Impact of US international tax structure change on India
The Obama administration’s new international tax proposals, also relevant to Indian multinationals, are estimated to raise $123 billion over the next 10 years.
The Obama administration released its fiscal year 2011 budget proposals that make significant changes to the current US international tax system. In total, the Obama administration’s international tax proposals estimate to raise around $123 billion over the next 10 years. These proposals are also relevant to Indian multinationals, which have so-called sandwich structures (i.e., Indian parent owns a US company that, in turn, owns one or more controlled foreign corporations).
Three of the US budget proposals that are particularly relevant to sandwich structures are as follows:
The deferral of interest expense deductions related to non-US source income until that income is repatriated and taxed in the US; the limitation on use of US foreign tax credit regime by basing a US company’s foreign tax credits on the amount of total foreign tax actually paid on total foreign earnings.
The administration also proposed to prohibit US companies from claiming foreign tax credit for foreign taxes paid on income that is not subject to current US tax; and the current taxation of excess returns associated with transfers of intangibles offshore in circumstances that suggest excessive income shifting out of the US.
In general, US corporations are subject to US tax on the earnings of any foreign subsidiaries only when such earnings are repatriated as a dividend. This year’s budget defers deduction of interest expense related to foreign income until that income is repatriated and taxed in the US.
This is more of a timing difference as the deferred interest expense should be deductible in a subsequent tax year when the related income is actually repatriated back to the US. Although primarily targeted at US-headquartered groups, this measure could potentially impact Indian multinational that uses the US as a leveraged sub-holding company jurisdiction for making its foreign investments.
The foreign tax credit proposals are largely unchanged from last year’s budget. Pursuant to Internal Revenue Code Section 902, a US corporation receives a deemed-paid foreign tax credit upon receipt of a dividend from certain foreign subsidiaries.
The deemed paid credit offsets US tax by the amount of the foreign tax paid subject to certain limitations, thereby avoiding double taxation of foreign income. Under the budget proposal, the deemed paid credit would be determined on a pooled basis rather than by an entity-by-entity approach. This would be accomplished by pooling the aggregate foreign taxes and earnings of all the foreign subsidiaries from which the US taxpayer can claim a deemed-paid foreign tax credit.
The proposal would effectively ‘blend’ the earnings and foreign taxes into a single pool. The deemed paid foreign tax credit that can be claimed would be limited by the amount of the consolidated earnings and profit of foreign subsidiaries that is actually repatriated to the US.
The proposal would prorate foreign taxes over the taxpayer’s entire foreign income, including deferred income, neutralising the effect of rate differentials. Thus, the taxpayer would not be able to cherry-pick high-tax countries from which to repatriate income and obtain foreign tax credit exceeding its blended rate.
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