This week, the Senate Finance Committee’s International 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. Reform Working Group released their final report. Over the last few months, this bipartisan working group has been analyzing different aspects of international tax reform while taking comment from the public. The International Tax Reform group was tasked with finding a bipartisan framework for reforming the taxation and regulation of overseas income, especially the income of multinational corporations. The co-chairs of this working group were Senator Rob Portman (R-Ohio) and Senator Chuck Schumer (D-NY).
Their framework for international tax reform has five pieces:
- Ending the lock-out effect
The U.S. has what is often called a “worldwide” system of taxation that requires American businesses to pay the 35 percent federal corporate tax rate on their income no matter where it is earned—domestically or abroad. Companies operating in foreign countries pay income taxes to the country in which those profits were earned. Then companies need to pay the difference between the U.S. 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 and the foreign corporate income tax rate to the U.S. treasury.
However, companies are able to delay or defer the additional U.S. tax on their foreign earnings by reinvesting the money in ongoing foreign operations.
The additional tax on the foreign earnings creates an incentive for corporations to keep capital overseas. This is what is called the lock-out effect. The United States is one of the few developed countries in the world that still taxes the worldwide profits of its resident corporations.
The bipartisan framework proposes moving 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. that eliminates that additional U.S. tax on corporate income that companies bring back to the U.S.
- Patent BoxA patent box—also referred to as intellectual property (IP) regime—taxes business income earned from IP at a rate below the statutory corporate income tax rate, aiming to encourage local research and development. Many patent boxes around the world have undergone substantial reforms due to profit shifting concerns. Regime
A few European countries have what is called a “Patent Box.” Patent boxes are systems that tax income related to intellectual property (IP) at a lower tax rate than the headline corporate income tax. For example, the United Kingdom’s corporate income tax is 20 percent. However, qualified IP is taxed at 10 percent. Countries have been enacting these to attract IP income (and the related tax revenue).
The working group discusses the enactment of a Patent Box to encourage companies to locate their IP in the United States and to incentivize research and development.
- Base Erosion
The working group stated that it is concerned that moving to a territorial tax system could increase the incentive to profit shift by multinational corporations. It stated that it is interested in limiting tax avoidance by multinational corporations through the use of “tax havens.” It discussed the “minimum taxes” on foreign earnings that were put forth by both President Obama and Chairman Dave Camp. These minimum taxes would disallow or limit the dividend exemption system on foreign income that isn’t taxed at a minimum effective rate. However, they stated that they are still “considering different options.”
- Interest Expense Limitations
Related to base erosion, the working group expressed concerns that companies could load up on debt in high tax countries (such as the United States) in order to increase their interest expense. Since interest is deductible against U.S. taxable incomeTaxable income is the amount of income subject to tax, after deductions and exemptions. For both individuals and corporations, taxable income differs from—and is less than—gross income. , it reduces the corporation’s tax liability in the United States. That interest is then passed to a subsidiary in a foreign country and taxed as profits at an often much lower tax rate.
Current law already restricts the amount of interest a corporations can deduct and many developed countries impose similar restrictions. The working group thinks that limitations should be imposed, but does not put forth any specifics on whether they should be strengthened or remain as they are.
- Deemed RepatriationTax repatriation is the process by which multinational companies bring overseas earnings back to the home country. Prior to the 2017 Tax Cuts and Jobs Act (TCJA), the U.S. tax code created major disincentives for U.S. companies to repatriate their earnings. Changes from the TCJA eliminate these disincentives.
As stated above, U.S. corporations do not need to pay the additional U.S. tax on their foreign profits until those profits are brought back to the United States. Currently, there is about $2 trillion of these deferred corporate profits reinvested overseas. The question is: if the United States transitions to a territorial system in which these profits are not taxed going forward, how should the tax code deal with the profits that are already deferred?
The working group discusses what is called “deemed repatriation.” This is where the U.S. Treasury deems all the deferred overseas profits of corporations have been repatriated or brought back to the United States. These profits would not be taxed at the full rate, but instead would be taxed at a discount rate and payable over several years.
The International Working Group’s report was one of 5 that was released.
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