Republicans say they’re going to switch to a “territorial” system to tax US companies. That usually means something specific: A government only taxes corporate profits earned within its borders.
But this proposal is a bit more, err, complex.
The Trump Administration and Republicans in Congress splashed the phrase “TERRITORIAL TAXATION” in all caps on the last page of their proposal, which describes their plan the following way:
It will replace the existing, outdated worldwide tax system with a 100% exemption for dividends from foreign subsidiaries (in which the U.S. parent owns at least a 10% stake).
OK sure, that sounds territorial. Right now, the US doesn’t tax profits earned by companies’ foreign subsidiaries until the subsidiaries repatriate those profits through dividends paid to the parent company. This part of the proposal would effectively remove the incentive to keep them offshore by exempting those dividends from tax.
But the next section says this:
To prevent companies from shifting profits to tax havens, the framework includes rules to protect the U.S. tax base by taxing at a reduced rate and on a global basis the foreign profits of U.S. multinational corporations. The committees will incorporate rules to level the playing field between U.S.-headquartered parent companies and foreign-headquartered parent companies.
…huh??
That doesn’t sound like a territorial tax system at all! That’s a global tax system! In that case, the proposal is not really a territorial tax system.
There are still ways that the following two things could be true, though:
(1) The new policy will give a 100-per-cent exemption for dividends from foreign subsidiaries, which is a way that domestic companies recognise foreign profits.
(2) The new policy will tax foreign profits “on a global basis”.
Republicans might just want to make companies pay a minimum global tax — though they don’t say at what rate — to prevent the base erosion and profit shifting (BEPS) problems that have caused so many headaches in the EU.
To do that, the US could tax foreign profits before they get to the dividend repatriation stage, which would remove companies’ incentive to reinvest overseas indefinitely to defer tax payments.
Of course, that doesn’t mean Congress will make them physically bring the cash back, which would force them to sell the investments held by their foreign subsidiaries. A significant share of those investments are in US securities, as this correspondent has covered with colleagues at the FT.
Rather, those companies will simply pay a one-time tax on that cash as if they had physically repatriated the profits. That policy is known as a “deemed repatriation”, and was generally expected. (The eurodollar market will live on!) From the proposal:
To transition to this new system, the framework treats foreign earnings that have accumulated overseas under the old system as repatriated.
Though… if companies don’t actually need to sell their investments and repatriate them, why include this provision?
Accumulated foreign earnings held in illiquid assets will be subject to a lower tax rate than foreign earnings held in cash or cash equivalents. Payment of the tax liability will be spread out over several years.
Anyone feeling bullish about non-US real estate?