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tion, which will prevent a taxpayer who has foreign losses from reducing his U.S. tax on U.S. income if the taxpayer also has foreign income equal to or greater than the amount of losses. However, in a case where an overall foreign loss exceeds foreign income in a given year, the excess of the losses can still reduce U.S. tax on domestic source income. In this case, if the taxpayer later receives income from abroad on which he obtained a foreign tax credit, the taxpayer receives the tax benefit of having reduced his U.S. income for the loss year while not paying a U.S. tax for the later profitable year. To reduce the advantage to these taxpayers, the committee has included a provision which requires that in cases where a loss from foreign operations reduces U.S. tax on U.S. source income, the tax benefit derived from the deduction of these losses should, in effect, be recaptured by the United States when the company subsequently derives income from abroad.

In general, the recapture is accomplished by treating a portion of foreign income which is subsequently derived as income from domestic sources. The amount of the foreign income which is to be treated as income from domestic sources in a subsequent year is limited to the lesser of the amount of the loss (to the extent that the loss has not been recaptured in prior taxable years) or 50 percent of the foreign taxable income for that year, or such larger percent as the taxpayer may choose. Thus, in any taxable year the amount subject to recapture is not to exceed 50 percent of the taxpayer's foreign income (before recharacterization) unless the taxpayer chooses to have a greater percentage of his foreign income so recharacterized. For purposes of the recapture provision, a "foreign loss" does not include foreign expropriation losses.

Issue

The issue is whether the loss recapture provisions should apply to losses sustained for tax purposes in taxable years beginning after the December 31, 1975, effective date in certain situations where the investments had become worthless prior to that date or their value was greatly reduced because of losses incurred prior to that date.

Explanation of provision

This provision was proposed by Senator Packwood. The loss recapture provisions do not apply in the case of a loss from the disposition of a bond, note, or other evidence indebtedness issued before May 14, 1976, by a foreign government or instrumentality thereof for property located in that country or stock or indebtedness of a corporation incorporated in such country. This provision is intended to provide relief where domestic corporations incur losses with respect to foreign subsidiaries because they were forced, under the threat of expropriation, to exchange their stock or assets for long-term debt obligations of a foreign government. This provision applies to Boise Cascade Corporation.

A second exception was proposed by Senator Talmadge. This exception is provided where an investment in the stock or indebtedness of a

corporation in which the taxpayer owned at least 10 percent of the voting stock is substantially worthless prior to the effective date but where the loss is not sustained for tax purposes until after the effective date if the taxpayer terminates its investment in the loss corporation or corporations by liquidating, selling or otherwise disposing its investment before January 1, 1977, and the loss corporation has suffered an operating loss in three out of the last five taxable years beginning before 1976 and sustained an overall loss for those five years. This provision applies to United Merchants and Manufacturing, Inc.

Another provision was added by Senator Curtis. In some cases, a corporation may want to continue an investment beyond 1976 in an attempt to try to make the investment profitable, although it may ultimately fail in that endeavor. A third exception provides that if a loss would qualify for the second exception to recapture but for the fact that the investment is not terminated in 1976, there is to be no recapture of the loss to the extent there was on December 31, 1975, a deficit in earnings and profits, if the investment is terminated before January 1, 1979. This provision applies to Nabisco, Inc.

12. Transitional Carryback of Foreign Taxes on Oil and Gas Extraction Income (sec. 1035(a) of the bill)

Present law

Present law contains a limitation on the amount of foreign taxes with respect to foreign oil and gas extraction income which are allowable as a credit. This limitation was phased in beginning in 1975. The limitation is equal to 50.4 percent of the foreign oil and gas extraction income in 1976 and 50 percent of that income in 1977 and later years. Foreign taxes in excess of the limitation are not allowable as a credit in that year and cannot be carried forward or back to any other year.

Issue

The issue is whether during the phase-in period some carry forward or carryback provision is appropriate to deal with situations where timing differences between foreign tax systems and the U.S. tax system can result in a taxpayer having no foreign tax credits in some years in which the taxpayer has taxable income for U.S. tax purposes and having excess foreign tax credits in other years in which the taxpayer has little or no U.S. tax liability.

Explanation of provision

This provision is in the House bill and no change was made by the Senate Finance Committee. The provision permits a carryback to any taxable year ending in 1975, 1976, or 1977. The extraction taxes which may be carried back may offset only extraction income in the same country to which the extraction taxes were paid. The amount which may be carried back to any taxable year is limited to the net U.S. tax liability on the extraction income from that country for the year after taking into account any other foreign tax credits.

This provision affects Natomas and various small oil companies with operations in Indonesia.

Revenue effect

It is estimated that this provision will reduce corporate income tax liability for the year 1976 by $5 million, for the years 1977 and 1978, $10 million, and for the year 1979, $5 million.

13. Transitional Rule for Recapture of Foreign Oil-Related Losses (sec. 1035(b) of the bill)

Present law

Present law, as amended by the Tax Reduction Act of 1975, requires that the foreign tax credit be computed under a separate overall limitation for foreign oil-related income and that any foreign oil-related losses for taxable years ending after December 31, 1975, be recaptured in future years. The amount of losses to be recaptured in any year is the lesser of all prior unrecaptured losses or 50 percent of foreign oil-related income for the year.

Issue

The issue is whether any transitional rule should be provided for taxpayers who made investments in 1975 and earlier years with the anticipation that the losses arising in the early years of those investments (generally the first 3 to 5 years) would be allowed to reduce U.S. tax on U.S. income without being subject to full recapture under the provisions of present law.

Explanation of provision

This provision was proposed by Senator Curtis. The provision allows a taxpayer to recapture certain foreign oil-related losses over a longer period than under present law. The longer period applies only to a foreign oil-related loss which is sustained in a taxable year ending before January 1, 1979, and which was incurred pursuant to a binding contract to explore or to develop oil or gas property entered into on or before July 1, 1974. Under this provision, not more than 15 percent of the loss is recaptured for each of the first four taxable years beginning with the first year for which a foreign tax credit is claimed on foreign oil and gas extraction income. Thereafter, any remaining loss is recaptured in accordance with present rules.

This provision benefits Sun Oil Company.

Revenue effect

It is estimated that this provision will reduce budget receipts by $21 million in fiscal year 1977 and $6 million in fiscal year 1978. However, the reduction in those years will be recaptured by increased receipts in the following years.

14. Definition of Foreign Oil-Related Income (sec. 1035(c) of the bill)

Present law

Under present law, the amount of the foreign tax credits allowable for taxes paid with respect to foreign oil and gas extraction income is limited to 50 percent (50.4 percent in 1976) of that income. Any excess credits arising under this limitation can only be used to offset foreign oil-related income. Generally, oil and gas extraction income means

taxable income from the extraction of oil and gas and from the sale of assets used in such extraction activities. Foreign oil-related income includes taxable income from the extraction of oil and gas, the processing of oil and gas into their primary products, the transportation of the products, and the sale of assets used in such activities.

In addition, dividends and interest from a foreign corporation are included in foreign oil-related income. Foreign oil-related income also includes an allocable portion of dividends from a domestic corporation which earns oil-related income if such dividends are treated as foreign source income (because less than 20 percent of such corporation's gross income is derived from U.S. sources). However, interest from a domestic corporation earning foreign-oil-related income, which is likewise treated as foreign source income if less than 20 percent of its gross income is from U.S. sources, is not treated as oil-related income.

a. Interest paid by domestic corporations

Issue

The question is whether interest from domestic corporations should be treated differently than dividends from domestic corporations (and from interest or dividends from foreign corporations) for purposes of determining foreign oil-related income.

Explanation of provision

This provision was proposed by Senator Bentsen. The provision revises the definition of foreign oil-related income to include interest from a domestic corporation provided the interest is treated as foreign source income by reason of the fact that less than 20 percent of such corporation's gross income is derived from sources within the United States. As in the case of dividends included under present law, only the portion of the interest attributable to foreign oil-related income is included. The apportionment standards for foreign source income (sec. 862 (b)) are to be used in making the allocation.

This provision affects many international oil companies (but not Aramco).

Revenue effect

It is estimated that the inclusion of interest in oil-related income will result in a decrease in budget receipts of $40 million in fiscal year 1977 and of $90 million thereafter.

b. Public utility income

Issue

The issue is whether income of a regulated public utility which has some activities relating to the transportation and distribution of natural gas should be subject to the separate overall limitation as foreign oil-related income.

Explanation of provision

This provision was proposed by Senator Curtis. The provision revises the definition of foreign oil-related income so that it does not include income from the transportation or distribution of natural gas by a regulated public utility for use within its own regulated public utility operations within the country in which it is incorporated and in which the regulated public utility is located.

This provision affects IU International Corporation.

c. Sale of stock in foreign corporation joining in consolidated return

Issue

The issue is whether income from the sale of stock in a foreign corporation earning foreign oil extraction income or foreign oil-related income should be treated in a manner similar to income from the sale of assets of the same foreign corporation in cases where the foreign corporation joins in the filing of a consolidated return with a U.S. corporation.

Explanation of provision

This provision was proposed by Senator Bentsen. The provision clarifies the definition of foreign oil-related income and foreign oil and gas extraction income in the case of the sale of stock of a foreign corporation entitled to be included as a member of a consolidated group. Since the income from such a corporation is included in the consolidated group for purposes of determining whether the income is foreign oil-related or foreign oil and gas extraction income, the sale of the stock is to receive the same treatment, to the extent the assets of the company whose stock is sold were used for the production of either foreign oil-related income or foreign oil and gas extraction income.

This provision benefits Tenneco, Inc.

15. Taxation of Foreign Oil-Extraction Income of Individuals (sec. 1035(d) of the bill)

Present law

Under present law, individuals are subject to the same limitation as corporations on the amount of foreign tax credits which can be claimed against foreign oil-extraction and foreign oil-related income. Individuals are thus limited to foreign tax credits equal to 50.4 percent of taxable extraction income in 1976 and 50 percent of taxable extraction income in 1977 and future years. Furthermore, any excess credits arising under this limitation can only be used to offset foreign oil-related income.

Issue

The issue is whether the 50-percent limitations is appropriate in the context of noncorporate taxpayers, since unlike corporations, the average tax rate of individuals may be lower or higher than the 48 percent rate.

Explanation of provision

This provision was suggested by Senator Fannin. The provision limits the allowable foreign tax credit on foreign oil and gas extraction income of individuals to the average U.S. effective rate of tax on that income. The provision achieves this result by establishing a separate overall foreign tax credit limitation for foreign oil and gas extraction income of taxpayers other than corporations.

This provision benefits the Clara Miller Trust and individuals on limited partnerships with the Hamilton Brother Corporation.

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