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November 11, 2016


We saw in Part I how Apple and other corporations engage in “profit shifting” from one taxing jurisdiction to another depending upon where they found the best deal, creating subsidiary corporations to carry out games of selling products and shifting profits between and among themselves.  Per the Prospect article, renowned tax professor Kimberly Clausing of Reed College estimates that 31 percent of corporate tax revenue was lost due to profit shifting in 2012. The IRS collected $242 billion in corporate tax revenue that year, but should have collected another $111 billion if profit shifting to foreign jurisdictions did not exist. The problem is dramatically increasing; in this tax year 2016 it is possible that more than 40 percent of potential corporate tax revenue will be lost. This is not a matter of fairness; it is rather a matter of accounting chicanery. Hundreds of billions of dollars are at stake and are badly needed to reduce the deficit, meet the needs of current budgets, help with Medicare, pre-school education etc.

Professor Clausing points out that “Unlike most trading partners, the U.S. system purports to tax the worldwide income of multinational corporations at the statutory rate of 35 percent, granting a tax credit for taxes paid to other countries. Yet, because U.S. taxation is not triggered unless income is repatriated, multinationals can avoid residual tax by indefinitely holding income abroad. . . As a result, the U.S. ‘worldwide’ system of taxation is substantially more generous to foreign income than many alternative systems of taxation.” The professor’s assessment is correct. Multinationals could theoretically keep the profits they book elsewhere forever and the IRS could never touch such troves if and until repatriated.

So what about this repatriation of profits rule? How can a California or Delaware corporation doing business in Ireland but with the bulk of their sales (and presumably profits) occurring in the U.S. claim that such sales occurred in Ireland and book their profits there and get away with it? Because they can, and that, readers, is a situation crying out for reform, like end it. These corporations should have to pay like you and I do, for the tax year just past with no repatriation rule.

What the professor did not further elaborate is another unfair shenanigan corporate accountants have exploited, one that even further reduces the multinationals’ tax liability to the U.S., and it is this. They can keep billions overseas in hidden accounts of subsidiaries, have the U.S. home corporation borrow from such accounts, and take interest deductions against income on what may be owed here on the home corporation’s taxes, essentially on money they borrowed from themselves! How sweet a deal is that?

That’s not all. When corporations may finally decide to bring their overseas income home (repatriation of income), they can bargain with the IRS on rate of tax to be paid on such funds. Thus for instance, say Apple wants to bring $10 billion home and the rate would be 30 per cent per the tax schedule. Lawyers for Apple can dicker to pay less and threaten not to repatriate any income being held overseas at all unless the IRS plays along; the IRS can take something or get nothing. If you or I went into our local IRS office and told the agent we will not pay the rate per schedule on our income but will pay if the rate is reduced to so and so, he or she would look at us as if we were from Mars, and with considerable justification. My advice: don’t try income shifting to Ireland or Bermuda unless you like doing jail time; that goodie is reserved for corporations, not human taxpayers.

So it’s a mess. Where do we begin to reform a tax code that allows taxpaying multinational corporations to call the shots on where and when income and profit shifting can take place, and even rates on income upon repatriation? Here’s the good news. Fortunately, we can straighten out all these zigs and zags that corporate accountants have taken us with their games played between subsidiaries here and there, and it involves a rather simple answer to the problem that will in time drain our treasury out of trillions of dollars if we don’t do it. Here’s the answer.

The remedy is called “sales factor apportionment,” or SFA, and if adopted would correct the evils of profit shifting. It would also amount to a territorial tax and would solidify tax revenues to our treasury, a crucial factor in reducing our long term deficit. Here is how it works. SFA would apportion U.S. corporate tax on worldwide company income based upon the ratio of U.S. sales to worldwide sales. SFA disregards all internal corporate transfer pricing between subsidiaries, so a “sale” to a true customer outside the company is all that matters. This allocation method based on true sales to buyers outside the company makes profit shifting within useless and without a business rationale.

SFA is also politically correct because its adoption not only ends artificial income shifting between high-tax and low-tax countries, it also achieves the Republicans’ goal of territoriality which is good for the country, and also by its terms and application achieves the Democrats’ goals of eliminating tax avoidance and maintaining tax revenue. If such a reform along with elimination of the quirk in the code that allows multinationals to hide their income overseas until they decide to repatriate it at a rate to be determined were adopted in tandem, we will have ended this ridiculous situation where subsidiaries (with the collusion of taxing authorities in low-tax jurisdictions) hand money to one another and pretend these are arms-length transactions when they have little to nothing to do with genuine third party sales of product.

So what’s not to like with such reforms in this area of artificial profit shifting? I can see nothing and am especially happy to understand that adoption of SFA will bring in hundreds of billions of dollars per annum to our treasury, a deficit-ridden agency desperate for revenues to pay the nation’s bills and fund important federal initiatives. So when the Congress gets back to business after this election, let’s agitate for the SFA and other reforms of the internal revenue code while, of course, keeping an eye on what the politicians are doing to other sections of the code under the banner of “reform.”    GERALD      E


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One Comment
  1. the following is a link of an article from one of the New Yorker January issues of this year by James Surowiecki that presents a similar solution, called a hybrid territorial system and points out some of the challenges in implementing tax system changes.

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