Current Tax Policies Handicap Our Global Companies

Monday, October 4, 2010 - 01:00

Editor: Ray, please describe your firm's practice.

Wiacek: Jones Day is one of the largest law firms in the world, with significant offices in the most important business and governmental cities in the world - from Washington to London, from New York to Tokyo. Our tax practice is consistent with that scope, with tax lawyers in major U.S. cities and in most important foreign cities.

We primarily represent a clientele of large multinational corporations. We do much cross-border finance for major banks. We plan and close commercial real estate transactions all over the world. We do tax planning with respect to intellectual property, because in the 21st century the most important key to business success probably is intellectual property. For example, we just completed planning for the manufacture and distribution of a major new anti-cancer drug for sale outside the United States. I am the head of the tax practice and based in the Washington office, where I started back in 1976.

I don't want to be immodest, but we think we are very good. In surveys of Fortune 50, 100 and 500 general counsel and significant legal officers, we frequently finish first as the "go to" law firm for big matters and best service. We finished first again in a survey released just a few weeks ago.

Editor: The White House Letter from the Business Roundtable and the Business Counsel (BRT-BC letter and its attachments) states that the U.S. tax system places U.S. corporations operating in foreign countries at a disadvantage with respect to their foreign-based competitors. It attributes this to the fact that the U.S. has the second-highest corporate tax rate in the OECD and that the U.S. is one of the few countries that taxes companies on their foreign earnings. What is your perspective?

Wiacek: The BRT-BC letter correctly calls out that the administration is proposing to increase taxes on foreign source income at a time when we are already impose the second-highest corporate tax rate in the developed world, and at a time when we are one of the very few countries that tax foreign source income at all.

The single biggest determinant of profit (after gross revenue) is often taxes. A company's tax line is often its biggest expense, bigger than advertising, bigger than R&D. With the second-highest corporate tax rate in the world, our companies' tax expense is disproportionately high, constraining profits. This leaves less money to create new products, to invest in new technology, or to make price concessions to land business versus our foreign competitors.

Moreover, as noted, we are one of the few countries that taxes worldwide income. Almost every other country - something like 80 percent of the world - is on what is known as the territorial system. Under this system, the only tax levied is the one imposed by the country in which a business activity is located. In contrast, a U.S. company gets taxed on its income earned inside the United States and it gets taxed by a foreign jurisdiction in that jurisdiction - for example, China. Then it gets taxed again in the U.S. when that foreign income is returned to the U.S. from the Chinese activity.

To avoid double taxation, the U.S. gives a foreign tax credit for the tax paid to the jurisdiction where the foreign activity is undertaken. But with the rest of the world imposing lower taxes, the credit is often less than the additional tax on the foreign income imposed by the U.S., resulting in net additional U.S. taxation.

For example, the China Income Tax (CIT) is imposed at a 25 percent rate, and, within the EU, Ireland has a 12.5 percent rate. When money earned in China or Ireland is returned to the U.S., it is subject to U.S. taxation on the difference between our 35 percent rate and the Chinese or Irish rate.

A Chinese company, or a French company competing in China, pays only the 25 percent CIT, with no additional tax. So they have more money left to build a needed warehouse or offer longer warranties. In sum, U.S. companies are suffering the double whammy of paying the second-highest corporate income tax rate in the world and having that rate imposed even on their foreign earnings, at a time when their competitors are paying a lower rate on their domestic income and are paying only the foreign tax on their foreign income.

Editor: Yet the administration is proposing to increase taxes on U.S. companies competing globally, by restricting the foreign tax credit and deferral. Why?

Wiacek: Our companies competing around the world are often our best, and the administration needs the revenue. As the famous bank robber Willy Sutton once said when asked why he robbed banks, "That's where the money is." And there is also a notion that our companies competing abroad are exporting jobs, attracted by tax rates lower than the high rate prevailing in the U.S.

Editor: What is the U.S. business response?

Wiacek: U.S. businesses go abroad because that's where the oil or bauxite is, for example, or that is where bananas grow. Leaving aside bananas, they go to expand and compete. Everyone knows we go to China because it has the largest emerging consumer market. Everyone wants us to sell autos there, for example. Does anyone think we can do that without a local distribution network, spare parts warehouses, warranty and repair centers? Does anyone really think we build those facilities because of the CIT 25 percent rate, to export U.S. jobs in exchange for lower taxes? If the U.S. "taxes up" the difference, does anyone think that will solve our jobs problem? Come on.

Editor: Let's turn to specifics. The administration has proposed changes to curtail deferral. Can you briefly explain deferral and the administration's proposal?

Wiacek: The anticompetitive effect of subjecting foreign income to U.S. tax is mitigated by delaying the imposition of the U.S. tax until the foreign income is returned to the U.S. This is referred to as "deferral."

Because the U.S. wants the tax revenue currently, it, in a sense, resents the deferral, and has a number of rules causing the foreign income of U.S. companies to be taxed in the U.S. on a current basis, whether or not returned to the U.S. Because U.S. companies are harmed by the high U.S. rate and the U.S. worldwide system, U.S. companies plan, within the law, to optimize deferral. The administration has not proposed the outright repeal of deferral, but instead views such planning as requiring "reform." Hence its proposals are technical and complicated. But in keeping with the note above - that much of this is simply about tax revenue - these "technical reforms" will raise taxes for our global companies by tens of billions of dollars.

Editor: Can you give me an example of a proposed technical change to deferral that in effect would raise taxes on U.S. multinationals by billions?

Wiacek: What was proposed was that a portion of one's expenses incurred in the U.S. won't be deductible until a like portion of one's foreign income is returned to the U.S. and subjected to U.S. taxation. So although deferral is not repealed outright, one pays for its continuation by losing current deductions to the same net effect - U.S. taxation of the international sector is increased. The theory is that U.S. expenses support the generation of foreign income and shouldn't be deducted until that foreign income is taxed.

Editor: I understand that the ability to claim credit for taxes paid to foreign countries on business done abroad - the so-called foreign tax credit - may be similarly curtailed. Can you discuss this?

Wiacek: This has happened already. Some of the administration's proposals in the foreign tax credit area became law in August to help pay for the Education Jobs and Medicaid Assistance Act. These are also very technical, as demonstrated by a one-line description of each. Thus, U.S. foreign tax credit law now separately limits credits earned in section 956 transactions, separately calculates credits for foreign income under treaties, denies credits for income earned in covered asset acquisitions, and prevents the separation of credits from income. These are all new limitations. Each was explained as a "reform" when proposed, and arguments supporting them as "reform" can be made. But if we didn't tax worldwide income to begin with, we wouldn't be arguing whether such changes are necessary. And we wouldn't be raising taxes on U.S. companies bidding, for example, on a big infrastructure project in Brazil against competitors from Germany or China or Japan.

Editor: What is the answer?

Wiacek: Well, it's probably political suicide to propose lowering corporate income taxes at this point in the economic and political cycle. But imposing the second-highest rate in the developed world can't be sustained forever. (As an aside, some of the administration's tax proposals were first made in the Ways and Means Committee, but the tax revenue to be raised was to be used to lower corporate taxes.) Perhaps less sensitive would be a move to the territorial system, freeing our companies to compete overseas without one eye on the U.S. tax system. The French call their leading companies "champions," and we should think more about championing our companies in the foreign arena. In the near term, leaving things alone may be best. Trying to "reform" international taxation when the economy and deficit make this a one-way street of tax increases is unhelpful. So perhaps the best thing for the administration to do is stand down until the international area can be analyzed under conditions less charged.

Editor: To borrow a maxim from the medical profession, "first do no harm."

Wiacek: Exactly, and our colleagues at the BRT and BC are working hard to make that clear.

Editor: Thank you for speaking with us.

Wiacek: Thank you for inviting me. Let's revisit this in the new year to see what further, if anything, passes Congress in 2010, and which proposals the administration continues to support in 2011.

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