The US budget plan for 2001 was announced in February. Big tax cuts are promised, partially offset by new revenue raisers but what is the true cost for taxpayers? Hal Hicks, Dave Benson and Margaret O’Connor of Ernst & Young, Washington DC sets out the planned changes

In the final year of its tenure, the Clinton Administration has decided to take a direct, and controversial, approach to so-called corporate tax shelters. Not exactly an unexpected development, given the US Treasury's release last July of its White Paper – The Problem of Corporate Tax Shelters: Discussion, Analysis, and Legislative Proposal, in which the Administration proposed both legislative fixes in its planned fiscal year 2001 budget, and new temporary and proposed regulations. The budget also contains a number of other important international tax proposals.

It is impossible at this early stage to predict which legislative proposals, if any, will be enacted. This year's presidential election also adds another variable to an already complicated process. That said, however, the Senate Finance Committee completed two days of hearings in early March on recommendations to improve the interest and penalty provisions of the tax code. The specific focus of attention was the recommendations made by the Joint Committee on Taxation and the Treasury Department to address corporate shelters.

Finance Committee chairman Bill Roth said at the hearing that a legislative solution was needed to combat the proliferation of shelters, which he views as a serious problem. Mindful of the balancing act that will be needed in developing any such legislation, Roth stated that it must be carefully crafted in a manner that "does not unduly affect legitimate transactions" and he cited the need for Congress to look at "when the taxpayer may rely on a tax opinion" as one of the three critical points legislation should contemplate. Transparency through enhanced disclosure of abusive transactions by promoters and taxpayers, and methods to discourage promoters and advisers of corporate tax shelters were noted as the two other key components of any legislative proposal. Congressional aides commented that Roth is considering crafting a specific legislative proposal addressing the corporate shelter issue over the next few weeks.

The Clinton Administration proposed its fiscal year 2001 budget plan on February 7, offering $350 billion in tax cuts over the next 10 years, offset in part by $182 billion in new revenues. Some of the most important measures were aimed at corporate shelters. Most of what the Administration proposed in its budget was similar to what had been in last year's budget plan, and which Treasury refined in the July White Paper.

It is notable, however, that the estimated revenue to be generated by the Treasury's so-called general anti-abuse provisions – $7.3 billion over five years – represents a dramatic increase from last year, when a comparable set of changes was estimated to raise about $2 billion over five years. The refinements made to these proposals over the course of the past year, as well as the additional information gleaned about the types of transactions at issue, is said to account for some of that difference. The following is a run-down of the corporate shelter proposals.

Increase disclosure with respect to certain reportable transactions: With respect to the proposed limits on corporate tax shelter transactions, the Administration added a requirement for greater disclosure of certain reportable transactions (ie those possessing any combination of delineated common characteristics of shelter transactions), accompanied by "monetary and procedural remedies" that would be imposed for failure to provide required disclosures.

Codify the economic substance doctrine: The Administration proposed to codify the so-called economic substance doctrine. Thus, the proposal would disallow tax benefits from any transaction in which the reasonably expected pre-tax profit of the taxpayer from the transaction is insignificant relative to the reasonably expected net tax benefits to the taxpayer from such a transaction. With respect to financing transactions, tax benefits would be disallowed if the present value of the tax benefits of the taxpayer to whom the financing is provided are significantly in excess of the present value of the pre-tax profit or return of the person providing the financing.

Limit dividend treatment for payments on certain self-amortizing stock: Another new proposal would limit the dividend treatment for payments on certain self-amortizing stock. This proposal is a follow-up to regulations under tax code section 7701(l) issued by the Treasury attacking 'fast-pay' arrangements in the domestic context. According to the Administration, the proposed legislation is a better long-term solution that also addresses its concerns about abusive fast-pay transactions in the international context. This proposal would be effective for distributions with respect to such stock made after the date of enactment.

The Clinton budget also included a number of other important international tax measures that should be of interest to the multinational community, including the items listed below.

Require reporting of payments to identified tax havens: The proposal would require that all payments (including money, and tangible and intangible property) to entities (including corporations, partnerships and disregarded entities, branches, trusts and estates), accounts or individuals resident or located in "identified tax havens" be reported on the taxpayer's annual income tax return. Jurisdictions would be included on a list of identified tax havens to be published by the Treasury Department based on certain criteria, including bank secrecy and deficiencies in information exchange.

Restrict tax benefits for income flowing through identified tax havens: The proposal would deny foreign tax credits for taxes paid to identified tax havens and would apply the foreign tax credit limitation rules separately to income earned in or through an identified tax haven. The proposal would also reduce by a factor (similar to the international boycott factor) a taxpayer's:

• otherwise allowable foreign tax credit or foreign sales corporation benefit attributable to income from an identified tax haven; and
• income attributable to an identified tax haven that is otherwise eligible for deferral.

This reduction of tax benefits would be based on a fraction, the numerator of which is the sum of the taxpayer's income and gains from an identified tax haven, and the denominator of which is the taxpayer's total non-US income and gains. The proposal would be effective for taxable years beginning after the date of enactment.

Prevent capital gains avoidance through basis shift transactions involving foreign shareholders: This proposal is designed to prevent taxpayers from offsetting capital gains by generating artificial capital losses through basis shift transactions involving foreign shareholders. It provides that the non-taxed portion of an extraordinary dividend, for purposes of section 1059, would include the amount of the dividend that is not subject to current US tax.

In the event that a treaty between the US and a foreign country reduces the rate of US tax imposed on the dividend (and the dividend is not otherwise subject to US tax), the non-taxed portion would be the amount of the dividend multiplied by a fraction, the numerator of which is the tax rate applicable without reference to the treaty less the tax rate applicable under the treaty, and the denominator of which is the tax rate applicable without reference to the treaty.

Similar rules would apply in the event that the foreign shareholder is not a corporation. This change would be effective for distributions on or after the date of first committee action.

Simplify taxation of property that no longer produces effectively connected income (ECI): The proposal would mark to market property (including rights to deferred income) at the time that the property ceases to be used in, or attributable to, a US trade or business. Section 864(c)(6), which treats as ECI certain deferred income that relates to transactions that took place while the taxpayer was engaged in a US trade or business, and section 864(c)(7), which treats as ECI gains from property that had been used in a US trade or business if sold or disposed of within 10 years from cessation of that business, would be eliminated.

The proposal, however, would not change the treatment under current law of deferred compensation for the personal services of an individual. The proposal would be effective for property that ceases to be used in, or attributable to, a US trade or business after the date of enactment.

Prevent avoidance of tax on US-accrued gains by expatriation: The proposal would repeal section 877 and instead impose a one-off tax on accrued gains at the time of expatriation, regardless of the taxpayer's subjective motivation for expatriating. Gifts by an expatriate to a US recipient would be taxable to the recipient. The proposal would apply to individuals expatriating on or after the date of first committee action.