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A Payoff to Second-Best Pragmatism: Rethinking Entity Classification for Foreign Companies

39 Pages Posted: 13 May 2017  

Jon Endean

Simpson Thacher & Bartlett LLP; Yale Law School

Date Written: February 1, 2017

Abstract

Whether it is an attempt by the Obama administration to curb corporate inversions or a strategy by the Trump administration to make U.S. businesses more competitive abroad, the world of international taxation seems primed to occupy policy conversations for the foreseeable future.

Yet perhaps few areas of law are as contentious while remaining so abstruse. Indeed, international taxation—while enormously important for global commerce and domestic companies alike—is extraordinarily complex. The consequence of this has been that companies with the resources to dream up sophisticated tax shelters are better positioned to take advantage of U.S. tax laws when operating transnationally.

One example of this is illustrative. Suppose two companies (one domiciled in the U.S. and one domiciled overseas) sold the exact same products in both the U.S. and overseas. The U.S. company would be treated differently under U.S. tax law—and would have to pay higher taxes by consequence—solely by its being a U.S. domiciliary. While the foreign company would be exempt from U.S. taxation on all its foreign revenue, the U.S. company would merely get a tax credit against its U.S. taxes on any income earned overseas. This reality has led to companies to come up with tax strategies (including inversions) such that they can avoid this disparate treatment, as such disparate treatment is a competitive disadvantage in the global marketplace.

The status quo is untenable, but it remains frustratingly difficult to reach a consensus on how to solve the problem. Many countries—including the United Kingdom and Japan—have followed a global trend towards a territorial system, or taxing companies only on revenue earned in that particular country. With the current political appetite for comprehensive tax overhaul legislation likely low, this paper argues for an elegant “second best” solution that could help crack down on corporate tax games while providing a road map towards a territorial system, bringing the U.S. into alignment with global trends.

Namely, this proposal suggests that in the same vein as the corporate check-the-box regulations promulgated during the Clinton administration, companies could simply elect whether they wish to be treated as a foreign or a domestic entity. While this would leave the vast majority of the tax code largely intact, it would have wide-reaching implications for tax law and corporate structuring (without upsetting current structures), provide a pathway towards a true territorial system, and potentially help uncover abusive tax shelters in the process.

Keywords: Taxation, International Taxation, Tax Shelters

JEL Classification: K34

Suggested Citation

Endean, Jon, A Payoff to Second-Best Pragmatism: Rethinking Entity Classification for Foreign Companies (February 1, 2017). 14 New York University Journal of Law and Business (Nov. 2017) Forthcoming. Available at SSRN: https://ssrn.com/abstract=2967149

Jon Endean (Contact Author)

Simpson Thacher & Bartlett LLP ( email )

2550 Hanover Street
Palo Alto, CA 94304
United States

Yale Law School ( email )

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