistance Act, designed to provide funding for teacher salaries and Medicaid benefits. To pay for this commitment, Congress tacked on several tax increases for U.S. multinational corporations, intended to tighten up the foreign tax credit and other international provisions. In one item of good news for multinationals, the Act corrects an error in legislation enacted earlier this year that had an adverse impact on their tax liability and balance sheets.

The main thrust of the legislation is to reduce the opportunities for U.S. multinationals to optimize the use of the foreign tax credit. There are four distinct foreign tax credit provisions in the Act:

1. an anti-splitting rule;
2. denial of the credit for “covered asset acquisitions”;
3. creation of a new credit “basket” for income items that are re-sourced under a treaty; and
4. limitations on the amount of credits freed up under the §956 “hopscotch rule.”

The net effect will be to reduce the available foreign tax credit for many multinationals.

There are also several non-foreign tax credit provisions that are intended to raise taxes from multinationals:

1. a limitation on the earnings and profits of an acquiring foreign corporation that may be taken into account in a §304(a) transaction, thus ensuring U.S. gross basis taxation of the deemed dividend;
2. for purposes of §864(e) interest allocation in an affiliated group, the definition of affiliated group is expanded to include 80%-owned foreign corporations whose gross income is more than 50% effectively connected; and
3. repeal of the special rules for 80/20 companies, which exempted from gross basis withholding interest and dividend payments from U.S. taxpayers whose gross income was at least 80% foreign-source and attributable to the active conduct of a foreign trade or business.

Most of these provisions are effective for taxable years beginning after 2010, but some take effect earlier. Certain provisions include grandfathering rules that will protect existing arrangements.

Finally, the Act corrects an unintended glitch created earlier this year as part of the so-called HIRE Act. That Act, which tightened up reporting requirements for overseas transactions, provided that the failure to report certain international transactions on a corporate tax return would result in the statute of limitations being held open for the entire return, until the proper reporting was made. This provision could have affected corporations' financial reporting, by requiring them to indefinitely hold open tax reserves on their books.
 
The recent legislation addresses this problem, but still allows the possibility of an open-ended statute of limitations. Under an amendment to the HIRE Act, the failure to report an international transaction on the corporate tax return will not affect the statute of limitations for the other portions of the return, but only if the failure to report is due to reasonable cause and not willful neglect. This “reasonable cause” standard may still give the IRS an opportunity to hold open the statute of limitations on the return, and corporate tax directors must still take care when closing out tax reserves on the books.

Patty Brickett
703.752.2782
pbrickett@argy.com

Jeff Schragg
703.770.6313
jschragg@argy.com

Yoli Martinez-Nadal
703.770.0593
ymartinez@argy.com

This is only a summary of the provisions of the Act. If you are interested in discussing how it affects your company, we would be glad to advise you.

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