planning and policyissues

International Tax Policy Debate.” Get past the “alphabet soup” of CEN / CIN / CON; address new research e.g., finding outbound investment to be a complement not a substitute for home inv

Planning and Policy Issues Raised by the Structure of the U.S International Tax Rules

Daniel Shaviro NYU Law School

Broader context

Chapter 2 of book-in-progress currently entitled “Fixing the

U.S International Tax Rules.” (Livelier suggestions welcomed.)

Initial conception: “Current Intellectual State of the Play in U.S International Tax Policy Debate.”

Get past the “alphabet soup” of CEN / CIN / CON; address

new research (e.g., finding outbound investment to be a

complement not a substitute for home investment)

“Alphabet soup” debate is fundamentally flawed - why only 1 margin; how do we link WW and national welfare

A better focus: market power in imposing WW residence-based tax, analogy to standard/optimal tariffs, prisoner’s dilemma if

WW & unilateral diverge

More on the broader context Project then expanded to include specific reform proposals

Proposal 1: exemption but with transition tax; fix source rules without regard to residence No subpart F!

Rationale: weakness of corporate residence concept; no

windfall for prior outbound investment; fixing source rules for ALL multinationals obviates any need for subpart F

Proposal 2: If stuck with ceasefire-in-place, enact

burden-neutral repeal of deferral & foreign tax credit, with outbound rate declining to (say) 5%

Rationale: eliminate distortions & incentive problems from

deferral & FTC planning; existing burden on outbound stays

Ch 2: Planning & Policy Issues from

the U.S Rules’ Main Building Blocks

Two key facts about U.S international tax rules:

(1) Horrible ratio of tax planning & compliance costs to revenue raised; huge behavioral responses (e.g., 2005 dividend tax

holiday) for a modest yield

Fixing this is necessary, but not sufficient, to support current law (& its mode of compromise between WW & exemption)

(2) Huge economic changes since rules took current form in

1962 - globalization, etc., indicate greatly reduced U.S

market power to impose tax burdens

Plan of Chapter 2

Examine the 5 key features of U.S international tax law to

help evaluate means of compromise / placement between the

WW & exemption poles

E.g., look at planning responses, importance / feasibility of

underlying goals, can rules be reformulated to work better

The 5 key features are: (1) corporate residence rules, (2)

source rules, (3) FTCs with limits, (4) deferral, (5) subpart F

Corporations as Taxpayers

Corporations as separate TPs: domestically, this only matters due to rates, etc., & double taxation

But internationally, the chief reason why 1962-era thinking

(which failed to recognize its importance) no longer prevails

If all corporate income could be & were taxed to individuals on

a flow-through basis, capital export neutrality (CEN) & possibly national neutrality (NN) would remain intellectually dominant

Corporations: (a) residence isn’t normatively meaningful & is highly elective (at least up-front), (b) no budget constraint if

can attract new equity, (c) boundaries between “persons” not fixed

(1) Corporate residence

US: defined via place of incorporation

This definition has been surprisingly successful historically,

reflecting home equity bias

Despite tax disadvantages of US WW regime, US companies have > $10 trillion foreign assets, > $1 trillion unrepatriated

foreign earnings

To a degree, this equity is now “trapped.” Anti-inversion rules prevent pure tax plays; require some degree of real ownership change

But underlying market power is increasingly a thing of the past

Change the residence definition?

Other countries often look to HQs, “real seat,” etc

A changed US definition might reduce electivity – but enough? And suppose HQs have positive externalities

Also, why tax outbound investment by “US companies”?

For shares owned by US individuals, depends on efficiency

tradeoffs at multiple margins (with underlying constraint of

limited market power to burden US incorporation)

For shares owned by foreign individuals, nationally beneficial to impose tax burdens IF have market power from value of US

incorporation – but why base the levy on outbound investment?

(2) Source rules

Important for both inbound & outbound investment (the latter, due to FTC limit)

Meaningful economic content is limited even for active business income, verging on non-existent for portfolio income

Active income: “transfer pricing is dead” (Sullivan 2008);

formulary apportionment a hot topic but no panacea

Another big problem is intra-group debt (a key motivation for

some recent US inversions)

US earnings-stripping rules are weak, reflecting reliance on

subpart F to do the job for US companies

Defining source for active

business income

Unavoidable, despite incoherence, unless we shift to purely

WW tax on individuals (with no or unlimited FTCs)

Arguably, source rules should be corporate residence-neutral

Multinationals have income-shifting opportunities (& risk of

penalty) that businesses in just 1 country may lack

If don’t get it “right,” cross-border enterprise is tax-subsidized or tax-penalized

This is likely to be inefficient UNLESS subsidy can be

rationalized as targeted tax competition for mobile investment

BUT – does it increase, or merely reallocate, home investment?

Source of passive income

Formalistic rules (residence of corporate entities, “cubbyhole” approach to defining financial instruments) invite avoidance

Thus, e.g., “only fools pay [US] withholding taxes on dividends today” (Kleinbard 2007) given total return swaps

Luckily, this is no big deal given the lack of motivation for taxing foreigners on inbound investment (although note that inbound is being defined in terms of corporate residence)

Small open economy scenario (where investors can demand the

WW after-tax rate) suggests limited or no ability to impose tax burdens on foreigners via tax on inbound

(3) Foreign tax credits with limits

Worst rules in US int’l taxation? Key to the horrendous

tradeoff between planning costs & revenue, bad marginal

incentives

Analysts tend to miss this because they assume the only

alternative (exemption aside) is unmitigated double taxation

But one should distinguish between relevant margins (investing outbound vs economizing on foreign taxes paid)

Analysts also tend to assume one must have FTCs with limits

OR unlimited FTCs

Unclear why 100% & 0% should be the only permitted marginal reimbursement rates (MRRs) (Good political economy, but bad

economics)

Effective MRRs > 100%?

Although the MRR is nominally “just” 100%, TPs can actually profit from paying more foreign taxes

Suppose FTC claims arose whenever one wrote the check Then “excess-limit” companies would profit from being paid $1

to pay someone else’s $100 foreign tax

While claims aren’t freely transferrable in this way, withholding taxes can come pretty close (e.g., on cum dividend stocks)

Addressed in the US via economic substance rules, but the

problem is more fundamental

(4) Deferral

Doctrinal in origin from separate corporate entities, but retained

in the US since 1962 as a deliberate policy choice

Bad rules in the same sense as FTCs – rationalized by effect (all else =) on tax burden for outbound investment, but (a) other means available for that, (b) bad effects at another margin

Central role (with FTC limits) in bad ratio of planning costs to revenue – note Kleinbard on the CFO as “master blender.”

New view (Hartman 1984): if repatriation tax at a fixed rate is

inevitable, no lock-in of overseas investment

BUT: rate may change, more tax holidays?, cross-crediting may create varying rates, note also accounting considerations

Transition issue …

(5) Subpart F

Two main categories: (a) passive income, (b) overseas tax

planning (such as “base companies” in tax havens)

Intra-group interest is formally (a) but substantively (b) Use without subpart F greatly eased by check-the-box rules. (More on this Friday at CBT Summer Conference.)

Many view the case for taxing (a) as stronger than that for (b) – including HM Treasury at one stage of current reform process

But I question this, if source (and earnings-stripping) rules can

be used to limit use of intra-group interest by all (not just

resident) multinationals

Arguments for applying subpart F to passive income but not base companies

(i) Prevent income tax avoidance by individuals – But this can

be accomplished by PFIC & FPHC-type rules

(ii) Why encourage corporate groups to place passive assets in CFCs? – Fair enough, but note subpart F’s residence distortion

(iii) Make deferral costlier for firms with mature CFCs – But this

is normatively ambiguous even if one favours more WW tax

(iv) Why not allow base companies to save foreign taxes? – OK (reflecting problems with FTC), but same concern applies to

foreign source passive income

(v) Can’t source countries address base companies? – They may not want to, we may be glad they don’t, same issue for

passive

And in conclusion …

(1) Things don’t look good for a WW residence-based corporate tax – but why give transition windfall for old investment?

(2) Source is a huge problem but unlikely to go away Use

residence-neutral rules, aim for neutrality as to cross-border

ownership (issues of targeted tax competition aside)

(3) Deferral and FTCs/limits are bad rules Repealing without

other changes would vastly increase tax burden on outbound – but why should the choices be thus limited?

(4) In a residence-based corporate tax with deferral or partial

exemption, the case for taxing passive income may be no or little