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Stopping “Abusive Tax Shelters” or Avoiding Tax Competition?

2 min readBy: Chris Atkins

Senators Carl Levin (D-MI) and Norm Coleman (R-MN) recently introduced the Tax Shelter and Tax Haven Reform Act of 2005 (S. 1565). The bill would make four major changes to federal law, in an effort to combat “abusive 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. shelters”:

· First, those who promote abusive tax shelters and aid in understating tax liability would face financial penalties; · Second, a host of provisions would prevent abusive tax shelters through prohibiting certain fee arrangements, requiring information sharing, and denying deductions; · Third, the bill would codify the economic substance doctrine for federal court hearings on abusive tax shelters, and; · Fourth, the bill would designate certain nations as “uncooperative tax havens” and impose reporting requirements and restrict tax benefits for corporations that invest in those countries

The fourth section would require any United States person to disclose money or property transfers to uncooperative tax havens, defined as those countries that impose no or nominal taxation and that do not, in the opinion of the United States Treasury, sufficiently disclose enough information to allow the U.S. to enforce its own tax laws. The fourth section would also impose a number of penalties on investment in uncooperative tax havens, including the denial of a 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. for taxes paid to such a country.

The broadness of the fourth section could sweep in those countries that are legitimately competing with the U.S. for business investment. Ireland, for instance, maintains a very low 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. rate (12.5 percent), causing numerous U.S. firms to invest there. Estonia does not tax corporate profits if those profits are reinvested domestically (a major incentive for export-intensive firms). If these countries decline to disclose information about investment from U.S. taxpayers, will the U.S. impose penalties on those taxpayers?

Administrative remedies are certainly important to combating corporate tax shelters, but Congress may also want to consider reducing the federal corporate tax rate, which is currently the third highest in the world (as reported in our report linked here). Our high rate undoubtedly leads many corporations to seek to minimize their tax payments, and lowering the rate could do more for tax administration than penalizing legitimate investments in low tax countries.