U.S. companies would face a minimum tax on the income they earn around the world under a plan released today by Senate Finance Chairman Max Baucus that marks his most significant proposal to revamp the tax code.
Baucus’s plan to restructure the international tax system would lower the corporate rate by an unspecified amount, end a rule that has encouraged companies to accumulate about $2 trillion in earnings in their foreign subsidiaries and impose a 20 percent tax on those stockpiled profits.
The proposal is the first of three drafts the Montana Democrat plans to release this week. It will be followed by proposals on tax administration and capital-cost recovery. Baucus, who is retiring from Congress at the end of 2014, said he wants to kick off discussions about revising the tax system.
“It’s time to move; it’s time to go,” Baucus told reporters in his office in Washington, saying his tax plan would prove politically popular. “You can create your own destiny.”
Whether he can succeed is far from clear. Efforts by Baucus and House Ways and Means Chairman Dave Camp to make the biggest changes to the U.S. tax code since 1986 are stalled, partly because of a partisan dispute over whether the government should collect more revenue as part of the changes. Camp is a Michigan Republican.
Corporate groups, including the Business Roundtable, issued statements within hours that criticized the Baucus plan. Roundtable President John Engler, who represents chief executives of large companies, said the senator’s approach would make many U.S. companies less competitive.
Baucus’s international tax plan is designed to be revenue neutral in the long run. He would reserve the one-time revenue of about $200 billion from the tax on accumulated earnings for an unspecified purpose.
The international system is one of the most technically complex areas of the U.S. tax code and potential changes are being watched closely by companies including Pfizer Inc. (PFE:US) and General Electric Co. (GE:US) that have significant global businesses.
General agreement exists across party lines on moving to a system that lessens burdens on companies that face lower-taxed foreign competition while tightening rules on U.S. companies’ tax-avoidance tactics.
President Barack Obama said today that the differences between the parties on business taxation “should be bridgeable.” Speaking at the Wall Street Journal CEO Council in Washington, he reiterated the administration’s support for a “modest, clear” global minimum tax without endorsing Baucus’s version of it.
Each detail in Baucus’s proposal affects companies in different ways depending on how they have set up their businesses, where they operate and where they have located their intellectual property.
His plan will make it tougher for companies to claim profits in low-tax countries, said Ed Kleinbard, a tax-law professor at the University of Southern California.
“This is obviously bad news for tech firms and pharmas and others that have effective tax rates in the single digits,” said Kleinbard, a former chief of staff of the congressional Joint Committee on Taxation. “It’s impossible that they will maintain foreign effective tax rates in the single digits.”
Under current law, U.S. companies owe taxes at the full federal rate of 35 percent on all income they earn around the world. They receive tax credits for payments to foreign governments and can defer U.S. taxation until they repatriate the money.
That system has encouraged companies to accumulate untaxed earnings in foreign subsidiaries. It also has created incentives for companies to move intellectual property out of the U.S. and into low-tax jurisdictions.
U.S. lawmakers such as Senator Carl Levin, a Michigan Democrat, have criticized maneuvers by companies including Apple Inc. and Microsoft Corp. (MSFT:US) that have reduced their tax bills.
Many other countries, including the U.K. and Japan, have shifted to what’s known as a territorial tax system in which U.S. companies would owe little or no taxes on their foreign income.
The Let’s Invest for Tomorrow America Coalition, which advocates for a territorial system, said that Baucus’s proposal would take the country further from a pro-growth position. Coalition members include Oracle Corp. (ORCL:US), Johnson & Johnson (JNJ:US) and Cisco Systems Inc. (CSCO:US)
“The Coalition cannot support policy provisions that are punitive against globally engaged American headquartered companies and make them increasingly vulnerable to takeover by competitors who are not subject to similar tax regimes either in the U.S. or in their home country,” Claire Buchan Parker, a coalition spokeswoman, said in a statement.
Baucus, in suggesting a hybrid between current law and a territorial system, is proposing two options for his minimum tax. The first would tax all income from foreign sales and services immediately at a rate equal to 80 percent of the new U.S. rate.
Baucus has said he hopes to lower the new tax rate to less than 30 percent. If it were set at 28 percent, for example, the minimum tax would be set at 22.4 percent.
That rate would apply to a company’s earnings in each jurisdiction, so that companies operating in high-tax areas would owe no incremental U.S. tax on their foreign earnings. A company operating in Ireland, by contrast, would effectively have to pay the U.S. the difference between the Irish tax rate of 12.5 percent and 22.4 percent.
The second option would set a lower minimum tax rate, 60 percent of the U.S. rate, while narrowing the definition of income eligible to only income from active business operations. Other income would be taxed at the full U.S. rate immediately.
The earnings that companies have accumulated under the current system would be taxed at 20 percent over eight years, regardless of whether companies have the money in liquid form and regardless of whether they bring it back to the U.S.
That tax would generate more than $200 billion, and Baucus hasn’t decided what to do with the revenue. Some could be used to ease the transition to the new system. Some could be used, as Obama has suggested, for infrastructure.
Devoting that revenue to rate reduction would make the plan increase the deficit in the long run.
“Tax reform isn’t going to be done in 15 minutes,” said Senator Ron Wyden, an Oregon Democrat. “Starting with the international reform is, I think, very sensible, because this goes right to the heart of what you get asked about at town hall meetings, which is how do you make it more attractive to create jobs here.”
In several ways, Baucus’s proposal is tougher on companies than the draft that Camp released in 2011. In particular, Camp’s one-time tax is smaller, at 5.25 percent. And Camp uses that revenue to make the permanent international tax system more generous for companies than Baucus does.
Senator John Thune of South Dakota said he prefers Camp’s approach.
“I want to see a territorial system, and I want to see a system that encourages people to to keep jobs in this country and to keep investment in this country,” said Thune, a Finance Committee member who is the third-ranking Republican in the Senate. “And I think today we don’t do that.”
Other features in Baucus’s draft include imposing immediate U.S. taxes on almost all income earned by companies from sales to U.S. customers.
It eliminates the so-called check-the-box rule that companies can use to have the Internal Revenue Service disregard some foreign subsidiaries for tax purposes.
Baucus is seeking comments from companies and senators by Jan. 17.
Senator Orrin Hatch of Utah, the top Republican on the Finance Committee, said he disagreed with Baucus’s decision to release the drafts while Democrats are proposing tax increases in a budget conference committee.
“My staff worked alongside the chairman’s for months, but the fact is that significant policy differences remain between both sides and a final agreement was never reached,” Hatch said. “I hope that once the budget conference negotiations have concluded that we can renew our discussions.”
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