At the recent 2011 OECD International Tax Conference in Washington, Manal Corwin, Treasury Deputy Assistant Secretary for International Tax Affairs, explained that political realities will make any future tax reform a difficult exercise. She stated that if tax reform in the U.S. is to be a revenue neutral exercise, then there will inevitably be winners and losers relevant to current law.
Background. U.S. individuals and corporations are generally taxable on income from outside the U.S. just as they are on income from inside the U.S. (Code Sec. 862) This is known as the “worldwide” tax system. This system theoretically eliminates any advantage that a U.S. corporation would receive from doing business in a low-tax country because all income, whether U.S. or foreign source, is taxed at the same U.S. rate. However, there nonetheless exist opportunities for certain corporations to earn and accumulate income at tax rates below the U.S. rate because foreign-source income is generally insulated from U.S. tax until it is repatriated and distributed to U.S. owners.
New insight. At the recent OECD conference, in response to criticism by U.S. multinationals that the U.S. tax regime is “out of sync” with the rest of the world because of a relatively high U.S. corporate income tax rate coupled with the worldwide taxation of foreign earnings that now differs from the approach taken by other leading jurisdictions, Corwin defended the U.S. position saying that the U.S. tax burden was only one aspect that contributed to overall U.S. competitiveness. Other factors that contribute to the competitiveness of the investment environment include innovation, skilled labor and education.
“It is important to think in those terms, because to the extent government expenditures can contribute to the competitiveness of U.S. companies, we have to ask ourselves whether these expenditures in the form of tax cuts offer the best return on our investment,” she said.
Jeffrey Owens, Director of the Centre for Tax Policy and Administration of the OECD suggested an alternate course. He noted that although larger countries, such as the U.S., are better able to resist downward pressure on their corporate income tax rate as compared to smaller ones, the OECD's view is for jurisdictions to move away from direct taxes (such as corporate and personal income taxes) towards broad-based indirect taxes such as a Value-Added Tax (VAT) and to focus on improved compliance. (For more on the benefits and drawbacks of a VAT)
Corwin acknowledged that VATs permitted other jurisdictions to modify their tax regimes, but noted that such revenue sources have been unavailable in the U.S. She did not elaborate.
She also stressed that the U.S. economy was considerably larger than that of many other nations and that the U.S.'s tax to GDP ratio was one of the lowest amongst OECD nations.
Owens said that several member countries were facing budget deficits on average of 8.8% and debt to GDP ratios of almost 100%.
“We have not seen these types of ratios in peacetime before,” he said. “Clearly action has to be taken to address them, not just here in the U.S., but around the world.”
Corwin said that U.S. international tax may or may not be part of overall tax reform, offering few clues as to which position the administration may ultimately pursue.
“It could be viewed independently or in conjunction with reform,” she said.
The administration's recent budget proposals outline some of the areas that would provide tweaking to the current system without any fundamental change to the overall international tax regime.
Alternatively, international tax reform could be done in conjunction with broader tax reform. She suggested that the U.S. could potentially shift to a territorial system in a manner that would be revenue raising. It would be less likely to see a shift to a territoriality system that would result in tax savings for U.S. multinationals.
References: For U.S. tax treatment of foreign income in general, see FTC 2d/FIN ¶O-1000 et seq.; United States Tax Reporter ¶8644 et seq.; TG ¶30350 et seq.