How to plan your global tax strategy for the 1990s.

• Author: O'Connor, Walter
• Position: Finance

How to plan your global tax strategy for the 1990s

In the 1960s, international taxation functioned on the premise that U.S. companies were investing abroad. In the 1980s, however, the flow has reversed. There is a significant inflow of investments from foreign countries. This requires a different mind-set by international tax experts.

At the present time, much of America - including Congress and to some extent the Internal Revenue Service - is out of sync with capital flow thinking. The February 5, 1989, edition of The New York Times commented that Citicorp is now more a domestic bank than an international bank. What was to be expected, given the significant pulling back by U.S. companies of their operations to the U.S., coupled with a significant inflow of foreign investment into the U.S.?

Another element in the international tax environment is what happened to Sub Part F. Instead of significant U.S. taxation emerging from that legislation, we have experienced an increase in foreign tax credits. Sub Part F has contributed to U.S. companies generating significant foreign taxes, which in turn revert to the U.S. as offsetting credits.

Still another factor is the "super royalty" concept. The Tax Reform Act (TRA) of 1986 enabled the U.S. government to reach beyond its borders and change transactions with foreign subsidiaries not only when they are entered into, but also after they have been consummated. This, of course, creates the impression that the government is trying to grab every bit of revenue that emanates from exporting U.S. technology. It is also an overreach in today's international business environment.

Indeed, there may be more revenue for the U.S. government in the taxation of the U.S. operations of foreign companies than there is in the taxation of investments abroad by U.S. companies. What is difficult, however, is to measure the income from U.S. activities of a foreign corporation. The IRS can monitor the U.S. parent and its foreign subsidiaries much easier than it can foreign entities operating in the U.S.

Finally, U.S. companies have tried to correct their international tax difficulties by adjusting transactions. The new environment, however, particularly with the TRA of 1986, requires the restructuring of organizations. Transfer pricing, licensing, financing arrangements, leasing, service activities - these were the mechanisms used in the past. Now, the restructuring of corporate entities will provide the solutions for years to come. The ultimate goal is restricting U.S. taxation to U.S. operations only.

Hot areas for planning

Given this background, what are the hot subjects in taxation and the planning opportunities that are available to the global company?

One: tax credits - Excess foreign tax credits face many U.S.-based companies dealing in international markets. These are the major reasons for it:

* U.S. tax rates have gone down and foreign tax rates have gone up. * Rules that determine which income of the U.S. taxpayer is foreign and which is U.S. source have changed. The new rules determine the source based on the residence of the taxpayer. This means U.S. source income does not help in calculating the foreign tax credit limitation. * Rules to fix which expenses are allocable to foreign source income have been complicated by new tax regulations. In effect, the regulations now attribute larger amounts of interest and R&D expenses to foreign source income, thereby making the utilization of foreign taxes as credits more difficult. * TRA 1986 introduced a multiplicity of "baskets" for calculating the foreign tax credit. What purports to be an overall limitation is really becoming a per-item limitation. This is even more restrictive than the old per-country...