Treasury Threatens to Double-Tax Some Businesses

Taxing earnings twice will disrupt enterprise operations and discourage overseas investments and acquisitions. Some companies working in overseas international locations may transfer their headquarters out of the U.S. to keep away from the tax.

Before the change, the Section 901 overseas tax credit score was extensively accessible to companies to eradicate double taxation on overseas earnings. Section 901 is a dollar-for-dollar credit score accessible to firms and people who pay earnings taxes abroad. Section 901 ensures that corporations aren’t double-taxed on the identical earnings. That considerably reduces their tax burdens and the prices of investing within the U.S. and overseas. Foreign tax credit are particularly useful for U.S. corporations working in international locations with which the U.S. doesn’t have a tax treaty, similar to Brazil, Chile and Argentina.

The ostensible goal of the brand new rules is to make sure the credit score is on the market solely on overseas earnings taxes, not every other tax. But its definition of “income tax” is just too slim. The new rules enable corporations to say the credit score for company earnings taxes or capital-gains taxes provided that the taxing overseas nation follows a newly created—and obscure—“net gain test.” Under the web achieve take a look at, corporations can declare the overseas tax credit score provided that the overseas nation follows explicit elements of the U.S. tax system, similar to permitting for depreciation, curiosity deductions and different customary guidelines of the U.S. company earnings tax code.

Brazil would probably fail the web achieve take a look at. Its transfer-pricing system fails to make specific reference to the “arm’s length principle,” a rule that requires corporations to function pretty with their overseas subsidiaries. Another instance is Hong Kong, which doesn’t enable curiosity deductions for curiosity funds to overseas events. Interest deductibility is vital within the new rules. That means roughly 1,300 U.S. companies working in Hong Kong can be vulnerable to double taxation.

The new rules vitiate the aim of the credit score, which is to permit U.S. corporations to flee double taxation within the absence of a tax treaty. And the implications will likely be extreme. Companies working in international locations outdoors the U.S. tax-treaty system have a expensive determination to make. They can threat IRS audits in the event that they declare the credit score, make the costly transfer to divest from these international locations, threat having to pay double tax on their overseas earnings, or depart the U.S.

Double taxation is all the time a nasty thought. It results in much less funding, fewer jobs, decrease wages and off-shoring. The Biden administration’s determination to slim the provision of the overseas tax credit score and improve the potential of corporations paying double tax on their overseas earnings can have direct financial penalties at house and overseas. If these rules aren’t reversed, the world economic system will endure and the U.S. will transfer nearer to a recession.

Mr. Nix is learning tax regulation at Georgetown University Law Center.