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International Taxation - Tax Research Paper


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This paper was completed in partial satisfaction of course requirements for ACCT 8570(2) - International Taxation - at Kennesaw State University during the Summer 2009 eight week semester. The paper outlines the effect of the international taxation policy reform that President Obama has proposed, specifically the change in the deductibility of foreign expenses before the recognition of foreign income. The reform is intended to force MNCs to recognize income and pay taxes sooner on earnings that previously would not have been repatriated for a long time, if at all, and/or to invest more resources in the U.S. rather than on outsourcing certain aspects of operations.

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International Taxation - Tax Research Paper

  1. 1. Kesha Haley July 14, 2009 ACCT 8570 International Taxation Tax Research Project In the May 4, 2009 press release by President Obama, the Administration revealed its plan for international tax reform. The need for reform comes out of the fact that, due to the “broken tax system written by well-connected lobbyists on behalf of well-heeled interests and individuals”, it’s perfectly legal for a “number of individuals and companies to abuse overseas tax havens to avoid paying any taxes at all” (Obama). The US tax codes give “competitive advantage to companies that invest and create jobs overseas compared to those that invest and create those same jobs in the U.S.”. The loopholes in the tax system are costing “taxpayers tens of billions of dollars a year” (Obama). Every year, US companies with subsidiaries in foreign tax havens get out of paying their fair share of US taxes. For example, in 2004, “U.S. multinational corporations paid about $16 billion of U.S. tax on approximately $700 billion of foreign active earnings – an effective U.S. tax rate of about 2.3%” when the top US corporate tax rate is 35%. Also, as President Obama has pointed out throughout his campaign, over 18,000 US companies have one Cayman Island addressed registered as their own. Very few of those companies actually have any physical presence in the country. President Obama announced proposals that addressed overseas tax evasion, tax loopholes, and US job creation. He is asking Congress to pass some laws that he anticipates will save Americans over $210 billion over the next ten years, which could be used to reduce the deficit, reduce taxes, and provide relief for individuals. The reform includes plans such as requiring foreign financial institutions to provide 1099s on their American customers, incentivizing companies to create jobs in the US instead of giving advantages to create jobs overseas through the reform of tax deferrals, cracking down on tax haven abuse, and closing foreign tax credit loopholes.
  2. 2. Currently, the rules for companies operating abroad as a subsidiary allow a company to avoid paying taxes on any profit until it is repatriated into the United States by the subsidiary. These companies only pay tax on the dividends they receive, if they receive any at all. If the subsidiary never pays any dividends, the parent company never pays any tax on that profit. However, that company can still take deductions against their US income for expenses incurred on their foreign operations. This treatment gives advantages to investors who invest and create jobs overseas as opposed to investing and creating jobs in the United States. In order to eliminate this issue, the Administration is proposing that deductions associated with foreign profits be deferred until such a time when the profits are repatriated into the United States. Corporations will only be able to take deductions related to foreign income when they pay US taxes on that income. The only expenses excepted are Research and Development expenses because those expenses are expected to provide benefit to the United States. When dealing with taxes, companies want to defer as much income and accelerate as many deductions as possible. This practice reduces taxable income and ultimately the tax liability. The current law does just this, although maybe unintentionally. The new proposal by the Obama administration will defer deductions for as long as the income is deferred. As a result of this, corporations will either invest more in the United States or be forced to repatriate more income into the United States, therefore paying more US taxes. Depending on the host country, the corporations may be subject to a withholdings tax on dividends on any money leaving the country as well as a tax on profits. Corporations that invest overseas will then be subject to higher rates and will pay more money in taxes. Currently, one corporation that invests in the United States is eligible to receive a deduction for all business expenses but is subject to a 35% tax rate. Meanwhile, a corporation with the same investment in a foreign country is still eligible to receive deductions for all business expenses, but is subject to a different, maybe much lower, tax rate. The company that invests in the United States is at a
  3. 3. disadvantage because the other company has more after-tax cash flow. More companies want to invest overseas. In 2011, when this proposal takes effect, companies that invest overseas will see an increase in their overall taxes. The company that invests overseas in a country that imposes a 25% income tax and 10% dividend tax has $200,000 US taxable income excluding foreign income and deductions as well as $300,000 foreign taxable income including $100,000 deductions. If they repatriate none of their income, they get no deduction against US income and they pay $70,000 in US taxes. They pay $75,000 in income taxes in the host country for a total tax of $145,000. If they decided to repatriate all of their after-tax income to the US in order to take advantage of the foreign deductions, they pay an additional $22,500 ([300,000-75,000]*.1) in dividend withholding taxes in the host country. In the United States, they will be able to take the deduction for the $100,000 expenses, and they will pay $105,875 ([200,000+300,000-75,000-22,500-100,000]*.35) for a total tax liability of $203,275. Meanwhile, the company that invested in the United States with the same $500,000 taxable income only pays $175,000 in total tax liability. President Obama’s proposal to reform international tax laws are expected to bring more money into the US in the form of taxes. Requiring that corporations defer deductions will help this cause in one or more of three ways: 1) companies that never repatriate their income and therefore never take deductions will pay more US taxes equal to the deduction times the US tax rate, 2) companies that do repatriate money into the US increase will pay more US taxes equal to the income minus the deductions times the US tax rate, and/or finally, 3) companies will take advantage of the overall lower tax liability and create jobs in the US.
  4. 4. BIBLIOGRAPHY Barack Obama Press Release May 4, 2009 The-President-On-International-Tax-Policy-Reform/ Barack Obama Press Release May 4, 2009 PLAYING-FIELD-CURBING-TAX-HAVENS-AND-REMOVING-TAX-INCENTIVES-FOR-SHIFTING-JOBS- OVERSEAS/