A. the sales are made in the country of incorporation of the subsidiary (IRC Section 954 (d)); B. the manufacturing or production occurred in the country of incorporation of the sales subsidiary (IRC Section 954 (d)); C. the sales of such products are made out of the country of incorporation of the subsidiary and the gross income from such sales (and other foreign base company income) is less than 30 percent of the subsidiary's gross income (IRC Section 954(b) (3) (A)); D. the subsidiary qualifies as a foreign Export Trade Corporation with 75 percent or more of its gross income from the sale of property grown, extracted, produced or manufactured in the United States, and the deferred income does not exceed the lesser of 12 times the export promotion expenses of the export trade corporation, or 10 percent of its gross receipts for the year, to the extent the income is invested in "export trade assets" (IRC Section 970). 3. Minimum distributions—combining foreign manufacturing and a foreign sales intermediary. If a U.S. corporation establishes a manufacturing subsidiary or subsidiaries in one or more countries with relatively high foreign tax rates, the products of such corporations and those of the U.S. parent corporation, may be sold through a foreign sales intermediary based in a jurisdiction with minimal local income taxes. If the rate of foreign taxes on the combined manufacturing and sales operations approximates 90 percent of the U.S. tax rate, U.S. corporate tax on the sales company income is deferred until its ultimate distribution. IRC Section 963. The considerable utility of this provision was summarized by corporate tax counsel in a professional tax publication as follows: "U.S. companies that at present do not have foreign subsidiaries operating in low-tax-rate countries can now consider creating such companies, certain in the knowledge that they will be shielded from current U.S. tax, even if these companies earn substantial Subpart F income, so long as the requirements of this section are met. U.S. companies which presently have foreign companies of this nature can now consider creating additional companies of this type." "How to Determine Eligibility and Claim Exemption for Minimum Distributions," in Practical Problems of Taxation of Foreign Income, published by the Journal of Taxation Inc. p. 120 (1965). 4. Inter-company pricing. Regulations under section 482 of the Internal Revenue Code apply a strict standard for arm's length inter-company pricing on sales by United States exporters to foreign affiliates, thus limiting the advantages of a foreign sales intermediary used for the distribution of U.S. exports. In comparison, inter-company sales between foreign manufacturing affiliates and related foreign sales companies are subject to foreign inter-company pricing rules which are often less strict than the U.S. section 482 regulations. The comparatively lenient foreign rules, in combintion with the rules discussed above, and the possibility of organizing a sales company in a low tax country, provide an additional impetus for foreign manufacture by U.S. companies. The CHAIRMAN. Are there any further questions? Mr. BYRNES. To what degree now in the Treasury do you have sort of a survey of what other foreign countries may be doing in the area of taxation? Mr. NOLAN. We have been working on a compilation of the provisions of the tax laws of other foreign countries which bear on this problem. Mr. BYRNES. You mentioned before, Mr. Nolan, there were a number of countries that provided certain tax advantages for export. I wonder if it would be helpful, if it is available in any tabulated form, to see just what some of these other trading countries do in terms of their tax policy vis-a-vis export business. Mr. NOLAN. Let us submit an analysis with regard to the foreign countries and their tax laws as they affect export activity. Mr. VOLCKER. This would be helpful, but this gets to be a very complex matter affected by private rulings as well as public laws. Just a simple matter, as a country that permits this kind of arrangement to operate, say, through Switzerland or some other low-tax country, is in effect providing the equivalent in a slightly different direc tion, and you have to appreciate the nuances of which countries the subsidiary can be located in, and what their tax is in turn, to fully recognize the impact. So it gets very complex, but we will certainly do what we can do. Mr. BYRNES. I realize it can get complex, but to the degree we can have it in a concise form, even if it is generalized-we know some countries think the tax law operates out of the hip pocket of someone rather than in the law, but to the extent you can get it on the basis of what their law is supposed to be, anyway, maybe this can be of some help. (The information requested follows:) PROVISIONS IN FOREIGN DIRECT TAXATION LAWS AFFECTING EXPORT ACTIVITIES On May 12, 1970, during the Treasury Department's presentation of its proposal for the Domestic International Sales Corporation to the House Ways and Means Committee, the Treasury Department was requested to submit information regarding the income tax laws and practices of other nations which operate to the advantage of export activities. The following description of foreign income tax law and practices is confined largely to other industrialized countries. It should be noted that in many foreign countries tax treatment favorable to export activities is frequently accorded on an informal, administrative basis and may, therefore, be difficult to identify. This memorandum is intended to suggest some of the income tax provisions and administrative practices that can affect the export of products from various foreign countries. Some of the most significant provisions that would affect tax planning for export sales were not intended as export incentives when adopted but evolved from traditional theories of tax jurisdiction and taxation of foreign source income. Devices having the effect of export incentives range well beyond income tax measures, including, among others, direct grants, government credit facilities, interest subsidies, insurance, guarantees, internal shipping subsidies, exchange control privileges, and tax measures other than those affecting income taxes. Some forms of government assistance may be available ostensibly for domestic as well as export activities, making it difficult to classify them solely as export incentives. Rebates of value-added and other turnover taxes provide an export inducement to exporters in countries having such sales tax systems. The following summary is not exhaustive nor has it been verified by counsel in each of the countries. It is nevertheless believed to be accurate and, except where specifically indicated, current. The summary consists of a list of seven specific types of provisions. Attached to the list are individual country summaries for 17 countries. It should be recognized that numerous U.S. corporations have established foreign subsidiaries which have benefited from the favorable treatment discussed in many of these countries. The various laws and practices are as follows: 1. Taxation of Foreign Source Income. Unlike the United States, many industrialized countries impose income taxes on a territorial basis, which means that foreign source income is often wholly or partially tax exempt. Such exemption may apply not only to income from direct investments abroad, but also to foreign sales of domestically-produced products either through a foreign subsidiary or through a branch or dependent or independent agent. In the case of most developed countries, exports can be made through controlled sales companies organized in low tax jurisdictions with a consequent tax shelter for the sales profits. For example, a manufacturing corporation, A, in country X, which may or may not be a subsidiary of a U.S. corporation may make its export sales through a related sales corporation, B, located in country Y where corporate taxes are minimal. To the extent Corporation B makes part of the profit that Corporation A would have made in direct sales, the tax burden is reduced. While most countries have protective provisions in their tax laws that permit the local tax authorities to reallocate income between related entities, different countries have different rules as to such allocations, and considerable flexibility is often found in intercompany pricing. In at least some cases (as indicated below) it is understood that no reallocation would result from the prices charged by Corporation A to B as long as Corporation A earned at least one-half of the combined profits. In some cases foreign sales corporations can establish purchasing and coordinating branches in the manufacturer's home country without affecting the income tax exemption of the foreign sales corporation, while facilitating exports through the sales corporation. 2. Specific Export Income Exemptions. Some countries, such as Ireland, have income tax exemptions for export sales. Such exemptions are sometimes limited to products produced in free-trade zones or depressed areas. As indicated below some countries extend income tax exemptions or other benefits to companies locating in depressed areas, but in practice the benefits are offered largely to companies with a high export or import substitution potential. 3. Accelerated Depreciation. Several countries (e.g., Japan, France) permit or have permitted accelerated depreciation allowances for assets used in export production. 4. Special Reserves (Market Development, Bad Debt). Several countries, (e.g., Australia, France, Japan, Spain) have permitted special deductions for export market development or special bad debt reserves in connection with export credits. 5. Special Deductions, Rate Reductions or Credits Related to Exports. Australia reduces payroll taxes by an amount related to export increases. New Zealand permits a deduction from income taxes of 15 percent of increased export receipts: France permits deductions for the expenses of establishing foreign sales offices although income from such offices may subsequently be exempt. 6. Favorable Inter-company Pricing Rules. Either express rules or administrative practices frequently provide an additional incentive for export transactions through related foreign subsidiaries. In some countries, administrative practice permits considerable flexibility in inter-company pricing rules. In some jurisdictions, rule-of-thumb allocations permit 50-50 divisions of taxable income, even in cases where the foreign subsidiaries perform minimal functions. 7. Discriminatory Allocation of Benefits Based on Export Production. In addition to provisions related formally or informally to exports, there are often benefits (tax holidays, capital grants, investment allowances, interest subsidies, etc.) designed to attract new investments which are not always tied to exports in the legislative enactments, but potential exports are an important factor in the granting of such benefits. In some cases, the import substitution effect is also of importance in granting such benefits. Not only are each of the devices listed above employed by one or more foreign countries, but the cumulative effect of these devices used by certain individual countries should not be overlooked. Thus, for example, Japan uses the following in combiation: 1. Accelerated depreciation based upon export performance; 2. A deductible reserve for the development of overseas markets; 3. Special deductions for a variety of activities producing foreign exchange; 4. Liberal entertainment expenses to promote export sales. Foreign Source Income AUSTRALIA Income derived by a resident Australian company from foreign sources is exempt from Australian income tax provided that it is not exempt from tax in the country of origin. The income earned by a foreign sales subsidiary of an Australian company is not subject to Australian income tax until distribution to Australian shareholders. Export Market Development Rebate Australian law provides a tax rebate (credit) of 42.5 percent of an expenditure incurred for export market development and also permits the full deduction of the expenditure incured. The combined effect, as computed under the tax laws, permits a total tax saving of 87.5 cents for each dollar of expenditure. Qualified expenditures include among others: market research, overseas advertising, certain travel expenses, labels and packaging for export, protection of property rights, the preparation of tenders or quotations, and the supplying of technical data. Payroll Tax A refund of payroll taxes is made in the event of an increase in export sales over a base period. BELGIUM Foreign establishments and subsidiaries Income from a foreign establishment of a Belgian company is taxed at a reduced income tax rate equal to one-fourth of the ordinary rate; provided the income was generated and taxed abroad. The income of a foreign sales subsidiary is not taxed until dividends are distributed. Upon distribution, the net dividends received (after deduction of foreign tax) are subject to a 10% tax withheld by the paying agent in Belgium. The amount remaining after the foreign tax and 10% Belgian tax is entitled to a 95 percent exemption in determining the Belgian company tax. The company income tax therefore applies to an amount equal to 5% of the net foreign source dividends. Development subsidies The Belgian government provides incentives for investment in certain areas of Belgium. The current provisions have a termination date of June 30, 1970. However, a new law to extend the provisions has been proposed. The incentives currently offered consist of interest subsidies, loan quarantees, capital, allowances (with tax exemption for such allowances), and exemption from the registration tax. It is understood that export projections are included in the criteria for determining the granting of such incentives. Foreign subsidiaries CANADA Canada does not presently tax currently the undistributed earnings of foreign sales subsidiaries. Dividends from a nonresident foreign corporation acting as a foreign sales subsidiary are exempt from Canadian income tax if more than 25 percent of the share capital is owned by the Canadian corporation receiving such dividends. A tentatively proposed Canadian tax reform would limit such exemption to foreign corporations in countries with which Canada has entered into income tax treaties. Grants Canada offers grants to companies, domestic or foreign, to locate in slow growth areas. These incentives are not expressly tied to export sales or import substitution. Most of the provinces also offer grants and loans to achieve the same desired objectives. The Province of Quebec has, however, an incentive program which is designed to aid companies who use "advanced technology" and "who are in position to supply world markets." Grants are also available to Canadian companies to encourage scientific research and development in Canada. To qualify for such assistance, recent amendments have required Canadian companies to be prepared to exploit the results of such research in Canada's export markets as well as in Canada. The grants are not available to companies excluded from selling to major export markets. DENMARK Foreign Permanent Establishment; Sales Subsidiaries Where a resident Danish company has income from a foreign establishment, the proportion of total Danish tax payable with respect to such income is reduced. The reduction amounts to 50 percent of the Danish income tax applicable to the before tax net income of the foreign branch or other establishment. A foreign sales subsidiary is not taxed currently on its sales profits. Dividends paid to a Danish corporation owning 25 percent or more of the shares of the subsidiary are taxed at a reduced rate of application for a refund with the reduction being computed in a manner comparable to the reduction for foreign branch income above. Export Sales FRANCE Profits on sales of goods which are manufactured in France and shipped abroad by a French company are taxed only to the extent that they are realized through the allocable to operations in Franch ("enterprise exploitée en France"). Profits are treated as foreign source income and not subject to current French income tax where they are: derived from establishments abroad (Conseil d'Etat. March 9, 1960); derived from operations abroad of dependent agents (Conseil d'Etat. June 5, 1937); derived from operations abroad which constitute a complete commercial cycle ("cycle commercial complet") (Conseil d' Etat, February 14, 1944). The territorial exemption applies to the foreign source profits when earned and when remitted to the French company. Foreign Sales Subsidiary Profits earned by a foreign sales subsidiary of a French company are not taxed currently in France. Upon distribution of a dividend from a foreign subsidiary to a French company, there is a 95% inter-company dividends received deduction. To obtain such deduction the parent must hold a minimum of 10% in the equity capital of the subsidiary or the cost acquisition of the participation must have been at least 10 million francs. The 5 percent taxable portion of the dividends represents a lump sum deduction to cover business expenses attributable to the exempt dividends. Distribution of Foreign Source Income to French Shareholders The tax exempt foreign source income of a French corporation, including income exempt under the territorial rules or under the 95 percent intercompany dividends received deduction is not taxed until a distribution to shareholders. Upon distribution a French company must make a supplementary tax payment (précompte) equal to one-half of the dividend to the French Treasury with respect to profits that did not bear the normal 50 percent French corporate tax rate. At the shareholder level, the shareholder is entitled to a credit equal to one-half the dividend, which is applied against his personal tax on the dividend grossed up by the credit. Inter-company Pricing Article 57 of the Code General des Impots provides that profits indirectly transferred to controlled enterprises outside of France through inter-company pricing are to be reallocated and that such adjustments may be based on comparison with the operations of similar enterprises operating normally. However, it is understood that, under administrative interpretation, Article 57 is not employed where exporting enterprises can establish that sales made by a parent French corporation to foreign subsidiaries at prices approximating cost do not have as their objective the shifting of income but are due to "commercial requirements." Specific Export Incentive Provisions 1. A 1959 reform law provided that depreciable assets (other than immovables) purchased or manufactured between January 1960 and January 1965, were entitled to special accelerated depreciation in the case of "exporting enterprises." The accelerated depreciation is equal to the straight-line depreciation multiplied by 150 percent of a fraction, the numerator of which is the export production and the denominator of which is total production. (Article 39A Code General des Impots). 2. French enterprises are allowed a special deductible reserve for middle term (2-5 years) loans extended to foreign customers (Article 39-1-5 Code General des Impots). The reserve allowance is more generous than normal bad debt reserves. 3. Expenses for establishing and operating foreign sales offices during their first three years of operation may be deducted against domestic income, even though future profits may be tax exempt. (See Article 39 Code General des Impots; Article 34 of the Law of July 12, 1965). GERMANY A resident German corporation is taxed on its worldwide income. When business profits are derived through a foreign "business establishment" they are deemed to be from a foreign source. This rule is applied to any fixed installation or facility which serves the business activity of the Germany enterprise. A permanent representative (whether dependent or independent) is included in this concept whether physical facilities are present or not. Broadly speaking, a foreign business connection is generally sufficient to create foreign source income.1 Some German commentators have stated that domestic source income is limited to profits derived from deliveries of goods to foreign countries by German enterprises which have no business connection whatsoever in the foreign country concerned. 1 Where there is no foreign connection, full German tax rates (without foreign tax credits) apply. 1 |