The comparative analysis of tax incentives provided by the United States, the United Kingdom, and Russia to domestic and foreign businesses.

• Author: Havard, Nadia

1. INTRODUCTION

   Tax is a powerful tool in the hands of lawmakers. It is probably one of the most complex and, at the same time, most flexible devices available to legislators for shaping national investment policies. Vigorous competition for investments among countries led to the creation of so-called "tax haven" regimes--national tax systems that impose minimal or no tax liability. (1) Other nations responded to the proliferation of tax havens by lowering their own tax rates. (2) For instance, although retaining taxation in place, both Russia and the United Kingdom have adopted tax laws equally attractive to foreign investors. (3)

   As the world economy is expanding, issues of tax competition among nations are becoming highly controversial. A number of organizations, including the United Nations, the World Trade Organization ("WTO"), and the Organization for Economic Co-Operation and Development ("OECD"), have established special dispute resolution procedures inviting nations to air their grievances and resolve them amicably. (4) Most of the disputes focus on reaching international consensus as to where income should be taxed. (5) Historically, active income has been taxed at its source and passive income at a taxpayer's place of residence. (6) Thus, the country where the income originated has the primary right to levy taxes and the country where the recipient of the income resides has a residual right to tax passive income. (7) In fact, international tax treaties are based on the presumption that the country in which the income recipient resides is in a better position to prevent double taxation. (8)

   Mindful of national differences at all levels, and in particular, in the area of taxation, this paper will focus on corporate tax laws of the United States, Russia, and the United Kingdom. The analysis will attempt to identify those explicit and implicit tax incentives that are likely to attract inbound investments in a particular economic environment.

   The first part of the analysis will explore tax incentives available to domestic businesses. The second part of the analysis will look into tax incentives promulgated for the purpose of attracting foreign businesses. Finally, the conclusion will summarize the findings and tax policy implications.

2. DOMESTIC TAXPAYERS

   1. Explicit Tax Incentives

      This analysis of explicit tax incentives will begin with the United States. "Domestic taxpayers" are defined to include "United States citizens, residents, domestic corporations, partnerships, and trusts." (9) Although any group of domestic taxpayers is far from being homogeneous, Congress gave preference to those who are engaged in export. In fact, by adopting the Foreign Sales Corporations Act ("FSC") in the early 1980s, Congress enabled American corporations to substantially increase their export operations. (10) Under the FSC regime, foreign sales corporations paid no tax on their income as received from a foreign income source. (11) Although American companies still paid state sales taxes, the relief from federal tax enabled them to lower sales prices and, thus, come ahead of their European competitors. (12) As could have been anticipated, the FSC tax regime was challenged by the European Union ("EU") before the WTO and on October 8, 1999, a WTO panel found the FSC to be in violation of global trading rules. (13) Even though the FSC Repeal Act repealed the original FSC law in November 2000, the FSC benefits have arguably survived. (14)

      Under the current Tax Code, as well as the 1993 Tax Act, U.S. domestic taxpayers are taxed not only on their income earned in the United States, but also on their worldwide active and passive income. (15) This heavy burden of taxation, however, is lightened by credits. For example, a foreign tax credit is available in an amount equal to the United States tax rate. It allows taxpayers to offset the taxes paid in a foreign jurisdiction, and thus, reduce their tax liability in the United States. (16)

      Additionally, active foreign income that stays abroad is not subject to taxation in the United States regardless of whether or not it is taxed by the source jurisdiction. (17) Not surprisingly, domestic taxpayers are willing not only to delay the receipt of active foreign income in the form of interest, dividends, or loans, but also to keep reinvesting it in a variety of international markets.

      Moreover, U.S. domestic taxpayers are allowed to average the taxes paid on active foreign source income and use a foreign tax credit in an amount that is equal to the averaged tax (subject to limitations of the United States tax rate). (18) Such flexibility permits taxpayers to diversify their foreign investments by investing in jurisdictions that levy low as well as high effective rates. The averaged foreign income tax might well be within the allowed tax rates recognized in the United States. Thus, the amount of a foreign tax credit will relatively accurately reflect effectively paid taxes and will allow a taxpayer to avoid double taxation on foreign income. (19)

      In addition to favorable tax policies related to foreign income, Congress exempted Internet transactions from taxation. (20) The exemption, however, is temporary because it was created by a moratorium rather than by a statute, and its duration depends upon further Internet developments. Studies have predicted, for example, that by 2003, state and local governments alone would be foregoing almost eleven billion dollars in revenue due to the exemption for Internet sales taxes. (21) The impact at the national level may be significantly greater. (22) Nevertheless, at present, domestic taxpayers can derive tax-free income from e-commerce.

      The British tax system resembles the American tax system in its effort to encourage exports. As a result, U.K. exporters benefit from paying, effectively, neither income nor sales taxes. In particular, zero-rate exemption authorizes U.K. exporters to receive a credit for the previously paid value added sales tax ("VAT"). (23) In addition to that, U.K. exporters pay no tax on their foreign income. (24)

      Unlike American taxpayers that are required to pay state taxes, U.K. taxpayers are relieved from paying any regional or city taxes. (25) These benefits, however, are available only to those companies that can be identified as U.K. residents. Section 66 of the Finance Act of 1988 defines U.K. residents as companies that either have been incorporated or have their "'central management and control' (i.e., [their] highest level of management, which may not necessarily be [their] board of directors) ... located in the United Kingdom." (26)

      Another tax relief comes to the U.K. companies in the form of favorable lending policies. For example, U.K. residents, unlike their foreign counterparts, are not subject to thin capitalization requirements. (27) Therefore, there are no restrictions on interest deductions on acquisition loans and disallowance of payments of gross interest on such loans if such loans are borrowed through U.K.-taxpaying branches. (28) Unlike American companies, that may exercise the election under section 338 and treat the amount paid for the equity of a target company as the acquisition of the underlying business and assets, U.K.-resident companies are restricted to cost basis in the acquired shares. (29) In fact, the cost basis is usually lower than the market value of the underlying business and assets and, therefore, insufficient to use all depreciation that might otherwise be available to the acquirer. To compensate for such apparent disadvantage, no tax, however, is imposed on dividends paid within the corporate structure. (30)

      Unlike the United States and the United Kingdom--countries with well-developed tax systems--Russia is still in the process of developing its tax laws. In recent years, radical steps have been taken by the Russian legislature to bring more certainty and stability to the area of taxation. In fact, nowadays, Russian domestic taxpayers can benefit from "decreas[ed] individual and corporate statutory rates, expan[sion] [of] business expense deductibility, ... depreciation rates [that are] in line with actual useful lives, and remov[al] [of] taxes on turnover." (31) Additionally, in order to encourage Russian companies to participate in the legalized cash flow, the Budget and Taxes Committee of the Russian Duma offered to unify VAT for all companies at the rate of about 15%. (32)

      Although the Russian Tax Code (also referred to as the "RTC") fixes corporate income tax at the rate of 24%, only 6% of this is federal tax. (33) The rest of the tax is regional and local. (34) The combination of federal, regional, and local taxes means that the effectively paid corporate income tax is lower than 24%, as regional authorities may further reduce the regional tax. (35)

      Some of the key tax incentives offered by the Russian legislature include low tax rates on dividends and interest. (36) Thus, dividends received by Russian taxpayers from other Russian companies are taxed at the rate of 6%, while those received from foreign companies are taxed at the rate of 15%. (37) At the same time, the interest may be taxed either at the rate of 15% or 0%. (38)

      Additionally, in order to stimulate business growth, the Russian tax legislature excluded certain items of income from taxation. For instance, nuclear power stations are taxed neither on capital nor on non-capital assets if such assets were received under either international treaties or Russian laws promulgated for the purpose of increasing the safety of nuclear power stations. (39) Non-taxable transfers of capital assets between parents and their subsidiaries are another example of tax-free transactions. (40)

      In addition to excluding certain items of income from taxation, the Russian Tax Code allows for ample deductions. In fact, the Russian Tax Code broadly defines permitted deductions as those "founded and substantiated by necessary...