Daimler-Chrysler Deja Vu

February 17, 2011

The announcement that the New York Stock Exchange would be purchased by Deutsche Börse AG has generated the predictable handwringing about America's decline as the financial epicenter of the world. As yet, however, we have not seen much attention paid to tax implications of the deal, in the same way the Daimler-Chrysler merger drew attention to the uncompetitiveness of the U.S. corporate tax system.

The irony of the current merger is that it may become a symbol of the flagging competitiveness of both the U.S. and Germany tax systems. As yesterday's Wall Street Journal (subscription required) outlined in an article titled, "Why Incorporate in the Netherlands? It's Less Taxing," the holding company for the combined Deutsche Börse AG/NYSE Euronext group will be registered in the Netherlands, not the U.S. or Germany.

One of the reasons, of course, is the fact that the Netherlands has a corporate tax rate of 25.5 percent compared to Germany's combined federal and sub-national rate in of 30.2 percent and the U.S. combined rate of 39.2 percent. Although, it should be noted that New York based firms pay a combined federal/state rate of 39.6 percent, higher than Japan's overall rate, plus the New York City rate of 8.85% of "net income allocated to New York City or 15% of business and investment capital allocated to New York City"].

In addition to a favorable tax rate, the Dutch offer a particularly attractive form of territorial taxation for foreign earnings in which, according to the WSJ, "international companies use their legal home base in the Netherlands to channel financial flows in order to reduce the amount of tax they have to pay in other countries."

According to the National Foreign Trade Council's Territorial Tax Study Report, "Dutch resident companies may qualify for a 100 percent exclusion of foreign branch profits. Furthermore, under the Dutch "participation exemption," dividends received from foreign subsidiaries, and capital gains realized on the disposal of such shares, are exempt from Dutch corporate tax."

By contrast, U.S. companies are taxed on their world-wide income at the full 35 percent federal rate (those taxes can be deferred until the income is repatriated), while Germany's territorial system is not as generous at the Dutch system. According to the NFTC report, "as a general matter, German resident corporations are taxed on foreign source income. Foreign branch income is fully exempt from gross income. Foreign source dividend income, however, is eligible for a 95 percent participation exemption."

President Obama has declared an interest in making the U.S. corporate tax system more competitive globally. It would seem that the first step is dramatically reducing the 35 percent federal rate and the second step is to seriously consider moving toward a territorial tax system for foreign earnings.

While U.S. multinationals cannot easily re-incorporate themselves in low-tax countries such as Ireland or the Netherlands - as many U.K. companies have done in recent years - they can reduce their tax bill and become more competitive by being acquired by, or merge with, a foreign based company and achieve the same end.

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