#Americansabroad and U.S. corporations have a lot in common bc they are both taxed on earnings outside the U.S. http://t.co/AOeUqIQ76T
— 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:
A concise summary! One wonders how in the world could this Administration not see the writing on the wall and bring the US law and policy into the world standard of territorial based taxation. Instead the Obama Administration just keeps trying to force a square peg into a round hole, with threats of penalties and economic disincentives for companies to invert. With regard to DNA persons (i.e. US Persons living abroad) the situation is even worse due to FATCA and the current witch hunt to find otherwise law abiding residents of other countries that fall within the US government definition of US Person and report them to the IRS. Great article.
John Richardson, excellent article.
There are some key differences between US citizens and US corporations being taxed by the US for earnings in other countries, yet there are substantial similarities. So it is good to address them both at the same time. US companies get a better deal for earnings abroad compared to US citizens living abroad, yet a point of the article is that the US is wrong to tax the non US earnings made in other countries for those living and paying taxes in other countries.
While a book may be written on the topic, one point not mentioned is the regulatory and COMPLIANCE burden on US citizens living abroad and US corporations for earnings and assets abroad, when trying to mesh tax systems of two countries with different types of taxes and different tax breaks that often mean the best tax breaks of either country get cancelled out. Also different currencies, gains just from currency fluctuations, and different financial years may add to complexity.
Unlike individual citizens companies may have substantial and in-house resources to sort through the complexities, requirements, and potential ambiguity of changing tax laws (and a point of the article is that it is wrong for the US government to force businesses to have as key focus on taxation and regulatory requirements rather than just getting on with business life). US Tax laws seem to assume that individual tax payers have similar tax compliance resources as companies with numerous time consuming forms required (far in excess to the number and complexity of forms and reporting required of US persons living in the US). NOT the case! The US persons living abroad are not all CPAs or experts in international taxation and they don’t have the resources of companies to sort through the requirements. Then individuals must engage expensive expert advice. In an article in the Wall Street Journal earlier this year it was mentioned that the cost of tax advice to complete US returns was from 3 to 20 times higher than for one’s country of residence. That is in addition to tax advice/forms for the country of residence. US tax and compliance for these people can’t be done with $79 TurboTax.
Another key difference between US citizens and US companies is that for many US citizens they have zero earnings and zero assets in the US, yet the US still wants to tax them. If a US company had zero business in the US then they would have left long ago and without the expense that a citizen might go through renouncing citizenship, if assets thresholds are met, the exercise of paying tax on all unrealised gains for all assets even if none are in the US, and if relatively wealthy paying an exit tax on top.
Unlike US companies, US citizens face potentially bankrupting fines if their accounts are not reported right: FBAR and 8938, with complex tax laws seemingly changing every year. For US citizens then there is this element of US government sponsored financial terrorism (“financial terrorism” to those terrorized) with potential noncompliance fines having no relation to tax owed that could exceed 1.5 times account balances, even if no tax is owed.
US citizens living abroad may also have accounts such as retirement, education, disability that may be tax advantaged in their country of residence but the US tax rules want to remove and penalise any advantage, while providing nil benefit for retirement, education, and disability. In this regard, US citizens rights to liberty and the pursuit of happiness are supposed to be protected by the Constitution. Yet clearly this protection is years late in coming.
US Citizens living abroad would want some of the tax advantages that US companies have, such as no US taxation on earnings (and sales of assets) unless the money is brought back to the US. For many that would be a definite plus.
Then there are some multibillion dollar companies like General Electric that don’t even pay corporate income tax on their US earnings – only pay tax on foreign earnings to the countries in which they earn them. This would be the dream of every US person living abroad.
There are lawsuits in the works that will help US persons abroad right the injustices of a tyrannical US government. The Alliance for the Defence of Canadian Sovereignty is one organisation with legal action against Canada for agreeing to laws to enforce US FATCA in Canada. Another is sponsored by fatcalegalaction dot com in the U.S. Soon the Supreme Courts of both countries will be engaged. The Founding Fathers are watching!
The measure of any policy is not in its goals but in its long-term effects. The long term effects of America’s corporate tax policy is that US corporations are at a competitive disadvantage. The long-term effect is that non-US companies will benefit from the impediments that US-based suffer.
Likewise, what are the long-term effects of FATCA? Let’s consider FATCA in Canada.
Canada is home to hundreds of thousands of Canadian citizens and residents whom FATCA regards as so-called “US persons”. These include long term Canadian citizens who relinquished US citizenship by swearing Canadian citizenship, only to have it constructively re-instated ex post facto by FATCA’s requirement that Canadian banks enforce mandatory discrimination based upon US place of birth. There are also many “border babies” – Canadians who were born in the US due to happenstance or medical necessity; they are Canadian citizens at birth and returned to Canada to live ordinary Canadian lives with no US economic nexus whatsoever.
Now Canada is in the absurd position of being a world leader in so-called “un-reported foreign bank accounts held offshore by US persons”. Now, untold hundreds of thousands of Canadians’ everyday savings, retirement and business accounts are essentially criminalized – and to be reported in detail to a foreign state.
The measure of any policy is its end effects. What are the end effects of FATCA in Canada? They include:
– A vast mount of angst, fear, mistrust and anger; the relationship of many Canadians to their US neighbor and supposed ally has been shattered.
– Record numbers of renunciations of US citizenship: waiting periods for this at US consulates are now 6 months and longer, despite the recent State Department decision to raise its fee for renouncing >400% to $2400.
– The current Harper Conservatives government utter loss of credibility and support among Canada’s large population of so-called “US persons”.
– A Charter-based lawsuit against the Canadian government that will take Canada’s FATCA IGA legislation to the Supreme Court of Canada, for (but not limited to) its unlawful discrimination based upon place of birth or nationality. Google “Alliance of Defence of Canadian Sovereignty” for info on that action.
I urge Forbes journalists to investigate the true effect of FATCA; I believe it will be revealed that FATCA has a profound deleterious effect on the ability of Americans to live, work, and do business abroad. The main beneficiary of FATCA will be non-US businesses.
While I agree with the principle of Territorial taxation, I disagree with Mr. Richardson’s proposal as much as I disagree unfetttered capitalism. Both propose theories that would work beautifully in utopia, but without major overhaul will crumble in reality. No where does unpolished territorial taxation account for the need of a corporation to make as much money as possible for its shareholders. There is no accountability. This has largely been the issue with the Inversion war cry. Of course Corporations invert…. They are corporations. They have no loyalty, honor or decency. They are an amalgamation of individuals geared to make a profit. Individuals within that amalgamation may be able to influence the others into the group to adopt some code of ethics, but the entity itself is a legal fiction. And the reason the corporate tax exists is because it provides a liability shield and other government benefits as if this entity was a legal person.
So what are we to do if the current system clearly doesn’t work and the unpolished territorial tax will be ripe for abuse. We introduce a third party whose interest in accurate reporting of corporate income exists, but is not the same as the governments. Instead of letting the corporations report a separate set of numbers to the government, the government has to use the same numbers that must be provided to shareholders. This introduces a third-party that requires the corporations to report accurately. And by using these numbers, we can now introduce a realistic implementation of Territorial tax.
But we can simplify this even further, A corporation’s true income is based on one thing and one thing only: Sales. Without sales, a business cannot function and where a sale is made is where it should be taxed. So instead of requiring shareholder reports to get more complicated to satisfy loopy reporting requirements, let’s simplify the tax. We tax the percentage of total profits based on the U.S. percentage of total global sales.
IE. if Apple sells 60% of its yearly $200 Billion in sales in the U.S., then you tax the resultant 60% of $50 billion in total profits, or $30 in U.S. profits by the tax rate. Even if we kept the current tax rate, Apple owes a $12 Billion tax bill versus a $20 Billion tax bill. Against the current system, Apple just got a reduction to a 24% tax rate and this is money they don’t have to play legal tricks with to use in the United States.
The recent DEG study puts the revenue increase to the government at $50 billion to $200 Billion overall. This money could have a variety of uses from tax reduction to infrastructure investment. Sales Factor Apportionment is what this is called and it is in fact, the 21st century solution for a 21st century economy.
Excellent & well-communicated piece – Made me look at the issue in a way I haven’t previously