Deal to Raise U.S. Revenue on Foreign Income Gets Closer

Lawmakers are starting to see the outlines of a bipartisan agreement on how to tax the income that U.S.-based corporations earn outside the country.

Such a system would make it easier for U.S. companies to bring home foreign income that has been taxed elsewhere while preventing profits booked in low-tax or no-tax jurisdictions from receiving the same benefit.

A deadlock-breaking agreement would respond to companies including Procter & Gamble Co. and General Electric Co. that have lobbied for change and complain that the U.S. tax code hurts their ability to compete globally. Under the current system, fewer than 100 companies have stockpiled more than $1.2 trillion in untaxed profits outside the U.S.

“There has been a lot of thinking and work done on these issues over the last couple of years, and I do think that has brought the parties closer together,” said Michael Mundaca, who was a senior Treasury Department tax official in the administrations of Presidents George W. Bush and Barack Obama.

The potential framework is conceptual, not the product of negotiations or the detailed bill-writing that would need to occur. An agreement on international taxation would probably happen only as part of a broader rewrite of the tax code. That is months if not years away and locked in a partisan dispute over how much revenue the government should collect.

Jacob J. Lew, sworn in today as Treasury secretary, told senators during his confirmation process that he saw the potential for agreement on international taxation.

‘Common Ground’

“There is considerable debate as to how to reform the international tax system,” Lew wrote in response to a question from Senator Orrin Hatch of Utah, the panel’s top Republican. “But I believe that there is common ground on this subject, including a mutual concern about preserving the U.S. tax base by reducing incentives that encourage the shifting of investment and income overseas.”

Senate Finance Committee members Rob Portman and Ron Wyden both said in interviews this week that they see room for a potential compromise.

Through meetings with Lew, who earlier served as White House chief of staff and head of the Office of Management and Budget, and his predecessor at Treasury, Timothy F. Geithner, Portman said he has seen more acceptance by the Obama administration of the current system’s disadvantages for U.S. companies. Portman, an Ohio Republican, said lawmakers could agree on a system that exempts foreign income along with rules that prevent companies from shifting profits outside the U.S.

‘Growing Consensus’

“You can do that,” he said in an interview. “Other countries have done it, so I think there’s a growing consensus around this.”

The debate is between what tax analysts call worldwide tax systems and territorial tax systems.

The U.S. system is nominally worldwide, meaning that companies with U.S. headquarters owe taxes on all of the income they earn around the world. They can receive credits for taxes paid to foreign governments and can defer U.S. taxation until they bring the money home.

That system gives U.S. companies an incentive to shift profits outside the country and park them there, a trend that has accelerated as companies expand their markets overseas.

General Electric

“We believe the U.S. tax system needs to be reformed to close loopholes, to lower the corporate rate and to provide a territorial system like virtually all other major industrialized countries,” GE spokesman Seth Martin said in a statement. “American companies need to be able to compete on a level playing field with their foreign competitors.”

GE has $108 billion outside the U.S., the most of any U.S.- based company, according to its Feb. 26 regulatory filing. Companies are required to disclose their untaxed profits annually.

The cash buildup has created pressure on companies such as Apple Inc. and Cisco Systems Inc. to seek legislative changes or find more productive uses for the money. They have failed to persuade Congress to repeat a 2004 tax holiday on offshore profits.

Cisco, which had $41.3 billion in untaxed profits outside the U.S. as of July 28, 2012, will continue making investments in Canada and other countries, said John Chambers, the company’s chairman and chief executive officer.

“We are assuming that we’re not going to get much help from Washington,” he said on Bloomberg Television Feb. 14. “We just ask them not to hurt us too much, and we’re going to go ahead and put our money to use based upon tax policy.”

Territorial System

In comparison with the U.S., most other industrialized countries operate under a so-called territorial system, which exempts all or almost all foreign income from home-country taxation. The U.K. and Japan have switched to territorial systems in the past few years.

Judging by the rhetoric, the gap between the administration and congressional Republicans on this issue remains wide.

Obama campaigned -- and won -- twice on curbing tax breaks that he says encourage U.S. companies to ship jobs overseas, signaling his intent to preserve the worldwide system. Each of his proposed annual budgets has called for limits on companies’ ability to defer U.S. taxation.

Other Democrats, such as Senator Carl Levin of Michigan, have proposed even tougher limits.

What’s changed in the past few months is the administration’s engagement with business groups and Republicans’ insistence on measures to prevent companies from shifting profits outside the U.S.

Administration’s Position

The administration’s statements have expressed its opposition to a “pure territorial system” -- allowing Obama to stake out a position without actually criticizing the Republican congressional proposals.

Drafts from Representative Dave Camp of Michigan and Senator Mike Enzi of Wyoming, both Republicans, include rules to limit companies’ ability to book their U.S. profits in low-tax jurisdictions to benefit from the territorial system.

The administration has been helpful because it “has not put any lines in the sand with respect to anything that has been proposed so far,” said Mundaca, who left Treasury in 2011 and is now a co-leader of national tax at Ernst & Young LLP in Washington.

One of Camp’s options is a form of the global minimum tax that the administration has suggested. Another option would apply only to income earned from intangibles such as patents, providing incentives for locating them in the U.S. and penalties for holding them in low-tax countries.

Encouraging Investment

Those approaches are compatible with Obama’s goals of limiting profit-shifting and encouraging investment in the U.S., Mundaca said.

The resulting hybrid system, Wyden said in an interview, could be called “territorial without the gaming.” His plan for a worldwide system would lower the 35 percent U.S. corporate rate and tax all income earned around the world as it is earned.

Wyden, an Oregon Democrat, said he recognized the difficulty of drafting such a compromise.

“There’s never been a piece of legislation that talented tax lawyers can’t get around,” he said.

Camp, the chairman of the House Ways and Means Committee, told reporters Feb. 26 that he expected to talk with Lew after his confirmation.

A hybrid system with limits on bringing home low-taxed income could hurt technology and pharmaceutical companies that have shifted intellectual property to low-tax countries. Companies with low effective tax rates have been urging Camp to soften his proposals.

Enzi said he agreed with Lew that there was room for common ground even though he hasn’t seen movement by the administration toward a territorial system.

“You’ve got to get into the discussion first, and we haven’t had that,” he said.