Business Tax Reform: Territorial System, VAT Highlight Senate Hearing

Witnesses share some common ground, much disagreement on strategies regarding international businesses

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Witnesses testifying Thursday at the latest Senate Finance Committee meeting on tax reform regarding tax treatment of international businesses, found some common ground but also considerable disagreement on the best strategies to employ.

Among other possible policies discussed, switching to a territorial system got a lot of attention, as well as the mention at the end of a value-added tax. But opinion was far from united on a number of points.

Sen. Max Baucus, D-Mont., opened the meeting with comments that addressed the need of the country to alter its tax structure to best help the economy and the corporations that do business around the world. Sen. Orrin Hatch, R-Utah, pointed to how tax policy had been structured in the past and how it was no longer adequate to cope with a world in which business has changed so drastically.

Philip R. West, a partner with Steptoe & Johnson LLP, spoke on his own behalf rather than that of his firm, but cited five criteria for evaluating international tax rules: revenue, equity or fairness, economic efficiency, competitiveness, and simplicity. The current tax code does "not score well" when measured against these criteria, he said. West argued that "most tax planning involves shifting income abroad, not shifting jobs abroad." Moving to a territorial system would not, in his opinion, adversely affect U.S. job creation, but repeal of the current system of tax deferral might.

James R. Hines Jr., professor of economics and law at the University of Michigan, advocated tax reform as a means of improving the conditions of American workers. He also pointed out that foreign countries do not generally subject the foreign income of their own companies to home-country taxation as an argument against a residence-based tax system.

Scott M. Naatjes, vice president and general tax counsel for Cargill Inc., spoke about the burdens of the current tax system on Cargill as an international corporation, and how the marginal tax rate is an important consideration with regard to planning, rather than the effective tax rate.

Finally, Reuven Avi-Yonah, professor of law and director of the international tax master of law program at the University of Michigan Law School, spoke about outbound (U.S. corporations investing overseas) and inbound (foreign corporations investing in the U.S.) taxation, and the need to change the definition of residence of all U.S. corporations in order to "police the boundary between U.S. and foreign corporations."

In questions asked after the testimony, the witnesses discussed the possibility of a change to a territorial system, and spoke against the use of a transition phase if such an action were taken. Avi-Yonah raised the issue of a VAT, pointing to other successful economies that use them. They agreed that the U.S. should not "chase" tax rates, arguing that it cannot compete with such economies as the Caymans, China and Ireland, but instead should compete with countries such as Brazil and India—which, Avi-Yonah pointed out, "have higher rates and do very nicely." He also argued against favoring businesses that operate offshore over those that operate domestically.

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