November 22, 2011
Rethinking U.S. Taxation of Overseas Operations
Reform Needed for "Subpart-F" Rules
Washington, DC, November 22, 2011-- The current U.S. system for taxing international businesses is out of step with today's global economy and needs to be reformed. Tax provisions applying to companies operating abroad—largely unchanged for nearly fifty years—have created distortions and inefficiencies that are a drag on growth both overseas and at home, according to a new study by the Tax Foundation.
"As globalization and competitiveness become more pressing concerns, serious reconsideration of the U.S. international tax system may be in order," said Tax Foundation Vice President for Legal & State Projects Joseph Henchman.
U.S. corporations operating overseas face a unique combination of burdens not borne by their international competitors: taxes owed to the United States, taxes owed to the country where the operating activity takes place, and a complex tax system that attempts to reduce the resultant economic harm but involves an array of credits and definitions, primarily the Internal Revenue Code's "Subpart F."
The provisions in Subpart F, originally adopted in 1962, call for so-called "passive" income like interest and dividends to be taxed immediately but permits "active" income to be deferred from U.S. taxes until it is brought back to the U.S.
To add to the complication, rents and royalties must not only be "active" to be eligible for deferral, but must also have been "received from a person other than a related person." Royalty income, unless received from third parties and even if it meets the stringent "active" test, is subject to Subpart F taxation. Thus, the tax treatment of royalties received from foreign operations under the U.S. company's direct ownership and operation is less favorable than those received from operations by third parties.
"Provisions of the corporate tax code like Subpart F should be scrubbed of policies that no longer work in today's global economy," said Henchman. "Exceptions originally meant to discourage firms from operating as overseas tax havens have instead introduced uncertainty and distortions for legitimate business activity. The 'active income' test can effectively police against tax haven behavior until such time that the United States decides to forego taxing profits from activities occurring beyond its borders."
Tax Foundation Special Report No. 197, "Rethinking U.S. Taxation of Overseas Operations," by Vice President for Legal & State Projects Joseph Henchman is available online.
The Tax Foundation is a nonpartisan research organization that has monitored fiscal policy at the federal, state and local levels since 1937. To schedule an interview, please contact Richard Morrison, the Tax Foundation's Manager of Communications, at 202-464-5102 or morrison@taxfoundation.org.