American business owners are accustomed to states and cities offering various tax incentives in order to lure them to do business in that jurisdiction. Different countries actually do the same thing. Countries will often provide a low tax rate for certain industries or permit certain outbound related party payments to be deductible from taxable income. In fact, the tax competition has become so dangerous to the fiscal stability of industrialized and developing nations that the Organization for Economic Cooperation and Development (the “OECD”), has established a framework for taxation called Base Erosion and Profit Shifting (“BEPS”).
BEPS is built around 15 distinct action items covering a vast array of tax issues ranging from taxing digital transactions to transfer pricing. The action items will give countries the tools they need to ensure that profits are taxed where economic activities generating the profits are performed and where value is created, while at the same time give business greater certainty by reducing disputes over the application of international tax rules, and standardizing requirements.
Of course, in order for BEPS to be effective it would require near universal adoption. Otherwise global capital will continue to find its way to nations with the most liberal tax policies. The United States is not keen to implement BEPS in its entirety. While the United States does indeed have a serious base erosion problem (more than most actually), its problems stem more from internal issues than external competition. The United States is the only large, industrialized nation that taxes its multi-national companies on their worldwide income. This single fact is responsible for countless multinational corporations to be organized outside the U.S. every year. That equates to hundreds of billions of dollars of potential tax revenue lost on an annual basis. Worse yet, when corporations are formed and operated outside the U.S. there are potential U.S. jobs that are lost to other nations. The net effect of less fiscal revenue and less jobs for Americans is devastating to the U.S. economy.
And, it’s not just the corporations that never get formed in the U.S. to begin with. The problem extends to long-time U.S. multinational corporations that engage in transactions dubbed “inversions” to effectively expatriate from the U.S. tax net. Additionally, while the United States currently taxes its multinational corporates on global income it provides virtually unlimited tax deferral on foreign earnings until they are repatriated into the U.S. The natural result is that U.S. based corporations go to extreme lengths to keep their non-U.S. earnings out of the U.S. This also has an adverse effect on the U.S. economy. Not only is the fiscal revenue indefinitely deferred but it also saps the U.S. of fresh investment. U.S. based multinationals are not reinvesting into the United States. Our international tax policy almost forces U.S. based multinationals to invest abroad rather than at home. U.S. multinationals are keenly aware that bringing earnings home will result in a high tax cost. In fact, the House Ways & Means Committee recently published a statistic claiming that U.S. companies currently held in excess of two trillion dollars offshore. One can only imagine the cost to American citizens of the lost tax revenue, lost jobs and lost U.S. reinvestment.
Needless to say, the U.S. is badly in need of international tax reform. Our current Congress is pushing forward on various reform measures to help the U.S. advance in the international tax competition. These reform measures will have wide-ranging repercussions to almost every American business. International operations will need to be reorganized in order to take full advantage of the new measures and avoid excess taxation that may result in certain circumstances.