a foreign insurance company from its investment of unearned premiums or reserves which are ordinary and necessary for the proper conduct of its business. Issue In order to write insurance and accept reinsurance premiums, foreign insurance companies may be required by the laws of various jurisdictions in which they operate to meet various solvency requirements in addition to specified capital and legal reserve requirements. Many jurisdictions also employ an internal rule-of-thumb as to what the ratio of surplus to earned premiums should be. In the United States, the National Association of Insurance Commissioners employs a ratio of 1 to 3 (surplus to earned premiums) as the guideline by which State regulatory agencies can measure the adequate solvency of companies insuring casualty risks. Where the foreign jurisdiction does not impose requirements as severe as those required in the United States, a foreign insurance company participating in a reinsurance pool composed principally of companies doing business in the United States must, for all practical purposes, maintain this ratio to satisfy the State insurance authorities involved. These various requirements mean that an insurance company must keep a reserve of assets in relatively short-term passive investments. As a result the question arises as to whether the income from these investments should be treated as tax haven income. Explanation of provision This provision was in the House bill and was not changed by the Senate Finance Committee. The provision adds a new exception to the definition of foreign personal holding company income (sec. 954 (c) (3) (C)). Under the exception, foreign personal holding company income does not include dividends, interest, and gains from the sale or exchange of stock or securities derived from investments made by an insurance company of an amount of assets equal to one-third of its premiums earned (as defined under sec. 832 (b) (4)) during the taxable year on insurance contracts (other than for life insurance and annuity benefits under life insurance and annuity contracts, to which sec. 801 pertains). The exception only applies to passive income received from a person other than a related person (as defined in sec. 954 (d) (3)). Also, the exception only applies with respect to premiums which are not directly or indirectly attributable to the insurance or reinsurance of related persons. The provision applies to taxable years of foreign corporations beginning after December 31, 1975, and to taxable years of U.S. shareholders within which or with which the taxable years of the foreign corporations end. This provision applies to the American International Group, Inc. Revenue effect It is estimated that this provision will result in a decrease in budget receipts of $11 million in fiscal year 1977 and of $10 million per year thereafter. 8. Shipping Profits of Foreign Corporations (sec. 1024 of the bill) Present law One of the categories of foreign base company tax haven income subject to current taxation under the subpart F provisions of the Code is income derived from, or in connection with, the use of an aircraft or vessel in foreign commerce, except to the extent that the profits are reinvested in shipping assets. a. Country of incorporation and registration Issue In general, foreign tax haven income includes income earned by a corporation outside the country of incorporation. In the case of shipping income, however, no distinction is made under present law between cases where a corporation derives its shipping income in the same country where it is registered and incorporated and flag of convenience corporations which operate all over the world (other than the country of incorporation.) The issue is whether shipping activities should be categorized as a base company activity when the corporation involved carries on its activities entirely in the country in which it is organized. Explanation of provision This provision was added in the House bill and was not changed by the Senate Finance Committee. It establishes an exception to the foreign tax haven rules for shipping income derived from the operation of a vessel or airplane between two points in the country in which the vessel or airplane is registered and the corporation owning the vessel or airplane is incorporated. This provision affects the Hall Corporation Shipping Ltd. b. Drilling rig service companies Issue The issue is whether an exception to the tax haven provisions should be added in the case of a supply shipping operation between a point on shore and nearby offshore points. Explanation of provision This provision was proposed by Senator Bentsen. It provides an exception from the foreign tax haven rules for shipping income derived from the transportation of men and supplies from a point in a foreign country to a point (such as an oil drilling rig) located on the continental shelf of that country or on the continental shelf adjacent to the continental shelf of that country. This provision will affect all companies in the business of servicing oil drilling rigs. Interest has been expressed in this provision by the Jackson Maritime Company and the Tidewater Marine Service, Inc. c. Short-term charter income Issue The issue is whether an exception to the tax haven provisions should be applied in the case of a foreign corporation if neither the corporation nor any related person is involved in the shipping business except by deriving short-term charter income. Explanation of provision This provision was proposed by Senator Long. It provides an exception from the foreign tax haven rules for shipping income derived by a corporation from the short-term charter of vessels if that corporation or any related person does not own any ships or shipping facilities and does not manufacture, grow or extract goods shipped on vessels used by that corporation. The Southern Scrap Materials Company, Ltd. expressed interest in this provision but since it owns ship facilities, this provision will have no application to that company. d. Investments in qualified shipping assets Issue When shipping assets are acquired by using funds obtained by unsecured loans, present law is unclear as to what shipping profits are considered as reinvested in shipping assets and thus entitle a controlled foreign corporation to an exclusion from the subpart F provisions. Explanation of provision This provision was in the House bill and not changed by the Senate Finance Committee. It clarifies the method of determining the amount of a controlled foreign corporation's qualified investments in shipping assets (sec. 955 (b) (4)). Under the provision that a liability evidenced by an open account or a liability secured only by the general credit of the corporation is to be taken into account in determining the amount of the corporation's qualified investments in shipping assets, to the extent that such a liability constitutes a claim against the corporation's shipping assets. As a result, payments made by the corporation in discharge of an unsecured liability are treated under the amendment as increasing qualified investments in shipping assets, to the extent that the unsecured liability constitutes a claim against the corporation's shipping assets. This provision has application to Hall Corporation Shipping Ltd. 9. Limitation on Definition of Tax Haven Income for Agricultural Products (sec. 1025 of the bill) Present law One of the categories of foreign tax haven income subject to current taxation under the subpart F provisions of the Code is base company sales income. The Tax Reduction Act of 1975 contained an amendment which provides that base company sales income does not include the sale of agricultural commodities which are not grown in the United States in commercially marketable quantities. Issue Questions have been raised as to whether this exclusion applies to all agricultural products which are of a different grade or variety from the same product grown in the United States. The Treasury has taken the position that the exception in present law is very narrow. In addition it is questioned whether all foreign grown agricultural goods should be excluded from the definition of tax haven income. Explanation of provision The basic provision was in the House bill. The modification made was suggested by the Treasury Department staff. The provision ex 74-375-76- 2 cludes, for purposes of the tax haven foreign base company sales rules of subpart F, agricultural commodities grown or produced outside the United States if sold for use, consumption, or disposition outside the United States. This provision applies to taxable years of foreign corporations beginnings after December 31, 1975, and to taxable years of U.S. shareholders within which or with which the taxable years of the foreign corporation. This provision will affect most of the international grain corporations. Cargill, Inc., has been mentioned specifically as one bene"beneficiary. Revenue effect It is estimated that this provision will reduce budget receipts by $17 million in fiscal year 1977, $15 million in fiscal year 1978, and $15 million in fiscal year 1981. 10. Repeal of the Per-Country Foreign Tax Credit Limitation (sec. 1031 of the bill) Present law and committee amendment In order to prevent a taxpayer from using foreign tax credits to reduce U.S. tax liability on income from sources within the United States, two alternative limitations on the amount of foreign tax credits which can be claimed are provided by present law. Under the overall limitation, the amount of foreign tax credits which a taxpayer can apply against his U.S. tax liability on his worldwide income is limited to his U.S. tax liability multiplied by a fraction the numerator of which is taxable income from sources outside the United States (after taking all relevant deductions) and the denominator of which is his worldwide taxable income. The alternative limitation is the per-country limitation. Under this limitation the same calculation made under the overall limitation is made on a country-by-country basis. The allowable credits from any single foreign country cannot exceed an amount equal to U.S. tax on worldwide income multiplied by a fraction the numerator of which is the taxpayer's taxable income from that country and the denominator of which is worldwide taxable income. The provision repeals the per-country limitation. Taxpayers will be required to compute the limitation of the amount of foreign tax which can be used to reduce U.S. tax under the overall limitation. The effect of this provision is that losses from any foreign country will reduce income from other foreign countries for purposes of calculating the foreign tax credit limitation, and thus will reduce the amount of foreign taxes which can be used from those countries as a credit against U.S. tax. Foreign losses will reduce U.S. tax on U.S. income only in cases where foreign losses exceed income from all foreign countries for the taxable year. Issue The issue is whether transitional rules for the repeal of the percountry limitation should be provided in certain limited situations where substantial investments of capital have been made under the assumption that the foreign tax credit could be computed under the per-country limitation. 1 Explanation of provision The basic provision eliminating the per-country limitation was in the House bill. In addition, the House bill contained two transitional rules, one relating to mining and one relating to business in Puerto Rico and possessions. The Finance Committee made no change in the modification reating to mining. It tightened up the provision relating to Puerto Rico and the possessions. Certain existing mining ventures were begun with substantial investments of capital under the assumption that the foreign tax credit could be computed under the per-country limitation. The provision permits a limited transitional rule under which the per-country limitation may be used for years beginning before 1979 for domestic corporations (whether or not included in a consolidated return) which have, as of October 1, 1975, satisfied four conditions. The four conditions are that the corporation had as of October 1, 1975: (1) been engaged in the active conduct of the mining of hard minerals (of a character for which a percentage depletion deduction is allowable (under sec. 613)) outside the United States or its possessions for less than 5 years; (2) had losses from the mining activity in at least 2 of the 5 years; (3) derived 80 percent of its gross receipts since the date of its incorporation from the sale of the minerals that it mined, and (4) made commitments for substantial expansion of its mining activities. A similar problem was presented with respect to certain ventures begun in Puerto Rico or other possessions and the provision applies the special transition period developed for mining ventures to existing ventures in Puerto Rico or other possessions. The House bill retained the per-country limitation in the case of income and losses from Puerto Rico and other possessions. Losses sustained on a per-country basis under this provision are subject to future recapture on a per-country basis. The transitional rule relating to mining is believed to benefit the Freeport Minerals Company. Other mining corporations may also benefit. The provision relating to Puerto Rico and the possessions applies to PPG Industries, Inc. Revenue effect It is estimated that the transitional rules with respect to mining will reduce budget receipts by $12 million in fiscal year 1977, $10 million in fiscal year 1978, and $5 million in fiscal year 1979. It is estimated that transitional rule with respect to Puerto Rico and the possessions will reduce budget receipts by $6 million in fiscal year 1977, $5 million in fiscal year 1978, and $3 million in fiscal year 1979. 11. Recapture of Foreign Losses (sec. 1032 of the bill) Present law and committee amendment Present law permits taxpayers subject to U.S. tax on foreign source income to take a foreign tax credit for the amount of foreign taxes paid on income from sources outside of the United States. However, there are certain situations in which the present foreign tax credit system may indirectly result not only in a reduction of U.S. taxes on foreign source income previously subject to foreign tax, but also in a reduction of U.S. tax on U.S. source income not subject to foreign tax. The provision provides for the repeal of the per-country limita |