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A Tax Plan to Stimulate the Economy and Reduce Federal Debt
by Andrew C. Powers. Mahopac, NY
In a recent 2013 case, Fifth Circuit Court of Appeals confirmed the U.S. Tax Court decision stating that what is commonly referred to as "Subpart F" income (which includes specific types of income earned by foreign corporations including purchases and sales or services between a foreign corporation and a related party) is to be taxed currently not as a deemed dividend distribution (as has always been the case since the enactment of Subpart F Internal Revenue Code provisions)-but instead as ordinary income thus denying this income the benefit of reduced tax rates. Although if an income tax is payable to a foreign tax jurisdiction on this income a credit is allowable against the U.S. tax liability, in many countries where a sale by a resident country is transacted outside the country where the corporation is located, the local jurisdiction will not charge income tax. So instead of paying tax as a deemed dividend of earnings and profits from a foreign subsidiary or otherwise related corporation at a 20% tax rate (formerly 15%), the income can be subject to the much higher marginal tax rates imposed on corporate income. However income that does not fall into the Subpart F category may be accumulated outside the U.S. by the U.S. owned foreign corporation and when ultimately distributed it will continue to be taxed as a dividend of E&P at the lower dividend rates.
I am of the opinion that, although similar plans have only been modestly successful in the past, that Congress should encourage the repatriation of accumulated earnings and profits and modify the Tax Code such that Subpart F earnings will continue to be taxed as a dividend. Taxing Subpart F income at ordinary income rates will onlly lead to further tax planning to avoid the Subpart F tax trap and although this Case law may bring in additional income for previous transactions where corporations were prepared to and planning to pay tax as a dividend, the tax revenue will be lost once businesses begin to structure transactions in a manner intended to avoid Subpart F. Under the existing U.S. tax law, in many respects it is economically punitive to repatriate accumulated earnings and profits (E&P) held by a controlled foreign corporation (CFC), particularly if the statutory and effective tax rates of the country that the foreign entity is incorporated in is less than the U.S. rate. At a time when the U.S. is suffering high unemployment, deficit spending and substantial debt, it is estimated that CFCs hold approximately $1 Trillion in untaxed cash that can be repatriated to stimulate the U.S. economy. But a tax incentive is needed for this to make prudent business sense.
While our elected representatives and the Executive Office continue their partisan debates and scratch their heads waiting for a sign from their political party leaders as to what they should do, I have a plan that, although we are too far gone for any one plan to work, if properly initiated can help reduce our national debt and stimulate our economy by creating jobs in the U.S. The plan is simple, and in order to work it must remain simple (the KISS formula):
1. Enact tax legislation effective immediately that any foreign E&P held by a CFC can be repatriated at a reduced rate of 10% after Section 78 gross up and being offset by any qualifying foreign tax credit (Section 78 of the Internal Revenue Code <IRC> requires, in simplistic terms, that foreign tax paid on the E&P be added back before it is taxed by the U.S. which can then be reduced by any qualifying foreign tax credit. Thus if $1 Trillion of untaxed E&P were repatriated to the U.S. this would generate $100 Billion in U.S. tax revenue.
2. The income tax paid that is attributable to repatriated E&P go to a special fund used to pay national debt within 6 months of being collected. It cannot go to the U.S. general fund or be used for any other purpose other than national debt repayment. Furthermore it would be required that the debt being paid be prioritized as first going to debt held by foreign lenders as a matter of national security.
3. An Investment Tax Credit (ITC) be re-enacted for a 36 month period, providing for a 10% ITC on qualifying investments. The definition of a qualified investment would include:
a. The ITC would only be available to corporations that took advantage of the CFC repatriation incentive.
b. The investment had to be made in an active trade or business located within the U.S. that created new jobs. The cost of newly hired employees would be considered as a qualifying investment as would be the first year specialized training of existing personnel working in a new line of business.
c. Qualifying assets would include only those substantially manufactured in the United States.
d. An additional credit would be available for the purchase and utilization of equipment that can be shown to increase efficiencies in product development thereby increasing gross revenues.
e. Documentation substantiating the investment would be required to be submitted with the annual corporation income tax return which would be filed in one IRS office designated to review this documentation. This required documentation must include a valid Form I-9, certified by an officer of the corporation, evidencing that the qualifying investment included only the cost of employing persons legally eligible to work in the United States. Corporations claiming the additional credit for enhanced efficiency equipment would need to substantiate an increase in production and sales revenues (and as a result net taxable income) over a three year period.
f. No special restrictions or burden would be placed on the corporation as to what type of business or technology qualified for investment or the ITC. Should Congress wish to provide an additional tax incentive for investment in Green Technology it may do so by increasing the amount of the credit; however use of the credit cannot be restricted to any one industry. The choice must be left to the business managers.
The original IRC 48 Investment Tax Credit. IRC Section 48 was enacted and codified in 1962 and provided a 7% ITC intended to further stimulate an already robust economy and to reduce unemployment. The credit was later increased to 10% in 1978 but repealed as part of the revamped Internal Revenue Code of 1986. The theory behind this credit is that by providing an incentive to restore product development in the U.S., it will generate employment opportunities both for the company enjoying the credit as well as the company producing the equipment purchased by that corporation. The more Americans who are employed, the greater the income tax revenues collected by the U.S. as well as increasing net disposable income which would further stimulate the economy including the recessed housing market as well as having a positive affect on the U.S. Gross Domestic Product index and trade balance.