Lessons the United States Can Learn From Other Countries' Territorial Systems for Taxing Income of Multinational Corporations

TAX POLICY CENTER | URBAN INSTITUTE & BROOKINGS INSTITUTION LESSONS THE UNITED STATES CAN LEARN FROM OTHER COUNTRIES’ TERRITORIAL SYSTEMS FOR TAXING INCOME OF MULTINATIONAL CORPORATIONS Rosanne Altshuler, Stephen Shay, and Eric Toder January 21, 2015 TAX POLICY CENTER | URBAN INSTITUTE & BROOKINGS INSTITUTION i ACKNOWLEDGEMENTS Altshuler is a professor of economics at Rutgers University. Shay is a professor of practice at Harvard Law School. Toder is an Institute fellow at the Urban Institute and codirector of the Tax Policy Center. The authors benefited from insights supplied at a conference titled “What the United States Can Learn from Other Countries’ Territorial Tax Systems,” which was held at the Urban Institute on February 28, 2014. The authors thank the conference participants for information and perspectives they supplied in the conference discussion and in private conversations and correspondence afterward. The authors also thank Amanda Eng for excellent research assistance and Brian Arnold, Alan Auerbach, Hugh Ault, Kim Clausing, Steven Edge, Ross Fallone, Joni Geuther, Harry Grubert, Peter Merrill, Manabu Nakamori, Erik Roeder, Matthew Ryan, and Richard Vann for helpful comments on an earlier draft of the report. All remaining errors are the responsibility of the authors. The findings and conclusions contained within are those of the author and do not necessarily reflect positions or policies of the Tax Policy Center or its funders. TAX POLICY CENTER | URBAN INSTITUTE & BROOKINGS INSTITUTION ii ABSTRACT The United States has a worldwide system that taxes the dividends its resident multinational corporations receive from their foreign affiliates, while most other countries have territorial systems that exempt these dividends. This report examines the experience of four countries – two with long-standing territorial systems and two that have recently eliminated taxation of repatriated dividends. We find that the reasons for maintaining or introducing dividend exemption systems varied greatly among them and do not necessarily apply to the United States. Moreover, classification of tax systems as worldwide or territorial does not adequately capture differences in how countries tax foreign-source income. CONTENTS TAX POLICY CENTER | URBAN INSTITUTE & BROOKINGS INSTITUTION iii Contents ACKNOWLEDGEMENTS ................................................................................................................................ i ABSTRACT .......................................................................................................................................................... ii INTRODUCTION .............................................................................................................................................. 1 ECONOMIC AND FISCAL CHARACTERISTICS OF THE UNITED STATES, AUSTRALIA, GERMANY, JAPAN, AND THE UNITED KINGDOM .............................................................................. 3 Size of Economy and Importance of Trade and Capital Flows ............................................................................. 3 Differences in Business Sector and Industry Characteristics.............................................................................. 5 General Tax Structures and Fiscal Position ............................................................................................................... 5 Rules for Taxing Business Income ................................................................................................................................. 7 HOW THE CURRENT US TAX SYSTEM WORKS ................................................................................. 10 The Building Blocks of the US International Tax System ................................................................................... 11 What Foreign-Source Income Is Subject to US Tax and When? ............................................................... 11 How the United States Prevents Double Taxation ....................................................................................... 15 Residency Rules ......................................................................................................................................................... 16 Does the United States Collect Corporate Tax Revenue from the Foreign Profits of US Firms? ........ 17 How Would MNC Behavior Change if the United States Enacted a Dividend Exemption System? ... 17 CASE STUDIES OF TERRITORIAL TAX SYSTEMS IN THE UNITED KINGDOM, JAPAN, GERMANY, AND AUSTRALIA ................................................................................................................... 19 The United Kingdom ....................................................................................................................................................... 20 Background: UK Corporate Taxation befor