TaxProf Blog

Editor: Paul L. Caron, Dean
Pepperdine University School of Law

Friday, July 13, 2018

Shanske: State Conformity And Tax Base Erosion

Darien Shanske (UC-Davis), States Should Conform to — and Improve — the New Federal Tax Provisions Meant to Counter Base Erosion:

The United States used to tax multinational corporations (MNCs) on the basis of their worldwide income, except that most foreign source income would only be taxed when actually repatriated to the United States. This structure naturally created considerable incentive to strip income out of the United States and then not to repatriate it.

Now, thanks to the TCJA, the United States is ostensibly only going to tax MNCs on their US source income. This shift to a so-called territorial system means, of course, that MNCs will continue to have incentive to shift income abroad in order to avoid US tax. The TCJA has two separate provisions meant to counter this: GILTI and BEAT. One question for the states is whether they should conform to these provisions. I think the answer is yes. I also think it is clear that states should improve these provisions when they adopt them.

There is a preliminary question as to whether states can — as a matter of federal constitutional law — conform to these provisions. I think the answer is again yes, but the details of the state law will matter a great deal. ...

The states pioneered an anti-income stripping regime that I would argue is simpler and likely more effective than even an improved GILTI and BEAT: mandatory worldwide combination using the single sales factor. This approach does not require the government to identify a particularly problematic form of income or deduction, which can have unexpected and undesired consequences. Instead, all income is income, and income is apportioned according to where an MNC makes its sales. We know that it is unlikely that an MNC makes many sales to final consumers in tax haven jurisdictions. Currently, no states require mandatory worldwide combination, but many permit taxpayers to choose it. If a state is unwilling to require worldwide combination, then an appealing option would be to conform to GILTI and the BEAT, with improvements, and then permit MNCs to choose if they would not prefer the simplicity of worldwide combination.

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