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On Monday, the Treasury Department released the Obama Administration’s Fiscal Year 2012 Revenue Proposals (the “Greenbook”). This memorandum summarizes the tax proposals that are of most interest to U.S. corporate taxpayers, financial institutions, insurance companies, hedge funds, private equity funds, and high-income individuals.1
The Greenbook generally reproposes all of last year’s Greenbook proposals that were not enacted into law,2 and also adds a handful of new provisions, the most relevant of which are discussed in Part VIII below.
In short, the proposals in the Greenbook would, if enacted:
The balance of this memorandum is divided into seven parts: Part II discusses the financial crisis responsibility fee; Part III discusses provisions relating to corporations; Part IV discusses the international tax provisions; Part V discusses the carried interest proposal; Part VI discusses provisions relating to dealers; Part VII discusses life insurance provisions; and Part VIII discusses certain other provisions.
The Greenbook proposes a nondeductible “financial crisis responsibility fee” of approximately 0.075% (in contrast to last year’s proposal of a 0.15% fee) on certain liabilities of U.S. financial institutions (and on non-U.S. based financial institutions based on the liability of their U.S. subsidiaries) with consolidated assets of $50 billion or more.
More specifically, the proposal would assess a fee on banks, thrifts, bank and thrift holding companies, brokers, and securities dealers; U.S. companies owning or controlling these types of entities as of January 14, 2010 would also be subject to the fee. The fee would be imposed on worldwide consolidated liabilities of U.S. financial firms, and on non-U.S. based financial firms based on the liabilities of their U.S. subsidiaries. The fee base would not include FDIC-assessed deposits of firms that own depositary institutions, and certain policy-related liabilities of insurance companies.
The fee would apply beginning in 2013.
The Greenbook reproposes last year’s proposal that would require a corporation to accrue interest income on the forward sale of its own stock. Under current law, a corporation does not recognize gain or loss upon the forward sale of its own stock.5 The proposal would treat a portion of the forward payment received by a corporation on a “postpaid” forward contract to sell its own stock as interest (rather than exclude it entirely). The proposal would be effective beginning in 2013.
The Greenbook reproposes last year’s proposal to repeal the “boot-within-gain” limitation. Under current law, if a U.S. shareholder of an acquired corporation receives stock, and “boot” consisting of property or money, in exchange for their stock, the U.S. shareholder recognizes gain equal to the lesser of the gain realized in the exchange and the amount of boot. As a result of this “boot within gain” limitation, if the exchanging shareholder has little or no built-in gain in its stock, the shareholder recognizes little or no gain upon the exchange, even if the exchange has the economic effect of a dividend. The Greenbook would repeal the boot-within-gain limitation and therefore would require a U.S. shareholder that receives stock, and property or money, from an acquiring corporation to treat the property or money as a dividend if the exchange has the effect of the distribution of a dividend, even if the shareholder has no built-in gain in the stock.6 The proposal would be effective beginning in 2013.
The Greenbook reproposes last year’s proposal that would expand the definition of control for purposes of section 249.
Under current law, if a corporation repurchases a debt instrument that is convertible into its stock, or into stock of a corporation in control of, or controlled by, the corporation, section 249 may disallow or limit the issuer’s deduction for a premium paid to repurchase the debt instrument.7 For this purpose, the definition of “control” includes only a parent corporation and its wholly-owned subsidiary.8 The proposal would expand the definition of “control” for section 249 purposes to include indirect 80% subsidiaries that are members of a controlled group under the definition in section 1563(a)(1).9 The proposal would be effective on the date of enactment.
Under current law, U.S. taxpayers may currently deduct interest and other ordinary and necessary business expenses, including expenses properly allocable to unrepatriated foreign source income that is deferred and not subject to current tax.
The Greenbook reproposes last year’s proposal that would require a taxpayer to defer its deduction of interest expense that is allocable to foreign source income and is not currently subject to U.S. tax. Any deferred deductions would be carried forward indefinitely and generally treated as current year expenses in any subsequent tax year in proportion to the amount of the previously deferred foreign source income that becomes subject to U.S. tax during that subsequent tax year. Deferred deductions would be placed in a separate pool from current year deductions and would be allowed as deductions in subsequent years only to the extent that previously deferred earnings are repatriated. The proposal would be effective beginning in 2012.
Under current law, a U.S. taxpayer is deemed to have paid a portion of foreign taxes paid by a foreign subsidiary in an amount proportionate to the ratio of (x) the dividend paid by the subsidiary to (y) the subsidiary’s earnings and profits.10 The deemed paid foreign tax credit is generally capped at an amount equal to the U.S. taxpayer’s pre-credit U.S. tax on the taxpayer’s aggregate foreign source income,11 with the cap applying separately to foreign source “passive” income and foreign source “general” income.12 Under current law, U.S. taxpayers may selectively distribute dividends from subsidiaries located in high-tax jurisdictions in order to maximize use of the U.S. taxpayer’s available deemed paid foreign tax credits, and to defer income on earnings of subsidiaries located in low-tax jurisdictions.
The Greenbook reproposes last year’s proposal that would require a U.S. taxpayer to pool all of its foreign taxes paid and earnings and profits repatriated to the U.S. taxpayer in the taxable year from each of its foreign subsidiaries with respect to which the U.S. taxpayer can claim a deemed paid foreign tax credit for the taxable year. The deemed paid foreign tax credit would be determined based on the amount of the consolidated earnings and profits of all of the foreign subsidiaries repatriated to the U.S. taxpayer during that taxable year. The proposal thus would create a blended foreign tax rate with respect to a U.S. taxpayer’s foreign source income (including dividend distributions from its foreign subsidiaries), and therefore is designed to prevent taxpayers from selectively repatriating high-taxed income. The proposal would be effective beginning in 2012.
Very generally, if a domestic corporation pays interest to a related foreign person, and the domestic corporation has a debt-to-equity ratio of greater than 1.5 to 1, section 163(j) denies the domestic corporation interest deductions to the extent that the corporation’s net interest expense exceeds 50% of the corporation’s adjusted taxable income. Interest expense that is disallowed under section 163(j) may be carried forward indefinitely and, to the extent 50% of the corporation’s adjusted taxable income in a subsequent year exceeds its net interest expense, the excess may be carried forward to the three subsequent tax years to increase the corporation’s adjusted taxable income for such years. In 2003, Congress enacted section 7874, which provides that, if a U.S. parent corporation is acquired by a foreign parent in certain “inversion transactions,” the foreign parent is treated as a domestic corporation or the former U.S. parent is required to recognize gain. U.S. parent companies that are acquired in transactions described in section 7874 are referred to as “expatriated entities.” In a recent study,13 the Treasury Department found evidence that expatriated entities have been using earnings stripping to reduce their U.S. tax.
The Greenbook also reproposes last year’s proposal to revise section 163(j) to further limit the ability of a domestic corporation to deduct interest payments made to a related expatriated entity. For expatriated entities, the debt-to-equity safe harbor would be eliminated and the 50% adjusted taxable income threshold for the limitation would generally be reduced to 25% of adjusted taxable income. Finally, for expatriated entities, the carryforward for disallowed interest would be limited to ten years and the carryforward of excess limitation would be eliminated. The proposal would be effective beginning in 2012.
The Greenbook reproposes last year’s proposal that would limit the shifting of income through intangible property transfers. The proposal would “clarify” the definition of intangible property for purposes of sections 367(d) and 482 to include workforce in place, goodwill, and going concern value. The proposal would also “clarify” that if multiple intangible properties are transferred, the IRS may value the intangible properties on an aggregate basis if that achieves a more reliable result. Additionally, the proposal would expressly permit the IRS to value intangible property taking into account the prices or profits that the controlled taxpayer could have realized. The proposal would be effective beginning in 2012.
The Greenbook reproposes last year’s proposal that would treat income and gain from a carried interest in a partnership that is received in exchange for services as ordinary income. In addition, the proposal would require the partner to pay self-employment taxes on such income, and gain recognized on the sale of a carried interest would generally be taxed as ordinary income, not as capital gain. However, in contrast to last year’s proposal, which applied to services interests in any partnership, the proposal is limited to income from a carried interest in a partnership only if (i) 50% of the partnership’s assets are investment-type assets (e.g., certain securities, real estate, partnership interests) and (ii) more than 50% of the partnership’s contributed capital is from partners whose partnership interests are passive assets held for the production of income.14
The proposal would be effective beginning in 2012.
The Greenbook reproposes last year’s proposal that would treat the gain and loss of dealers from section 1256 contracts as ordinary gain or loss. Under current law, commodities dealers, commodities derivatives dealers, dealers in securities, and option dealers are subject to mark-to-market treatment each year on their “section 1256 contracts,”15 but the gain or loss is treated as 60% long-term and 40% short-term capital gain.16 The Greenbook would treat all gain and loss realized by dealers from section 1256 contracts as ordinary income or loss. The proposal would be effective for taxable years beginning after the date of enactment.
In general, taxpayers are not subject to current federal income tax with respect to the “inside buildup” of value of an insurance contract, and these earnings and any death benefits received under a life insurance or endowment contract are generally exempt from tax.17 Similarly, individuals generally defer federal income tax on amounts received under an annuity contract. Because death benefits are exempt from tax and amounts received under an annuity are tax deferred, section 264(a) generally denies interest expense deductions on indebtedness used to purchase life insurance contracts, endowment contracts, or annuities. In addition, under section 264(f), a pro rata portion of a taxpayer’s overall interest expense allocable to annuities, insurance policies, or endowments with cash surrender values is generally disallowed. However, the section 264(f) disallowance does not apply with respect to insurance contracts for individuals who are officers, directors, employees, or 20% owners of the taxpayer. As a result, taxpayers that do not directly borrow to fund premium payments with respect to life insurance, endowments, or annuity contracts with respect to officers, directors, employees, or 20% owners of the taxpayer are not denied interest expense, even though the death benefits from these policies are exempt from tax (and annuity proceeds are tax deferred) and even though the taxpayers can use the benefits and proceeds to fund their tax deductible interest expense.
The Greenbook reproposes last year’s proposal to expand section 264(f) and deny a taxpayer’s pro rata portion of interest expense allocable to policies with cash surrender value on individuals who are officers, directors, or employees of a taxpayer, but would retain the current law exemption for contracts relating to 20% owners of the holder or beneficiary of the contract. The proposal would be effective for contracts issued in or after 2012.18
The Greenbook reproposes last year’s proposal (i) to require the purchaser of an existing life insurance contract that provides for a death benefit equal to or exceeding $500,000 to report the purchase price, the buyer and seller’s taxpayer identification numbers (“TIN”s), and the issuer and policy number, to the IRS, the insurance company that issued the policy, and to the seller and (ii) to require the insurance company to report the gross benefit payment, the buyer’s TIN, and the insurance company’s estimate of the buyer’s basis to the IRS and to the payee, upon the payment of any benefits to the buyer. The proposal would be effective beginning in 2012.
Under current law, the purchaser of a policy for value (“transfer-for-value”) generally does not qualify for the general tax exemption for death benefit proceeds, subject to limited exceptions in the case of a transfer involving a carryover basis or in the case of a transfer to the insured or to certain parties treated as related to the insured. The Greenbook proposes to modify the transfer-for-value rules to ensure that buyers of policies are taxable on death benefit proceeds and do not qualify for the carryover basis or related party exceptions. The proposal would be effective beginning in 2012.
The Greenbook proposes to change the proration rule used by insurance companies to determine the amount of the “dividend received deduction” to which an insurance company is entitled.19 The proposal would be effective beginning in 2012.
The Greenbook reproposes last year’s proposal to deny a U.S. insurance company a deduction for reinsurance premiums paid to an affiliated foreign reinsurance company with respect to U.S. risks insured by the insurance company or its U.S. affiliates. This year’s proposal is broader than last year’s,20 but would permit U.S. companies that are subject to the proposal to exclude from income any ceding commissions or reinsurance recovered with respect to policies for which a reinsurance premium deduction was wholly or partially denied under the proposal (in the same proportion that the reinsurance premium deduction was denied). The proposal would be effective beginning in 2012.
1 The Greenbook also provides for a number of proposals with respect to energy-related tax provisions. We discuss those provisions in a separate memorandum that can be found at http://www.cadwalader.com/assets/client_friend/021711EnergyTaxProvisionin2012Budget.pdf.
2 The proposals from last year’s Greenbook that were enacted into law include (i) increased foreign account reporting (“FATCA”; sections 1471-1474), (ii) provisions for withholding on equity swaps and securities loans (section 871(m)), (iii) the repeal of the 80/20 company rules, (iv) the codification of the economic substance doctrine (section 7701(o)), and (v) rules to prevent splitting of foreign income and foreign taxes for tax credit purposes (section 909).
All references to section numbers are to the Internal Revenue Code of 1986, as amended, or the Treasury regulations issued thereunder.
3 Under current law and until section 6041(i) becomes effective, payments made to corporations are exempt from IRS Form 1099 reporting requirements.
4 Under current law and until section 6041(i) becomes effective, an IRS Form 1099 is required only on payments of $600 or more for services.
5 Section 1032.
6 In general, in making the determination of whether the exchange has the effect of the distribution of a dividend, the taxpayer must look to the earnings and profits of the acquirer corporation. Section 356(a).
7 The issuing corporation’s deduction will generally be disallowed to the extent the repurchase price exceeds the adjusted issue price of the debt plus the normal call premium for a nonconvertible bond. Therefore, the corporation may deduct only the amount of the normal call premium, unless it can demonstrate to the IRS that the excess premium amount represents an increase in the cost of borrowing, rather than an increase in the cost of the conversion feature. Section 249(a).
8 Section 249(b). For these purposes, “control” means the ownership of at least 80% of the vote and value of the corporation. Section 368(c).
9 Section 1563(a)(1) provides that one or more chains of corporations connected with a common parent corporation through 80% or more in stock ownership (by voting power or by value) are part of the same controlled group. See section 1563(a)(1).
10 Section 902.
11 Sections 901 and 904.
12 Section 904(d).
13 See “Report to the Congress on Earnings Stripping, Transfer Pricing and US Income Tax Treaties” (November 28, 2007) at http://www.treas.gov/offices/tax-policy/library/ajca2007.pdf.
14 Although the scope of “held for the production of income” is unclear, it appears that if a dealer holds a partnership interest as inventory or as a hedge, the partnership interest is not being held for the production of income.
15 Very generally, section 1256 contracts include regulated futures contracts, nonequity options, dealer equity options, and dealer securities future contracts that are traded on or subject to the rules of a qualified board or exchange, as well as many foreign currency contracts. Section 1256.
16 Section 1256.
17 Death proceeds on policies purchased for value generally are taxable.
18 For these purposes, any material increase in death benefits under a contract or other material change in a contract would be treated as a new contract. In the case of a master contract, the addition of covered lives to the contract would be treated as a new contract only with respect to the additional covered lives.
19 The proration rule was initially addressed in Revenue Ruling 2007-54 (August 16, 2007). However, Treasury and the IRS subsequently determined that the issue would be most appropriately addressed by regulation and therefore suspended Revenue Ruling 2007-54. See Revenue Ruling 2007-61 (September 25, 2007).
20 Last year’s proposal applied only if the amount of reinsurance premiums paid to the foreign reinsurer was more than 50% of the total amount of insurance premiums received by the U.S. insurance company. This year’s proposal does not contain this threshold.
21 Section 351(b)(1), 356(a).
22 Section 351(b)(2), 356(c).
23 Sections 351(b) and (g) and 354(a)(2)(C).