In early May, President Obama unveiled proposed changes to the tax code that could dramatically affect the financial reporting of businesses with foreign interests. According to the Obama administration, the proposed changes to the tax code are an attempt to reverse or slow the trend of U.S. jobs moving overseas.
Current views are that the current tax code provides a competitive advantage to companies that create jobs and invest overseas compared to those that create those same jobs in the U.S. The proposal aims to remove opportunities to evade taxes — legally and illegally — through offshore tax havens.
“Though these provisions have not been finalized as of this writing, the proposed changes could significantly affect both businesses and individuals with overseas investments,” says Lien Le, CPA, director of International Tax for Briggs & Veselka Co. “We advise that you talk with your CPA for more information about how you can best prepare to deal with these changes when they do take effect.”
Smart Business spoke with Le about the proposed changes to the tax code and how they could potentially affect you and your business.
Under the proposed changes, how will reforms in deferral rules curb tax advantages for investing and reinvesting overseas?
As of now, businesses that invest overseas can take current deductions on their U.S. tax returns for expenses supporting their overseas businesses. U.S. businesses can ‘defer’ paying U.S. taxes on the profits from those overseas investments until earnings are repatriated. Thus, U.S. taxpayer dollars are used to provide a significant tax advantage to companies who invest overseas in comparison to those who invest and create jobs at home.
The Obama administration proposed reforms of deferral rules so that, other than those for research and experimentation expenses, companies are not allowed deductions on their U.S. tax returns for expenses supporting their overseas investments until payment of taxes on their offshore profits is made. This provision would take effect in 2011.
So, will foreign tax credit loopholes be closed?
Current law allows U.S. businesses that pay foreign taxes on overseas profits to claim a credit against their U.S. taxes. Certain U.S. businesses may have used loopholes to artificially inflate or accelerate these credits. The proposal would close these loopholes, raising $43 billion from 2011 to 2019.
Will the research and experimentation (R&E) tax credit for investment in the U.S. be extended?
Currently, the R&E tax credit provides an incentive for businesses to invest in R&E in the United States. This incentive is set to expire at the end of 2009. The Obama administration proposes making the R&E tax credit permanent to enable businesses to make long-term investments in research and innovation. This will provide a tax cut of $74.5 billion over 10 years for businesses that invest in the United States.
How will loopholes for ‘disappearing’ offshore subsidiaries be eliminated?
Historically, U.S. companies have been required to report certain income shifted from one foreign subsidiary to another as passive income subject to U.S. tax. Since 1996, the ‘check-the-box’ regulations have allowed companies to make their foreign subsidiaries ‘disappear’ for tax purposes, allowing them to legally shift income to tax havens. As a result, the taxes they owe the United States disappear as well. The Obama administration proposes to reform these rules to require certain foreign subsidiaries to be considered as separate corporations for U.S. tax purposes. This provision would take effect in 2011.
Will the abuse of tax havens by individuals be more heavily scrutinized?
Currently, certain Americans can avoid paying U.S. taxes by housing their money in offshore accounts with little worry that the financial institution or the country of their offshore accounts will disclose the information to the IRS. In addition to initiatives taken within the G-20 to impose sanctions on countries judged by their peers not to have established information sharing standards, the Obama administration proposes disclosure and enforcement measures to make it harder for financial institutions and individuals to evade U.S. taxes.
The Obama administration estimates this package would raise $8.7 billion over 10 years by:
■ Withholding taxes from accounts at financial institutions that do not share information with the United States — This proposal requires foreign financial institutions that have dealings with the United States to sign ‘Qualified Intermediary’ agreements with the IRS to exchange as much information about their U.S. customers as U.S. financial institutions report. If they don’t sign the agreement, foreign financial institutions may face the presumption that they are facilitating tax evasion and taxes would be withheld on payments to their customers.
■ Shifting the burden of proof and increasing penalties for individuals who seek to abuse tax havens — The Obama administration also proposes stringent reporting standards for overseas investments by increasing penalties and imposing negative presumptions on individuals who fail to disclose foreign accounts and extending the statute of limitations for enforcement.
The Obama budget will enable the IRS to hire nearly 800 new employees dedicated to international enforcement, with the goal of increasing the ability to crack down on offshore tax avoidance.
Lien Le, CPA, is the director of International Tax for Briggs & Veselka Co. Reach her at [email protected].
