May 4 (Bloomberg) -- President Barack Obama will propose today to outlaw three offshore tax-avoidance techniques U.S. companies such as Caterpillar Inc. and Procter & Gamble Co. want to use to save $190 billion over the next decade and make it riskier for Americans to stash money in tax-haven banks.
Obama and Treasury Secretary Timothy Geithner will target 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, an administration official said.
The proposal, 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.
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 official said.
‘Bad Stuff’
“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 Obama administration expects companies to lobby against the proposals, the president believes his tax proposals strike at loopholes that give multinational companies an unfair advantage over companies that operate only within the U.S., an Obama official said last night on condition of anonymity.
In 2004, U.S.-based multinational corporations paid about $16 billion of U.S. tax while earning about $700 billion offshore, or an effective tax rate of about 2.3 percent, an administration official said. The top marginal tax rate for U.S. companies is 35 percent.
Obama and Geithner will outline four tax proposals ahead of a more detailed budget they will unveil later this week.
The biggest of the requests is the repeal of the so-called check-the-box rules, which took effect in 1997. The rules were 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.
Tax Havens
The Clinton administration realized that the rules made it easy for U.S.-based 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 Clinton administration intended the rules to help U.S. companies minimize their foreign tax liability, not to avoid the IRS, said Andrew Lyon, a former Treasury Department tax official who is now a principal at PricewaterhouseCoopers LLP’s Washington office.
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,” Lyon said.
Lobbying Push
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, an Obama official said. Obama believes the rules have no economic substance other than avoiding U.S. tax, the official said.
“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.
‘Wiped Out’
“Everything they’ve done is going to get wiped out,” Olson said. 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.
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.
The proposal stopped short of an outright repeal of U.S. tax-deferral rules, as feared by a coalition of companies spearheaded by the Business Roundtable, U.S. Chamber of Commerce, and National Foreign Trade Council, all Washington- based trade associations.
Letters to Leaders
In letters to congressional officials including House Speaker Nancy Pelosi and Senate Majority Leader Harry Reid, 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.
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.
Offshore Money
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.
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.
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