Tax Break

John Fisher, international tax consultant

Archive for the tag “United States”

Territorial expansion

“You ain’t seen nothing yet!”

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.

“What have I done?”

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.

Just get off your backside and do something!

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.

Washington the dream factory

Who were Rodgers and Hammerstein trying to kid?

Last year, the Oscar for Best Actor was awarded to someone who feigned inability to speak coherently. This year, the same award went to someone who chose not to speak. The 2012 Academy Award for Best Supporting Actor went to that prize’s oldest recipient best known for playing a singing sailor whose most memorable line, nearly 50 years ago, was whistling his children to attention that they might greet the evergreen Julie Andrews who tried to con everyone into thinking she was a nun.

I think it was Founding Father Benjamin Franklin who adopted the ancient line “Speak little, do much” and Hollywood appears to finally have caught on. The candidates for US President, on the other hand, have clearly not taken a leaf out of Hollywood’s book and now, in the wake of that Muppet Show cast vying for the Republican Nomination whose “Pin The Tail on The Donkey” approach to corporate tax rates I dealt with in a previous post, President Obama has now weighed in with a load more useless verbage on the subject.

Measured by the higher level of  tax in his proposal – 28%, the relevant bits of the president’s Federal Budget Proposal for 2013 are, by definition, more responsible than those of his competitors. But, other than talking vaguely about a broadening of the tax base to cover the drop from 35% and ensure a fairer, leaner system, he was a bit short on the facts. He wants to close loopholes but, given that there are interest groups jealously guarding every one, he does not say which ones. He wants to encourage manufacturing with a 25% rate but does not note that some of the biggest loopholes are in that sector. He wants to encourage relocation of activities back to the US from abroad and proposes a minimum tax on overseas profits of which he provides no details.

Go on. Admit it. You thought the last President of Chile was a General.

Non Americans (that’s me, folks) find all this lack of detail strange. Among the 34 members of the OECD (the rich nations’ club) the only nation other than the United States to run a pure presidential system is Chile – the French have a hybrid approach that includes a prime minister who has the support of the National Assembly, and everybody else runs some form of parliamentary system.  As such, in countries that still call football football, when the Head of Government comes up with a budget there is usually a fighting chance that, at least most of it, will be passed since, overall, he has the confidence of the parliament. That is what we Old World people understand Heads of Governments are supposed to do. Otherwise we could employ a secretary to announce legislation and save a lot of time,money and teeth whitener.

Not in the US. When President Obama made his Budget proposal it was a request to Congress and there is not the faintest risk of it becoming law – in other words he could join the dream world of the irresponsible opposition even though he is the incumbent. Pure Hollywood.

There are, of course, certain anomolies in the US system. The president has to ask Congress to declare War which makes a lot of sense, considering the amount of expense and gore a silly mistake can cause. BUT, he does have the power to turn out the lights on all of us by messing around with those secret codes in the briefcase always carried by a military man at his side.

Her typing wasn't half bad either

On second thoughts, I think I will keep taking the US president seriously. As much as I value the professional abilities of my secretary, if she had her “finger on the button” I would be nervous every time she went for the remote control to adjust the airconditioning.

For tax advisor and country

"Tax Resident Kane" doesn't have the same ring to it

There is a framed football shirt hanging on my son’s wall. It is half blue, half white – the blue half sporting the insignia of the Israel Football Association and the white half the Three Lions of England. Scrawled in indelible marker across the English half is the inscription “Good Luck, Bobby Charlton” ( for the benefit of American readers -and absolutely NOBODY else on earth – Sir Bobby Charlton is to English football what Babe Ruth was to American baseball).

My son is part of an ever growing phenomenon in the modern global village- the dual citizen. The Economist ran an article last week questioning the continued relevance of citizenship as a basis for a person’s rights and responsibilities vis a vis a particular country given the almost ad hoc way in which citizenship can be acquired. The recommendation, in a world where the military draft is becoming increasingly rare, was for tax residence to supersede citizenship.

Hallelujah!  If you have been wondering what we international tax advisors  are going to do for a living when the European Union institutes the Common Consolidated Corporate Tax Base (CCCTB) and the US Congress adopts a Territorial Tax Basis – we are saved!  As soon as The Economist’s proposals are accepted by the world’s legislatures anybody wanting to do whatever citizens do in a country will need to prove  tax residence, and that means fees.

At a cursory glance the concept of residence looks fairly consistent internationally – many countries insisting that, if an individual spends over 183 days (six months in plain speech) within their borders, they are resident. But, as the Eagles said:  “You can check out any time you like, but you can never leave” – in addition to differing  applications of the 183 day rule between a single tax year and straddling two tax years, nation after nation traps individuals with further multi-year calculations  as well as a host of additional tests that point in only one direction – the national piggy-bank. Warring tax authorities are forced into the tie-breaker clause in the double tax treaty they hopefully concluded earlier and, given the subjective nature of some of the tests, they often end up fighting it out around a negotiating table.

What does all this mean for this brilliant alternative to citizenship? Fast forward to 2015. Giovanni, the Italian plumber we met a few posts back  who is now working under Single Market rules in the UK,  turns up at his local Town (City) Hall on March 15,  to register to vote in the upcoming  General Election. The clerk asks for proof of his days present in the UK since last April 5 (the potty fiscal year end there). Giovanni proves 200 days but the clerk, after calling the tax residence hot line,  points out that in calendar year 2014 he was probably still resident in Italy under Italian law since he was present there for 239 days in the calendar (fiscal) year, and, it was as yet unclear, whether he would be similarly classified in 2015 depending on future circumstances. He tells him to go and get a tax opinion. Giovanni, who despite being a plumber is not flush with cash, tells the clerk that he cannot afford an opinion. “In that case”, the clerk informs him, “We can approach the Italian authorities and institute Mutual Agreement Procedures under the tax treaty”. Being Italian, Giovanni has an inbred aversion to tax authorities, especially those he has not been reporting to for the last thirty years, so he scrams fast –  internationally disenfranchised.

Then there is  the situation of tax exiles. On the assumption that, as long as there is tax there will be tax exiles, in a world of economic growth their numbers are likely to increase. So it would seem quite possible that, in the foreseeable future, Monaco and Andorra could become so popular that one or both of them could claim a permanent seat at the United Nations Security Council.

World War III

Personally, if there is a need to change the current system, I would go for pledge of support to a national football team. When push comes to shove everybody only really supports one team and, although I have never asked my son whether he is for England or Israel, I do recall taking his older brother to an Israel v Argentina game in the early nineties with Diego Maradona playing (Americans -ask your friends). There was almost a riot between Argentine fans and Israeli fans – ironically the Argentinian contingent being made up almost exclusively of people who had fled the Junta in the early eighties and sought and found refuge in Israel.

And if you think there is anything trivial about the football idea, Bill Shankly,the legendary manager of Liverpool famously said: “Some people think football is a matter of life and death. I assure you, it’s much more serious than that.”

Post Navigation