Obama proposes minimum tax rate on foreign earnings

President Obama has set out his proposals for corporate tax reform in the US, and it will comes as no surprise to those in the offshore finance centres that anti-offshore rhetoric continues to underpin many of the changes. 

The key element of the plan is to cut the corporate tax rate to 28% from the current 35% rate, but at the same time closing loopholes used by corporations to reduce their tax burdens.

The US corporate tax system currently has notionally the second highest statutory corporate tax rate among developed countries (although in reality, the enormous deductions that are permitted mean that many companies pay far less in reality) and the US Treasury has concluded that the current system is “uncompetitive, unfair, and inefficient”.

The most important aspect of the proposals so far as international finance cerntres are concerned is the proposed establishment of a new minimum tax on foreign earnings, to encourage domestic investment.  The Treasury report says that the current system “is subject to gaming, as corporations manipulate complex tax rules to minimize taxes and, in some cases, shift profit actually earned in the United States to low-tax jurisdictions.”
The current US tax system allows foreign subsidiaries of US-based multinationals to defer taxes on their overseas income until they repatriate it to the United States. However, as many companies reinvest, rather than repatriate, a significant portion of their income overseas they may permanently avoid US taxes on much of it. This gives US corporations a significant opportunity to reduce overall taxes paid by shifting profits to low-tax jurisdictions — either by moving their operations and jobs there or by relying on accounting tools and transfer pricing principles to book profits there.

Under Obama's proposals, income earned by subsidiaries of US corporations operating abroad would be subject to a minimum rate of tax, although as yet there is no indication of what rate might be set for such a proposal, and nor is there any discussion of how such a plan would be operated and enforced in practice.

A second initiative in the plan, which mirrors what is going on in some Scandinavian countries, is the proposal to treat “carried interest” as income, rather than capital gains - something which has been trailled for some time now but which remains hugely unpopular with the private equity and venture capital industry.  Today, fund managers pay the capital gains rate of 15% on their carried interest but, under Obama's proposal, it would be increased to an ordinary income rate that, for most fund managers, would be around 35%.

The Obama proposals are likely to be very unpopular with international finance centres and fund managers alike, but they can take comfort from the fact that the plan is unlikely to be passed through a Congress that has been paralyzed on tax matters, at least until the November elections.