Borderline Case International Tax Policy, Corporate Research and Development, and Investment (1997) / Chapter Skim
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I International Tax Policy and Technology Investments
I International Tax Policy and Technology Investments
1 THE TAXATION OF FOREIGN DIRECT INVESTMENT: OPERATIONAL AND POLICY PERSPECTIVES
Pages 9-38
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From page 11... ...
Countries differ widely, however, in the tax rates they apply, the definitions of the tax base, and the special incentives they offer for investment. Nevertheless, the first and most important tax burden on foreign direct investment (FDI)
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From page 12... ...
In other cases the source rules are governed by bilateral tax treaties. What is clear, however, is that the de facto rules that govern the sourcing of income are at least as important for understanding the effective taxation of foreign direct investment as tax rates, depreciation rules, and tax credits.
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From page 13... ...
Distinguishing excess credit and excess limitation positions is critically important for the financial behavior of a corporation. Changed Incentives for Foreign Direct Investment: The Tax Reform Act of 1986 Outward Investment The three most significant aspects of TRA86 for outward investment, in order of importance, were as follows: (1)
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From page 14... ...
There is thus no calculation of foreign-source taxable income from which depreciation allowances are deducted and against which investment tax credits can be offset. The tax base to which the corporation statutory tax rate is applied is simply dividends received minus allocable deductions, grossed up by the average rate of foreign taxation.
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By 1992, about the same fraction of foreign-source income in the general basket was in excess credit as had been the case in 1984. They conclude that the primary reason for this was a decline in average foreign tax rates between 1983 and 1992; it was not attributable in large part to changes in the income or dividend repatriation patterns, or location decisions, of U.S.-based multinational corporations.
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, the objective was to prevent fungible income from being earned in low tax rate foreign jurisdictions and thus to increase the amount of available foreign tax credits that could offset taxes paid on other income to foreign governments. In other cases (e.g., high withholding tax interest)
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In general, the creation of separate foreign tax credit baskets increases the effective taxation of foreign-source income, because it makes it more difficult in certain cases to credit foreign income taxes against U.S. tax liability.
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multinational corporations to investigate how taxation affects their location decisions. Although they find that host country effective tax rates have a significant effect on both the probability that a location will be chosen and the amount of capital invested there, they find no consistent effect of the parent's excess credit position, which should affect whether it is the tax rate of the host country or the home country that is effective at the margin.
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find it profitable to utilize these ownership-specific advantages in B rather than A Which choice is taken depends on an array of factors including transportation costs, tariffs, the expropriability of intangibles via licensing arrangements, export subsidies, and the tax rules that apply to foreign direct investment.
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The other is to lower the statutory rate to 25 percent, or even to 10 percent, as Ireland has done. Presume that both policies provide equal Hall-Jorgenson-King-Fullerton effective tax rates.
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On the contrary, the debate over trade policy continues, with the economist's view sometimes prevailing and sometimes not prevailing. The risk is that the prejudices and misconceptions regarding trade policy will simply be attached to the issues of international tax policy, thereby blurring issues rather than sharpening them.
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The distortion could be due to domestic tax policy, the lack of perfect capital markets for "infant" industries, or some other practice. In general, it is better to eliminate the distortion than to counteract it with trade policy because trade intervention introduces new distortions even if it reduces others.
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In addition, a unilateral free trade stance is less viable politically in the face of commercial policy interventions by foreign governments unless it is accompanied by "concessions" made by other countries. In summary, the trade policy prescriptions are (1)
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In a completely closed economy, production efficiency is compatible with either consumption taxes or a pure income tax, where "pure" implies a HaigSimons comprehensive definition of income, including integration of the corporate and personal income tax systems. Under a pure income tax the cost of capital to firms will exceed the rate of return received by savers, but it will be equal for all firms, preserving production efficiency.
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What pattern of tax rates and systems, including the corporate, personal, and withholding tax rates and the system of double taxation relief, will ensure that free trade in capital is achieved? The answer to this question depends on, among other things, what assumptions are made about the extent of capital and labor mobility.
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Countries' corporate tax rates need not be identical for production efficiency to occur. For any given set of personal tax systems, a high corporate rate would be offset by higher imputation credits granted at the personal level to shareholders in the affected corporations.
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This would involve a flatrate business tax, no additional personal income tax on corporate income, and no withholding taxes. To summarize what international tax systems are consistent with free trade in capital, defined as equal hurdle rates for all investments, either a pure residencebased or a pure source-based system with equal tax rates in all countries is consistent with production efficiency.
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From page 28... ...
Instead all capital-exporting countries offer some form of offset to taxes imposed by the source country, either in the form of a limited tax credit for foreign taxes paid or by exempting foreign-source income from the taxation that is applied to domestic-source income. However, as discussed above, some countries with imputation systems of integration can effectively impose an additional level of taxes on foreign direct investment.
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From page 29... ...
Alternatively, should the United States seek to extend the range of policies that if adopted multilaterally, can, by enhancing free trade in capital, potentially lead to increased national income at home and abroad? This is a critical question underlying all policy analysis of international tax policy, but it is usually left implicit.
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From page 30... ...
Whether it does or does not depends on the structure of the income tax in place. If, for example, all countries scrupulously practiced nondiscrimination of business enterprises, levied no withholding taxes, and operated territorial systems of taxation, any two corporations with the same real operations and results spread over the world would pay the same total tax, regardless of the residency of the parent corporations and even in the face of varying tax rates across countries.
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There may, though, be a case for favoring foreign operations if some sectors are perfectly competitive and some are oligopolistic and if trade policy, but not tax policy, can be sector
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To stanch the outward flow of taxable income, countries that have relatively high tax rates must establish an enforcement structure to monitor transfer pricing, earnings stripping, and other methods of income shifting. Tax havens can be classified into two types.
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From page 33... ...
that the costs due to tax havens and income shifting are appropriately dealt with via a multilateral agreement restricting statutory corporate tax rates to a small band and imposing sanctions on countries that choose not to comply. Countries would be permitted to be magnets for real investment, but they would have to do so by offering investment tax credits rather than low statutory tax rates.
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From page 34... ...
It encourages low rates because high rates are less likely to be offset by credits from the home country government once the United States gets out of the business of offering foreign tax credits. Only Japan and the United Kingdom will remain, and these countries have tax sparing treaties with many developing countries essentially exempting foreign-source income earned in the treaty partners' countries from residual taxation by the home country.
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From page 35... ...
Nevertheless, as national economies become more integrated and as barriers to trade in goods and services fall, the importance of international taxation for the efficient functioning of capital markets will become a central concern. Free trade in capital is achieved only if the hurdle rate for investment is equal regardless of the location of the real activity, the nationality of the corporation doing the investing, and the nationality of the ultimate owner of the equity income.
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From page 36... ...
tax system to defend its revenues with policy and enforcement measures that are more stnngent than those applied to domestic compliance. The United States should also pursue multilateral means to harmonize corporate tax rates so as to reduce the incentives for income shifting and the reward to tax havens that practice "predatory tax protectionism." There is no reason, from either a global or a national perspective, that U.S.-parented multinational enterprises should pay more tax than a foreign-parented group with similar operations, but neither is there a compelling argument for tax breaks on the grounds of "ownership protectionism." Finally, although both a territorial and a worldwide system of taxation could be consistent with global free trade, there are important differences between the two systems.
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From page 37... ...
1985. "Tax policy and foreign direct investment." Journal of Public Economics 107121.
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From page 38... ...
1991. "International tax simplification." American Journal of Tax Policy 8(2)
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