STUDY: U.S. System Improves, But Work Remains.

• Author: Moriarty, George B.
• Position: Taxation

An updated version of FEI's 1996 survey on international taxation finds that despite improvement, the U.S. tax code still puts domestic companies at a disadvantage.

"The United States seeks to tax the worldwide income of U.S. businesses and U.S. citizens. Many other countries exempt foreign source income either by statute (France) or by treaty (Germany). Moreover, the United States is the only major industrial county that taxes the foreign income of nonresident citizens."

This statement first appeared in the 1996 FEI Research Foundation study, "Taxation of U.S. Corporations Doing Business Abroad: U.S. Rules and competitiveness Issues." To the regret of U.S. businesses, the same wording is used in the second edition, due to be published in July.

The authors, Peter Merrill and Carl Dubert, principal and director, respectively, at PricewaterhouseCoopers LLP, acknowledge the positive changes made to the code since 1996, primarily by Congress. They highlight areas of continuing concern to financial executives operating internationally and present the status of the U.S. in relation to other tax jurisdictions. All of these points center around the important message that the U.S.'s highly complex tax structure places domestic corporations at a disadvantage to foreign competitors, and that an uncompetitive tax system in today's global economy carries greater consequences than ever before.

Continuing Areas of Concern

Congressional efforts, although meaningful, have not addressed all of the original concerns. Indeed, one major issue is the allocation of interest expense. The U.S. is one of the few countries that allocates interest expense to foreign source income using a "fungibility" theory, Merrill and Dubert explain. Congress imposed this requirement, which has to do with interest allocation on a consolidated business, as part of the 1986 Act. Worse yet, the authors point out, the allocation rule operates on a "water's edge" rather than "global" basis. The result is that U.S. interest expense is taken into account in the allocation formula, but foreign interest is not. This can lead to double taxation because foreign countries do not recognize U.S. interest expense as a deduction.

"This was added at the last minute [in 1986] in subcommittee to plug a revenue hole," says Merrill. "It's not sound from a policy standpoint, but it remains out there." He says the issue received some attention from Congress last year and was included in legislation that...