Kyl Bill Would Allow Look-Through Payments to Related Foreign Corporations

S. 750. A bill to amend the Internal Revenue Code of 1986 to allow look-through treatment of payments between related foreign corporations; to the Committee on Finance.

Mr. KYL. Mr. President, the 108th Congress began the necessary process, as part of the American Jobs Creation Act, of rationalizing the way the United States taxes the foreign income of U.S.-based companies, thereby helping U.S. employers to be more competitive in international markets. There was one provision, however, that passed both the Senate and the House but that was dropped out of the conference report at the eleventh hour for reasons that were unrelated to the merits of the provision. That provision extended the general rule of tax deferral to dividends, interest, rents and royalties that are paid out in the ordinary course of active business activities by one foreign affiliate of a U.S. company to another affiliate in another country. Today, I am introducing legislation to make this important change.

The United States taxes U.S. companies on their worldwide income, but the general rule is that foreign subsidiary income is not taxed by the United States until the subsidiary earnings are brought back to the U.S. parent, usually in the form of a dividend. Subpart F of the Internal Revenue Code sets forth a number of exceptions to this general rule. Subpart F imposes current tax on subsidiary earnings generally when that income is passive in nature. One such exception taxes the U.S. parent when a subsidiary receives dividends, interest, rents or royalties from another subsidiary that is located in a different country. If the two subsidiaries are in the same country, however, current taxation does not apply.

The proposal I am introducing today would extend this "same- country" treatment to payments between related foreign subsidiaries that are located in different countries. This proposal is identical to the one that passed the Senate last year.

Today's global economy is significantly different from the environment that existed when the subpart F rules were first introduced in 1962. As the global economy has changed, the traditional model for operating a global business has changed as well. In today's world, it makes no sense to impose a tax penalty when a company wants to fund the operations of a subsidiary in one country from the active business earnings of a subsidiary in a second country. For example, to operate efficiently, a U.S.-based manufacturer will probably establish specialized manufacturing sites, distribution hubs, and service centers. As a result, multiple related-party entities may be required to fulfill a specific customer order. U.S. tax law today inappropriately increases the cost for these foreign subsidiaries to serve their customers in a very competitive business environment by imposing current tax on these related-party payments, even though the income remains deployed in the foreign market.

Further, financial institutions have established foreign subsidiaries with headquarters in a financial center, such as London, and branches in multiple countries in the same geographic region. This permits an efficient "hub and spoke" form of regional operation; however, this efficient business model may make it difficult for the same country exception under current law to be met for payments of dividends and interest.

Under the existing rules, American companies are at a real and significant competitive disadvantage as compared to foreign-based companies. By creating current U.S. taxation of active business income when subsidiaries make cross-border payments, U.S.-based multinationals are penalized for responding to market or investment opportunities by redeploying active foreign earnings among foreign businesses conducted through multiple subsidiaries. To remove this impediment, subpart F should be amended to provide a general exception for interaffiliate payments of dividends, interest, rents or royalties that are generated from an active business.

The right answer is to apply "look-through" treatment to payments of dividends, interest, rents and royalties between subsidiaries. If the underlying earnings would not have been subject to subpart F, the payments should not be subpart F income. Look- through treatment for payments of dividends, interest, rents and royalties should be permitted as long as the payments are made out of active business, non-subpart F, income. "Look-through" principles are already well-developed for other purposes of the Internal Revenue Code. For example, a look-through approach to the characterization of foreign income is used for purposes of calculating foreign tax credits. A consistent application of look-through principles would simplify the interaction between subpart F and the foreign tax credit rules.

If we want to keep U.S.-based multinational companies--who employ millions of workers here at home -- headquartered in the United States, we must modernize our tax rules so that our companies can be competitive around the globe I urge my colleagues to cosponsor this legislation to make a modest change in the law that will enhance the position of U.S.-based employers trying to succeed in competitive foreign markets.