Senate bill would enshrine international tax gimmicks

Senate bill would enshrine international tax gimmicks
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The version of the GOP tax plan that came charging out of the Senate Finance committee just before Thanksgiving break — the version the full Senate takes up this week, and the version most likely to become law — reads like it was written in a rush. This is especially true of the several diverse provisions ostensibly designed to prevent U.S. multinationals from avoiding tax on their foreign earnings.

Those sections, like so many paintballs shot at a wall, present no clear pattern. But step back, tilt your head, and squint: you’ll see that even all the splotches taken together do not in fact put a stop to the tax games that multinationals presently play. Instead they codify and sanctify them.

Here’s a simplified version of one of the most important of these games:

Let’s say Apple wants to sell smartphones in France. It sets up a subsidiary, “Scrapple” incorporating it on the island of Jersey (Think: Channel, not Long Beach). In reality, Scrapple is just another compartment in Apple’s purse. But because it is technically a separate corporation, it is taxably a separate person.

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Apple then sends cash to Scrapple, and this is cast as Apple’s investment in Scrapple. Scrapple then sends the same cash back to Apple, and this is cast as Scrapple’s contribution toward the cost of the research and development that Apple conducts in Cupertino, Calif. “Naturally” having paid a share of the cost of the R&D, Scrapple receives a share of its fruits. Scrapple owns the profit attributable to R&D on every phone sold in France. That’s most of the profit.

Jersey does not tax these profits. France doesn’t either. Under current treaty provisions, which the U.S. has vigorously defended, France captures only the thin slice of profit attributable to retail distribution in France.

Given that no one else is taxing these profits, does the U.S.?

Under the law as it stands, the U.S. taxes Scrapple’s profits only when Scrapple pays them out to Apple in the form of a dividend. And with these dividends, Apple plays a political-financial waiting game. It sits tight collecting investment returns on the still unpaid tax, all the while lobbying for a “one-time-only” tax holiday — such as occurred in 2004 and such as is again planned in the Senate bill. In the meantime, acting through Scrapple, it has broad leeway to invest the profits, including in U.S. stocks, bonds, and bank accounts. And should it for some reason need the money in its main purse compartment, it itself can borrow from third parties against these profits, explicitly mortgaging up to 2/3rds of its Scrapple stock.

So, as things stand, the bulk of the profit that Apple makes on phones sold in France (and other foreign countries) is taxed only by the U.S., only much later, and only at a rate that is substantially discounted relative to the rate paid on most other kinds of business profits.

The Senate bill does not repair this strange asymmetry. On the contrary, it cements it.

First, the Senate bill eliminates entirely the eventual tax on dividends from foreign subsidiaries.

Second, in a complicated provision, a Matryoshka doll of specially defined terms, the bill creates a new category of foreign subsidiary income, taxed immediately to the parent, called “global intangible low taxed income.” It seems clear that Scrapple’s R&D-based profits on French phone sales would indeed be GILTI. But, GILTI profits are not punished. Rather, GILTI profits get at a 50 percent discount. They are taxed at 10 percent, half the general corporate rate, which elsewhere in the bill is reduced from 35 percent to 20 percent.

Third, the Senate adds a “base erosion and anti-abuse tax” (BEAT), which as first glance seems like it might save the day. But it does not. This provision insures that deductible payments from Apple to Scrapple do not reduce Apple’s tax rate below 10 percent. Again, the backstop rate is only 10%. And in any event Apple’s only disbursement to Scrapple in the R&D cost-sharing scenario is characterized as an investment not a deductible payment.

So the figure that seems to emerge from these various splats on the wall is this: Apple and other U.S. multinationals will pay tax on R&D-derived profits from their foreign sales at half the general corporate rate.

Why this oddly targeted giveaway — especially in light of what other taxpayers are being asked to give up in this same bill?

The best among several bad rationales appears to be this: encouraging R&D in the U.S. But even putting aside that the U.S. already does plenty to encourage R&D, these new provisions are a strange medicine. They apply only to foreign sales, even though the same R&D goes into domestically sold products. Given that some of the benefit of a lower rate on R&D profits is probably passed on to consumers through lower prices, the question arises: Is the Senate planning to have U.S. taxpayers subsidize phones sold in France but not phones sold in Florida?

But at this point in the debate — if we can call it that — the “why” questions such as this are being crowded out by the “what’s.” It is so difficult to discern what the Senate bill actually does, that there’s little time, space or energy left for evaluating its rationale.

That’s a problem for good policy.

Astoundingly, the president wants a bill on his desk before Christmas that he can sign as a present to the American people. But the Senate ought to slow down and give the American people the gift of good government.

Chris William Sanchirico is the Samuel A. Blank Professor of Law, Business and Public Policy and co-director of the Center for Tax Law and Policy at the University of Pennsylvania Law School.