An Excerpt From:
K&L Gates Global Government Solutions ® 2012: Annual Outlook
January 2012
Tax
House Ways and Means Committee Offers Alternative International Tax System
With the continuing integration of the global economy, the U.S. tax code has
come under increasing criticism for stifling the ability of U.S. businesses to compete
with non-U.S. competitors. The United States is the only major industrialized nation
that continues to tax its businesses on worldwide income. Non-U.S. counterparts
generally tax their businesses only on income earned in-country (although some
exceptions exist for certain passive income such as interest, which may be taxed
currently but at a substantially lower marginal tax rate than corporate profits).
In addition, the U.S. corporate tax rate is the second highest among major
industrialized nations; only Japan’s is higher.
On October 26, 2011, House Ways
& Means Committee Chairman David
Camp unveiled a plan to overhaul the
U.S. system of corporate international
taxation. The committee proposal would
replace the current method that taxes
worldwide corporate income with a
territorial system that exempts most
foreign-source corporate income from
taxation in the United States. In addition,
the U.S. marginal corporate tax rate
would be reduced from 35 to 25 percent.
The Ways and Means proposal is a
discussion draft intended to stimulate
debate and generate feedback from the
corporate community as the debate over
tax reform evolves. Because it arises out
of the House tax-writing committee and
was released with statutory language as
well as a general description, tax insiders
are treating the proposal as a serious
effort. It is the first in a series of reform
proposals that the committee has signaled
it plans to release; individual and
domestic corporate reforms are slated for
a later time.
Highlights of the Ways and Means
Proposal
The proposal would reduce the U.S.
marginal corporate tax rate to 25
percent The proposal is intended to be
revenue-neutral; specific base-broadening
policies to replace the revenues lost
by reducing the corporate rate are not
addressed in the draft and are expected
to be included in future releases from the
committee.
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The proposal also would exempt 95
percent of non-U.S. corporate earnings
from U.S. taxation when profits are
brought back, or repatriated, as
dividends to the United States from
a foreign subsidiary. In addition, the
proposal would eliminate foreign tax
credits on exempted income. Foreign tax
credits would continue to be available
for use with non-exempt foreign income,
including passive and highly mobile
income. In general, the proposal
would impose no limits on deductions
for business expenses. Five percent of
repatriated profits would be taxed in lieu
of allocating expenses between
U.S.-source and foreign-source income.
The proposal includes a series of
anti-abuse options designed to prevent
erosion of the U.S. tax base, including
“thin capitalization” rules that would
limit certain interest expense deductions,
and income-shifting rules to prevent U.S.
companies from avoiding U.S. tax by
transferring intangible property to foreign
companies that pay little or no tax. The
proposal also would keep the existing
Subpart F rules in place. Passive and
highly mobile foreign income, including
interest and royalties, would continue to
be currently taxed.
The proposal includes a transition rule that
would impose a “deemed-repatriation”
tax of 5.25 percent on all accumulated
foreign earnings currently held offshore.
Unlike several recent proposals in
K&L Gates Global Government Solutions ® 2012 Annual Outlook
Congress aimed at reducing the tax cost
of actually bringing earnings of controlled
foreign corporations (CFCs) into the
United States, the proposal would tax the
earnings of CFCs even if the funds were
not physically repatriated. This tax could
be spread over a period of eight years.
The proposal largely leaves open the
question of how companies would
transition from a worldwide system
to a territorial system. The draft does
not resolve whether and how U.S.
multinationals would be able to benefit
from unused foreign tax credits. It also
does not consider whether temporary
international tax provisions, including
the active financing exception and the
controlled foreign corporation
look-through rules, would be allowed to
expire or be made permanent as part
of the overall reform package. It will be
difficult for U.S. businesses to assess how
they will be affected by the committee’s
territorial proposal with these important
issues unanswered.
Moreover, rather than simplifying the tax
code, the draft could create complexities
of its own. For example, the base
erosion options would impose significant
recordkeeping burdens on businesses in
order to appropriately allocate income
and costs to specific intangible property.
The Ways and Means Committee
is actively seeking feedback on the
proposals in the territorial draft. The draft
is expected to serve as an important
marker in discussions about tax reform
throughout 2012 that may lead to
comprehensive reform, possibly in 2013.
Thus, businesses that engage early in
the reform process will likely have a
meaningful impact on the shape of any
ultimate legislation.
Mary Burke Baker (Washington, D.C.)
mary.baker@klgates.com
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