J. Clifton Fleming, Jr. (BYU) presents An Early Look at Real Worldwide v. Territorial Taxation After the TCJA (with Robert Peroni (Texas) & Stephen Shay (Harvard) today at Boston College today as part of its Tax Policy Workshop Series hosted by Jim Repetti, Diane Ring, and Shu-Yi Oei:
In the run up to enactment of the 2017 Tax Cuts and Jobs Act (TCJA) one of the principal U.S. tax policy issues was how foreign source active business income of U.S. multinational enterprises (MNEs) should be taxed by the United States if the system of deferring U.S. tax on active income of a foreign subsidiary was ended. Should active foreign income be taxed under a territorial or exemption system—i.e. bear no residual U.S. tax—or should it be subjected to real worldwide taxation—i.e. current taxation at regular U.S. rates coupled with a credit for foreign income tax paid limited to the U.S. tax on the foreign-source income as measured for U.S. tax purposes.
The opposing sides were not without common ground. Both agreed that the existing U.S. system for taxing the foreign-source active-business income of U.S. MNEs was bad because it generally did not impose U.S. tax until the active income of foreign subsidiaries was repatriated, either through dividends or by sale of subsidiary stock at a price reflecting accumulated foreign-source income.
This was problematic for the advocates of territoriality because it required payment of a U.S. tax before CFC earnings could be directly accessed by U.S. parents when no home country tax would have to be paid by MNEs from some competitor countries. It was unacceptable to world-wide taxation advocates because the resulting deferral of U.S. tax effectively created a preferential tax rate for CFC income that encouraged U.S. MNEs to locate operations in, and engage in income shifting to, low-tax foreign countries. The two sides were, however, at loggerheads over whether the foreign-source active-business income of U.S. MNEs should bear a current U.S. tax at regular rates, subject to a limited foreign tax credit, or should bear no U.S. tax at all. Neither view prevailed in the TCJA. One purpose of this article is to take a preliminary look at the extent to which the TCJA caused a degree of movement in either direction. The substantive analysis will begin by examining the Joint Committee on Taxation’s revenue scores for the relevant TCJA provisions. This article will then argue that although those scores are the best currently–available estimates of effects on U.S. tax revenues before considering dynamic macro-economic effects, the manner in which revenue estimates are constructed tends to conceal important elements of what has happened. Accordingly, this revenue effects approach requires taking additional considerations into account. The article will also explain why the post-TCJA U.S. outbound international income tax regime remains far removed from full worldwide taxation and will suggest steps that would move it towards that end.
This choice of focus means that the Base Erosion and Anti-Abuse Tax (the “BEAT”) will not be discussed. Although the BEAT is a prominent feature of the TCJA international provisions and although it has an impact on the foreign-source income of U.S. MNEs in certain limited circumstances, its primary effect is with respect to the U.S.-source income of comparatively large foreign corporations.
The task undertaken here is neither a simple nor a precise exercise because the relevant TCJA provisions have components cutting in offsetting ways that require the Joint Committee’s revenue scores to be used with caution. Moreover, reaching a conclusion requires comparing the pre TCJA U.S. regime for taxing the foreign-source active business income of U.S. MNEs with the system delivered by the TCJA and then attempting to evaluate the effects of the differences. Thus part II of this article delineates that comparison. Part III summarizes the Joint Committee on Taxation’s scoring of the TCJA changes and concludes that according to that scoring, the TCJA gave us a more complex system that has a virtually inconsequential tilt in the direction of worldwide taxation. From that standpoint, the major impact of the TCJA is change that raises new issues and increases complexity, thus providing an employment bonanza for lawyers and accountants, but that does not produce clear movement towards either territoriality or real worldwide taxation. In part IV, however, we argue that although the Joint Committee score reflects a reasonable approach, it needs to include additional considerations. When it is expanded to do so, the TCJA international provisions appear to be revenue-losers that tilt materially towards territoriality, although not nearly so much as territoriality advocates had hoped.
Part V concludes that the TCJA has left us with a complicated outbound international regime that falls somewhere between world-wide taxation and territoriality. Consequently the debate between territoriality advocates and real worldwide taxation advocates remains unresolved and the latter still have work to do. Thus, part V also suggests steps that can push the post TCJA regime in the direction of real worldwide taxation and explains why the GILTI regime may be a Trojan horse that serves as a platform for a future move to real worldwide taxation.