As Seen in Law 360
U.S. politicians have talked about corporate tax reform for years, and experts say they may finally be spurred to take action following high-profile European investigations that have left companies such as Apple and Starbucks on the hook for billions of dollars collectively in back taxes.
Within weeks of the European Commission’s announcement in August that Apple Inc. had arranged an unfair sweetheart tax deal in Ireland and must now repay $14.5 billion to the republic, the U.S. Department of the Treasury said that it plans on limiting how multinational companies can claim credits for foreign taxes paid as a result of such investigations.
Both presidential candidates have also proposed tax changes to deter companies from moving their profits overseas as public anger mounts at the perception that corporations aren’t paying their fair share of taxes on domestic soil.
But experts say that companies don’t want to be seen as tax evaders and that they would prefer to see meaningful tax reform to help them bring their earnings back home where they will have more flexibility with spending and borrowing.
“Companies want to be seen as paying a reasonable amount of tax … but the tax rate is so high in the U.S. compared to so many other countries that it’s simply uncompetitive,” Ryan Dudley of Friedman LLP said.
As the tide shifts with a changing global tax environment, a Republican blueprint for tax reform, bills in Congress to change how multinationals’ earnings get taxed and changes proposed by the Democratic and Republican presidential candidates, experts share with Law360 what kind of changes businesses would like to see in the U.S. corporate tax code.
A Lower Tax Rate
Although multinational companies may be vilified for aggressive tax planning, experts say that they can hardly be blamed when the U.S. federal corporate tax rate stands at 35 percent, in addition to state and local taxes, and taxes overseas can be 12 percent to 25 percent.
The U.S. may be able to sustain a higher tax rate than other countries because of other attractive investment factors such as its market size and currency strength, but the current disparity is significant enough to discourage local investing, Dudley said.
“This is a simple matter of competitiveness. If the objective is to allow U.S. businesses to compete globally without engaging in complex, resource-consuming tax planning, the rate should be reduced,” Dudley said.
Stuart Rosow of Proskauer Rose LLP agreed that the nominal corporate tax rate should be lowered but added that a range of 20 percent to 25 percent would be more reasonable. Republican presidential candidate Donald Trump has proposed a corporate tax rate as low as 15 percent, and though certain private entities would prefer the rate to be as low as possible, Rosow said that businesses also generally want to be seen as paying their fair share of taxes.
“I don’t know how effective 15 percent would be as opposed to a 20 percent or 25 percent rate,” Rosow said. “I don’t know that it lures more business activity to the U.S. Taxes are not the only reason why people choose to conduct business here or elsewhere.”
A Territorial System
Another reason why experts say the U.S. tax code puts businesses at a disadvantage on the international stage is its worldwide system of taxation whereby it taxes income earned overseas by a foreign subsidiary once that income is repatriated.
“Most other countries do not have a worldwide system of tax and only tax income earned in the country,” Larissa Neumann of Fenwick & West LLP said.
A territorial tax regime, potentially with the caveat that offshore earnings are taxed at a minimal effective rate overseas, would resolve many of the issues with the current tax system, Dudley said.
“In that environment, there is no reason to leave earnings overseas — they can be brought back without incremental tax,” he said. “In that environment, there is no reason for companies to invert because U.S. operations will be taxed in the U.S., and the offshore operations are not going to be taxed in the U.S. regardless of where the company is incorporated.”
Permanent Repatriation Provisions
America’s current system dictates that when a parent company repatriates its offshore earnings, it will get a credit for foreign taxes paid on those earnings. However, that credit may not amount to much if the foreign tax in the overseas jurisdiction is much lower than in the U.S.
“If a company earns income in Ireland and pays tax in Ireland, why should the Irish income be subject to the same tax rate as in the U.S.?” Rosow asked. “There is certainly an argument that says, ‘Okay, if a company pays a certain amount of tax on income earned in Ireland, shouldn’t the company be done and then bring that income back to the U.S. without any further tax?’ and that argument has some strength to it if one says the Irish tax is at least a responsible tax.”
Politicians have proposed allowing U.S. multinationals to bring their offshore earnings back home at a lower tax rate as a one-time provision, but such a provision should be made permanent, Neumann said.
“It would bring income into the U.S. and also reduce the so-called stateless income claims,” she said. “Allowing U.S. multinationals to repatriate their offshore cash tax efficiently would limit the European Commission's ability to say that any repatriated income should be subject to tax in the EU. It would be a win-win for the U.S. government and U.S. multinationals.
“The most important thing that [survey respondents] wanted was consistency,” he said. “As businesses get more sophisticated or technology changes, there will necessarily be some tinkering. What they don’t want is that every year, there are provisions that expire, and there is really no ability to plan long-term.”
One example of inconsistency is how the Internal Revenue Service views capital costs to be recovered, which means that a business could have a bonus depreciation in one year and not have it the next year, Greenwald noted.
“Have a depreciation policy that doesn’t really need annual tinkering. … Decide how you want capital costs to be recovered, and leave it alone for a while so businesses can plan their capital purchases appropriately on a multiyear basis,” he said.
Simple Reporting Obligations With Fairer Penalties
International reporting obligations can be complex, and there can be steep penalties associated with unintentional reporting failures that sometimes have little or no effect on tax liability, Dudley said.
“It can be expensive and potentially dangerous for companies to make errors or unintended omissions from the returns, and that just builds into the overall cost of trying to comply with U.S. tax laws and all the reporting obligations that are imposed by the IRS,” Dudley said. “We’re seeing more and more of these penalties being imposed, and they're being imposed on individuals and midsize businesses where even $10,000 can be a reasonably material amount.”
An an example, a business may get penalized for failing to report the activities of a dormant foreign subsidiary that has no impact on the corporation’s overall tax liability. The reporting standard for investments in foreign corporations and mutual funds also requires considerable detail that is probably excessive and unnecessary for the IRS to have on an annual basis unless there are major transactions taking place, according to Dudley.
“If the reporting obligations were to be reduced so that the associated cost of compliance could be reduced, I think that would help significantly,” he said. “I think also that the penalties need to be imposed in a more equitable manner taking into account whether any of the actions were intended or whether they have any real impact on the tax position of the taxpayer.”