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1 1 (December 12, 2017)

handle is hein.crs/govcfzq0001 and id is 1 raw text is: FF.~*\* Updated December 12, 2017 Key Issues in Tax Reform: International Tax Issues Issues surrounding the taxation of U.S. multinational corporations have been a major impetus for tax reform and are some of the main arguments for tax measures to lower the statutory corporate tax rate of 35% and revise the current system for taxing foreign source income. C 'u ' 't Lzw, A territorial or source-based system taxes only income earned in the country and excludes foreign source income. A worldwide system taxes both income earned in the country and foreign source income, but allows a credit for income taxes paid to foreign jurisdictions. Most countries have largely territorial systems. The U.S. system has elements of both. While it taxes worldwide income, earnings of foreign subsidiaries of U.S. multinationals are not taxed until they are repatriated (paid as dividends to the parent). Earnings of foreign branches and royalties and interest payments are taxed currently. A foreign tax credit is allowed, but limited to the total U.S. tax due. This limit is applied separately to active and passive income. This overall limit allows cross-crediting so that firms can use excess credits from high-tax countries to offset U.S. tax on earnings in low-tax countries. Deferral of tax on earnings of foreign subsidiaries and cross-crediting introduce elements of territorial taxation, and the United States collects relatively little foreign source income. In common with many other countries, the United States taxes certain easily shifted income of foreign subsidiaries on a current basis. These rules are called CFC rules (for controlled foreign corporations) or Subpart F rules (for the tax code section). Subpart F income includes passive income of subsidiaries and certain other income such as income from sales and services subsidiaries in foreign countries where the production and consumption takes place in other countries. The effectiveness of Subpart F has been reduced by check-the-box regulations that allow payments between subsidiaries to be disregarded. Four issues are of concern: the effect on investment abroad, revenue losses due to profit-shifting, repatriation, and inversion. Broadly speaking, strong territorial elements of the U.S. system provide an incentive to invest in countries with low tax rates of their own and a disincentive to invest in high- tax countries, including a disincentive to invest in the domestic economy. According to traditional economic analysis, world economic welfare is maximized by a system that applies the same tax burden to prospective (marginal) foreign and domestic investment so that taxes do not distort investment decisions. National welfare is maximized, however, by encouraging more investment in the United States. (For a discussion of these principles, as well as other international issues and details of various proposals, see CRS Report RL34115, Reform of US. International Taxation: Alternatives, by Jane G. Gravelle.) Some of the arguments for lowering the U.S. statutory corporate tax rate, which is the highest of almost all countries, relate to the concern about domestic investment. The location of investment, however, is driven by effective rather than statutory tax rates; U.S. effective tax rates are more in line with those in other countries (see CRS Report R41743, International Corporate Tax Rate Comparisons and Policy Implications, by Jane G. Gravelle). Profit shifting involves the movement of profits without real activities to countries with low tax rates, such as the Cayman Islands and Bermuda. Considerable evidence points to significant profit shifting by U.S. multinationals. Profit shifting is driven by statutory tax rates. Profit shifting primarily rests on two methods: leveraging and transfer pricing of intangibles. Firms can shift profits by borrowing in high-tax countries. Transfer pricing involves the sale of intangible assets (such as drug formulas, technological advances, and trademarks), charging a low price to subsidiaries in low-tax countries. Firms also use cost contribution arrangements where a low- tax subsidiary contributes to research in the United States for a share of the rights to the intangible. Deferral of tax causes a tax to be triggered when foreign subsidiaries repatriate income. When there are no foreign tax credits to offset U.S. tax, each dollar repatriated results in a tax at the statutory rate. Estimates indicate that firms have around $2.5 trillion of accumulated profits offshore. This repatriation tax could be eliminated in a system that taxed foreign source income currently (a worldwide tax without deferral) or a territorial tax where foreign source income is not taxed. Inversions occur when a U.S. firm moves its headquarters abroad, currently by merging with a foreign firm. Mergers where the U.S. firm maintains 80% or more ownership are treated as U.S. firms, while 60% to 80% ownership triggers other, less costly tax effects. Inversions grew rapidly in 2014 and 2015, but have declined somewhat in 2016 according to Commerce Department data. Some of the decline in inversions may be due to a series of regulations that made it more difficult to invert and limited some of the potential benefits, such as indirect repatriations through loans to the new parent and leveraging. (See CRS Report 'O 'T mppm qq\ a ' p\w gn'a', ggmm I 'S 11LULANJILiN,

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