Academic journal article Texas Law Review

Deferral of U.S. Tax on International Income: End It, Don't Mend It-Why Should We Be Stuck in the Middle with Subpart F

Academic journal article Texas Law Review

Deferral of U.S. Tax on International Income: End It, Don't Mend It-Why Should We Be Stuck in the Middle with Subpart F

Article excerpt

Professor Keith Engel has written an interesting paper on antideferral reform,1 which contains four proposals for revising the Subpart F regime: (1) an Antidiversion/Harmful Tax Competition proposal; (2) a Reciprocity proposal; (3) a Repatriation Exemption proposal; and (4) a Minimum Repatriation proposal. Before presenting these proposals, Professor Engel describes at length the history of antideferral legislation in the United States and concludes that Subpart F represents a reasonable compromise between a complete end to deferral that would reflect the capital-export neutrality theory2 and an exemption or territorial system that would reflect capital-- import neutrality concerns.3 In Professor Engel's view, the arguments in favor of each of these theories of international taxation "are ultimately inconclusive, thereby justifying . . . appropriate grounds for a middleground compromise."4 It should surprise no one that I respectfully but strongly disagree with this statement because I believe that the case for designing international tax rules in an income tax system to reflect capital-- export neutrality is rather compelling, and that the case for designing international tax rules based on capital-import neutrality is rather weak.5 It follows that I also believe that the case for a middle-ground, compromise approach for dealing with the international tax deferral issue is also weak, particularly one designed along the lines of the Subpart F provisions.

That said, Professor Engel does take a step in the right direction with his Antidiversion/Harmful Tax Competition proposal and Minimum Repatriation proposal, which would move Subpart F in the direction of cutting back further on the deferral privilege. Unfortunately, however, this move in the right direction would come at a tremendous cost in terms of adding substantial additional complexity to an already extremely complex set of provisions in Subpart F; these two proposals are not administrable by taxpayers or the government at a reasonable cost.6 As Professor Engel himself points out, the Antidiversion/Harmful Tax Competition proposal would require the IRS and taxpayers to undertake a detailed analysis of the tax laws of each foreign country in which the foreign corporation operates.' The Minimum Repatriation proposal would depend on creating a new transfer pricing-type regime for determining the amount of the controlled foreign corporation's (CFC's) deemed minimum repatriation. The main beneficiary of this latter proposal would not be the coffers of the U.S. Treasury (since the costs of administration might well exceed any additional revenue raised), but rather the transfer pricing practice departments of the large law firms and Big Five accounting firms (who would be provided with a new source of revenue from their clients). And, at the end of the day, deferral would continue for many types of foreign source business income of CFCs and for all types of foreign source income of belowten-percent U.S. shareholders of CFCs and for any U.S. shareholders in a non-CFC (provided that the corporation did not meet the definition of a foreign personal holding company or passive foreign investment company). The structural defects of Subpart F would also remain.8

By contrast, Professor Engel's Reciprocity proposal and Repatriation Exemption proposal would represent a major step in the wrong direction (as aptly called by Professor Engel, a "significant retreat" from U.S. leadership in the antideferral area)9 and have the potential to gut even the limited antideferral protections of the current Subpart F rules. Moreover, as Professor Engel himself points out about the Reciprocity proposal, the mechanics of obtaining and enacting reciprocity would be very difficult, if not impossible, and it is unclear how or whether these reciprocity agreements would be enforced by foreign countries.10 His Repatriation Exemption proposal would remove one distortion resulting from the current Subpart F regime-the tax on repatriation that encourages CFCs to retain their deferred foreign earnings offshore (rather than repatriate them). …

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