U.S. MNCs’ Offshore Operations: An Unbiased View

Abstract

Washington is abuzz with activity surrounding the taxation of US MNC’s international operations. This article attempts to provide an unbiased view of the international tax policy issues the US is facing. The author is a former senior government official and a former tax advisor to US MNCs. Those with strong views on one side or the other, will likely agree with some of the article’s conclusions, but disagree with others. Preliminary conclusions include:

1) US MNCs are clearly using creative international tax planning to shift substantial income out of the US. Although some US jobs have been lost as a result of this tax planning, companies have accomplished most of their tax objectives through aggressive transfer pricing and creative tax structures. To the extent US jobs have been lost, lower wages or other non-tax reasons have likely been the primary cause.

2) Given the inherently factual nature of the income shifting problem and the willingness of US MNCs to spend whatever it takes to defend their position, anyone who believes the IRS can effectively enforce the arm’s-length standard is an eternal optimist -- or delusional!

3) Excess income shifting may have hoist US MNCs on their own petard and be the primary reason they are pursuing a tax holiday or a territorial system. Without one of these legislative actions, US MNCs may be challenged by either their auditors or the SEC on their financial accounting assumption that accumulated low-tax foreign earnings are indefinitely reinvested.

4) Because of their ability to shift income, US MNCs have a competitive advantage over US domestic companies -- to the extent they are competitors. However, certain proposed solutions to the income shifting problem may put US MNCs at a competitive disadvantage with foreign MNCs.

As a result of these preliminary conclusions, the article concludes: It will be difficult for tax policy makers to accomplish the dual goals of creating a level playing field between (i) US MNCs and US domestic companies, and (ii) US MNCs and foreign MNCs. One option is to reduce the corporate tax rate to 15% or less, but this could be politically very difficult. Another option is to attempt to structure an anti-income-shifting rule that targets income shifted out of the US, rather than income located in a low-tax foreign jurisdiction. This second option would allow US MNCs to compete with foreign MNCs by continuing to shift income from high-tax foreign countries to low-tax foreign countries.

If neither proposal is possible, US tax policy makers will need to make a choice. Specifically, do they favor US MNCs at the expense of US domestic companies? Or, do they put US MNCs and US domestic companies on a relatively level playing field, but then potentially put US MNCs at a competitive disadvantage with foreign MNCs?

Keywords: International taxation, US MNCs, Subpart F, Worldwide Tax System, Territorial Tax System, Competitiveness, and Corporate Tax Reform