In June, the House of Representatives passed the American Jobs Creation Act of 2004 (H.R. 4520). Now that the House has approved the bill, the stage is set for a conference with the Senate, which passed the companion Jumpstart Our Business Strength (JOBS) Act (S. 1637) in May. It is possible that the Congress will not be able to act on a compromise tax bill until the fall.
The House and Senate bills include a number of provisions that could impact corporate and financial transactions, including the following:
- Reduced corporate tax rate for domestic manufacturing
- One-time incentive to repatriate foreign earnings
- Treatment of corporate expatriation transactions
- S corporation reform
- NOL carryback and AMT NOL provisions
- Treatment of transfers to creditors in divisive reorganizations
- Clarify definition of nonqualified preferred stock
- Modify Section 355 active business test
- Extend foreign tax credit carryforward period
- Reporting of taxable mergers and acquisitions
- Expanded disallowance of deduction for interest on exchangeable debt
- Mandatory basis adjustments on partnership distributions and transfers
- CEO declaration required as part of corporate tax return
- Expanded holding period requirement for reduce tax rate on preferred stock dividends; and,
- Accrual of interest on contingent payment convertible debt instruments
- Reduced corporate tax rate for domestic manufacturing. The House and Senate bills repeal the extraterritorial income exclusion regime. The ETI incentive for manufacturing exports was declared unlawful by the World Trade Organization. In lieu of the ETI, the House bill provides for a reduced 34% tax rate on income from domestic manufacturing (to be reduced to 32% after 2006). The Senate bill would provide a tax deduction equal to a 5% of the income derived from domestic manufacturing (to be increased to 9% by 2009).
- Incentive to repatriate foreign earnings. The House and Senate bills provide a one-time incentive for U.S. multinational corporations to repatriate accumulated foreign earnings. Repatriated earnings would be taxed at an effective tax rate of 5.25%. The reduced tax rate would apply to the excess of the dividends received over the taxpayer’s average annual repatriation level over certain prior years. The dividend must be used for certain purposes within the United States. The House bill would limit the amount of eligible dividends to the greater of US$500 million or the amount shown the in the financial statements as earnings permanently invested outside the United States.
- Corporate expatriations. The House and Senate bills restrict the use of NOLs and other tax carryforwards to offset income and gains related to certain corporate expatriations. The Senate bill, moreover, essentially deny any U.S. tax benefit from the expatriation if the former shareholders of the U.S. corporation own at least 80% of the new foreign parent. The House bill applies retroactively to tax years ending after March 4, 2003. The Senate bill applies to expatriation transactions completed after March 20, 2002, and to certain expatriations completed after Dec. 31, 1996.
The House bill imposes a 15% excise tax on stock options and other stock-based compensation held by specified holders (generally, senior executives) during a period of six months before and after the expatriation transaction, generally effective March 4, 2003. The Senate bill is similar but with a 20% excise tax rate and an effective date of July 11, 2002.
- S corporation reform. The House bill includes various provisions to simplify the taxation of S corporations and expand S corporation availability, including treating family members as one shareholder and increasing the maximum number of S corporation shareholders from 75 to 100.
- NOL carryback and AMT NOL provisions. The Senate bill provides an election to carryback NOLs arising in 2003 for five years and waives the 90% limitation on AMT NOL carryforwards. The House bill repeals the 90% limitation on using AMT foreign tax credits for tax years beginning after Dec. 31, 2004.
- Transfers to creditors in divisive reorganizations. The Senate bill limits the amount of money or other assets that a parent corporation can transfer to its creditors without recognition of gain in distributions (spin-offs or split-offs) involving a divisive reorganization to the amount of the basis of the assets contributed to the Spinco.
- Definition of nonqualified preferred stock. Stock that is “nonqualified preferred stock” is treated as taxable “boot” in corporate transactions, subject to certain exceptions. Preferred stock is stock that is “limited and preferred as to dividends and does not participate in corporate growth to any significant extent.” The Senate bill clarifies the definition of “nonqualified preferred stock” by providing that such stock is not treated as participating in corporate growth to any significant extent unless there is a real and meaningful likelihood of the shareholder actually participating in the earnings and growth of the corporation.
- Section 355 active business test. One of the requirements for tax-free treatment under Section 355 in a corporate spin-off or split-off is that the distributing corporation and the corporation to be distributed must each be engaged in a five-year active business. If the group is in a holding company configuration it is often necessary for the group to restructure in order for the parent company to be able to satisfy the five-year active business requirement. The Senate bill applies the five-year active business test under Section 355 on an affiliate group basis, rather than a separate company basis.
- Foreign tax credit carryforwards. The Senate bill extends the foreign tax credit carryforward period from five years to 20 years and reduces the carryback period from two years to one year.
- Reporting of taxable mergers and acquisitions. The House bill requires an acquiring corporation or stock transfer agent (or acquired corporation if prescribed by Treasury) to file a return and furnish that information to shareholders where any gain or loss is recognized by the acquired corporation’s shareholders by reason of the acquisition of such corporation’s stock or assets. The return should contain the following information: a description of the transaction; the name and address of each shareholder of the target corporation recognizing gain on the transaction; consideration paid to each shareholder listed; and other information prescribed by Treasury. The Senate bill is substantially similar.
- Expanded disallowance of deduction for interest on exchangeable debt. The Senate bill expands the present-law disallowance of interest deductions on certain corporate convertible or equity-linked debt that is payable in, or by reference to the value of, equity of the issuer or a related person. The disallowance would be expanded to include interest on corporate debt that is payable in, or by reference to the value of, any equity held by the issuer (or any related party) in any other person, without regard to whether such equity represents more than a 50% ownership interest in such person. Capitalization of the disallowed amount would be allowed with respect to the equity of persons other than the issuer and related parties. The provision does not apply to debt that is issued by an active dealer in securities (or a related party) if the debt is payable in, or by reference to, the value of equity held in its capacity as a dealer in securities.
- Repeal special rules for FASITs. The House and Senate bills repeal the special rules for financial asset securitization trusts, with transitional relief for FASITs in existence on the date of enactment to the extent that regular interests issued by the FASIT prior to the date of enactment continue to remain outstanding in accordance with their original terms.
- Treatment of stripped bonds to apply to stripped interests in bond and preferred stock funds. The House and Senate bills authorize Treasury regulations to extend, in appropriate cases, original issue discount treatment similar to the stripped bond and stripped preferred stock rules to direct and indirect taxpayer interests in funds substantially all of the assets of which consist of either bonds or preferred stock. The regulations are not intended to cover funds primarily holding tax-exempt obligations. Regulations would apply prospectively except when necessary to prevent abuse.
- Mandatory basis adjustments on partnership distributions and transfers. Under present rules, a partnership does not adjust the basis of partnership property following the transfer of a partnership interest unless the partnership has made an election under Section 754. If an election is in effect, adjustments are made with respect to the transferee partner to account for the difference between the transferee partner’s proportionate share of the adjusted basis of the partnership property and the transferee’s basis in it partnership interest.
The Senate bill eliminates the election and makes the basis adjustment mandatory for transfers of partnership interests and certain partnership distributions, except in the case of the transfer of a partnership interest by reason of the partner’s death.
The House bill requires a partnership to adjust the basis of the partnership’s property in case of transfers of partnership interests with a “substantial built-in loss.” Substantial built-in losses are defined as a proportionate share of partnership assts exceeding a partner’s partnership interest by more than US$250,000. Similar basis adjustment rules would apply when partnership property with substantial built-in losses (greater than US$250,000) is distributed to partners, requiring the partnership to reduce its basis in other partnership property by an equivalent amount.
~ Deny installment treatment for all readily tradable debt. Under the present law, the installment method is not available if the taxpayer sells property in exchange for a readily tradable evidence of indebtedness that is issued by a corporation or a government or political subdivision. Under the Treasury regulations the indebtedness is considered regularly tradable if it is regularly quoted by brokers or dealers making a market in such obligations or is a part of an issue a portion of which is in fact traded on an established securities market. No similar provision under present law prohibits the use of the installment method where the taxpayer sells property in exchange for readily tradable indebtedness issued by a partnership or an individual. The Senate bill makes the installment method unavailable to all dispositions in exchange for readily tradable debt, regardless of the nature of the issuer of such debt.
- Limitation on importation and transfer of built-in losses. The Senate bill provides that, if net built-in loss property is imported into the U.S. in a tax-free organization or reorganization from persons not subject to U.S. tax, then the basis of each property so transferred is its fair market value. A similar rule applies in the case of the tax-free liquidation by a domestic corporation of its foreign subsidiary.
The Senate bill also provides that if the aggregated adjusted bases of property contributed by a transferor (or by a control group of which the transferor is a member) to a corporation exceed the aggregate fair market value of the property transferred in a tax-free incorporation, the transferee’s aggregate bases of the property is limited to the aggregate fair market value of the transferred property. Under the provision, any required basis reduction is allocated among the transferred properties in proportion to their built-in losses immediately before the transaction. The proposals generally apply to transactions and liquidations after December 31, 2003.
- Expand authority to disallow tax benefits. The Senate bill expands Internal Revenue Code Section 269 (Acquisitions Made to Evade or Avoid Income Tax) by including acquisitions that do not involve an acquisition of control. The proposal would be effective for stock and property acquired after Feb. 13, 2003.
- CEO declaration as part of corporate income tax return. The Senate bill requires the CEO of a corporation to sign a declaration under penalties of perjury that the corporation’s income tax return complies with the law and that the CEO was provided reasonable assurance of the accuracy of all material aspects of the return. The declaration would be part of the income tax return.
- Holding period for preferred stock. The Senate bill extends the holding period for dividends on certain preference stock (attributable to a period aggregating in excess of 366 days) for purposes of qualifying dividends to be taxed at the lower capital gain rate. Such stock must be held for more than 120 “good” holding period days during the 240-day period beginning 120 days before the ex-dividend date.
- Treatment of contingent payment convertible debt instruments. Under the Senate bill, any regulations which require original issue discount to be determined by reference to the comparable yield of a noncontingent fixed rate debt instrument is to be applied as requiring that such comparable yield be determined by reference to a noncontingent fixed-rate debt instrument which is convertible into stock. For purposes of this rule, the comparable yield would be determined without taking into account the yield resulting from the conversion of a debt instrument into stock.
The bills also include extensive tax shelter provisions, make significant changes to U.S. international tax rules and address certain leasing transactions. These proposals would be effective, expect as otherwise noted, from the date of enactment. Included as a companion document to this Alert is a summary side-by-side comparison of some of the key provisions in each bill. A comprehensive 80-page side-by-side comparison is available on request.
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This alert is correct to the best of our knowledge and belief as at the date of this alert. It is, however, written in general terms and professional advice must always be obtained before any action is taken.
Contact Robert F. Keane with comments or questions at