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US tax reform hopes become mired in foreign cash piles

President Donald Trump discusses the federal budget as Treasury Secretary Steve Mnuchin (R) looks on in the Roosevelt Room of the White House on February 22, 2017 in Washington, DC.
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President Donald Trump discusses the federal budget as Treasury Secretary Steve Mnuchin (R) looks on in the Roosevelt Room of the White House on February 22, 2017 in Washington, DC.

Republican attempts to make progress on tax reform after the party's failure on healthcare are being undermined by a lack of consensus on handling US companies' offshore earnings, an issue set to spark fierce lobbying and discord.

The White House and Republican lawmakers want to scrap the US practice of taxing American companies on their worldwide earnings rather than domestic income alone, which is loathed by multinationals and marks the US as an odd one out globally.

But congressional aides and independent experts agree there is no problem-free way to move the US from worldwide to domestic-only taxation, also known as a territorial system. "I don't think the thinking is well formed at the moment," said a Republican aide.

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The current system has resulted in companies led by Apple and Microsoft stockpiling hundreds of billions of dollars of "locked out" earnings overseas, because America's 35 per cent corporate tax rate only becomes payable when the income is repatriated.

At the same time, it has inspired other businesses such as Medtronic and Mylan to escape the US tax net by using so-called "inversion" deals to move their tax addresses overseas, drawing scorn from both Republicans and Democrats.

Bemoaning the system of worldwide taxation, an approach abandoned by most of the US's biggest trading partners over the past 30 years, the tax chief of one big US manufacturer said: "We would take any other country's system over the US."

While the White House, Senate and House of Representatives are yearning to notch up a big legislative achievement — and see tax as their best hope — the most concrete part of a joint tax announcement made last week was a step backwards on ending worldwide taxation.

Policymakers said they were ditching a plan for a border adjusted tax, which would have created a quasi-territorial system by imposing a tax on imports to the US while exempting exports.

For Republicans, offshore earnings need to be tackled in three steps.

First, they need to work out how to treat companies' existing offshore earnings. Second, they must decide how to exempt future foreign earnings. Third, they need to ensure an end to taxing foreign earnings does not trigger a new surge of tax avoidance to other countries.

"You are going to have cheerleaders and opponents no matter what path you pick," says the Republican aide.

Apple revealed this week that its offshore stash of cash and marketable securities had grown to $246bn. The next largest in 2016 was Microsoft's $116bn, followed by Cisco with $62bn and Google parent Alphabet with $52bn, according to the rating agency Moody's.

Jim Carter, who was head of tax for the Trump administration's transition team, says it was a "foregone conclusion" that the earnings would be subject to some form of mandatory one-off tax. The Trump campaign tax plan proposed a levy of 10 per cent, a generous giveaway in the eyes of Democrats given the standard 35 per cent rate.

One fight with companies will be over whether there is a single blanket rate, or a "bifurcated" rate, with a higher tax on cash and a lower tax on earnings that have been invested in M&A deals or facilities.

The tax chief at the manufacturer, which has reinvested a big chunk of its overseas earnings, said: "We don't have the option of just saying we'll write you a cheque. We don't want to be forced into a situation where we actually have to sell assets."

On future foreign earnings, eliminating US taxation is less simple than it sounds. "It is not clear that a 'perfect' or pure territorial tax system exists," said the Tax Foundation, a think-tank, in a report this week.

France, Germany and Japan exempt only 95 per cent of foreign income from taxation, not the 100 per cent exempted by the UK and Australia. How to measure that percentage is another potential source of disagreement.

Mr Carter said: "I'd imagine in negotiations on the Hill Democrats would want something less than 100 per cent, but there would need to be trade-offs and compromises."

It remains to be seen, however, whether Republicans will try to make a tax deal with Democrats or go it alone.

Worries about a move to domestic-only taxation backfiring are real. The fear is that if policymakers cannot lower the headline US corporate rate enough to satisfy executives, a territorial system would give them more incentive than ever to shift US profits overseas as a means of tax avoidance.

Worries about a move to domestic-only taxation backfiring are real. The fear is that if policymakers cannot lower the headline US corporate rate enough to satisfy executives, a territorial system would give them more incentive than ever to shift US profits overseas as a means of tax avoidance.

Another alternative would focus on the use of intellectual property in tax avoidance — common in the technology and pharmaceuticals sectors — by imposing a tax on foreign income derived from IP. This was proposed in 2014 by Dave Camp, the then Republican chairman of the tax-writing House ways and means committee, but it prompted an outcry from business.

The Republican aide said: "What is not yet fully in bloom is the political opposition we will face to whatever the committees come out with."

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