By Oxford Analytica - 09/25/07 06:02 PM EDT
The main targets of the measure are corporations such as Accenture and Tyco — which conduct the bulk of their operations in the United States, but are incorporated in Bermuda. However, the provision would have more wide-ranging effects, and may reduce the attractiveness of U.S. operations to many corporations.
Rep. Lloyd Doggett (Texas), the author of a new bill designed to close a tax loophole covering transfers between U.S. subsidiaries and their offshore parent corporations, is a senior Democrat on the House Ways and Means Committee, the primary tax-writing committee. Doggett has a keen interest in many tax issues, particularly in measures that would mitigate the application of the higher tax rates mandated by the Alternative Minimum Tax (AMT) to an increasing number of middle-class taxpayers. While his AMT reform efforts are widely popular, Doggett’s new bill concerning corporate transfers is much more controversial.
Tax treatment of transfers
A key provision in the Doggett bill would change the current tax treatment of transfers between a corporate subsidiary and its parent:
• Reciprocal tax treaties. The United States has established reciprocal tax treaties with 58 countries (and has less formal agreements with many others). The Doggett bill would have the greatest impact on companies incorporated in jurisdictions that lack such a double tax avoidance treaty with Washington.
• ‘Treaty shopping’ loophole. Currently, many companies that maintain legal domiciles offshore are able to make tax-free transfers from their U.S. subsidiaries to subsidiaries in countries that maintain reciprocal tax treaties with the United States. This practice is known as “treaty shopping,” and is deemed by corporate tax experts to be a sound strategy for minimizing a corporation’s tax liability.
Doggett’s proposal would change the system for setting withholding rates on earnings by the U.S. subsidiaries of foreign corporations. Generally, these companies are subject to withholding at a 30 percent rate, but reciprocal tax treaties often significantly reduce or eliminate entirely these U.S. withholding taxes. Corporations headquartered in many European countries — including the United Kingdom and the Netherlands — are not subject to withholding. Companies in other countries are subject to higher rates: Japan’s rate is 10 percent and India’s 15 percent. Doggett’s concern is that companies manipulate the system so as to route their U.S. earnings through a country with a zero rate, when the reality is that the company is located in a Caribbean tax haven that lacks a double tax treaty with the U.S.
For companies that could be engaged in treaty shopping, Doggett contends taxes should be withheld at the 30 percent rate:
• The measure requires that companies making transfers of earnings from their U.S. subsidiaries be subject to withholding rates no less than the rate that would apply if the payment were made directly to the foreign parent corporation.
• The congressional Joint Committee on Taxation estimates that the change will generate nearly $7.5 billion in total revenues over 10 years, and that 90 percent of these revenues will emanate from jurisdictions without tax treaties with the United States (including Caribbean tax havens, many Latin American countries and Singapore).
• The greatest impact for firms that are headquartered in jurisdictions that have a double tax treaty will be felt by Japanese firms, many of which currently route their U.S. earnings through a European financing unit, since the Japan-U.S. tax treaty allows for withholding at the 10 percent rate.
Prospects of passage
The tax proposal has been included as an amendment to the controversial farm bill, passed by a vote of 231-191 in the House of Representatives on July 28 — which President Bush has threatened to veto it in its current form. The Senate this month began considering its own version of the legislation.
Problematic provisions such as the Doggett amendment are frequently attached to more popular legislation as a backdoor means for achieving support for — or at least acquiescence in — a controversial policy:
• Revenue from the provision is earmarked to finance nutrition programs. If the Doggett tax provision is withdrawn from the farm bill, under pay-as-you-go budget deficit rules, legislators would either have to slash farm subsidies, or craft a new means for financing nutrition programs.
• Strong business community opposition has arisen to the provision, especially from the influential National Association of Manufacturers (NAM).
• Treasury Secretary Henry Paulson has criticized the measure, particularly as he believes it would have anti-competitive effects. Paulson convened a conference in July to examine the competitiveness effects of current U.S. corporate tax code.
Regardless of the overall progress of the farm bill, Paulson will press to weaken or eliminate the Doggett provision. He has already indicated his opposition to the amendment in a letter to Republican members of Congress:
• Counter to tax-cutting trend. The Doggett provision goes against the trend of Bush corporate tax policy.
• Job losses? Republican members of Congress claim that 5 million jobs at U.S. subsidiaries of foreign corporations could be eliminated if the Doggett provision is enacted; further, it would discourage future direct investment in the United States.
• Attractiveness of U.S. operations? Foreign business executives claim that the provision would be a negative factor in considering whether to conduct business in the United States. There is a widespread perception among foreign firms that the United States has become a more challenging environment in which to do business, in part due to recent regulatory changes such as adoption of the 2002 Sarbanes-Oxley Act.
• Possible retaliation? Additionally, the Doggett gambit may threaten the network of reciprocal tax treaties that the United States has in place with many countries. If the measure conflicts with the terms of these treaties, U.S. companies or their subsidiaries operating abroad may face retaliation.
Strong administration opposition, accompanied by business community pressure, may result in the defeat of this provision during the current congressional term — regardless of the larger prospects for the farm bill. Yet if the Doggett amendment is defeated, it could well resurface in a different form — particularly if the Democrats pick up seats in Congress in the 2008 elections.
Corporate tax competitiveness considerations will remain significant regardless of who occupies the White House after January 2009. Nonetheless, this provision may once again seem attractive in future discussions of ways to raise revenue. Doggett is particularly focused on reducing the AMT’s bite, and any incoming administration must confront this issue. This or some other form of tax on corporate revenues may resurface as a comparatively “pain-free” revenue source.
Oxford Analytica is an international consulting firm providing strategic analysis on world events for business and government leaders. See www.oxan.com.