US president Barack Obama unveiled a $3800bn 2011 fiscal year budget proposal on February 1 that includes new language on international tax reforms. The comprehensive proposals also cover tax increases for high-income tax payers and corporations.

The current budget on the table, dubbed ‘the fiscal year 2011 revenue proposals’, calls for raising revenues of $150.9bn over the next 10 years from international tax reforms, according to a report from the Vale Columbia Center on Sustainable International Investment. The current plan replaces a May 2009 version and aims to further prevent multinationals with US operations from avoiding US taxes by shifting money to overseas locations.

Despite some differences, most of the new proposals were repeats from last year’s version, which would have raised $210bn, tax experts say.

President Obama clearly seeks to end tax preferences for overseas shelters and close perceived corporate loopholes which give companies investing overseas an unfair advantage over companies investing in the US. In addition, he hopes to end tax breaks for oil, gas and coal companies.

“I am not a fan of all of Obama’s proposals but I think overall they’re a winner because they attack the worst abuses of our systems of arm’s-length transfer pricing with a backstop, a sort of minimum tax, on high-value intangibles parked in tax havens,” says former US Treasury department economist Martin Sullivan, who has written hundreds of tax-­related articles for Tax Notes and Tax Notes International.

“Most importantly, the new version has added a proposal that would subject excess returns in low-tax countries to an immediate US tax. This is big news. The details have not yet been hashed out. But the business community is outraged,” says Mr Sullivan. Excess returns from low-tax regions are still being determined by the US Treasury, he adds.

Deferred revision

Mr Sullivan points out that, under current rules, large portions of low-tax area profits earned by US multinationals escape the US tax knife, and enormous profits are being made. “One major reason is that foreign income of foreign subsidiaries is not subject to US tax until dividends are paid to the US parent corporation. This delayed payment of their US tax — often a permanently delayed payment — is called deferral – and it was at the heart of the escalating debate on US international tax rules,” Mr Sullivan says. The language on deferrals was substantially weakened in the revised proposals.

The similarity of this year’s tax package to last year’s “may indicate a reticence on the part of the government to engage deeply in the subject of tax reform right now”, says Clint Stretch, managing principal for tax policy for the New York-based Deloitte tax group.

At the heart of the international proposals lies the issue of companies shifting money to low-tax rate regions.

Broadly, President Obama proposes measures designed to raise US revenue and generate taxes. One way is to clamp down on multinationals moving their investment intangibles overseas and invest locally.

Damaging multinationals?

Some critics say the tax revisions could hurt the competitiveness of US multinationals conducting widespread offshore business, with many multinationals themselves expressing concerns that the higher US tax rate will make them less competitive in a global marketplace with lower offshore tax rates.

Echoing these sentiments, many pro-­business groups argue that the Obama plan will make US companies more vulnerable because overseas competitors don’t pay the 35% US corporate tax rate, considered among the highest of industrialised nations. Some executives claim it will leave them subject to foreign takeovers and stifle American investments and business development.

But Mr Sullivan disagrees with this theory. “There could be some small investment [fallout] where US companies start doing less investing offshore. But we are going to see a movement of profits. A US multinational could shut down a holding company and invest, say in Ireland with a 12% tax rate, and paper profits will have a lot of movement,” he says.

US multinationals such as Google and Yahoo!, for example, have relocated their overseas headquarters to lower tax areas of Switzerland; and Amazon and Microsoft have moved to Luxembourg, a major global financial centre.

Joe Calianno is a partner and head of the international technical tax group at Grant Thornton LLP in Washington, DC, and a former IRS executive. “If passed, the proposals could prove detrimental to US multinationals,” he says. Especially vulnerable are high-tech firms and pharmaceuticals that transfer intangible property to low-tax controlled foreign corporations (CFCs), he adds.

The main intent of Mr Obama’s tax package is to raise revenue, but Mr Calianno thinks that, overall, it will hurt US multinationals. “These proposals for international tax reform seem to be going in the opposite direction to where most other countries are going and, if enacted, could put US multinationals at a competitive disadvantage in the global marketplace.” Other countries are more business-friendly and amenable to attracting foreign investments, he observes. “In the end we must ask, are we going in the right direction? It is a policy issue.”

Additionally, the 2011 proposals focus on several significant new proposals.

The first proposal stipulates that if a US taxpayer (company or individual) transfers intangible property from the US to a related CFC that is subject to a low foreign effective tax rate in a situation that suggests excessive income shifting, then an amount equal to the excess return would be treated under subpart F tax rules – income in a separate foreign tax credit limitation basket, according to Mr Calianno.

When a US company transfers its intangible property offshore, then the company “generally must pay a toll charge as a result of the transfer often resulting in higher US taxable income”, he says. “This proposal goes a step further by requiring the company to pick up certain income earned by the CFC, even if not repatriated back to the US in the form of a ­dividend if the requirements of the proposal are satisfied.”

An advantage to business in this year’s budget is that the new proposals cut out language from last year limiting the ability of a US company to elect to treat certain “foreign entities” as “disregarded entities”. A foreign entity that is treated as disregarded generally is treated as a branch of its owner for US tax purposes, Mr Calianno says.

“Many US multinationals which invest overseas have organisational structures with the foreign disregarded entities that would have been negatively impacted and disrupted if that proposal were pursued. It was not included in this year’s proposals, fortunately,” says Mr Calianno.

In addition, the new proposal scales back the deferred deductions proposal from last year. The new version would defer the deduction of interest expense that is properly allocated and apportioned to a taxpayer’s foreign-source income not currently subject to US taxes, Mr Calianno says.

Deferring interest expense could have a disproportionate effect on US-based multinationals that have relatively high degrees of US borrowing to fund and invest in offshore operations, he adds.

Employment impact

Some tax critics believe the new proposals could negatively impact jobs in a struggling economy. The National Association of Manufacturers (NAM) says that President Obama’s proposals seeking billions of dollars in new business taxes will weaken job creation. “These tax increases will only create more costs for manufacturers, making it difficult for them to retain and create jobs in this fragile economy, and to be able to compete with other countries where their governments do not impose such burdens,” says Jay Timmons, NAM’s executive vice-president.

One thing is sure: the proposed tax provisions will undergo more intense congressional scrutiny and public debate. Many experts doubt they will pass this year. But if passed, they will become effective at the beginning of 2011.

KEY FACTS:THE NEW TAX PROPOSALS

DROPPED: the check-the-box repeal from the former version.WEAKENED: the deferred deduction proposal, a plus for business.REFORMED: foreign tax credit so residual US tax is determined on an average, or pooled, basis; mostly unchanged from 2009 package.REFORMED: the foreign tax credit so taxes and income are always matched – mostly unchanged.REVISED DOWNWARD: revenue to be raised by international business tax earnings.

_{Source: Martin Sullivan}

IN FOCUS

2011 budget plans Overall 2011 spend:

$3830bnDiscretionary spend:

$1410bnProjected 2011 deficit:

$1270bnCombined deficits, 2011/20:

$8530bn

In February, the US Treasury Department also released the Green Book on 2011 Tax Revenue, which spells out the proposed details more fully.

_{Source: The US White House}