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Aug. 26 — The notion of charging expatriating companies an exit tax based on their offshore earnings is becoming increasingly central to the presidential campaign of Democratic nominee Hillary Clinton after being batted around Washington for a few years.
“If they want to go, they're going to have to pay to go,” the former New York senator and secretary of state said in describing her economic plan in Warren, Mich., earlier in August, repeating a variation on the idea she has mentioned often during her campaign.
Clinton's plan as described on her website would require a U.S. company to immediately pay corporate income tax on overseas income it has deferred if the ultimate parent's tax residency moves to a non-U.S. jurisdiction. The concept has picked up some airtime recently, featured in a television spot played heavily during coverage of the summer Olympic games.
“How would we make the economy work for everyone?” a grave announcer intones. “By making big corporations and those at the top finally pay their fair share in taxes. And those companies that move overseas, she'd charge them an exit tax.”
In the ad, a cartoon image of office buildings travels over a choppy ocean toward an unknown shoreline as the announcer promises that Clinton would use the money earned through the tax to make “the largest investment in creating good-paying jobs since World War II.”
The exit tax isn't Clinton's only proposal dealing with international taxes—or even the only one concerning corporate inversions or expatriations. But something about the simple concept of making corporate exiters “pay” and using the money to invest in jobs seems designed to tap into populist anger about the increasing concentration of wealth in the hands of a few.
“There's an intuition to it, it's simple,” said Steven Rosenthal, a senior fellow at the Tax Policy Center, a think tank jointly established by the Brookings Institution and the Urban Institute. “Collect the tax before they escape.”
Rosenthal said the Clinton campaign contacted him to talk about the exit tax in the fall of 2015, when Clinton was locked in a tough primary fight against the independent Vermont Sen. Bernie Sanders, whose campaign focused on international trade deals he claimed harmed American workers and the corrupting influence of money on the political system.
In a year in which the Republican nominee, real estate magnate and reality TV star Donald Trump, has run a protectionist campaign blasting trade deals such as the North American Free Trade Agreement and the Trans-Pacific Partnership, the exit tax seems to fit into a larger narrative of looking out for American workers in a hostile economic world—a notion both parties can support, another practitioner suggested.
“Whether it's companies moving to Mexico to open a factory or companies that are moving overseas, this seems to be a bipartisan issue, at least at the presidential level,” said Kyle Pomerleau, director of federal projects at the Tax Foundation, a right-leaning Washington think tank.
The political simplicity and compelling logic of the exit tax would likely continue should Clinton win in November, elevating it as a legislative priority in the new Congress.
The exit tax sits alongside other proposals to discourage or end corporate expatriations. Clinton's campaign platform also calls for reducing the threshold by which the Internal Revenue Service can disregard a relocation of tax residency. Under her plan, if the new company formed by a reorganization has 50 percent or more of the old company's shareholders, it will still be a U.S. company for tax purposes.
In addition, the plan calls for restrictions on earnings stripping, which occurs when companies use excessive intercompany debt to move income through interest deductions—seen as a primary incentive behind corporate inversions and expatriations, because U.S. laws tightly restrict such maneuvers for U.S. resident companies.
If the entire platform were enacted into law, the exit tax would have a narrower focus than its rhetoric might imply, covering only companies that somehow avoid the 50 percent threshold or are acquired by a larger foreign corporation.
On the website, the Clinton campaign said that limiting expatriations through a smaller foreign entity doesn't go far enough.
“This would be an important step forward, but alone is not sufficient,” the website reads. “In the absence of additional measures, corporations could still game the 50 percent threshold or barely meet it, and the tax system would continue to favor corporations that move their residence abroad through foreign takeovers.”
Clinton's three-pronged approach would seem to cover all of the scenarios under which a company might attempt to change its residency for purely tax reasons.
“It's kind of a belt and suspenders situation,” said Reuven Avi-Yonah, a professor of international tax at the University of Michigan Law School.
Rosenthal, one of the early advocates of the exit tax, said encompassing all manner of corporate exits—an inversion through a merger with a foreign entity as well as an outright takeover by a larger one—maintains a fairer playing field.
“Any corporation that escapes the U.S. tax net, whether through deliberate inversions or being acquired, represents in my view a hole in the tax web to allow unrepatriated earnings to escape taxation,” he said.
Foreign acquisitions, however, haven't earned the same level—or flavor—of outrage generated by a recent spate of corporate inversions. In 2014, a series of high-profile and iconic U.S. firms including Burger King, Pfizer Corp. and Walgreen Co. either considered or undertook inversion transactions, stoking public controversy and vaulting the issue into the political fray. President Barack Obama derided the maneuver as exploiting an “unpatriotic tax loophole.”
An acquisition by a foreign firm tends to be viewed more as a tough but fair example of global capitalism—even if tax savings are a factor.
“If you start blocking acquisitions by foreigners, it almost gets to the point where people start worrying that you're blocking legitimate transactions,” said David Rosenbloom, a professor of international tax at New York University School of Law and a member of Caplin & Drysdale.
But defenders of the exit tax say it is aimed at deals that are specifically motivated by tax incentives because it targets companies with large amounts of deferred income—the more money offshore, the bigger the tax hit.
“It makes sense. You have this huge pile of money, it's overseas, it's money that's owed, and this just makes sure that the taxes are paid before the company in effect leaves the country,” said Chuck Marr, director of federal tax policy for the Center on Budget and Policy Priorities, a left-leaning think tank. “You'd never write a law saying, ‘let's have tax forgiveness to make it easier for other companies to buy U.S. companies.' ”
Part of the exit tax's appeal is that it hits at what is seen as a significant driver of inversions, as well as tax avoidance in general—the ability of U.S. companies to stockpile earnings offshore to avoid U.S. corporate income tax. The U.S., unlike most of the world, taxes the worldwide income of its resident companies, minus a credit for foreign taxes paid. Those taxes, however, can be delayed if the company defers income overseas.
That stockpiled cash—which some reports claim is as high as $2.4 trillion—has become a major political flash point. Companies including Apple Inc. and Microsoft Corp. have come under fire for tax structures that allow them to locate highly valuable intangible assets in low-tax jurisdictions such as Ireland.
Thus, the exit tax would have the biggest effect on the corporate inversions and expatriations that have already been deemed the most problematic, targeting several of the most controversial parts of the U.S. corporate tax system at once.
The tax would have less of an effect on companies that haven't yet accumulated large offshore earnings, which some view as a potential flaw if it isn't accompanied by other measures to discourage expatriations.
“There are various reasons why people invert. One of them is to gain access to amounts of cash that have been accumulated offshore,” said Rosenbloom of NYU. “It would hit that kind of objective. But the more common objective, I think, is to lever up your U.S. operations, so you can do business in the U.S. as a foreign company, and get the benefits from that. If you take a company that didn't have much offshore build-up of cash—and there are plenty of those—they might not have much of an exit tax.”
Treasury has already attempted to address many of these issues through regulations—an approach the administration blames on an inactive Congress.
Following the surge of inversion activity in 2014, Treasury issued Notice 2014-52 to, among other things, curb the use of “hopscotch loans” by newly inverted companies to gain access to cash that had previously been held offshore (185 DTR G-8, 9/24/14).
In 2015, it followed those rules with Notice 2015-79, cracking down on other tactics used in an inversion, including the use of a third country to further reduce the company's effective tax rate (224 DTR GG-1, 11/20/15).
Most recently, in April 2016, Treasury released a new batch of regulations (REG-108060-15) using Section 385 to target earnings stripping through intercompany debt—a common post-inversion technique—and enhancing Section 7874 to target so-called serial inverters (REG-135734-14, T.D. 9761). The earnings stripping rules have provoked a furious response from Republican lawmakers.
The basic idea of an exit tax has been proposed by several Democratic lawmakers, including Sen. Sherrod Brown (Ohio), Sen. Dick Durbin (Ill.) and Rep. Lloyd Doggett (Texas).
Doggett's version initially applied a 50 percent shareholder continuity threshold for the exit tax. The latest version of his bill (H.R. 5125), now entitled the Corporate Expatriates and Inverters Tax Fairness Act (presented as the Corporate EXIT Fairness Act), released after Clinton's campaign picked up the idea, includes all instances when a tax residency is changed.
But despite its popularity, the concept has never been scored by either the Congressional Budget Office or the Joint Committee on Taxation. The Department of Treasury estimated that Obama's proposals to stop inversions would save $14 billion in revenue over the next 10 years—but that proposal doesn't include an exit tax, and it doesn't affect foreign acquisitions one way or the other.
Nor has anyone looked deeply into how such a measure would affect investment into or out of the U.S.
Inversions don't present Europe with the same vexing issue confronting U.S. lawmakers. Exit taxes have been the norm in the European Union for years, although they're designed around a different set of incentives. As most European countries have transitioned into territorial systems, offshore cash holdings haven't become a significant issue.
The U.K., for instance, requires exiting companies to pay a tax based on the appreciated value of their assets. Because shares from subsidiaries are exempt in most cases, the tax often hits companies with U.K. intangible assets the most, according to Heather Self, a partner at Pinsent Masons in London.
A tighter versions of the exit tax was included in an earlier draft for a set of anti-tax avoidance measures being considered by the European Parliament, but was ultimately dropped from the final package.
Supporters of an exit tax in the U.S. also note that similar provisions already exist in the law for individuals. The Expatriation Tax requires any U.S. citizen with a net worth of $2 million or more to pay taxes on the appreciated value of their assets upon renouncing U.S. citizenship. The law also levies taxes on deferred compensation plans, such as individual retirement accounts.
Just as a wave of corporate inversions provoked a political backlash, high-profile examples of U.S. taxpayers renouncing their citizenship—such as Facebook Inc. co-founder Eduardo Saverin, whose declaration of Singapore citizenship allegedly saved him $700 million in capital gains tax—resulted in calls for tougher laws on personal expatriations.
However compelling the logic behind an exit tax, it is something that is generally viewed as working within the current international corporate tax system—if a broader overhaul eliminated offshore stockpiles, or repatriated them, it would have little effect. This is a disappointing aspect for those who are seeking a broader rewrite of international tax rules.
“It's not haphazard, but it's just a patch to a system that doesn't work very well,” said Pomerleau of the Tax Foundation.
Most plans for an overhaul of the U.S. corporate tax system include provisions to deal with current deferred offshore holdings and prevent or discourage future stockpiling—a concept that, as of yet, Clinton has neither endorsed nor disavowed.
Others, though, see hints of a broader plan in Clinton's rhetoric—such as her promise to spend $275 billion on infrastructure improvement, funded through “business tax reform”—what Height Securities LLC analyst Henrietta Treyz called “code for repatriation.”
But the specific focus on expatriations—while one that appears to tug at the gut of most Americans—can sometimes miss the bigger picture, others argue.
“It's a partial solution. It's only attacking foreign firms that used to be U.S. firms,” said Eric Toder of the Urban Institute. “The broader problem is that foreign firms get certain tax advantages that U.S. firms don't.”
Clinton's proposals on earnings stripping would level that playing field, at least in part, but if the exit tax focus eclipses other priorities, that nuance could be lost during the complicated sausage-making of legislation.
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Clinton's plan on inversions and the exit tax is at http://src.bna.com/hZ1.
Copyright © 2016 The Bureau of National Affairs, Inc. All Rights Reserved.
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