Reforming the US corporate tax structure by switching to a territorial system - Essay Example

Reforming the US corporate tax structure by switching to a territorial system The tax system that is applied by USA to tax its corporate sector has an overall effect on the US economy, since it determines the total revenues that can collected from taxes, and the consequent annual federal budget capacity (Mullins, 7). Currently, the USA corporate tax system is orientated towards a more foreign tax credit system, also known as a worldwide tax system, which taxes the USA corporate both for the incomes earned domestically and also the revenues earned abroad (United States Congress, 186).

This form of taxation has some limitations in that it opens avenues for the multinational corporations to apply accounting and other legal avenues of tax avoidance to reduce the taxes that they pay domestically to the USA government. The corporate apply the tax credit system that allows the MNCs to reduce their tax burden by the amount they pay in foreign taxes (Taxfoundation.org, n.p.). Therefore, switching to a territorial system structure will be more advantageous to the USA government tax collection system.

This is because, a territorial system will replace the taxation of the incomes of the USA corporations from everywhere in the world, into the taxation of the corporations that are only operating within the USA (Drabkin, Serwin and Tyson, 12). While this might seem like a disadvantage since it will reduce the incomes that are generated from the foreign-based companies, it is highly advantageous because it will ensure that the multinational corporations that are incorporated domestically within the USA do not deduct the expenses consumed by their franchises, branches or subsidiaries overseas (Taxfoundation.org, n.p.). This will prove to be a great tax advantage for the USA, since the multinational corporations incorporated domestically will be forced to have to pay taxes on all the revenues generated annually, without the existing loopholes of tax reductions offered by deducting the expenses of the subsidiaries operating abroad.

Multinational companies incorporated in the USA are able to reduce their domestically paid taxes through shifting the domestically earned incomes into the low tax foreign countries where their subsidiaries operate, through allocating the domestic incomes into the interest expenses and other fixed costs incurred by the subsidiaries (Taxfoundation.org, n.p.). Additionally, the domestic incomes earned by the USA multinationals is reduced through having the multinationals lower the taxes payable through inflating the inter-organizational prices for their transactions with their overseas subsidiaries (Mullins, 22).

Therefore, through switching to a territorial system tax structure, the USA will be able to seal all these loopholes that the multinationals have been using to repatriate their domestically earned incomes to foreign jurisdictions where the taxation is much lower. This will in turn ensure that all, the domestically earned incomes by the multinationals will be subjected to taxation, thus increasing the tax base and the total tax revenues collected from the USA multinationals, when compared to the current foreign tax credit system (Drabkin, Serwin and Tyson, 27).

Additionally, the territorial tax system structure will be able to tap on the incomes covered by the financial assets held by the foreign-based subsidiaries of the multinationals, which in turn means that the USA tax base will be able to tax the whole domestic income of the multinational based at home, while also taxing on the financial asset incomes of the foreign subsidiaries, thus increasing the tax revenue collected from the corporate taxes (United States Congress, 187). In addition, the adoption of the territorial system will be advantageous, since it will enable the multinationals to stop repatriating their domestically earned incomes to the foreign jurisdictions where the taxation is lower, making it possible for the companies to expand and also create more employment opportunities for the USA population (Drabkin, Serwin and Tyson, 35).

However, while the adoption of the territorial system would be advantageous to the USA tax revenue collection capacity, it could be somehow eroding the benefits of all the foreign incomes that are generated from the foreign jurisdictions. In this respect, the strategy of switching to a territorial system that would effectively reform the current structure of taxation in the USA is the application of the 95:5 rule. Under this strategy, the territorial system will act as a hybrid of both the current worldwide system of taxation and also a territorial system, where the multinationals are exempted from paying 95% of the taxes on revenues they generate from abroad, and only required to pay 5% taxes on such revenues (Drabkin, Serwin and Tyson, 37).

This system will prove to be beneficial, since it will ensure that the foreign-tax base capacity is not lost entirely, while ensuring that the domestically earned incomes will be subjected to taxation entirely (United States Congress, 186). The effect would be a very effective hybrid taxation system that is orientated more towards the territorial system structure. Switching to a territorial system improves capital import neutrality (CIN), through ensuring that the multinationals incorporated in the USA will only pay taxes for the income they earn domestically (Mullins, 47).

This will then mean that they are not burdened by more taxes like they are currently under the worldwide tax structure, where they pay tax on incomes generated domestically and also incomes generated internationally to the USA government (Taxfoundation.org). This will ensure that the tax burden for the USA corporate is lowered, and they are equally competitive to the corporations incorporated in other jurisdictions (United States Congress, 187). The notable change that will be required to implement the switching into a territorial system is to change the laws of computation of the deductible expenses, such that the deductions that were previously made in terms of expenses for the overseas subsidiaries would no longer be deducted from the taxable income of the USA corporations income that is earned domestically (Mullins, 21).

Works Cited Drabkin, Eric, Serwin, Kenneth and Tyson, Laura. Implications of a Switch to a Territorial Tax System in the United States: A Critical Comparison to the Current System. Berkeley Research Group, 2013. 1-41. Print. Mullins, Peter J. Moving to Territoriality? Implications for the United States and the Rest of the world. International Monetary Fund, 2006. 5-51. Print. Taxfoundation.org. A New Way to Tax Corporations: Switching to a Territorial System. Tax Foundation, January 09, 2012. Web. December 11, 2014.

< http://taxfoundation.org/article/new-way-tax-corporations-switching-territorial-system> United States Congress. Options to Improve Tax Compliance and Reform Tax Expenditures. Washington, D.C: U.S. G.P.O, 2005. 186-190. Print.