Academic journal article The George Washington International Law Review

The Case for Tax Sparing along with Expanding and Limiting the Subpart F Regime

Academic journal article The George Washington International Law Review

The Case for Tax Sparing along with Expanding and Limiting the Subpart F Regime

Article excerpt


I am particularly happy to participate in this important conference at The George Washington University School of Law. I feel as though I am caught in the middle of bipolar, policy approaches to international tax, championed by two outstanding George Washington Law School professors of international tax, Professor Robert Peroni and Professor Karen Brown. Professor Peroni has argued persuasively that the United States should end deferral, a policy under which U.S.-controlled foreign corporations (CFCs) are generally not subject to U.S. taxation until the earnings are distributed, essentially by adopting the partnership model for taxing the foreign source income of CFCs.1

On the other hand, Professor Brown has made compelling arguments for the adoption of an exemption system for investment in developing countries (DCs), particularly those in Africa.2 Under an exemption system, CFCs would not be subject to taxation in the United States, either at the time that foreign income is earned or at the time that such income is repatriated. Professor Brown's proposed exemption system would have an effect similar to that of a tax sparing policy. Under a tax sparing policy, pursuant to a treaty, for foreign tax credit purposes, the United States would treat CFCs as having paid the full foreign tax on foreign income, even though the income is subject to a lower tax pursuant to a tax holiday.

The George Washington University School of Law is, indeed, privileged to have these two outstanding international tax scholars on its faculty. This Symposium is also privileged to host Professor Paul McDaniel, the author of an important and excellent paper entitled The U.S. Tax Treatment of Foreign Source Income Earned in Developing Countries? I am, indeed, honored to have the opportunity to offer the following comments on Professor McDaniel's Article and to set forth my views on both the need for reform of the Subpart F regime and on the advisability of the adoption by the U.S. Treasury of a tax sparing policy.

This Article proceeds as follows: Part II provides a brief comment on the current deferral system; Part III addresses the economic case for a tax sparing policy; Part IV provides a brief examination of Professor McDaniel's policy options; and Part V sets out the author's policy prescription.


I would like to start with a comment on the economic effect of the current system of deferral. Professor McDaniel claims that the current U.S. system prevents DCs from offering tax incentives, like tax holidays, to attract foreign direct investment (FDI).4 I have a small quibble with this statement, a quibble that goes to the heart of the deferral concept. I believe that his characterization is a bit too broad because, under the current deferral system for active income, tax incentives will provide an advantage as long as the income is not repatriated. As Professor McDaniel points out, long-term deferral approximates the benefits of exemption because of the lack of an interest charge on the deferral benefit.

I believe that it is fair to say that the current deferral system is not, in and of itself, enough to encourage investment in DCs, even with substantial tax incentives. Subject to the Subpart F inclusion rules, the current deferral regime is available for CFCs wherever the foreign investment exists; therefore, the current deferral regime does not offer a greater incentive for investment in DCs than does investment in developed countries that offer tax incentives. Finally, it is important to remember that the deferral regime applies not just to tax holidays; it also applies to any situation in which the foreign corporate tax rate is lower than the U.S. corporate tax rate, such as with Ireland's 10% corporate tax rate.


In addressing the question of whether tax sparing benefits or other incentives should be made available to DCs, it seems that the first issue is whether it is important for a DC to be concerned about the level of its inbound FDI. …

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