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Alexandria, Virginia 22310-9998
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Denis Kleinfeld, C.P.A., J.D.

First appeared in the April 2002 issue of the Offshore Investment Magazine

April 2002


By:  Denis Kleinfeld

 Companies like individuals, can either pay tax or do something to avoid tax.  They can, if the situation demands, move out from under the tax system. Multi-national companies, whether public or private, are showing just what they think of their home country tax systems. They are not paying but expatriating.  It is what is known as voting with your feet.

 As almost everyone in the world knows, Americans are typically very provincial. Likely, well over 90% of Americans do not even have passports. Basically, their attitude is that America is the best place to be and why would anyone want to go anywhere else? But the fact is that even American companies, of all sizes and shapes, are moving offshore.

 It is clear that there is a confusing political war going on over the tax system of the United States of America.  The same arguments being raised in support of or against the current tax system are applicable to the other OECD countries. On the one side are the proponents who say that the tax system as it currently exists has got to go. As one presidential candidate said, "Put a stake through its heart".  On the other side, there are those who feel wealth redistribution and campaign contributions are all important so that the current system must be kept in place and even expanded. In my view, mere political and special interest ideologies are rarely supported by the economics of reality.

 An article in the Wall Street Journal quoted the Secretary of the Treasury, Paul O'Neil, on his views of the US tax system. He criticized the tax code as an "abomination" that makes it difficult for individuals and corporations to comply with the law.  The article noted that the outspoken Treasury Secretary former Chairman and Chief Executive of the multi-national Alcoa Inc. has said previously that he would like to eliminate the corporate income tax al together.  He recognizes that, for the present, it would be politically difficult, so is satisfying himself with proposing "simplification".

 The Treasury Department has announced that it is making tax simplification a priority for 2002.  It is expected that they will issue its first set of papers on the subject shortly. A spokesperson for the Treasury has stated that, "our income tax system is inherently complex because income is difficult to measure.  To achieve simplification, we must do a better job of reconciling tax and economics."  That, it is fair to say, will be impossible unless government recognizes that tax is a cost and a cash burden on business solely made necessary in order to pay for the basic services required of an orderly government.  The necessity to pay for government services does not mean that paying taxes is a patriotic duty. I pay my plumber also but he does not fee I need to salute him when he fixes my toilet.

 What is confusing is the message being given by government. While the administration recognizes that the complexities of the tax code are bewildering and undermine the effectiveness of multi-national businesses to compete in the global environment, at the same time the Treasury, and particularly the IRS, is planning a fresh attack on corporate tax planning which is focused on reducing or minimizing the tax burden.  In other words, the tax bureaucrats intend to make the tax system more complex and impossible to administer.

 As can be expected, numerous politicians and their campaign-contributing, special interest groups have jumped on the band wagon to effectively prohibit multi-national corporations from expatriating from the United States of America.  One recent proposal in Congress was intended to send a strong message to companies that try to avoid taxes by expatriating. Under the proposed legislation, a foreign corporation that acquired a domestic corporation in an "expatriation transaction" would be treated as if it were incorporated in the state under whose laws the domestic corporation was organized.

 The proposal contained a fairly complex and convoluted definition of corporate expatriation transactions among a plethora of other provisions.  So much for simplification.  The feeling of some politicians is that major US corporations are trading in their US citizenship to set up their operations for tax reduction purposes in offshore havens.  What the politicians do not like is that a lot of companies feel that improving their earnings that is their net earnings per share after tax is powerful enough so that "maybe the patriotism issue needs to take a back seat to that." Seeing how the United States of America came into existence because of the tax revolt at the Boston Tea Party, it is hard to equate the need for government to tax as patriotism.  Personally, I have never seen too many ticker tape parades down Fifth Avenue for the benefit of the Internal Revenue Service.

 Cooler heads prevail occasionally in the political arena. In this case, a majority in the House of Representatives defeated this proposal regarding corporate expatriation.  So for the time being, the ability to move a corporation out of the United States of America into an offshore environment for the purpose of reducing the tax burden is still allowable. As one of the Big Four accounting firms states in their website, "For all of its complexity, the area of international tax boils down to a single imperative. Reduce your global effective tax rate."

 Not all lawmakers are enthralled by the expansion of the tax system.  Some have reiterated their request that the Secretary of the Treasury continue resisting international tax harmonization efforts. As one Senator put it, "workers, investors, and entrepreneurs should be allowed to lower their tax burdens by shifting economic activity to jurisdictions with policies that reward wealth creation by the private sector."  Just another way of giving the same message as the accounting firm's website.

 The New York State Bar Association Committee on Foreign Activities of US taxpayers has also waded in on the issue.  It released a report criticizing the Treasury's so-called "Subpart F" study. Subpart F are the main, mind-boggling rules enacted, along with the inter-company pricing, to curtail the deferral of tax on foreign income of US taxpayers through foreign corporations.  The Bar committee believed that the study went too far in the direction of justifying the current Subpart F rules and was not even-handed in evaluating alternative policy choices. Should they really expect a fair and balanced report by a government agency?

 Basically, the Bar report suggests that more attention should have been given to alternative systems for taxing foreign income such as the territorial regimes that have long been used in several foreign countries. Importantly, it was pointed out that the Treasury study did not address the often raised concerns that Subpart F, particularly in combination with other tax rules applicable to international operations, inhibits the ability of US base multi-nationals to compete with their foreign competitors.  What government bureaucrats seem to forget is that if businesses are not competitive and have no earnings per share after tax then there will be no business from which to obtain taxes.

 This same concern was recently raised with the Secretary of the Treasury by the Coalition for Tax Competition. It observed that the current tax system is forcing many US businesses to move their headquarters to other countries and is harming their competitiveness in global markets. Essentially, the Coalition would like the current administration to adopt a territorial tax system for corporate income - a tax system much like those being used right now in offshore jurisdictions. This, it feels, would boost the competitiveness of US businesses while fulfilling their international trade obligations.

 Territorial taxation is based on the common sense notion that governments should tax only that income earned inside their borders.  The Coalition believes that adopting a territorial tax system has numerous benefits including pro-simplification, pro-tax reform, and pro-competitiveness. It is also WTO compliant and particularly desirable now that the economy is sluggish. All of which is true.  It should be expected that anything that makes this much sense will be fought tooth and nail by the tax bureaucrats, their knowtowing supporters in private practice, and the welfare industry.

 Perhaps the best and most important view is the one expressed by the actual companies paying tax.  For example, in looking at the SEC Form S-4 Registration Statement of Fruit of the Loom, Ltd,. which was incorporated in the Cayman Islands, the Board of Directors' letter by the US company to stockholders laid out quite clearly the reason for its corporate inversion or what is otherwise referred to as a corporate expatriation. 

 The letter to the stockholders said, "The Board of Directors believes that the reorganization will enable the company to create better returns for our stockholders.  The use of a Cayman Islands holding company will allow the company to organize its international business activities so that it will be able to benefit for more favorable business, tax and financing environments than would be available to us if our parent company were to remain a United States corporation.  The use of a Cayman Islands parent corporation is expected to reduce corporate income taxes because the Cayman Islands generally impose no corporate income taxes on foreign income.  By contrast, the United States imposes corporate income tax on the worldwide income of the United States corporations. The United States imposes significant costs for companies like Fruit of the Loom that conduct a substantial portion of their operations outside the United States. These costs are expected to reduce to the extent that our operations are conducted after the reorganization by FTL Cayman or its foreign subsidiaries." Sort of lays it right on the line.

 Do not expect Government or their supporters to give up easy. German Chancellor Shroeder called for the European Union to be allowed to make tax policy for EU member countries. The International Monetary Fund, the OECD and the World Bank announced plans to lead a new "international tax dialogue" which will enhance cooperation and technical assistance in the tax area.  Do proposals like this not make you feel all warm and fuzzy? Clearly, the IMF, OECD and World Bank did such a good job for Argentina that they now want to do it for you too.

 Patriotism only goes so far.  It is not going to keep an individual or a corporation in any country when its economic survival is on the line. Corporations may not actually vote in elections but they vote in other ways. For multi-national corporation faced with an oppressive and unyielding tax burden, it should only be expected that they will make a rational response to an irrational situation.  The protest vote they will make is with their feet when they move out of the country.   

Denis Kleinfeld is a principal of the Miami, Florida-based Kleinfeld Law Firm. Mr. Kleinfeld's primary practice focus is on sophisticated national and international income, estate and wealth protection planning for private clients, privately held companies and directors of public companies.


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