Alternative minimum tax and foreign corporations. (International Taxation)by Peller, Michael S.
The corporate alternative minimum tax (AMT) was enacted by TRA86 to tax corporations that have substantial economic income, but pay no, or nominal, regular tax because of tax preferences or because of net operating loss (NOL) or credit carryforwards. Many foreign corporations which had never been subject to U.S. federal taxation may now find themselves subject to the AMT. This article discusses how the AMT applies to foreign corporations operating in the U.S..
Generally, the AMT is imposed at a rate of 20% of alternative minimum taxable income (AMTI) minus an exemption amount (up to $40,000). AMTI is determined by starting with taxable income before NOLs and then adding or subtracting certain preferences and adjustments. Preferences are certain items for which there has been a benefit for regular income tax purposes (e.g., tax-exempt interest from certain private activity bonds). Preferences are always positive (i.e., increase AMTI). Adjustments can be positive or negative. An example of an adjustment would be depreciation recomputed under a method different from the method used for regular tax purposes for post-1986 tangible personal property.
Further, NOL carryforwards can offset a maximum of 90% of AMTI. Therefore, even corporations with large NOLs may be subject to AMT.
Generally, AMT attributable to temporary differences between taxable income and AMTI may be carried forward as a credit to offset future regular tax liability.
The Book Income Adjustment--Applicable
Perhaps the most significant adjustment required for the AMT is the excess book income adjustment. The book income adjustment is an important concern for foreign corporations. For taxable years beginning in 1987, 1988 and 1989, this adjustment is computed by taking 50% of the excess of the corporation's "adjusted net book income" over AMTI calculated before this adjustment. Book income is adjusted to disregard any federal income taxes and foreign taxes for which a foreign tax credit has been taken. For taxable years beginning after 1989, the adjustment is computed by taking 75% of the excess of the corporation's "adjusted current earnings" over AMTI before the adjustment.
Adjusted current earnings are determined by computing AMTI without certain adjustments and without an NOL deduction. For years beginning in 1987 through 1989, the book income adjustment can only be positive (i.e., increase AMTI); while for years beginning after 1989, the adjustments can be negative, but only to the extent of previous post- 1989 positive adjustments.
IRC Sec. 56 specifies a hierarchy of the applicable financial statements that must be used to determine adjusted net book income. Highest priority is given to filings with the SEC. Then, in descending order of importance, the following financial statements may be used: certified audited financial statements; financial statements provided to a government entity; or other financial statements used for creditors, shareholders, etc. The financial statement available with the highest level of priority must be used.
With respect to U.S. operations of foreign corporations, these priority rules apply to financial statements prepared by any U.S. trade or business of a foreign corporation or attributable to more than one such trade or business. It would, therefore, appear that a foreign corporation's worldwide financial statements could not be used for this purpose because such financial statements are not prepared by or attributable to its U.S. operations.
Further, in some cases, a foreign corporation may be required to use a financial statement that is prepared under the GAAP of a foreign country. This would occur, for example, when a foreign corporation prepares a certified audited financial statement using the accounting principles of its home country for its U.S. business. Such statement is to be incorporated in the corporation's worldwide financial statements. A review statement may also be prepared by the U.S. business under U.S. GAAP for use by its creditors. Under the priority rules, the corporation must use the financial statement prepared under the accounting principles of its home country. The statements must be in U.S. dollars. There is an anti-abuse rule to prevent manipulation of the applicable financial statement rules to reduce the amount of the book income adjustment.
If a foreign corporation does not have any of the applicable financial statements described above, for years beginning prior to 1990, Sec. 56 requires that the corporation use earnings and profits (E&P) as a measure of book income. Further, E&P may be elected as a measure of book income by entities that do not have financial statements that fall within the first three categories (i.e., SEC filings; audited financials; or government filings). As noted above, after 1989 adjusted current earnings must be used.
E&P is similar to taxable income with adjustments made to reflect some economic income and expenses that are not reflected in taxable income (e.g., disallowed portion of meals and entertainment expenses). Also, E&P is reduced by federal income tax expense and certain foreign tax expense.
Book Income Adjustment--Effectively
Temp. Regs. provide that in computing the book income adjustment, a foreign taxpayer must use effectively connected net book income (if an appropriate financial statement is used) or effectively connected E&P (if the E&P election was made).
These provisions can often cause a substantial reduction or elimination of the book income adjustment for foreign corporations operating in the U.S. via a branch structure (e.g., international banks). For example, certain expenses which are allocated to effectively connected income for tax purposes may be significantly larger than would appear on a corporate financial statement. This would include allocation of interest expense under Reg. Sec. 1.882-5 and allocations of head office administrative expenses to U.S. operations. The following items would be deemed non-effectively connected income and therefore would have to be eliminated from the income shown on applicable financial statements:
* Interbranch income and expenses;
* Dividends, interest and royalties paid by a more than 50%-owned foreign subsidiary; and
* Subpart F income.
As a final note, an exemption under a U.S. income tax treaty can cause income to be excluded from "book income."
As an example of these rules, if a foreign corporation has a real estate business in the U.S. and also derives dividend income from security investments (unrelated to the real estate business), only the income from the real estate business would constitute book income for AMT purposes. If the foreign corporation had income from investment real property in the U.S. such income would constitute book income only if the corporation elected to treat such income as effectively connected under IRC Sec. 882(d). (See U.S. Treas. Temp. Reg. Sec. 1.56-IT(b) (7) exs. 10 and 11.)
Branch Profits Tax--Relation to AMT
Another concern of foreign corporations is the relationship between the AMT and the branch profits tax (BPT). As noted above, AMT is imposed to the extent it exceeds the regular tax. Under IRC Sec. 26(b), regular tax is defined to include all taxes imposed by Chapter 1 of the IRC, with certain exceptions. The Technical and Miscellaneous Revenue Act of 1988 has included the tax imposed by IRC Sec. 884 (relating to branch profits tax) as such an exception. Therefore, BPT liability will not reduce an AMT liability.
In determining effectively connected E&P for AMT purposes, the Temp. Regs. refer to effectively connected E&P for BPT purposes. Nevertheless, effectively connected E&P will not be the same for both purposes because there are statutory exceptions for BPT that do not apply to AMT. These include international shipping operations, certain distributions by foreign sales corporations, certain FIRPTA transactions and certain Subpart F insurance income.
Essentially, a two-track system for tax planning and computing tax liabilities has been created by the enactment of the AMT. Foreign corporations that were not liable for federal taxes in the past, now may be subject to AMT. This can result because a corporation had been utilizing NOL carryovers or because its financial statements reflect large book income. Therefore, proper tax planning to reduce or eliminate the AMT is crucial. One planning suggestion for 1989 might be to elect to use current E&P for the book income adjustment. For example, there are times it may be advantageous to accelerate or defer income to a year that the corporation pays AMT, because the AMT rate is lower than the regular tax rate. Temp. Regs. have provided some guidance in this area and more guidance should be forthcoming.
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