President Obama's Plans To Change International Business Taxation

In May, 2009, the Obama administration unveiled its much-anticipated proposals for international tax reform.

According to an announcement by the Treasury Department issued on May 4 under the title ‘Leveling the Playing Field,’ the reforms seek to achieve two broad objectives: removing tax incentives for US companies to invest overseas; and curbing the use of offshore jurisdictions by both companies and wealthy individuals. The proposals, however, affect many areas of corporate tax policy and would modify the law surrounding companies’ ability to defer tax on foreign earnings, foreign tax credits and the classification of foreign businesses.

“Today, President Obama and Secretary Geithner are unveiling two components of the Administration's plan to reform our international tax laws and improve their enforcement,” said the Treasury. “First, they are calling for reforms to ensure that our tax code does not stack the deck against job creation here on our shores. Second, they seek to reduce the amount of taxes lost to tax havens – either through unintended loopholes that allow companies to legally avoid paying billions in taxes, or through the illegal use of hidden accounts by well-off individuals.”

When combined with additional international tax reforms that are due to be unveiled in the Obama administration's full budget later in May, these initiatives would raise USD210bn over the next 10 years.

One of the most significant aspects of the proposed reforms for companies is the sweeping changes to ‘deferral’ – the part of the tax code which Obama blames for allowing companies to “ship jobs overseas.”

According to the Treasury, under current rules, businesses that invest overseas can take immediate deductions on their US tax returns for expenses supporting their overseas investments but nevertheless "defer" paying US taxes on the profits they make from those investments. This, the government argues, means that “a significant tax advantage” is given to companies who invest overseas relative to those who invest at home. Under the proposed reforms, the deferral rules would be changed so that – with the exception of research and experimentation expenses – companies cannot receive deductions on their US tax returns supporting their offshore investments until they pay taxes on their offshore profits. This provision would take effect in 2011, and the Treasury expects that an additional USD60.1bn in tax revenues would be raised from 2011 to 2019 as a result.

In addition, the proposals would change the tax code to prevent US companies from artificially inflating or accelerating foreign tax credits, which companies claim against their US taxes for taxes paid on foreign profits. This would raise an additional USD43bn from 2011 to 2019.

The tax revenues raised by these two provisions would be used to make permanent the Research and Experimentation Tax Credit, which has been extended temporarily many times and is next due to expire at the end of 2009.

The second element of the international tax reforms, entitled “Getting Tough on Overseas Tax Havens” (as opposed to “domestic” tax havens) seeks to raise USD95.2bn over the next 10 years by changing rules surrounding ‘passive’ income, increasing disclosure requirements for individuals with offshore banks accounts, strengthening the Qualified Intermediary program, and beefing up penalties for failure to disclose information. They include:

• Eliminating Loopholes for "Disappearing" Offshore Subsidiaries: The Obama administration proposes to reform 'check the box' rules to require certain foreign subsidiaries to be considered as separate corporations for US tax purposes. This is designed to prevent companies from making their foreign subsidiaries "disappear" when shifting passive income. This provision would take effect in 2011, raising USD86.5bn from 2011 to 2019.
• Cracking Down on Offshore Tax Evasion by Individuals: In addition to initiatives taken within the G-20 to impose sanctions on countries judged by their peers not to be adequately implementing information exchange standards, the Obama Administration proposes a comprehensive package of disclosure and enforcement measures to make it more difficult for financial institutions and wealthy individuals to evade taxes. The Administration "conservatively" estimates this package would raise USD8.7bn over 10 years by:
• Withholding Taxes From Offshore Accounts: This proposal requires foreign financial institutions that have dealings with the United States to sign an agreement with the IRS to become a "Qualified Intermediary" and share as much information about their US customers as US financial institutions do, or else face the presumption that they may be facilitating tax evasion and have taxes withheld on payments to their customers.
• Shifting the Burden of Proof and Increasing Penalties: In addition, the Obama Administration proposes tightening the reporting standards for overseas investments, increasing penalties and imposing negative presumptions on individuals who fail to report foreign accounts, and extending the statute of limitations for enforcement.
• New Resources for IRS Enforcement: As part of the Obama Administration's budget, the IRS will hire nearly 800 new employees devoted to international enforcement, increasing its ability to crack down on offshore tax avoidance.

The reforms build on proposals by Senate Finance Committee Chairman Max Baucus and House Ways and Means Chairman Charles Rangel – as well as other Democratic leaders like Senator Carl Levin and Congressman Lloyd Doggett.

Rangel, who drafted similar legislative proposals in 2007, said: “Today’s announcement by President Obama and Secretary Geithner is another strong step toward fulfilling the Administration’s promise to strengthen opportunities for investment and job creation here in the US For too long, our tax laws have rewarded companies that invest and keep their money overseas and turned a blind eye to the use of tax havens by the wealthy."

He added: “Our tax code should reward companies that thrive by continuing to invest in America and American workers. I applaud President Obama’s commitment to simplifying our tax code and look forward to working with the Administration to close these loopholes.”

However, Baucus issued a more cautious response to the proposals, and said that more study is required to see how American companies will be influenced by the suggested policies.

“The President’s proposals highlight an important point — our corporate international tax system needs reforming,” he commented. “There are a number of Finance Committee ideas reflected here, such as the proposal to address offshore tax evasion and making the R&D credit permanent for businesses, but further study is needed to assess the impact of this plan on US businesses.”

“I want to make certain that our tax policies are fair and support the global competitiveness of US businesses,” Baucus added. “These policies must be designed to encourage economic growth and create good-paying jobs Americans need right now. The proposals announced by the President today set the table for tax reform, and I look forward to sitting down with the Administration soon to take up these issues.”

Business, however, is understandably hostile to the proposals, with the National Foreign Trade Council (NFTC) describing them as “counterproductive” during a time of economic stagnation.

“The international tax provisions announced today would saddle US-based multinational companies with what amounts to a tax increase at a time when they are doing all they can to remain competitive and protect and grow US jobs,” observed NFTC Vice President for Tax Policy Cathy Schultz.

“We are disappointed that today’s announcement did not mention reforming the corporate tax rate, which is the second highest in the world,” said Schultz, adding: “The tax provisions proposed today would just pile on an additional tax, jeopardizing US-based multinational companies’ ability to compete both here and overseas.”

US Chamber of Commerce Chief Economist Dr. Marty Regalia argued that deferral has been “mischaracterized” as a tax break when it actually provides a “vital mechanism” for US companies to claim relief from double taxation.

“The United States is the only major industrialized country which double taxes the overseas earnings of our companies. Since other countries don’t subject their companies to double taxation, US companies need deferral to stay competitive in the global marketplace,” he said.

“A huge tax hike on US employers is not the way to stimulate our economy. Congress should reject this approach,” Regalia warned.

In September, 2010, a bill which proposed a payroll tax holiday to companies hiring American workers to replace those at a foreign-based operation whilst removing tax breaks from those companies moving operations abroad has been voted down by the Senate.

The bill, known as the Creating American Jobs and Ending Offshoring Act, would have given companies a two-year holiday from social security payroll withholding taxes for each employee they hired to replace a worker at a foreign-based facility. In return, the bill would have barred companies from taking tax credits or deductions against company income taxes for the cost of closing a US-based facility to move the operation overseas. In addition, companies that closed a US-based business and expanded a similar foreign business, for the purpose of importing products for sale in the US, would no longer have been allowed to defer US income taxes on those foreign subsidiaries.

Democrats argued that the legislation would have created new jobs and erected barriers to those firms 'shipping jobs overseas'. "The bill we tried to pass today is based on simple common sense: to keep American jobs here in America, we should stop forcing taxpayers... across the nation to pay for giveaways that reward companies for sending American jobs overseas," stated Sen. Harry Reid, Senate Majority Leader and a co-sponsor of the bill, following the September 28 vote.

"But Republicans continued their job-killing agenda by protecting these tax breaks for CEOs who offshore American jobs, and preserving the same failed Republican policies that cost eight million Americans their jobs," Reid remarked.

But Chuck Grassley, the ranking Republican on the Senate Finance Committee, countered that the bill would merely have given foreign firms a competitive advantage over US manufacturers in vital overseas markets.

“The legislation that was defeated in the Senate today would make US companies pay an extra tax, of up to 35%, compared to foreign competitors, and really hit companies like John Deere, where they have big overseas markets,” Grassley said.

The Iowa Republican also suggested that no evidence exists to support the view that deferral rules - the bete noir of the Obama administration - motivate firms to avoid US tax. These rules allow a US corporation to defer paying US tax on the earnings of its foreign subsidiaries until such earnings are sent back to the parent.

"So, this bill is completely contrary to a half-century of bipartisan thinking as to when it is appropriate to deny deferral, and when it is not. To the contrary, there obviously could be many reasons for a foreign subsidiary of a US corporation selling goods into the United States," Grassley noted. "There could be a need to be near to certain overseas markets, or the good in question may not be found in appreciable quantities in the United States. There could be quite a lot of reasons having nothing to do with tax, but the sponsors of this bill don’t seem to understand that."

Grassley said the real issue with taxes on American companies that have foreign subsidiaries is that “corporate tax rates in the United States put US employers and, in turn, our workforce at a competitive disadvantage.”