However, the new tax law deviates from territorial taxation in the treatment of intangible gains, which make up the bulk of the profits of some of the largest U.S. multinationals. By abolishing the tax on repatriated dividends, TCJA has increased rewards for income transfer: profits are now not only exempt from tax abroad, but are also exempt from tax when returned to the U.S. parent company. To counter this, TCJA has included GILTI, the low-tax global intangible income tax. This low tax rate on intangible gains, when incurred, reduces the incentive to move these gains out of the United States. Determining the source of income is crucial in a territorial system, as the source often determines whether or not the income is taxed. For example, Hong Kong does not tax residents on dividend income earned by a company outside Hong Kong. [158] The source of income is also important in residence regimes that provide tax credits in other countries. Such a credit is often limited by either jurisdiction or local tax on total income from other jurisdictions. If a lower U.S.
tax rate on foreign profits encourages U.S. companies to shift investments abroad, it could hurt the wages and productivity of American workers. As tax economist Jane Gravelle of the Congressional Research Service told Congress, “[The transition to a territorial system] would make foreign investment more attractive. That would lead to overseas investment, and it would reduce the capital that workers in the U.S. have, so it would have to lower wages. A territorial tax would exempt U.S. multinationals from tax on their foreign profits. (They would still be subject to U.S.
corporate tax on their domestic profits.) President Trump and Republican congressional leaders have proposed a territorial tax with a domestic corporate tax rate of 20% (see chart). Countries do not necessarily use the same tax system for individuals and businesses. For example, France uses a residential system for individuals but a territorial system for businesses,[150] while Singapore does the opposite,[151] and Brunei and Monaco tax corporate income but not personal income. [152] [153] The current American system is a hybrid between a territorial system and a global system. The Tax Cuts and Jobs Act (TCJA) eliminated the taxation of repatriated dividends, but expanded the taxation of income from CFCs. The current system can be characterized as a territorial system of normal return on foreign investment, defined in U.S. tax law as a return of up to 10% on tangible assets, as these returns are not subject to U.S. corporate income tax.
The result is that U.S. companies that invest abroad and companies based abroad from countries with territorial systems pay only the local corporate tax rate in the countries where they invest physical fixed assets. In addition, U.S. companies no longer have an incentive to circumvent U.S. taxes by outsourcing production to local companies, as would be the case with global taxation. Fortunately, there are countries that administer a territorial tax system – a system in which countries only tax income earned within their geographical boundaries. Proponents often argue that a territorial system would improve the “competitiveness” of U.S. companies. But these claims have little to do with overall job creation in the United States or the wages of ordinary workers, and are not supported by evidence: international taxation is the study or determination of tax on a person or company that is subject to the tax laws of different countries or the international aspects of the tax laws of a single country. Governments generally limit the scope of their income taxes in one way or another territorially or provide for compensation with the taxation of extraterritorial income. The nature of the restriction usually takes the form of a territorial, residence-based or exclusionary system.
Some governments have attempted to alleviate the various constraints of each of these three major systems by adopting a hybrid system with the characteristics of two or more. In a territorial tax system, international companies pay taxes to the countries in which they reside and earn their income. This means that territorial tax systems generally do not tax income that companies receive abroad. A global tax system, on the other hand, such as the one previously applied by the United States, requires corporations to pay taxes on global income, regardless of where it is earned. In order to simplify administration or for other programs, some governments have introduced “supposed” income schemes. These regimes tax a particular category of taxpayers according to the tax regime applicable to other taxpayers, but on the basis of a presumed level of income as if the taxpayer had received it. Disputes may arise as to the appropriate levy. Dispute resolution procedures vary considerably and enforcement issues are much more complicated at the international level. The ultimate dispute resolution for a taxpayer is to leave their jurisdiction and take any property that may be seized. For governments, the final solution may be confiscation of property, imprisonment or dissolution of the entity. What is a territorial tax and does the U.S.
have one? Of the 27 European OECD countries on today`s map, 19 have an entirely territorial tax system that exempts all dividend and capital gains income from foreign sources from domestic tax. In the other eight countries, this income is partially exempt from domestic tax. No European OECD country has a global tax system. Countries adopt territorial tax systems – also known as source-based tax systems – through so-called “opt-in exemptions”. These allow multinational enterprises to exclude or deduct income generated abroad from their domestic tax base, ensuring that such profits are taxed only in the country where they were generated. The implementation of territorial systems requires the definition of the source of a multinational`s profits. This was easy because most of the profits were due to physical assets with a fixed location, such as factories, equipment, and structures. Today, however, an increasing proportion of profits come from the return on intangible assets such as patents, trademarks, and copyrights. Companies in technology, pharmaceuticals and other sectors have been able to reduce their tax liability by shifting ownership of intangibles and profits from intangibles to low-tax jurisdictions where little real economic activity takes place. By charging affiliates in high-tax jurisdictions a royalty for these intangible assets, they reduce their overall tax bill.