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Thursday, 28th March 2024
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Proposals create uncertainty as to long term tax treatment of US foreign investment Back  
Barack Obama’s administration’s proposals on the tax treatment of the offshore profits of US multinationals creates uncertainty as to the long term tax treatment of investment decisions of US companies, writes Adrian Crawford.
The eagerly-awaited proposals of the Obama Administration for changes to the US tax treatment of the offshore profits of US multinationals were announced in outline on 4th May. They have had a rather mixed reception both in the United States and overseas.

What changes are proposed?
The good news is that deferral will continue. A US multinational which currently qualifies for the deferral of US taxes on the profits of its Irish subsidiary will continue to be entitled to that treatment. The profits will be taxed in Ireland as before and will be subject to US taxation only if, and to the extent that, they are repatriated to the United States.

Three significant changes have been announced. Their impact, if any, on the tax treatment of individual CFCs (Controlled Foreign Corporation) will vary depending on the precise structure used and, of course, on the detail of the legislation eventually enacted. It is envisaged that these changes should take effect from 2011.

It is proposed that the US ‘check-the-box’ rules be amended to require certain non-US subsidiaries to be treated as separate corporations for US tax purposes. These rules, which were introduced in 1997, allow the business operations of a number of foreign subsidiaries to be seen as the activities of a single corporation when viewed from the United States.

The perceived mischief against which this proposed amendment is directed appears to be the use of non-US subsidiaries to shift income from one CFC to another. This might be achieved through a financing, leasing or licensing arrangement. Where the lender, lessor or licensor is based in a lower-tax jurisdiction than its counterpart, the effect will be to reduce the overall non-US tax burden of the group. However, this non-US tax objective can be achieved with or without the making of a check-the-box selection.

What are the possible results of a change in this area? The first possibility is that taxpayers will leave their structures unchanged with the result that the passive income is currently taxed in the United States. This would appear to make sense only where the US tax rate is lower than the rate applicable to the CFC which is making the interest, lease or royalty payments. The second is that the structure is unwound with the result that the local corporation tax liability of the active CFC is increased. This may be good news for non-US tax authorities but does not lead to any increase in US tax revenues. The third is a possible shifting of the active business of non-US subsidiaries from CFCs in relatively high-tax jurisdictions (where currently the local corporation tax liability can be reduced without a corresponding increase in US tax liabilities) to lower-tax jurisdictions such as Ireland.

It is difficult to see that this change will result in a substantial increase in US tax revenues or US employment.
The second proposed change is a denial of current US tax deductions for certain expenses (such as interest) whilst the third proposal is to amend the foreign tax credit rules. It is not thought likely that these will have a significant impact in many cases involving Irish investments.

The debate in the United States prompted by these proposals is already taking predictable lines. On one side the thesis is that any changes to tax law which encourage US multinationals to create jobs at home rather than abroad are good in themselves. The fact that non-US (including Irish) multinationals are significant employers in the United States does not feature strongly in this analysis. On the other side, the argument is that US multinationals serving (and profiting from) international markets need to establish subsidiaries and to employ people close to these markets. The deferral provisions as they are currently found in US tax law have been developed over the years to allow US-headquartered multinationals to remain competitive with non-US businesses competing in the same markets where the competitors enjoy the benefits of a territorial rather than a worldwide approach to the taxation of multinational profits. This constituency argues that the effect of the proposed changes must be to render US multinationals less competitive in international markets.

Ireland, like other countries, is concerned with the possible impact of these proposals on US-sourced FDI. It is probably a truism that anything which creates uncertainty as to the long-term tax treatment of investment decisions can only be unhelpful. Having been a destination of choice for US investment, Ireland has justifiable grounds for concern.

On the positive side, Ireland offers investors (whether from Ireland, the United States or elsewhere) an attractive package which includes, but is certainly not limited to, a relatively simple and very transparent corporate tax regime. Whether or not the proposed changes are enacted in their current form, US multinationals which seek profitably to do business with the 95 per cent of the world’s population found beyond US borders will conclude that, for compelling commercial reasons, they need to establish business structures outside the United States. Once that key decision has been made on non-tax business grounds, Ireland will continue to have a very compelling case for attracting its share of the foreign investment dollar. Indeed, certain of the proposed changes, by making it more difficult for US multinationals to reduce their tax bills in higher-tax countries outside the United States, may make it interesting for US multinationals to increase rather than reduce their commitment to Ireland.

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