Getting Serious About Cross-Border Earnings Stripping: Establishing an Analytical Framework

70 Pages Posted: 1 Apr 2015

See all articles by J. Clifton Fleming

J. Clifton Fleming

Brigham Young University - J. Reuben Clark Law School

Robert J. Peroni

University of Texas at Austin - School of Law

Stephen E. Shay

Boston College Law School

Date Written: March 31, 2015


The term “corporate inversion” is used to identify several transactional forms by which U.S. resident corporations are converted into foreign corporations or into U.S. subsidiaries of foreign corporations. These transactions are currently a large concern to U.S. tax policy makers and a lively debate is in progress regarding the best way forward.

From a tax standpoint, corporate inversions are driven by the triple objectives of (1) enabling inverting U.S. corporations to escape U.S. taxation of their foreign-source income, (2) enabling U.S. corporations to effectively repatriate foreign-source income without paying a U.S. tax on such income, and (3) enabling those U.S. corporations to move U.S.-source income out of the U.S. tax base by means of deductible expense payments — a tactic known as cross-border earnings stripping. In previous work, we have explained how the first two of these objectives could be forestalled if the definition of a U.S. domestic corporation were broadened to include a shareholder ownership test and if the U.S. international income tax system were changed into a real worldwide system. In this Article, we address ways to forestall the third objective by imposing limits on earnings stripping.

Focusing on inversions, however, results in a view of earnings stripping that is far too narrow. A principal emphasis of this Article is that earnings stripping presents challenges to the U.S. tax base that are much broader than corporate inversions and so we have developed an analytical framework for identifying responses to the full menu of earnings stripping tactics employed by multinational enterprises (MNEs), of which inversions are only a part.

That framework shows that deductions for interest payments on intra-MNE debt, which are the largest contributor to earnings stripping, are also the most vulnerable to criticism from a policy standpoint. Consequently, we examine various approaches to limiting earnings stripping interest deductions and conclude that the best promise lies in employing a proportionate allocation approach to distinguish between interest expenses that are deductible as real costs and interest expenses that should be nondeductible because they are costless foreign related party payments that do not effect a proper inter-nation income allocation.

We conclude that distinguishing between properly deductible and properly nondeductible cross-border payments for services is much more difficult and requires reliance on transfer pricing law. Finally, this Article advances understanding of the proper taxation of royalties paid by a U.S. subsidiary to a foreign member of an MNE but concludes that the ultimate resolution of that issue requires further work.

Most importantly, this article shows that cross-border earnings stripping is devastating to the tax bases of both worldwide and territorial international tax systems. Thus, action needs to be taken to curtail the use of earnings stripping to erode the U.S. tax base without waiting to resolve the controversy over whether the United States should adopt a territorial system or instead significantly strengthen its badly flawed worldwide system.

Keywords: Income Taxation, International Taxation, Earnings Stripping, Inversions, Corporate Inversions, Interest Expense, Thin Capitalization

JEL Classification: H20, H21, H25, H87, K34

Suggested Citation

Fleming, J. Clifton and Peroni, Robert Joseph and Shay, Stephen E., Getting Serious About Cross-Border Earnings Stripping: Establishing an Analytical Framework (March 31, 2015). North Carolina Law Review, Vol. 93, p. 673, 2015, BYU Law Research Paper No. 15-11, Available at SSRN:

J. Clifton Fleming (Contact Author)

Brigham Young University - J. Reuben Clark Law School ( email )

430 JRCB
Brigham Young University
Provo, UT 84602
United States

Robert Joseph Peroni

University of Texas at Austin - School of Law ( email )

727 East Dean Keeton Street
Austin, TX 78705
United States

Stephen E. Shay

Boston College Law School ( email )

140 Commonwealth Avenue
Chestnut Hill, MA 02467
United States

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Abstract Views
PlumX Metrics