The last thing America needs is job losses. We will get this if the Biden administration does not change its plan for double taxation of some of the largest corporations in the country.
Earlier this year, the Treasury Department finalized regulations that could have a catastrophic impact on U.S. businesses operating in foreign countries. In President Biden’s most influential tax change to date, the Treasury Department has limited the ability of companies to claim foreign tax credits under Section 901 for income taxes paid in foreign countries. Some companies will have to pay local corporate taxes on the foreign taxes they already pay.
Income taxation will twice disrupt business operations and discourage foreign investment and acquisitions. Some companies operating in foreign countries may relocate outside the United States to avoid the tax.
Prior to the change, the foreign tax credit under section 901 was widely available to businesses to eliminate double taxation of foreign income. Section 901 is a dollar-for-dollar loan available to corporations and individuals who pay income taxes in a foreign country. Section 901 ensures that companies are not double taxed on the same income. This significantly reduces their tax burdens and investment costs in the United States and abroad. Foreign tax credits are especially useful for American companies operating in countries with which the United States does not have tax agreements, such as Brazil, Chile and Argentina.
The apparent purpose of the new provisions is to ensure that credit is only available to foreigners incomes taxes, not other taxes. But his definition of “income tax” is too narrow. The new regulations allow companies to claim credit for corporate income taxes or capital gains taxes only if the foreign tax country follows the newly created – and vague – “net profit test”. According to the net profit test, companies can claim a foreign tax credit only if the foreign country follows certain aspects of the US tax system, such as depreciation, interest deductions and other standard rules of the US Corporate Tax Code.
Brazil is likely to fail the net profit test. Its transfer pricing system fails to make explicit reference to the “untied hands” principle, a rule that requires companies to work honestly with their foreign subsidiaries. Another example is Hong Kong, which does not allow the deduction of interest on interest payments to foreigners. Deduction of interest is crucial in the new provisions. This means that approximately 1,300 US companies operating in Hong Kong will be at risk of double taxation.
The new regulations violate the purpose of the loan, which is to allow American companies to avoid double taxation in the absence of a tax agreement. And the consequences will be severe. Companies operating in countries outside the US tax treaty system have to make costly decisions. They may risk IRS audits if they apply for a loan, make an expensive move to exempt from these countries, risk paying double tax on their foreign income, or leave the United States.
Double taxation is always a bad idea. This leads to less investment, fewer jobs, lower wages and offshoring. The Biden administration’s decision to restrict access to foreign tax credit and increase the ability of companies to double their foreign income tax will have direct economic consequences at home and abroad. If these regulations are not repealed, the world economy will suffer and the United States will approach a recession.
Mr. Knicks is studying tax law at Georgetown University Law Center.
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