Tax Foundation: Rethinking U.S. Taxation of Overseas Operations

By Jonathan Prokup

Our in-house and private-practice corporate readers will likely enjoy one of the Tax Foundation’s newest reports: Rethinking U.S. Taxation of Overseas Operations. As the abstract describes:

The United States produces a third of the world’s wealth but contains less than 5 percent of the world’s population. This disparity pushes many U.S. businesses and entrepreneurs to embrace globalization to improve productiv­ity and expand market reach. Large and small businesses alike are increasingly using the tools of faster information, cheaper transporta­tion, and overseas workforces that blur the traditional notions of taxes and services based on geographic lines.

The U.S. government can effectively pro­mote this dynamism and growth with a tax system that taxes profits earned in the United States but leaves taxation on activity occurring in other countries to those other countries. Instead of pursuing this economic concept of neutrality, however, the U.S. government seeks to tax the profits of U.S. corporations wherever in the world they are earned. This worldwide tax system differs from most other countries, where only activity within the country’s borders is taxed (territoriality).

U.S. corporations operating overseas there­fore 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).

Many of the report’s “key findings” won’t come as news to our corporate readership.  For example, one of the findings is that “Under Subpart F, ‘active’ income can be deferred from U.S. tax until repatriated home, while ‘passive’ income (royalties, interest, dividends) is generally subject to immediate U.S. taxation.”

Nevertheless, the report makes a number of interesting criticisms of the Subpart F regime – e.g., that the regime is based on an outdated model of corporate operations. The solution, according to the report, is to move to a territorial tax system, an idea that has drawn recent support from the House Ways and Means Committee as well as GOP presidential candidates. As the report acknowledges, however, ““[F]rom a tax collection standpoint, it could be said that a worldwide tax system is better than a territorial taxation system as a tax revenue source.” (citation omitted)  Given the federal government’s yawning budget deficits, the interests of the “tax collection standpoint” may well prove paramount.

The complete report is available here.

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