M.A.D. has to be the best acronym ever. “Mutual Assured Destruction” is what the world looked like it was heading for 50 years ago this week when the young John F Kennedy faced down Nikita Khrushchev in the Cuban Missile Crisis. October 16, 1962 has gone down in history as the morning National Security Adviser McGeorge Bundy walked into the Oval Office to show the President the images captured of missile sites being constructed in Cuba.

Well, it turns out that US Presidents don’t get their priorities in a twist that easily and, despite the general impression that from that point on until the Soviets backed down 12 days later,  there was a “Do not disturb” sign hanging on the White House door, JFK did in fact manage to multi-task throughout.

One of the things he succeeded in doing that very day whilst contemplating the potential death of an estimated 200 million people on both sides of the Atlantic, was sign into law the Revenue Act of 1962. This would not be worth mentioning had it not been for the fact that the Revenue Act of 1962 has probably had more lasting effect on the world than those bases in Cuba. It was that piece of legislation that introduced the American people to Subpart F of the Internal Revenue Code. The non-deferral of  Controlled Foreign Corporation (CFC) income was born.

The US tax system that has been  the vanguard of   tax development since the early 20th century, has been through an evolutionary process as regards international taxation.  Starting in 1918, at the end of the First World War, the authorities introduced a system of  credits for foreign taxes paid so as to avoid double taxation. As they perceived breaches in the system they sealed them while, at the same time, showing increased fairness with underlying credits for taxes paid by the US owned foreign corporations that existed here and there.

Following the Second World War and introduction of the Marshall Plan to help get Europe back on its feet, there was an explosion in the number of US owned foreign corporations and Congress started to wake up to the possibility that US corporations, faced with massive taxes at home, might be shielding their profits in low tax jurisdictions. Hence, in 1962 – just in time for the possible destruction of mankind as we know it – legislation was passed to prevent the deferral of tax in foreign corporate tax planning strategies.

It has been downhill ever since. Countless changes in the law have led to a labyrinth of regulations that, it is generally believed, have left the US Treasury none the much richer while leaving  tax lawyers and CPAs very much richer (I always had a soft spot for Kennedy). Meanwhile, much of the world has caught on to CFC which has become the byword in my profession for “This is complicated – we will need to give you a quote”.

What is of keen interest is the gradual move internationally away from a worldwide system of taxation, as practiced in the US, to a modified territorial system. The Territorial approach, which is also gaining traction in the US, broadly does not seek to tax or give foreign tax credit for dividends received by resident companies from foreign affiliates. The arguments in favour of a territorial system are broadly that they will allow companies to be entirely competitive in foreign markets and there will be free repatriation of income leading to increased investment at home. Against the territorial system is the argument that more activity and income will be moved offshore creating permanent tax advantages.

Astute readers will have noticed that somebody here, by definition, must be  dancing with the fairies. The kindest explanation as to why both sides are able to claim that a territorial system will cause capital flows in precisely opposite directions, is that nobody really has a clue  but they want to find support for their chosen philosophy of international taxation. The Worldwiders are firm believers in creating tax equality among resident taxpayers. The Territorials believe that you have to equalize the tax costs between international competitors that operate in the same jurisdiction, so that everybody is competing on a level playing field and capital can flow to where it obtains the best after-tax returns. It is worth noting, by the way, that the place where the best after-tax returns are achieved is likely not to be the place of most efficient exploitation of capital since the lower tax rate distorts the return.

Now, I like my dose of Kant and Descartes as much as the next man, but – in the real world (and that is the political world) – philosophy is to international taxation what a bicycle is to a fish. Governments need to balance budgets. Ask the Greeks – they gave philosophy to the world, and sadly not much else. Socrates, Plato and Aristotle will not save them  from drinking economic hemlock. Governments do what they have to do and hope that some thinkers somewhere will support them.

In practice  – and that is definitely the most important term in the taxation lexicon – 27 of the 34 members of the OECD (The “I am rich and couldn’t give a sod about the rest” club of wealthy nations) have adopted some form of territorial taxation – 10 of them since 2000.  The most common features are: a reduced corporate tax rate to make the home country more competitive; the creation of a simplified CFC system or something similar to prevent blatant artificial siphoning of profits to low tax jurisdictions (Britain, a new convert to territorial taxation,  is at the forefront of new developments on this); preferential tax treatment for the exploitation of local   R&D since much of that siphoning of profits previously mentioned relates to dubious IP ownership in low-tax jurisdictions; preferential tax treatment of group finance companies to keep the finance income onshore;  restriction of interest expenses at head office level to those used in the production of head office income so as not to unfairly reduce the home country tax base; and strict transfer pricing legislation to bayonet the wounded.

Meanwhile, real business profits from foreign operations are repatriated free of charge, or close to free of charge. Repatriation can still be a bummer where dividend withholding tax from the foreign jurisdiction is prohibitively high – but there too, several countries are moving  towards low withholding taxes on substantial corporate holdings.

According to the statistics (I don’t believe I said that) this practical hybrid territorial system is working well which fits in with the one piece of tax philosophy I do subscribe to in my day job- “If it ain’t broke, don’t fix it”. On the other hand, the US system appears totally broke. Whichever way the election goes in November, the President and Congress should look closely at the experiences of their OECD colleagues. Fifty-odd years after the revolutions in Cuba and the US international tax system, it is time for legislators to show real courage and do what they were elected and paid to do.