Commentators discuss two different models of international tax regimes. Under a worldwide system, residents are taxed on their foreign-source income and receive a credit for any foreign income taxes paid. Under a territorial system, foreign-source income is exempted and foreign taxes are ignored. Regimes that contain elements of a worldwide regime along with elements of a territorial regime are often described as hybrid systems. It has been claimed that the Tax Cuts and Jobs Act (TCJA) moved the United States from a worldwide system to a territorial system and thereby aligned the U.S. tax regime with that of its major trading partners.
In a two-part report on the international tax aspects of TCJA, Professor Daniel Shaviro argues that not only is this before-and-after description of U.S. tax regime inaccurate but also that the categories themselves are analytically useless.
Under prior law, income earned by foreign subsidiaries of U.S. multinational corporations (MNCs) was usually shielded from current U.S. taxation until the earnings were distributed or the shares were sold. Following the enactment of TCJA dividends received from a foreign subsidiary are effectively tax-free. However, the new BEAT (base erosion and antiabuse tax) and GILTI (global intangible low-taxed income) provisions strengthen the current Ssubchapter F regime and provide that in many instances U.S. MNCs will be taxed on the current foreign-source earnings of their foreign subsidiaries. Thus, the U.S. international tax regime, both before and after TCJA, is better described as hybrid rather than either worldwide or territorial. However, Shaviro argues that as tax systems anywhere along the spectrum between pure worldwide and pure territoriality – neither of which has been adopted by any major country – can be described as hybrid, the term is meaningless.
Part One of the report reviews the central themes of international taxation: the concepts of “inbound” and “outbound” investment, the taxation of domestic-source income, and taxation of foreign-source income. He analyzes the possible approaches to some of the issues that arise, not from the perspective of how well they accord with an idealized worldwide or territorial tax system, but rather from the perspective of how they play out in practice. For example, because purely domestic corporations may have considerably less opportunity to respond to global tax competition than do MNCs, a source country may find it beneficial to lower the tax burden that it imposes on the latter but not on the former. One way to do so would be deliberately to tolerate some degree of profit shifting by MNCs. The question that then arises is what Shaviro describes as the Goldilocks problem: how to permit a degree of profit shifting that is neither too much nor too little, but just right. He sums up his overview with a comment on unilateral versus strategic analysis of international tax provisions. A country acts strategically when it is mindful, not only of other countries’ tax rules, but also takes into consideration how other countries will respond to a change in its tax rules. For example, lowering the corporate tax rate might be beneficial if one assumes that the tax rate in other countries will remain constant. However, if other countries respond the lowering of U.S. corporate tax rates by lowering their own rates, the contemplated benefits may not materialize.
Part Two of the report describes the key international provisions of TCJA (BEAT, GILTI, and FDII) in light of the overview in Part One. BEAT and GILTI delineate the extent to which MNC may shift their profits into tax havens. They do not attempt to eliminate profit shifting but rather to constrain it, in conformance with Shaviro’s Goldilocks principle. Shaviro describes the mechanics of these provisions and then discusses the problems with some of the rules and how MNC might be able to avoid the new taxes with proper planning techniques. FDII (foreign-derived intangible income) differs from BEAT and GILTI in that it is a pro-taxpayer provision. Modeled on other countries’ “patent box” regimes, it effectively lowers the tax that corporations pay on income from intangibles. Shaviro argues of the three provisions, FDII is the hardest to defend, both because it clearly constitutes a prohibited export subsidy by the WTO rules and because there are much more effective means of pursuing FDII’s ostensible ends.
Shaviro’s rejection of labels and his preference for examining the real world effects of existing or proposed rules is characteristic of much of his work in the field of international taxation. He has in the past castigated the debate over whether Capital Export Neutrality (CEN), Capital Import Neutrality (CIN), or Capital Ownership Neutrality (CON) should guide policy making as “alphabet soup” and “the battle of anagrams.” He has argued that as opposed to the nefarious concept of global welfare, policy makers should direct their focus on maximizing domestic welfare. He has denounced the blind acceptance of the foreign tax credit, and this critique plays out in the current report when he analyzes the marginal reimburse rate of foreign taxes under GILTI. The current report is one more example of Shaviro’s distinctive approach to international taxation.