International Tax Reform Considered by Senate Finance Committee
On March 17, 2015, the Senate Finance Committee held a two-hour hearing on reforming the provisions of the Internal Revenue Code dealing with the taxation of cross-border income. Four individuals testified at the hearing: Pam Olson an attorney with PricewaterhouseCoopers holding the title United States Deputy Tax Leader & Washington National Tax Services Leader, Anthony Smith, Vice President of Tax & Treasurer of Thermo Fisher Scientific Inc., Rosanne Altshuler, Professor of Economics and Dean of Social and Behavioral Sciences of Rutgers University, and Steve Shay, Professor of Practice of Harvard Law School. Olson and Shay have held senior positions in the Treasury’s Office of Tax Policy in the past. Although international tax reform has been discussed for year in Washington and no substantive legislation has been enacted, the current discussion may build a consensus that will lead to legislation, most likely after the next Presidential election in 2016.
The materials prepared for the hearing and the hearing itself identified various factors providing an impetus for international tax reform in the United States as well as the policy issues to be addressed in crafting tax legislation to respond to those factors. Although the Senate Finance Committee has not yet drafted a legislative proposal, the questions asked by the senators during the hearing as well as their comments provide some insights as to the broad outlines of any bipartisan legislation that may follow.
External forces prompting consideration of international tax reform
In general, there appears to be a consensus that the provisions of the Internal Revenue Code dealing with the taxation of cross-border income should be revised to reflect various changes occurring since the last major revision of the Code’s international tax provisions in 1986. These factors, which are interrelated, include:
- a general reduction, over a number of years, in statutory corporate tax rates of the OECD member countries other than United States that has made the US statutory corporate tax rate an outlier among developed countries,
- the movement of various significant US trading partners from a worldwide income tax system (that the US has) to a territorial income tax system,
- the adoption, by numerous jurisdictions, of various IP incentive regimes (“patent boxes”),
- the continuing phenomenon of corporate inversions by which US multinational groups are migrating out of the United States in order to reduce their US tax burden,
- the concern that the US corporate income tax system may make US companies targets for takeovers by foreign competitors,
- the long-standing efficacy of multinational groups, particularly US multinational groups, in structuring their operations to minimize taxes paid in high-tax jurisdictions and to locate income in low-tax (and no-tax) jurisdictions,
- for U.S. companies, the resulting “lockout effect” created by this structuring (i.e., the resistance that US multinationals have to repatriate funds to their US group due to the residual US tax that would be owed on such income (post-foreign tax credit) as well as the financial accounting consequences of not “permanently reinvesting” such low-tax earnings), and
- the joint initiative of the G-20 and the OECD to address BEPS (base erosion and profit shifting) as well as the legislative proposals now being proposed in various countries ahead of the final set of BEPS recommendations, which will very likely raise the effective tax rate of US multinational groups.
Policy considerations shaping international tax reform
There also is some consensus that the enumerated factors need to be addressed by changes in the Internal Revenue Code to remedy various maladies of the current tax system including (i) erosion of the US tax base (through earnings stripping and corporate inversions), (ii) lack of competitiveness of US companies in the global marketplace (the high statutory tax rate and the lockout effect), (iii) a need to stimulate investment and job growth, particularly in the area of R&D (or as a defensive measure, to respond to competitive pressures as other countries change their tax systems to encourage R&D), and (iv) distortions created by the current US deferral regime for taxing offshore income. No doubt there is variation among the senators in their perception of the degree of the necessity of each policy consideration.
There probably is no consensus today as to whether any legislative changes should be revenue neutral and how to address the BEPS issues raised by US multinationals’ tax planning. In particular, there has been little discussion as to which tax expenditures should be eliminated or reduced in order to fund a reduction in the statutory corporate tax rate and whether and how US CFC rules (subpart F) should be revised to address BEPS. Today, it probably would be safe to say that some senators support legislation that would result in an overall reduction in the percentage of tax revenue provided by the corporate income tax, while others would insist on a package of changes that are revenue neutral.
BEPS as a factor
Although the Obama administration's budget proposals include several provisions intended to respond to various BEPS action items, somewhat surprisingly, the senators at the hearing as a group did not dwell on the consequences of BEPS for the US fisc or US multinationals in shaping any tax reform proposal. The one exception was Senator Charles Schumer of New York. In discussing BEPS, Senator Schumer said the rest of the world is already acting on BEPS, they are “stealing our tax base” and the worst thing the United States can do is “sit on the sidelines.” He also said that US CEOs expected to begin to see the impact of BEPS on the US tax base “in months not years.” The United Kingdom’s new diverted profits tax was offered as an example of such BEPS legislation.
Although BEPs was not widely addressed, discussion of a minimum tax on CFC’s income implicitly addresses BEPS – both erosion of the US tax base and erosion of the tax base of other high-tax countries. Also, a “revenue neutral” corporate tax rate cut and a move to a per-country minimum tax on CFC income would effectively tighten the foreign tax credit and limit the impact source state tax increases on the US fisc by limiting cross-crediting by US multinationals. Tightening of US base erosion rules also was discussed.
Potential changes being considered
International tax reform raises numerous issues, and over the years various proposals have addressed these issues. Nevertheless, there has been much discussion in Washington of two key potential changes in the Code. First, a cut in the top corporate (now 35%) to be paid for by broadening the tax base (i.e., eliminating many deductions and tax credits) such as described in Senator Wyman’s proposed legislation. Such a rate cut is thought to make inversions and tax-driven foreign takeovers less attractive. Second, there has been discussions of moving the United States from a worldwide tax system to a territorial tax system in order to align the US tax system with the systems of the major US trading partners and address the “lock out effect” Senator Camp has proposed such legislation. The territorial system discussed would not be a pure territorial system, i.e., some income of CFCs would be taxed in the year earned. The types of income to be taxed currently and the tax rate have been the subject of much discussion. Such a minimum tax would address BEPs issues.
In general, business interests seek a low corporate tax rate and a territorial system with an exception for limited categories of income that would be taxed at a low rate. Such reforms very likely would not be revenue neutral. The Obama Administration has proposed an unspecified corporate tax rate cut, a broadening of the tax base and a minimum tax on all income of CFCs (and foreign branches) of 19 percent. Some senators questioned the witnesses as to what should be the proper rate for such a minimum tax.
There was also discussion during the hearing of R&D incentives. Some senators expressed interest in patent box regimes and asked witnesses how effective such regimes might be compared to current R&D credit. Some witnesses supported the concept, while one called it bad tax policy as incentives for education and infrastructure are more effective.
International tax reform is being addressed by a bipartisan working group of senators, including Senator Schumer of New York who may become the leader of the Democratic minority when, the current leader, Senator Harry Reid retires. The working group is due to report the results of its effort in May. What this group achieves will likely influence future discussions on this topic.
 The written testimony of the witnesses and a video of the hearing are available at http://www.finance.senate.gov/hearings/hearing/?id=3942c973-5056-a032-52c6-1743fbaa52e8/. The US CFC rules (subpart F) were enacted 20 years earlier – in the early 1960s. For a detailed discussion, see the report prepared by the Joint Committee on Taxation in advance of the hearing: Present Law and Selected Polciy Issues in the Taxation of Cross-Border Income, March 16, 2015 (JCX-51-15). The recent introduction of dynamic scoring could introduce an additional element of controversy in to any efforts to build consensus around a particular legislative proposal as there is some belief that it is sensitive to the assumptions necessary for the economic models to provide a revenue estimate. Two of the more prominent proposals are the 2011 Camp discussion draft on a participation system for foreign income and the 2010 Gregg-Wyman Bipartisan Tax Fairness and Simplification Act of 2010, which would cut corporate tax rates and move to a per-country foreign tax credit limitation.
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