**Income Tax – International Rules**
There is scope for reform of U.S. international tax rules, according to Kenneth W. Dam, Deputy Secretary at the U.S. Treasury. Speaking today at the Tax Foundation’s 65th National Conference in Washington, the Deputy Secretary took the opportunity to address the “phenomenon” of corporate inversions, which he said has spotlighted the international rules of U.S. corporate income tax. He described inversions as the deliberate expatriation of a U.S. corporation through a change of corporate address, typically from a U.S. state to an offshore center.
**Impaired Ability to Compete Abroad**
Reportedly, the international tax rules of the United States no longer serve its national interest. Notwithstanding that in the age of globalisation international transactions generate a large and growing share of the national income of the U.S., changes to the international provisions of the U.S. corporate tax code in recent decades have ignored this trend.
These changes have impaired rather than improved the ability of American companies to compete abroad. *”More often, changes to the tax code have focused on increasing tax revenues rather than assuring the competitiveness of U.S. business operations, and thus, strengthening the health of our economy,”* he said.
**Corporate Inversion Transactions – Symptom or Disease?**
Secretary Dam pointed out that U.S. companies choose to move their corporate situs abroad for a very simple reason: to save U.S. tax dollars. This happens when they are able to reduce the U.S. tax they pay on their operations in the U.S., as well as being able to reduce their overall tax on earnings from foreign operations. The first is done through “earnings stripping”, while the inverting enterprise may be able to shift income outside the United States by transferring assets or business opportunities from the U.S. subsidiary to the new foreign parent. This moves the income and appreciation from these assets and opportunities outside the U.S. tax jurisdiction, even though the costs associated with their development were deducted for U.S. tax purposes.
Further, there may be opportunities to exploit the network of tax treaties the United States maintains around the world. By achieving resident status for treaty purposes in a country with which the U.S. has a tax treaty, the new parent in an inversion transaction may qualify for reduced U.S. withholding tax on certain kinds of income.
**Level Playing Field**
Moves to prohibit corporate inversions confuse the symptoms with the disease, however, according to the Treasury Official. The disease is that the U.S. corporate tax system does not create a level playing field for U.S. companies. Corporations that choose to invert are taking advantage of the same opportunity available to any foreign company to reduce U.S. taxes on U.S. operations. Mr. Dam also feels that it is possible that the growing number of acquisitions of U.S. companies by foreign companies is in part caused by the U.S. tax rules. When a U.S. company and a foreign company are considering a merger, it can be more tax-effective for the foreign enterprise to acquire the U.S. enterprise, rather than the other way around.
Evidence also shows that U.S.-based start-up companies are choosing to incorporate abroad to reduce U.S. taxes on their U.S. business. *”An approach that narrowly targets inversions without eliminating the underlying cause is not a real solution for the long term. We need legislation to take away the incentive to invert. Only then can we create a level playing field for U.S. and foreign companies.”*
Already, the U.S. Treasury has made it clear how it would deal with these incentives. Some initiatives include:
– support of amendments to the Tax Code to disallow cross-border inter-corporate interest payments as deductions against U.S. tax, to the extent that the corporate group’s level of U.S. indebtedness relative to assets exceeds its worldwide ratio of indebtedness to assets.
– reexamination of regulations relating to income shifting, particularly by transfers of intangibles; including rules related to reporting, documentation and penalities.
– review of the Tax Code’s organisation and reorganisation provisions, as well as the implementing regulations, as they apply to international transactions.
– a thorough study of existing tax treaties, which are intended to reduce or eliminate double taxation of income
On the last, Treasury has said a determination will be made as to whether any of the existing treaties have provisions that can be used instead to eliminate taxation on income; any treaties that operate in this matter will be renegotiated.
**Competitive Tax Rules**
In addition to the proposed tax changes, Deputy Secretary Dam said there are other areas that must be addressed to make sure that the international tax rules promote the competitiveness of U.S. companies. Inversion transactions avoid the application of the U.S. international tax rules to income from foreign operations, allowing those operations to remain competitive.
In order for the United States to remain a place in which businesses choose to be headquartered, the competitiveness concerns must be addressed. *”To truly level the playing field we need to revisit the U.S. tax rules for foreign earned income. These rules have not kept pace with the rules of our major trading partners. If we want U.S. businesses, and thus the U.S. economy, to be competitive in international transactions, then we have to reconsider our international tax rules,”* said Mr. Dam.
He concluded that foreign direct investment by American firms is good not just for the U.S. firm and the foreign economy recipient, but also for the U.S. economy. If this is so, the U.S. Government must ensure that it is not unintentionally discouraging this investment through obsolete rules that tax foreign income twice or that tax the income in a way that is harsher than the tax regimes of its major trading partners.
The US Treasury Department is on record as saying it looks forward to working with the Congress next year on much-needed reforms of the international tax rules – reforms, according to Mr. Dam, that will ensure *”the United States is the preeminent country in the world for headquarters, for operations, and for investment.”*