For the last three or four years, there has been plenty of discussion of comprehensive tax reform. That includes as recently as this week,...
For the last three or four years, there has been plenty of discussion of comprehensive tax reform. That includes as recently as this week, with the White House and Republican congressional leaders both talking about the issue.
President Barack Obama has mentioned tax reform in his State of the Union Addresses, and his administration has released a framework for business tax reform. Earlier this year, House Ways and Means Committee Chairman Dave Camp, R-Michigan, released a 979-page comprehensive plan.
The push for change seems to be coming from corporate America. The United States has the highest statutory corporate tax rate in the developed world. Likewise, its system of taxing the foreign income of U.S. corporations is viewed by many as outdated and out of step with the rest of the developed world.
As a result, much of corporate America has been pushing for a significant reduction in the corporate tax rate. It also has been pushing for a shift to a territorial type of system in which the foreign income of U.S. corporations would either not be taxed or very lightly taxed by the United States.
In looking at corporate America and tax reform, it helps to break corporate America into four groups.
The first group is publicly-traded U.S. corporations. This group would include U.S. companies whose stock is traded on the New York Stock Exchange or NASDAQ. The second group is non-publicly-traded U.S. corporations. This group would include large non-publicly-traded U.S. corporations, such as Cargill and Koch Industries, as well as small closely-held U.S. corporations. The third group is small foreign corporations, and the final group is large foreign corporations, such as Royal Dutch Shell, Samsung and Toyota.
All four corporate groups are interested in corporate tax reform. But, in many cases, they have differing interests making corporate tax reform that much more difficult.
The first group, publicly-traded U.S. corporations, generally views earnings per share (EPS) as the most important financial indicator. Many times, the expression, “P & L is King” is used to refer to the goal of this first group. P& L refers to profit and loss, which is used to calculate a company’s EPS. A company’s effective tax rate also impacts the calculation of its EPS. A lower effective tax rate will result in a higher EPS and vice versa.
As a result, publicly-traded U.S. corporations almost always want reform of the corporate tax system that will result in a lower effective tax rate. This is most easily achieved by lowering the statutory corporate tax rate. Tax provisions such as the research and development tax credit and the manufacturing deduction also lower a company’s effective tax rate.
These provisions are sometimes referred to as permanent differences. They result in a permanent difference between a company’s taxable income and its financial accounting income. That translates into a lower effective tax rate for publicly-traded U.S. corporations.
The second group composed of non-publicly traded U.S. corporations almost always views cash flow as the most important financial indicator. Many times, the expression, “Cash is King” is used to refer to the goal of this second group.
This group of companies has little to no interest in EPS or effective tax rates. Any provision in the tax law that enhances a company’s cash flow is generally welcomed by this second group.
Consequently, a corporate tax rate cut, a permanent difference (such as the research and development tax credit) and a temporary difference (such as accelerated depreciation) are all greatly valued by non-publicly-traded U.S. corporations. All of these tax provisions enhance a company’s cash flow.
The third group composed of small foreign corporations almost always wants to avoid having to file a U.S. tax return. Many times that seems to be one of the most important objectives of a small foreign corporation with respect to the U.S. tax system.
This objective is easily accomplished by a foreign corporation. A foreign corporation will almost always form a U.S. subsidiary to conduct business in the United States.
As a result, the foreign corporation will not file a tax return with the United States. Rather, the U.S. subsidiary will file such a return. In addition, the U.S. subsidiary may include information identifying its foreign parent corporation, but the foreign parent will not file a tax return with the United States.
The fourth group, large foreign corporations, will almost always use a U.S. subsidiary to conduct business in the United States. An important part of tax reform for large foreign corporations is to preserve the deduction for interest payments from the U.S. subsidiary to the foreign parent.
Many times a foreign corporation will fund its U.S. subsidiary with a loan. The interest payments on the loan from the U.S. subsidiary to the foreign parent will be deducted by the U.S. subsidiary. In many cases, it will be free of the 30% U.S. withholding tax that typically applies to such payments because the foreign parent is a resident of a country that has a comprehensive income tax treaty with the United States.
The result is that the U.S. tax base is stripped by the interest payments. The United States is greatly concerned by the tax consequences of interest payments from a U.S. subsidiary to its foreign parent corporation. In contrast, the foreign corporation and its U.S. subsidiary want to preserve the interest deduction that is currently available to the U.S. subsidiary without any further tightening of the interest deduction rules.
Corporate America has been pushing hard for tax reform for several years. And both the Obama administration and many members of Congress agree that corporate and business tax reform is needed. However, the differing interests of corporate America make it difficult to achieve tax reform.
Christopher Hanna is a Bush Institute fellow and the Alan D. Feld Endowed Professor of Law and Altshuler Distinguished Teaching Professor at SMU’s Dedman School of Law.
