Fleming, Peroni, and Shay’s new work proposes a shareholder-based test for determining corporate residence. Under this test, a foreign corporation would be treated as a U.S. tax resident for a taxable year if 50% or more of its shares were beneficially owned by U.S. residents at the end of the preceding year. The corporation will be treated as presumptively satisfying this test if its shares are traded on a U.S. market or are marketed to U.S. investors. The presumption can be rebutted by either the corporation or the IRS, with evidence that the U.S. beneficial ownership of the shares is in fact below the 50% threshold. Finally, corporations organized under U.S. law would remain domestic residents, as under current law, regardless of the shareholder composition.
The authors argues that current law, which effectively lets corporations elect tax residency by choosing an entity’s place of incorporation, incentivizes inversions and allows U.S. companies to erode the U.S. tax base through earnings stripping transactions and by holding earnings offshore in foreign subsidiaries.
In previous works, the authors advocated for a comprehensive worldwide system for taxing US multinational enterprises (MNEs), that limits opportunities for deferral and earnings stripping. Doubling down on worldwide taxation, however, necessitates a less manipulable definition of corporate residence. In this context, the current work is a critical element of the authors’ broader vision for international corporate tax reform. The authors note, however, that a defensible concept of corporate residency would still be necessary if the U.S. were to switch to a territorial system that exempts foreign source income, because even territorial systems generally tax passive and tax haven income earned worldwide. (In case you’re wondering, the authors are also skeptical of the political prospects for the House GOP’s destination-based cash flow tax reform proposal).
What policy considerations should determine the definition of corporate residence? By emphasizing the importance of a definition that limits potentials for avoidance, the work shares similarities with the instrumental proposals by George Yin (UVA) and Adam Rosenzweig (Wash U), but ultimately bears the most resemblance to Omri Marian’s (UC-Irvine) functional approach that would define corporate residence in a manner in accordance with the policy goals of the corporate tax. The authors conclude that main purpose for the corporate tax is to indirectly tax shareholders—albeit imprecisely and with a partial incidence on labor—and thereby limit the benefits of deferral and rate arbitrage for investments through corporations. The authors consequently argue that “a shareholder tax leads to a shareholder-based residence definition.”
Although it seems reasonable to couple a tax targeting shareholders to a shareholder-based residence definition, it could be that a policy goal of indirectly taxing different classes of corporate shareholders would be best served through another definition of corporate residence. It would be interesting, in a possible future work, to model the effect of a residence-based definition on the tax burdens of various shareholder classes, and to measure these resulting burdens against the policy goals of corporate taxation.
One advantage of the current definition is certainty. Under a shareholder-based definition, however, how would MNEs know their status, particularly when U.S. shareholders hold their interests indirectly through intermediaries? The authors suggest that systems such as FATCA and the EU Anti-Money Laundering Directive already require certain entities to identify beneficial owners, and these could be expanded to facilitate a shareholder-based corporate residence definition.
In the case of FATCA, however, publicly traded nonfinancial foreign entities are not required to identifying their beneficial owners (as one of the categories of “Excepted NFFEs”) and other nonfinancial entities are only required to identify “substantial U.S. owners” holding 10% or more of the stock. Obligating every foreign corporation (including those that are publicly traded) to identify U.S. beneficial owners for purposes of the residency test could significantly increase administrative burdens from what is required under FATCA. Future advances in information technology and future iterations of FATCA and the OECD Common Reporting Standard may allow for easier identification of beneficial owners by a broader range of entities. In this respect, the authors’ forward-thinking approach reimagines the possibilities for substantive redesign (and improvement) of tax laws, in the context of a global effort towards increasing financial transparency and information exchange.