TIPRA's Effect on U.S. Owned Foreign Business Operations
After being cleared by both the House and Senate, on May 17, 2006, President Bush signed the Tax Increase Prevention and Reconciliation Act of 2005 (TIPRA) into law. According to the Congressional Budget Office, TIPRA will result in a tax relief of $70 billion for the period from 2006 to 2010. Not only does TIPRA bring tax relief for income earned from U.S. sources, but it also brings tax relief to U.S. businesses with foreign operations.
With regard to taxing income from sources outside the United States, TIPRA effects certain sections of the financial services industry; it affects deemed income inclusions for income earned by Controlled Foreign Corporations; it repeals the Foreign Sales Corporation (FSC) regime’s binding contract relief; and it repeals the Extra Territorial Income Exclusion (ETI) regime’s transition rules and binding contract exception.
To prevent certain U.S. owners of Controlled Foreign Corporations from postponing or deferring the payment of taxes on income earned abroad until such earned income is repatriated to the United States, on October 16, 1962, President J. F. Kennedy signed into law the Revenue Code’s Subpart F Rules. These rules contain the United States’ anti-deferral regime for U.S. Controlled Foreign Corporations (CFC’s). In general, pursuant to this regime U.S. owners of CFC’s have to pay taxes on all income earned abroad, irrespective whether these funds were repatriated to the United States, or not. However, there are exceptions to this rule, one of which allows U.S. businesses with manufacturing operations abroad not to pay taxes on unrepatriated income earned from sales of manufactured goods within the CFC’s country of incorporation and manufacturing, i.e., CFC manufactures and sells in its country of registration. This exception prevents this U.S. anti-deferral regime from putting U.S. manufacturers at a disadvantage with their competitors.
A temporary exception similar in kind was extended to certain sections of the financial industry by the Taxpayer Relief Act of 1997, according to which the mentioned exemption was to expire at the end of 1998. However, the exemption was modified and extended by subsequent legislation, the last of which was the American Jobs Creation Act of 2004. Pursuant to AJCA 2004, this deemed income exclusion was to expire at the end of 2006. TIPRA extends this relief through December 31, 2008. This measure provides that income from banking, financing, and insurance business operations of a CFC will not be classified as deemed income. To qualify for this exception, earnings must, inter alia, be earned by the CFC in its country of registration from active financing business operations, i.e., active financing income.
TIPRA also provides for temporary look-through treatment of payments between related foreign CFC’s with Foreign Personal Holding Company Income. Pursuant to this, CFC’s will be able to receive cross border payments of dividends, interest, rents, and royalties from related parties from operations funded with un-repatriated non-Subpart F income of the payor, without such payments being classified as deemed income. This temporary exception is effective for tax years beginning after December 31, 2005, and before January 1, 2009.
The extraterritorial income exclusion (ETI) regime has been repealed by the American Jobs Creation Act of 2004. Its full effect was to be phased in from 2005 until 2007. AJCA 2004 also provided for a contract relief measure which was applicable to contracts with unrelated parties that were in effect before September 17, 2003. Although TIPRA repeals both these measures (phase-in and contract relief), the general transition rule according to which certain percentages of ETI benefits may be retained, will remain in effect for 2006. As mentioned earlier, TIPRA also repeals the FSC binding contract relief measure.
Please note, since the purpose of this article is to give a broad, general overview of TIPRA with regard to its effect on foreign business operations, Subpart F’s various other applicable requirements and exemptions were not mentioned and discussed.