President Trump has submitted the outline of his income tax plan, reportedly in bullet points on a single sheet of paper, to Congress. Although some have derided the lack of detail provided, the submission at least makes it very clear what is going on–and will likely help underscore the allegiance to special interests that opponents to what I considr a no-brainer tax fix may be serving.
On the corporate side, the reduction of the top rate to 15% will address three very important tax issues, all spawned by the fact that US corporate income tax (for those unable to cut a sweetheart deal) is higher than just about any other place on earth. The current problem areas I see them are three:
—inversions, where a company paying full freight in the US reincorporates on paper, usually through a merger with a foreign firm, in a low-tax country like Ireland (where the tax rate is in the low teens). Pharmaceutical companies, which have few ways of reducing their taxable income, have been the most prominent group doing this. At the stroke of a pen, their after-tax income goes up by 30%.
—transfer pricing, a long-time standby of multinationals. That’s where goods made by a third party in, say, China and destined for ultimate sale in the US are bought for, say, $10 each by the on-paper subsidiary of a US firm. The goods are marked up by Hong Kong to $20 and sold for that to the US parent. Since foreign firms doing business in Hong Kong pay no corporate tax, that $10 markup, which probably remains in a bank in Hong Kong, allows the parent to avoid paying $3.50 or so in tax to the IRS.
—intellectual property transfer, a variation on transfer pricing. A US firm transfers its patents, ownership of its brand name… to a subsidiary in a low-tax jurisdiction. Ireland is a favorite destination. It pays royalties to the subsidiary for the use of the intellectual property, generating an expense that reduces US income otherwise taxed at 35%, while paying less than half that to the country where the intellectual property is now domiciled.
One major effect of these strategies is that all of the cash saved is trapped abroad. This is because IRS regulations require corporations repatriating such foreign income to pay tax on the transfers equal to the difference between the US and foreign tax rates. That’s the reason multinationals are constantly lobbying Congress to declare a tax holiday for repatriations like these.
It will be interesting to see what happens.
Note: the one virtue of what I consider the otherwise loony border tax is that it would remove the appeal of the extensive network of transfer pricing/IP transfer schemes already in place. More about this tomorrow.