US Congress Mulls Territorial Corporate Taxation
Monday October 31 2011 | 09:41 AM

The House of Representatives Ways and Means Committee Chairman, Dave Camp (R - Michigan) has unveiled more details of his party’s plan for United States international tax reform that would move to a territorial tax system.

In advocating the need for international tax reform, Camp cited several reasons why current US tax policies need to be changed. These included the fact that, at 35%, the US may soon have the highest corporate tax rates in the industrialized world; and its worldwide system of taxation is a remnant from 50 years ago and means that American employers face double taxation compared to their foreign competitors.

Many US business leaders have already urged that the US tax system should adopt the territorial tax systems of some of the country’s major trading partners. It has been said that territoriality – under which a particular country, as a general rule, should only tax income earned within its borders – could deal with some of the tax issues that US multinationals face when doing business abroad, in that they would, no longer, be discouraged from repatriating foreign earnings by the imposition of a 35% residual US tax at the time of repatriation.

Camp emphasized that “America is losing ground. In 1960, US-headquartered companies comprised 17 of the world's largest 20 companies – that’s 85%. By 2010, just six – or a mere 30% – US-headquartered companies ranked among the top 20.”

While asking for all stakeholders to consult on the proposals, Camp stated that, “instead of having laws on the books that encourage hiring US workers, our outdated international tax system encourages employers to keep profits and jobs outside of America. Now is the time to adopt tax policies that empower American companies to become more competitive and make the US a more attractive place to invest and create the jobs this country needs.”

Camp said that the US corporate tax rate could be reduced to 25% by broadening the tax base. The Committee is examining the participation exemption for certain foreign-source income (the territorial system) “because it reforms one of the most complex and challenging areas of federal tax law.”

The proposed reforms would exempt 95% of foreign-source income from US tax. The exemption would apply to dividends paid by foreign companies to US corporate shareholders owning at least 10% of their shares. It would also apply to capital gains from sales of shares in foreign companies by 10% US corporate shareholders.

Thus, the effective US tax rate on most foreign dividends would be 1.25% (the new 25% rate multiplied by the 5% of income that is not exempt) – putting, it was said, American companies on a more level playing field with foreign competitors and ending the “lock-out effect” that discourages these companies from bringing foreign earnings back to the US.

Furthermore, in a transition period, a 5.25% tax would apply to all existing foreign earnings currently held offshore, whether or not such earnings are repatriated. Taxpayers could, however, use a rateable portion of their foreign tax credit carryovers to further reduce the 5.25% tax, and they could elect to pay this tax in up to eight annual instalments. Once paid, such earnings would benefit from the 95% exemption if brought back to the United States as a dividend.

Together with anti-deferral rules that immediately and fully tax domestic companies on the passive income of foreign subsidiaries, the Committee has also developed other anti-abuse measures, including a thin capitalization rule. That would disallow a portion of a US company’s net interest expense if it is a member of a worldwide group that fails two tests: the US group is overleveraged relative to the worldwide group; and the US company’s net interest expense exceeds a certain percentage of adjusted taxable income.

John Engler, President of the Business Roundtable, an association of chief executive officers of leading US companies, commented that the proposals mark "a significant advancement for corporate tax reform that has the potential to bring the US tax system much closer in alignment to the tax systems of other developed countries. We believe that these significant gains in US tax competitiveness can be achieved in a revenue-neutral fashion in the short-term, while significantly aiding deficit reduction in the long-term."