On July 8, 2015, the International Tax Reform Working Group, co-chaired by Senators Rob Portman (R-OH) and Chuck Schumer (D-NY), released its long-awaited International Tax Bipartisan Tax Working Group Report (“the Report”). With the 2015 Congress focused on a bipartisan effort to enact international tax reform, it is important to take a deeper look into 3 of the initiatives proposed in the Report. The focus of this article is to provide a glimpse into what is being considered.
Initiatives to be examined include:
- Backing a Territorial System to avoid the “Lock-Out Effect”
- Enhancing Foreign Investment in US Real Estate
- Addressing Individual International Tax Challenges
A Territorial System Avoids The “Lock-Out Effect”
The Report observes that one of the most obvious problems with the current US international tax system, is the “lock-out effect” that results from our current outdated approach to business taxation. While the US system generally taxes worldwide income, it also allows for deferral of many types of income in offshore companies. As a result, this policy has become an incentive for companies, as well as for individuals, to retain and reinvest non-US earnings offshore. Recent estimates are that US multinational corporations alone have more than $2 trillion invested offshore. This figure does not include the foreign investments of small to mid-sized companies or individuals.
According to the Report, if the US moves to a more territorial tax system in which offshore earnings are taxed lightly or not at all when repatriated to the US, the financial incentive for US companies to build up offshore earnings would be lessened. Right now, every member of the G-7 other than the US has territorial tax system. These tax systems exempt from domestic tax 95% to 100% of dividends from offshore subsidiaries paid from active earnings.
International Tax Reform Objectives
The Report concludes that international tax reform must try, “to move the U.S. international tax system in a direction that keeps the U.S. economy globally competitive with their foreign rivals… it is imperative to adopt a dividend exemption regime in conjunction with robust and appropriate base erosion rules.”
Foreign Investments in US Real Estate
Under the provisions of the Foreign Investment in Real Property Tax Act (FIRPTA) of 1980, US federal income tax payment and return filing requirements are imposed on otherwise passive non-US investors when they sell or transfer specified interests in US real estate. The domestic real estate industry has advocated for years that FIRPTA either be repealed in its entirety or significantly narrowed in its scope. The problem is that in its present form, FIRPTA discourages much needed equity investments in the US real estate sector by global investors.
In the first quarter of 2015, the Senate Finance Committee approved a bipartisan package of FIRPTA amendments. Although the Report expresses general support for the bipartisan reform legislation, it only specifically endorses two of the initial proposals as follows:
- Raise from 5% to 10% the holdings of publicly-traded real estate investment trusts (REITs) that would be exempt
- Exempt foreign pension plans from FIRPTA on the grounds of creating a level playing field with tax-exempt domestic pension plans
Individual International Tax Reform Issues
The Report highlights the individual international tax issues, in particular the mounting challenges faced by US expatriates. The convergence of FATCA and FBAR requirements has made individual US tax compliance increasingly complicated. Beyond being complicated, it is quite costly for US taxpayers living abroad. There have been numerous reports of such taxpayers experiencing difficulty opening and maintaining financial accounts with non-US financial institutions.
The free movement of taxpayers to work and live abroad has provided many benefits to the domestic economy. Several US tax policies, such as the foreign tax credit and the foreign earned income exclusion, have encouraged such international work. There is a growing sense that current trends in US tax compliance – including FATCA and FBAR – are discouraging such activities. The Report urges both the House and the Senate to consider these issues when enacting international tax reform.
What Happens Next With International Tax Reform?
In terms of the next phase of international tax reform discussion, it seems likely that Congress will not move forward with international tax reform right away. Given this realization, both parties are in favor of using a short-term patch, with hopes of passing a package of permanent tax extenders and international tax reform in the fourth quarter of 2015. House Ways and Means Committee Chairman Paul Ryan (R-WI) confirmed a commitment to such an approach. The former Republican Vice Presidential candidate announced on July 9 that Congress needed to set the stage for moving forward with international tax reform when the representatives and senators return from the August recess.
Still, the likelihood Congress will ultimately be able to pass international tax reform this year remains unclear. While there seems to be a broad bipartisan consensus on the general parameters for an international tax reform package, there are equally broad areas of uncertainty with respect to many of the critical details. Such details need to be resolved before international tax reform can successfully navigate the Congressional process. It’s a big step from broad consensus to voting on final legislation with all the details ironed out.
Since the US system of taxing international income is incongruent with contemporary international norms, this big step is essential to take to move forward in the global marketplace. The international tax team at LSL CPAs will stay on top of these issues as they progress, keeping our clients up to date.
