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Sometimes, Tax Policy is Also Foreign Policy

4 min readBy: Scott Greenberg

Two days ago, Congressman Paul Ryan sent a letter to President Obama, inquiring about the 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. implications of the recent Iran nuclear agreement:

I write to inquire whether you also intend to waive tax code provisions directed at illicit Iranian behavior, including its support for terrorism… Under current law, U.S. companies and individuals located or doing business in Iran and certain other countries face punitive taxes under U.S. law… Your policy raises serious questions about whether you intend to keep in place tax rules that discourage conducting business with Iran.

What does the U.S. tax code have to do with the Iran nuclear agreement? To understand the substance of Congressman Ryan’s letter, it’s important to review how the U.S. tax code treats profits that American businesses make overseas.

The U.S. is one of six developed countries with a 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. , which means that American businesses are required to pay U.S. taxes on income they earn anywhere in the world. This means that companies operating abroad are required to pay taxes twice: once to the country in which they operate, and once to the U.S. government. A worldwide tax system makes it harder for U.S. companies to compete overseas with foreign companies that are only taxed once.

To mitigate the high burden of paying taxes to two countries, the U.S. government generally allows businesses to claim foreign tax credits for income taxes paid to other governments. This means that, while businesses operating abroad still have to file two tax returns, the more they pay in taxes to foreign governments, the less they have to pay to the United States. Without foreign tax creditA tax credit is a provision that reduces a taxpayer’s final tax bill, dollar-for-dollar. A tax credit differs from deductions and exemptions, which reduce taxable income, rather than the taxpayer’s tax bill directly. s, it would likely be prohibitively expensive for U.S. businesses to operate abroad.

Here’s where foreign policy comes in. U.S. businesses can usually claim foreign tax credits for taxes paid anywhere in the world. However, there are a few foreign governments whose taxes cannot be counted towards foreign tax credits. Specifically, U.S. companies cannot claim the foreign tax credit for taxes paid to any foreign country that:

  • The U.S. government does not recognize,
  • The U.S. has severed diplomatic relations with,
  • The U.S. does not conduct diplomatic relations with, or that
  • Has been designated by the State Department as a sponsor of terrorism

Currently, there are five countries where U.S. businesses cannot claim foreign tax credits: Cuba, Iran, North Korea, Sudan, and Syria. All five of these countries fall into one or more of the categories above; in particular, Iran, Sudan, and Syria have all been designated by the State Department as state sponsors of terrorism. U.S. companies cannot claim foreign tax credits for taxes paid to these five governments, making it very expensive for them to do business in those countries.

However, the President of the United States has the authority to waive this restriction of the foreign tax credit if he determines that doing so “is in the national interest of the United States and will expand trade and investment opportunities for United States companies.” For instance, in September 2004, President George W. Bush issued an executive order lifting several sanctions on Libya, following diplomatic negotiations. As part of this order, the President allowed U.S. businesses to claim foreign tax credits for taxes paid to Libya’s government.

Congressman Ryan’s recent letter stems out of a concern that President Obama will use his executive authority to waive the restriction of foreign tax credits on taxes paid to Iran. Ryan writes, “I understand that you plan to waive many key U.S. sanctions… Has the administration made any direct or indirect commitment or promise of any kind, whether or not in writing, that you will exercise your waiver authority [regarding foreign tax credits] with respect to Iran?”

In practical terms, waiving the restriction of foreign tax credits on Iran means that it would suddenly become much more profitable for U.S. businesses to operate in Iran. This would likely open up even more trade and investment between the two nations. The move would be controversial among those who are skeptical of normalizing U.S.-Iran relations, including Congressman Ryan.

The Joint Comprehensive Plan of Action between Iran, the U.S., and five other nations, released in July, does not make any direct reference to U.S. foreign tax credits. However, the preamble of the agreement states that it will “produce the comprehensive lifting of all UN Security Council sanctions as well as multilateral and national sanctions related to Iran’s nuclear program, including steps on access in areas of trade, technology, finance and energy,” which might include U.S. foreign tax credits as well. In addition, Congressman Ryan seems to be concerned about potential unwritten side agreements between the U.S. and Iran that might have included a commitment to waive the restrictions on foreign tax credits.

The U.S. tax code touches upon virtually every area of federal policy, from healthcare to agriculture. Congressman Ryan’s letter is a reminder that the tax code is connected to foreign policy as well.