Earlier in 2009, President Obama followed through on a campaign pledge by proposing revisions to the U.S. income taxation of multinational corporations’ foreign source income. Obama’s position was that permitting U.S. corporations to defer recognition of their foreign source income until they repatriate the income encouraged U.S. corporations to ship jobs overseas and deprived the U.S. Treasury of revenue that could be spent on programs including health care reform.
As a background note, the U.S. is the only major industrialized country that substantially taxes its residents, corporations included, on their worldwide income rather than just their income from domestic sources. U.S. multinationals are able to defer paying U.S. income tax on much of their foreign source income until they repatriate the income to the U.S., often as dividends or deemed dividends from the foreign subsidiary corporation to the U.S. parent corporation. Every other major industrialized country recognizes that multinationals pay income tax in the countries where they operate and do not double tax multinationals by taxing them a second time on foreign source income. Furthermore, the U.S. taxes corporations at a higher rate than the majority of its trading partners. Critics of Obama’s plan have noted that increasing U.S. corporate taxation of multinationals would move the U.S. in the opposite direction of our trading partners who are lowing taxes on their own multinationals to give them a competitive edge.
Initially, Obama believed that weakening the deferral regime would raise approximately $200 billion in tax revenue over 10 years. He also believed it would encourage U.S. companies to create jobs in the U.S. rather than create jobs overseas. Obama’s proposals included:
- Eliminating tax deductions for certain expenses to support foreign operations until those operations’ income is repatriated;
- Postponing the use of foreign tax credits,
- Eliminating certain check-the-box planning for foreign subsidiaries; and
- Increasing funding for IRS enforcement activities.
The U.S. business community argued that Obama’s proposals would reduce U.S. multinationals’ competitiveness, which in turn would cause them to reduce their level of U.S. employment oriented to supporting their overseas operations. Some multinationals could leave the U.S. altogether. The companies opposed to Obama’s weakening of the deferral regime included cutting edge technology companies heavily invested overseas as well as more traditional export oriented manufacturing companies. The message to the administration was clear, raising U.S. corporate taxes would:
- Expand the existing disparity between U.S. taxation of multinationals on a worldwide basis and the rest of the industrialized world's approach to taxing multinationals on their domestic source income, and
- Discourage U.S. corporations from expanding U.S. operations and increasing U.S. employment to support foreign operations and foreign sales.
Obama may not have permanently scrapped his efforts to weaken the deferral regime. Obama could again advance his anti-deferral reforms as part of a larger tax reform effort reminiscent of the Tax Reform Act of 1986. In 1986, Congress expanded the tax base by eliminating tax breaks for favored industries. Congress was able to use the revenue raised by eliminating tax breaks to provide taxpayers with across the board tax rate reductions. The result of the Tax Reform Act of 1986 was a broader tax base, lower tax rates, and greater equity among similarly situated taxpayers. Obama could also scrap the deferral proposals altogether and raise revenue through increasing enforcement of existing tax law with more audits of U.S. multinationals. U.S. multinationals should continue to proactively review their international tax profile to ensure compliance with existing tax law and be aware that Obama has indicated his preference for weakening the current deferral regime.