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Saturday, March 24, 2007

NY Times: Foreign Companies Get Tax Cut Denied to U.S. Firms

Interesting article in today's New York Times: Foreigners Get Benefit of Tax Cut, by David Cay Johnston:

A 2003 tax cut that President Bush promoted as a way to create jobs in the United States includes a provision that has given some foreign companies a financial advantage over their American competitors by making it cheaper for them to raise capital. The heart of the issue is in the treatment of the payments to investors as either interest, like bond payments, or as dividends, from stocks, which qualify for a lower tax rate under the 2003 law. Foreign companies can sell securities known as hybrids, which are bonds with interest payments that are treated as dividends and taxed at the lower rate. The option is unavailable to American companies. ...

Investors in the United States must pay income taxes of as much as 35% on interest earned from lending money to American companies, but their tax is limited to just 15% on foreign bonds with no maturity date. Americans are taxed at the 15% rate on dividends, but for American companies, dividends paid on shares come from after-tax profits while foreign companies are allowed to deduct the cost of their payments on the hybrid bonds in their home countries. ...

Yesterday, one Democrat in Congress who has long fought tax shelters introduced legislation to halt the subsidy. “Why are we spending American taxpayer dollars to subsidize foreign companies?” asked the congressman, Richard E. Neal of Massachusetts. “I’ll be taking a serious look at this issue in the Ways and Means Committee, and if the Bush administration believes this provision is worthwhile, they should step forward publicly and justify its place in our tax code.”

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Although Johnson doesn't mention any code sections in his article, let me see if I have this right.

Section 1(h)(11) allows foreign corporations to use hybrids to lower the cost of access to funds. In their home jurisdiction, they deduct the payments as interest and here the payments are characterized as dividends.

To achieve this, these corporations have to meet the requirements of (1)(h)(11)(C), that is become a qualified foreign corporation. One of the requirements is that they be eligible for benefits under a comprehensive tax treaty.

Yet, Johnson name drops two countries that do not have treaties with the U.S.: Bermuda and the Cayman Islands. Presumably countries with their "tax" headquarters there

1) don't need deductions in light of low tax rates anyways and

2) aren't eligible for treaty benefits because the Limitation on Benefit (LOB) sections of existing treaties would bar them from claiming the benefits of Treaties.

Of course, if the company did qualify for comprehensive tax treaty and could structure a hybrid to be called debt in that country, then yes, this is a subsidy to foreign corporations vis-a-vis domestic ones.

But why work Bermuda and the Cayman Islands into it?

Posted by: Philip Cleary | Mar 24, 2007 10:20:37 AM

Philip Cleary asks "why work Bermuda and the Cayman Islands into it?"

The answer is out of consideration for the reader who is not a tax expert, but may well recal that earlier in this decade the use of mail drops to escape American taxes prompted fierce bidding between Republicans and Democrats over who could posture to voters as the toughest on the issue of inversions.

The refernce in my arrticle was to how this had come up in the public debate over JGTRAA.

Posted by: David Cay Johnston | Mar 24, 2007 5:43:36 PM

Hi I have a question.

Say Company A is headquartered in Bermuda, and they want to buy shares of Company B which trades on the NYSE, but is based in the Marshall Islands. Which company, if any, would be taxed? I have been spending hours on-line doing different web searches and can't seem to find a straightforward answer. Your help is much appreciated.

Posted by: Micah | Jul 9, 2007 2:02:57 AM