For business tax reform to be sustainable in a global environment, the United States tax system must be designed to ensure that business profits earned within the United States are subject to the same U.S. taxation regardless of where a multinational corporation is incorporated.
Today’s tax system does not achieve this objective, and its failure to do so creates inbound earning stripping opportunities for foreign-based multinational enterprises that allow them to achieve a lower tax burden with respect to their U.S. operations than can be achieved by U.S.-based multinational enterprises conducting those same operations.
{mosads}Thus, U.S.-based multinational enterprises are competitively disadvantaged by our own tax system.
How does this inbound earning stripping problem arise? When a U.S. subsidiary makes a cross-border tax deductible payment to a low-taxed offshore affiliate, the overall income of the multinational enterprise has not changed. The multinational enterprise has simply moved assets from one affiliate entity’s pocket to another affiliate’s pocket.
But, from a U.S. tax perspective, this related party (intercompany) transaction is quite lucrative. This intercompany transaction affords the U.S. affiliate with a U.S. tax deduction that reduces the U.S. corporate tax liability of the U.S. affiliate.
The intercompany payment in turn creates income in the hands of the low-taxed offshore affiliate that often escapes U.S. taxation and often avoids any meaningful taxation in the offshore jurisdiction.
Multinational enterprises come to every jurisdiction, including the United States, with a toolbox of tax planning techniques. So, to have a sustainable system of business taxation, the United States simply must address inbound earnings stripping by addressing each type of earning stripping transaction.
Foreclosing one, but not all, of the earning stripping techniques simply motivates a foreign-based multinational enterprise to use other tax planning tools.
Moreover, the U.S. Subpart F regime has historically served as an important backstop to protect against the inbound earning stripping strategies of U.S.-based multinational enterprises, but that regime does not apply to foreign-based multinational enterprises.
Corporate inversions are a telltale symptom of the larger inbound earning-stripping disease.
Corporate inversions represent a statement by U.S.-based multinational enterprises that the financial benefits associated with the inbound earning stripping opportunities afforded to foreign-based multinational enterprises are so compelling that U.S.-based companies are willing to enter into a corporate inversion transaction.
In so doing, the post-inversion company can avail itself of the same inbound earning stripping opportunities as its foreign-based competitors without the impediment of the U.S. subpart F regime.
Thus, instead of attacking the corporate inversion messenger in isolation, Congress should focus its attention on the inversion message, namely, that the inbound earning stripping techniques available to foreign-based multinational enterprises, if left unchecked, create an unlevel playing field that fuels the corporate inversion phenomenon.
Said differently, corporate inversions tell Congress that it must solve the inbound earning stripping problem on a holistic basis if it wants to eliminate the tax incentives for these transactions.
Congress should be rightly concerned about the migration of U.S. origin profits to low-tax jurisdictions and the erosion of the U.S. tax base via inbound earning stripping transactions. But, at the same time, Congress needs to adopt solutions to the inbound earning stripping problem that do not create unintended negative consequences.
To that end, Congress should ensure that any resulting legislation will protect the U.S. tax base from the systemic inbound earning stripping techniques in a manner that does not disadvantage U.S.-based multinational enterprises vis-à-vis their foreign-based competitors.
In the past, Congress has simply relied on the Subpart F regime to protect against the inbound earning stripping opportunities of U.S.-based multinational enterprises, but Subpart F measures do not impact the tax planning activities of foreign-based multinational enterprises.
Thus, Congress must adopt measures to protect the U.S. tax base against inbound earning stripping techniques of multinational enterprises and must do so in a manner that provides even-handed treatment. Congress must take up the challenge of reforming inbound taxation in order for business tax reform to be sustainable.
An important metric for evaluating policy proposals to address this concern should be whether or not those measures are even-handed or instead create a tax disadvantage for U.S.-based multinational enterprises that is not felt by foreign-based competitors.
Bret Wells is professor of law and the George Butler research professor of law at the University of Houston Law Center. Professor Wells teaches and writes in the fields of tax law and oil and gas law.