Territoriality in Search of Principles and Revenue: Camp and Enzi

This article reviews proposals by House Ways and Means Committee Chairman Camp and Senator Mike Enzi to shift the United States from its current system of deferring taxation of active foreign income to a system that would exempt foreign business income from U.S. tax. (Neither proposal would materially affect the present U.S. system for taxing U.S.-source income.) The major contributions of the Camp Proposal lie in its recognition of the need to (i) make the treatment of foreign branches and foreign subsidiaries more neutral, and (ii) protect the U.S. tax base from excess interest deductions and the base-eroding incentives of very low foreign tax environments that stimulate U.S. income shifting. However, these improvements to current law would not justify changing to an exemption regime under the Camp Proposal in light of its many weaknesses, which include (but are not limited to) (i) material under-allocation of expenses to exempt foreign income, (ii) material loopholes in its anti-abuse rules for protecting the U.S. tax base, (iii) an apparent failure to tax gain upon transfers of appreciated assets into the exemption regime, (iv) foreign tax credit changes that would result in additional erosion of the U.S. tax base and (v) a misguided proposal for a reduced tax rate on royalties earned from foreign persons. The Enzi Proposal has similar weaknesses while lacking the strengths of the Camp Proposal. Our analysis of the Camp and Enzi Proposals highlights that U.S. international tax reform is integrally related to U.S. corporate, shareholder and business pass-through taxation. A full consideration of any international business taxation proposal must be in the context of the overall income tax regime within which the international rules must operate. Chairman Camp has promised a comprehensive tax reform proposal; and business and financial products elements have been put forward. However, a final evaluation of his international proposal must await release of a completed, integrated tax reform package, including final corporate and individual tax rates. Senator Enzi’s proposal is a stand-alone reform and apparently is intended for adoption irrespective whether the corporate tax rate is reduced or other tax reforms are enacted. In a recent article we articulated how a principled exemption system should be designed so as to protect the U.S tax base. It is possible to modify the Camp and Enzi Proposals to address their weaknesses in ways consistent with a principled exemption system. We recognize that such changes would make them unattractive to many in the multinational corporate community; however, that likely is true of any exemption system that would be a material improvement over current law. In our view, unless a shift to an exemption system would constitute a material improvement over current law, the likely revenue losses and transition costs of such a change would outweigh the benefits