New Section Denies Tax Credits from Some Acquisitions

Sellers want to sell stock. Buyers want to buy assets. Though this common truism applies in the international acquisition context as much as in the domestic, it has become a little more complicated in the international arena as of late.

The Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010 added a provision that reduces the benefit of certain structuring techniques.

Sec. 901(m) reduces the amount of foreign tax credits available when there is a covered asset acquisition that occurs after 2010. Briefly, a covered asset acquisition is when a U.S. tax basis is created that is eligible for cost recovery from an election or transaction that is not subject to U.S. taxation and that results in higher U.S. tax basis than the foreign tax basis. The foreign tax annually attributed to the difference, prospectively, is not allowed as a foreign tax credit for U.S. tax purposes.

Congress enacted Sec. 901(m) to raise tax revenue so it could extend certain other tax deduction and tax credit provisions in the entire law. In addition, it seems some taxpayers were “double dipping” on foreign acquisitions by obtaining additional tax depreciation/amortization or other deductions through an election or check-the-box planning without a corresponding U.S. tax charge to get the step-up while also being permitted to benefit from the foreign tax imposed on the difference. Sec. 901(m) removes the double dip. Although not readily apparent, some view this provision as curbing the perceived advantages of making a foreign versus a domestic acquisition.

Practical Implications

Taxpayers and their advisors will have to determine the implication this provision will have on making an election or structuring a transaction to obtain a step-up in the U.S. tax basis of assets in a foreign acquisition and, if applicable, will require ongoing annual computations. Practically, because the corporate tax rates of industrialized countries are now lower than in the United States, obtaining the deductions from the step-up is probably worth more than losing the tax credits on the difference.

The financial accounting implications for acquisitions to which Sec. 901(m) applies will also need to be considered. It appears that companies that cannot assert permanent reinvestment of these earnings may find that the after-tax results are not as favorable with this provision as they were in the past. Note, there are some situations where it is not beneficial to make a Sec. 338 election (or using check-the-box structuring), particularly if there will be a U.S. tax asset basis step-down or if relatively high tax effective rate historic earnings exist in the target that the acquirer wishes to access.

This is not a taxpayer-friendly provision. It does not allow disregarded deductions – such as intercompany disregarded leveraging – that may exist under foreign law to be taken into consideration in determining the amount of foreign tax credits that are disallowed under this provision. Also, Sec. 901(m) does not prohibit deducting taxes, which can lessen the bite of this provision. However, taxpayers cannot pick and choose among subsidiaries as to which taxes they want to credit and which they want to deduct. Annually, you either have to credit all taxes or deduct all of them.

Sec. 901(m) is a complex statute. It does not seem as if it will make covered asset type acquisitions obsolete in the foreign context, but they will not be as beneficial as in the past. Further, this provision will create some additional administrative burdens to make the initial and ongoing calculations and record keeping a little more challenging.

This article first appeared in the Pennsylvania CPA Journal, a publication of the Pennsylvania Institute of Certified Public Accountants.