In some situations involving hybrid arrangements, it is possible for a taxpayer to ‘split’ creditable foreign taxes from associated foreign income. As such, a tax credit could be allowed for foreign taxes on income not subject to U.S. federal income tax.

 

Superficially, this change makes sense. After all, why should a tax credit be given out for income not subject to tax? However, this change is only necessary because we have the most convoluted foreign tax system in the world.

As a principle of national sovereignty, a country should only govern what happens in its borders. And that means should only tax what occurs inside its borders. Yet we are one of only 5 countries that tax worldwide income. This means that we tax revenue made in other countries – even if they have already paid taxes there. The rest of the world has a territorial tax system – you only pay taxes for activity that happens inside your country.

 

What this system means is that U.S businesses are forced to pay taxes twice. Firstly, to the country where they do business, and then again to the U.S. taxman. To make matters worse, U.S. corporate taxes are the highest in the world! This means U.S companies are at a serious disadvantage to their foreign competitors who do not have this burden. In order to stay in business, many companies have created hybrid arrangements to ease the burden of big government. This is the only way they have been able to keep their doors open, and to continue helping the U.S economy.

 

This rule change does address one minor problem. But in doing so, it makes the whole situation worse.

 

If we want a flexible, fair and transparent corporate tax system, we must abandon this failed method of worldwide taxation, and follow the rest of the world in adopting a territoriality based system.

 

U.S. Department of Treasury: $18.5 billion

Joint Committee on Taxation: $10.2 billion