Deere & Company's Testimony at W&M Oversight Hearing on International Tax Laws

STATEMENT OF

[2] Deere & Company is the world's largest producer and distributor of agricultural equipment and a leading producer and distributor of construction and grounds care equipment. It also finances and leases equipment and has insurance and health care operations. Deere employs approximately 26,000 people in the United States and 37,000 worldwide.

[3] The company has factories in nine states and eleven countries. Our products are distributed and serviced worldwide by a large number of independent John Deere dealers.

[4] We have aggressive growth objectives both in this country and abroad. Our experience is that growth here and abroad is complimentary. Our presence abroad helps our U.S. exports and helps provide product volumes that keep U.S. products less expensive for our customers. Sometimes products produced for markets abroad also have a use in the U.S. Our balance of payments -- from a U.S. perspective -- is clearly positive.

[5] For Deere to continue expanding our businesses at a level acceptable to our shareholders, Deere clearly must continue to expand and be competitive overseas.

[6] One of the greatest challenges faced by Deere and other multinational companies is the complexity of U.S. international tax rules. Many provisions of the U.S. tax code not only result in a paperwork burden unmatched anywhere in the world, but also hinder the ability of American companies to compete in the international arena. Mr. Chairman, we appreciate your leadership in examining this issue. Your legislation (H.R. 2018) addresses many areas where the U.S. Code could be improved. I would like to focus on a few specific areas of interest to Deere and other manufacturers. Three key tax issues that affect our competitiveness overseas are: the foreign interest expense allocation; the active financing income exemption; and, the foreign tax credit ordering rules. The way these issues are currently handled causes U.S. manufacturers to be less competitive with overseas manufacturers and, as a result, reduces U.S. manufacturers' ability to sell U.S. products overseas. For this reason, we have advocated for several years that U.S. international tax laws must be addressed in these areas.

(1) Foreign Interest Expense Allocation

[7] The maximum foreign tax credit a U.S. company can receive is equal to the U.S. tax rate times the foreign taxable earnings less the U.S. expenses incurred to generate those earnings. In determining the U.S. expense incurred, Regulation 1.861-11T requires that the total U.S. affiliated company interest expense be allocated between domestic and foreign source income based on assets.

[8] The Deere U.S. credit and leasing companies only finance equipment sold or leased within the U.S. The Deere U.S. credit and leasing company assets represent over 50 percent of the total asset allocation base. By comparison, foreign assets are less than 13 percent of total assets. The credit and leasing companies account for 80 percent of the U.S. consolidated income tax return interest expense. The tax regulations force a disproportionate allocation of interest expense to foreign assets. The arbitrary interest expense allocation has reduced Deere's foreign tax credit by 11 to 20 percent in recent years. The resulting double taxation of foreign earnings makes Deere and other manufacturers less competitive in foreign markets.

[9] Currently, the interest expense allocation regulation exempts certain financial institutions, including chartered banks and thrifts, from the 861-11 allocation. However, other active domestic finance companies that are defined in Section 1.904-4(e)(3) of the Regulations are actually performing the same functions as chartered banks and thrifts (such as Deere's credit and leasing operations), but are not included in the exemption.

[10] We recommend that the exemption to the interest allocation regulation be expanded to include all active domestic financial institutions. In this manner, our foreign income will be more accurately reflected and our eligibility for an appropriate level of foreign tax credit will be restored. This issue must be addressed to ensure that U.S. companies' international tax burden approximates that of our competitors.

(2) Active Financing Income Exemption

[11] Another important foreign tax issue to equipment manufacturers is the exemption for active financing income. In 1997 Congress adopted an exception to subpart F of the Code for foreign finance companies that comply with the significant active business tests in Section 954(h)(2)(A) of the Code. Prior to its adoption, subpart F taxed all income on foreign loans and leases as the income was earned, rather than permit such income to be deferred until foreign dividends were paid. The law viewed all finance activity as passive investment activity.

[12] However, Section 954(h)(2)(A) established an exception to the subpart F rules for foreign finance companies where their principal business activity is to provide financing to unrelated parties located in the country in which the foreign finance company was organized. This exception strengthens the business carried on by the foreign finance companies.

[13] Moreover, the exception was, and continues to be, extremely important to equipment manufacturers such as Deere as we expand our markets overseas and as we expand financing activities abroad to South America, Eastern Europe and Asia. All of these markets have a high demand for our products, but customers have had difficulty in securing adequate financing for their purchases of equipment. With the expansion of our financing operations overseas during the period of the exemption, this problem has been minimized and Deere, like other equipment manufacturers, is able to compete successfully in the foreign marketplace.

[14] The exemption for active financing income is scheduled to expire on December 30, 2000. Deere recommends that the active financing income exemption be made permanent. A permanent exemption would enable Deere and other manufacturers to continue to expand our financing operations overseas, export more equipment abroad and expand our U.S. workforce.

(3) Foreign Tax Credit ordering Rules

[15] The third area of concern to Deere and other manufacturers is the manner in which corporations must use unused foreign tax credits. Currently, unused foreign tax credits that are earned in a given year must be used before any carryover credits can be used in that year. As a result, equipment manufacturers that are experiencing a downturn find it very difficult to claim any carryover foreign tax credit in years of reduced profits.

[16] Many companies often find that in a downturn (1) lower manufacturing activity reduces foreign royalty income; (2) foreign source export sales income is greatly reduced as the demand for equipment softens overseas; (3) foreign dividends are withheld to finance the buildup of inventory and trade receivables abroad; (4) U.S. interest expense allocated to foreign source income increases as U.S. borrowings increase to finance the buildup of similar U.S. inventory and receivables; and (5) the combination of lower foreign source income and rising 861 interest expense allocations reduces a company's ability to claim a foreign tax credit. And without the benefit of a foreign tax credit, that company's foreign earnings are being double taxed.

[17] Accordingly, we recommend that the Committee establish "ordering rules" for foreign tax credits similar to the rules governing net operating losses. These rules would permit the "earliest-to-expire" carryover credit to be used before any credit that is earned in the current year -- just as currently is the case with NOL carryovers. In this manner, a company would be able to maximize its foreign tax credit carryovers without losing them during a downturn. This would enable equipment manufacturers to maximize their foreign tax credits and remain competitive in their overseas markets following a downturn.

[18] In summary, Deere & Company must be able to compete effectively overseas in order to continue to provide jobs to its employees, expand its business and provide genuine value to its shareholders. The three recommendations that we are making today will favorably affect all U.S. equipment manufacturers. Moreover, they will strengthen our ability to compete favorably overseas and therefore provide more jobs in and exports from this country.

[19] Thank you.