Tax Article - Corporate Tax Rate Cuts and Phase Out of FSC/ETI and Approved by House

The House approved the American Jobs Creation Bill of 2004 (HR 4520), which would repeal the IRC's foreign sales corporation/extraterritorial income tax (FSC/ETI) regime to comply with a European Union (EU) complaint that it illegally subsidizes exports. The Bill also contains several encouraging tax breaks for businesses.

The Senate must act on HR 4520 before a conference can begin to reconcile the bill with the Senate's counterpart, the Jumpstart Our Business Strength (JOBS) Bill (Sen 1637), which the Senate passed on May 11. 

Business Tax Breaks

HR 4520 contains numerous tax breaks that are unrelated to the FSC/ETI tax regime. It would extend the Code Sec. 179 business expensing for two years. By comparison, Sen 1637 allows a business to increase the amount of expensing. Both bills would repeal the 90-percent limitation on offsetting foreign tax credits against the alternative minimum tax (AMT), although HR 4520 would expand the AMT exemption amount from $7.5 million to $20 million of gross receipts.

In addition, HR 4520 would encourage repatriation of overseas earnings with an 85-percent deduction within a six-month window. Earnings would need to be reinvested in the U.S. to qualify, although the nature of the investment is not specified. The Senate bill would tax qualified dividends at 5.25 percent for a limited time.

Additional Corporate Tax Rates Cuts for Manufacturers

In Addition, HR 4520 contains two tax cuts for corporations. 

The first would gradually lower the tax rate from 35 to 32 percent by 2007 on certain manufacturing income of C corporations. The reduction would apply to income from the sale or exchange or any lease, rental or license of property manufactured, produced, grown or extracted within the U.S. Exactly what qualifies would be defined by regulations to be drafted after passage, said Joint Committee on Taxation Chief of Staff George Yin at the markup. Some tough "line drawing" would need to be done, he commented. Construction, engineering or architectural services performed in the U.S. would also qualify for the reduction.

The second cut would set a 32 percent tax rate by 2013 for all C corporations with taxable income between $7 million to $20 million. The cut would apply to manufacturing and service activities. The rate would be 33 percent for income between $75,000 and $1 million from 2005 through 2007. It would decline to 32 percent for income between $75,000 and $1 million from 2008 through 2010. Thereafter, the rate would remain at 32 percent while the upper limit would expand to $5 million in 2011 and 2012 and to $20 million in 2013. This provision would cover 99.7 percent of C corporations, said a Ways and Means staff member.

By contrast, Sen 1637 would grant all businesses a nine-percent tax deduction for manufacturing activities instead of cutting rates. The Ways and Means bill targeted C corporations because S corporations already received a tax cut when personal tax rates were reduced by the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA) (P.L. 107-16 ) and Jobs and Growth Tax Relief Reconciliation Act of 2003 (JGTRRA) (P.L. 108-27 ), a Ways and Means spokesperson said prior to the markup. Thomas had added that a tax cut creates less distortion than a deduction.

Three-Year Transition of FSC/ETI Repeal

The bill would gradually phase out the FSC/ETI regime. U.S. taxpayers would retain 100 percent of FSC/ETI benefits prior to 2005. They would receive 80 percent of FSC/ETI benefits for transactions during 2005 and 60 percent for those in 2006, with full repeal of benefits for transactions in 2007. However, the FSC/ETI regime would still apply to all transactions in the ordinary course of business that were undertaken pursuant to an existing contract in effect on January 14, 2002, and thereafter.

International Tax Reforms

HR 4520 also contains many reforms of international taxation similar to those in Sen 1637 . A significant difference is that the House bill would reduce the number of foreign income categories, or "baskets," from nine to two. The Senate's bill does not include this reduction. Instead, it would extend the foreign tax carryforward period to 20 years.

Conference

The Senate must formally act on HR 4520 before a conference can begin. A likely scenario is for the chamber to remove the House language, insert the text of Sen 1637, pass it and request a conference with the House to resolve differences. This could happen as early as the week of June 20.

EU Leader Welcomes Vote

EU Trade Commissioner Pascal Lamy congratulated the House on its vote. "I very much hope that both the House and Senate can now agree on a final text so that an FSC/ETI repeal bill is rapidly adopted and signed into law by President Bush," stated Lamy. "Let's hope the time will shortly come to put this long-standing dispute behind us once and for all."

White House Support

The Bush administration, in a written policy statement, urged the Congress to move quickly on enacting FSC/ETI legislation in order to end the tariffs that have been imposed on U.S. exports by the EU since March 1. The administration said it plans to work with conferees to move a final bill toward "budget neutrality."

If you have any questions, please contact Feeley & Driscoll's Boston CPA team, Email us or call 1 (888) 875-9770.

related links