U.S. Plays Lone Ranger on International Tax to Its Detriment
It lies somewhere beyond foolish to assume that the United States, in the year 2018, has the only important voice in international affairs.
Yet, that is precisely the assumption that permeates the international provisions in the newly enacted Tax Cuts and Jobs Act (TCJA). What in heaven's name were the folks responsible for these provisions thinking? Or, more precisely, what were they NOT thinking?
A blithe “us against them” attitude and a cavalier regard for U.S. obligations under international agreements emerge clearly from the legislative text. The consequences will play out for years and handicap the United States in seeking to influence the development of rules in the area of international taxation. With the U.S. government isolating itself, U.S. companies and their affiliates are likely to pay heavily in additional foreign taxes.
The 2017 legislation includes many positive changes in U.S. tax law, including important changes in the international provisions. Most significantly, the new law altars for the better several antiquated aspects of the pre-existing tax regime and directly addresses the substantial buildup of non- or low-taxed income in tax havens in a reasonable way.
Going forward, when a U.S. company has a foreign subsidiary engaged in an active business in another country, the earnings of that subsidiary will not be subject to U.S. tax in many, and perhaps most, situations unless the income is subject to a low rate of foreign tax.
But the new law also contains some startling provisions, with unsettling consequences.
First, the new law may well violate U.S. obligations under both tax and trade agreements. For example, it appears to backtrack on the repeated U.S. assurance that it will not adopt discriminatory rules.
In early December, finance ministers of five European countries (Germany, France, Britain, Spain, and Italy) wrote Treasury Secretary Mnuchin to highlight provisions of the legislation that impose a tax on payments from U.S. companies to related foreign affiliates. Those provisions appear to violate nondiscrimination requirements of tax and trade agreements.
Other rules in the legislation limit the ability of U.S. companies to use credits for foreign taxes to satisfy their obligations to the U.S. government. Tax treaties explicitly guarantee that the credits will be allowed and a similar, but much less significant, rule in the Tax Reform Act of 1986, relating to the alternative minimum tax, was generally acknowledged as a violation of tax treaty obligations.
It is true that the U.S. Constitution allows Congress to enact laws overriding treaty obligations, but actually enacting such laws sparks adverse reactions abroad. And Congress said nothing at all about a treaty override in the new law.
If the 2017 tax bill had progressed through Congress in a typical manner, these issues might have been aired and perhaps addressed in the legislative process. The lightning speed of the legislative exercise precluded anything of that sort.
Moreover, the legislation adopts a unilateral view of taxation — the United States versus the rest of the world — in several of the international provisions. These rules lump all foreign investment, and thus all foreign countries, together, in sharp contrast to the country-by-country approach reflected in the bilateral treaty network of the U.S. and every other country.
Independently, the legislation includes deliberate incentives for U.S. exports, probably in violation of international trade agreements and another source of irritation for our foreign trading partners.
In the Washington sausage factory that produced the TJCA, two issues dominated the attention of both elected officials and the public: tax rates (for corporations, pass-through entities and individuals) and the deduction for state and local taxes.
There was neither time nor mental bandwidth for public scrutiny and debate on the hundreds of other tax issues buried inside the mammoth statutory text, including the international provisions.
International tax policy is in a transformative stage. European tax authorities and tax examiners in many other countries seek greater tax from U.S. multinationals such as Google, Facebook and Apple and their affiliates.
Foreign tax examiners pursue “base erosion and profit shifting” with the single-minded view that U.S. companies should be contributing more to their coffers. The U.S. government has historically been a leader in policy discussions and in protecting the interests of its companies abroad.
By taking an obvious "America First" view and a casual attitude toward treaty commitments, the U.S. risks undermining both its moral authority in shaping tax policy and its effectiveness in dealing with other countries. That is bound to be costly not only in policy impact but in hard dollar terms.
Peter A. Barnes and H. David Rosenbloom are international tax attorneys at Caplin & Drysdale, Chartered. Prior to joining the firm, Barnes was senior international tax counsel for General Electric and served as U.S. deputy international tax counsel at the U.S. Treasury. Rosenbloom also spent time at the U.S. Treasury serving as director of the Office of International Tax Affairs. Additionally, Barnes is a senior fellow at Duke University teaching at the law school and at the Sanford School of Public Policy. Rosenbloom directs the International Tax Program at New York University School of Law.
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