Tax Analysts Blog

A Safe Harbor for Deferral?

Posted on Mar 6, 2012

President Obama's proposed minimum tax on offshore profits remains the talk of the town. That tells you something about the nerdy crowd I hang out with. (Until recently I thought glee was the emotion one feels when contemplating capital export neutrality. Turns out it's a TV show).

But back to taxes. The gist of the minimum tax is that certain offshore profits -- those subject to very low effective rates -- would lose deferral treatment. Instead they would be taxed on an accrual basis. The difference is one of timing.

Accrual treatment means profits are taxed currently in the year the money is earned. Deferral means the corporation can delay the tax until the profits are repatriated to the U.S. There's an enormous economic benefit to paying taxes later rather than sooner.

My earlier post suggested the minimum tax might take the form of a low-tax kickout rule. In particular, a rule based on a fixed percentage (say 50%) of the prevailing U.S. statutory rate. Flunk the kickout rule and your affected profits lose deferral.

Here's a twist we didn't address. Should the foreign effective rate be determined by reference to each country, or by reference to each taxpayer ?

A per-country model has the benefit of predictability. It wouldn't take long for tax advisors to figure out which countries have effective rates so low they spell trouble. That would result in a de facto blacklist of tax havens where you're stuck with accrual. Similarly, safe harbors for deferral would likely develop. ("Avoid countries X, Y and Z and you'll steer clear of the minimum tax.")

Is that how the minimum tax should operate? Is the per-country approach conceptually valid? Many observers regard blacklists as sloppy and imprecise. The same can be said of safe harbors or 'angel lists'. Both are subject to the law of unintended consequences. [Would foreign governments lobby their way off the accrual blacklist?]

A per-taxpayer model would be based on an accounting ratio that's unique to each company: taxes paid divided by book income. That figure can differ for firms in the same country depending on their business model and earnings profile.

We leave you with the following food for thought. If the corporate minimum tax were to become a reality, should U.S. firms be able to determine in advance whether their foreign affiliates are subject to the tax (by virtue of a per-country rule )? Or should they go about their business and determine whether they're hit by the tax at the close of the year (by virtue of a per-taxpayer rule)?

What say you?

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