When people think of the corporate tax cuts included in Trump and the Congressional Republicans’ 2017 Tax Cuts and Jobs Act (TCJA), they usually think of the corporate tax rate cut from 35 percent to 21 percent. But that wasn’t the only corporate giveaway. Almost as important was TCJA’s failure to curb offshore tax evasion. The 2017 law merely replaced a set of sketchy rules that favored offshore profits over domestic profits with a new set of sketchy rules that do the same. A bill introduced today by Rep. Lloyd Doggett and Sen. Sheldon Whitehouse would finalize this to follow a simple principle: We should tax our companies’ offshore and domestic profits the same way.
Current law tax offshore profits of American companies more easily than domestic profits. This was true of the old law as well, although the details were different. This has long created tax incentives for companies to use accounting gimmicks to generate their U.S. profits in countries with very low or no corporate taxes – offshore tax havens.
For example, the Cayman Islands have no corporate income tax. It has a population of only 63,000 people, but U.S. companies said they made $ 58.5 billion in profits there in 2017, roughly 10 times the total gross domestic product (total economic output) of this tiny country. It is clear that our laws have long allowed companies to make ridiculous claims about the location of their profits. Back in 2008, the Government Accountability Office found that nearly 19,000 companies were headquartered in a single five-story office building in the Cayman Islands.
The 2017 Tax Act drafters had an opportunity to end this nonsense, but in some ways they may have made it worse because the new rules encourage companies to move real operations – and the jobs that come with them – offshore to offshore lower profit tax rates.
Under the Tax Incentives for Outsourcing Act introduced today by Doggett and Whitehouse, the Tax Act would no longer provide such incentives. Offshore profits would be taxed at a tax rate at least as high as the US tax rate regardless of where they are earned. So a company would gain nothing by claiming that its profits are made in Bermuda or the Cayman Islands rather than the United States. The bill, which is a stronger version of the legislation that the same legislature put in place at the previous Congress, would solve this and several other problems with our international tax rules, grossing nearly $ 800 billion over a decade.
Under the TCJA, some US company offshore profits are not subject to US tax, while others are taxed at no more than half the tax rate applicable to domestic profits.
The rules do not tax offshore profits at all unless they exceed 10 percent of the value of the company’s offshore property, plant and equipment. Tangible assets are what most people consider “real” investments, like machinery, factories, and shops.
The rules only assume that offshore profits of more than 10 percent of these assets are profits from other types of assets (intangible assets such as patents) that are more easily relocated overseas. The rules call these gains Global Low-Taxed Intangible Income (GILTI), which may be taxable depending on whether they are subject to foreign taxes.
One problem is that companies could increase the amount of US tax-exempt offshore profits as they move more of their tangible assets (and possibly related jobs) overseas. This can result in a smaller proportion of their foreign profits exceeding the 10 percent threshold.
Another problem is that offshore profits, even if identified as GILTI and subject to U.S. taxes, are effectively taxed at 10.5 percent, which is only half of the 21 percent levied on domestic corporate profits. In other words, TCJA always rewards companies that can convert US profits into foreign profits, whether that means moving profits on paper or moving actual business operations.
Another problem is that the rules apply globally to all foreign profits, not per country. American companies are granted a tax credit (FTC) on their US taxes equal to the taxes they paid to foreign governments on their overseas profits. This is useful because it prevents double taxation. Under current law (just like the previous law), nothing prevents companies from using excess credit generated by profits in higher tax countries to offset US taxes due on profits in lower tax countries. The GILTI rules should (in theory) impose a minimum tax on excess profits offshore to prevent profit shifting. However, TCJA’s failure to ban FTC mutual crediting weakens this minimum tax significantly.
The bill introduced today would address these and several other issues. It would remove the exemption that applies to some offshore profits and tax them all at the same tax rate that applies to domestic profits (which would be 21 percent if Congress didn’t change this). The Foreign Tax Credit (FTC) would be applied on a country basis.
The bill would also block inversions, the practice by which American companies claim that a merger with a foreign company converted them into a foreign company for tax purposes, even though most of their ownership has not changed. It would also treat companies managed and controlled in the US as American companies for tax purposes – meaning they wouldn’t benefit from listing this five-story Cayman Islands office building as their legal headquarters.
Equally important, the bill also prevents foreign-owned companies from manipulating debt to strip US revenue. American companies that are subsidiaries of overseas corporations sometimes claim to have borrowed from their overseas parent companies and make interest payments to them, and then tell the IRS that they have little or no US profits to report as a result. In reality, the “lender” and the “borrower” in this situation are all part of the same company and controlled by the same people. Therefore, the purpose of the agreement is no other than US tax avoidance. The bill would be tough by capping deductions for interest payments when a US affiliate claims a disproportionate portion of the interest expense.
While the details seem complicated, the principle is simple. Businesses should be taxed in the same way regardless of whether they claim their profits are made domestically or abroad. This is the way to prevent large multinational companies from avoiding taxes and taking an unfair advantage over domestic companies that do not enter into complex agreements with tax havens.