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Ways and Means Committee examines options for U.S. international tax reform

Joint Committee on Taxation, “ Present Law and Recent Global Developments Related to Cross-Border Taxation” (Feb. 23, 2016).

On February 24, the House Ways and Means Committee held a public hearing to focus on the global tax environment in 2016 and implications for U.S. international tax reform. Expert witnesses and members of the committee weighed in on factors impacting the extent and timing of U.S. international tax reform. In connection with the hearing, the Joint Committee on Taxation prepared a report entitled “Present Law and Recent Global Developments Related to Cross-Border Taxation.”

Background. U.S. policymakers are often concerned with the “competitiveness” of the U.S. tax system on a global scale, in respect to both economic growth and the general economic well-being of the U.S. population. These, in turn, depend heavily on the level of investment and employment in the U.S.

In the cross-border context, concerns about the competitiveness of the U.S. tax system have centered on policy objectives that include:

1. Fostering the growth of U.S. multinational enterprises (MNEs) abroad;
2. Encouraging domestic investment by U.S. and foreign businesses; and
3. Promoting U.S. ownership, as opposed to foreign ownership, of U.S. and foreign-sited assets.

Over the past decade, there have been a number of policy developments around the world, and in OECD countries (i.e., 34 countries that have ratified the Convention on the Organization for Economic Co-operation and Development, including the U.S.) in particular, that have led policymakers to question whether the U.S. tax system is competitive:

1. A decline in statutory corporate income tax rates in OECD countries—for example, in 2015, the U.S. had the highest combined statutory corporate income tax rate (39.0%) among OECD countries, while Ireland had the lowest (12.5%);
2. A significant increase in the number of OECD countries that have adopted tax systems that exempt active foreign-source income from home-country taxation (i.e., a territorial system of taxation); and
3. The promotion of domestic investment in research and development (R&D) to generate innovation through the establishment of preferential tax regimes for income derived from intellectual property (IP) (so-called “patent box regimes”).

To this end, much attention has been devoted to cross-border acquisitions involving U.S. MNEs that are largely motivated by tax considerations. For example, in corporate inversion transactions, a U.S. corporation engages in a series of transactions with the effect of moving its U.S. headquarters to a lower-taxed foreign jurisdiction in an effort to obtain certain tax benefits (e.g., minimizing U.S. federal taxes). Furthermore, by engaging in series of post-inversion transactions, certain foreign operations (including shares in foreign corporations) may be transferred to the new foreign parent or its foreign subsidiary(ies). If these transactions are respected, U.S. tax may no longer apply to the foreign earnings arising from the transferred foreign operations and to distributions of such foreign earnings to the new foreign parent or its foreign subsidiary(ies). By further “leveraging” the U.S. operations (including the U.S. corporations), the U.S. taxable base may be further eroded via the payments of deductible royalties, interest, or other fees to the new foreign parent or its foreign subsidiary(ies)..

Over the past few months, Pfizer and Johnson Controls (see Weekly Alert ¶  3  1/28/2016) have both announced plans to effectively move their headquarters to Ireland. Despite the enactment of Code Sec. 7874 (rules related to expatriated entities and their foreign parents), the regs thereunder, and other IRS guidance, Treasury Secretary Jacob Lew has acknowledged that “there is only so much Treasury can do to prevent” corporate inversions (see Weekly Alert ¶  1  11/25/2015). There is general consensus that any definitive action to address corporate inversions must come from Congress.

In addition, the recent G20/OECD base erosion and profit shifting (BEPS) recommendations (see Weekly Alert ¶  21  10/15/2015), along with the European Union illegal State aid investigations that appear to disproportionately target U.S. MNEs (see Weekly Alert ¶  2  02/18/2016 for prior coverage), have also highlighted the need for U.S. international tax reform.

In this regard, White House Council of Economic Advisers Chairman Jason Furman recently noted that it has been 30 years since the U.S. last passed fundamental federal tax reform. He said that the U.S. worldwide system of taxation is in practice, a “stupid territorial” system that “collects little revenue from the overseas operations of subsidiaries of U.S multinationals” (see ¶  4  02/09/2016 for prior coverage).

According to House Ways and Means Committee Chairman Kevin Brady (R-TX), many more U.S. MNEs may “be forced to restructure their business operations and move U.S. activities, such as research and development, overseas,” due to concerns with higher taxes, higher compliance cost, double taxation, and other adverse tax implications resulting from the OECD’s BEPS project recommendations. He also called the EU illegal State aid investigations a “whole new arsenal of new revenue-grabbing tax measures” and noted that such investigations “are threatening to impose retroactive taxes going back ten years on American businesses.”

The hearing–in general. The following witnesses testified at the February 24 House Ways and Means Committee hearing:

  • Michelle Hanlon, Professor of Accounting, Massachusetts Institute of Technology (MIT) Sloan School of Management.
  • Raymond Wiacek, Partner, Jones Day Law Firm.
  • Itai Grinberg, current Associate Professor of Law, Georgetown University Law Center, and previous Counsel to the President’s Advisory Panel on Federal Tax Reform (2015).
  • Edward Kleinbard, Professor of Law and Business, University of Southern California’s Gould School of Law, and previous Chief of Staff of the Joint Committee on Taxation.

At the hearing, these witnesses and the members of the committee addressed and debated a number of topics. Concern was expressed about U.S. MNEs that continue to undertake corporate inversions, the shifting of jobs outside of the U.S. in order for U.S. MNEs to benefit from preferential regimes offered by other countries (e.g., patent boxes in Ireland and the U.K.) to comply with the “nexus approach” agreed to under the G20/OECD BEPS project, and the EU State aid investigations seeking to retroactively impose taxes on American companies. Other topics of discussion are briefly summarized below.

Lockout effect. Ms. Hanlon testified about the “lockout effect,” a colloquial reference to the possibility that the overseas earnings of U.S. corporations are being “locked out” and not reinvested in the U.S., because U.S. corporations have a tax incentive to reinvest foreign earnings offshore rather than repatriate them back to the U.S. According to Ms. Hanlon, U.S. MNEs whose foreign earnings are locked out of the U.S. are forced to borrow in the U.S. to fund their operating needs.

Such a lockout effect disappears if repatriation of overseas earnings has no tax consequence—for example, if foreign earnings were exempt from or subject to a reduced rate of U.S. tax. Representative Jim McDermott (D-WA) told the committee that the last time U.S. MNEs were allowed to repatriate foreign earnings back to the U.S. at a reduced rate of U.S. tax, it was a failure. (For an article on the 2004 “repatriation holiday” and subsequent proposals, see Weekly Alert ¶  14  10/20/2011.)

RIA observation: Temporary Code Sec. 965 provided a temporary dividends-received deduction for repatriated foreign earnings. In particular, it permitted an one-time 85% deduction for certain dividends received by a U.S. corporation from certain foreign subsidiaries. According to a 2014 memorandum prepared by the JCT, the effect of a stand-alone voluntary repatriation bill, based on the “usage” of Code Sec. 965 in the 2004-2006 period as well as other assumptions and evidence, was estimated to raise revenue in the first two years (2014-2015) and then lose revenue over the next several years (2016-2024), for a combined loss of almost $96 billion.

Corporate rate reduction and dividend exemption system. Ms. Hanlon urged the committee members to act on U.S. international tax reform, stating that the high U.S. corporate tax rate and worldwide system of taxation is out of line with the rest of the world and may drive U.S. MNEs out of the U.S. in order to remain competitive with other MNEs.

Mr. Wiacek acknowledged that tax cost is not the only factor in foreign competition. However, he asked how anyone could think that tax cost is not part of the competition, when it impacts the bottom line. When the U.S. loses in this competition, it has terrible effects on jobs in U.S. communities.

“Nobody is defending the status quo,” said Representative Peter Roskam (R-IL).

Impact on small businesses and individuals. A member of the committee asked whether small businesses and individuals are impacted by the foreign competition concerns faced by U.S. MNEs. Using General Electric’s (GE’s) move from Connecticut to Massachusetts for tax reasons as an example, Mr. Wiacek made reference to the restaurants (as well as other local businesses) in Connecticut that would no longer benefit from the GE employees who move to Massachusetts. The point was made that tax costs impacting the bottom line of U.S. MNEs may impact small businesses and the individuals that run those businesses.

Additionally, with respect to younger workers, Mr. Grinberg said: “Over time there will be corporations that migrate offshore or are incorporated offshore to start, and more and more of their high skilled opportunities will be staffed abroad… I really do fear there will be fewer opportunities for younger people in the U.S.”

Revenue neutrality. Asked how a reduction in the U.S. corporate tax rate (including other tax reform measures) would be funded in order to maintain revenue neutrality, the majority of the witnesses indicated that U.S. corporate tax reform need not be revenue neutral. Mr. Kleinbard disagreed.

Many times during the hearing, the idea of using a U.S. federal consumption tax (such as a value added tax) to broaden the U.S. tax base was mentioned. When asked “yes” or “no,” the majority of the witnesses indicated that they would support a consumption tax.

Next steps. Ways and Means Tax Policy Subcommittee Chair Charles Boustany (R-LA) reportedly indicated after the hearing that his subcommittee is working on international tax proposals and hopes to have them done by the end of March. According to reports, among the proposals he is considering are lower corporate tax rates in the U.S., a dividend exemption tax system, and a so-called “innovation box.”

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