Proposed Tax bill will have to deal with double taxation avoidance and WTO rules before it becomes law

A theory that is doing the rounds is that the bill perhaps aims to set off the promise of additional revenue against hopes that the new tax regime may entice MNCs to locate more production and jobs to the U.S., outweighing international concerns.

The Republican tax bill that was unveiled last week in the U.S. congress has multinational companies worried since it will disrupt their global supply chains by slapping a 20% tax on cross border transactions.

Many European multinationals which have a small tax profile in the U.S. due to their tax treaties and tax strategy could be hard hit if the proposed bill becomes law, said tax experts.

According to experts on taxation, the Republican bill is likely to run afoul of international tax treaties, global standards that forbid the double taxation of profits as well as World Trade Organization (WTO) rules.

The proposed 429 page bill, backed by Republican U.S. President Donald Trump, has caught corporate tax strategists by surprise and sent them scrambling to understand its dynamics and goals, as well as whether Congress is likely ever to vote on it.

These proposals are part of a broad tax reform brought by Republicans in the House of Representatives on Thursday, which promises to lower the overall tax burden and simplify the U.S. tax code.

The proposed bill has drawn severe criticism for further burdening the federal budget deficit and being in favor of big businesses and rich people.

Despite the criticism, tax experts say, the corporate tax includes some potentially worthy proposals worthy of further discussions. They opine that the proposed slapping of 20% excise tax against transfer-pricing mechanisms MNCs use to leverage that tax strategy is an issue that needs further debate.

Multinational companies set their own prices of goods, services and intellectual property rights and keep moving them between their national businesses.

Under global standards, the prices of these goods and services should resemble those available in the open market. However if a foreign parent charges its U.S. affiliates inflated price, it can reduce its U.S. tax bill and effectively shift profits to a lower-tax country, thus reducing its overall tax profile in the U.S.

“Clearly there’s a transfer-pricing issue and something should be done,” said Steven Rosenthal, senior fellow at the Tax Policy Center, a nonpartisan Washington think tank. “I would view this 20-percent excise tax as a blunt instrument to address the problem. And the problem with blunt instruments is sometimes they hit what you want to hit, and sometimes they hit what you don’t want to hit,” said Rosenthal, former legislation counsel at Congress’s Joint Tax Committee.

Under the proposed Republican bill, U.S. business units that import products, non-interest fees to foreign parents or affiliates in the course of doing business, pay royalties or other tax-deductible, would either pay a 20% tax on these or agree to treat the amounts as income connected to their U.S. business and subject to U.S. taxes.

The new proposed tax rule, would only apply to businesses with payments from U.S. units to foreign affiliates exceeding $100 million, will take effect only after 2018, once it becomes law.

According to Michael Mundaca, co-director of the national tax department at the accounting firm Ernst & Young, European companies which sell foreign-made products in the U.S. through local distribution units could be among those most affected.

If these tax proposals becomes law, these companies could end up paying tax twice on their goods and products.

“That would be a structure that would at least initially be hit by the full force” of the excise tax, said Mundaca, a former U.S. Treasury Department assistant secretary for tax policy.

He went on to add, “I am sure they are making calls right now to their counterparts in the U.S. Treasury looking for some explanation … and making the point that this might be contrary to treaty obligations.”

Gavin Ekins, an economist at the Tax Foundation, a conservative think tank, has predicted that most MNCs are likely to opt to avoid the excise tax by choosing to pay the U.S. corporate tax on all the profits related to products sold in the United States. Those include profits on activities conducted overseas, like manufacturing or research, which are also subject to foreign income taxes.

The proposed tax bill perhaps aims to set off the promise of additional revenue against hopes that the proposed new tax may entice MNCs to locate more production and jobs to the U.S., outweighing international concerns.

However it is to be seen whether MNCs will be amenable to double taxation with the tax debate heating up.

It is likely that they will lobby hard against it, with domestic corporations linked to foreign affiliates possibly concerned as well.

There is also a lot of uncertainty as to how the new rules will work in practice.

From the bill’s language, it is also unclear how companies will calculate their income which are “effectively connected” to their U.S. business, said Ekins from Tax Foundation.

“You don’t know what profit is included when you choose ‘effectively connected income’ and don’t know the formula,” said Ekins.

“Is it just for that product line? All the income that comes in from every other company or from every other source?”

On Monday, the House tax committee is scheduled to begin considering amendments to the Republican tax bill.


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