Summary of Recent Developments in Federal Tax Policy The next - - PDF document

VENTAPS: Venable Tax Policy Summary

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Summary of Recent Developments in Federal Tax Policy

The next several months promise to be busy ones for tax policy makers on Capitol Hill. This Report — the first of a series — summarizes the key recent business-related and other developments in the tax policy area, and provides insight as to what might happen later this year. This Report was prepared by Sam Olchyk, who this month joined Venable after serving as a Legislation Counsel with the congressional Joint Committee on Taxation and, prior to that, as a Tax Counsel with the Senate Finance Committee.

Replacement of FSC/ETI rules introduced by bi-partisan group of the House Ways and Means Committee Members

On April 11, 2003, Representatives Philip M. Crane (R-IL), Chairman of the House Ways and Means Trade Subcommittee, and Charles B. Rangel (D-NY), Ranking Member of the House Ways and Means Committee, introduced legislation that would repeal the export-related tax benefits created by the Foreign Sales Corporation (FSC) rules and the Extraterritorial Income Exclusion Act (ETI). The proposed legislation would replace these export-related benefits with a deduction for domestic manufacturers that will reduce their effective tax rate on domestic manufacturing income. Another key co-sponsor of the legislation is Rep. Donald Manzullo (R-IL), Chairman of the House Small Business Committee. To briefly summarize the relevant FSC/ETI history, in 2000, the World Trade Organization (WTO) declared that the FSC rules constituted a prohibited export subsidy under the relevant WTO agreements. In an effort to comply with the WTO ruling, in December 2000 Congress repealed the FSC rules and replaced them with the ETI rules. Within days, the European Union challenged the ETI rules (on the same grounds as the challenge of the FSC rules). The WTO subsequently ruled that the ETI regime (like the predecessor FSC rules) constituted a prohibited export subsidy. Last month, the members of the European Union approved a list of over 1,800 U.S. products that would be targeted for EU trade sanctions unless the United States repeals the ETI rules. The trade sanctions could amount to $4.03 billion per year against U.S. exports. The European Commission is expected to approve the sanctions list in the next few weeks; the list then would be sent to the WTO for its approval. The Crane-Rangel-Manzullo legislation, also known as the Job Protection Act of 2003 (H.R. 1769), would allow a company to claim a tax deduction based on the percentage of its U.S. manufacturing revenues as compared to its worldwide manufacturing revenues. A company with 100 percent domestic manufacturing operations would be entitled to a 10 percent deduction (once the legislation is fully phased-in). H.R. 1769 would not affect transactions that are subject to a binding contract in effect on April 11, 2003. The Crane-Rangel-Manzullo legislation has the support of several large domestic manufacturers, including Caterpillar, Microsoft, Boeing and United Technologies, and could indeed lay the foundation for any legislative solution to the FSC/ETI dispute. Last year, House Ways and Means Committee Chairman William M. Thomas (R-CA) introduced H.R. 5095, the American Competitiveness Act of 2002. H.R. 5095 would have replaced the ETI rules with a series of tax incentives mostly designed to benefit U.S. companies doing business overseas. The bill was not brought before the Ways and Means Committee for consideration. Chairman Thomas is expected to introduce a significantly revised version of H.R. 5095 before Congress adjourns for its Memorial Day recess.

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Budget resolution leaves little time for Congressional tax-writing committees

While much of political Washington has been focusing on the last-minute “handshake” agreement by some Senators to limit the size of the tax cut in the reconciliation bill in the Fiscal Year 2004 Budget Resolution to $350 billion, less attention has been paid to the ambitious schedule established for the tax-writing committees. The Budget Resolution instructs the House Ways and Means Committee to report a tax bill not later than May 8, 2003, with tax cuts of not more than $550 billion (over the period 2003 through 2013). The Senate Finance Committee is instructed to report a tax bill not later than May 8, 2003, with tax cuts of not more than $350 billion (over the period 2003 through 2013). Given that Congress is not scheduled to return from recess until April 28 (Senate) or April 29 (House of Representatives), the tax-writing committee members will have less than 10 working days to agree on the components of a tax cut bill, hold a mark up session, and file the report. Senate Finance Committee Chairman Charles E. Grassley (R-IA) has indicated that the Senate Finance Committee tax cut package could include proposals that would accelerate the tax incentives enacted in 2001 (including the individual tax rate cuts, the child credit, and marriage penalty relief), as well as small business tax incentives and alternative minimum tax relief. House Ways and Means Committee Chairman William M. Thomas has not yet indicated what might be included in the House Ways and Means Committee tax cut package, although one proposal under consideration would tax dividend income at rates similar to the capital gains rates.

House passes energy tax incentives and corporate inversion provisions as part of energy bill; legislation awaits Senate action

On April 11, 2003, the House of Representatives passed H.R. 6, a comprehensive energy policy bill, by a vote of 247-175. Included in H.R. 6 are $18.7 billion in tax incentives for energy conservation, reliability, and production of traditional and alternative fuels that the House Ways and Means Committee passed earlier in the month as part of H.R. 1531, the Energy Tax Policy Act of 2003. Also included in the comprehensive energy bill are two provisions regarding “corporate inversion” transactions. For this purpose, a “corporate inversion transaction” is defined as any transaction in which: (1) a U.S. corporation becomes a subsidiary of a foreign entity (or substantially all of its properties are transferred to a foreign entity); (2) the former shareholders of the U.S. corporation hold (by reason of holding stock in the U.S. corporation) 80 percent or more of the stock of the foreign entity; and (3) the foreign entity (together with other 50-percent owned entities) does not have substantial business activities in the foreign entity’s country of incorporation. A provision in the energy bill denies the tax benefits of corporate inversion transactions completed after March 4, 2003 and before January 1, 2005, effectively imposing a moratorium on these transactions. Another provision in the energy bill expresses the sense of Congress “that passage of legislation to fix the underlying problems with our tax laws is essential and should occur as soon as possible, so United States corporations will not face the current pressures to engage in inversion transactions.” Regarding any expected Senate action, the Senate Finance Committee reported an energy tax bill that provided $15.6 billion in tax incentives for the energy sector. However, the Senate Energy Committee has yet to report an energy policy bill and, because of the immediate attention being focused on the reconciliation bill, it is unlikely that the Senate will act on the energy bill prior to this summer (or possibly in September).

Tax deductibility of settlement payments being questioned by Senators

Recent media stories regarding large settlement payments with federal and state regulatory agencies, such as the $1.4 billion settlement with Wall Street firms that is currently under review by the SEC, has caught the attention of some Members of Congress. Of particular concern to the Members is whether the companies are claiming a tax deduction with respect to the settlement payments, and to what extent are the agencies taking into account the after-tax effects in the negotiations with the companies. On February 28, 2003, Senator Charles Grassley (R-IA), Chairman of the Senate Finance Committee, Senator John McCain (R-AZ), Chairman of the Senate Commerce Committee, and Senator Max Baucus (D-MT), Ranking Member of the Senate Finance Committee, wrote to SEC Chairman William Donaldson expressing their “concern about press reports that [the settlements of lawsuits against certain Wall Street firms] are being structured to maximize the amount of the

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payments that are tax deductible, thereby leaving the American taxpayer to pick up much of the tab…This is unacceptable.” Because of the high-profile nature of this issue — the involvement of well-known companies, the large amounts at stake, and the heightened sensitivity to corporate accountability in a post-Enron environment — it would not be surprising to see the tax-writing committees become more involved in the issue. A starting point could be a proposal that the Senate Finance Committee was to consider last year in connection with a scheduled markup of the “Small Business and Farm Economic Recovery Act” (the markup never occurred). The proposal, which was included in the Chairman’s mark-up of the bill, would deny a deduction for any payment (whether by suit, agreement, or otherwise) to, or at the direction of, a government agency (federal, state or local) in relation to the violation of any law or the investigation or inquiry into the potential violation of any law. The proposal would apply with respect to any payments, including those where there is no admission of guilt or liability. An exception would apply to restitution payments that are paid to the specific persons who are actually harmed by the conduct of the taxpayer.

Senate passes the CARE Act and tax shelter legislation by an overwhelming margin

On April 9, 2003, the Senate passed legislation that is designed to provide incentives for charitable contributions by individuals and businesses. Known as the Charity, Recovery, and Empowerment Act of 2003 (or more simply, the CARE Act), the legislation includes tax incentives designed to encourage charitable giving incentives, improving the oversight of tax-exempt organizations, and other charitable and exempt organization proposals. For example, the legislation would permit tax-free distributions from IRAs for charitable purposes, and would expand the charitable contribution deduction rules regarding donations of food inventory. The CARE Act includes provisions that offset the $13.2 billion cost of the bill — most notably, the clarification of the economic substance doctrine — as well as other provisions designed to curtail tax

• shelters. The legislation also contains a provision that would require a corporation’s chief executive officer to sign the

corporate tax return. The Ways and Means Committee has not yet acted on a companion bill (and is unlikely to do so until after it has reported the reconciliation tax cut bill. VENTAPS: Venable Tax Policy Summary is published by the law firm of Venable LLP, 1201 New York Avenue, NW, Suite 1000, Washington, DC 20005. Internet address: http://www.venable.com. It is not intended to provide legal advice

• r opinion. Such advice may only be given when related to specific fact situations.

Sam Olchyk is a Partner in Venable’s Legislative and Business Transactions Groups. If you have any questions concerning this report, please contact Mr. Olchyk at 202-962-4034 or at solchyk@venable.com