The President’s Paradoxical Reforms for U.S. Companies’ Foreign Oil and Gas Income
Background Paper No. 20
Executive Summary Improving economic performance is the touchstone of most federal policies, and for good reason. When the economy grows more rapidly, it creates jobs faster, incomes rise faster, and wealth grows faster. Prosperity is integrally linked to national well-being; hence policies promoting economic growth are often well received, while policies inhibiting growth have an extra and important hurdle to overcome.
Expanding international trade remains generally popular, for example, because opening foreign markets increases jobs and wages while international competition at home is good for consumers. Opening foreign markets is an empty concept, however, without competitive U.S. companies able to take advantage of foreign market opportunities.
U.S. International tax policy is an important impediment to achieving the goals of U.S. trade policy. It often raises costs above those of U.S. companies’ competitors. It limits their ability to organize operations most efficiently on a global basis. And it limits their flexibility to respond to new market challenges and opportunities.
The oil and gas industry in the U.S. is typical in many ways of U.S. companies competing overseas. They are aggressive and they are successful. These companies must integrate their U.S. and foreign operations to maximize their efficiency and competitiveness. A high degree o f integration also means that thousands of jobs in the U .S. depend critically on their employer’s success overseas.
The U.S. oil and gas industry directly employs almost 60,000 Americans in the U.S. in jobs directly dependent on these companies’ international operations. Over 140,000 additional Americans are employed in the U.S. by U .S. suppliers to the oil and gas industry’s foreign operations. About 200,000 Americans, therefore, owe heir jobs directly to the overseas success of U.S oil and gas companies.
An additional 150,000 Americans are employed in the U.S. supporting those working for the oil companies and their suppliers. In total then, over 350,000 Americans owe their jobs to the international success of the U .S. oil and gas industry.
Seven changes to the international tax provisions of the Internal Revenue Code included in the President’s fiscal year 1998 budget submission would directly and further impede the ability of U.S. companies to compete abroad. Three of these provisions target U .S. oil and gas companies’ foreign income and activity for special attention. These proposals would:
- End deferral for petroleum companies ‘ active income by expanding the definition of Subpart F to include oil and gas income generated abroad.
- Create a new foreign tax credit limitation for oil and gas income, thereby segregating this income from all other income in the general foreign tax credit limitation.
- Deny a foreign tax credit for taxes paid to a foreign government if the company receives “benefits” from the foreign government unless the foreign government imposes a generally applicable income tax on all businesses, domestic and foreign.
There are six distinct problems with the President’s proposals relating to foreign oil and gas income:
- Damages U.S. Companies’ International Competitiveness. The President’ s proposals would further increase the U.S. tax liability on U.S. foreign oil and gas income. The increase in the U.S. tax burden would be significant in many cases. The proposals, therefore, would drive these companies from certain markets and force them to reduce operations in others, thereby ceding valuable opportunities to the foreign competition.
- Differential Taxation of Foreign Oil and Gas Income. The President’s proposals clearly target U.S. subsidiaries’ foreign oil and gas income for special treatment under the tax law. U.S. tax law already puts U.S. petroleum companies at a competitive disadvantage vis-à-vis foreign-based companies. The effect of this special treatment is to put these companies at a further competitive disadvantage. In addition, this treatment also exacerbates the differential tax burden between U.S. – owned oil and gas companies operating abroad and many other U .S.-owned foreign companies.
- Lack of Justification. As yet the Treasury has not made a serious argument for why or in what circumstances current policies fail. Presumably, the Administration believes the current policy is inadequate to prevent abuse in certain circumstances, but it has not yet described these circumstances or the abuse.
- Purposeless Complexity. The proposal to include foreign oil and gas income in a separate foreign tax credit limitation basket would further complicate the international tax provisions for no apparent purpose other than to levy additional tax on U .S. oil companies ‘ foreign operations.
- Policy-less Attack on Deferral. The proposal to expand the definition of Subpart F to include foreign oil and gas income represents a further, unwarranted, and dubious erosion of the policy of deferring U .S. tax on active income earned abroad by U.S.-owned subsidiaries.
- Overly Broad and Restrictive Application. The “generally applicable” test in the Administration’s proposal remains unspecified. Moreover, any specification is likely to result in a test that is overly restrictive. Further, even if the foreign income tax is not generally applicable by whatever metric is applied, the income tax can only be operating as a surrogate for a royalty to the extent the royalty has been waived or reduced from what would normally be charged. The U.S. taxpayer should be allowed to demonstrate that a reasonable royalty payment has been made, in which case the income tax cannot be a surrogate for a royalty.
In summary, the President’s proposals relating to foreign oil and gas income of U.S. multinational companies run counter to the Administration’s goals of expanding free trade; they violate tax neutrality both in general and as between U.S. companies in differing industries; and they would seriously impede the competitiveness of one of the country’s more successful industries. Against these difficulties, the lack of serious justification for the proposals is remarkable.