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The Houston Chronicle

May 21, 2002

Islands a tropical haven from grind of U.S. tax code

By Jim Barlow

THE mad dash for the islands is on.

No, it's not Houstonians seeking fun and sun. It's Houston corporations - and others elsewhere - seeking to pay less in taxes.

They are making those moves despite snide comments about the patriotism of their executives and demagoguing from members of Congress.

The islands we're talking about don't collect corporate income taxes from the companies that move there. And companies aren't really moving. They are simply setting up a paper headquarters in those tropical paradises.

It's instructive to look at why they feel that move is necessary.

For some of the more arcane details of the U.S. tax laws we're about to visit, let me credit the writings of Chris Edwards and Veronique de Rugy of the Cato Institute, a Washington-based think tank that leans toward libertarian views.

First, all the companies moving have one thing in common. They earn a significant portion of their income from sales or services outside the United States.

Second, that's where they will get those tax savings - on their foreign sales.

They will continue to pay corporate income taxes on their sales in the United States. But not on foreign sales.

You can expect to see more of this rush to the islands. After all, one-third of the sales of the 500 largest U.S. companies come from foreign affiliates.

Unlike many other developed countries, the United States taxes corporations on their worldwide revenues. For example, if I'm based in Houston and manufacture here but sell the majority of my widgets in, say, France, then I pay U.S. corporate tax on my French sales.

About half of the developed countries - France and the Netherlands are examples - don't tax income from foreign sources.

Now, U.S. companies will also pay taxes in foreign countries for their sales there.

And they may credit the foreign taxes they pay against their U.S. taxes.

There are just two problems with that approach, both of which work against American companies.

The U.S. corporate income tax is 35 percent. If a U.S. company sells goods or services in Belgium, which has a 40 percent corporate income tax, it may not offset the entire 40 percent against its U.S. corporate tax bill. It may only charge off 35 percent, the same rate as the U.S. tax.

But in the United Kingdom, which has a 30 percent corporate tax rate, our U.S. widget maker will pay the 30 percent to the Brits, then an additional 5 percent to the U.S. government.

Now, U.S. companies may aggregate foreign taxes - that is try and blend earnings in foreign low- and high-tax countries to reduce their U.S. taxes. But that's making business decisions not on what's best for growing sales and profits but on what's best to reduce taxes.

But the real disincentive is the complexity of the U.S. tax laws. You see, U.S. corporations don't pay taxes on foreign profits until they bring them home. And naturally, over the years American companies have found all sorts of reasons not to bring home those profits for as long as possible. Postpone taxes long enough, put that money out drawing interest, and voila, you earn enough that, in effect, the added income pays the taxes.

In retaliation, the the U.S. government has aggressively expanded its taxation of foreign income of U.S. companies.

As a result, U.S. companies faced a set of Byzantine rules on their foreign income. It's become so complicated that one study found 46 percent of federal tax compliance costs for the Fortune 500 companies stemmed from rules on foreign income.

By moving their incorporation to Bermuda or the Cayman Islands, companies no longer have this problem. They pay the 35 percent corporate income tax on the business they do here. They pay no taxes on the business they do elsewhere.

Which leads us to a final point.

Corporations really don't pay income taxes. Their customers do, in the form of higher prices.

Any countries that have radically lowered or eliminated their corporate taxes - Ireland comes to mind - have seen prosperity soar as companies flock in to take advantage of the lower tax rates.

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