NCPA - National Center for Policy Analysis

Rethinking U.S. Taxation of Overseas Operations

December 2, 2011

The United States produces a third of the world's wealth but contains less than 5 percent of the world's population.  This disparity pushes many U.S. businesses and entrepreneurs to embrace globalization to improve productivity and expand market reach.  Large and small businesses alike are increasingly using the tools of faster information, cheaper transportation and overseas workforces that blur the traditional notions of taxes and services based on geographic lines, says Joseph Henchman, vice president of legal & state projects at the Tax Foundation.

This trend of globalized business relations and trans-market activity has forced many governments to reassess their tax structures, specifically in regard to how they treat international activity.  Two options are widely implemented:

  • The worldwide system that is used in the United States burdens all American businesses with corporate taxes, regardless of their location around the world.
  • A territorial system, which is much more widely used by developed economy, taxes only those operations within a country's geographic boundaries and leaves the taxation of its own companies operating abroad to foreign governments.

As the United States is one of the few developed nations that still maintains a worldwide system, its businesses with foreign operations face significantly greater compliance costs than international competitors.  Stipulations within specific provisions of the corporate taxation system of these companies allow them to defer IRS taxes on certain forms of income if that money is not repatriated.  While this helps to offset the natural disadvantage created by the complicated tax system, it discourages remittances back to domestic operations.

Were the United States to move towards a territorial tax system, the outlook for American businesses operating abroad and the economy as a whole would be brightened.

  • American companies would face fewer compliance costs and would not have to dedicate as many resources to inefficient accounting efforts to calculate and minimize tax burdens.
  • Such a policy would create greater tax parity between American and foreign companies, allowing them to compete more equitably.
  • A territorial tax would also remove impediments that discourage foreign firms from headquartering in the United States.

Source: Joseph Henchman, "Rethinking U.S. Taxation of Overseas Operations: Subpart F, Territoriality and the Exception for Active Royalties," Tax Foundation, November 22, 2011.

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