What are the ramifications and/or impacts of the US switching to a territorial tax system?

• Published date: 01 October 2020
• Author: Jacquelyne Gilman,Leslie Anandane
• Date: 01 October 2020
• DOI: http://doi.org/10.1002/jcaf.22465

COLUMNS

What are the ramifications and/or impacts of the US

switching to a territorial tax system?

Jacquelyne Gilman | Leslie Anandane

Murray Koppelman School of Business,

Brooklyn College, Brooklyn, New York

Correspondence

Jacquelyne Gilman, Murray Koppelman

School of Business, Brooklyn College,

Brooklyn, NY 11210.

Email: jacquelyne.gilman@gmail.com

Abstract

In this article, we focus on the potential impacts of switching to a territorial

tax system in the US. Under the worldwide tax system the US used over the

years, income is included in the firm's taxable income, but their foreign

income taxes paid can be claimed as deductions or credit to avoid double taxa-

tion With a territorial tax system approach, firms would only be paying taxes

on the portion of their income being made in their home country. We focus on

different studies that analyze the ways in which the US has moved towards a

territorial tax system over the years. We also use studies done on the UK and

Japan, G-7 nations that have switched to a complete territorial tax system in

recent years, to compare their motives and outcomes to what would potentially

happen in the US.

KEYWORDS

international tax, multinational corporations, territorial tax

1|INTRODUCTION

In a home country with a worldwide system, income

earned by foreign subsidiaries can be subject to addi-

tional tax in the home country when repatriating divi-

dend payments. This is not the case for home countries

with territorial tax. Under the territorial approach,

income received from foreign subsidiaries in the form of

dividend payments is partially or wholly excluded from

the parent firm's taxable income. “Under the worldwide

approach, dividends received from foreign subsidiaries

are included in the parent firm's taxable income, but for-

eign income taxes paid can be claimed as either a deduc-

tion or a credit (subject to limitations) to mitigate the

double taxation of foreign-source income”(Atwood,

Drake, Myers, & Myers, 2012). So, after-tax income is

usually higher for MNCs (multinational corporations)

with parent firms in territorial countries. Those who

advocate for adopting a territorial tax system in the

United States, use these facts to support their argument

that MNCs under a worldwide system are at a

disadvantage because there are more taxes imposed in

this system (Id.)

The need for tax reform comes from the fact that

the US currently has the highest corporate tax rate

of all Organisation for Economic Co-operation and

Development (OECD) countries (Donohoe, McGill, &

Outslay, 2013, p. 714). This tax rate disincentivizes US

multinational corporations to repatriate their dividends

back to the US, since they can keep their funds in coun-

tries with much lower tax rates. Global tax rates have

declined greatly since the US last tax reform in 1986 (not

including the TCJA [Tax Cuts and Jobs Act] in 2017),

from an average of 47.2% to 24.5% (76). As of 2017, $2.6

trillion was being held abroad (Slemrod, 2018, p. 76).

Investments into intangible capital have grown to 140%

of investment into tangible capital, up from 80% in the

1980s (Id.). Now, this is an issue because shifting income

created by intangible capital to other, lower corporate tax

countries, is easy. Territorial tax may also take care of the

issue with cross credits. Currently, multinationals can

use excess tax credits that they got by paying taxes on

Received: 30 June 2020 Accepted: 18 July 2020

DOI: 10.1002/jcaf.22465

214 © 2020 Wiley Periodicals LLC J Corp Acct Fin. 2020;31:214–218.wileyonlinelibrary.com/journal/jcaf