Monday, February 02, 2015

Obama Administration international tax reform proposals - part 2: 14% one-time transition tax on previously untaxed foreign income

My prior post discussed the Obama Administration's proposal, in its 2016 budget, to replace the current US tax regime for US companies' foreign earnings (involving deferral, foreign tax credits, and nominal imposition of the full domestic rate).  The proposal would replace all this with a 19% "minimum tax" on foreign earnings - in effect, a worldwide system without deferral, but with something rather like nonrefundable, 85% per-country foreign tax credits.

Whatever else the proposal would or wouldn't do, it would prospectively eliminate the tax on repatriating foreign earnings.  US companies would now be able to bring home as much of their foreign earnings as they liked, without thereby incurring further US tax liability.  But since the 19% minimum tax would only apply to new earnings - not to earnings generated in the past that were benefiting from deferral - it would confer a gigantic windfall gain on US companies if it were enacted without a one-time transitional adjustment for elimination of the previously deferred tax.

The foreign earnings that would benefit from the windfall gain, absent an adjustment, are currently believed to exceed $2 trillion.  Ignoring foreign tax credits, the deferred tax at the current 35% corporate rate would currently stand at $700 billion, and this amount would in effect be growing annually at the rate by which those foreign earnings were growing.

Despite the fact that companies may not anticipate ever paying anything close to the full amount (i.e., $700 billion minus foreign tax credits), it makes sense not to just give the revenue away.  Among other adverse effects, companies' reluctance to repatriate would be even greater than it already is if they figured out the repatriation tax might simply go away some day without any transitional adjustment.

The Administration has therefore proposed a one-time, 14% transition tax on previously untaxed foreign income.  A foreign tax credit would be allowed for "the amount of foreign taxes associated with such earnings multiplied by the ratio of the one-time tax rate to the maximum US corporate tax rate for 2015."  To illustrate what that means, note that a 14% one-time transition tax rate is 40% of the current maximum US corporate tax rate of 35%.  This would result in 40 cents of transition tax reduction for every dollar of associated foreign tax credits.

There is big money here.  For example, the proposal reportedly would cost such companies as Apple, Microsoft, Pfizer, and probably also General Electric, more than $10 billion each.  Somehow I doubt that the companies would much like this, and they do not entirely lack friends on Capital Hill.  Thus, while Congressman Camp also had a transition tax (at a lower rate) in his international tax reform proposal, the political prospects for enactment would seem to depend on Congress's being sufficiently desperate for the money, such as to offset other revenue losses in a corporate or international tax reform plan that lowered corporate rates in addition to eliminating the repatriation tax.

The Administration wants to use the transition tax revenues as a source of increased funding for highway and other infrastructure projects.  In my view, the US badly needs more such spending.  Of course, money is fungible, and purported earmarking can therefore lack any bottom-line substantive significance unless political actors actually treat it as meaningful (which here I suppose they might).  But the linkage is presumably meant, not just to associate the proposal with public support for higher infrastructure spending, but also to stand as an alternative to the revenues simply being used to fund other business tax cuts.

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