I feel like taking a little break — two or three days —from international taxation.
Fortunately, there are even more important — at least in the medium term — tax topics. The most pressing tax issues today are presented by two time bombs in current law: (i) the sunset of the Bush tax cuts and (ii) the metastasis of the alternative minimum tax.
John Kerry's acceptance speech last night made reference to the US rules for taxing multinationals. I thought that his comment presents a nice opportunity to pull together some of the prior analysis and extend it to outsourcing.
Kerry promised to:
close the tax loopholes that reward companies for shipping jobs overseas. Instead, we will reward companies that create and keep good paying jobs where they belong, in the good old U.S.A. We value an America that exports products, not jobs. And we believe American workers should never have to subsidize the loss of their own job.
Your posts make it clear that I should say more about how a multinational can have “extra” value. But, tomorrow. Today, as promised, formulary apportionment.
“Formulary apportionment” is the most talked about alternative to the arm's-length method discussed yesterday. Most US states use formulary apportionment to attribute a multistate business' income to the taxing state. As the name suggests, a formula is used to figure out how much income a business earns in a taxing jurisdiction. The classic formula allocates on the basis of three factors: the business' property, payroll, and sales. Each year, the business figures out what percentage of its property, payroll, and sales are located in the taxing state. These percentages are averaged. This average percentage is applied to the business' income to figure out the portion of the income to be taxed.
As noted yesterday, the US does not tax foreign income of foreign corporations, even when the foreign corporation is a wholly-owned subsidiary of a US corporation. Under this regime, a US parent corporation with a subsidiary in a low-tax (tax haven) jurisdiction has an incentive to park income in the tax haven by (i) paying the subsidiary too much for goods and services and (ii) charging the subsidiary too little for goods and services. The US polices this with two mechanisms: First, some very mobile income, like royalties, of a controlled foreign corporation is taxed to US shareholders as earned by the foreign corporation. Second, there are rules that attempt to insure that parent/subsidiary transactions are priced at “arm's length.” The arm's-length rules don't work, which calls the entire regime into question.
The multinationals discussion thus far has felt a bit like a trip down memory lane. Today, however, we have a topic, foreign subsidiaries, that is so topical that there is news today! (My source is today's The Wall Street Journal Online.)
Part IV noted that the US' foreign tax credit regime represented altruism in the interests of encouraging trade and helping developing countries. Well, once one takes foreign subsidiaries into account, one realizes that we have done less.
Thank you all for the posts. Compare Jim's comments on Part III to Paul's on Part IV and you get the contours of the contemporary debate. Dan's, PGL's, and Jim's posts flesh out how complicated these issues are in the real world. (Jim, I really hope that Michael takes the blog back over before I have to talk about consumption taxes.) In the end, I do not have a view on the deduct vs. credit issue with regard to foreign taxes, because I do not understand the welfare effects of international trade adequately at this time. But, I can focus the analysis so that others can apply their views of trade.
Which gets us back to the foreign tax credit.
Jotwell Blenderlaw