S. 96-110

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Senate Bill 96 (110th Congress)
Export Products Not Jobs Act of 2007
Sponsor: Sen Kerry, John F.
Committees: Senate Finance


Contents

Update Status

Note: the following is status provided by automatic update from thomas.loc.gov.


S. 96-110A bill to amend the Internal Revenue Code of 1986 to ensure a fairer and simpler method of taxing controlled foreign corporations of United States shareholders, to treat certain foreign corporations managed and controlled in the United States as domestic corporations, to codify the economic substance doctrine, and to eliminate the top corporate income tax rate, and for other purposes.
January 4, 2007: Referred to Senate committee. Status: Read twice and referred to the Committee on Finance.

Summary of bill effects

CRS Summary

From Bill Summary and Status at thomas.loc.gov:

SUMMARY AS OF: 1/4/2007--Introduced.

Export Products Not Jobs Act - Amends the Internal Revenue Code to: (1) revise rules and definitions relating to the taxation of controlled foreign corporations to limit deferral of tax for certain types of income earned overseas; (2) treat certain foreign corporations managed and controlled in the United States as domestic corporations for income tax purposes; (3) define "economic substance" for purposes of evaluating tax shelter transactions; (4) impose a penalty for underpayments of tax resulting from transactions lacking in economic substance; (5) deny a tax deduction for interest on such underpayments; and (6) eliminate the 35% income tax rate on corporations and personal service corporations.

Summary provided by Senator Kerry's office

From the Congressional Record, pp. S 99-100

OVERVIEW

The Export Products Not Jobs Act makes sweeping changes to the current international tax laws by: (1) ending tax breaks that encourage companies to move jobs overseas by eliminating the ability of companies to defer paying U.S. taxes on foreign income; (2) simplifying current-law Subpart F rules; (3) closing abusive corporate tax loopholes; and (4) repealing the top corporate tax rate.

Current tax laws allow companies to defer paying U.S. taxes on income earned by their foreign subsidiaries, providing a substantial tax break for companies to move investment and jobs overseas. Except as provided under the Subpart F rules, American companies generally do not have to pay taxes on their active foreign income until they repatriate it to the United States.

The Export Products Not Jobs Act eliminates deferral so companies will be taxed on their foreign subsidiary profits in the same way they are taxed on their domestic profits. This new system will apply to profits in future years. In order to ensure that American companies can compete in international markets, income companies earn when they locate production in a foreign country that serves that foreign country's home markets can still be deferred.

The Subpart F rules which govern the taxation of foreign subsidiaries controlled by American companies have become increasingly complicated over time, adding to the overall complexity of the tax code and making it easier for companies to exploit loopholes to escape paying taxes. Under this bill, the complexity created by the current Subpart F rules will be eliminated and a simpler, more transparent system will be put into place.

In a tax system without deferral, U.S.-based multinational corporations might be tempted to locate their top-tiered entity overseas to avoid taxation on the income of a foreign subsidiary. This legislation would strengthen the corporate residency test by preventing companies from incorporating in a foreign jurisdiction to avoid U.S. taxation on a worldwide basis. The current law test that is based solely on where the company is incorporated is artificial, and allows foreign corporations that are economically similar to American companies to avoid being taxed like American companies. Determining residency based on the location of a company's primary place of management and control will provide a more meaningful standard.

In order to prevent abusive tax transactions, the legislation includes a provision that would codify the judicially-developed economic substance test, which disallows transactions where the profit potential is insubstantial compared to the tax benefits. This proposal is identical to the economic substance provisions that have been passed repeatedly by the Senate.

The revenue saved from ending deferral, strengthening the corporate residency test, and shutting down abusive tax shelters will be used to lower the maximum corporate tax rate from 35 percent to 34 percent. The tax differential between U.S. corporations and foreign corporate rates has grown over the last two decades. This proposal, in combination with the deduction for domestic manufacturing activity when fully phased-in in 2009, will result in a corporate tax rate of 31 percent for domestic manufacturing activity. The "Export Products Not Jobs Act" moves in the right direction towards narrowing this gap.

SUMMARY OF PROVISIONS

I. Reform and Simplification of Subpart F Income

Subpart F Income Defined

Present law

Generally within the U.S., 10-percent shareholders of a controlled foreign corporation (CFC) are taxed on the pro rata shares of certain income referred to as Subpart F income. A CFC generally is defined as any foreign corporation in which U.S. persons (directly, indirectly, or constructively) own more than 50 percent of the corporation's stock (measured by vote or value), taking into account only those U.S. persons that own at least 10 percent of the stock (measured by vote only). Typically, Subpart F income is passive income or income that is readily movable from one taxing jurisdiction to another. Subpart F income is defined in code section 952 as foreign base company income, insurance income, and certain income relating to international boycotts and other violations of public policy.

Export Products Not Jobs Act

This legislation strikes code section 952 and replaces it with a new definition of Subpart F income. Generally, Subpart F income is defined as all gross income of the controlled foreign corporation with exceptions for certain types of income. Subpart F income of a CFC for any taxable year is limited to the earnings and profits of the CFC for that taxable year. Subpart F will continue to include income related to international boycotts.

Exceptions to Subpart F Income

Present law

Subpart F income is defined in the code rather narrowly and the definition lists the income that it includes. Subpart F income is currently taxed, and other income of a U.S. person's CFC that conducts foreign operations generally is subject to U.S. tax only when it is repatriated to the United States.

Temporary Active Financing Exception

Under current law, there are temporary exceptions from the Subpart F provisions for certain active financing income, which is income derived in the active conduct of a banking, financing, or similar business, or in the conduct of an insurance business. This temporary exception expires at the end of 2008. To be eligible for this exception, substantially all transactions must be conducted directly by the CFC or a qualified business unit of a CFC in its home country.

Export Products Not Jobs Act

Under the legislation, Subpart F income is generally all income of a CFC except for active home country income of the CFC. Active home country income constitutes qualified property income or qualified service income and is derived from the active and regular conduct of one or more trades or businesses within the home country. The home country is defined as the country in which the CFC is created or organized.

Qualified property income is defined as income derived in connection with: (1) the manufacture, production, growth, or extraction of any personal property within the home country of the CFC; or (2) the resale in the home country of the CFC of personal property manufactured, produced, grown, or extracted within the home country of such corporation for the resale of such property by the CFC in the home country. The property has to be sold for use or consumption within the home country in either case.

Qualified services income is defined as income derived in connection with the providing of services in transactions with customers who, at the time the services are provided, are located in the home country. Services are required: (1) to be used in the home country; or (2) to be used in the active conduct of trade or business by the recipient where substantially all of the activities in connection with the trade or business are conducted by the recipient in the home country.

Under the "Export Products Not Jobs Act," the current-law temporary active financing exception is repealed. The legislation includes a de minimis exception providing that if the Subpart F income of a CFC is less than the lesser of five percent of gross income, or $1 million, the Subpart F income of the CFC is zero for that taxable year.

For purposes of calculating the Subpart F income of a CFC, properly allocated deductions are allowed.

A CFC can elect to be treated as a domestic corporation. The election will apply to the taxable year for which it is made and all subsequent taxable years unless revoked with the consent of the Secretary. If a CFC chooses to make an election to be treated as a domestic corporation, pre-2008 earnings and profits are not included in gross income.

Captive Insurance Income

Present Law

Under current law, special rules apply to captive insurance companies that have related person insurance income which is defined as any insurance income attributable to a policy of insurance or reinsurance with respect to which the person (directly or indirectly) insured is a U.S. shareholder in the foreign corporation or a related person to such a shareholder. These companies are formed to insure the risks of the owners. Under current law, a lower ownership threshold applies to determine whether a captive insurance company is treated as a CFC subject to the current-law income inclusion rules of Subpart F. Under this lower ownership threshold, a captive insurance company is treated as a CFC if 25 percent or more of the stock is owned by U.S. persons.

The special rules for captive insurance companies were added in 1986 because Congress was concerned that the ownership of these companies was often dispersed widely and that these companies were not covered by the otherwise applicable ownership threshold for a CFC.

Export Products Not Jobs Act

The bill retains, in simplified form, the present-law concept of related person insurance income, and also retains the lower ownership threshold for captive insurance companies that are treated as CFCs. Captive insurance income that meets the requirements of the active home exception, like other active home country services income, however, can be deferred.

Effective Date

The above described provisions apply to taxable years beginning after December 31, 2007.

II. Corporate Residency Definition

Present Law

The place of incorporation or organization determines whether a corporation is treated as foreign or domestic for purposes of U.S. tax law. A corporation is treated as domestic if it is incorporated or organized under the laws of the United States or of any State.

Export Products Not Jobs Act

The bill amends the rules for determining corporate residency for publicly-traded companies incorporated or organized in a foreign country, by basing such corporation's residence on the location of its primary place of management and control. A company incorporated or organized in the United States is still considered a domestic corporation in any event. Primary place of management and control is defined as the place where the executive officers and senior management of the corporation exercise day-to-day responsibility for the strategic, financial, and operational decision-making for the company (including direct and indirect subsidiaries).

Effective Date

The proposal would be effective for taxable years beginning on or after two years after the date of enactment. A corporation that is in existence on the date of enactment and is incorporated in a country in which the United States has a comprehensive tax treaty is not affected by this provision.

III. Shutdown of Abusive Tax Shelters

Clarification of Economic Substance Doctrine

Present Law

Under current law, there are specific rules regarding the computation of taxable income. In addition to these statutory provisions, courts have developed several doctrines that can be applied to deny the tax benefits of motivated transactions, even though the transaction meets the requirements of a specific tax provision. Generally, courts have denied tax benefits if the transaction lacks economic substance independent of tax considerations.

Export Products Not Jobs Act

Clarifies that a transaction has economic substance only if the taxpayer establishes that: (1) the transaction changes in a meaningful way (aside from Federal income tax consequences) the taxpayer's economic position; and (2) the taxpayer has a substantial non-tax purpose for entering into such a transaction and the transaction is a reasonable means of accomplishing such purpose. This proposal applies to transactions entered into after the date of enactment.

Penalty for Understatements Attributable to Transactions Lacking Economic Substance

Present Law

Under current law, there are various penalties for understatements. There is a 20 percent accuracy-related penalty imposed on any understatement attributable to any adequately disclosed listed transaction or certain reportable transactions (``reportable transaction understatement). The penalty is increased to 30 percent if such a transaction is not adequately disclosed in accordance with regulations.

Export Products Not Jobs Act

The bill imposes a 40 percent penalty on any understatement attributable to any transaction that lacks economic substance (``noneconomic substance underpayment). The rate is reduced to 20 percent if the taxpayer discloses the transaction in accordance with regulations. This proposal applies to transactions entered into after the date of enactment.

Denial of Deduction for Interest on Underpayments Attributable to Noneconomic Substance Transactions

Present Law

Under current law, no deduction for interest is allowed for interest paid or accrued on any underpayment of tax which is attributable to the portion of any reportable transaction understatement for which the facts were not adequately disclosed.

Export Products Not Jobs Act

The bill extends the disallowance of interest deductions to interest paid or accrued on any underpayment of tax attributable to any noneconomic substance underpayment. The proposal applies to transactions after the date of enactment in taxable years ending after such date.

IV. Repeal of Top Corporate Marginal Income Tax Rate

Present Law

The maximum corporate rate is 35 percent and this rate applies to taxable income in excess of $10 million. The maximum rate on corporate taxable gains is 35 percent. A corporation with taxable income in excess of $15 million is required to increase its tax liability by the lesser of three percent of the excess, or $100,000.

Export Products Not Jobs Act

The bill repeals the top corporate rate of 35 percent. The highest marginal tax rate will be 34 percent and the maximum rate of tax on corporate net capital gains will also be 34 percent. The 34 percent rate applies to income in excess of $75,000. The proposal applies to taxable years beginning after December 31, 2007.

History / Previous versions of this bill

Kerry introduced a similar bill in the 109th Congress as S.3777.

This legislation embodies several items of Kerry's economic platform from his 2004 Presidential campaign.


Criticism of the corporate tax cut

This bill includes a reduction in corporate tax rates, which evokes a predictable response of knee-jerk criticism from some quarters, if they have not bothered to consider the rationale set forth by Kerry.

In a July 2005 editorial in the Financial Times (ref 1) Kerry explains:

Today, our tax policy rewards US multinational companies for locating operations abroad and reinvesting profits overseas. It is hard to imagine a more backward policy. By allowing companies to defer paying taxes on foreign income until they bring it home, we invite a double-whammy on our economy. First, companies have a tax advantage to move jobs overseas. Corporate taxes are, on average, one-third lower abroad. Second, companies face a tax when they bring earnings back and, therefore, have an incentive to reinvest profits in foreign economies.

In sanctioning these foreign tax havens, US companies who choose to stay at home suffer a disadvantage. Not only is this bad for business and a strain on capital; it is a disaster for American workers. There are 1.6m more unemployed Americans today than there were in 2000.

I propose a two-step solution. First, eliminate this perverse incentive for companies to house operations overseas. Second, use the tax savings to lower the corporate tax rate across the board at home. This means taxing companies on the profits of their foreign subsidiaries as they earn them, just like domestic profits. US companies must remain competitive in a global economy, so deferral would still be permitted for income earned when a company houses production in a foreign country solely to serve its market. But if you open a call centre in India to serve American customers, you have to pay taxes just like call centres in the US do.


Floor statement

From the Congressional Record, beginning on page S.98:

Mr. KERRY. Mr. President, today I am introducing the "Export Products Not Jobs Act." Our tax code is extremely complicated. In 1994, the IRS estimated that a family that itemized their deductions and had some interest and capital gains would spend 11 1/2 hours preparing their Federal income tax return. A decade later in 2004, this estimate increased to 19 hours and 45 minutes. It is time for Congress to pass bipartisan tax legislation in the style of the Tax Reform Act of 1986, which greatly simplified the tax code. And our tax reform should be based upon the following three principles: fairness, simplicity, and opportunity for economic growth.

Citizens and businesses struggle to comply with rules governing taxation of business income, capital gains, income phase-outs, extenders, the myriad savings vehicles, recordkeeping for itemized deductions, the alternative minimum tax (AMT), the earned income tax credit (EITC), and taxation of foreign business income. I believe that our international tax system needs to be simplified and reformed to encourage businesses to remain in the United States. And today, I am introducing legislation that I hope will be fully considered as we continue our discussions on tax reform.

Presently, the complexities of our international tax system actually encourage U.S. corporations to invest overseas. Current tax laws allow companies to defer paying U.S. taxes on income earned by their foreign subsidiaries, which provides a substantial tax break for companies that move investment and jobs overseas. Today, under U.S. tax law, a company that is trying to decide where to locate production or services--either in the United States or in a foreign low-tax haven--is actually given a substantial tax incentive not only to move jobs overseas, but to reinvest profits permanently, as opposed to bringing the profits back to re-invest in the United States.

Recent press articles have revealed examples of companies taking advantage of this perverse incentive in our tax code. For instance, some companies have taken advantage of this initiative by opening subsidiaries to serve markets throughout Europe. Much of the profit earned by these subsidiaries will stay in the European countries and the companies therefore avoid paying U.S. taxes. Other companies have announced the expansion of jobs in India. This reflects a continued pattern among some U.S. multinational companies of shifting software development and call centers to India, and this trend is starting to expand include the shifting critical functions like design and research and development to India as well. Some companies are even outsourcing the preparation of U.S. tax returns.

The Export Products Not Jobs Act would put an to end to these practices by eliminating tax breaks that encourage companies to move jobs overseas and by using the savings to create jobs in the United States by repealing the top corporate rate. This legislation ends tax breaks that encourage companies to move jobs by: 1. eliminating the ability of companies to defer, paying U.S. taxes on foreign income; 2. closing abusive corporate tax loopholes; and 3. repealing the top corporate rate. It removes the incentive to shift jobs overseas by eliminating deferral so that companies pay taxes on their international income as they earn it, rather than being allowed to defer taxes.

Last Congress, the Ways and Means Subcommittee on Revenue held a hearing on international tax laws. Stephen Shay, a former Reagan Treasury official, testified that our tax rules ``provide incentives to locate business activity outside the United States.

Furthermore, he suggested that taxation of U.S. shareholders under an expansion of Subpart F would be a "substantial improvement" over our current system. The Export Products Not Jobs Act does just that.

Our current tax system punishes U.S. companies that choose to create and maintain jobs in the United States. These companies pay higher taxes and suffer a competitive disadvantage with a company that chooses to move jobs to a foreign tax haven. There is no reason why our tax code should provide an incentive that encourages investment and job creation overseas. Under my legislation, companies would be taxed the same whether they invest abroad or at home; they will be taxed on their foreign subsidiary profits just like they are taxed on their domestic profits.

This legislation reflects the most sweeping simplification of international taxes in over 40 years. Our economy has changed in the last 40 years and our tax laws need to be updated to keep pace. Our current global economy was not even envisioned when existing law was written.

My Export Products Not Jobs Act will in no way hinder our global competitiveness. Companies will be able to continue to defer income they earn when they locate production in a foreign country that serves that foreign country's markets. For example, if a U.S. company wants to open a hotel in Bermuda or a car factory in India to sell cars, foreign income can still be deferred. But if a company wants to open a call center in India to answer calls from outside India or relocate abroad to sell cars back to the United States or Canada, the company must pay taxes just like call centers and auto manufacturers located in the United States.

Currently, American companies allocate their revenue not in search of the highest return, but in search of lower taxes. Eliminating deferral will improve the efficiency of the economy by making taxes neutral so that they do not encourage companies to overinvest abroad solely for tax reasons.

The Congressional Research Service stated in a 2003 report that, "[a]ccording to traditional economic theory, deferral thus reduces economic welfare by encouraging firms to undertake overseas investments that are less productive--before taxes are considered--than alternative investments in the United States." Additionally, a 2000 Department of Treasury study on deferral stated, "[a]mong all of the options considered, ending deferral would also be likely to have the most positive long-term effect on economic efficiency and welfare because it would do the most to eliminate tax considerations from decisions regarding the location of investment."

The "Export Products Not Jobs Act" would modify the rules for determining residency for publicly-traded companies by basing a corporation's residence on the location of its primary place of management and control. This will prevent companies from locating in tax havens, but basically maintaining their operations in the United States. This provision should not hinder foreign investment in the United States. Existing companies that are incorporated in foreign countries with a comprehensive tax treaty with the United States will not be affected by this provision.

Massachusetts is an example of a state that benefits from foreign investment. Two foreign companies have recently expanded investment in Massachusetts. Our tax system should not discourage foreign investment, but it should not encourage companies to locate in tax havens.

The revenue raised from the repeal of deferral and closing corporate loopholes would be used to repeal the top corporate tax rate of 35 percent. The tax differential between U.S. corporate rates and foreign corporate rates has grown over the last two decades and the repeal of the top corporate rate is a start in narrowing this gap.

The Export Products Not Jobs Act would promote equity among U.S. taxpayers by ensuring that corporations could not eliminate or substantially reduce taxation of foreign income by separately incorporating their foreign operations. This legislation will eliminate the tax incentives to encourage U.S. companies to invest abroad and reward those companies that have chosen to invest in the United States. I urge my colleagues to join me in this effort, and I ask unanimous consent that summary of the Export Products Not Jobs Act, as well as the text of the legislation, be printed in the RECORD.

References

  1. Op Ed: John Kerry: Two-part Solution to Corporate Tax Regime, Financial Times, July 21, 2005
  2. Floor statement by John Kerry on introduction of S.96 in the 110th Congress: Congressional Record pp. S98-S100. January 5, 2007.
  3. Floor statement by John Kerry on introduction of S.3777 in the 109th Congress: Congressional Record pp. S8621-S8622. August 2, 2006.

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