The United States Foreign Tax System - Research Paper Example

?U.S. Foreign Tax System Introduction Globalization has become the norm of U.S. business world. The increasing adaptation of globalization by both large and small companies has changed the traditional ideas of tax reforms that earnings can be taxable if only they are earned within geographical boundaries. In order to promote this dynamism, it is necessary that the U.S. government collect taxes from income that is earned only within the nation and companies that are earning profit outside the U.S. boundaries should be allowed to follow the tax rules of the countries in which they are doing business. However, in reality the U.S. government ignores this concept of neutrality and imposes taxation on profits earned by U.S. companies in any country outside the border. Thus, U.S. companies who seek to spread businesses overseas are burdened with a combination of tax systems. Such companies are required to pay taxes to the U.S. Government as well as the government of the countries where they are conducting their activities (Henchman, 2011, pp.1-2). This paper contains my proposals as a tax professional to my U.S based client who wants to expand his business into foreign markets. Taxpayer’s organizations My client can establish chain of hotels or restaurants in a foreign country. This will make my client fall under deferral system of U.S. foreign tax. Under this system, subsidiary companies that are situated in other countries can be exempted from U.S. taxation unless such revenue is repatriated to the parent company like in the form of dividends. Also, I will advice my client to launch hotels in countries that are keen on promoting tourism by easy tax credits and ready development loans. For instance in Peru, foreign investors on hotel industry are given tax incentives and tax returns even before the investments are completed or the recommended constructions are completed (Finkelstein, 2012). The second type of organization that my client can establish is manufacturing company. This will benefit my client if he sells the manufactured products to foreign clients with foreign titles. Such income will fall under foreign income category although the company is situated with the U.S. Moreover, in the initial year since my client will be new in the foreign market his sales volumes will be low. In that case my suggestion will be to conduct activities from the U.S. without opening subsidiary company in the foreign country. In this way he will be able to avoid local taxes in the country on income earned from local sources. Tax mitigation on repatriate earnings A major portion of income earned by U.S. companies is derived from foreign sources. Both the United States and the country in which the company is executing its activities prefer to impose taxes on the company. The governments of both countries try to benefit from these companies thereby establishing double taxation concept. Although the U.S. government attempts to mitigate its tax claim, these overlapping tax impositions create complications for U.S. tax collectors. This provides opportunities to multinational companies to avoid taxes. Subsidiary companies are confronted with high tax rates in countries where they operate. As an owner of a multinational company, my client will have an incentive to get income remittances in one of the forms that propose tax deductions. The incentive will not be in the form of dividends. A remittance that is subject to tax deductions directly reduces tax payments of source country. On the other hand, dividend expenses may only generate unusable surplus of credits. The strategy is to keep the rates of tax less than that on dividends on the forms of payments that fall under the category of tax deductions. This will be more beneficial if the parent company that is situated within US has surplus of credit. It will be then profitable for my client to conduct payments in these tax-deductible forms. The surplus of credits can also be utilized for counterbalancing any remaining U.S. tax on such payments. The principle impact will be that payments can be deducted against source-country taxes (Altshuler & Newlon, 1993, p.88). Foreign tax credits In order to offset U.S. tax on revenue generated in one foreign country, excess credits can be used that accrue from income generated in another foreign country. This concept is termed as cross-crediting and can be done by using foreign tax credit carryovers. Cross-crediting can reduce the taxable income from foreign sources. If my client’s company is in the status of excess limitation which means the U.S. tax liability on income derived from other countries is more than its foreign tax credits, then any income of the company from its subsidiary branch in a low tax country will face excess tax. The tax amount will be similar to the amount that would have been paid had the income was derived from U.S. source. If my client’s company has excess credit, then it can be used to counterbalance the U.S. tax to be paid on revenues earned from low tax countries. In such a case, there can be violation of capital-export neutrality because tax will be favourable for investments in low tax countries than investments in the U.S. or in the high tax countries (Altshuler & Newlon, 1993, p.82). My client will be facing deferral system of U.S. taxation if his company is situated in U.S. but income is derived by providing services to foreign countries. This is because in deferral system of taxation, any income earned by an U.S. company from anywhere in the world is taxable by the U.S. government. However, revenues earned by my client’s subsidiaries that are situated in other countries can be exempted from U.S. taxation unless such revenue is repatriated to the parent company like in the form of dividends. Another concept of U.S. taxation is sourcing. Under this system my client can shift the earnings of his U.S. company that is garnered from foreign services from one category to another. This can be done without increasing the volume of revenues that can be taxable under U.S. tax system. For instance, if goods are sold to buyers who are foreign nationalities, then such revenues are regarded as foreign income by the U.S. taxation system (Kogan, 2013, p.15). Accumulated earnings tax The accumulated earnings tax was first enacted in the year 1921, and the present form of the tax was imposed by Section 531 of the Internal Revenue Code of 1954. Under this Section, any income that is earned by a U.S. company which is “in excess of the reasonable needs of the business for the purpose of avoiding income tax on dividends distributed to shareholders” (Stone, 1969, p.919) faces the accumulated earnings tax. In order to access the margin of revenue beyond which excess income will fall under this tax, the Congress and the courts have focused on the reasonable requirement by companies, but have not focused on the tax avoidance aspects for such accumulations. Under Section 35 any amount of the income or profit is not taxable that is retained by the company to serves its reasonable requirements. Therefore, if the accumulated earnings are not more than the reasonable needs of the company as well as needs that are anticipated in advance, then such earnings are not taxable even if such earnings were accumulated for the purpose of tax evasion. My client can be burdened by accumulated earnings tax if he is served by a timely notice that his accumulated revenues are unreasonable under Section 531. In such a case, my client can give a timely notice in return claiming that he can prove with enough facts about the reasonableness of such revenue accumulation. He can state needs like “capital and inventory requirements, increasing costs and inherent risks in the business and general economy” (Stone, 1969, p.921). Foreign sourced losses If the expenses of any multinational company exceed the income, then such losses can influence the remaining credit calculations. Such losses can be shifted to domestic income thereby minimizing the impact on other credit calculations. Such losses can also be allocated on other categories of foreign revenue, and this can possibly lower the amount of credit available in those categories. The losses can also be allocated on both domestic and foreign revenues to limit the effect on credit calculation. After applying any kind of allocation rule, the next thing to be determined is that if later on profit emerges in a category of revenue whose loss has already been allocated to other categories, then what the impact will be. However, there is possibility that my client can incur “overall net operating loss that may be carried forward”. In such case, the carryover will have impact on credit calculation in subsequent years (Ault & Arnold, 2010, p.461). My client can get best treatment for his losses if the country in which he incurred losses has tax rate not higher than U.S. tax rate. Also that country must have provision for carrying forward net operating loss. This will make my client eligible for second tax benefit on income earned from that foreign country because no U.S. tax was imposed on that income. This can happen even if my client incurred losses in previous years that reduced U.S. taxable income from U.S. source (A Review of the overall foreign loss rules, 2009, p.9). Conclusion In this era of globalization when U.S. companies are rapidly expanding to solidify grounds in the foreign markets, the U.S. tax system must strive to encourage this dynamism. The tax system must focus on imposing taxes on income derived from U.S. sources and exempt those incomes that are derived from foreign sources. This is mainly because foreign incomes are always taxed in source countries. Although for a tax collector, a worldwide tax system is more advantageous than territorial tax system, it is however the latter system that can enhance international trade competitiveness. References 1. A Review of the overall foreign loss rules (2009), Tax Notes International, retrieved on July 6, 2013 from: http://tax.uk.ey.com/NR/rdonlyres/eqknqw3dw6xqcdxx3eaxtksbtck 4hhevqnpyiph5g34hmloecpc3net4xz4ii6kptx3zpa44k5liuhyley5cgqi62ch/ITSinthenews003.pdf 2. Altshuler, R. & T.S. Newlon (1993). The Effects of U.S. Tax Policy on the Income Repatriation Patterns of U.S. Multinational Corporations, NBER, retrieved on July 6, 2013 from: http://www.nber.org/chapters/c7994.pdf 3. Ault, H.J. & B.J. Arnold (2010). Comparative Income Taxation: A Structural Analysis, Kluwer Law International 4. Finkelstein, A. (2012), Peru Woos Hotel Investors With Easy Tax Credits and Ready Development, World Property Channel, retrieved on July 7, 2013 from: http://www.worldpropertychannel.com/latin-america-vacation-news/claudia-cornejo-mohme-peru-foreign-trade-and-tourism-dept-proinversion-peru-real-estate-market-new-hotels-in-peru-6149.php 5. Henchman, J. (2011), Rethinking U.S. Taxation of Overseas Operations, taxfoundation, retrieved on July 6, 2013 from: http://taxfoundation.org/sites/taxfoundation.org/ files/docs/sr197.pdf 6. Kogan, K. (2013). Selling abroad requires careful tax planning, Lawyer, retrieved on July 6, 2013 from: http://www.chadbourne.com/files/Publication/85ce7a39-2adc-49b4-80e8-35877e212c16/Presentation/PublicationAttachment/3e4b03fa-083e-43d0-b5dc-3e4f93c3dbfd/sellingabroadtax_Kogan.pdf 7. Stone, N.G. (1969). The Accumulated Earnings Tax: Displacement of the Avoidance Test and a Suggested Business Purpose Test, Boston College Law Review, 10(4), 919-931 Read More