IRS LMSB Deputy Commissioner (International) Barry Shott recently stated in a reported speech that:

  • at least half of the U.S. corporate groups have a foreign parent,
  • to the extent the domestic corporations own foreign operations, nearly 60% of their profits are in low or no tax jurisdictions, and
  • more than 60% of the international transactions of the domestic corporations occur within the corporations’ multinational groups.

Shott also identified “Tier 1 issues” in the international area to include:

  • Hybrid instrument transactions
  • Tax free repatriations
  • Foreign tax credit arbitrage
  • Exit strategies under section 936
  • Cost sharing and transfer of intangibles offshore

Significance to the System

The meanings of these statements are not entirely clear, but the overall drift is surprising. The first set of facts suggests that taxing foreign income will be increasingly difficult because (1) the foreign-owned US groups need no longer have foreign subsidiaries, and so need not have deferred income off-shore waiting for potential repatriation, and (2) difficult transfer pricing issues will have even more settings in which to arise.

Many will argue that these facts support movement to a system that does not attempt to tax foreign income. The IRS will argue that these facts support enhanced enforcement. The Treasury seems to be on the fence at the moment, but the views of the current Treasury probably are irrelevant at this point, given the upcoming change in Administrations. A compromise could be a reduction in the U.S. corporate tax rate, which would reduce the pressure on corporate taxpayers to “save” taxes in various way involving offshore activities.

But a significant reduction in the already low corporate tax revenues, coupled with the apparently unabating need for federal revenue, could make thinkable that once unthinkable alternative: the VAT. A relatively low-rate credit-method VAT remitted by businesses is being advocated by former Assistant Secretary for Tax Policy Michael Graetz. It has the advantage of using businesses as a tax collection arm, which probably is the best role for business to play. Perhaps a VAT should be substituted for, rather than added onto, the corporate income tax, but most countries with a VAT retain a corporate income tax, and eliminating the latter might be politically difficult.

The collections from such a VAT could allow raising the standard deduction substantially for individuals, thus effectively swapping the VAT that consumers would never “see” for millions of individual income tax returns. This swap possibly could be extended to a portion of payroll taxes, which are similarly regressive as is the VAT.

Significance to the U.S. Groups

U.S. groups either are owned by a foreign parent or may have that structure to look forward to. Generally the U.S. parent should not be sandwiched between the foreign parent and foreign subsidiaries, which historically were used by the U.S. parent to operate abroad. When a foreign corporation acquires a U.S. group, reshuffling of the composition of the group frequently is desirable. Although there will no longer be a need for the U.S. parent to operate abroad through foreign subsidiaries, the process of unwinding such structures tax free can be challenging.

An even more important issue that comes up at the time of the acquisitions of U.S. groups by foreign parents is the method of financing, and locating of interest deductions in the U.S., in cases of stock purchases.

On a day-to-day basis, being a U.S. subsidiary of a foreign parent, as contrasted with being a U.S. public company or privately held company, may present a different set of tax-related issues, including these:

  • Repatriation of earnings to the foreign parent under treaties
  • Exacerbated and different transfer pricing issues and transactions
  • Different opportunities and perils under section 304 involving sales of subsidiaries inside the group
  • Financing issues, possibly involving the hybrid financing instruments mentioned by Commissioner Shott
  • Debt/equity issues, with the foreign parent being interested in holding more debt relative to stock of the U.S. parent
  • Earnings stripping issues under section 163(j)

Interest paid to a related person that is not taxed or that is subject to a treaty-reduced withholding tax can be disqualified interest and thus not deductible, or not deductible currently, under section 163(j).

Non Public C Corporations

A final feature of the foreign-owned U.S. corporation that can be overlooked is that it will be one of only three categories of corporations that still report as C corporations: (1) U.S. publicly owned corporations, (2) U.S. privately held corporations that somehow can’t fit under subchapter S or just haven’t converted (it’s never too late), and (3) U.S. subsidiaries of foreign parents that may, themselves, not be publicly held.

This means that these corporations share the C corporation space with corporations that have very different concerns and opportunities, such as stock buy-backs, tax-free acquisitions using the corporation’s stock as acquisition currency, the ability to control their “groups,” etc.


The foreign-owned domestic corporation has its own special interests and concerns that require different approaches to familiar tax questions.