Low Tax Nations Absorb Obama's Tax Broadside

by Robert Lee, Tax-News.com, London

11 May 2009

While US business groups have been harshly critical of President Obama’s proposals to curb tax advantages for multinationals investing overseas, the low-tax jurisdictions which could suffer as a result of the reforms say it is still too early to fully assess their probable impact.

According to the Treasury’s statement, published on May 4, US multinational corporations paid about USD16bn of US tax on approximately USD700bn of foreign active earnings in 2004 – the most recent year for which data is available – for an effective tax rate of about 2.3%. Moreover, nearly one-third of all foreign profits reported by US corporations in 2003, it added, came from “just three small, low-tax countries: Bermuda, the Netherlands, and Ireland.”

“There is no higher economic priority for President Obama than creating new, well-paying jobs in the United States,” the Treasury said. “Yet today, our tax code actually provides a competitive advantage to companies that invest and create jobs overseas compared to those that invest and create those same jobs in the US."

A central plank of Obama’s proposals is reform of the ‘deferral’ rules so that businesses that invest overseas cannot take immediate deductions on investment expenses while deferring the payment of income tax on profits made from those investments. However, this, the US business lobby argues, would effectively amount to a tax increase on companies at precisely the time that they need the opposite. What’s more, it is debatable whether the reforms will actually result in less foreign investment by US multinationals in favour of domestic investment.

"What we can deduce from his statement is that the proposed changes to deferral of tax on foreign profits is not as severe as had been anticipated and this will be of benefit to US companies operating in Ireland", said Pat Wall, chair of the American Chamber of Commerce in Ireland’s Taxation Group. "The rules of the game have changed but they have changed for everyone. The proposed changes will impact every jurisdiction and Ireland will continue to maintain its relative tax competitiveness which has been very important in attracting foreign direct investment (FDI).

"President Obama's speech did not have specific details on how the proposed reforms will work and the devil will be in the detail," Wall added. "It will be 2011 before any proposals become law and there will be much discussion and lobbying on Capitol Hill in the meantime.”

However, Wall thinks that the proposed changes to deferral of tax on foreign profits are “not as severe as had been anticipated” and he expects US companies to continue operating in Ireland.

“The proposed changes will impact every jurisdiction and Ireland will continue to maintain its relative tax competitiveness which has been very important in attracting foreign direct investment,” he observed.

Attracted by a corporate tax rate of 12.5% and a network of double tax treaties, including one with the United States, US firms have invested heavily in Ireland over the past decade and now employ approximately 100,000 people. In 2007, they exported an estimated EUR83bn (USD110bn) of products and services from Ireland into world markets.

"The fact that President Obama referenced Ireland in his speech means the US administration is aware of the success of Ireland's policy of adopting a very competitive corporate tax rate,” said Wall. However, he added that it also served to highlight the difference between Ireland, where US companies have substantial operations and the Netherlands which is a preferred location for US holding companies with very little business operations.

Although the Netherlands has a sophisticated tax system with relatively high tax rates, some aspects of its fiscal system are extremely attractive and make it the ideal location in which to base international trading operations. Dutch holding companies coming within the "participation exemption rules" pay no tax on income received from a subsidiary whether by way of dividends or otherwise. To come within the "participation exemption rules" the Dutch holding company must hold at least 5% of the subsidiary's shares - a rule which makes Holland a particularly attractive jurisdiction relative to other countries that require much higher percentage shareholdings. Attractive fiscal incentives are further enhanced by a large network of double taxation treaties.

Jan Kees de Jager, the Netherlands' finance secretary was said to be “not happy" with being singled out by Obama as a “low-tax” nation, pointing out that, with a corporate tax rate of 25.5%, the Netherlands is a middle-ranking country in the worldwide tax league. He also insisted that the Netherlands has “very transparent” tax laws and expressed dismay at appearing on a list “between Ireland and Bermuda.”

De Jager said that the Dutch government would work with the US administration to ensure that the Netherlands does not end up on any future ‘blacklists’ and expects the Treasury to clarify the tax proposals in due course.

However, the Cayman Islands, which has been on the receiving end of much of Obama’s anti-tax haven invective, does not expect to be unduly impacted by the proposed changes announced by the US Treasury. This is because, according to Anthony Travers, Chairman of the Cayman Islands Financial Services Association (CIFSA), the number of US corporations that have subsidiaries in the Cayman Islands and that have benefited from the deferral rule “is statistically insignificant.”

“CIFSA doubts that there will be any material adverse effect to the Cayman financial industry,” he was quoted as saying by Cayman Net News.

According to the US Treasury’s statement, the American tax system “is rife with opportunities to evade and avoid taxes through offshore tax havens.” But Travers pointed out that, far from sucking money out of the United States, the Cayman Islands is actually “an essential part of the US financial architecture” and a conduit for international investment into, rather than out of, the country.

“Having a registered office address in the Cayman Islands is driven by commercial considerations, not by tax avoidance. It allows companies to raise capital and conduct global business,” he said.

Meanwhile, Bermudian Finance Minister Paula Cox has applauded Obama for seeking to right the American economy through “sensible incentives.” However, she insisted that Bermuda is not a country “that assists wealthy Americans to evade taxes,” emphasizing that the jurisdiction is continuing to expand its network of Tax and Information Exchange Agreements.

"Our longest-standing TIEA is with the US and the Ministry of Finance has an effective working relationship with the US Internal Revenue Service," Cox told The Royal Gazette.

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