U.S. Treasury Targets Foreign Tax Credit Use Amid EU’s Probesby
New rule aims at ‘splitter’ schemes to inflate credits’ value
Official notice comes two weeks after EU finding on Apple
The U.S. Treasury Department took fresh steps on Thursday to curb tax avoidance by multinational corporations, announcing new curbs on a loophole through which companies artificially use credits for foreign taxes they pay to improperly lower their U.S. tax bills.
In a notice that took direct aim at the European Union’s push to have its member states collect more taxes from U.S. companies’ overseas units, Treasury officials said they’re writing new rules that would restrict how corporations can use credits on their foreign tax payments to reduce their U.S. tax bills. The official notice puts corporate tax planners on notice that officials will challenge any strategies that violate their intended rules.
The measure will focus on tax-planning strategies in which companies separate foreign tax payments from the underlying income that they’re based on. That separation -- which Treasury’s notice described as a “splitter” arrangement -- allows companies to artificially inflate credits they use to cut their U.S. tax bills.
Officials with the Treasury and the Internal Revenue Service said it was possible that U.S. companies that find themselves subject to new tax bills as a result of EU investigations could use splitter arrangements to reduce their U.S. taxes. Last month, the European Commission found that Ireland must collect $14.5 billion in back taxes from Apple Inc. after determining that the iPhone maker received a special tax deal that violated so-called “state-aid” rules, which are aimed at fostering competition.
Apple and Ireland have both said they’ll appeal the finding. An Apple spokesman didn’t immediately respond to a request for comment. EU regulators, meanwhile, are conducting probes of the tax arrangements of other U.S. companies, including McDonald’s Corp. and Amazon.com Inc.
“The Treasury Department and the IRS are aware that, in anticipation of a large foreign-initiated adjustment that relates to a prior taxable year, a taxpayer may take steps to separate the additional payment of foreign income tax from the income to which it relates,” said the IRS notice about the proposed regulations. “Such foreign-initiated adjustments may arise under European Union (EU) state aid law, to the extent EU state aid payments result in creditable foreign taxes.”
In effect, the new rule would disallow corporations from using foreign tax credits unless the companies actually bring home to the U.S. -- or repatriate -- the overseas earnings on which they’ve paid the foreign taxes. Repatriation of overseas income triggers the 35 percent U.S. corporate tax rate, one of the highest in the world -- and companies can use foreign tax credits to reduce or eliminate it. Treasury officials are worried that without the new rule, companies could claim artificially inflated foreign tax credits tied to offshore money they haven’t brought home.
U.S. officials have grown increasingly concerned that more than $2 trillion in offshore earnings that U.S. multinationals haven’t yet repatriated is now fair game for European countries.
Mark J. Mazur, Treasury’s assistant secretary for tax policy, said the new regulation would close “another tax loophole that contributes to the erosion of our tax base.”
“Today’s action protects the U.S. tax base by ensuring that such credits are only available when corporations repatriate their foreign earnings,” Mazur said.
Unlike other industrialized countries, the U.S. taxes its multinational companies on their global income -- but it allows them a dollar-for-dollar credit against the foreign taxes they’ve paid. The system is designed to prevent double taxation of profit.
In the case of Apple -- if the European regulators’ order is upheld -- the U.S. could stand to lose $14.5 billion in tax revenue if the company claims a credit for that new tax obligation.
Before the rule announced Thursday, a loophole in the tax code allowed U.S. multinationals to claim what Treasury called an “artificially inflated foreign tax credit” without repatriating the underlying foreign earnings. In other words, companies got U.S. tax-cutting credits for money they left in overseas subsidiaries, untaxed in the U.S.
In so-called splitter arrangements, companies change their ownership structures or find ways to pool their foreign earnings to “generate substantial amounts of foreign taxes deemed paid, without repatriating” the profit to which the foreign taxes relate.
The new regulation will “help curtail the use of aggressive tax planning tactics that take advantage of our broken international tax system,” according to a Treasury Department release.
President Barack Obama’s administration, members of Congress and Republican presidential nominee Donald Trump have all called for reducing taxes on companies’ offshore earnings as a way of prompting repatriation. But they haven’t agreed on a rate: Obama has suggested 14 percent; Trump, 10 percent; and House Republicans propose a top rate of 8.75 percent.
By tying the use of foreign tax credits to repatriation, Treasury and IRS officials signaled that they’re concerned about their improper use and their power to erode the domestic corporate tax base.
Some 7,190 corporations claimed over $109.6 billion in foreign tax credits in 2012, according to the most recently available IRS data. Those companies reduced the U.S. tax they owed on nearly $420 billion in foreign income. Overall, the credits allowed companies to slice about 37 percent off aggregate corporate income taxes that year.
U.S. companies try to minimize their U.S. taxes by gearing the size of their credits to the size of the anticipated domestic tax hits when they repatriate foreign income. Under U.S. rules, companies can combine income and credits from high-tax countries, like Japan and Germany, with those from low-tax countries, like Ireland and the Netherlands. While companies can’t claim refunds for unused foreign tax credits, they can apply the leftover to other tax years -- one year back, or 10 years forward.
Edward Kleinbard, a University of Southern California professor and a former chief of staff of the congressional Joint Committee on Taxation, called the corporate technicians who blend and refine such arrangements “tax distilleries” in a 2011 paper.
In 2007, foreign tax credits helped U.S. parent companies pay an average tax of just 3.3 percent on foreign income brought home, according to a 2012 paper by a pair of international tax specialists at the IRS and Congressional Budget Office.
The IRS has tried to crack down on splitters, also known as foreign tax credit generators, in recent years as they’ve proliferated in flavor and variety. Treasury cautioned that despite its plan for the new rule, which builds on a 2015 regulation, companies still have ways to misuse foreign tax credits to skirt U.S. tax bills. “Certain loopholes remain that allow such tax arrangements to occur,” the agency said.