Policy Documents

Territorial Tax Study Report

Paul W. Oosterhuis, LaBrenda Garrett-Nelson, Fred T. Goldberg, Jr., Francis Grab, Kimberly Tan Majure –
June 11, 2002

There has been growing interest in some academic circles, on Capitol Hill, and within the Treasury Department for serious consideration of U.S. international tax reform in the form of a territorial tax exemption system. In recent years, international tax reform proposals generallyand, in particular, ways to improve competitiveness and promote simplification, have been discussed at length. On March 20, 2002, for example, House Ways and Means Committee member Amo Houghton (R-NY) introduced the "International Tax Simplification and Fairness for American Competitiveness Act of 2002," a bill to simplify taxation rules for U.S. businesses operating abroad. Also this year, congressional focus on corporate inversion transactions and the resulting introduction of bills to curtail “corporate expatriations,” have highlighted the issue of whether flaws in the U.S. international tax rules undermine an American company’s ability to compete in the global marketplace. Last year, the Joint Committee on Taxation released a report on U.S. tax simplification, which stated the Committee's cumulative findings for an 18-month simplification study (the "JCT Report"). In the last Congress, Rep. Houghton and Sander Levin (D-MI) introduced a bipartisan international tax simplification bill. A companion bill was introduced in the Senate Finance Committee by Senators Orrin Hatch (R-UT) and (now chairman) Max Baucus (D-MT).

The specific concept of reforming the U.S. international tax system by shifting to a territorial tax regime has arisen most recently in the context of the unfavorable WTO decision regarding the FSC regime, and was further catalyzed by a similarly unfavorable decision regarding the ETI, or FSC-replacement, legislation. The WTO's decisions that both the FSC and the ETI regimes provided illegal export subsidies have caused substantial concern among U.S. taxpayers. This concern is firmly rooted in the common perception that the territorial tax systems as maintained by several European countries do, in fact, provide effective export tax incentives, yet survive or circumvent WTO constraints. The decisions, in turn, have sparked significant interest in a territorial exemption regime as a possible mechanism for complying with international trade obligations while improving U.S. competitiveness in a global economy.

The concept of a territorial regime has also been discussed in the context of so-called corporate inversion transactions. Many companies reportedly are considering reincorporating in a tax haven jurisdiction to avoid the application of various U.S. international tax rules. Concerns over the spread of these transactions have led to calls for adopting a territorial system to discourage companies from considering inversions.

In addition, certain proponents believe that territorial exemption systems improve "tax competition" between countries seeking to attract foreign investment. Such competition, they believe, will ultimately drive down income tax rates in such countries, and improve the global economy overall.

Finally, serious consideration has been given as to whether a territorial exemption regime could address the historically perceived need for U.S. tax simplification.

In light of these considerations, the NFTC decided to undertake a study to evaluate the efficacy of implementing some form of a territorial tax exemption system in the United States. In so doing, 32 member companies formed a study group (the "Territorial Study Group") to review the basic features of the "traditional" territorial systems, as well as the features of one ormore possible alternative exemption systems, and to evaluate each variation in terms of future U.S. competitiveness, effect on current WTO issues, tax simplification and long term stability. The Group then considered whether a switch to any model of territorial exemption system would be more likely to address these considerations than simply adopting specific reforms to the current U.S. tax system.

This paper describes the specific issues considered by the Territorial Study Group, and presents the Group's findings and recommendations.