Potential Changes to Certain International Provisions of the Tax Code proposed by the Biden Administration

In May, the U.S. Department of Treasury released General Explanations of the [Biden] Administration’s Fiscal Year 2022 Revenue Proposals, which specifies the many corporate tax changes proposed to take effect in 2022, including several modifications to the international provisions of the Internal Revenue Code.

This article presents a brief overview of some of those changes, namely the rules regarding Foreign Derived Intangible Income (FDII), anti-inversion, and sourcing of income from the disposition of an interest in a hybrid entity, as well as the elimination of certain deductions related to foreign income items. 

FDII is defined as “the portion of a domestic corporation’s intangible income that is derived from export operations.” The FDII inclusion, codified in IRC § 250, is calculated based on gross sales derived from certain tangible depreciable property located abroad. In addition to the income inclusion, IRC § 250 also makes available a deduction of 50% (in most circumstances) of the FDII included in the taxpayer’s gross income. The permanent benefit of this 50% deduction is a lowered effective corporate tax rate for those taxpayers able to utilize it. If approved, the Biden proposal would repeal the 50% deduction enumerated in § 250, an elimination that will significantly decrease the incentive to have significant exports and tangible property abroad. In place of the § 250 deduction, Biden would create a new general business credit equal to 10% of the expenses associated with the creation of U.S. jobs through onshoring of foreign trade or business. There may be additional changes to the R&D sections of the Code to encourage investment within the U.S., but information detailing these changes has not yet been published. 

The Biden proposal would also disallow various deductions that would otherwise be allocable to tax-exempt foreign income, including foreign income that’s removed from a taxpayer’s income (e.g., a dividends received deduction). The disallowance of these deductions is meant to further the breadth of § 265, which disallows deductions that arise from income that is otherwise excluded from income. Effectively, this disallowance would lower the foreign tax credit limitation by excluding foreign income not actually included in a taxpayer’s gross income from the overall calculation of the limitation. 

Finally, Biden’s proposal would alter the anti-inversion rules, as well as the sourcing and characterization of gain/loss from the sale of hybrid entity interest. The anti-inversion rules were designed to prevent different methods of taxation on the income derived from the sale or conversion of a hybrid entity interest solely based on where the new parent company resides (e.g. in the U.S. versus abroad). The rules, as written currently, are not triggered unless the shareholders of a U.S. parent company receive 80% or more of a new foreign parent’s stock in an exchange or merger transaction. The Biden proposal would alter the anti-inversion rules by replacing the 80% shareholder continuity test with a much lower “greater than 50% continuity” test.  As for hybrid interests, the proposal would not change the overall realization or recognition of gain or loss on the sale of a hybrid entity interest but would change the sourcing and characterization of these gains, likely to source more gain/loss to the U.S. than in the past. 

While all these changes are just proposed at this time, taxpayers should prepare for the scenario where at least some, if not all, will be adopted into law for the tax year 2022 and beyond. Schneider Downs is continuously monitoring new proposals and guidance as they’re released. Our experienced tax professionals would be happy to discuss any concerns you may have, international or otherwise, in this ever-changing tax landscape.

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Material discussed is meant for informational purposes only, and it is not to be construed as investment, tax, or legal advice. Please note that individual situations can vary. Therefore, this information should be relied upon when coordinated with individual professional advice.

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