Addressing an Opaque Foreign Income Subsidy With Expense Disallowance
172 Tax Notes Federal 699 (2021)
25 Pages Posted: 9 Aug 2021
Date Written: August 2, 2021
Allowing U.S. shareholder deductions for expenses allocable to exempt foreign dividends and the portion of GILTI exempted by deduction is an opaque subsidy for foreign investment. This article’s analysis concludes that gross income offset by deductions whose object is to exempt foreign income from U.S. tax (exemptive deductions) is a class of income wholly exempt from taxes for purposes of applying the deduction disallowance rule of Section 265(a)(1) to such deductions. The amounts potentially subject to disallowance are substantial. This analysis raises questions for taxpayers who have taken deductions for these expenses and have not established a financial statement reserve or reported the position.
Based on the analysis in this article, a notice and comment regulation confirming the application of Section 265 to income offset by an exemptive deduction would reasonably interpret the statute. The Treasury Department’s Fiscal Year 2022 Revenue Proposals would amend Section 265 to disallow deductions allocable to a class of foreign gross income that is exempt from tax or taxed at a preferential rate through a deduction. The proposal states that no inference should be drawn regarding current law. Under the analysis in this article, the Treasury has authority to adopt a regulation irrespective of whether the legislative proposal is adopted.
The contributions of this article are to identify exemptive deductions as an expense disallowance issue, to illuminate its effect as a subsidy and its revenue importance, and to show how different legal avenues, including statutory interpretation, regulation, legislation and their combinations, are available to the government to address the issue.
Keywords: Federal tax, international tax, deductions, tax policy
JEL Classification: H2, H3, K3
Suggested Citation: Suggested Citation