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COM-
RPT
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HIST
, HRRepNo 108-755, Conference Committee Report
on the American Jobs Creation Act of 2004, HR
4520, (October 8, 2004), Part 03 of 08
|
House
Bill
The House bill adds two new exceptions from the
definition of
U.S.
property for determining current income inclusion by
a
U.S.
10-percent shareholder with respect to an investment
in
U.S.
property by a controlled foreign corporation.
The first exception generally applies to securities
acquired and held by a controlled foreign
corporation in the ordinary course of its trade or
business as a dealer in securities. The exception
applies only if the controlled foreign corporation
dealer: (1) accounts for the securities as
securities held primarily for sale to customers in
the ordinary course of business; and (2) disposes of
such securities (or such securities mature while
being held by the dealer) within a period consistent
with the holding of securities for sale to customers
in the ordinary course of business.
The second exception generally applies to the
acquisition by a controlled foreign corporation of
obligations issued by a U.S. person that is not a
domestic corporation and that is not (1) a U.S.
10-percent shareholder of the controlled foreign
corporation, or (2) a partnership, estate or trust
in which the controlled foreign corporation or any
related person is a partner, beneficiary or trustee
immediately after the acquisition by the controlled
foreign corporation of such obligation.
Effective date. --The House bill provision is
effective for taxable years of foreign corporations
beginning after
December 31, 2004
, and for taxable years of
United States
shareholders with or within which such taxable years
of such foreign corporations end.
Senate
Amendment
The Senate amendment is the same as the House bill.
Conference
Agreement
The conference agreement follows the House bill and
the Senate amendment.
8. Election not to use average exchange rate for
foreign tax paid other than in functional currency
(sec. 308 of the House bill, sec. 224 of the Senate
amendment, and sec. 986 of the Code)
Present
Law
For taxpayers that take foreign income taxes into
account when accrued, present law provides that the
amount of the foreign tax credit generally is
determined by translating the amount of foreign
taxes paid in foreign currencies into a U.S. dollar
amount at the average exchange rate for the taxable
year to which such taxes relate.236
This rule applies to foreign taxes paid directly by
U.S. taxpayers, which taxes are creditable in the
year paid or accrued, and to foreign taxes paid by
foreign corporations that are deemed paid by a U.S.
corporation that is a shareholder of the foreign
corporation, and hence creditable in the year that
the U.S. corporation receives a dividend or has an
income inclusion from the foreign corporation. This
rule does not apply to any foreign income tax: (1)
that is paid after the date that is two years after
the close of the taxable year to which such taxes
relate; (2) of an accrual-basis taxpayer that is
actually paid in a taxable year prior to the year to
which the tax relates; or (3) that is denominated in
an inflationary currency (as defined by
regulations).
Foreign taxes that are not eligible for translation
at the average exchange rate generally are
translated into U.S. dollar amounts using the
exchange rates as of the time such taxes are paid.
However, the Secretary is authorized to issue
regulations that would allow foreign tax payments to
be translated into U.S. dollar amounts using an
average exchange rate for a specified period.237
House
Bill
For taxpayers that are required under present law to
translate foreign income tax payments at the average
exchange rate, the House bill provides an election
to translate such taxes into U.S. dollar amounts
using the exchange rates as of the time such taxes
are paid, provided the foreign income taxes are
denominated in a currency other than the taxpayer's
functional currency.238
Any election under the provision applies to the
taxable year for which the election is made and to
all subsequent taxable years unless revoked with the
consent of the Secretary. The House bill authorizes
the Secretary to issue regulations that apply the
election to foreign income taxes attributable to a
qualified business unit.
Effective date. --The House bill provision is
effective with respect to taxable years beginning
after
December 31, 2004
.
Senate
Amendment
The Senate amendment is the same as the House bill.
Effective date. --The Senate amendment
provision is effective with respect to taxable years
beginning after
December 31, 2004
.
Conference
Agreement
The conference agreement follows the House bill and
the Senate amendment. In addition, the conference
agreement provides that the election does not apply
to regulated investment companies that take into
account income on an accrual basis. Instead, the
conference agreement provides that foreign income
taxes paid or accrued by a regulated investment
company with respect to such income are translated
into U.S. dollar amounts using the exchange rate as
of the date the income accrues.
9. Eliminate secondary withholding tax with
respect to dividends paid by certain foreign
corporations (sec. 309 of the House bill, sec. 215
of the Senate amendment, and sec. 871 of the Code)
Present
Law
Nonresident individuals who are not U.S. citizens
and foreign corporations (collectively, foreign
persons) are subject to U.S. tax on income that is
effectively connected with the conduct of a U.S.
trade or business; the U.S. tax on such income is
calculated in the same manner and at the same
graduated rates as the tax on U.S. persons (secs.
871(b) and 882). Foreign persons also are subject to
a 30-percent gross basis tax, collected by
withholding, on certain U.S.-source passive income
(e.g., interest and dividends) that is not
effectively connected with a
U.S.
trade or business. This 30-percent withholding tax
may be reduced or eliminated pursuant to an
applicable tax treaty. Foreign persons generally are
not subject to
U.S.
tax on foreign-source income that is not effectively
connected with a
U.S.
trade or business.
In general, dividends paid by a domestic corporation
are treated as being from
U.S.
sources and dividends paid by a foreign corporation
are treated as being from foreign sources. Thus,
dividends paid by foreign corporations to foreign
persons generally are not subject to withholding tax
because such income generally is treated as
foreign-source income.
An exception from this general rule applies in the
case of dividends paid by certain foreign
corporations. If a foreign corporation derives 25
percent or more of its gross income as income
effectively connected with a U.S. trade or business
for the three-year period ending with the close of
the taxable year preceding the declaration of a
dividend, then a portion of any dividend paid by the
foreign corporation to its shareholders will be
treated as U.S.-source income and, in the case of
dividends paid to foreign shareholders, will be
subject to the 30-percent withholding tax (sec.
861(a)(2)(B)). This rule is sometimes referred to as
the "secondary withholding tax." The
portion of the dividend treated as U.S.-source
income is equal to the ratio of the gross income of
the foreign corporation that was effectively
connected with its U.S. trade or business over the
total gross income of the foreign corporation during
the three-year period ending with the close of the
preceding taxable year. The U.S.-source portion of
the dividend paid by the foreign corporation to its
foreign shareholders is subject to the 30-percent
withholding tax.
Under the branch profits tax provisions, the
United States
taxes foreign corporations engaged in a
U.S.
trade or business on amounts of
U.S.
earnings and profits that are shifted out of the
U.S.
branch of the foreign corporation. The branch
profits tax is comparable to the second-level taxes
imposed on dividends paid by a domestic corporation
to its foreign shareholders. The branch profits tax
is 30 percent of the foreign corporation's
"dividend equivalent amount," which
generally is the earnings and profits of a
U.S.
branch of a foreign corporation attributable to its
income effectively connected with a
U.S.
trade or business (secs. 884(a) and (b)).
If a foreign corporation is subject to the branch
profits tax, then no secondary withholding tax is
imposed on dividends paid by the foreign corporation
to its shareholders (sec. 884(e)(3)(A)). If a
foreign corporation is a qualified resident of a tax
treaty country and claims an exemption from the
branch profits tax pursuant to the treaty, the
secondary withholding tax could apply with respect
to dividends it pays to its shareholders. Several
tax treaties (including treaties that prevent
imposition of the branch profits tax), however,
exempt dividends paid by the foreign corporation
from the secondary withholding tax.
House
Bill
The provision eliminates the secondary withholding
tax with respect to dividends paid by certain
foreign corporations.
Effective date. --The provision is effective
for payments made after
December 31, 2004
.
Senate
Amendment
The Senate amendment is the same as the House bill.
Conference
Agreement
The conference agreement follows the House bill and
the Senate amendment.
10. Equal treatment for interest paid by foreign
partnerships and foreign corporations (sec. 310 of
the House bill, sec. 228 of the Senate amendment,
and sec. 861 of the Code)
Present
Law
In general, interest income from bonds, notes or
other interest-bearing obligations of noncorporate
U.S. residents or domestic corporations is treated
as U.S.-source income.239
Other interest (e.g., interest on obligations of
foreign corporations and foreign partnerships)
generally is treated as foreign-source income.
However, Treasury regulations provide that a foreign
partnership is a U.S. resident for purposes of this
rule if at any time during its taxable year it is
engaged in a trade or business in the United States.240
Therefore, any interest received from such a foreign
partnership is U.S.-source income.
Notwithstanding the general rule described above, in
the case of a foreign corporation engaged in a U.S.
trade or business (or having gross income that is
treated as effectively connected with the conduct of
a U.S. trade or business), interest paid by such
U.S. trade or business is treated as if it were paid
by a domestic corporation (i.e., such interest is
treated as U.S.-source income).241
House
Bill
The House bill treats interest paid by foreign
partnerships in a manner similar to the treatment of
interest paid by foreign corporations. Thus,
interest paid by a foreign partnership is treated as
U.S.-source income only if the interest is paid by a
U.S.
trade or business conducted by the partnership or is
allocable to income that is treated as effectively
connected with the conduct of a
U.S.
trade or business. The House bill applies only to
foreign partnerships that are predominantly engaged
in the active conduct of a trade or business outside
the
United States
.
Effective date. --This House bill provision
is effective for taxable years beginning after
December 31, 2003
.
Senate
Amendment
The Senate amendment is the same as the House bill.
Conference
Agreement
The conference agreement follows the House bill and
the Senate amendment.
11. Look-through treatment of payments between
related controlled foreign corporations (sec. 311 of
the House bill, sec. 222 of the Senate amendment,
and sec. 954 of the Code)
Present
Law
In general, the rules of subpart F (secs. 951-964)
require U.S. shareholders with a 10-percent or
greater interest in a controlled foreign corporation
to include certain income of the controlled foreign
corporation (referred to as "subpart F
income") on a current basis for U.S. tax
purposes, regardless of whether the income is
distributed to the shareholders.
Subpart F income includes foreign base company
income. One category of foreign base company income
is foreign personal holding company income. For
subpart F purposes, foreign personal holding company
income generally includes dividends, interest, rents
and royalties, among other types of income. However,
foreign personal holding company income does not
include dividends and interest received by a
controlled foreign corporation from a related
corporation organized and operating in the same
foreign country in which the controlled foreign
corporation is organized, or rents and royalties
received by a controlled foreign corporation from a
related corporation for the use of property within
the country in which the controlled foreign
corporation is organized. Interest, rent, and
royalty payments do not qualify for this exclusion
to the extent that such payments reduce the subpart
F income of the payor.
House
Bill
Under the provision, dividends, interest, rents, and
royalties received by one controlled foreign
corporation from a related controlled foreign
corporation are not treated as foreign personal
holding company income to the extent attributable or
properly allocable to non-subpart-F income of the
payor. For these purposes, a related controlled
foreign corporation is a controlled foreign
corporation that controls or is controlled by the
other controlled foreign corporation, or a
controlled foreign corporation that is controlled by
the same person or persons that control the other
controlled foreign corporation. Ownership of more
than 50 percent of the controlled foreign
corporation's stock (by vote or value) constitutes
control for these purposes.
Effective date. --The provision is effective
for taxable years of foreign corporations beginning
after
December 31, 2004
, and taxable years of
U.S.
shareholders with or within which such taxable years
of such foreign corporations end.
Senate
Amendment
The Senate amendment is the same as the House bill.
Conference
Agreement
The conference agreement does not include the House
bill or Senate amendment provision.
12. Look-through treatment under subpart F for
sales of partnership interests (sec. 312 of the
House bill, sec. 223 of the Senate amendment, and
sec. 954 of the Code)
Present
Law
In general, the subpart F rules (secs. 951-964)
require U.S. shareholders with a 10-percent or
greater interest in a controlled foreign corporation
to include in income currently for U.S. tax purposes
certain types of income of the controlled foreign
corporation, whether or not such income is actually
distributed currently to the shareholders (referred
to as "subpart F income"). Subpart F
income includes foreign personal holding company
income. Foreign personal holding company income
generally consists of the following: (1) dividends,
interest, royalties, rents, and annuities; (2) net
gains from the sale or exchange of (a) property that
gives rise to the preceding types of income, (b)
property that does not give rise to income, and (c)
interests in trusts, partnerships, and real estate
mortgages investment conduits ("REMICs");
(3) net gains from commodities transactions; (4) net
gains from foreign currency transactions; (5) income
that is equivalent to interest; (6) income from
notional principal contracts; and (7) payments in
lieu of dividends. Thus, if a controlled foreign
corporation sells a partnership interest at a gain,
the gain generally constitutes foreign personal
holding company income and is included in the income
of 10-percent
U.S.
shareholders of the controlled foreign corporation
as subpart F income.
House
Bill
The provision treats the sale by a controlled
foreign corporation of a partnership interest as a
sale of the proportionate share of partnership
assets attributable to such interest for purposes of
determining subpart F foreign personal holding
company income. This rule applies only to partners
owning directly, indirectly, or constructively at
least 25 percent of a capital or profits interest in
the partnership. Thus, the sale of a partnership
interest by a controlled foreign corporation that
meets this ownership threshold constitutes subpart F
income under the provision only to the extent that a
proportionate sale of the underlying partnership
assets attributable to the partnership interest
would constitute subpart F income. The Treasury
Secretary is directed to prescribe such regulations
as may be appropriate to prevent the abuse of this
provision.
Effective date. --The provision is effective
for taxable years of foreign corporations beginning
after
December 31, 2004
, and taxable years of
U.S.
shareholders with or within which such taxable years
of such foreign corporations end.
Senate
Amendment
The Senate amendment is the same as the House bill.
Conference
Agreement
The conference agreement follows the House bill and
the Senate amendment.
13. Repeal of foreign personal holding company
rules and foreign investment company rules (sec. 313
of the House bill, sec. 211 of the Senate amendment,
and secs. 542, 551-558, 954, 1246, and 1247 of the
Code)
Present
Law
Income earned by a foreign corporation from its
foreign operations generally is subject to U.S. tax
only when such income is distributed to any U.S.
persons that hold stock in such corporation.
Accordingly, a U.S. person that conducts foreign
operations through a foreign corporation generally
is subject to U.S. tax on the income from those
operations when the income is repatriated to the
United States through a dividend distribution to the
U.S. person. The income is reported on the U.S.
person's tax return for the year the distribution is
received, and the United States imposes tax on such
income at that time. The foreign tax credit may
reduce the U.S. tax imposed on such income.
Several sets of anti-deferral rules impose current
U.S. tax on certain income earned by a U.S. person
through a foreign corporation. Detailed rules for
coordination among the antideferral rules are
provided to prevent the U.S. person from being
subject to U.S. tax on the same item of income under
multiple rules.
The Code sets forth the following anti-deferral
rules: the controlled foreign corporation rules of
subpart F (secs. 951-964); the passive foreign
investment company rules (secs. 1291-1298); the
foreign personal holding company rules (secs.
551-558); the personal holding company rules (secs.
541-547); the accumulated earnings tax rules (secs.
531-537); and the foreign investment company rules (secs.
1246-1247).
House
Bill
The provision: (1) eliminates the rules applicable
to foreign personal holding companies and foreign
investment companies; (2) excludes foreign
corporations from the application of the personal
holding company rules; and (3) includes as subpart F
foreign personal holding company income personal
services contract income that is subject to the
present-law foreign personal holding company rules.
Effective date. --The provision is effective
for taxable years of foreign corporations beginning
after
December 31, 2004
, and taxable years of U.S. shareholders with or
within which such taxable years of foreign
corporations end.
Senate
Amendment
The Senate amendment provision is the same as the
House bill provision.
Conference
Agreement
The conference agreement follows the House bill and
the Senate amendment.
14. Determination of foreign personal holding
company income with respect to transactions in
commodities (sec. 314 of the House bill, sec. 206 of
the Senate amendment, and sec. 954 of the Code)
Present
Law
Subpart F foreign personal holding company
income
Under the subpart F rules, U.S. shareholders with a
10-percent or greater interest in a controlled
foreign corporation ("U.S. 10-percent
shareholders") are subject to U.S. tax
currently on certain income earned by the controlled
foreign corporation, whether or not such income is
distributed to the shareholders. The income subject
to current inclusion under the subpart F rules
includes, among other things, "foreign personal
holding company income."
Foreign personal holding company income generally
consists of the following: dividends, interest,
royalties, rents and annuities; net gains from sales
or exchanges of (1) property that gives rise to the
foregoing types of income, (2) property that does
not give rise to income, and (3) interests in
trusts, partnerships, and real estate mortgage
investment conduits ("REMICs"); net gains
from commodities transactions; net gains from
foreign currency transactions; income that is
equivalent to interest; income from notional
principal contracts; and payments in lieu of
dividends.
With respect to transactions in commodities, foreign
personal holding company income does not consist of
gains or losses which arise out of bona fide hedging
transactions that are reasonably necessary to the
conduct of any business by a producer, processor,
merchant, or handler of a commodity in the manner in
which such business is customarily and usually
conducted by others.242
In addition, foreign personal holding company income
does not consist of gains or losses which are
comprised of active business gains or losses from
the sale of commodities, but only if substantially
all of the controlled foreign corporation's business
is as an active producer, processor, merchant, or
handler of commodities.243
Hedging transactions
Under present law, the term "capital
asset" does not include any hedging transaction
which is clearly identified as such before the close
of the day on which it was acquired, originated, or
entered into (or such other time as the Secretary
may by regulations prescribe).244
The term "hedging transaction" means any
transaction entered into by the taxpayer in the
normal course of the taxpayer's trade or business
primarily: (1) to manage risk of price changes or
currency fluctuations with respect to ordinary
property which is held or to be held by the
taxpayer; (2) to manage risk of interest rate or
price changes or currency fluctuations with respect
to borrowings made or to be made, or ordinary
obligations incurred or to be incurred, by the
taxpayer; or (3) to manage such other risks as the
Secretary may prescribe in regulations.245
House
Bill
The House bill modifies the requirements that must
be satisfied for gains or losses from a commodities
hedging transaction to qualify for exclusion from
the definition of subpart F foreign personal holding
company income. Under the House bill, gains or
losses from a transaction with respect to a
commodity are not treated as foreign personal
holding company income if the transaction satisfies
the general definition of a hedging transaction
under section 1221(b)(2). For purposes of the House
bill, the general definition of a hedging
transaction under section 1221(b)(2) is modified to
include any transaction with respect to a commodity
entered into by a controlled foreign corporation in
the normal course of the controlled foreign
corporation's trade or business primarily: (1) to
manage risk of price changes or currency
fluctuations with respect to ordinary property or
property described in section 1231(b) which is held
or to be held by the controlled foreign corporation;
or (2) to manage such other risks as the Secretary
may prescribe in regulations. Gains or losses from a
transaction that satisfies the modified definition
of a hedging transaction are excluded from the
definition of foreign personal holding company
income only if the transaction is clearly identified
as a hedging transaction in accordance with the
hedge identification requirements that apply
generally to hedging transactions under section
1221(b)(2).246
The House bill also changes the requirements that
must be satisfied for active business gains or
losses from the sale of commodities to qualify for
exclusion from the definition of foreign personal
holding company income. Under the House bill, such
gains or losses are not treated as foreign personal
holding company income if substantially all of the
controlled foreign corporation's commodities are
comprised of: (1) stock in trade of the controlled
foreign corporation or other property of a kind
which would properly be included in the inventory of
the controlled foreign corporation if on hand at the
close of the taxable year, or property held by the
controlled foreign corporation primarily for sale to
customers in the ordinary course of the controlled
foreign corporation's trade or business; (2)
property that is used in the trade or business of
the controlled foreign corporation and is of a
character which is subject to the allowance for
depreciation under section 167; or (3) supplies of a
type regularly used or consumed by the controlled
foreign corporation in the ordinary course of a
trade or business of the controlled foreign
corporation.247
For purposes of applying the requirements for active
business gains or losses from commodities sales to
qualify for exclusion from the definition of foreign
personal holding company income, the House bill also
provides that commodities with respect to which
gains or losses are not taken into account as
foreign personal holding company income by a regular
dealer in commodities (or financial instruments
referenced to commodities) are not taken into
account in determining whether substantially all of
the dealer's commodities are comprised of the
property described above.
Effective date. --The House bill provision is
effective with respect to transactions entered into
after December 31, 2004.
Senate
Amendment
The Senate amendment is the same as the House bill.
Conference
Agreement
The conference agreement follows the House bill and
the Senate amendment.
15. Modifications to treatment of aircraft
leasing and shipping income (sec. 315 of the House
bill, sec. 221 of the Senate amendment, and sec. 954
of the Code)
Present
Law
In general, the subpart F rules (secs. 951-964)
require U.S. shareholders with a 10-percent or
greater interest in a controlled foreign corporation
("CFC") to include currently in income for
U.S. tax purposes certain income of the CFC
(referred to as "subpart F income"),
without regard to whether the income is distributed
to the shareholders (sec. 951(a)(1)(A)). In effect,
the Code treats the U.S. 10-percent shareholders of
a CFC as having received a current distribution of
their pro rata shares of the CFC's subpart F income.
The amounts included in income by the CFC's U.S.
10-percent shareholders under these rules are
subject to U.S. tax currently. The U.S. tax on such
amounts may be reduced through foreign tax credits.
Subpart F income includes foreign base company
shipping income (sec. 954(f)). Foreign base company
shipping income generally includes income derived
from the use of an aircraft or vessel in foreign
commerce, the performance of services directly
related to the use of any such aircraft or vessel,
the sale or other disposition of any such aircraft
or vessel, and certain space or ocean activities
(e.g., leasing of satellites for use in space).
Foreign commerce generally involves the
transportation of property or passengers between a
port (or airport) in the U.S. and a port (or
airport) in a foreign country, two ports (or
airports) within the same foreign country, or two
ports (or airports) in different foreign countries.
In addition, foreign base company shipping income
includes dividends and interest that a CFC receives
from certain foreign corporations and any gains from
the disposition of stock in certain foreign
corporations, to the extent the dividends, interest,
or gains are attributable to foreign base company
shipping income. Foreign base company shipping
income also includes incidental income derived in
the course of active foreign base company shipping
operations (e.g., income from temporary investments
in or sales of related shipping assets), foreign
exchange gain or loss attributable to foreign base
company shipping operations, and a CFC's
distributive share of gross income of any
partnership and gross income received from certain
trusts to the extent that the income would have been
foreign base company shipping income had it been
realized directly by the corporation.
Subpart F income also includes foreign personal
holding company income (sec. 954(c)). For subpart F
purposes, foreign personal holding company income
generally consists of the following: (1) dividends,
interest, royalties, rents and annuities; (2) net
gains from the sale or exchange of (a) property that
gives rise to the preceding types of income, (b)
property that does not give rise to income, and (c)
interests in trusts, partnerships, and real estate
mortgage investment conduits ("REMICs");
(3) net gains from commodities transactions; (4) net
gains from foreign currency transactions; (5) income
that is equivalent to interest; (6) income from
notional principal contracts; and (7) payments in
lieu of dividends.
Subpart F foreign personal holding company income
does not include rents and royalties received by a
CFC in the active conduct of a trade or business
from unrelated persons (sec. 954(c)(2)(A)). The
determination of whether rents or royalties are
derived in the active conduct of a trade or business
is based on all the facts and circumstances.
However, the Treasury regulations provide certain
types of rents are treated as derived in the active
conduct of a trade or business. These include rents
derived from property that is leased as a result of
the performance of marketing functions by the lessor
if the lessor (through its own officers or employees
located in a foreign country) maintains and operates
an organization in such country that regularly
engages in the business of marketing, or marketing
and servicing, the leased property and that is
substantial in relation to the amount of rents
derived from the leasing of such property. An
organization in a foreign country is substantial in
relation to rents if the active leasing expenses248
equal at least 25 percent of the adjusted leasing
profit.249
Also generally excluded from subpart F foreign
personal holding company income are rents and
royalties received by the CFC from a related
corporation for the use of property within the
country in which the CFC was organized (sec.
954(c)(3)). However, rent and royalty payments do
not qualify for this exclusion to the extent that
such payments reduce subpart F income of the payor.
House
Bill
The provision repeals the subpart F rules relating
to foreign base company shipping income. The bill
also amends the exception from foreign personal
holding company income applicable to rents or
royalties derived from unrelated persons in an
active trade or business by providing a safe harbor
for rents derived from leasing an aircraft or vessel
in foreign commerce. Such rents are excluded from
foreign personal holding company income if the
active leasing expenses comprise at least 10 percent
of the profit on the lease. This provision is to be
applied in accordance with existing regulations
under section 954(c)(2)(A) by comparing the lessor's
"active leasing expenses" for its pool of
leased assets to its "adjusted leasing
profit."
The safe harbor will not prevent a lessor from
otherwise showing that it actively carries on a
trade or business. In this regard, the requirements
of section 954(c)(2)(A) will be met if a lessor
regularly and directly performs active and
substantial marketing, remarketing, management and
operational functions with respect to the leasing of
an aircraft or vessel (or component engines). This
will be the case regardless of whether the lessor
engages in marketing of the lease as a form of
financing (versus marketing the property as such) or
whether the lease is classified as a finance lease
or operating lease for financial accounting
purposes. If a lessor acquires, from an unrelated or
related party, a ship or aircraft subject to an
existing FSC or ETI lease, the requirements of
section 954(c)(2)(A) will be satisfied if, following
the acquisition, the lessor performs active and
substantial management, operational, and remarketing
functions with respect to the leased property. If
such a lease is transferred to a CFC lessor, it will
no longer be eligible for FSC or ETI benefits.
An aircraft or vessel is considered to be leased in
foreign commerce if it is used for the
transportation of property or passengers between a
port (or airport) in the United States and one in a
foreign country or between foreign ports (or
airports), provided the aircraft or vessel is used
predominantly outside the United States. An aircraft
or vessel will be considered used predominantly
outside the United States if more than 50 percent of
the miles during the taxable year are traversed
outside the United States or the aircraft or vessel
is located outside the United States more than 50
percent of the time during such taxable year.
It is expected that the Secretary of the Treasury
will issue timely guidance to make conforming
changes to existing regulations, including guidance
that aircraft or vessel leasing activity that
satisfies the requirements of section 954(c)(2)(A)
shall also satisfy the requirements for avoiding
income inclusion under section 956 and section
367(a).
It is anticipated that taxpayers now eligible for
the benefits of the ETI exclusion (or the FSC
provisions pursuant to the FSC Repeal and
Extraterritorial Income Exclusion Act of 2000), will
find it appropriate, as matter of sound business
judgment, to restructure their business operations
to take into account the tax law changes brought
about by the bill. It is noted that courts have
recognized the validity of structuring operations
for the purpose of obtaining the benefit of tax
regimes expressly intended by Congress. It is
intended that structuring or restructuring of
operations for the purposes of adapting to the
repeal of the ETI exclusion (or the FSC regime) will
be considered to serve a valid business purpose and
will not constitute tax avoidance, where the
restructured operations conform to the requirements
expressly mandated by Congress for obtaining tax
benefits that remain available. For example, it is
intended that a restructuring undertaken to transfer
aircraft subject to existing FSC or ETI leases to a
CFC lessor, to take advantage of the amendments made
by this bill, would serve a valid business purpose
and would not constitute tax avoidance, for purposes
of determining whether a particular tax treatment
(such as nonrecognition of gain) applies to such
restructuring. It is intended, for example, that if
such a restructuring meets the other requirements
necessary to qualify as a "reorganization"
under section 368, the transaction will also be
deemed to meet the "business purpose"
requirements under section 368, and thus, qualify as
a reorganization under that section.
Effective date. --The provision is effective
for taxable years of foreign corporations beginning
after December 31, 2004, and taxable years of U.S.
shareholders with or within which such taxable years
of foreign corporations end.
Senate
Amendment
The provision provides that "qualified leasing
income" derived from or in connection with the
leasing or rental of any aircraft or vessel is not
treated as foreign personal holding company income
or foreign base company shipping income of a
controlled foreign corporation. The provision
defines "qualified leasing income" as
rents or gains derived in the active conduct of a
leasing trade or business with respect to which the
controlled foreign corporation conducts substantial
activity, provided that the leased property is used
by the lessee or other end-user in foreign commerce
and predominantly outside the United States, and
such lessee or other enduser is not related to the
controlled foreign corporation (within the meaning
of sec. 954(d)(3)).
In determining whether an aircraft or vessel is used
in foreign commerce, it is intended that foreign
commerce encompass the use of an aircraft or vessel
in the transportation of property or passengers: (1)
between an airport or port in the United States
(including for this purpose any possession of the
United States) and an airport or port in a foreign
country; (2) between an airport or port in a foreign
country and another in the same country; or (3)
between an airport or port in a foreign country and
another in a different foreign country. It is
intended that an aircraft or vessel be considered as
used predominantly outside the United States if more
than 70 percent of its miles traveled during the
taxable year are traveled outside the United States,
or if the aircraft or vessel is located outside the
United States for more than 70 percent of the time
during the taxable year.
Effective date. --The provision is effective
for taxable years of foreign corporations beginning
after
December 31, 2006
, and taxable years of U.S. shareholders with or
within which such taxable years of such foreign
corporations end.
Conference
Agreement
The conference agreement follows the House bill with
the following clarifications. First, the terms
"aircraft or vessels" include engines that
are leased separately from an aircraft or vessel.
Second, if a lessor acquires (from a related or
unrelated party) or aircraft or vessel subject to an
existing lease, the requirements of section
954(c)(2)(A) are satisfied if, following the
acquisition, the lessor performs active and
substantial management, operational, and remarketing
functions with respect to the leased property.
However, if an existing FSC or ETI lease is
transferred to a CFC lessor, the lease will no
longer be eligible for FSC or ETI benefits.
16. Modification of exceptions under subpart F
for active financing (sec. 316 of the House bill,
sec. 226 of the Senate amendment, and sec. 954 of
the Code)
Present
Law
Under the subpart F rules, U.S. shareholders with a
10-percent or greater interest in a controlled
foreign corporation ("CFC") are subject to
U.S. tax currently on certain income earned by the
CFC, whether or not such income is distributed to
the shareholders. The income subject to current
inclusion under the subpart F rules includes, among
other things, foreign personal holding company
income and insurance income. In addition, 10-percent
U.S. shareholders of a CFC are subject to current
inclusion with respect to their shares of the CFC's
foreign base company services income (i.e., income
derived from services performed for a related person
outside the country in which the CFC is organized).
Foreign personal holding company income generally
consists of the following: (1) dividends, interest,
royalties, rents, and annuities; (2) net gains from
the sale or exchange of (a) property that gives rise
to the preceding types of income, (b) property that
does not give rise to income, and (c) interests in
trusts, partnerships, and real estate mortgage
investment conduits ("REMICs"); (3) net
gains from commodities transactions; (4) net gains
from foreign currency transactions; (5) income that
is equivalent to interest; (6) income from notional
principal contracts; and (7) payments in lieu of
dividends.
Insurance income subject to current inclusion under
the subpart F rules includes any income of a CFC
attributable to the issuing or reinsuring of any
insurance or annuity contract in connection with
risks located in a country other than the CFC's
country of organization. Subpart F insurance income
also includes income attributable to an insurance
contract in connection with risks located within the
CFC's country of organization, as the result of an
arrangement under which another corporation receives
a substantially equal amount of consideration for
insurance of other country risks. Investment income
of a CFC that is allocable to any insurance or
annuity contract related to risks located outside
the CFC's country of organization is taxable as
subpart F insurance income (Treas. Reg. sec.
1.953-1(a)).
Temporary exceptions from foreign personal holding
company income, foreign base company services
income, and insurance income apply for subpart F
purposes for certain income that is derived in the
active conduct of a banking, financing, or similar
business, or in the conduct of an insurance business
(so-called "active financing income").250
With respect to income derived in the active conduct
of a banking, financing, or similar business, a CFC
is required to be predominantly engaged in such
business and to conduct substantial activity with
respect to such business in order to qualify for the
exceptions. In addition, certain nexus requirements
apply, which provide that income derived by a CFC or
a qualified business unit ("QBU") of a CFC
from transactions with customers is eligible for the
exceptions if, among other things, substantially all
of the activities in connection with such
transactions are conducted directly by the CFC or
QBU in its home country, and such income is treated
as earned by the CFC or QBU in its home country for
purposes of such country's tax laws. Moreover, the
exceptions apply to income derived from certain
cross border transactions, provided that certain
requirements are met. Additional exceptions from
foreign personal holding company income apply for
certain income derived by a securities dealer within
the meaning of section 475 and for gain from the
sale of active financing assets.
In the case of insurance, in addition to temporary
exceptions from insurance income and from foreign
personal holding company income for certain income
of a qualifying insurance company with respect to
risks located within the CFC's country of creation
or organization, temporary exceptions from insurance
income and from foreign personal holding company
income apply for certain income of a qualifying
branch of a qualifying insurance company with
respect to risks located within the home country of
the branch, provided certain requirements are met
under each of the exceptions. Further, additional
temporary exceptions from insurance income and from
foreign personal holding company income apply for
certain income of certain CFCs or branches with
respect to risks located in a country other than the
United States, provided that the requirements for
these exceptions are met.
House
Bill
The House bill modifies the present-law temporary
exceptions from subpart F foreign personal holding
company income and foreign base company services
income for income derived in the active conduct of a
banking, financing, or similar business. For
purposes of determining whether a CFC or QBU has
conducted directly in its home country substantially
all of the activities in connection with
transactions with customers, the House bill provides
that an activity is treated as conducted directly by
the CFC or QBU in its home country if the activity
is performed by employees of a related person and:
(1) the related person is itself an eligible CFC the
home country of which is the same as that of the CFC
or QBU; (2) the activity is performed in the home
country of the related person; and (3) the related
person is compensated on an arm's length basis for
the performance of the activity by its employees and
such compensation is treated as earned by such
person in its home country for purposes of the tax
laws of such country. For purposes of determining
whether a CFC or QBU is eligible to earn active
financing income, such activity may not be taken
into account by any CFC or QBU (including the
employer of the employees performing the activity)
other than the CFC or QBU for which the activities
are performed.
Effective date. --The House bill provision is
effective for taxable years of foreign corporations
beginning after
December 31, 2004
, and taxable years of U.S. shareholders with or
within which such taxable years of foreign
corporations end.
Senate
Amendment
The Senate amendment is the same as the House bill.
Conference
Agreement
The conference agreement follows the House bill and
the Senate amendment.
17. Ten-year foreign tax credit carryover;
one-year foreign tax credit carryback (sec. 201 of
the Senate amendment and sec. 904 of the Code)
Present
Law
U.S. persons may credit foreign taxes against U.S.
tax on foreign-source income. The amount of foreign
tax credits that may be claimed in a year is subject
to a limitation that prevents taxpayers from using
foreign tax credits to offset U.S. tax on
U.S.-source income. The amount of foreign tax
credits generally is limited to a portion of the
taxpayer's U.S. tax which portion is calculated by
multiplying the taxpayer's total U.S. tax by a
fraction, the numerator of which is the taxpayer's
foreign-source taxable income (i.e., foreign-source
gross income less allocable expenses or deductions)
and the denominator of which is the taxpayer's
worldwide taxable income for the year.251
In addition, this limitation is calculated
separately for various categories of income,
generally referred to as "separate limitation
categories." The total amount of the foreign
tax credit used to offset the U.S. tax on income in
each separate limitation category may not exceed the
proportion of the taxpayer's U.S. tax which the
taxpayer's foreign-source taxable income in that
category bears to its worldwide taxable income.
The amount of creditable taxes paid or accrued (or
deemed paid) in any taxable year which exceeds the
foreign tax credit limitation is permitted to be
carried back to the two immediately preceding
taxable years (to the earliest year first) and
carried forward five taxable years (in chronological
order) and credited (not deducted) to the extent
that the taxpayer otherwise has excess foreign tax
credit limitation for those years. Excess credits
that are carried back or forward are usable only to
the extent that there is excess foreign tax credit
limitation in such carryover or carryback year.
Consequently, foreign tax credits arising in a
taxable year are utilized before excess credits from
another taxable year may be carried forward or
backward. In addition, excess credits are carried
forward or carried back on a separate limitation
basis. Thus, if a taxpayer has excess foreign tax
credits in one separate limitation category for a
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