CTJ
Citizens forTax Justice
Revised May 20, 2009
Contact:Steve Wamhoff (202) 299-1066 x33Rebecca Wilkins(202) 299-1066 x32
Obama’s Proposals to Address Offshore Tax Abuses Are a Good Start, but More Is Needed
On May 4, President Obama proposed several measures to protect the U.S. tax system fromoffshore tax abuses. The proposed measures, which address both tax avoidance and taxevasion, are steps in the right direction but could be stronger. The additional details madepublic by the Treasury Department on May 11 provide more reason to be hopeful, but alsoillustrate certain gaps in the administration’s approach. For example, the President proposesto limit the rules allowing corporations to “defer” their U.S. taxes on foreign income. He would not repeal “deferral” altogether and he would largely exempt technology andpharmaceutical companies from even the weak limits he proposes. He proposes sensible stepsto reduce abuses of the foreign tax credit and the “check-the-box” rules that allowmultinational corporations to cause their subsidiaries’ income to “disappear.” His proposals tocrack down on the use of secret accounts in offshore tax havens are also positive steps butcould be much stronger.
Offshore Tax Abuses
There are two problems that thePresident hopes to address with hisproposals. First, the tax code may create an incentive for companies tobase their operation and jobs offshorerather than here in the U.S. Second,many individuals and corporations areabusing the tax system through off-shore schemes to avoid or evade theirU.S. taxes on their U.S. income.This report focuses more on thesecond problem, the problem of offshore tax abuses, because this isprobably the greater threat andbecause the President’s proposals aremore focused on this problem.
ProblemProposed Solution
"Deferral"Defer deductions for expenses (except R&E)related to deferred income
60.1
Foreign Tax CreditDetermine credit on "pooling basis"
24.5
Foreign Tax CreditPrevent "splitting" foreign income and foreigntaxes
18.5
"Check-the-box" rules.Reform business entity classification rules forforeign entities
86.5
Intangible propertyLimit shifting of income through transfers ofintangible property
2.9
Earnings strippingLimit earnings stripping by expatriated entities
1.2
RepatriationRepeal rule limiting taxable gain in repatriation ofearnings in cross-border reorganizations
0.3
80/20 CompaniesRepeal 80/20 company rules which allowtaxpayers to avoid withholding on U.S. dividends
1.2
Hedge fund "dividendloophole"Prevent the avoidance of dividend withholdingtaxes
1.4
Dual-capacity taxpayersDeny foreign tax credit for payments made inexchange for specific economic benefits
4.5
Offshore tax havensCombat under-reporting of income throughoffshore jurisdictions.
8.7
Total Revenue Impact209.9
Offshore Tax Avoidance (not necessarily illegal) Offshore Tax Evasion (definitely illegal)
The President's Proposals to Address Offshore Tax Abuses
Revenue Impact(in billions of dollars)
2
The problem of U.S. tax abuses is straightforward. Too many American individuals andcorporations are paying less than their fair share because they are taking advantage of offshore tax schemes that are not available to most ordinary Americans.Many of these offshore tax schemes fall into two categories, which are described below.
1. Multinational Corporations Abusing U.S. Tax Rules
Some companies abuse the rules that determine if and when the U.S. will tax income they make abroad. They use complicated techniques to shift income offshore to delay orcompletely eliminate the U.S. tax on that income. For example, many corporations manipulatethe rules related to “deferral” by making their U.S. income appear to be foreign income, sothat they can “defer” U.S. taxes indefinitely.These abuses may sometimes be illegal (meaning they constitute tax
evasion
). More often, they are practices that have never been found to violate U.S. tax laws, even though they clearly leadto results never intended by Congress (meaning they constitute tax
avoidance
). Many of theseare practices that
ought to be illegal
.Either way, these abuses usually involve sham transactions (transactions that have no realeconomic substance) that make a corporation’s domestic income appear to be income earnedabroad so that the U.S. company can enjoy the tax advantages that are available for “foreign”income.
2. Individuals Hiding Income in Tax Havens
Some Americans are simply hiding their income from the IRS, which is obviously always illegal(meaning it constitutes tax
evasion
). Most Americans have few, if any, opportunities to hidetheir income from the IRS, but wealthy people have many opportunities to hide their incomein countries that prevent their banks from providing any information to the U.S. taxenforcement authorities.In other words, wealthy Americans can engage in complicated transactions involving countriesthat we think of as “tax havens” to hide their income from the IRS. The use of tax havens fortax evasion has been estimated to cost around $100 billion a year. That’s a lot of revenue thatcould go to education, health care or other investments we need but instead is lost becausesome wealthy people are willing to cheat on their taxes.
President Obama’s Proposals
The proposals announced by the President on May 4 (and described in more detail by theTreasury on May 11) would take some small steps to reduce the ability of individuals to hidetheir income in tax havens, but the bulk of his proposals are more focused on abuses by corporations. American individuals are supposed to pay U.S. taxes on all their income, regardless of where itis earned. American taxpayers receive a credit against their U.S. taxes for foreign taxes they pay, to avoid double-taxation.
3
American corporations are often effectively exempt from paying U.S. taxes on their overseasprofits because they can “defer” U.S. taxes on those profits indefinitely – until the profits arerepatriated (brought back to the U.S.). Even when the foreign income is repatriated (typically through a dividend paid to a U.S. parent company from its foreign subsidiary), the U.S. parentcompany still receives a credit for any foreign tax paid in order to avoid double-taxation whenthe foreign government has taxed the income already.Several of the President’s proposals address abuses of deferral and the foreign tax credit. Healso proposes more limited, but nonetheless important, steps to crack down on tax evasion by individuals using tax havens.
Defer Deductions for Expenses Related to Foreign Income on which Tax is Deferred (with Exceptionfor R&E)Projected Nine-Year Revenue Impact: $60.1 Billion
Corporations are allowed to defer paying taxes on the profits of their offshore subsidiariesuntil those profits are brought home (repatriated). But some of the expenses a corporationincurs to earn offshore profits are deductible against their U.S. taxable income right away. Allowing immediate deductions of these expenses is, at best, a tax subsidy for movingoperations offshore. Even worse, it makes corporations even more tempted to devise schemesto make it appear that their U.S. income is being earned offshore.The Obama administration gives the example of a U.S. corporation that borrows money toacquire stock of a foreign corporation. The U.S. corporation can often take an immediatededuction against its U.S. taxes for the interest on the debt, even though U.S. taxes on any income generated by the foreign investment can be deferred indefinitely.In 2007, House Ways and Means Chairman Charlie Rangel (D-NY) proposed, as part of a largertax reform bill, to require that corporations defer deductions for expenses related to earningforeign income so long as they defer U.S. taxes on that foreign income. There is an intuitivelogic to this reform. Right now, companies not only have a zero U.S. tax rate on theirunrepatriated profits, but a
negative
tax rate because they can deduct some of the costs of earning those profits. The Rangel reform would reduce this “tax arbitrage,” and would thusreduce some of the perverse incentive to move operations offshore or to shift income offshorethrough sham transactions. But it would be less effective than doing away with deferralaltogether.While Congressman Rangel’s proposal was weaker than the optimal reform (repealingdeferral), President Obama’s proposal is even weaker than Rangel’s proposal. Theadministration would require corporations to defer deductions for expenses on foreignincome insofar as they defer U.S. taxes on that income, just as Rangel proposed, but theadministration would further water down this reform by exempting research andexperimentation expenses from the change.
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