- New York congressman's controversial bill frames the upcoming debate over corporate tax issues.
- Marie Leone
CFO.com | US - November 01, 2007
Rep. Charles Rangel (D-NY) hit a corporate nerve when he issued his new tax reform bill last Friday.
Since Rangel chairs the House Ways and Means Committee, the group
most responsible for writing U.S. tax policy, his proposed bills are
tracked closely and elicit a good deal of both criticism and support.
Most groups with vested interests in the bill already have announced
they will scrutinize its provisions and implications in the coming
weeks.
A few, however, are weighing in early, including the trade
association Financial Executives International and the U.S. Treasury
Department. FEI likes Rangel's proposal to cut the top marginal
corporate income tax rate from the current 35 percent to 30.5 percent.
But the group is less keen on several "revenue offset" provisions that
would, for example, defer research and development deductions for
U.S.-based companies and repeal the last-in, first-out (LIFO)
accounting method for inventory.
The offsets, noted FEI chief executive Michael Cangemi, would hurt
U.S. competitiveness in the global marketplace. "Competitiveness is the
name of the game in the world economy, and all aspects of corporate tax
reform should put U.S. companies on a level playing field with their
foreign competitors," Cangemi said in his official statement.
Treasury Secretary Henry Paulson vowed to oppose the bill, echoing
the White House's position. In a statement, Paulson asserted that
Rangel's "large, complex tax bill would dramatically raise taxes in
ways that in my judgment would hinder America's ability to compete in
the global economy."
To be sure, Paulson's main thrust seemed to be promotion of the
president's alternative-minimum-tax patch, a proposal floated in
February aimed at stopping an automatic tax increase that would affect
individual taxpayers — mostly middle-class workers. If the 40-year-old
tax rule is not adjusted by the end of the year, about 20 million
middle-class taxpayers could be subject to the AMT, which would force
them into the highest income tax bracket for 2008.
Paulson has called on Congress to apply the AMT patch within the
next few weeks to stop the automatic increase, rather than debate the
issue as part of Rangel's larger bill.
The nonpartisan Tax Foundation noted that Rangel's proposal to cut
the corporate rate would drop the United States in the combined
federal-state tax rate ranking from the second highest to fourth
highest among industrialized nations. Japan has the highest tax rate of
the group, at 39.5 percent, and Rangel's proposal would put the United
States behind Canada and Italy.
The Tax Foundation conceded that although the Rangel proposal may
seem inadequate compared to tax cuts delivered by international trading
partners, it is a signal that, "Congress is finally trying to catch the
wave of corporate income tax reduction that has been sweeping the
developed world for more than a decade." The report said that five
industrialized countries cut their corporate income tax rates in 2006,
with eight more — including Germany — slated to decrease rates by
January 1, 2008.
Whether Rangel's bill has a chance of passing in its current form
remains unclear. But the proposal has framed the debate. Here's a list
of the key corporate provisions contained in Rangel's Tax Reduction and
Reform Act of 2007 that executives — and their lobbyists — will likely
face in the months to come:
• Reduction of the corporate tax rate. The bill cuts the top corporate marginal tax rate from 35 percent to 30.5 percent (Estimated cost over 10 years: $364 billion.)
• Repeal of the deduction for domestic production activities.
The tax break, according to Rangel, benefits only a few corporations,
providing a 3.15 percent rate cut on domestic manufacturing income.
(Estimated to raise over 10 years: $115 billion.)
• Allocations of expenses and taxes for repatriated income.
The provision would require U.S.-based companies that defer income
through controlled foreign corporations to also defer the associated
deductions. Currently, corporations are allowed to take deferred
deductions and account for them on a current basis. (Estimated to raise
over 10 years: $106 billion.)
• Repeal of worldwide allocation of interest.
Current law, which has yet to take affect, allows U.S. corporations to
elect special interest allocation rules that reduce the amount of
interest expense allocated to foreign assets. (Estimated to raise over
10 years: $26 billion.)
• Limitations on treaty benefit for deductible payments.
The bill would prevent foreign multinationals that are incorporated in
tax haven countries from avoiding tax on income earned in the United
States. The provision addresses multinationals that route income
through structures that allow a U.S. subsidiary to make a deductible
payment to a country that has a tax treaty with the Unites States.
Usually, the company repatriates the earnings in the tax-haven country
after the deduction is taken. (Estimated to raise over 10 years: $6
billion.)
• Repeal of the LIFO inventory accounting method. Any
income recorded using the last-in, first-out accounting method for
booking inventory would be spread over eight years. (Estimated to raise
over 10 years: $107 billion.)
• Repeal of the inventory valuation choice method.
The bill would require corporations to value inventories at cost,
eliminating the opportunity to choose between the lower of cost and
market value. (Estimated to raise over 10 years: $7 billion.)
• Elimination of the special service provider rule.
The provision would prevent larger corporations (defined as C
corporations in the tax rules) that use the accrual method of
accounting from taking advantage of the special rule pertaining to
service providers. The current rule allows C corporations not to
account for amounts that will go uncollected based on the history of
the service provider. (Estimated to raise over 10 years: $225 million.)
• Permanent extension of enhanced small business expensing.
The bill would extend the current threshold amounts that small
businesses can count as a tax-deductible expense. The rule is scheduled
to expire in 2010, but the proposal would allow businesses to continue
at current levels — that is, $125,000 (indexed for inflation) with a
phase-out threshold of $500,000 (also indexed for inflation). After
2010, if the law is not changed, small businesses would only be able to
expense $125,000, with a $500,000 phase-out threshold, and neither
expense mark would be indexed for inflation. (Estimated cost over 10
years: $21 billion.)
• Increase in the amortization period for intangible assets.
The bill would increase the current 15-year amortization period for
intangibles to 20 years. (Estimated to raise over 10 years: $21
billion.)
• Clarification of the economic substance doctrine.
In any transaction that economic substance analysis is required, the
doctrine would be satisfied only if: (1) the transaction changes — in a
meaningful way — the corporation's economic position (apart from
federal income tax consequences); and (2) the corporation has a
substantial non-federal tax purpose for entering into the transaction.
The provision also imposes a 20 percent penalty on understatements that
stem from a transaction lacking economic substance. The fine rises to
40 percent if relevant facts are not adequately disclosed. (Estimated
to raise over 10 years: $4 billion.)
• Decrease in the deductions allowed for dividends received.
For 20-percent-owned corporation, the deduction would drop from 80
percent to 70 percent. For dividends currently eligible for a 70
percent reduction, the tax break would fall to 60 percent. (Estimated
to raise over 10 years: $5 billion.)
• Recognition of ordinary income on stock-option exercises.
This provision pertains to small businesses defined as S corporations
by the Internal Revenue Service. For S corporations with a tax-exempt
employee stock ownership plans (ESOP), the bill would require that
option holders recognize the amount of income that was shifted to the
tax-free ESOP when they recognize or sell the options. (Estimated to
raise in 10 years: $606 million.)
• Termination of special rules for DISCs.
This would end the domestic international sales corporation (DISC)
provision. DISCs, which are allowed to defer recognizing income, were
established in a 1971 tax law to encourage exporting. (Estimated to
raise over 10 years: $881 million.)
• Clarification of gain recognition in spin-off transations.
The bill would force corporations to treat distribtuions of debt in a
tax-free spin-off transaction in the same way as distributions of cash
or other properties. Currently, when a subsidiary distributes its own
debt to a parent corporation prior to a spin-off, it is considered a
tax-free transaction. (Estimated to raise over 10 years: $235 million.)
