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Law Professor Urges Legislation to Address Foreign Source Income Tax

AUG. 12, 2003

Law Professor Urges Legislation to Address Foreign Source Income Tax

DATED AUG. 12, 2003
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650 Timber Lane

 

Devon, PA 19333

 

August 12, 2003

 

Honorable Pamela F. Olson

 

Assistant Secretary (Tax Policy)

 

Treasury of the United States

 

Washington, D.C.

 

 

Dear Assistant Secretary Olson;

 

 

[1] This is to suggest that the Treasury Department propose legislation to treat as foreign source the income of foreign subsidiaries (and foreign hybrids owned by foreign subsidiaries) operating from a U.S. office to the extent the income is attributable to furnishing equity capital and other financing to foreign affiliates (including foreign hybrids), exercising management supervision and control with respect to the foreign affiliates, and supplying services to the foreign affiliates that are incident to furnishing equity capital and other financing and exercising management supervision and control. Qualifying entities might be required to file a special tax return as a "Section XXX Entity."1

[2] I write as an adjunct professor teaching courses in tax policy and international tax planning in a law school graduate tax program and from experience in the federal government, a multinational corporation, and law firms.

[3] This suggestion is made in light of the uncertain outcome of legislation to repeal the ETI provisions and enact new foreign tax rules. The Crane-Rangel bill, H.R. 1769, would lower the section 11 rate on U.S. manufacturing income to compensate companies for loss of the export provisions. Chairman Thomas's H.R. 2896 incorporates a number of changes that respond to competitiveness concerns of U.S. multinationals. Neither bill would move the U.S. to full or "pure" territoriality, and under both bills the U.S. tax system would continue to distinguish sharply between U.S. and foreign incorporated companies.

[4] U.S. companies, to obtain the benefit of deferral of U.S. tax on their foreign income, still would have to use foreign subsidiaries. Because neither bill would change applicable source-of-income rules, the activities of these foreign subsidiaries still would have to be located outside the United States. Currently, U.S. multinationals often place holding-financing-management functions in foreign subsidiary corporations, or in foreign hybrids owned by foreign subsidiaries, located in countries such as the Netherlands that tax lightly or not at all income from sources outside their borders. The countries in which these entities are located benefit substantially from the significant number of associated high level jobs.

[5] Unless something is done in connection with passage of either H.R. 1769 or H.R. 2896, both U.S. and foreign multinationals will continue to be effectively precluded from using a U.S. location for their foreign holding-financing-management entities.

[6] A different location policy would seem to be better for the country. The U.S. would lose little or no section 11 tax, compared to the status quo, if it permitted and welcomed these entities to be located within the United States by treating their income as foreign source. In fact, the country would gain revenues from taxes on the employees if the jobs were in the U.S. instead of abroad. Additional revenues would come from added business for U.S. based third-party suppliers. The U.S. could be an attractive location not only for the holding-financing-management entities of U.S. multinationals for their foreign operations, but also for the comparable entities of foreign multinationals. Many, perhaps a great many, high level, world class jobs might be located or relocated to the U.S. instead of being sited abroad.

[7] If Treasury decides to propose legislation along these lines, it would be helpful if an accompanying memorandum provided text and examples to show how Treasury and the IRS will construe the statutory terms (hopefully, broadly) and how they will apply section 482 to the holding-financing-management entities and to the foreign affiliates with which they deal (hopefully, in a manner consistent with the purposes of the legislation).

[8] Thank you for your time in considering this letter.

Very truly yours,

 

 

Cornelius C. Shields

 

cc: Gregory Jenner, Deputy Assistant Secretary (Tax Policy), Treasury

Barbara Angus, International Tax Counsel, Treasury

Patricia Brown, Deputy International Tax Counsel, Treasury

Emily Parker, Acting Chief Counsel, IRS

Henry Hicks, Associate Chief Counsel (International), IRS

Robert Winters, Chief Tax Counsel, Majority, House Ways and Means

John Buckley, Chief Tax Counsel, Minority, House Ways and Means

Mark Prater, Chief Tax Counsel, Majority, Senate Finance

Russ Sullivan, Chief Tax Counsel, Minority, Senate Finance

George Yin, Chief of Staff, JCT

 

FOOTNOTE

 

 

1 The proposed legislation is taken from the draft territoriality statute which I sent to you by letter dated July 4, 2002 (see also 27 Tax Notes International 589, 29 July 2002, and 2002 WTD 145-18 Database 'Worldwide Tax Daily 2002', View '(Number'). In that draft the part described above appears twice with slight word variation, once for U.S. multinationals (headed "Headquarters and Holding Subsidiaries for Foreign Operations"), and once for foreign multinationals (headed "Headquarters and Holding Subsidiaries of Foreign Parent Corporations"), and was available to both foreign and domestic subsidiaries.

 

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