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Florida Tax Review

Abstract

The Report of the President's Advisory Panel on Federal Tax Reform (the "Report") recommends the U.S. adopt a territorial tax system that would exclude income earned by U.S. taxpayers actively conducting foreign businesses. This exclusion would also apply to dividends received from controlled foreign corporations to the extent such dividends were attributable to the corporation's conduct of active foreign businesses. The Report justifies this recommendation by stating that a territorial system is simpler than the current global approach employed by the U.S. and that a territorial tax will improve efficiency. In an accompanying article, Professor McDaniel has demonstrated that simplicity cannot be achieved under a territorial or global system. Under either system, the U.S. will have to address source issues, transfer pricing issues and IRC Section 367 concerns.

This article focuses on the Report's efficiency arguments for a territorial tax. The Report asserts that a territorial tax will permit U.S. multinationals to compete more effectively in low-tax jurisdictions and will eliminate the tax bias against repatriating earnings. The Report anticipates that its proposal might generate concern about a potentially significant efficiency problem—whether a territorial system would cause U.S. businesses to allocate more jobs and assets overseas to low-tax countries.

The study referred to by the Report to support its conclusion is Where Will They Go if We Go Territorial? Dividend Exemption and the Location Decisions of U.S. Multinational Corporations, by Rosanne Altshuler and Harry Grubert. In their careful study, Altshuler and Grubert say that they cannot “make any firm prediction of how location behavior would change if the U.S. were to adopt a dividend exemption system." They further note that "the analysis provides no consistent or definitive evidence that dividend exemption would induce a large outflow of investment to low-tax locations."

The Report relies heavily on the Altshuler-Grubert article to bolster its assertion that the territorial system would not adversely affect U.S. production. Note, however, that the Altshuler-Grubert article does not conclude that aterritorial system would have no effect on the investment of U.S. capital. The Report correctly states that the Altshuler-Grubert article found no evidence that a territorial system "would induce a large outflow...." The Report incorrectly uses this lack of evidence to leap to the inference that "the territorial system the Panel has proposed would not drive U.S. jobs and capital abroad...."

This inference is inappropriate. As lawyers, we have been trained that a lack of evidence means that no conclusion can be reached. Although the Report uses the absence of conclusive findings to support the assertion that there will be no adverse effect, a careful reading of the Altshuler-Grubert article reveals that Altshuler and Grubert view their results as inconclusive. They are very careful to point out that their analysis produces mixed results about whether an exemption system would lead to more foreign direct investment ("FDI") by U.S. multinationals. Indeed, as this article will discuss, the Altshuler-Grubert paper leaves many unanswered questions that make it impossible to conclude what effect a territorial tax will have on domestic investment.

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