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US Congress Looks At Territorial Taxation

by Mike Godfrey, Tax-News.com, Washington

13 September 2011


The Senate Committee on Finance has held a hearing on how international corporate tax issues should be dealt with, as momentum gathers for comprehensive reform of the United States tax code

In his opening statement, the Committee’s Democrat Chairman Max Baucus pointed out that US-based multinational companies (MNCs) now generate, on average, nearly half their income from foreign affiliates, compared to just 17% in 1977, while foreign direct investment (FDI) in the US is also essential to the health of the US economy. Over the past ten years, he noted, FDI in the US has totalled USD1.7 trillion, supporting five to six million American workers.

He concluded therefore that the tax code should not deter potential FDI in the US or encourage US businesses to relocate jobs overseas; nor should it hamper American competitiveness overseas.

Orrin Hatch, the Committee’s Republican Ranking Member, agreed that the US tax code in relation to international business operations needed urgent attention, as, while the code has remained largely unaltered for about 80 years, the fundamental issue therein remains unchanged.

“When income is earned in one country by a resident of another country, both the country where the income is earned and the country where the resident resides have legitimate claims to tax the income,” he stated. “Arguably, one of the basic goals of an international tax system is to resolve the competing claims of the source country and the residence country in order to avoid the double taxation that can result when both countries exercise their taxing powers.”

On those considerations, Baucus noted that US business leaders have urged the government to make the US tax system more like the territorial tax systems of some of the US’s major trading partners, and Hatch also looked forward to a discussion within the US on whether a territorial tax system would be more appropriate in present global markets.

It was said that territoriality - under which a particular country, as a general rule, should only tax income earned within its borders – could deal with some of the tax issues that US MNCs face when doing business abroad. For example, as was pointed out by Hatch, the US international tax system “discourages, and some would say penalizes, US MNCs from repatriating foreign earnings by imposing a 35% residual US tax at the time of repatriation.”

As a result, he added, those MNCs “are sitting on large piles of cash earned from foreign operations. Yet these same corporations are actually borrowing money. One of the reasons for this borrowing is that their cash is trapped offshore, and these corporations will be subject to a 35% US tax for repatriating their cash back to the US.” Adoption of a territorial system, it is said, could alleviate that problem.

At the hearing, the Vice President and General Tax Counsel of Cargill, Incorporated, Scott M. Naatjes, testified in support of a move to a territorial tax system, stating that “most developed countries have adopted territorial tax systems that do not tax dividends or gains from the active conduct of foreign business operations of their MNCs, because they want to attract and strengthen their MNCs, attract capital from abroad, and create the headquarters jobs and synergies associated with managing a global enterprise in their country.”

The US income tax system for non-US income, he said, “was adopted at a time when the US was the dominant provider of global capital and US MNCs were a dominant vehicle for FDI; US corporate income tax rates were equal to or lower than the tax rates of our trade partners; and foreign MNC competitors of US MNCs were also subject to global income taxation.”

In the current situation, he advised that the US should get rid of its current worldwide tax system, and the anti-deferral and expense allocation rules, that together make US MNCs inefficient investment vehicles for non-US business opportunities.

A comprehensive report in our Intelligence Report series describing how to get an optimal blend of tax-efficiency and profits from global manufacturing operations through judicious use of offshore and onshore techniques, and showing how the corporate supply chain is full of opportunities to save tax while optimising efficiency, is available in the Lowtax Library at http://www.lowtaxlibrary.com/asp/subs_reports.asp and a description of the report can be seen at http://www.lowtaxlibrary.com/asp/description_report8.asp
TAGS: tax | investment | business | foreign direct investment (FDI) | corporation tax | offshore | multinationals | United States | tax reform

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