Rethinking the U.S. Taxation of Overseas Operations

November 22, 2011

Today we released a new Special Report, analyzing the rules U.S. corporations are subject to when it comes to reporting and paying taxes on profits earned abroad. Some of the most complicated and outdated provisions are contained in a section of the code called “Subpart F,” which dates from the Kennedy administration.

Vice President for Legal & State Projects Joseph Henchman takes readers through the rules and makes recommendations for how the system could be improved. From today’s press release:

U.S. corporations operating overseas face a unique combination of burdens not borne by their international competitors: taxes owed to the United States, taxes owed to the country where the operating activity takes place, and a complex tax system that attempts to reduce the resultant economic harm but involves an array of credits and definitions, primarily the Internal Revenue Code’s “Subpart F.”

The provisions in Subpart F, originally adopted in 1962, call for so-called “passive” income like interest and dividends to be taxed immediately but permits “active” income to be deferred from U.S. taxes until it is brought back to the U.S.

To add to the complication, rents and royalties must not only be “active” to be eligible for deferral, but must also have been “received from a person other than a related person.” Royalty income, unless received from third parties and even if it meets the stringent “active” test, is subject to Subpart F taxation. Thus, the tax treatment of royalties received from foreign operations under the U.S. company’s direct ownership and operation is less favorable than those received from operations by third parties.

More research on corporate income taxes here.


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