Obama Seeks End of Corporate Tax Break to Raise $190 Billion

By Ryan J. Donmoyer

May 4 (Bloomberg) -- President Barack Obama proposed raising about $190 billion over the next decade by outlawing three offshore tax-avoidance techniques used by U.S. companies such as Caterpillar Inc. and Procter & Gamble Co.

Obama’s plan also would make it riskier for Americans to stash money in tax-havens.

The tax code is “full of corporate loopholes that makes it perfectly legal for companies to avoid paying their fair share,” Obama said at the White House today, as he outlined the plan along with Treasury Secretary Timothy Geithner.

Obama’s announcement drew immediate criticism from two major business groups, the U.S. Chamber of Commerce and the Business Roundtable. John Castellani, president of the Roundtable called it in a statement “the wrong idea at the wrong time for the wrong reasons.” The Roundtable is made up of chief executives of the biggest U.S. companies.

The corporate and individual tax proposals, which will be part of a detailed budget the administration releases later this week, would generate about $210 billion in tax revenue over the next decade. For the biggest chunk, the administration is targeting a strategy that allows U.S.-based multinational companies to effectively hide from the Internal Revenue Service the role their foreign subsidiaries play in shifting profits into low-tax jurisdictions such as the Cayman Islands.

That part of the plan, affecting tax rules known as “check the box,” would net $86.5 billion in revenue between 2011-2019 by overhauling regulations created in Democrat Bill Clinton’s administration and later written into law by a Republican- controlled Congress after Clinton tried to withdraw the rules.

Tax Changes

The proposal, combined with a $60.1 billion plan to limit many expense deductions for American companies that take advantage of laws allowing them to defer tax on foreign profits and a $43 billion crackdown on abusive foreign tax credits, would be the biggest tax increase on U.S. corporations since 1986. Obama also would shift the burden of proof to individuals when the IRS alleges assets are being hidden in certain offshore bank accounts, the White House said in a statement.

“This is bad stuff,” Kenneth Kies, a tax lobbyist at the Washington firm Federal Policy Group, said of Obama’s plans. “This is going to be the biggest fight for the corporate community in the next two years.” Kies represents General Electric Co., Anheuser-Busch Cos. and Microsoft Corp., among others.

While the administration expects companies to lobby against the proposals, the president said his plan strikes at loopholes that give multinational companies an unfair advantage over companies that operate only within the U.S.

Offshore Jobs

“I want to see our companies remain the most competitive in the world,” Obama said. “But the way to make sure that happens is not to reward our companies for moving jobs off our shores or transferring profits to overseas tax havens.”

In 2004, U.S.-based multinational corporations paid about $16 billion in U.S. taxes while earning about $700 billion offshore, an effective tax rate of about 2.3 percent, according to the administration statement. The top marginal tax rate for U.S. companies is 35 percent; drug companies such as Amgen Inc. and technology companies such as Microsoft are among companies that make the biggest use of tax-deferral benefits.

The rules were originally designed to reduce paperwork for companies and the IRS by allowing companies to classify entities within their corporate structure in the most tax-efficient manner without inviting a tax challenge.

Unintended Consequence

Clinton administration officials realized they also had made it easy for multinationals to create entities whose only purpose was to shift profits into low-tax countries and out of reach of the tax authorities, according to a January Government Accountability Office report that found 83 of the 100 biggest companies had subsidiaries in tax havens.

Once the assets were in the haven, the U.S. parent company borrowed from the subsidiary. The interest payments were deductible in the U.S. and tax-free in the haven, the GAO said. The nonpartisan congressional Joint Committee on Taxation recommended in 2005 that the rules be repealed.

As a package, Obama’s proposal “is just a massive change and targeting what really has been a growth area for the U.S. economy: the overseas activities of U.S. firms,” said Andrew Lyon, a former Treasury Department tax official who is now a principal at PricewaterhouseCoopers LLP’s Washington office.

Stephen Shipman, a portfolio manager at Century Management, an Austin, Texas, hedge fund, said the result would be double- taxation for many companies that operate overseas.

Economic Impact

“The simple thinkers in the White House will learn that such policies will result in less economic exchange, both overseas and here in the United States,” Shipman said.

When the Clinton administration tried to rescind the benefits of the tax rules in such cases, companies mounted a lobbying effort and got Congress to back the rule. The Obama administration argues the rules have no economic substance other than avoiding U.S. tax.

“Check-the-box was responsible for a lot of currently taxable passive income disappearing from the system,” said Lee Sheppard, a tax lawyer and contributing editor at Tax Notes, a weekly industry journal.

Obama’s plan will be “surprising and cause a lot of pain” to U.S. companies, said Pamela Olson, a former top tax policy official in President George W. Bush’s Treasury Department. Many companies structured their international operations over the last decade based on rules such as check-the-box.

Counting Revenue

The Obama Treasury Department could have made most of the changes administratively, she said. By making it a legislative proposal, the new administration can count any revenue that results from the policy change in its budget.

The president wants to get the legislation through Congress this year, White House press secretary Robert Gibbs said. Today’s proposals represent “a down payment on longer-term tax reform.”

Obama’s other corporate tax plans are patterned on those made in 2007 by House Ways and Means Committee Chairman Charles Rangel, a New York Democrat, an administration official said.

The first would defer most expense deductions, including those for interest paid, for U.S.-based multinationals, until U.S. tax is paid on the foreign income.

That would end a practice where companies deduct 35 cents of a dollar of interest paid to a foreign subsidiary that owes little or no tax in the country where it is located, the Obama administration official said. Such tax arbitrage, while now legal, reduces companies’ overall tax burdens often at the expense of the U.S. Treasury.

Business Coalition

The proposal stopped short of an outright repeal of U.S. tax-deferral rules, as feared by a coalition of 200 companies and trade groups ranging from Alcoa Inc. to Yum! Brands, Inc. that was spearheaded by the Business Roundtable, U.S. Chamber of Commerce and National Foreign Trade Council, all Washington- based trade associations.

The provisions are widely used by multinationals to reduce the percentage of U.S. taxes they actually pay. GE, for example, has deferred tax on a cumulative $75 billion over the last decade, according to filings. Palo Alto, California-based Hewlett-Packard Co. has deferred U.S. tax on $12.9 billion since 2005, while Microsoft has accumulated $7.5 billion that has never been taxed by the U.S. Even American International Group Inc., bailed out by the U.S. in 2008, deferred $3.9 billion in taxes on its foreign earnings in the same year.

GE’s Advantage

GE’s structure as an industrial company with a finance unit gives it an advantage using tax credits, which helps earnings. The company doesn’t expect a retroactive component in current proposals, Chief Financial Officer Keith Sherin told analysts at a March 19 meeting in New York.

“You may lose those tax benefits going forward if they either disallow deductions in the U.S. for funding overseas assets or require you not to be able to permanently reinvest your earnings overseas,” Sherin said. “So our anticipation is that in the cases we’re looking at you may end up in a situation where legislatively we don’t get those same tax benefits.”

In letters to congressional officials including House Speaker Nancy Pelosi, a California Democrat, and Senate Majority Leader Harry Reid, a Nevada Democrat, the trade groups warned such a repeal would hurt U.S. companies’ competition with their foreign rivals by increasing operating costs. That would make U.S. companies vulnerable to takeover and cost American jobs, they said.

Obama’s proposal would divert the revenue it collects to making permanent a research and experimentation tax credit that is popular with many of the same businesses protesting the end of the tax-deferral rules, the administration official said. That credit, which has expired 13 times, is due to expire again Dec. 31; while the research credit is renewed only temporarily, there has been only one year since 1986 when it and the tax deferral rules haven’t been on the books at the same time.

Foreign Tax Credits

Another Obama proposal would end abuses of foreign tax- credit rules. U.S. tax law gives companies a dollar-for-dollar credit for taxes paid for foreign governments, but companies are projected to use techniques over the next decade to artificially inflate or accelerate those credits by $43 billion, the administration official said. The Obama budget would recoup that revenue, the official said.

For individuals, Obama will propose shifting the burden of proof when the IRS believes money is being hidden offshore. In cases where individuals bank with financial institutions that haven’t agreed to report certain account information to the IRS, the individual will have to prove he or she doesn’t own the account, rather than requiring the IRS to prove ownership.

The change is projected to generate about $9 billion in new revenue between 2011 and 2019, and Obama believes it will yield substantially more, the administration official said.

Toughened Enforcement

Geithner said that in addition to the tax law changes, the Internal Revenue Service is “making an unprecedented effort” to strengthen enforcement. The president’s budget includes money to hire 800 new IRS employees.

Obama’s proposals could be superseded by recommendations by a panel led by Paul Volcker, whom the president named to make recommendations on tax overhaul by December, the administration official said. The panel won’t be constrained by the budget’s proposals, the official said.

To contact the reporter on this story: Ryan J. Donmoyer in Washington at rdonmoyer@bloomberg.net

Last Updated: May 4, 2009 15:07 EDT

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