Robust Foreign Investment In US Defies Corporate Tax Rate

by Mike Godfrey, Tax-News.com, Washington

29 August 2008

A Grant Thornton LLP analysis of new Internal Revenue Service (IRS) data has found that US corporations controlled by foreigners are now responsible for a larger share of total US corporate assets and earnings than ever before, despite a US corporate tax rate that is among the highest in the world.

The most recently released IRS Statistics of Income bulletin reveals that the total receipts of foreign-controlled domestic corporations (FCDCs) in 2005 reached USD3.5 trillion, which is USD450 billion more than in 2004, twice the 1996 level and almost 90 times the level reported in 1971.

These FCDC receipts in 2005 represented 13.7% of all US corporate receipts, also an all-time high. Just 10.7% of all corporate receipts came from FCDCs in 1996, while just 2.1% came from FCDCs in 1971. IRS researchers define an FCDC as any domestic corporation in which over 50% of the stock is owned by a foreign individual, corporation, partnership, estate or trust.

The asset growth of FCDCs has been even more staggering. FCDCs reported assets of over USD9.2 trillion in 2005, up 15.7% from 2004 and more than three times the 1996 level. FCDC assets represented 13.9% of all US corporate assets in 2005, another all-time high. FCDC assets made up just 10.6% of all corporate assets in 1996 and an even smaller 1.3% of total assets in 1971.

Grant Thornton noted in its analysis that this explosion in foreign investment "defies the deterrent effect" of high US corporate tax rates, which have become less and less competitive over the last two decades.

“Despite the high corporate tax rates, many foreign multinationals recognize the importance of the US market from a global standpoint,” said Joseph Calianno, a partner in Grant Thornton LLP’s National Tax Office. “They understand that the business and profit opportunities in the United States often outweigh the tax costs of doing business in the United States.”

However, Grant Thornton believes that there is some evidence in the IRS data of a reluctance to enter the US market, and that FCDC assets and earnings may have grown even more robustly if the US had more competitive rates.

The number of FCDCs operating and filing returns in the US has remained largely stagnant for over 10 years, even as total assets and receipts have gone up. With total corporate filings continuing to increase every year, FCDCs now represent a smaller percentage of total domestic corporations than they did in 1996.

The US corporate tax rate has changed little since the late 1980s while countries all over the world have been cutting rates to compete for investment and spur economic growth. The US now has an average combined state and federal corporate rate of almost 40%, the second highest to Japan among OECD countries. There is a growing consensus across the ideological spectrum that the US needs to cut its corporate rate to remain competitive in a global economy. The idea has been long championed by conservatives, but many Democrats have recently supported lowering rates.

“A real, meaningful reduction in the US corporate tax rate would likely stimulate even greater investment by foreign based multinationals into US corporations,” Calianno said. “Several other countries in recent years have reduced corporate tax rates in an attempt to attract such investment and, for the most part, such measures have been successful.”

While a rate reduction would also help US-based multinational groups (a multinational group with a US parent at the top of the chain), it would be an ineffectual measure if there was a corresponding tax cost that essentially wipes out the benefit, Grant Thornton said, noting that many proposals to cut corporate tax rates impose other restrictions that limit the benefits of the proposed rate cut.

“US-based multinational groups often feel they are at a disadvantage compared to certain foreign-based multinational groups because of high US corporate tax rates, a US tax system that taxes US corporations on their worldwide income, and the application of certain anti-deferral regimes, such as the subpart F regime,” Calianno said.

Anti-deferral rules such as subpart F often require US companies to include certain types of income earned by their foreign subsidiaries into income even though such income has not been repatriated.

The IRS data also show that FCDCs are paying taxes. The income tax paid by FCDCs after tax credits jumped to USD42.4 billion in 2005, an increase of over 40% from 2004.

Most FCDC receipts come from corporations with owners in just a few countries. FCDCs with foreign owners from the United Kingdom, Japan, Germany, Netherlands, Canada and France were responsible for over three-quarters of all FCDC receipts in 2005. Most of the FCDC receipts are also earned in just a few industries. Over 80% of FCDC receipts came from the manufacturing, wholesale trade, and the finance and insurance industries.

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