How IRS Can Get $718 Billion in Tax Revenue | International Tax Lawyer
On October 4, 2016, the US Public Interest Research Group, Citizens for Tax Justice, and the Institute on Taxation and Economic Policy issued a report called “Offshore Shell Games 2016: the Use of Offshore Tax Havens by Fortune 500 Companies”. The report calculates that eliminating all tax deferral on Fortune 500 US companies’ foreign earnings would allow the IRS to collect almost $718 Billion in additional US tax revenue.
Where does the Amount of $718 Billion Come From?
This amazing report targets the estimated $2.5 trillion in offshore earnings which are assumed to be mostly help by the US companies’ foreign subsidiaries in tax havens. The report calculates that the top 30 (meaning top 30 companies by the amount of offshore holdings) of the Fortune 500 companies account for two-thirds of the total, with Apple ($215 billion), Pfizer ($194 billion), and Microsoft ($124 billion) topping the list. It should be noted that some of the other estimates calculate the amount of total offshore earnings of US companies to be in excess of $5 trillion, i.e. double the amount used by the report.
The number of foreign subsidiaries owned by US multinationals is also impressive – the estimate runs as high as 55,000 subsidiaries owned just by Fortune 500 companies. The report states that, although many offshore subsidiaries do not show up in companies’ SEC filings, at least 367 of the Fortune 500 companies maintain subsidiaries in tax havens and the top 20 account for 2,509 of those entities. Subsidiaries of US multinationals reported profits of more than 100 percent of national GDP for five tax havens, including 1,313 percent for the Cayman Islands and 1,884 percent for Bermuda.
The most popular country for organizing the subsidiaries remains the Netherlands. However, Ireland, Luxembourg, Switzerland, Bermuda and Cayman Islands closely follow Netherlands in terms of their popularity among US multinationals.
How is $718 Billion Calculated?
The report sets forth its methodology for the calculation of $718 Billion. In essence, the report focuses on the data from 58 Fortune 500 companies to estimate the additional tax all of the companies would owe upon repatriation of funds to the United States. The final tax rate amount to about 28.8% of the repatriated income; the rest (i.e. the difference between the 35% US statutory rate and the 28.8%) is assumed to be the foreign tax rate that the companies will be able to use as a foreign tax credit to offset their US tax liability. Once 28.8% rates is applied to $2.5 trillion, the total amount of additional tax due to the IRS by the Fortune 500 companies is estimated to be close to $718 Billion.
This methodology, however, is not without its flaws. First, as I already referenced above that the amount of funds in foreign subsidiaries may be substantially higher than the estimated $2.5 trillion. Second, the report’s assumption of 6.2% of foreign tax rate may be too generous, especially for foreign companies owned by US persons for generations; in reality, a lot of companies are able to escape all taxation on a substantial amount of their income. Hence, the $718 Billion amount may actually be an understatement.
How Does the Report Propose to Collect the $718 Billion?
The report offers three approaches to the problem of collecting the $718 billion. The first approach is deceptively simple – end all tax deferral. The problem that I see with this approach is that it essentially expands US tax jurisdiction to foreign entities (which are non-resident alien business structures) to the extent that these entities automatically become US persons as soon as any US person becomes an owner of all or any part of them. In addition to the obvious legal problems with such an approach, there is also a potential to create a real chilling effect to US activities overseas. At the very least, the proposed course of action should be modified to include only controlled foreign entities and large US corporations.
The second approach is less radical; the report suggests tighter anti-inversion rules, elimination of the check-the-box election and the elimination of aggressive tax planning through intellectual property transfers. While many of these rules may be effective to combat future aggressive tax planning, they are unlikely to influence the current IRS inability to collect the $718 billion in additional tax revenue.
Finally, the report also lends support to the Obama administration’s (which is actually not a resurrection of older proposals) tax proposal to treat as subpart F income excess profits earned by a controlled foreign corporation from US-developed intangibles. The administration’s proposal is to expand the definition of Subpart F income to all excess income taxed at 10% or less (later expanded to 15%) would be included in subpart F. While a sensible proposal, it also seems to fall short of the expected $718 billion in additional tax revenue.
Also, it seems strange that all of the proposals seems to put foreign companies owned by small US firms and those owned by large US firms on the same footing. This kind of seemingly non-discriminatory approach has had a disproportionally heavy impact on small US firms’ ability to conduct business overseas due to lower resources that small firms can devote to the same type of tax compliance as that required of the Fortune 500 companies.