John Kerry's acceptance speech last night made reference to the US rules for taxing multinationals. I thought that his comment presents a nice opportunity to pull together some of the prior analysis and extend it to outsourcing.
Kerry promised to:
close the tax loopholes that reward companies for shipping jobs overseas. Instead, we will reward companies that create and keep good paying jobs where they belong, in the good old U.S.A. We value an America that exports products, not jobs. And we believe American workers should never have to subsidize the loss of their own job.
His web site says a bit more:
Close Loopholes In International Tax Law That Encourage Outsourcing. Today's tax law provides big breaks for companies that send American jobs overseas. Current “deferral” policies allow American companies to avoid paying American taxes on the income earned by their foreign subsidiaries and encourage them to keep their profits parked overseas, not reinvested in America. As president, John Kerry will end deferral that encourages outsourcing and will shut down other loopholes to make the tax code work for the American worker, not provide tax breaks for companies that ship jobs overseas.
Kerry is troubled by the ability of US corporations to defer a full US tax indefinitely by using foreign subsidiaries to do business in low-tax jurisdictions. Accordingly, he would look through these corporations and impose a current US tax as the subsidiaries earn money (reduced, of course, by a credit for any foreign taxes on those earnings). This is consistent with current financial accounting rules, as earnings of foreign subsidiaries are included immediately in the parent's (consolidated) financial statements. (Although, as noted in a prior post, the US taxes on those earnings are not booked until the earnings are paid to the US parent as dividends.)
There is an important point in the Kerry website note: The US respecting foreign subsidiaries rewards outsourcing. By “outsourcing,” I mean a US business having an independent foreign business provide goods or services for the US business that, historically, the US business provided for itself. To the extent that (i) the independent foreign business is in a low-tax country and, this may be unlikely, (ii) those low taxes are reflected in lower prices from the foreign business, little can be done to reduce the US tax incentive to export. But, under current law, outsourcing makes it easier to move the extra profit in a multinational — which, in this context, most would view as profit attributable to non-asset intangible value, like know-how and non-patented technology — outside the reach of an immediate, full US tax. Kerry's proposal to look through foreign subsidiaries would get at this incentive to outsource.
It is important to note that full look-through does not eliminate all incentives to move offshore. Most obviously, there still are problems from the averaging of foreign tax rates for purposes of the limit on the foreign tax credit. (This was discussed in an earlier post.) For example, a US business with operations primarily in high-tax countries still will be able to avoid all tax on some item of US income by moving the US income to a law-tax jurisdiction. Similarly, a US business with operations primarily in low-tax jurisdictions can move US income to a high-tax jurisdiction at no extra tax cost. These problems will be worse once the ETI bills become law, as they cut back on the 1986 restrictions on averaging.