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More on Inversions: Foreign-Owned Companies Pay a Higher Effective Tax Rate than U.S. Companies

By: Scott Hodge

One of the common themes in the debate over corporate inversions is that these transactions will erode the U.S. taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. base and cost the Treasury billions of dollars in lost taxes.

What is interesting is that the latest IRS data for 2011 shows that the U.S. subsidiaries of foreign corporations pay a higher effective tax rate than do all active corporations in general. The IRS data for active companies with more than 50% foreign ownership indicate that in 2011 these companies paid $35.7 billion in income taxes on $130 billion in income subject to tax, for an effective tax rate of 27%. By contrast, the average effective tax rate for all active C-corporations was 22% in 2011.

Of the $220 billion in corporate income taxA corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual income tax. es collected by the U.S. Treasury that year, 16% was paid by foreign-owned companies.

Many press stories on the inversion issue give the false impression that by changing their headquarters to another country (the U.K. for example), the “new” company will stop paying U.S. income taxes. Nothing could be further from the truth. These companies will continue to pay U.S. income taxes on the profits they make in the U.S. What changes is that their foreign earnings will no longer be subject to the U.S. worldwide tax systemA worldwide tax system for corporations, as opposed to a territorial tax system, includes foreign-earned income in the domestic tax base. As part of the 2017 Tax Cuts and Jobs Act (TCJA), the United States shifted from worldwide taxation towards territorial taxation. .

The solution to the inversion “problem” is for the U.S. to cut its 35% federal corporate tax rate to at least a reasonable 25% and move to a territorial tax systemA territorial tax system for corporations, as opposed to a worldwide tax system, excludes profits multinational companies earn in foreign countries from their domestic tax base. As part of the 2017 Tax Cuts and Jobs Act (TCJA), the United States shifted from worldwide taxation towards territorial taxation. like most other industrialized nations. The irony is that the U.S. already offers a territorial tax system for foreign-based companies doing business in the U.S. They pay U.S. income taxes on their American-earned profits and don’t pay U.S. income taxes on their foreign earnings. It is time for American-based companies to be treated the same way as their global competitors.

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