Foreign tax reform bill.

A bill to improve the application of U.S. tax laws to American businesses operating abroad was introduced in May by House Ways and Means Committee Chairman Dan Rostenkowski (D-IIi.) and Willis Gradison (R-Ohio), a committee member.

The Foreign Income Tax Rationalization and Simplification Act of 1992, HR 5270, would affect both U.S.-based and foreign-based multinational companies. Although it probably will not be enacted this year, the bill may be reintroduced in the future.

The provisions affecting U.S. multinationals contain good and bad news. On the plus side, U.S. taxpayers would be permitted to include interest expenses and assets of foreign subsidiaries (rather than just U.S. subsidiaries, as under current law) for allocating interest expenses between U.S. and foreign source income. This generally would increase the amount of the foreign tax credit that is available to companies with significant foreign debt.

On the down side, the rules relating to the overseas inventory sales would be changed so income from such sales would be primarily U.S.-source income rather than foreign-source income. This would reduce the foreign tax credit available to U.S. companies selling inventory overseas.

Another piece of bad news is income deferral for controlled foreign corporations would be ended by generally treating all income of these companies as currently taxable. Under current law only certain passive-type income (interest, dividends, rents, royalties, etc.)of foreign subsidiaries currently is taxable to U.S. parent companies, while the remainder is deferred until distributed.

The tax credit available under section 936 for certain income of U.S. companies operating in Puerto Rico would be scaled back to 85% of the benefit available under current law.

The provisions relating to foreign multinationals are almost entirely bad news. In the transfer pricing area, the bill sets a minimum amount of taxable income to be reported by 25% foreign-owned U.S. corporations that engage in more than a threshold level of transactions (the lesser of $2 million or 10% of the U.S. company's gross income) with foreign related parties.

Unless exempt by tax treaty, foreign shareholders owning 10% or more of U.S. corporations would be subject to U.S. tax on any gain from disposition of the U.S. company stock.

Observation: The provisions directed at U.S. multinationals would be favorable for some taxpayers but unfavorable for many others. The provisions directed at foreign multinationals are generally all unfavorable and may have the unintended effect of provoking foreign governments to retaliate against U.S. companies operating abroad.

Edited by Herbert M. Paul, CPA, New York City (individual); Andrew R. Biebl, CPA, Biebl, Ranweiler & Co., New Ulm, Minnesota (small business); Robert Willens, CPA, senior vice-president at Lehman Brothers, New York City (corporate); Marianne Burge, CPA, director of international tax services, Kenneth Kral, CPA, international tax partner, and Jack Buhsmer, CPA, international tax manager, at Price Waterhouse,

New York City (international).