— Citizenship Lawyer (@ExpatriationLaw) October 9, 2014
On October 8, 2014 I had a “Guest Post” appear at Forbes. The post discusses the uniquely American policy of taxing economic activity that takes place outside the United States. The U.S. claims the right to tax this activity because it is the activity of a “U.S. Person” (which would include either a DNA citizen or a U.S. corporation). You can read the complete article at Forbes, but it includes:
Inversions, Planning & Corporate Tax Rates
By John Richardson
To combat inversions and other tax planning techniques for corporations, do you think Congress should lower corporate tax rates?
With or without “inversions” Congress MUST lower corporate tax rates.
There are at least two reasons for this:
First, U.S. corporate tax rates are the highest in the world, with the obvious consequence that almost every other country on the planet offers a more competitive tax environment; and
Second, U.S. corporate rates are so high that the primary business of U.S. corporations has become finding ways to create a lower “effective tax rate” and NOT about selling the products of the corporation. Anecdotal evidence suggests that corporate tax planners have been successful and that most U.S. corporations pay less than the official 35% rate. That said, U.S. tax rates are NOT the reason for corporate inversions. U.S. tax rates do NOT affect the rate of tax paid on profits earned in the U.S.
What “inversions” have done is to have drawn attention to BOTH the problem of high U.S. corporate tax rates AND the reality that the U.S. claims the right to tax “foreign profits” that are NOT earned in the United States. Yes, the U.S. is the only country in the world that claims the right to tax profits that are earned in other countries. In the same way that the U.S. requires American citizens who do NOT live in the U.S. to pay U.S. tax on earnings outside the U.S., American Corporations are required to pay tax on profits that are earned outside the U.S. Significantly Americans living abroad are renouncing their citizenship in unprecedented numbers. (In fact the U.S. Government has just increased the “renunciation fee” by more than 400%.) President Obama has implied that “inversions” are the corporate equivalent of “renouncing citizenship”. U.S. companies are performing “inversions” – renouncing citizenship – at an unprecedented rate.
It is important to note that these “renunciations of citizenship” (whether personal or corporate) are NOT the result of high U.S. tax rates. They ARE the direct result of the uniquely American policy of claiming the right to levy taxes on money earned in other countries and (at least in the case of Americans abroad) on people who are NOT residents of the U.S. (Because U.S. citizens abroad also pay tax in their country of residence, they may be subjected to significant double taxation.) Once again, the United States of America is the ONLY modern country that has such a tax policy.
How U.S. Corporate Taxation Works (At the risk of oversimplification)
We will assume the standard 35% U.S. corporate tax rate and see how this applies for profits earned in the U.S. and outside the U.S.
Profits earned in the U.S. – Assuming a 35% tax rate
All companies (U.S. or foreign) will pay 35% tax on profits earned in the U.S. An “inversion” does not affect this principle.
Profits earned outside the U.S. – Assuming a 15% Local tax rate
Imagine a U.S. corporation carrying in business in Country X which has a 15% tax rate. Further imagine that the U.S. company must compete with a German company in Country X. Each company will pay a 15% tax to the Government of Country X.
The German company will pay no further taxes. It is free to do what it wishes for the benefit of the company and for the shareholders. This includes investing all it’s “after tax” profit in the U.S.
The U.S. company is NOT finished. If the U.S. company attempts to bring its profits back to the U.S. it will be required to pay the difference between the 35% U.S. tax and the 15% Country X tax (35% – 15%) = 20% as a U.S. tax for the privilege of bringing the profits to the U.S. (It is easy to understand the reluctance to bring the profits back to the United States.) To bring the profits back to the U.S. is to transfer 20% of PROFITS EARNED OUTSIDE THE U.S., to the U.S. government. To pay this 20% is to lose that money for future investment use IN THE UNITED STATES. Yet, the German company could actually take it’s complete “after tax earnings” and invest those earnings in the U.S.
By claiming the right to levy taxes on profits earned outside the U.S., the U.S. has created an environment that:
– discriminates against U.S. companies by imposing costs on them that are NOT shared by non-U.S. companies; and
– makes it harder for U.S. companies to pay dividends to its U.S. shareholders (the company can’t bring the money back to the U.S.)
– restricts the investment of productive capital in the U.S.
– makes it more difficult to finance dividends to U.S. shareholders
The sad reality is that: U.S. tax policy discriminates against U.S. companies and punishes them for being American.
U.S. corporate tax policy means that every U.S. company carrying on business outside the U.S. carriers a U.S. tax discount, making it worth less than non-U.S. companies.
For that matter, the U.S. policy of citizenship-based taxation means that every U.S. citizen residing outside the United States, carries a “U.S. tax discount”.
This point needs to be repeated in two different ways:
The U.S. tax policy of attempting to tax profits earned outside the U.S., earned by people who earned those profits outside the U.S., has made U.S. citizens and corporations abroad, worth less than the citizens and corporations of any other country.
It is therefore quite understandable for corporations to NOT want to be treated as U.S. persons. This is what they hope to achieve through an “inversion”.
Corporate Inversions 101 – A Simplified Explanation
In its simplest terms an “inversion” will result in the Corporation ceasing to be a U.S. corporation. After the inversion, the corporation will no longer be subject to the U.S. policy which levies taxes on earnings outside the U.S. It will be free to invest its profits in the U.S. and will NOT be subject to U.S. discrimination based on U.S. citizenship. (It is incredible that the German company is free to invest it’s Country X earnings in the U.S. and that the U.S. company must first pay the repatriation tax). A primary motivation for the corporate inversion is to allow U.S. companies to compete more effectively against non-U.S. companies in markets outside the U.S. Inversions will also free U.S. companies to invest more “after tax” profits in the U.S.
Of course, both the U.S. company and the German company will be subject to the full 35% U.S. tax rate on profits earned in the U.S. After the inversion, the U.S. company will no longer be subject to U.S. tax on profits earned OUTSIDE the U.S. Furthermore, it will be easier for the U.S. company to both:
Invest its profits in the U.S. (the U.S. does want investment doesn’t it?); and
Make it easier for U.S. companies to pay dividends to its shareholders (this is a desirable policy isn’t it?).
A “Wake Up Call” for U.S. Tax Policy
Although U.S. tax rates are important and must NOT be uncompetitive, the recent discussion of “inversions” and of Americans abroad “renouncing citizenship”, should prompt a rethinking of how the U.S. tax system should work. Who should be subject to U.S. tax? For what reason? On what kind of income?
U.S. tax policy follows U.S. citizens and U.S. corporations into other countries
U.S. tax laws follow their citizens and companies into other countries (where they also pay significant tax) and levy U.S. taxes on the capital base of other countries. The increasingly aggressive position of the IRS and extraterritorial legislation like FATCA (which imposes frightening obligations of disclosure and threats of penalty on Americans abroad) has made the problem more urgent. In fact, there is strong evidence that FATCA (AKA the worldwide hunt for U.S. persons) is a primary reason that Americans abroad believe that they must renounce their U.S. citizenship).
In the case of “DNA” Americans abroad: U.S. tax policy of taxing Americans abroad imposes a capital tax on other nations
For example for individuals (who pay the U.S. tax when the money is received):
– capital gains are NOT taxed in Switzerland,
– the sale of a principal residence is NOT taxed in Canada.
The decision to not tax these transactions is a policy decision made by these countries to allow their taxpayers to retain their capital. It is obviously intolerable to allow the U.S. to THEN extract this capital from these countries on the basis that it was a U.S. citizen who sold the house. As FATCA makes this a bigger issue, one can expect that U.S. citizens will become less welcome in other countries.
In the case of “non-DNA” U.S. corporations abroad
The profits are not subject to U.S. tax until the profits are brought back to the U.S. It makes no sense for corporations to bring their “offshore profits” back to the U.S. U.S. tax policy does not encourage investment, in America, by American companies. (Better to let the non-American companies do this.)
In conclusion …
The question is NOT whether U.S. corporate tax rates should be lowered (although they obviously should) to combat inversions, the question is whether the U.S. should:
Continue its destructive and anti-competitive policies of being the only country in the world which attempts to levy taxes on profits earned in other countries by people (in the case of Americans abroad) who do NOT live in the U.S.; or
Join the rest of the world by taxing ONLY the profits and property that are within its jurisdiction. This is called “territorial taxation”.
The answer to this question depends on whether the U.S. believes that it is PART of the world or whether the U.S. believes that it is THE world.
The answers are:
No, the U.S. should not lower tax rates in order to stop inversions. The issue is not the tax rate. The U.S. should stop attempting to tax profits earned in other countries which are already taxed in the country where the profits are earned.
Yes, the U.S. should lower tax rates to make “tax planning techniques” for corporations less relevant. The primary business of
corporations should NOT be about tax reduction.
The U.S. must stop attempting to tax profits and incomes earned in other countries. To do so is (like FATCA) “territorial overreach.
John Richardson is a lawyer based in Toronto, Canada with Citizenship Solutions.
Comments on the article:
The great thing about “online articles” is that they allow for comments. In many cases the comments “add to” the article. The comments to this article do “add to” the article. Hence, I include them as follows: