A Tax Victory for Multinationals

The White House drops its proposed reform of "check-the-box" tax rules. Will it pick it up again?
Marie LeoneFebruary 12, 2010

When the Obama Administration released its budget for fiscal 2011 last week, tax executives at U.S. multinationals breathed a sigh of relief. Conspicuously missing from the budget was a controversial proposal to reform the “check-the-box” tax rule, a loophole in the tax code that companies have been exploiting since its creation during the Clinton presidency. According to the Office of Management and Budget, tightening the loophole would have put an extra $87 billion into Treasury Department coffers over the next decade.

The check-the-box rule allows companies simply to mark off several items on an Internal Revenue Service form to declare that their foreign subsidiaries should be treated as disregarded entities, rather than corporations with passive income that is subject to U.S. taxes. The effect is “to make foreign subsidiaries ‘disappear’ for U.S. tax purposes,” said IRS commissioner Douglas Shulman last year.

Such a disappearing act enables a U.S. parent company to set up structures to move cash between high- and low-tax jurisdictions without triggering Subpart F of the Internal Revenue Code, says Jonathan Lysenko, international tax director at accounting firm Amper, Politziner & Mattia. Subpart F is the tax code chapter containing the complex “anti-deferral” rules that force companies to pay tax on certain foreign-source income in the year it was earned, rather than when the U.S. parent repatriates the profits. Being classified as a disregarded entity keeps a subsidiary clear of Subpart F, says Lysenko.

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The check-the-box reform would have made it tough for any U.S.-based multinational to designate foreign subsidiaries as disregarded entities. That in turn would have “severely restricted the ability of U.S. taxpayers to reduce their effective global tax rate,” asserts Seth Entin, a tax attorney with Greenberg Traurig. Indeed, multinationals have exercised their tax-reducing powers to the limit in the past few years. The White House says that in 2004, which is the most recent year for which data is available, U.S. multinational corporations paid about $16 billion in U.S. taxes on approximately $700 billion of foreign active earnings — an effective U.S. tax rate of 2.3%.

To be sure, the Administration’s proposal sparked “a massive outcry” from executives at U.S. multinationals. Not only did critics complain that the proposal was “at best unclear and at worst misguided,” says Entin, they also argued that reforming the check-the-box rules would put U.S. companies at a competitive disadvantage with foreign competitors that operate under territorial tax regimes, as opposed to the worldwide regime used by the United States.

Under a territorial system, a company’s foreign profits are exempt from home-country taxes and instead are taxed by the country where the income is earned. A worldwide system, like the one used by the United States, taxes corporate profits when they are repatriated, or distributed to the parent company or shareholder. At that point, an American company can apply to the IRS for a tax credit for the levies paid to a foreign country, up to the U.S. tax rate. But applying for the refund is sometimes onerous.

Entin says it’s unlikely the check-the-box proposal will resurface in Congress, as no lawmaker seems to have backed the plan. But he wouldn’t rule out the possibility that the Obama Administration will resurrect the idea later this year. If it does, “hopefully it will be part of a better-thought-out strategy toward international tax, rather than some sort of Band-Aid approach where no one understands the reasoning or purpose behind it,” says Entin.