Why it is critical to reexamine global tax strategies.

• Author: O'Leary, Patrick J.
• Position: International

Why it is critical to reexamine global tax strategies There have been a number of changes in recent years in how various countries administer tax legislation--changes which will have a significant impact on the financial position of multinationals. These new developments should be a cause for concern as organizations operate in the global marketplace and coordinate their tax strategy with overall corporate objectives.

Gone are the days when a tax paid in one country was simply a credit in another. Today, the emphasis is balanced between the overall effective tax rate and the tax rate paid. In order to entice new business, countries will often allow a tax deferral period or a complete holiday from tax. It is increasingly necessary to evaluate the money paid at a lower effective tax rate against the time value of the money not paid due to a tax deferral or holiday. The strategy of paying taxes in a country and receiving credits for them in another is not as viable as improving cash flow through tax deferral.

Average tax rates worldwide often range between 20 percent and 60 percent of a company's income. The impact of such rates on the cash flow and earnings per share is obvious. Yet, without effective tax planning, income may easily be taxed two or more times as it is shifted among various entities within the organization. Taxes paid in one country do not guarantee a corresponding credit in another country. If the country in which the tax is paid has a higher tax rate than the country giving the credit, the country giving the credit often will allow credit only to the extent that its lower rate would have imposed tax. Even if the credits are given for the full amount, excess foreign tax credits often can't be utilized.

Therefore, to the extent that a competitor has a more efficient strategic plan for global taxes, its competitive edge will certainly be enhanced.

For example, U.S. multinational corporations are finding their tax world far more complex under the Tax Reform Act of 1986. Many also will find their U.S. tax bills higher. TRA 86 makes a number of far-reaching changes, the most important of which are:

* The creation of new, separate foreign tax credit baskets for various types of income, including passive income. This reduces the relief given for global double taxation.

* Revisions to the rules for allocating expenses to foreign sources, effectively denying a U.S. tax deduction for some expenses.

* The expansion of anti-abuse provisions to include banking and certain shipping income.

* The creation of a new "super" royalty concept to reduce deferral. This places the tax consequences of intercompany technology transfers in the hands of local tax authorities.

* And a great expansion of the compliance burden for foreign operations, significantly increasing the administrative burden in coping with the new tax changes.

These changes express Congressional concern that under prior law it was too easy for taxpayers to generate low-taxed, foreign-source income to soak up excess foreign tax credits, thereby reducing their U.S. tax liability. Thus, while the 1986 Act retains the overall limitation that allows taxpayers to use excess credits by averaging high-and low-taxed business income, it severely restricts the ability to use low-taxed, passive foreign income to absorb excess credits. Furthermore, the changes reduce foreign taxable income and available credits while increasing U.S. taxable income. Taken as a whole, the changes exacerbate the excess-credit problems all multinationals face as a result of the overall reduction in U.S. tax rates.

The Tax Reform Act caused sweeping changes in the United States and also triggered foreign tax reform worldwide. Globally, the trend has been toward decreased rates. For example, in December of...