Transcript - International Tax Policy Forum

US INTERNATIONAL
TAX POLICY:
OVERVIEW
International Tax Policy Forum
Briefing for Congressional Staff
March 5, 1999
US International Tax Policy
Contents

Economic perspective
– Global economic change: 1962-1999
– US investment abroad: help or hurt US economy?
– US international competitiveness: does it matter?

US law and policy
–
–
–
–
Overview
Foreign tax credit
Deferral regime
Policy
2
Economic Perspective
Topics

Global economic change: 1962-1999

US investment abroad: help or hurt US economy?

US international competitiveness: does it matter?
3
Global economic change
Technological drivers

Cost of info processing, $/instruction/second:
– Reduced by 10,000 times in 20 years (1975-1995)

Cost of communications, 3 minute telephone call
from NYC to London
– In 1960 = $50 (1996 $), $1 today

Electronic commerce -- the next wave
4
Global economic change
Deregulation, privatization




Transportation sector
Communications sector
Electric power sector
Pipeline sector
5
Global economic change
US Foreign direct investment (FDI)
 Declining US share of world FDI
Direct investment stock
1967
US share of world
50.4%

1996
25%
Declining US share of corp. headquarters
World’s 20 largest corps.
1960
1996
Number US corps.
18
8
6
Global economic change
Foreign direct investment

In 1996, 21,000 foreign affiliates of US companies
compete with 260,000 affiliates of foreign MNCs

Rising competition ...
ROR on assets (bef. int. & tax)
Nonfinancial foreign subs
1985
11.8%
1995
9.8%
7
Global economic change
US economy is far more dependent on FDI
US corporate profits
Share from foreign source
1960-69
7.5%
1990-97
17.7%
Sales of S&P 500 co’s
Foreign subs’ share
1985
25%
1997
34%
8
Global economic change
US Market in the 1960’s ...

In 1962, US companies focused on US market
– US economy was 40% of world GDP
– Scale economies achieved w/o foreign operations
– Little import competition
– Little foreign activity within US borders
9
Global economic change
30
25
20
15
10
Average,
G-7
Japan
Italy
United
States
Germany
France
Canada
0
United
Kingdom
5
US investment abroad (as % of GDP) trails behind
average for G-7 countries.
Source: World Investment Report 1997, United Nations.
10
Global economic change
US market today ...

Increased competition with US borders
– 14% of US nonbank corp assets foreign owned
– US imports have tripled to 9.6% of GDP

Foreign markets key to growth and profits
– Foreign sales of S&P 500 companies are growing
at 10%/yr vs 3%/yr domestically (1986-1997)
– 75% of world GDP is now outside US
11
Global economic change
1962
1997
Direct
Portfolio
Direct
Portfolio
Portfolio share of U.S. investment abroad has increased.
In 1997, 58% of US investment abroad was portfolio
investment, compared to 13% in 1962.
12
Global economic change
Market integration
 GATT, WTO and global reductions in tariff walls
 Regional trade agreements
– Euro Econ Area, NAFTA, ASEAN, Mercosur, etc.


Half of the 153 FTAs notified to GATT/WTO since
1990
MNCs view their business regionally
13
US FDI: help or hurt US economy?
The issue ...

Some argue US investment abroad comes at the
expense of domestic economy. Under this view,
Subpart F needed to protect US workers.

By contrast, the OECD finds:
“domestic firms and their employees generally gain
from the freedom of businesses to invest
overseas. As with trade, FDI generally creates net
benefits for host and source countries alike.”1
1
OECD, Open Markets Matter: The Benefits of Trade and
Investment Liberalization, 1998.
14
US FDI: help or hurt US economy?
Why US companies invest abroad
 FDI primarily attracted by consumer markets
abroad, not low wages
– 81% of FDI in high wage/income countries (1996)
– Only 9% of foreign sub sales are back to US (1995)
– Foreign sub employment has declined as a share of
domestic employment: 5.0% in 1982 to 4.9% in
1996

According to the UN ...
“accessing markets will remain the principal motive
for investing abroad”1
1 UNCTAD,
World Investment Report, 1997
15
US Companies Operate Abroad to
Sell Into Foreign, Not US, Markets
9%
68%
23%
The overwhelming majority of goods and services produced by UScontrolled foreign corporations are sold into foreign markets. In
1995, less than 10 percent of US-controlled foreign corporation
sales were exported to the US. (Source: PricewaterhouseCoopers
16
analysis based on US Department of Commerce data.)
US FDI: help or hurt US economy?
Why US companies invest abroad
 Transportation costs
 Tariffs
 Local content requirements
 Control vs. license valuable intangibles
17
US Investment and Jobs Abroad Have Not Increased
Relative to Domestic Investment and Jobs
10%
9%
8%
7%
6%
5%
4%
3%
2%
1%
0%
Foreign share of investment
6.9%
6.4%
5.0%
4.8%
Foreign share of employment
1982
1995
Employment in US CFCs dropped from 5.0% of US civilian
employment in 1982 to 4.8% in 1995. Similarly, gross output of UScontrolled foreign corporations has declined from 6.9 percent of US
GDP in 1982 to 6.4 percent in 1995. (Source: PricewaterhouseCoopers
calculations based on US Department of Commerce data.)
18
US FDI -- help or hurt US economy?
Impact on US employment

Foreign and domestic employment of US MNCs
are complements not substitutes:
“labor demand of US multinationals is linked
internationally at the firm level, presumably
through trade in intermediate and final goods, and
this link results in complementarity rather than
competition between employers in industrialized
and developing countries.”1
1 Riker
and L. Brainard, US Multinationals and Competition from Low
Wage Countries, NBER WP No. 5959, March 1997.
19
US FDI -- help or hurt US economy?
Impact on US employment
 US parents pay higher wages than purely
domestic companies1
– low paid production workers benefit more than
higher paid workers (in % terms)

According to the Council on Economic Advisers,
“On a net basis, it is highly doubtful that US direct investment
abroad reduces US exports or displaces US jobs. Indeed, US
direct investment abroad stimulates US companies to be more
competitive internationally ... [and] to allocate their resources
more efficiently, thus creating a healthier domestic operations,
which, in turn, tend to create jobs.” 2
1 Doms
and B. Jensen, Comparing wages, skills, and productivity between domestic
and foreign owned manufacturing establishments in the United States, mimeo, October
1996.
20
2 US CEA, Economic Report of the President, 1991, p. 259.
US FDI -- help or hurt US economy?
Impact on national income
 Rate of return on foreign sub assets is about 30%
higher than on domestic corporate investment
(1995)
 Foreign profits were $150 billion in 1997,
accounting for almost 18% of all US corp. profits
 The most recent IRS data shows that foreign subs
of US parents distributed $50 billion or 67% of
earnings and profits (1994 tax returns)
21
US FDI -- help or hurt US economy?
Impact on exports
 1996 data:
– Foreign subs purchase $194 billion of merchandise
exports from US
– US MNCs export $213 billion to unaffiliated co’s
– In total, US MNCs account for $407 billion of
exports, 65% of US merchandise exports

According to the OECD,
“Each dollar of outward FDI is associated with $2
of additional exports and with a bilateral trade
surplus of $1.7”1
1 OECD,
Open Markets Matter: The Benefits of Trade and Investment Liberalization,
1998, p. 50
22
US Companies Finance Foreign
Subs Primarily with Foreign Capital
$
24%
$
62%
$
14%
76% of the financing of US-controlled foreign corporations comes
from foreign sources -- not US parents. Debt and equity from US
parents financed less than 24% of total assets in 1995.
Source: PricewaterhouseCoopers calculations based on US Dept. of
Commerce data.
23
US FDI -- help or hurt US economy?
In conclusion, US FDI ...
 is complementary with US employment
 sells over 90% into foreign (not US) markets
 is overwhelmingly in high wage countries
 expands exports
 increases shareholder returns
 is associated with better wages in US
 benefits foreign economies, too
24
International competitiveness:
does it matter?
US MNCs ...
 locate over 70% of assets & jobs in US
 Invest and pay more per job at home than abroad
(including in developed countries)
 perform 88% of R&D in US (vs. 67% of sales)
 overwhelmingly have US leadership
 supply foreign subs much more heavily from US
sources
1 Source:
L. D’Andrea Tyson, They are not us: why American ownership still matters,
The American Prospect, Winter 1991, pp. 37-49
25
International competitiveness:
does it matter?
If US taxes foreign source income of its MNCs
more heavily than other countries …
... then market share of US MNCs will drop
– US portfolio investment will go to foreign MNCs
– Foreign acquisitions of US companies (Chrysler,
Amoco, Bankers Trust, TransAmerica, etc.)

New foreign investment will be under foreign parent

Foreign hdqtrs. necessary for corp. integration relief
– Foreign (vs. US) acquisitions of foreign companies

Foreign MNCs can pay more for foreign earnings
26
US Double Taxes Corp. Income
IRS
$26.00 Shareholder Tax
(40% Rate x $65)
Shareholders
$35 Corporate Tax
(35% Rate x $100)
$65 Dividend
$100 of
Operating
Income
Company
61% Tax Rate on Corporate Income
27
Corporate Taxation in OECD
Member Countries, 1990
Classical
Corporate-shareholder integration
income tax
Netherlands
Switzerland
U.S.
Shareholder level
Corporate level
Imputation
System
Tax credit
method
Special personal
tax rate
Australia
Finland
France
Germany*
Ireland
Italy
New Zealand
Norway
Turkey
U.K.
Canada
Portugal
Spain
Austria
Belgium
Denmark
Greece
Japan
Luxembourg
Sweden
Germany*
Iceland#
*/ Hybrid tax system (relief from double taxation at both corporate and shareholder levels).
#/ Deduction for dividends paid may offset fully the corporate and personal income tax for dividends up
to 15% of capital value. Dividends in excess of this limit are fully taxed at both levels.
Sources: Sijbren Cnossen, Reform and Harmonization of Company Tax Systems in the European
Union, Research Memorandum 9604. Erasmus University, Rotterdam.
OECD, Taxing Profits in a Global Economy: Domestic and International Issues, 1991, p. 57.
28
The US International Tax
System: Law and Policy




Overview
Foreign Tax Credit
Deferral
Policy
29
The US International Tax
System: Overview
30
International Tax: Overview


International tax rules are needed to prevent
double taxation of cross-border operations—
taxation by two countries of the same income.
Countries use various mechanisms to avoid
double tax:
– “Territorial” systems exempt foreign source income
– “Worldwide” systems allow a credit (or, in some
cases, a deduction) for foreign taxes
31
International Income Taxation,
OECD Countries, 1990
No.
Territorial tax system
By statute
By treaty1
Worldwide tax system
By statute
By treaty2
1
Austria
Australia4
Greece
Ireland
2
Belgium3
Canada
Iceland
Norway
Portugal
5
3
France
Denmark
Italy
4
Finland
Sweden
Japan
5
Luxembourg
Germany
New Zealand
6
Netherlands
Spain
7
Switzerland6
Turkey
8
U.K.
9
U.S.
1
2
3
4
5
6
For nontreaty countries, worldwide tax with credit.
For nontreaty countries, worldwide tax with deduction.
Exemption of 90% of gross dividend.
Treaty countries with tax system similar to Australia's.
25% ownership requirement and tax system similar to Denmark's.
Credit for Swiss tax on foreign dividends effectively exempts these dividends from
Swiss tax.
Source:
OECD, Taxing Profits in a Global Economy: Domestic and International Issues, 1991,
pp. 63-64.
32
The US System:
Worldwide Taxation

The US has a “worldwide” tax system
– The US taxes all income of US persons (citizens,
corporations, and “residents”), whether earned here
or abroad.
– The other country also often taxes amounts earned
by US persons there.
– This requires a mechanism to avoid double taxation
by both the US and the other country of the same
earnings.
33
The US System: Foreign Tax
Credit and Deferral


The US relieves international double taxation by
allowing a credit for foreign taxes.
As in the case of US subs, tax generally is
imposed on the foreign earnings of foreign subs
only when they are paid as a dividend (or
otherwise “repatriated” to the US)
34
The US International Tax System:
The Foreign Tax Credit
35
The Foreign Tax Credit:
Background

The US was the first country to provide a foreign
tax credit, which we did by statute in 1918.

A foreign tax credit has been allowed in some form
under US law ever since.
36
The Foreign Tax Credit:
Background

The purpose of the US foreign tax credit is to
eliminate double tax on foreign income.

The foreign tax credit is a dollar-for-dollar offset of
the foreign tax against the US tax on foreign
income--not US income.

Numerous limitations apply.
37
The Foreign Tax Credit:
Computation

A formula is used to determine the tax the US
would have imposed on the foreign income:
Foreign source taxable income
Worldwide taxable income

X US tax on worldwide
taxable income
A foreign tax credit is allowed for the lesser of this
“limitation” amount and the amount of foreign tax
actually paid or accrued.
38
The Foreign Tax Credit:
Computation

This computation must be done separately for
each “basket” of foreign source income.

The purpose of the “basket” rules is to prevent
averaging of taxes among different types of
income.
39
Foreign Tax Credit Baskets

General Limitation
Income

High Withholding Tax
Income

Passive Income

Shipping Income

Financial Services
Income

DISC Dividends

FSC Distributions

Foreign Trade Income

10-50 Dividends
(until 2002)
40
Steps to Compute
Foreign Tax Credit Limitation
1. Determine US and Foreign Source Taxable
Income:
– Gross Receipts (minus cost of goods sold)
– Other Gross Income
2. Determine Deductions Allocable to US and
Foreign Income.
3. Determine Net US and Foreign Source Income.
41
Steps to Compute
Foreign Tax Credit Limitation
4. Determine FTC Category (“Basket”)
– Characterize Gross Income
– Source Gross Income
5. Allocate and Apportion Deductions among FTC
Categories of Gross Income.
6. Determine Amount of Creditable Foreign Taxes
Within Each Category.
42
Source of Income Rules
Different Source Rules for Different Types of
Income:




Income from the Sale
of Purchased Inventory
Income from the Sale
of Manufactured
Inventory
Dividends
Interest





Rents
Royalties
Sale of Stock
Sale of Intangibles
Other
43
Expense Allocation Rules
Different Allocation Rules for Different Expenses:

Interest

Research & Development

General & Administrative

Other
44
Example 1




USCO has a foreign subsidiary in Country X that
performs services in Country X.
The subsidiary earns $1,000, on which it pays
Country X income tax at a rate of 35% ($350).
If all the Country X earnings are distributed as a
$650 dividend to USCO, USCO would be allowed
a foreign tax credit of $350.
Foreign tax credit limit = $350
$1,000 Foreign Income
$1,000 Taxable Income
X
$350 (US tax before FTC)
45
Example 1 (cont.)

Therefore, USCO would have no net US tax
liability on those earnings.

It does not matter when the US taxes the earnings
in this case.
46
Example 2
Allocating and apportioning expenses reduces
the maximum amount of foreign tax credit a US
company may receive.

Same as Example 1, except:
– The foreign subsidiary has $200 of allocable
expenses against foreign income which are not
deductible in calculating foreign-country tax.
47
Example 2 (cont.)
– If all the Country X earnings are distributed as a
$650 dividend to USCO, USCO would be allowed a
foreign tax credit of $280, leaving $70 of foreign
taxes paid for which USCO would receive no credit.
Foreign tax credit limitation = $280
($1,000 Foreign Income - $200 Allocable Expenses)
$1,000 Taxable Income
X
$350
(US tax before
FTC)
48
Other Rules




FTC is Elective
When FTC allowed -either when paid or
when accrued
Holding period
Carryover/Carryback
Rules --2 Back and 5
Forward





Overall Foreign
Losses/Recapture
Currency Exchange
Rules
Look-thru Rules
Alternative Minimum
Tax--90% Limitation
No FTC allowed for
taxes paid/accrued to
certain foreign countries
49
Typical Obstacles to
FTC Utilization

Foreign tax rates higher than US tax rate

Separate basket limitations

Required allocation and apportionment of
deductions

“Overall foreign loss” recapture
50
The US International Tax
System: “Deferral” Regime
51
Deferral

US generally defers its tax on foreign earnings of
foreign subs until they are remitted.

US tax is imposed on foreign earnings when they
are earned (or deemed earned) by a US person
(i.e., US corporation, citizen or resident individual).
52
Deferral (cont.)

Fundamental TIMING principle of US tax law.

Issue under this system is not WHETHER, but
WHEN, US person will be taxed on foreign
earnings.
53
Exceptions

The general rule always has been to defer US tax
on foreign earnings of foreign subs.

However, various exceptions to this general rule
have been enacted over the years.
– Subpart F income

Foreign personal holding company income

Foreign base company sales income

Foreign base company service income
54
Exceptions to Deferral (cont.)
– Subpart F income (cont.)

Subpart F insurance income

Subpart F shipping income

Foreign oil and gas extraction income

Foreign oil related income

Illegal payments
– Section 956 Income (investment in US property)
55
Exceptions to Deferral (cont.)
– PFIC
– Personal Holding Company Income
– Foreign Personal Holding Company Income
– Foreign Investment Company Income

Where an exception applies, a US person may be
subject to current US tax (or an interest charge) on
foreign source income, even though it has not
received the income.
56
Exceptions to Deferral (cont.)

Present law is complex because there are many
sets of potentially overlapping exceptions.

Application of exceptions to deferral typically has
depended on two factors:
– Level of US ownership
– Type of income involved
57
Policy Issues
58
Policy issues
US policy reflects a balance between different
goals:




CEN. Foreign investment should bear same tax
burden as domestic investment (so-called “capital
export neutrality” or CEN).
Competitiveness. US companies should not
bear higher tax burden on foreign income than
foreign competitors.
Harmonization. Follow international tax norms.
Protect US tax base. Foreign activities of US
companies should not jeopardize US tax base.
59
Policy issues

CEN could be achieved by
– Taxing foreign source income when earned
– With unlimited foreign tax credit

Competitiveness could be achieved by
– Exempting from US tax income from FDI

US System more closely follows CEN by taxing
worldwide income, but
– Limits foreign tax credit (to project US tax base)
– Generally defers tax until income remitted (for
competitiveness)
60
Policy issues


Some argue that US policy should move closer to
CEN by further limiting deferral.
Others view the increasingly competitive global
marketplace as justification for limiting anti-deferral
rules.
– More level playing field vis-à-vis foreign MNCs
– Allows reinvestment of foreign earnings before tax
– Offsets other problems in US system
Numerous foreign tax credit limits (causing
international double taxation)
 Lack of corp. integration (domestic double taxation)

61
Policy issues
CEN reconsidered:




No country (incl. US) has a CEN system
Half of OECD countries exempt income from FDI
Imposing CEN at corporate level may cause
individuals to invest in foreign MNCs
Theoretical case for CEN assumes “perfect
competition” e.g., NO intangibles, NO strategic
competition, etc.1
1 Michael
Devereux and Glenn Hubbard, Taxing Multinationals, ITPF, 1999.
62