By William H. Byrnes, Associate Dean, Walter H. & Dorothy B. Diamond International Tax & Financial Services Graduate Program
Faced with growing pressure to close the rapidly increasing budget deficit, President Obama outlined a series of proposed changes to the international tax system. The plan is touted as ''''levelling the playing field'''' and filling tax loopholes that allow U.S. corporations operating overseas to avoid U.S. income tax. The following is a discussion of some of the more important aspects of the proposals and the effects of the plan in a policy context.
Author Professor Byrnes writes: The following is a survey of some of the more important aspects of President Obama''''s tax proposals, firstly applicable to corporations and secondly to individuals that will impact deferral and international financial centers (tax havens)... [T]his survey does not address the reduction of U.S. withholding tax pursuant to equity swaps referencing U.S. equities.
(1) Deny immediate deductions on foreign investments when profits are deferred... The proposed change follows Congressman Rangel''''s from 2007 (H.R. 3970) to not allow a business to take these deductions until it pays taxes on the offshore profits. Interestingly, President Obama is seeking a major tax incentive carve-out for research and experimentation expenses, allowing these to be immediately expensed. Ironically, this tax incentive will be a boon to the tech and pharmaceutical companies whose use of deferral is a substantial driver for closing down the deferral loopholes.
(2) Revise the check-the-box rules to hamper foreign tax avoidance... President Obama''''s proposal would amend the check the box rules so that U.S. companies that establish certain offshore subsidiaries must treat them as corporations rather than as disregarded entities for U.S. tax purposes, effectively eliminating this technique for reducing foreign tax without triggering US taxation.
(3) Further limit the deductibility of interest payments by expatriated parties (earning stripping)... The proposal is that debt between related inverted parties may not claim the debt-to-equity safe harbor of 1.5 to 1, and that any interest deduction corresponding to this related party debt be reduced to a maximum 25% of adjusted taxable income, from 50%...
(4) Limit the shifting of income to a tax haven through the transfer of intangible property...To mitigate future controversy, President Obama proposes that for IRC Sections 482 and 367(d) workforce in place, goodwill and going concern will be included when determining the value of intangible property, and that such value will be determined at the standard of its highest and best use...
(5) Close loopholes in foreign tax credit (FTC) application... The first loophole occurs when corporations use the FTC to claim FTCs for foreign tax paid on profits that are not subject to U.S. tax... President Obama''''s proposal would not allow this splitting of foreign taxes from foreign income. A second loophole occurs when a U.S. parent controls several foreign subsidiaries and manipulates which of the foreign subsidiaries repatriates dividends based upon which among the subsidiaries has incurred substantial levels of foreign tax...President Obama''''s proposal requires that the FTC be calculated on a consolidated basis of all the foreign subsidiaries'''' income, both high and low taxed...
(6) Eliminate special tax treatment of U.S. companies with 80% foreign revenue... A U.S. company (80/20 company) with at least 80% of its gross income over a three-year testing period arising from foreign source active trade or business is not required to withhold on dividends and interest paid to foreigners... President Obama proposes to eliminate this federal withholding tax exception.
(7) Prevent tax avoidance when repatriating tax-deferred earnings via cross-border reorganizations...
(8) Revise Qualified Intermediary (QI) program... The Obama administration proposes [that]... 1) U.S. financial institutions must withhold 20-30% of all payments of U.S. income to non-QIs with the burden on the underlying income recipient to seek a refund by providing her identity and foreign bona fides; 2) QIs may not have any affiliates that are non-QIs; 3) QIs must file a 1099 form for each U.S. customer, just as U.S. banks must;...
(9) Bolster IRS'''' ability to promote international reporting compliance. President''''s Obama''''s plan would include hiring 800 new IRS staff to increase international enforcement and increase the IRS''''s enforcement budget by nearly $400 million. The statute of limitations would be increased on international tax enforcement to six years after the taxpayer submits required information...
Draft Legislation to Implement Proposed Changes
President Obama was a cosponsor of The Stop Tax Haven Abuse Act (S. 506) (STTHAA) while he was in the Senate. The bill was initially introduced on February 17, 2007. On March 2, 2009 a revised version of the bill was introduced by Senator Carl Levin. This bill is the first piece of the puzzle to implement President Obama''''s proposals...
Will the Plan have the Desired Policy Effect?
...[W}hy should corporations operating in foreign countries have the option of deferring a portion of their income until a time that''''s convenient for them to repatriate the funds?
Under this view of deferral, President Obama''''s plan does nothing more radical than bring taxation of the multinational in line with taxation of the carpenter''''s paycheck and of the mom and pop hardware store''''s modest revenue. But while it may be difficult to argue with the emotional appeal of this call to fairness, fairness is only one part of the analysis. Other principles and additional economic analysis must inform any examination of tax reform.
Of primary importance to the debate is an analysis of the economic consequences of foreign investment by domestic companies. Answering the clamor for fairness is an equally vociferous reply that in today''''s global village, U.S. economic welfare and leadership are dependent on the tax benefits provided to domestic companies operating overseas. The argument is made that limitations on deferral hurt U.S. global competitiveness and reduce the U.S.''''s economic health and growth...
In addition to the fairness and convenience principles, the principle of neutrality should play a primary role in evaluating the wisdom of tax reform. Neutral tax reform does not distort the economy by influencing behavior in the marketplace. Adam Smith addressed neutrality as part of his efficiency principle. His efficiency principle stated that tax polic
