[Congressional Record Volume 152, Number 105 (Wednesday, August 2, 2006)]
[Senate]
[Pages S8621-S8626]
From the Congressional Record Online through the Government Publishing Office [www.gpo.gov]

      By Mr. KERRY:
  S. 3777. A bill to amend the Internal Revenue Code of 1986 to ensure 
a fairer and simpler method of taxing controlled foreign corporations 
of United States shareholders, to treat certain foreign corporations 
managed and controlled in the United States as domestic corporations, 
to codify the economic substance doctrine, and to eliminate the top 
corporate income tax rate, and for other purposes; to the Committee on 
Finance.
  Mr. KERRY. Mr. President, today I am introducing the Export Products 
Not Jobs Act of 2006. Tomorrow, the Senate Finance Committee will hold 
a hearing to tackle the issue of tax reform and will hear from the 
chairman and vice chairman of the President's Advisory Panel on Federal 
Tax Reform. The panel's report took a broad look at our current tax law 
and made numerous recommendations. I agree with some of the 
recommendations and have concerns about others, but believe that the 
report provides a good starting place for a thorough discussion of tax 
reform.
  In 1994, the IRS estimated that a family that itemized their 
deductions and had some interest and capital gains would spend 11\1/2\ 
hours preparing their Federal income tax return. This estimate has 
increased to 19 hours and 45 minutes in 2004. It is time for Congress 
to pass bipartisan tax legislation in the style of Tax Reform Act of 
1986, which greatly simplified Tax Code. And our tax reform should be 
based upon the following three principles: fairness, simplicity, and 
opportunity for economic growth.
  Our Tax Code is extremely complicated. Citizens and businesses 
struggle to comply with ru1es governing: taxation of business income, 
capital gains, income phase-outs, extenders, the myriad savings 
vehicles, recordkeeping for itemized deductions, the alternative 
minimum tax, AMT, the earned-income tax credit, EITC, and taxation of 
foreign business income. I believe that our international tax system 
needs to be simplified and reformed to encourage businesses to remain 
in the United States. And today, I am introducing legislation that I 
hope will be fully considered as we begin our discussions on tax 
reform.
  Presently, the complexities of our international tax system actually 
encourage U.S. corporations to invest overseas. Current tax laws allow 
companies to defer paying U.S. taxes on income earned by their foreign 
subsidiaries, which provides a substantial tax break for companies that 
move investment and jobs overseas. Today, under U.S. tax law, a company 
that is trying to decide where to locate production or services--either 
in the United States or in a foreign low-tax haven--is actually given a 
substantial tax incentive not only to move jobs overseas but to 
reinvest profits permanently, as opposed to bringing the profits back 
to re-invest in the United States.
  Recent press articles have revealed examples of companies taking 
advantage of this perverse incentive in our Tax Code. For instance, 
some companies have taken advantage of this initiative by opening 
subsidiaries to serve markets throughout Europe. Much of the profit 
earned by these subsidiaries will stay in Ireland and the companies 
will therefore avoid paying U.S. taxes. Other companies have announced 
the expansion of jobs in India. This reflects a continued pattern among 
some U.S. multinational companies of shifting software development and 
call centers to India, and this trend is starting to expand to include 
the shifting of critical functions like design and research

[[Page S8622]]

and development to India as well. Some companies are even outsourcing 
the preparation of U.S. tax returns.
  The Export Products Not Jobs Act of 2006 would put an to end to these 
practices by eliminating tax breaks that encourage companies to move 
jobs overseas and by using the savings to create jobs in the United 
States by repealing the top corporate tax rate. This legislation ends 
tax breaks that encourage companies to move jobs by: (1) eliminating 
the ability of companies to defer paying U.S. taxes on foreign income; 
(2) closing abusive corporate tax loopholes; and (3) repealing the top 
corporate rate. It removes the incentive to shift jobs overseas by 
eliminating deferral so that companies pay taxes on their international 
income as they earn it, rather than being allowed to defer taxes.
  Last month, the Ways and Means Subcommittee on Revenue held a hearing 
on international tax laws. Stephen Shay, a former Reagan Treasury 
official, testified that our tax rules ``provide incentives to locate 
business activity outside the United States.'' Furthermore, he 
suggested that taxation of U.S. shareholders under an expansion of 
Subpart F would be a ``substantial improvement'' over our current 
system. The Export Products Not Jobs Act of 2006 does just that.
  Our current tax system punishes U.S. companies that choose to create 
and maintain jobs in the United States. These companies pay higher 
taxes and suffer a competitive disadvantage with a company that chooses 
to move jobs to a foreign tax haven. There is no reason why our Tax 
Code should provide an incentive that encourages investment and job 
creation overseas. Under my legislation, companies would be taxed the 
same whether they invest abroad or at home; they will be taxed on their 
foreign subsidiary profits just like they are taxed on their domestic 
profits.
  This legislation reflects the most sweeping simplification of 
international taxes in over 40 years. Our economy has changed in the 
last 40 years and our tax laws need to be updated to keep pace. Our 
current global economy was not even envisioned when existing law was 
written.
  The Export Products Not Jobs Act of 2006 that I am introducing today 
will not hinder our global competitiveness. Companies will be able to 
continue to defer income they earn when they locate production in a 
foreign country that serves that foreign country's markets. For 
example, if a U.S. company wants to open a hotel in Bermuda or a car 
factory in India to sell cars, foreign income can still be deferred. 
But if a company wants to open a call center in India to answer calls 
from outside India or relocate abroad to sell cars back to the United 
States or Canada, the company must pay taxes just like call centers and 
auto manufacturers located in the United States.
  Currently, American companies allocate their revenue not in search of 
the highest return, but in search of lower taxes. Eliminating deferral 
will improve the efficiency of the economy by making taxes neutral so 
that they do not encourage companies to overinvest abroad solely for 
tax reasons.
  The Congressional Research Service stated in a 2003 report that, 
``[a]ccording to traditional economic theory, deferral thus reduces 
economic welfare by encouraging firms to undertake overseas investments 
that are less productive--before taxes are considered--than alternative 
investments in the United States.'' Additionally, a 2000 Department of 
Treasury study on deferral stated, ``[a]mong all of the options 
considered, ending deferral would also be likely to have the most 
positive long-term effect on economic efficiency and welfare because it 
would do the most to eliminate tax considerations from decisions 
regarding the location of investment.''
  The revenue raised from the repeal of deferral and closing corporate 
loopholes would be used to repeal the top corporate tax rate of 35 
percent. The tax differential between U. S. corporate rates and foreign 
corporate rates has grown over the last two decades and the repeal of 
the top corporate rate is a start in narrowing this gap.
  The Export Products Not Jobs Act of 2006 would promote equity among 
U.S. taxpayers by ensuring that corporations could not eliminate or 
substantially reduce taxation of foreign income by separately 
incorporating their foreign operations. This legislation will eliminate 
the tax incentives to encourage U.S. companies to invest abroad and 
reward those companies that have chosen to invest in the United States. 
I urge my colleagues to join me in this effort, and ask for unanimous 
consent that the full text of the bill be printed in the Record.
  There being no objection, the text of the bill was ordered to be 
printed in the Record, as follows:

                                S. 3777

       Be it enacted by the Senate and House of Representatives of 
     the United States of America in Congress assembled,

     SECTION 1. SHORT TITLE; AMENDMENT OF 1986 CODE.

       (a) Short Title.--This Act may be cited as the ``Export 
     Products Not Jobs Act''.
       (b) Amendment of 1986 Code.--Except as otherwise expressly 
     provided, whenever in this Act an amendment or repeal is 
     expressed in terms of an amendment to, or repeal of, a 
     section or other provision, the reference shall be considered 
     to be made to a section or other provision of the Internal 
     Revenue Code of 1986.

             TITLE I--FOREIGN TAX REFORM AND SIMPLIFICATION

     SEC. 101. REFORM AND SIMPLIFICATION OF SUBPART F.

       (a) In General.--Subpart F of part III of subchapter N of 
     chapter 1 (relating to controlled foreign corporations) is 
     amended by striking sections 952, 953, and 954 and inserting 
     the following:

     ``SEC. 952. SUBPART F INCOME DEFINED.

       ``(a) In General.--For purposes of this subpart, except as 
     provided in this section, the term `subpart F income' means 
     the gross income of the controlled foreign corporation.
       ``(b) Exceptions for Certain Types of Income.--Subpart F 
     income shall not include--
       ``(1) the active home country income (as defined in section 
     953) of the controlled foreign corporation for the taxable 
     year, or
       ``(2) any item of income for the taxable year from sources 
     within the United States which is effectively connected with 
     the conduct by the controlled foreign corporation of a trade 
     or business within the United States unless such item is 
     exempt from taxation (or is subject to a reduced rate of tax) 
     pursuant to a treaty obligation of the United States.
     For purposes of paragraph (2), income described in paragraph 
     (2) or (3) of section 921(d) shall be treated as derived from 
     sources within the United States and any exemption (or 
     reduction) with respect to the tax imposed by section 884 
     shall not be taken into account.
       ``(c) Limitation Based on Earnings and Profits.--
       ``(1) In general.--For purposes of subsection (a), the 
     subpart F income of any controlled foreign corporation for 
     any taxable year shall not exceed the earnings and profits of 
     such corporation for such taxable year.
       ``(2) Recharacterization in subsequent taxable years.--If 
     the subpart F income of any controlled foreign corporation 
     for any taxable year was reduced by reason of paragraph (1), 
     any excess of the earnings and profits of such corporation 
     for any subsequent taxable year over the subpart F income of 
     such foreign corporation for such taxable year shall be 
     recharacterized as subpart F income under rules similar to 
     the rules applicable under section 904(f)(5).
       ``(3) Special rule for determining earnings and profits.--
     For purposes of this subsection, earnings and profits of any 
     controlled foreign corporation shall be determined without 
     regard to paragraphs (4), (5), and (6) of section 312(n). 
     Under regulations, the preceding sentence shall not apply to 
     the extent it would increase earnings and profits by an 
     amount which was previously distributed by the controlled 
     foreign corporation.
       ``(d) De Minimis Exception.--If the subpart F income of a 
     controlled foreign corporation for any taxable year 
     (determined without regard to this subsection and section 
     954(a)) is less than the lesser of--
       ``(1) 5 percent of gross income, or
       ``(2) $1,000,000,

     the subpart F income of such corporation for such taxable 
     year shall be treated as being equal to zero.
       ``(e) Special Rules Relating to Boycotts, Bribes, and 
     Certain Foreign Countries.--
       ``(1) In general.--Subpart F income of a controlled foreign 
     corporation for any taxable year (determined without regard 
     to this subsection) shall be increased by the sum of--
       ``(A) the product of--
       ``(i) the gross income of the corporation reduced by its 
     subpart F income (as so determined), and
       ``(ii) the international boycott factor (as determined 
     under section 999),
       ``(B) the sum of the amounts of any illegal bribes, 
     kickbacks, or other payments (within the meaning of section 
     162(c)) paid by or on behalf of the corporation during the 
     taxable year of the corporation directly or indirectly to an 
     official, employee, or agent in fact of a government, and
       ``(C) the gross income of such corporation which is derived 
     from any foreign country during any period during which 
     section 901(j) applies to such foreign country and which is 
     not otherwise treated as subpart F income (as so determined).
       ``(2) Special rule for illegal payments.--The payments 
     referred to in paragraph (1)(B) are payments which would be

[[Page S8623]]

     unlawful under the Foreign Corrupt Practices Act of 1977 if 
     the payor were a United States person.
       ``(3) Income derived from foreign country.--The Secretary 
     shall prescribe such regulations as may be necessary or 
     appropriate to carry out the purposes of paragraph (1)(C), 
     including regulations which treat income paid through 1 or 
     more entities as derived from a foreign country to which 
     section 901(j) applies if such income was, without regard to 
     such entities, derived from such country.

     ``SEC. 953. ACTIVE HOME COUNTRY INCOME.

       ``(a) In General.--For purposes of section 952(b), the term 
     `active home country income' means, with respect to any 
     controlled foreign corporation, income derived from the 
     active and regular conduct of 1 or more trades or businesses 
     within the home country of such corporation which 
     constitutes--
       ``(1) qualified property income, or
       ``(2) qualified services income.
       ``(b) Qualified Property Income.--For purposes of this 
     section--
       ``(1) In general.--The term `qualified property income' 
     means income derived in connection with--
       ``(A) the manufacture, production, growth, or extraction 
     (in whole or in substantial part)of any personal property 
     within the home country of the controlled foreign 
     corporation, or
       ``(B) the resale by the controlled foreign corporation 
     within its home country of personal property manufactured, 
     produced, grown, or extracted (in whole or in substantial 
     part) within that home country.
       ``(2) Property must be used or consumed in home country.--
     Paragraph (1) shall only apply to income if the personal 
     property is sold for use or consumption within the home 
     country.
       ``(c) Qualified Services Income.--For purposes of this 
     section--
       ``(1) In general.--The term `qualified services income' 
     means income (other than qualified property income) derived 
     in connection with the providing of services in transactions 
     with customers which, at the time the services are provided, 
     are located in the home country of such corporation.
       ``(2) Services must be used in home country.--Paragraph (1) 
     shall only apply to income if the services--
       ``(A) are used or consumed in the home country of the 
     controlled foreign corporation, or
       ``(B) are used in the active conduct of a trade or business 
     by the recipient and substantially all of the activities in 
     connection with the trade or business are conducted by the 
     recipient in such home country.
       ``(3) Special rule for insurance income.--If income of a 
     controlled foreign corporation--
       ``(A) is attributable to the issuing (or reinsuring) of an 
     insurance or annuity contract, and
       ``(B) would (subject to the modifications under section 
     954(c)(2)(B)) be taxed under subchapter L of this chapter if 
     such income were the income of a domestic corporation,
     such income shall be treated as qualified services income 
     only if the contract covers only risks in connection with 
     property in, liability arising out of activity in, or lives 
     or health of residents of, the home country of such 
     corporation.
       ``(4) Anti-abuse rule.--For purposes of this subsection, 
     there shall be disregarded any item of income of a controlled 
     foreign corporation derived in connection with any trade or 
     business if, in the conduct of the trade or business, the 
     corporation is not engaged in regular and continuous 
     transactions with customers which are not related persons.
       ``(d) Home Country.--For purposes of this section, the term 
     `home country' means, with respect to a controlled foreign 
     corporation, the country in which such corporation is created 
     or organized.

     ``SEC. 954. OTHER RULES AND DEFINITIONS RELATING TO SUBPART F 
                   INCOME.

       ``(a) Deductions To Be Taken Into Account.--For purposes of 
     determining the subpart F income of a controlled foreign 
     corporation for any taxable year, gross income, and any 
     category of income described in subsection (b) or (c) of 
     section 953, shall be reduced by deductions (including taxes) 
     properly allocable to such income or category. The Secretary 
     shall prescribe regulations for the application of this 
     subsection.
       ``(b) Election by Controlled Foreign Corporation To Be 
     Treated as Domestic Corporation.--
       ``(1) In general.--If--
       ``(A) a foreign corporation is a controlled foreign 
     corporation which makes an election to have this subsection 
     apply and waives all benefits to such corporation granted by 
     the United States under any treaty, and
       ``(B) such foreign corporation meets such requirements as 
     the Secretary shall prescribe to ensure that the taxes 
     imposed by this chapter on such foreign corporation are paid,

     such corporation shall be treated as a domestic corporation 
     for purposes of this title.
       ``(2) Period during which election is in effect.--
       ``(A) In general.--Except as provided in subparagraph (B), 
     an election under paragraph (1) shall apply to the taxable 
     year for which made and all subsequent taxable years unless 
     revoked with the consent of the Secretary.
       ``(B) Termination.--If a corporation which made an election 
     under paragraph (1) for any taxable year fails to meet the 
     requirements of subparagraph (B) of paragraph (1) for any 
     subsequent taxable year, such election shall not apply to 
     such subsequent taxable year and all succeeding taxable 
     years.
       ``(3) Treatment of losses.--If any corporation treated as a 
     domestic corporation under this subsection is treated as a 
     member of an affiliated group for purposes of chapter 6 
     (relating to consolidated returns), any loss of such 
     corporation shall be treated as a dual consolidated loss for 
     purposes of section 1503(d) without regard to paragraph 
     (2)(B) thereof.
       ``(4) Effect of election.--
       ``(A) In general.--For purposes of section 367, any foreign 
     corporation making an election under paragraph (1) shall be 
     treated as transferring (as of the 1st day of the 1st taxable 
     year to which such election applies) all of its assets to a 
     domestic corporation in connection with an exchange to which 
     section 354 applies.
       ``(B) Exception for pre-2007 earnings and profit.--
       ``(i) In general.--Earnings and profits of the foreign 
     corporation accumulated in taxable years beginning before 
     January 1, 2007, shall not be included in the gross income of 
     the persons holding stock in such corporation by reason of 
     subparagraph (A).
       ``(ii) Treatment of distributions.--For purposes of this 
     title, any distribution made by a corporation to which an 
     election under paragraph (1) applies out of earnings and 
     profits accumulated in taxable years beginning before January 
     1, 2007, shall be treated as a distribution made by a foreign 
     corporation.
       ``(iii) Certain rules to continue to apply to pre-2007 
     earnings.--The provisions specified in clause (iv) shall be 
     applied without regard to paragraph (1), except that, in the 
     case of a corporation to which an election under paragraph 
     (1) applies, only earnings and profits accumulated in taxable 
     years beginning before January 1, 2007, shall be taken into 
     account.
       ``(iv) Specified provisions.--The provisions specified in 
     this clause are:

       ``(I) Section 1248 (relating to gain from certain sales or 
     exchanges of stock in certain foreign corporations).
       ``(II) Subpart F of part III of subchapter N to the extent 
     such subpart relates to earnings invested in United States 
     property or amounts referred to in clause (ii) or (iii) of 
     section 951(a)(1)(A).

       ``(5) Effect of termination.--For purposes of section 367, 
     if--
       ``(A) an election is made by a corporation under paragraph 
     (1) for any taxable year, and
       ``(B) such election ceases to apply for any subsequent 
     taxable year,

     such corporation shall be treated as a domestic corporation 
     transferring (as of the 1st day of such subsequent taxable 
     year) all of its property to a foreign corporation in 
     connection with an exchange to which section 354 applies.
       ``(c) Special Rule for Certain Captive Insurance 
     Companies.--
       ``(1) In general.--Solely for purposes of applying this 
     subpart to related person insurance income--
       ``(A) the term `United States shareholder' means, with 
     respect to any foreign corporation, a United States person 
     (as defined in section 957(c)) who owns (within the meaning 
     of section 958(a)) any stock of the foreign corporation,
       ``(B) the term `controlled foreign corporation' has the 
     meaning given to such term by section 957(a) determined by 
     substituting `25 percent or more' for `more than 50 percent', 
     and
       ``(C) the pro rata share referred to in section 
     951(a)(1)(A)(i) shall be determined under paragraph (5) of 
     this subsection.
       ``(2) Related person insurance income.--For purposes of 
     this subsection--
       ``(A) In general.--The term `related person insurance 
     income' means any income which--
       ``(i) is attributable to a policy of insurance or 
     reinsurance with respect to which the person (directly or 
     indirectly) insured is a United States shareholder in the 
     foreign corporation or a related person to such a 
     shareholder, and
       ``(ii) would (subject to the modifications provided by 
     subparagraph (B)) be taxed under subchapter L of this chapter 
     if such income were the income of a domestic insurance 
     company.
       ``(B) Special rules.--For purposes of subparagraph (A)--
       ``(i) The following provisions of subchapter L shall not 
     apply:

       ``(I) The small life insurance company deduction.
       ``(II) Section 805(a)(5) (relating to operations loss 
     deduction).
       ``(III) Section 832(c)(5) (relating to certain capital 
     losses).

       ``(ii) The items referred to in--

       ``(I) section 803(a)(1) (relating to gross amount of 
     premiums and other considerations),
       ``(II) section 803(a)(2) (relating to net decrease in 
     reserves),
       ``(III) section 805(a)(2) (relating to net increase in 
     reserves), and
       ``(IV) section 832(b)(4) (relating to premiums earned on 
     insurance contracts),

     shall be taken into account only to the extent they are in 
     respect of any reinsurance or the issuing of any insurance or 
     annuity contract described in subparagraph (A).
       ``(iii) Reserves for any insurance or annuity contract 
     shall be determined in the same

[[Page S8624]]

     manner as if the controlled foreign corporation were subject 
     to tax under subchapter L, except that in applying such 
     subchapter--

       ``(I) the interest rate determined for the functional 
     currency of the corporation and which, except as provided by 
     the Secretary, is calculated in the same manner as the 
     Federal mid-term rate under section 1274(d), shall be 
     substituted for the applicable Federal interest rate,
       ``(II) the highest assumed interest rate permitted to be 
     used in determining foreign statement reserves shall be 
     substituted for the prevailing State assumed interest rate, 
     and
       ``(III) tables for mortality and morbidity which reasonably 
     reflect the current mortality and morbidity risks in the 
     corporation's home country shall be substituted for the 
     mortality and morbidity tables otherwise used for such 
     subchapter.

       ``(iv) All items of income, expenses, losses, and 
     deductions shall be properly allocated or apportioned under 
     regulations prescribed by the Secretary.
       ``(3) Exception for corporations not held by insureds.--
     Paragraph (1) shall not apply to any foreign corporation if 
     at all times during the taxable year of such foreign 
     corporation--
       ``(A) less than 20 percent of the total combined voting 
     power of all classes of stock of such corporation entitled to 
     vote, and
       ``(B) less than 20 percent of the total value of such 
     corporation,

     is owned (directly or indirectly under the principles of 
     section 883(c)(4)) by persons who are (directly or 
     indirectly) insured under any policy of insurance or 
     reinsurance issued by such corporation or who are related 
     persons to any such person.
       ``(4) Treatment of mutual insurance companies.--In the case 
     of a mutual insurance company--
       ``(A) this subsection shall apply,
       ``(B) policyholders of such company shall be treated as 
     shareholders, and
       ``(C) appropriate adjustments in the application of this 
     subpart shall be made under regulations prescribed by the 
     Secretary.
       ``(5) Determination of pro rata share.--
       ``(A) In general.--The pro rata share determined under this 
     paragraph for any United States shareholder is the lesser 
     of--
       ``(i) the amount which would be determined under paragraph 
     (2) of section 951(a) if--

       ``(I) only related person insurance income were taken into 
     account,
       ``(II) stock owned (within the meaning of section 958(a)) 
     by United States shareholders on the last day of the taxable 
     year were the only stock in the foreign corporation, and
       ``(III) only distributions received by United States 
     shareholders were taken into account under subparagraph (B) 
     of such paragraph (2), or

       ``(ii) the amount which would be determined under paragraph 
     (2) of section 951(a) if the entire earnings and profits of 
     the foreign corporation for the taxable year were subpart F 
     income.
       ``(B) Coordination with other provisions.--The Secretary 
     shall prescribe regulations providing for such modifications 
     to the provisions of this subpart as may be necessary or 
     appropriate by reason of subparagraph (A).
       ``(6) Related person.--For purposes of this subsection--
       ``(A) In general.--Except as provided in subparagraph (B), 
     the term `related person' has the meaning given such term by 
     subsection (d)(3).
       ``(B) Treatment of certain liability insurance policies.--
     In the case of any policy of insurance covering liability 
     arising from services performed as a director, officer, or 
     employee of a corporation or as a partner or employee of a 
     partnership, the person performing such services and the 
     entity for which such services are performed shall be treated 
     as related persons.
       ``(7) Regulations.--The Secretary shall prescribe such 
     regulations as may be necessary to carry out the purposes of 
     this subsection, including--
       ``(A) regulations preventing the avoidance of this 
     subsection through cross insurance arrangements or otherwise, 
     and
       ``(B) regulations which may provide that a person will not 
     be treated as a United States shareholder under paragraph (1) 
     with respect to any foreign corporation if neither such 
     person (nor any related person to such person) is (directly 
     or indirectly) insured under any policy of insurance or 
     reinsurance issued by such foreign corporation.
       ``(d) Other Definitions and Rules.--For purposes of this 
     section--
       ``(1) Treatment of branches.--If--
       ``(A) a controlled foreign corporation carries on 
     activities through a branch or similar establishment with a 
     home country other than the home country of such corporation, 
     and
       ``(B) the carrying on of such activities in such manner has 
     substantially the same effect as if such branch or similar 
     establishment were a wholly owned subsidiary of such 
     corporation,

     this subpart shall, under regulations prescribed by the 
     Secretary, be applied as if such branch or other 
     establishment were a wholly owned subsidiary of such 
     corporation.
       ``(2) Home country.--For purposes of paragraph (1)--
       ``(A) In general.--The term `home country' has the meaning 
     given such term by section 953(d).
       ``(B) Branch.--In the case of a branch or similar 
     establishment, the term `home country' means the foreign 
     country in which--
       ``(i) the principal place of business of the branch or 
     similar establishment is located, and
       ``(ii) separate books and accounts are maintained.
       ``(3) Related person defined.--For purposes of this 
     section, a person is a related person with respect to a 
     controlled foreign corporation, if--
       ``(A) such person is an individual, corporation, 
     partnership, trust, or estate which controls, or is 
     controlled by, the controlled foreign corporation, or
       ``(B) such person is a corporation, partnership, trust, or 
     estate which is controlled by the same person or persons 
     which control the controlled foreign corporation.

     For purposes of the preceding sentence, control means, with 
     respect to a corporation, the ownership, directly or 
     indirectly, of stock possessing more than 50 percent of the 
     total voting power of all classes of stock entitled to vote 
     or of the total value of stock of such corporation. In the 
     case of a partnership, trust, or estate, control means the 
     ownership, directly or indirectly, of more than 50 percent 
     (by value) of the beneficial interests in such partnership, 
     trust, or estate. For purposes of this paragraph, rules 
     similar to the rules of section 958 shall apply.''.
       (b) Conforming Amendment.--The table of sections for 
     subpart F of part III of subchapter N of chapter 1 is amended 
     by striking the items relating to sections 953 and 954 and 
     inserting:

``Sec. 953. Active home country income.
``Sec. 954. Other rules and definitions relating to subpart F 
              income.''.

       (c) Effective Date.--The amendments made by this section 
     shall apply to taxable years of controlled foreign 
     corporations beginning after December 31, 2006, and taxable 
     years of United States shareholders with or within which such 
     taxable years of such corporations end.

     SEC. 102. TREATMENT OF FOREIGN CORPORATIONS MANAGED AND 
                   CONTROLLED IN THE UNITED STATES AS DOMESTIC 
                   CORPORATIONS.

       (a) In General.--Section 7701(a)(4) of the Internal Revenue 
     Code of 1986 (defining domestic) is amended to read as 
     follows:
       ``(4) Domestic.--
       ``(A) In general.--The term `domestic' means, when applied 
     to a corporation or partnership, a corporation or partnership 
     which is created or organized in the United States or under 
     the law of the United States or of any State unless, in the 
     case of a partnership, the Secretary provides otherwise by 
     regulations.
       ``(B) Income tax exception for publicly-traded corporations 
     managed and controlled in the united states.--Notwithstanding 
     subparagraph (A), in the case of a corporation the stock of 
     which is regularly traded on an established securities 
     market, if--
       ``(i) the corporation would not otherwise be treated as a 
     domestic corporation for purposes of this title, but
       ``(ii) the management and control of the corporation occurs 
     primarily within the United States,

     then, solely for purposes of chapter 1 (and any other 
     provision of this title relating to chapter 1), the 
     corporation shall be treated as a domestic corporation.
       ``(C) Management and control.--For purposes of this 
     paragraph, the management and control of a corporation shall 
     be treated as primarily occurring within the United States if 
     substantially all of the executive officers and senior 
     management of the corporation who exercise day-to-day 
     responsibility for making decisions involving strategic, 
     financial, and operational policies of the corporation are 
     primarily located within the United States. The Secretary may 
     by regulations include other individuals not described in the 
     preceding sentence in the determination of whether the 
     management and control of the corporation occurs primarily 
     within the United States if such other individuals exercise 
     the day-to day responsibilities described in the preceding 
     sentence.''.
       (b) Effective Date.--The amendments made by this section 
     shall apply to taxable years beginning on or after the date 
     which is 2 years after the date of the enactment of this Act.

                 TITLE II--ECONOMIC SUBSTANCE DOCTRINE

     SEC. 201. CLARIFICATION OF ECONOMIC SUBSTANCE DOCTRINE.

       (a) In General.--Section 7701 is amended by redesignating 
     subsection (o) as subsection (p) and by inserting after 
     subsection (n) the following new subsection:
       ``(o) Clarification of Economic Substance Doctrine; Etc.--
       ``(1) General rules.--
       ``(A) In general.--In any case in which a court determines 
     that the economic substance doctrine is relevant for purposes 
     of this title to a transaction (or series of transactions), 
     such transaction (or series of transactions) shall have 
     economic substance only if the requirements of this paragraph 
     are met.
       ``(B) Definition of economic substance.--For purposes of 
     subparagraph (A)--
       ``(i) In general.--A transaction has economic substance 
     only if--

       ``(I) the transaction changes in a meaningful way (apart 
     from Federal tax effects) the taxpayer's economic position, 
     and
       ``(II) the taxpayer has a substantial nontax purpose for 
     entering into such transaction

[[Page S8625]]

     and the transaction is a reasonable means of accomplishing 
     such purpose.

     In applying subclause (II), a purpose of achieving a 
     financial accounting benefit shall not be taken into account 
     in determining whether a transaction has a substantial nontax 
     purpose if the origin of such financial accounting benefit is 
     a reduction of income tax.
       ``(ii) Special rule where taxpayer relies on profit 
     potential.--A transaction shall not be treated as having 
     economic substance by reason of having a potential for profit 
     unless--

       ``(I) the present value of the reasonably expected pre-tax 
     profit from the transaction is substantial in relation to the 
     present value of the expected net tax benefits that would be 
     allowed if the transaction were respected, and
       ``(II) the reasonably expected pre-tax profit from the 
     transaction exceeds a risk-free rate of return.

       ``(C) Treatment of fees and foreign taxes.--Fees and other 
     transaction expenses and foreign taxes shall be taken into 
     account as expenses in determining pre-tax profit under 
     subparagraph (B)(ii).
       ``(2) Special rules for transactions with tax-indifferent 
     parties.--
       ``(A) Special rules for financing transactions.--The form 
     of a transaction which is in substance the borrowing of money 
     or the acquisition of financial capital directly or 
     indirectly from a tax-indifferent party shall not be 
     respected if the present value of the deductions to be 
     claimed with respect to the transaction is substantially in 
     excess of the present value of the anticipated economic 
     returns of the person lending the money or providing the 
     financial capital. A public offering shall be treated as a 
     borrowing, or an acquisition of financial capital, from a 
     tax-indifferent party if it is reasonably expected that at 
     least 50 percent of the offering will be placed with tax-
     indifferent parties.
       ``(B) Artificial income shifting and basis adjustments.--
     The form of a transaction with a tax-indifferent party shall 
     not be respected if--
       ``(i) it results in an allocation of income or gain to the 
     tax-indifferent party in excess of such party's economic 
     income or gain, or
       ``(ii) it results in a basis adjustment or shifting of 
     basis on account of overstating the income or gain of the 
     tax-indifferent party.
       ``(3) Definitions and special rules.--For purposes of this 
     subsection--
       ``(A) Economic substance doctrine.--The term `economic 
     substance doctrine' means the common law doctrine under which 
     tax benefits under subtitle A with respect to a transaction 
     are not allowable if the transaction does not have economic 
     substance or lacks a business purpose.
       ``(B) Tax-indifferent party.--The term `tax-indifferent 
     party' means any person or entity not subject to tax imposed 
     by subtitle A. A person shall be treated as a tax-indifferent 
     party with respect to a transaction if the items taken into 
     account with respect to the transaction have no substantial 
     impact on such person's liability under subtitle A.
       ``(C) Exception for personal transactions of individuals.--
     In the case of an individual, this subsection shall apply 
     only to transactions entered into in connection with a trade 
     or business or an activity engaged in for the production of 
     income.
       ``(D) Treatment of lessors.--In applying paragraph 
     (1)(B)(ii) to the lessor of tangible property subject to a 
     lease--
       ``(i) the expected net tax benefits with respect to the 
     leased property shall not include the benefits of--

       ``(I) depreciation,
       ``(II) any tax credit, or
       ``(III) any other deduction as provided in guidance by the 
     Secretary, and

       ``(ii) subclause (II) of paragraph (1)(B)(ii) shall be 
     disregarded in determining whether any of such benefits are 
     allowable.
       ``(4) Other common law doctrines not affected.--Except as 
     specifically provided in this subsection, the provisions of 
     this subsection shall not be construed as altering or 
     supplanting any other rule of law, and the requirements of 
     this subsection shall be construed as being in addition to 
     any such other rule of law.
       ``(5) Regulations.--The Secretary shall prescribe such 
     regulations as may be necessary or appropriate to carry out 
     the purposes of this subsection. Such regulations may include 
     exemptions from the application of this subsection.''.
       (b) Effective Date.--The amendments made by this section 
     shall apply to transactions entered into after the date of 
     the enactment of this Act.

     SEC. 202. PENALTY FOR UNDERSTATEMENTS ATTRIBUTABLE TO 
                   TRANSACTIONS LACKING ECONOMIC SUBSTANCE, ETC.

       (a) In General.--Subchapter A of chapter 68 is amended by 
     inserting after section 6662A the following new section:

     ``SEC. 6662B. PENALTY FOR UNDERSTATEMENTS ATTRIBUTABLE TO 
                   TRANSACTIONS LACKING ECONOMIC SUBSTANCE, ETC.

       ``(a) Imposition of Penalty.--If a taxpayer has an 
     noneconomic substance transaction understatement for any 
     taxable year, there shall be added to the tax an amount equal 
     to 40 percent of the amount of such understatement.
       ``(b) Reduction of Penalty for Disclosed Transactions.--
     Subsection (a) shall be applied by substituting `20 percent' 
     for `40 percent' with respect to the portion of any 
     noneconomic substance transaction understatement with respect 
     to which the relevant facts affecting the tax treatment of 
     the item are adequately disclosed in the return or a 
     statement attached to the return.
       ``(c) Noneconomic Substance Transaction Understatement.--
     For purposes of this section--
       ``(1) In general.--The term `noneconomic substance 
     transaction understatement' means any amount which would be 
     an understatement under section 6662A(b)(1) if section 6662A 
     were applied by taking into account items attributable to 
     noneconomic substance transactions rather than items to which 
     section 6662A would apply without regard to this paragraph.
       ``(2) Noneconomic substance transaction.--The term 
     `noneconomic substance transaction' means any transaction 
     if--
       ``(A) there is a lack of economic substance (within the 
     meaning of section 7701(o)(1)) for the transaction giving 
     rise to the claimed benefit or the transaction was not 
     respected under section 7701(o)(2), or
       ``(B) the transaction fails to meet the requirements of any 
     similar rule of law.
       ``(d) Rules Applicable to Compromise of Penalty.--
       ``(1) In general.--If the 1st letter of proposed deficiency 
     which allows the taxpayer an opportunity for administrative 
     review in the Internal Revenue Service Office of Appeals has 
     been sent with respect to a penalty to which this section 
     applies, only the Commissioner of Internal Revenue may 
     compromise all or any portion of such penalty.
       ``(2) Applicable rules.--The rules of paragraphs (2) and 
     (3) of section 6707A(d) shall apply for purposes of paragraph 
     (1).
       ``(e) Coordination With Other Penalties.--Except as 
     otherwise provided in this part, the penalty imposed by this 
     section shall be in addition to any other penalty imposed by 
     this title.
       ``(f) Cross References.--

  ``(1) For coordination of penalty with understatements under section 
              6662 and other special rules, see section 6662A(e)
  ``(2) For reporting of penalty imposed under this section to the 
              Securities and Exchange Commission, see section 
              6707A(e).''.

       (b) Coordination With Other Understatements and 
     Penalties.--
       (1) The second sentence of section 6662(d)(2)(A) is amended 
     by inserting ``and without regard to items with respect to 
     which a penalty is imposed by section 6662B'' before the 
     period at the end.
       (2) Subsection (e) of section 6662A is amended--
       (A) in paragraph (1), by inserting ``and noneconomic 
     substance transaction understatements'' after ``reportable 
     transaction understatements'' both places it appears,
       (B) in paragraph (2)(A), by inserting ``and a noneconomic 
     substance transaction understatement'' after ``reportable 
     transaction understatement'',
       (C) in paragraph (2)(B), by inserting ``6662B or'' before 
     ``6663'',
       (D) in paragraph (2)(C)(i), by inserting ``or section 
     6662B'' before the period at the end,
       (E) in paragraph (2)(C)(ii), by inserting ``and section 
     6662B'' after ``This section'',
       (F) in paragraph (3), by inserting ``or noneconomic 
     substance transaction understatement'' after ``reportable 
     transaction understatement'', and
       (G) by adding at the end the following new paragraph:
       ``(4) Noneconomic substance transaction understatement.--
     For purposes of this subsection, the term `noneconomic 
     substance transaction understatement' has the meaning given 
     such term by section 6662B(c).''.
       (3) Subsection (e) of section 6707A is amended--
       (A) by striking ``or'' at the end of subparagraph (B), and
       (B) by striking subparagraph (C) and inserting the 
     following new subparagraphs:
       ``(C) is required to pay a penalty under section 6662B with 
     respect to any noneconomic substance transaction, or
       ``(D) is required to pay a penalty under section 6662(h) 
     with respect to any transaction and would (but for section 
     6662A(e)(2)(C)) have been subject to penalty under section 
     6662A at a rate prescribed under section 6662A(c) or under 
     section 6662B,''.
       (c) Clerical Amendment.--The table of sections for part II 
     of subchapter A of chapter 68 is amended by inserting after 
     the item relating to section 6662A the following new item:

``Sec. 6662B. Penalty for understatements attributable to transactions 
              lacking economic substance, etc.''
       (d) Effective Date.--The amendments made by this section 
     shall apply to transactions entered into after the date of 
     the enactment of this Act.

     SEC. 203. DENIAL OF DEDUCTION FOR INTEREST ON UNDERPAYMENTS 
                   ATTRIBUTABLE TO NONECONOMIC SUBSTANCE 
                   TRANSACTIONS.

       (a) In General.--Section 163(m) (relating to interest on 
     unpaid taxes attributable to nondisclosed reportable 
     transactions) is amended--
       (1) by striking ``attributable'' and all that follows and 
     inserting the following: ``attributable to--
       ``(1) the portion of any reportable transaction 
     understatement (as defined in section 6662A(b)) with respect 
     to which the requirement of section 6664(d)(2)(A) is not met, 
     or

[[Page S8626]]

       ``(2) any noneconomic substance transaction understatement 
     (as defined in section 6662B(c)).'', and
       (2) by inserting ``AND NONECONOMIC SUBSTANCE TRANSACTIONS'' 
     in the heading thereof after ``TRANSACTIONS''.
       (b) Effective Date.--The amendments made by this section 
     shall apply to transactions after the date of the enactment 
     of this Act in taxable years ending after such date.

  TITLE III--ELIMINATION OF HIGHEST CORPORATE MARGINAL INCOME TAX RATE

     SEC. 301. ELIMINATION OF HIGHEST CORPORATE MARGINAL INCOME 
                   TAX RATE.

       (a) In General.--Section 11(b)(1) (relating to amount of 
     tax imposed on corporations) is amended by striking 
     subparagraphs (C) and (D) and inserting the following new 
     subparagraph:
       ``(C) 34 percent of so much of the taxable income as 
     exceeds $75,000.''.
       (b) Certain Personal Service Corporations.--Section 
     11(b)(2) is amended by striking ``35 percent'' and inserting 
     ``34 percent''.
       (c) Conforming Amendments.--
       (1) Section 11(b)(1) is amended by striking the last 
     sentence.
       (2) Section 1201(a) is amended--
       (A) by striking ``35 percent'' each place it appears and 
     inserting ``34 percent'', and
       (B) by striking ``last 2 sentences'' and inserting ``last 
     sentence''.
       (3) Paragraphs (1) and (2) of section 1445(e) are each 
     amended by striking ``35 percent'' and inserting ``34 
     percent''.
       (4) Section 1561(a) is amended by striking ``last 2 
     sentences'' and inserting ``last sentence''.
       (d) Effective Date.--The amendments made by this section 
     shall apply to taxable years beginning after December 31, 
     2006.
                                 ______