Why Do MNCs Pay So Little Foreign Tax?
Or
What’s a “Double Irish Dutch Sandwich”?
George White
Kelley School, Indiana University
Double Irish Dutch Sandwich
US
Parent
A
Irish
Parent
Bermuda
Alter-ego
B
Irish
Sub
Dutch
Filling
C1
C
2
US corporate income tax structure
• Worldwide (or global) system: US taxes all
income, regardless of source (foreign or
domestic) of US-chartered corporations
• Contrast with “territorial” system under which
only domestic-source income taxed, e.g., UK
which exempts dividends from controlled
foreign corporations (CFCs).
Worldwide system
• Economic theory: “capital export neutrality”
• Theory holds $ of income earned in foreign county X
should be taxed the same as $ of income earned in
US
• Opposing theory: “capital import neutrality”
• Theory holds all income earned in foreign country X
should be taxed the same, w/o regard to taxpayer’s
country of residence
Worldwide system
• Side effect: increased risk of economic double
taxation, i.e., same income being taxed by US
and foreign country.
• “Source” country always takes precedence over
“residence” country. Source country taxes
income first; US defers to source country thru
foreign tax credit (FTC)
Foreign Tax Credit
• FTC provides credit against US tax liability
for foreign tax on foreign-source income
• FTC does not permit credit against US tax
liability for foreign tax on US-source
income
• FTC limits credit to US tax liability for
foreign tax on foreign-source income by
fraction
US Tax on Foreign Business Operations
Domestic
Income
Foreign
Income
Domestic
Corp.
YES
YES
Foreign
Corp.
YES
NO
Overview
Under worldwide
system, US taxes all
income (domestic and
foreign) of domestic
corps.; but taxes only
US income of foreign
corp. This gives rise to
“deferral privilege.”
“Deferral” privilege
• Critics of deferral see it as violation of “capital export
neutrality” because earnings of foreign subs not
currently taxed at US rate
• Supporters of deferral see it as consistent with “capital
import neutrality” because earnings of foreign subs are
taxed at local rate, thus assuring US-owned foreign
subs remain competitive with foreign-owned
corporations chartered in counties employing
“territorial” system, e.g., UK.
“Deferral” privilege
•
Base company play: US Parent sells product to Swiss sub at discount;
Swiss sub sells to German sub at FMV; profit stays in low-tax Switzerland
where it’s deferred indefinitely
US Parent
Swiss sub
German sub
Subpart F
• Limited elimination of deferral
• Deferral terminated for passive income of CFCs
(controlled foreign corporations), e.g., Swiss sub
• Passive income of CFCs must be reported by US
Parent currently, even though not repatriated
• Distinction between active and passive income
based on premise that intangible assets are readily
movable to different tax jurisdictions; not so easy to
move tangible assets of active business, e.g., mfg
business
Deferral privilege limited
•
Base company play: US Parent sells product to Swiss sub at discount; Swiss
sub sells to German sub at FMV; profit stays in low-tax Switzerland where it’s
deferred indefinitely
US Parent
Swiss sub
German sub
• Subpart F requires US Parent to include in current income the Swiss sub’s
profit, even though not repatriated to US
Double Irish Dutch Sandwich
US
Parent
A
Irish
Parent
Bermuda
Alter-ego
B
Irish
Sub
Dutch
Filling
C1
C
2
Double Irish Dutch Sandwich
• Step A : USP transfers to Irish Parent (with
IRS approval) rights to exploit search
technology in foreign markets.
• Step B: Irish Parent licenses search
technology to Irish Sub
• Step C1: Irish Sub pays royalty to Dutch Filling
• Step C2: Dutch Filling pays royalty to Bermuda
Alter-ego
Double Irish Dutch Sandwich
• Step A : Effectively transfers foreign profits out of
US tax jurisdiction. (Note: if sole purpose of
structure was to avoid US tax, it would end here.)
• Step B: Preliminary step to avoid Irish tax on
foreign profits
• Step C1: No withholding tax on royalty (per tax
treaty)
• Step C2: No Dutch tax on royalty income; no
withholding tax on royalty payment