Two notices on Subpart F reform are the latest attempts to provide taxpayers guidance on issues that were uncertain.
Notice 2007-13 significantly liberalises the substantial assistance rules, which were introduced by the Treasury and IRS to prevent possible evasion of the foreign base company services rules. Under the notice, direct or indirect substantial assistance by a US person to a controlled foreign corporation (CFC) will continue to give rise to Subpart F income, but only if the cost of such assistance is 80% or more of the total cost of performing the services. The substantial assistance rules will be retained in these limited circumstances to prevent taxpayers from shifting assistance-related profits from the US taxpayers to related CFCs in low-tax jurisdictions.
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Donald Korb and Kim Majure: Subpart F reform will enable US multinationals to remain competitive |
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"The Subpart F substantial assistance notice is a step to update and rationalise applicable guidance in light of the increasing specialisation and coordination of functions in multiple geographical locations," said Donald Korb, Chief Counsel at the Internal Revenue Service in Washington, DC. "At the same time, the revised rules continue to focus on enabling the IRS to achieve compliance and prevent abuses," he continued.
Notice 2007-9 provides guidance on the CFC look-through rule, which grants an exclusion from Subpart F income for certain dividends, interest, rents, and royalties received or accrued by one CFC from another related CFC.
"[The changes] are consistent with the recent legislative and regulatory trend of reforming the US Subpart F rules to allow US multinationals to remain competitive in the global economy," said Kimberly Majure, a partner at Miller & Chevalier Chartered in Washington, DC.
The Subpart F rules were introduced, in the 1960s to stem the flow of assets and income that was being sent abroad as a way of avoiding taxation. "Congress was seeing the US tax base eroding because more and more cash was being parked overseas, which isn't good not only from a fiscal point of view but from an American economic growth point of view," said Majure.
In part, the regulations put a stop to this practice by treating income from highly mobile business activity, for example income of a shell entity established in a low tax jurisdiction that earns income but has no real business activity there, as income in the US. As the rules developed, they became increasingly convoluted as the boundaries of a mobile, yet active, business were tested on a case by case basis.
Because of their complexity, reform of the Subpart F provisions has not been easy. In December 2000, the Treasury department released a comprehensive study of the rules.
"The aim of the CFC look-through rule was to make it easier for US multinationals who earned money abroad from active businesses to move it around in their foreign groups to let them take advantage of business opportunities in different countries," said Marc Gerson, partner at Miller & Chevalier Chartered in Washington, DC.
The American Jobs Creation Act, which inserted a domestic production activities deduction into section 199 of the Internal Revenue Code in 2004, saw many international tax reform provisions, including some relating to Subpart F, put on hold due to revenue constraints.
Then the Tax Increase Prevention and Reconciliation Act 2005 enacted the CFC look-through rule.
"This is a new exception from Subpart F, which allows foreign subsidiaries to redeploy earnings within their foreign group without being subject to Subpart F," explains Gerson.
Because of budgetary constraints, the provision was only enacted temporarily, until the end of 2008. The fight is now on to get this provision extended and the signs so far are encouraging.
Technical corrections made to the provision, together with Notice 2007-9, have provided guidance to make sure the rule operates properly, that it doesn't have unintended consequences and that it is not abused by tax payers.
"Hopefully this will show that the rule is implemented and working as Congress intended it to, which will help when trying to get an extension of the CFC look-through rule beyond the expiration date. Furthermore, some are looking at the CFC look-through rules as a test case for further Subpart F reforms," said Gerson.
Some taxpayers could be hesitant to employ the CFC look-through rule, given that it is temporary and there were questions relating to it. But Notice 2007-9 addresses a number of these uncertainties and builds a case for the provision being extended, meaning more companies may take advantage of the rule.
"Taxpayers have to keep in mind that the IRS is going to be very wary that opening the gates will provide opportunities for abuse," said Majure. "There is the balancing act between economic competitiveness of the US multinationals versus fiscal protectionism," she added.
Further fiscal changes are planned in the US to clarify the situation. "The realities of the new ways of doing business internationally in a competitive manner will also inform guidance that is on its way on the so-called contract manufacturing issue," said Korb. "That guidance will provide further clarity both concerning what are unobjectionable cases as well as the problematical ones which will be the focus of IRS compliance activity." CS
