The United Kingdom's Move to Territorial Taxation

November 16, 2012

Until recently, the United Kingdom had a similar taxation system to the United States. At one point, both countries had a "worldwide" tax system in which companies were taxed at home for any earnings that were made in foreign countries, says the Tax Foundation.

However, the United Kingdom has pivoted to what is known as a "territorial" tax system, in which earnings made overseas are not taxed domestically. This move has been lauded by an overwhelming number of companies and a majority of countries in the Organization for Economic Cooperation and Development, which have already adopted the territorial tax system.

There are many reasons that the United Kingdom ultimately decided to make this switch:

  • First, it allows the country to remain a competitive place to set up businesses.
  • Second, there are steep compliance costs associated with the worldwide tax system.
  • Moreover, it was very simple for companies to avoid payment of taxes.

The United Kingdom's tax system is now a model for how the United States should change its tax system. There are several features of the United Kingdom's tax code that make it competitive.

  • There are exemptions for various foreign-source dividends.
  • Furthermore, it allows domestic tax deductions for foreign-source expenses.
  • Additionally, there are strengthened anti-avoidance measures such as limits on the deductibility of interest payments, enforcement of tax on controlled foreign affiliates based in low-tax jurisdictions, and regulations that qualify diverted intellectual property as taxable.

The success of the United Kingdom's transition should allay any fears that U.S. policymakers have about shifting to a territorial tax system. For instance, unemployment has leveled off and is not affected by the recent policy change in the United Kingdom. Furthermore, tax revenues as a share of the gross domestic product have also increased despite the tax rate cut.

Source: "The United Kingdom's Move to Territorial Taxation," Tax Foundation, November 13, 2012.

 

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