2007 Issue 1 - New York City Bar Association

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H E R M A N G O L D M A N L E C T U R E 1. All foreign income, whether from business operations or passive investments, would be taxed currently, on an accrual basis, by the U.S. No deferral of tax on foreign source income would be permitted. 22 As a result, U.S. income tax considerations would not affect the decision whether to operate in branch or subsidiary form, a situation that does not currently exist, e.g., the branch form is preferred if foreign losses are expected that can offset U.S. source income whereas if profits are expected, the use of a subsidiary provides the opportunity to defer U.S. on those profits. 2. An FTC would be allowed for all foreign income taxes paid by the U.S. taxpayer on its foreign source income. a. The allowable credit would be limited to the U.S. tax on the foreign source income. b. Two baskets—active business income and passive investment income—would be retained. c. Because worldwide averaging of business income presents too much opportunity for eliminating U.S. tax on foreign source income, a per-country limitation (with two baskets in each country) should be employed. 23 d. As discussed in further detail in following parts of this paper, a number of elements of the current U.S. FTC system would continue, e.g., look-through rules and allocation of deduction rules. The implications of these basic elements and additional needed rules are detailed further in subsequent parts of this paper. 22. For extensive discussions of a proposal to end deferral, see Robert J. Peroni, J. Clifton Fleming, Jr., and Stephen E. Shay, Getting Serious About Curtailing Deferral of U.S. Tax on Foreign Source Income, 52 SMU L. Rev. 455 (1999); J. Clifton Fleming, Jr., Robert J. Peroni and Stephen E. Shay, An Alternative View of Deferral: Considering a Proposal to Curtail, Not Expand, Deferral, 20 Tax Notes Int’l 547 (2000). Senator John Kerry has introduced legislation to require current taxation of the income of controlled foreign corporations, coupled with a reduction in the corporate tax rates. S. 3777, The Export Products, Not Jobs, Act, 109 th Cong., 2d Sess. (2006). Note that this element of the model eliminates the concerns expressed in the Panel Report, note 2, at 133, that the current system discourages repatriation of dividends from foreign subsidiaries. 23. See ABA Task Force, note 4, at 672, for a discussion of a similar proposal. T H E R E C O R D 76
P A U L R. M C D A N I E L Territorial System In very brief terms, the following sets forth the basic elements of a (near) ideal territorial system. 1. The residence country could include foreign source income in its tax base but exempt foreign source business income. Exempt income includes both branch income and dividends from foreign subsidiaries paid out of foreign business income. 2. Typically, countries adopting such a system do not extend the exemption to foreign investment income. As per the Panel Report, such income may be taxed currently, with a foreign tax credit allowed. 3. Foreign source losses are not permitted to offset domestic source income. Implications of the foregoing and the rules necessary to implement a territorial system are discussed in subsequent parts of this paper. III. Supporters of a territorial system frequently assert that such a system is more simple than a WWI/FTC system. 24 Typically, little analysis accompanies this assertion. And, indeed, there is no basis for such a statement. In fact, virtually all the elements that add up to complexity in a WWI/ FTC system are, or should be, present in a territorial system. And, when additional elements of the Panel proposal are factored in, the U.S. international tax system would be made more rather than less complex. The following discussion identifies the elements that can create complexity, or in any event are necessary, in a model WWI/FTC system. As each rule is identified, its role in a territorial system is considered, including an assessment whether there is greater or less pressure on the rule in one system versus the other. 25 Source of income rules Source of income rules play a critical role in the current U.S. interna- 24. See, e.g., Panel Report at 174; Christian, note 3, at 40 (territoriality is simplest system “without question”); Larkins, note 3, at 250. 25. The best analysis of why an exemption system is not more simple than a WWI/FTC system is in Hugh J. Ault, U.S. Exemption/Territorial System vs. Credit-Based System, 32 Tax Notes Int’l 725 (2003). 2 0 0 7 V O L. 6 2 , N O. 1 77
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2007 Issue 1 - New York City Bar Association

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