[House Hearing, 106 Congress]
[From the U.S. Government Publishing Office]






 
       IMPACT OF U.S. TAX RULES ON INTERNATIONAL COMPETITIVENESS

=======================================================================

                                HEARING

                               before the

                      COMMITTEE ON WAYS AND MEANS
                        HOUSE OF REPRESENTATIVES

                       ONE HUNDRED SIXTH CONGRESS

                             FIRST SESSION

                               __________

                             JUNE 30, 1999

                               __________

                             Serial 106-92

                               __________

         Printed for the use of the Committee on Ways and Means


                    U.S. GOVERNMENT PRINTING OFFICE
66-775 CC                   WASHINGTON : 2001

_______________________________________________________________________
            For sale by the U.S. Government Printing Office
Superintendent of Documents, Congressional Sales Office, Washington, DC 
                                 20402




                      COMMITTEE ON WAYS AND MEANS

                      BILL ARCHER, Texas, Chairman

PHILIP M. CRANE, Illinois            CHARLES B. RANGEL, New York
BILL THOMAS, California              FORTNEY PETE STARK, California
E. CLAY SHAW, Jr., Florida           ROBERT T. MATSUI, California
NANCY L. JOHNSON, Connecticut        WILLIAM J. COYNE, Pennsylvania
AMO HOUGHTON, New York               SANDER M. LEVIN, Michigan
WALLY HERGER, California             BENJAMIN L. CARDIN, Maryland
JIM McCRERY, Louisiana               JIM McDERMOTT, Washington
DAVE CAMP, Michigan                  GERALD D. KLECZKA, Wisconsin
JIM RAMSTAD, Minnesota               JOHN LEWIS, Georgia
JIM NUSSLE, Iowa                     RICHARD E. NEAL, Massachusetts
SAM JOHNSON, Texas                   MICHAEL R. McNULTY, New York
JENNIFER DUNN, Washington            WILLIAM J. JEFFERSON, Louisiana
MAC COLLINS, Georgia                 JOHN S. TANNER, Tennessee
ROB PORTMAN, Ohio                    XAVIER BECERRA, California
PHILIP S. ENGLISH, Pennsylvania      KAREN L. THURMAN, Florida
WES WATKINS, Oklahoma                LLOYD DOGGETT, Texas
J.D. HAYWORTH, Arizona
JERRY WELLER, Illinois
KENNY HULSHOF, Missouri
SCOTT McINNIS, Colorado
RON LEWIS, Kentucky
MARK FOLEY, Florida

                     A.L. Singleton, Chief of Staff

                  Janice Mays, Minority Chief Counsel

Pursuant to clause 2(e)(4) of Rule XI of the Rules of the House, public 
hearing records of the Committee on Ways and Means are also published 
in electronic form. The printed hearing record remains the official 
version. Because electronic submissions are used to prepare both 
printed and electronic versions of the hearing record, the process of 
converting between various electronic formats may introduce 
unintentional errors or omissions. Such occurrences are inherent in the 
current publication process and should diminish as the process is 
further refined.




                            C O N T E N T S

                               __________

                                                                   Page

Advisory of June 15, 1999, announcing the hearing................     2

                               WITNESSES

American Express Company, Alan J. Lipner.........................    20
Bouma, Hermann B., H.B. Bouma....................................    93
Caterpillar Inc., Sally A. Stiles................................    24
Chip, William W., European-American Business Council, and 
  Deloitte & Touche LLP..........................................   111
Coalition of Service Industries, Harvey B. Mogenson..............   106
Conway, Kevin, National Association of Manufacturers, and United 
  Technologies Corporation.......................................   100
CSX Corporation, Peter J. Finnerty...............................    27
DaimlerChrysler Corporation, John L. Loffredo....................    16
Dean, Warren L., Jr., Subpart F Shipping Coalition, and Thompson 
  Coburn LLP.....................................................   140
Deloitte & Touche LLP:
    Philip D. Morrison...........................................    69
    William W. Chip..............................................   111
European-American Business Council, William W. Chip..............   111
Finnerty, Peter J., CSX Corporation, and Sea-Land Service, Inc...    27
General Motors Corporation, William H. Laitinen..................   116
Green, Richard C., Jr., UtiliCorp United.........................    12
Hamond, David, Section 911 Coalition.............................   124
H.B. Bouma, Hermann B. Bouma.....................................    93
Houghton, Hon. Amo, a Representative in Congress from the State 
  of New York....................................................     9
International Tax Policy Forum, and Columbia University, R. Glenn 
  Hubbard........................................................    47
Laitinen, William H., General Motors Corporation.................   116
Levin, Hon. Sander M., a Representative in Congress from the 
  State of Michigan..............................................     5
Lipner, Alan J., American Express Company........................    20
Loffredo, John L., DaimlerChrysler Corporation...................    16
Merrill, Peter R., PricewaterhouseCoopers LLP, and National 
  Foreign Trade Council, Inc.....................................    78
Morgan Stanley Dean Witter & Co., Harvey B. Mogenson.............   106
Morrison, Philip D., Deloitte & Touche LLP, and National Foreign 
  Trade Council, Inc.............................................    69
Murray, Fred F., National Foreign Trade Council, Inc.............    55
National Association of Manufacturers, Kevin Conway..............   100
National Foreign Trade Council, Inc.:
    Fred F. Murray...............................................    55
    Philip D. Morrison...........................................    69
    Peter R. Merrill.............................................    78
PricewaterhouseCoopers LLP, Peter R. Merrill.....................    78
Sea-Land Service, Inc., Peter J. Finnerty........................    27
Section 911 Coalition, David Hamod...............................   124
Stiles, Sally A., Caterpillar Inc................................    24
Subpart F Shipping Coalition, Warren L. Dean, Jr.................   140
Thompson Coburn LLP, Warren L. Dean, Jr..........................   140
United Technologies Corporation, Kevin Conway....................   100
UtiliCorp United, Richard C. Green, Jr...........................    12

                       SUBMISSIONS FOR THE RECORD

Ad Hoc Coalition of Finance and Credit Companies, LaBrenda 
  Garrett-Nelson, joint statement................................   152
Alexander, Hon. Bill, American Citizens Abroad, Geneva, 
  Switzerland, statement and attachment..........................   161
AlliedSignal, Larry Bossidy, joint statement and attachment......   157
American Bankers Association, statement..........................   159
American Citizens Abroad, Geneva, Switzerland, Hon. Bill 
  Alexander, statement and attachment............................   161
American Petroleum Institute, statement..........................   165
Blecher, M. David, Hewitt Associates, LLC, statement.............   189
Bossidy, Larry, Business Roundtable, and AlliedSignal, joint 
  statement and attachment.......................................   157
Brown, Timothy A., International Organization of Masters, Mates & 
  Pilots, Linthicum Heights, MD, Marine Engineers' Beneficial 
  Association, joint statement...................................   193
Business Roundtable, Larry Bossidy, joint statement and 
  attachment.....................................................   157
Council of Great City Schools, Rod Paige, joint statement........   174
Crowley Maritime Corporation, Michael G. Roberts, letter and 
  attachments....................................................   176
Ernst & Young LLP, Peter Kloet, Michael F. Patton, and John 
  Wills, letter..................................................   179
Decker, Jane, Joint Venture: Silicon Valley Network, San Jose, 
  CA, letter.....................................................   201
Financial Executives Institute, Morristown, NJ, statement........   183
Frank Russell Company, Tacoma, WA, Warren Thompson, statement....   186
Garrett-Nelson, LaBrenda:
    Ad Hoc Coalition of Finance and Credit Companies, and 
      Washington Counsel, P.C., joint statement..................   152
    Washington Counsel, P.C., statement..........................   213
Gould, Jeffrey L., Youngstein & Gould, London, England, letter 
  and attachment.................................................   214
Hewitt Associates, LLC, M. David Blecher, statement..............   189
Houston Public Schools, Rod Paige, joint statement...............   174
International Organization of Masters, Mates & Pilots, Linthicum 
  Heights, MD, Timothy A. Brown, joint statement.................   193
Interstate Natural Gas Association of America, statement.........   194
Investment Company Institute, statement..........................   199
Joint Venture: Silicon Valley Network, San Jose, CA, Larry 
  Langdon, and Jane Decker, letter...............................   201
Kloet, Peter, Ernst & Young LLP, letter..........................   179
Langdon, Larry, Joint Venture: Silicon Valley Network, San Jose, 
  CA, letter.....................................................   201
LeMaster, Roger J., Tax Council, letter..........................   212
Leonard, Robert J., Washington Counsel, P.C., statement..........   213
Marine Engineers' Beneficial Association, Lawrence H. O'Toole, 
  joint statement................................................   193
Moss, Ralph L., Seaboard Corporation, letter.....................   206
Murrell, Richard, Tropical Shipping, Riviera Beach, FL, letter...   212
NEU Holdings Corporation, Whippany, NJ, Richard W. Neu, letter 
  and attachment.................................................   205
O'Toole, Lawrence H., Marine Engineers' Beneficial Association, 
  joint statement................................................   193
Paige, Rod, Council of Great City Schools, and Houston Public 
  Schools, joint statement.......................................   174
Patton, Michael F., Ernst & Young LLP, letter....................   179
Roberts, Michael G., Crowley Maritime Corporation, letter and 
  attachments....................................................   176
Seaboard Corporation, Ralph L. Moss, letter......................   206
Section 904(g) Coalition, statement and attachment...............   208
Tax Council, Roger J. LeMaster, letter...........................   212
Thompson, Warren, Frank Russell Company, Tacoma, WA, statement...   186
Tropical Shipping, Riviera Beach, FL, Richard Murrell, letter....   212
Washington Counsel, P.C.:
    LaBrenda Garret-Nelson, joint statement......................   152
    LaBrenda Garret-Nelson, and Robert J. Leonard, statement.....   213
Wills, John, Ernst & Young LLP, letter...........................   179
Youngstein & Gould, Jeffrey L. Gould, London, England, letter and 
  attachment.....................................................   214


       IMPACT OF U.S. TAX RULES ON INTERNATIONAL COMPETITIVENESS

                              ----------                              


                        WEDNESDAY, JUNE 30, 1999

                          House of Representatives,
                               Committee on Ways and Means,
                                                    Washington, DC.
    The Committee met, pursuant to notice, at 10:02 p.m., in 
room 1100, Longworth House Office Building, Hon. Bill Archer 
(Chairman of the Committee) presiding.
    [The advisory announcing the hearing follows:]

ADVISORY

FROM THE COMMITTEE ON WAYS AND MEANS

                                                CONTACT: (202) 225-1721
FOR IMMEDIATE RELEASE

June 15, 1999

No. FC-12

                      Archer Announces Hearing on

               Impact of U.S. Tax Rules on International

                            Competitiveness

    Congressman Bill Archer (R-TX), Chairman of the Committee on Ways 
and Means, today announced that the Committee will hold a hearing on 
the impact of U.S. tax rules on the international competitiveness of 
U.S. workers and businesses. The hearing will take place on Wednesday, 
June 30, 1999, in the main Committee hearing room, 1100 Longworth House 
Office Building, beginning at 10:00 a.m.
      
    Oral testimony at this hearing will be from both invited and public 
witnesses. Also, any individual or organization not scheduled for an 
oral appearance may submit a written statement for consideration by the 
Committee or for inclusion in the printed record of the hearing.
      

BACKGROUND:

      
    The tax rules that apply to individuals and businesses with 
international operations are among the most complex in the Internal 
Revenue Code. These international tax rules often cause U.S. taxpayers 
to structure their domestic and international activities in particular 
ways. For instance, the current rules may effectively prevent a 
taxpayer from undertaking a particular activity in a specific location, 
business entity, or manner otherwise consistent with the taxpayer's 
business interests. Similarly, the current rules may create incentives 
to structure business activities in a particular location, entity, or 
manner. Some of the consequences of these U.S. international tax rules 
are intended; many, however, are either unintended or result from 
competing tax, economic, or social policies in the international tax 
rules.
      
    In announcing the hearing, Chairman Archer stated: ``I have long 
been interested in reform of our international tax rules. I strongly 
believe that our tax rules must help, rather than hinder, the 
competitiveness of American workers and businesses. People in too many 
businesses, large and small, have described to me how our tax law has 
affected their decisions regarding place of incorporation, choice of 
business entity, and location of business assets and operations. Having 
the tax system-rather than business, economic, or family 
considerations-drive these decisions is troubling.
      
    I am truly concerned by what I see happening to our economy. Are 
the current rules arbitrary or unfair? Is the U.S. tax system 
contributing to the de-Americanization of U.S. industry? Do our tax 
laws force U.S. companies to be domiciled in foreign countries? Are we 
making it a foregone conclusion that mergers of U.S. companies with 
foreign companies will always leave the resulting new company 
headquartered overseas? I want the Committee to examine (1) the effect 
that our current international tax rules have on U.S. workers and 
businesses, and (2) the policies (tax or otherwise) our international 
tax rules ought to reflect and implement.''
      

FOCUS OF THE HEARING:

      
    The hearing will focus on the impact of current U.S. tax rules on 
international competitiveness including that on cross-border 
transactions, international operations of U.S.-based companies, and the 
treatment of U.S. citizens working in foreign countries. The hearing 
will examine some of the problems caused by the current rules and 
proposed solutions to these problems.
      

DETAILS FOR SUBMISSIONS OF REQUESTS TO BE HEARD:

      
    Requests to be heard at the hearing must be made by telephone to 
Traci Altman or Pete Davila at (202) 225-1721 no later than the close 
of business, Tuesday, June 22, 1999. The telephone request should be 
followed by a formal written request to A.L. Singleton, Chief of Staff, 
Committee on Ways and Means, U.S. House of Representatives, 1102 
Longworth House Office Building, Washington, D.C. 20515. The staff of 
the Committee will notify by telephone those scheduled to appear as 
soon as possible after the filing deadline. Any questions concerning a 
scheduled appearance should be directed to the Committee staff at (202) 
225-1721.
      
    In view of the limited time available to hear witnesses, the 
Committee may not be able to accommodate all requests to be heard. 
Those persons and organizations not scheduled for an oral appearance 
are encouraged to submit written statements for the record of the 
hearing. All persons requesting to be heard, whether they are scheduled 
for oral testimony or not, will be notified as soon as possible after 
the filing deadline.
      
    Witnesses scheduled to present oral testimony are required to 
summarize briefly their written statements in no more than five 
minutes. THE FIVE-MINUTE RULE WILL BE STRICTLY ENFORCED. The full 
written statement of each witness will be included in the printed 
record, in accordance with House Rules.
      
    In order to assure the most productive use of the limited amount of 
time available to question witnesses, all witnesses scheduled to appear 
before the Committee are required to submit 300 copies, along with an 
IBM compatible 3.5-inch diskette in WordPerfect 5.1 format, of their 
prepared statement for review by Members prior to the hearing. 
Testimony should arrive at the Committee office, room 1102 Longworth 
House Office Building, no later than, Monday, June 28, 1999. Failure to 
do so may result in the witness being denied the opportunity to testify 
in person.
      

WRITTEN STATEMENTS IN LIEU OF PERSONAL APPEARANCE:

      
    Any person or organization wishing to submit a written statement 
for the printed record of the hearing should submit six (6) single-
spaced copies of their statement, along with an IBM compatible 3.5-inch 
diskette in WordPerfect 5.1 format, with their name, address, and 
hearing date noted on a label, by the close of business, Wednesday, 
July 7, 1999, to A.L. Singleton, Chief of Staff, Committee on Ways and 
Means, U.S. House of Representatives, 1102 Longworth House Office 
Building, Washington, D.C. 20515. If those filing written statements 
wish to have their statements distributed to the press and interested 
public at the hearing, they may deliver 200 additional copies for this 
purpose to the Committee office, room 1102 Longworth House Office 
Building, by close of business the day before the hearing.
      

FORMATTING REQUIREMENTS:

      
      Each statement presented for printing to the Committee by a 
witness, any written statement or exhibit submitted for the printed 
record or any written comments in response to a request for written 
comments must conform to the guidelines listed below. Any statement or 
exhibit not in compliance with these guidelines will not be printed, 
but will be maintained in the Committee files for review and use by the 
Committee.
      
    1. All statements and any accompanying exhibits for printing must 
be submitted on an IBM compatible 3.5-inch diskette in WordPerfect 5.1 
format, typed in single space and may not exceed a total of 10 pages 
including attachments. Witnesses are advised that the Committee will 
rely on electronic submissions for printing the official hearing 
record.
      
    2. Copies of whole documents submitted as exhibit material will not 
be accepted for printing. Instead, exhibit material should be 
referenced and quoted or paraphrased. All exhibit material not meeting 
these specifications will be maintained in the Committee files for 
review and use by the Committee.
      
    3. A witness appearing at a public hearing, or submitting a 
statement for the record of a public hearing, or submitting written 
comments in response to a published request for comments by the 
Committee, must include on his statement or submission a list of all 
clients, persons, or organizations on whose behalf the witness appears.
      
    4. A supplemental sheet must accompany each statement listing the 
name, company, address, telephone and fax numbers where the witness or 
the designated representative may be reached. This supplemental sheet 
will not be included in the printed record.
      
    The above restrictions and limitations apply only to material being 
submitted for printing. Statements and exhibits or supplementary 
material submitted solely for distribution to the Members, the press, 
and the public during the course of a public hearing may be submitted 
in other forms.
      
    Note: All Committee advisories and news releases are available on 
the World Wide Web at ``HTTP://WWW.HOUSE.GOV/WAYS__MEANS/''.
      

    The Committee seeks to make its facilities accessible to persons 
with disabilities. If you are in need of special accommodations, please 
call 202-225-1721 or 202-226-3411 TTD/TTY in advance of the event (four 
business days notice is requested). Questions with regard to special 
accommodation needs in general (including availability of Committee 
materials in alternative formats) may be directed to the Committee as 
noted above.
      

                                


    Chairman Archer. Good morning. Today, the Committee is 
holding what the Chair believes to be one of the most important 
hearings that we will conduct for the entire year and that is 
the effect of U.S. tax rules on our country's global 
competitiveness.
    As you all know, I have been a long-time advocate of 
fundamental tax reform. In short, I do not believe we will ever 
fix the income tax. That is perhaps an issue for another day. I 
will continue to push to completely eliminate income as the 
base of taxation because rather than this negative way to tax, 
we could adopt a border adjustable consumption tax and one that 
gets the IRS completely out of our everyday lives. In my view, 
the notion of taxing the foreign earnings of American 
corporations and not having a border adjustable Tax Code are 
absurd in a competitive global economy. We force our businesses 
to enter this arena with one hand tied behind their backs 
relative to the Tax Codes of the countries where corporations 
are competing against us.
    However, those of you who still need convincing that we 
should throw out our current income tax, I suggest you look 
closely at the rules that apply to international transactions. 
These rules are unbelievably complex and often at odds with our 
economic goals. Professionals spend a lifetime trying to 
understand the complexities of how we tax foreign source income 
and, yet, there is massive disagreement among the experts 
because of the complexities.
    Our current tax rules are grossly outdated. The basic 
Subpart F rules, for example, were enacted in 1962. These rules 
reflect the economic climate of that time. In 1962, the United 
States was a net exporter of capital and ran a trade surplus. 
Imports and exports were only one-half of the percentage of GDP 
that they are today. U.S. companies focused on the domestic 
market and international trade had relatively little effect on 
our economy. My how things have changed since 1962.
    To put things in perspective, in 1962, the cost of college 
was described by President Kennedy has skyrocketing to 
astronomical levels of $1,600 a year. In 1962, a Japanese 
motorcycle company called Honda decided to start making cars 
for the first time. In 1962, Bill Gates was probably more 
concerned about his second grade teacher than computer 
software. The world has changed and our tax laws need to change 
to.
    In particular, I have been troubled by some aspects of the 
recent acquisitions of U.S. companies. I do not have anything 
against foreign investment in the United States. It is part of 
a healthy, open economic system. I am very concerned that our 
tax law increasingly puts American companies at a disadvantage 
in the world marketplace. How we tax foreign source income will 
influence what kind of economy we have in the long-run, 
specifically, whether we have a strong and vibrant economy with 
competitive workers and companies, whether we can create more 
jobs for export which pay on average 17 percent more to the 
workers of this country.
    As a growing consensus develops behind the need to re-
examine and modify our international tax rules, there have been 
some significant studies and reports in this area, and we will 
hear about them from several witnesses today.
    The Treasury Department is also undertaking a study of the 
Subpart F rules. I do not know whether I will agree with 
anything in the Treasury's study, but I do know that we need to 
have an open-minded debate. I urge us all, Congress, the 
administration, and the private sector, to get involved in this 
debate. Our long-term economic well-being is at stake.
    If there is anyone here on the minority, I would be happy 
to recognize them for a statement. Mr. Levin, would you like to 
make a statement on behalf of the minority or do you want to 
wait until you make your statement from the witness stand?
    Mr. Levin. I think I will wait for the latter. I think once 
will be enough.
    Chairman Archer. All right.
    Mr. Levin. Thank you.
    Chairman Archer. Well, we are fortunate to start off today 
with two respected Members of the Ways and Means Committee. I 
hope that this augurs that there is bipartisanship on this 
entire issue. We are happy to recognize first Mr. Levin of 
Michigan?

STATEMENT OF HON. SANDER M. LEVIN, A REPRESENTATIVE IN CONGRESS 
                   FROM THE STATE OF MICHIGAN

    Mr. Levin. Thank you, Mr. Chairman, and my colleagues on 
the Ways and Means Committee and especially hello to the 
gentleman next to me. We have been working together in the 
international tax area for a number of years. And I fully 
concur with your discussion, with your suggestion, Mr. 
Chairman, that we very much need to debate the international 
tax field. Wherever one comes from, I think it is vital that we 
continue to do that. And Mr. Houghton and I are pleased to 
report to you on our further package of proposals.
    This is the fourth bill that we have put together and the 
third on a bipartisan basis with Senators Hatch and Baucus.
    This bill contains a long list of proposals unified by a 
common theme. The way we tax the income of U.S. companies doing 
business abroad should reflect the economic realities of doing 
business abroad and should facilitate the efficient allocation 
of resources. Guided by that principle, our bill seeks to 
further amend the U.S. international tax regime in a way that 
will simplify the reporting burden, enhance the competitiveness 
of U.S. businesses and their workers, and promote exports.
    This bill seeks to further update the U.S. international 
tax regime by bringing it into further sync with the realities 
and demands of the modern business environment. We made 
substantial progress though there are no doubt continuing 
problems in the 1997 legislation, and let me just review them 
very quickly so we have that background.
    As you know, one of the changes related to active 
financing. Our Tax Code generally defers taxation of 
manufacturing income of U.S. controlled foreign corporations, 
CFCs, until that income is repatriated. In enacting the 1997 
legislation, we recognized that the time has come to apply the 
same common sense policy to financial services companies, 
banks, brokers, insurance companies, auto financing companies, 
that we apply to manufacturers.
    Second, reporting by so-called 10/50 companies. A number of 
American companies engage in business abroad through joint 
ventures in which they hold more than 10 percent but less than 
50 percent of the equity. Prior to 1997, each so-called 10/50 
venture was treated separately for purposes of determining 
foreign tax credit limitations. This rule resulted in 
tremendous reporting burdens for U.S. companies doing business 
through multiple 10/50 ventures with little impact, little 
impact on their ultimate tax liability. Thanks to reforms 
enacted in the 1997 act, a look-through rule will kick in 
beginning in the year 2003 that will allow U.S. companies to 
group income from 10/50 ventures, greatly reducing their 
reporting burden. Another change related to the overlap between 
P-FIC and CFC rules.
    So there has been some progress, but much work remains to 
be done. And let me highlight, if I might, just a few of the 
key provisions in H.R. 2018. And my colleague and friend, Mr. 
Houghton, will give a more general overview.
    One of the changes is to make the deferral of active 
financing income permanent. The last change, the change I 
mentioned, is due to expire at the end of the year.
    Mr. Chairman and my colleagues, I hope as we look at 
expiring provisions, we will take a hard look at this provision 
because, as with other expiring provisions of the Tax Code, 
such as the R&D credit, expiration of this provision and 
uncertainty as to whether it will be extended impairs 
businesses' ability to plan ahead, and I don't think I need to 
elaborate on that view, Mr. Chairman and my colleagues.
    The second proposed change, and I referred earlier to the 
treatment of 10/50 companies, that would not go into effect 
until the year 2003 and this bill proposes would make it 
effective at the beginning of next year.
    Let me just spend a little more time on a provision 
relating to section 202 to make domestic loss recapture rules 
mirror foreign loss recapture rules. Currently, if a U.S. 
company experiences a loss in its foreign operations in a given 
year, it may deduct that loss against U.S. source income. If 
the foreign operations turn a profit in a subsequent year, the 
loss is recaptured, i.e., the U.S. company is required to 
characterize a portion of that profit as U.S. source income, 
thus, effectively reducing its ability to use foreign tax 
credit. This ensures that the company will not receive a double 
benefit. But a similar rule does not apply when a U.S. company 
experiences a loss in U.S. operations in 1 year and a profit in 
a second subsequent year.
    Our bill proposes to correct this asymmetry and I elaborate 
on this on my statement to Mr. Chairman, which I know you will 
place in the record.
    Let me finish by referring to two issues that will be 
discussed by further panels where----
    Chairman Archer. Mr. Levin, let me make a general 
observation that without objection, all written statements of 
every witness will be inserted in full into the record.
    Mr. Levin. Thank you. And I shall finish, Mr. Chairman, by 
reference to two studies that this bill of Mr. Houghton and 
others of our colleagues and mine proposes. A study, first of 
all, of treating the European Union as a single country for tax 
purposes. And perhaps we will want to go into this further. Mr. 
Houghton had an oversight hearing where this issue was 
discussed at great length. It is not a simple issue. We clearly 
need to study it to prepare to be able to act on it. The second 
study, our bill would direct Treasury to study current rules 
for allocating interest expense between domestic and foreign 
operations and the effect that those rules have on different 
industries.
    We have made some progress but we need to continue this 
effort. We can help bring our Tax Code further up-to-date in a 
way that will make U.S. companies and U.S. goods produced by 
American workers more competitive. These are goals on which I 
am sure we can all agree, and I am committed to continue to 
work with Members of this Committee and with Mr. Houghton and 
the Senate to advance those goals.
    Thank you, Mr. Chairman.
    [The prepared statement follows:]

Statement of Hon. Sander M. Levin, a Representative in Congress from 
the State of Michigan

    Thank you Mr. Chairman for giving me the opportunity to 
testify before this Committee. I am pleased to report to you on 
the package of international tax simplification proposals that 
Mr. Houghton and I, along with a number of our colleagues, have 
put together in this session.
    This is the fourth such bill on which I have had the 
privilege to work with Mr. Houghton, and our third with 
Senators Hatch and Baucus.
    The bill, H.R. 2018, contains a long list of proposals 
unified by a common theme: The way we tax the income of U.S. 
companies doing business abroad should reflect the economic 
realities of doing business abroad and should facilitate the 
efficient allocation of resources. Guided by that principle, 
our bill seeks to amend the U.S. international tax regime in a 
way that will simplify the reporting burden, enhance the 
competitiveness of U.S. businesses and their workers, and 
promote exports.
    There has not been a major review of our international tax 
regime since 1986. The commercial landscape has changed 
significantly since then. Increasingly, as international 
business transactions have become the norm, it has been 
necessary to re-assess when rules designed to rein in tax 
avoidance have the effect of deterring or severely burdening 
transactions undertaken for legitimate and, from the point of 
view of American competitiveness, desirable, economic reasons.
    Today, companies regularly take advantage of the gains in 
efficiency that come from locating strategically in multiple 
points around the globe. It is not uncommon for a U.S. company 
to rely on a support network based in several different 
countries. This is how companies operate in today's business 
environment. Not only does strategic location around the globe 
make U.S. companies more competitive, it also can increase 
demand for U.S. exports, since U.S. companies operating 
overseas are very likely to purchase U.S. goods and services.
    Our International Tax Simplification bill seeks to update 
the U.S. international tax regime by bringing it in to sync 
with the realities and demands of the modern business 
environment.
    We made substantial progress towards that end in the 
Taxpayer Relief Act of 1997 and in international tax 
simplification measures enacted last year. Some of our changes 
were in the following areas:

          Active Financing: Our Tax Code generally defers taxation of 
        manufacturing income of U.S. controlled foreign corporations 
        (CFCs) until that income is repatriated. This rule ensures that 
        a German subsidiary of a U.S. company will be taxed in the same 
        way as other German-based companies with which it competes. It 
        will not be handicapped by current U.S. taxation of its income 
        in addition to German taxation of the same income. In enacting 
        the Taxpayer Relief Act of 1997, we recognized that the time 
        has come to apply the same common-sense policy to financial 
        services companies--banks, brokers, insurance companies, auto 
        financing companies--that we apply to manufacturers.
          Reporting by 10/50 Companies: A number of U.S. companies 
        engage in business abroad through joint ventures in which they 
        hold more than 10% but less than 50% of the equity. Prior to 
        1997, each so-called 10/50 venture was treated separately for 
        purposes of determining foreign tax credit limitations. This 
        rule resulted in tremendous reporting burdens for U.S. 
        companies doing business through multiple 10/50 ventures with 
        little impact on their ultimate tax liability. Thanks to 
        reforms enacted in the Taxpayer Relief Act, a ``look-through'' 
        rule will kick in beginning in 2003 that will allow U.S. 
        companies to group income from 10/50 ventures, greatly reducing 
        their reporting burden.
          Overlap Between P-FIC and CFC Rules: Prior to 1997, confusing 
        and sometimes conflicting regimes applied when a controlled 
        foreign corporation (CFC) engaged in active business 
        accumulated enough income from passive investments to trigger 
        rules regarding passive foreign investment companies (P-FIC). 
        The 1997 Act eliminated this problem by providing that under 
        most circumstances the P-FIC rules will not apply to CFCs 
        engaged primarily in active business.

    I am pleased by the progress we made in the last Congress. 
But much work remains to be done. Our goal in this Congress is 
to build on the accomplishments of the last Congress. Let me 
highlight a few of the key provisions in H.R. 2018:

          Make Deferral of Active Financing Income Permanent (Sec. 
        101): The rule that makes active financing income exempt from 
        current taxation (like manufacturing income) is due to expire 
        at the end of this year. As with other expiring provisions of 
        the Tax Code (such as the R&D credit), expiration of this 
        provision and uncertainty as to whether it will be extended 
        impairs businesses' ability to plan ahead. The lack of 
        predictability is an unnecessary cost that reduces 
        competitiveness.
          Accelerate Look-Through Treatment for 10/50 Companies (Sec. 
        204): As I mentioned earlier, the ``look-through'' rule that 
        will simplify reporting for U.S. companies engaged in 10/50 
        joint ventures will not kick in until January 1, 2003. Our bill 
        proposes acceleration of this much-needed element of 
        simplification to January 1, 2000.
          Make Domestic Loss Recapture Rule Mirror Foreign Loss 
        Recapture Rule (Sec. 202): Currently, if a U.S. company 
        experiences a loss in its foreign operations in a given year, 
        it may deduct that loss against U.S.-source income. If the 
        foreign operations turn a profit in a subsequent year, the loss 
        is ``recaptured''--i.e., the U.S. company is required to 
        characterize a portion of that profit as U.S.-source income 
        (thus, effectively reducing its ability to use foreign tax 
        credits). This ensures that the company will not receive a 
        double benefit--first, the benefit of applying a foreign loss 
        against U.S. income, and second, the benefit of a foreign tax 
        credit on the subsequent foreign-source income. A similar rule 
        does not currently apply when a U.S. company experiences a loss 
        in U.S. operations in one year and a profit in a subsequent 
        year. Thus, a loss attributable to domestic operations in a 
        given year must be spread over worldwide income. This reduces 
        the loss carryover the company would have but for its foreign 
        income, and it reduces the limit against which the company may 
        apply foreign tax credits.
          Our bill proposes to correct this asymmetry by allowing a 
        U.S. company in the latter situation to characterize U.S. 
        income in a subsequent year as foreign-source income. Instead 
        of suffering a double detriment as a result of a loss 
        attributable to U.S. operations, the detriment would be offset 
        by an increase in the company's foreign tax limitation in a 
        subsequent year when U.S. operations are profitable.

    In addition to the foregoing examples, and a list of other 
proposals, our bill calls for the study of issues that are 
becoming increasingly important as the commercial environment 
in which U.S. companies operate evolves. These include:

          Treating the European Union as a Single Country for Tax 
        Purposes (Sec. 102): The anti-deferral regime in Subpart F is 
        subject to certain exceptions for transactions that take place 
        within a single country. Our bill would require the Department 
        of Treasury to study whether the European Union should be 
        treated as a single country for such purposes.
          Interest Allocation (Sec. 309): Our bill would direct 
        Treasury to study current rules for allocating interest expense 
        between domestic and foreign operations and the effect that 
        those rules have on different industries.

    I am very encouraged by the progress we have made to date 
in the area of international tax simplification. By continuing 
this effort, we can bring our Tax Code up to date in a way that 
will make U.S. companies and U.S. goods produced by American 
workers more competitive. Those are goals on which I am sure we 
can all agree, and I am committed to working with the Members 
of this Committee to advance those goals.
    Thank you, Mr. Chairman.

                                


    Chairman Archer. Mr. Houghton, we are pleased to have you 
as a witness before the Committee and welcome. You may proceed.

 STATEMENT OF HON. AMO HOUGHTON, A REPRESENTATIVE IN CONGRESS 
                   FROM THE STATE OF NEW YORK

    Mr. Houghton. Thank you very much. Thank you, Mr. Chairman. 
Well, Mr. Chairman, I appreciate the opportunity to be here, 
not only to testify here with people who I am sure have the 
feelings about our tax system, but also with Mr. Levin, who I 
have got tremendous respect for. Mr. Levin has spelled out a 
lot of the things. I am not going to go into the details. The 
testimony will be submitted for the record. I just want to hit 
some of the high spots.
    Really because of your concerns, a number of the provisions 
in our prior bills have been enacted. For example, simplifying 
the translation of foreign taxes using average exchange rates, 
an extension of tiers for the indirect foreign tax credit. 
Those things were all a result of what you did and reaction to 
some of the pieces of legislation that Mr. Levin and I have put 
forward.
    As Mr. Levin has said, we had a hearing of the Oversight 
Committee last week on the bill and other international tax 
simplification issues. In our bill, 2018, it contains about 26 
provisions to change the tax law affecting multinational 
corporations. And I am not going to go into the details at this 
time. They are all spelled out. Be glad to talk about them 
whenever you would like.
    But I do want to mention a concern I expressed last week 
and that is the disconnect between our tax laws and our trade 
laws. On the one hand, we pass trade laws to encourage exports 
by U.S. companies, then we retain or impose restrictive tax 
laws relating to the multinationals themselves. So many times 
these tax laws place U.S. companies at a disadvantage vis-a-vis 
their competitors overseas.
    Since I have been on this Committee, we have passed a 
variety of trade laws: NAFTA, GATT, African Growth, CBI, NTR 
for China each year. Why? The reason being to break down, 
obviously, the trade barriers to increase opportunities for 
American workers and American companies to trade overseas.
    Now are markets are open. I don't think there is a more 
open economic system in this world. So we need to continue to 
push for markets to be open abroad and it is a constant, 
constant push. It is important we update U.S. international tax 
laws now, and we need to re-work the system so that it helps 
U.S. businesses become more competitive. Today, the tax laws I 
believe stand in the way, and I think that Mr. Levin would 
agree with that.
    And our bill, we hope, will help. But beyond that, we need 
to take a hard look at Subpart F, as well as the foreign tax 
credit provisions of the Code.
    So, Mr. Chairman, I appreciate being here. I applaud your 
efforts of holding this hearing and the goals and objectives 
you spelled out and it is important that we address these now.
    If I could really sort of sum up, I think that there are 
three or four big things. Every so often, you need to open the 
file and take a look at what you have got and judge is this 
what we intended in the first place? And as far as our tax laws 
now, I have got to believe there is a lot of correction to be 
made. Second, tax laws should be compatible with our trade 
laws. Third, there should be no double taxation, that was the 
whole concept initially. And the fourth thing is to simplify 
it, to simplify because as these things go and corrode and get 
more complicated, they obliterate the real reason for the law 
in the first place.
    Thank you very much.
    [The prepared statement follows:]

Statement of Hon. Amo Houghton, a Representative in Congress from the 
State of New York

    I wish to thank Chairman Archer and Representative Rangel 
for the opportunity to appear before the Committee to discuss 
the issue of the U.S. international tax laws and how that 
affects the competitiveness of our multinational companies vis-
a-vis their foreign counterparts. I am appearing here today 
with my colleague, Sander Levin from Michigan, a Member of this 
Committee.
    Mr. Levin and I have introduced a bill, H.R. 2018, 
``International Tax Simplification for American Competitiveness 
Act of 1999.'' The bill contains twenty-six (26) provisions to 
change tax law affecting multinational companies. Most are 
simplification proposals. Some are included in separate tax 
bills before this Committee. This is the third international 
tax simplification bill we have introduced in as many 
Congresses. Because of your concerns regarding the negative 
effect of the international tax system on U.S. multinationals, 
a number of our proposals in the earlier bills have been 
enacted, and I thank you for that.
    I do not intend to dwell on the detailed provisions in our 
bill. The Oversight Subcommittee had a hearing last week. There 
was a good discussion of the various provisions in the bill, as 
well as other international tax issues. We will hear more on 
those from today's witnesses.
    I would to like to take a minute to emphasize a concern 
which I mentioned the other day at the Oversight hearing. This 
is the disconnect between our tax laws and trade laws. On the 
one hand we pass trade laws to encourage exports by U.S. 
companies, then we retain or impose restrictive tax laws 
relating to multinationals which not only are complex, but in 
many cases place our companies at a disadvantage vis-a-vis 
their foreign competitors. As a result, we hear horror stories 
about complexity, mountains of paperwork, legions of talented 
people gathering tax information, ``name'' companies moving 
abroad, etc.
    Since I have been on this Committee, Congress has passed a 
variety of trade laws, including implementation of NAFTA, 
Uruguay Round of GATT, normal trade relations for China on an 
annual basis, and recently the African Growth and Opportunities 
Act and the Caribbean Basin Initiative. The policy behind each 
of these bills has been to break down trade barriers and expand 
export opportunities for U.S. firms and workers. Our markets 
are open. It is important that we push for open markets abroad.
    It is important that we update U.S. international tax laws 
now. I believe it is time to rework the system so that it helps 
U.S. businesses become more competitive. A strong economy in 
the U.S. is driven by how competitive our companies are around 
the globe. Today the international tax laws stand in the way. 
Our bill will help. Beyond that we need to take a hard look at 
Subpart F as well as the foreign tax credit provisions of the 
Code.. Many of the complexities of the Code spring from these 
provisions. The provisions can lead to double taxation. They 
can throw up roadblocks to capital formation.
    In the 1960s, the U.S. accounted for more than 50% of 
cross-border direct investment. By the mid-1990s, that had 
dropped to 25%. In the 1960s, 18 of the world's largest 
corporations, ranked by sales, were headquartered in the U.S. 
By the mid-1990s that number had dropped to 8. Despite the 
decline of U.S. dominance of world markets, the U.S. economy is 
far more dependent on foreign direct investment than ever 
before. In the 1960s, foreign operations averaged just 7.5% of 
U.S. corporate net income. By contrast, over the 1990-1997 
period, foreign earnings represented 17.7% of all U.S. 
corporate net income. The same story is true regarding exports. 
They have gone from 3.2% of national income to 7.5% in a 
comparable period.
    Mr. Chairman, I applaud you for holding this hearing. It is 
a most important subject. The law as now constituted frustrates 
the legitimate goals and objectives of American business and 
erects artificial and unnecessary barriers to U.S. 
competitiveness. Neither the large U.S. multinationals nor the 
Internal Revenue Service are in position to administer and 
interpret the web of complexity that makes up the foreign tax 
provisions in our Code. It is important that we address these 
issues as we are doing today. It is also important that we take 
action. Thank you, Mr. Chairman.

                                


    Chairman Archer. The Chair is grateful to both of you 
because I do not think there is enough interest on the part of 
either members or the general public in this issue, which is 
going to loom as more vital to the welfare of every working 
American in the next century. That is why I said I think this 
may be one of the most important hearings that we will have 
this year. I wish it could be beamed into the homes of every 
single American so that Americans would have an understanding 
of how they are not really insulated from this, but they 
ultimately are directly connected with it. I, of course, agree 
with everything that both of you have said, and I thank you for 
your work on your legislation.
    Does any other member wish to inquire?
    [No response.]
    If not, thank you very much.
    Mr. Levin. Thank you.
    Mr. Houghton. Thank you.
    Chairman Archer. We will be pleased to welcome our next 
panel: Mr. Green, Mr. Loffredo, Mr. Lipner, Ms. Stiles, and Mr. 
Finnerty. If you will come to the witness table, please?
    Good morning and welcome. Mr. Green, if you would lead off, 
the Chair would be pleased to hear your testimony. If you will 
identify yourself first for the record and that would be true 
for each of you. You may proceed. Under the rules of the 
Committee, we would ask you to try to stay within the 5 minute 
on your oral testimony and your entire written statement will 
be inserted in the record.
    Mr. Green, you may proceed.

    STATEMENT OF RICHARD C. GREEN, JR., CHAIRMAN AND CHIEF 
   EXECUTIVE OFFICER, UTILICORP UNITED, KANSAS CITY, MISSOURI

    Mr. Green. Thank you, Mr. Chairman. I have submitted a 
written statement and these oral comments are a summary of 
that. My name is Rick Green. I am chief executive officer of 
UtiliCorp United, an international energy company headquartered 
in Kansas City, Missouri.
    Let me first acknowledge that much of the business 
community is grateful for the efforts of this Committee to 
improve our Nation's ability to compete in the global economy. 
And I do welcome this opportunity to address what I think is a 
very serious problem that unfairly constrains international 
growth aspirations of American companies. The inequity that I 
am talking about is that of the interest allocation rules of 
the U.S. Tax Code. This problem looms large over many American 
companies doing business abroad. And we at UtiliCorp support an 
economy-wide solution.
    However, I can best describe the inequity that poses the 
problem to our competitiveness by looking at the industry I 
know best: regulated utilities. This industry offers an 
especially poignant example of the problem. The global needs of 
energy are poised for explosive growth. To meet the growing 
needs, companies, markets, governments need to dramatically 
alter the way we do business. The vigorous demands of this 
marketplace are pointing to the fault lines in our tax rules. 
This impairs what otherwise would be a strong competitive 
instinct of our American companies. Huge amounts of capital are 
going to be required to take advantage of these emerging 
opportunities. Unfortunately, outdated interest allocation 
rules act as a strong disincentive, literally trapping American 
corporate funds in foreign countries where they cannot be 
efficiently utilized.
    When U.S. companies doing business overseas prepare their 
returns under present law, tax on foreign income is paid in the 
foreign country and again in the United States, but without 
full credit. That is double taxation, pure and simple. Many of 
the foreign competitors have no such burden. Their profits from 
the United States are free to go home, strengthen their 
operations on their own turf and fund other international 
ventures, possibly even including additional U.S. acquisitions. 
As an American chief executive officer, I would love to have 
that choice. But as it is, I only have one choice, that is to 
leave such funds overseas or take a double tax hit.
    In some respects, the concerns I have raised would apply to 
many U.S. corporations doing business internationally. But my 
operating arena, the utility industry, is especially hurt by 
existing interest allocation rules. The current interest 
apportionment formula harms an industry such as mine because a 
disproportionate amount of U.S. interest is allocated to 
foreign source income thereby reducing and sometimes 
eliminating the foreign tax credit and creating a double tax. 
Some of the contributing factors to this are the facts that 
utilities are capital intensive businesses, holding long-lived 
assets that are among the more highly leveraged U.S. companies. 
The greater the leverage, the greater the interest expense, the 
greater the interest to be allocated, therefore decreasing the 
foreign tax credit.
    Also, because of our inability to transport electricity or 
gas over long distances, particularly over an ocean, U.S. 
utilities must establish a taxable presence where the utility 
customer resides. This means the U.S. utilities generally do 
not have the ability to generate low tax foreign income to 
offset the disadvantage caused by the interest allocation 
rules.
    Foreign utility companies generally are not subject to the 
same regulatory restrictions as U.S. utility companies in 
making foreign investments. This is a serious competitive 
disadvantage. U.S. tax law should not further compound this 
problem.
    The proposed solution we would like you to consider 
eliminates double taxation, changing the allocation rules to 
take into account foreign interest in the interest allocation 
formula. As I have stated, we believe the solution should be 
available to all U.S. companies eligible for foreign tax 
credit. However, Mr. Chairman, we understand there may be 
revenue constraints and if it is not possible to enact this 
with an immediate effective date, we hope you will consider a 
phased in approach, phased in across all American industry with 
an initial focus on those most negatively impacted.
    Mr. Chairman, American know-how, muscle, capital have built 
an energy system that is the envy of the world. In fact, it is 
clear to foreign corporations that they cannot be successful in 
the emerging global energy market unless they are a player in 
our U.S. markets. U.S. tax policy should not unduly 
disadvantage U.S. companies in their efforts to expand 
internationally. We, therefore, respectfully request relief 
from double taxation we presently face under the existing 
interest allocation rules.
    Thank you, Mr. Chairman, for the opportunity to appear 
here.
    [The prepared statement follows:]

Statement of Richard C. Green, Jr., Chairman and Chief Executive 
Officer, UtiliCorp United

    Mr. Chairman . . . Members of the Committee, my name is 
Rick Green and I am the Chief Executive Officer of UtiliCorp 
United, an international energy company based in Kansas City, 
Missouri. Much of the business community is already grateful 
for the efforts of this Committee to resolve some of the more 
critical issues facing our country in dealing with increasingly 
sophisticated and vigorous international competition.
    Therefore, I welcome this opportunity to address a very 
serious problem that unfairly constrains the international 
growth aspirations of American companies--the inequity of 
interest allocation rules in the U.S. Tax Code that limit the 
ability of American businesses to compete.
    Let me emphasize that this problem looms large over many 
American companies doing business abroad. I can best describe 
the nature and extent of this threat to our competitiveness by 
reference to the industry that I know best--regulated energy 
suppliers. And as will become evident, this industry offers an 
especially poignant example of the problem.
    Although my comments have a utility industry focus, at 
UtiliCorp we've identified a possible remedy to this inequity 
for your consideration which we think would apply to all U.S. 
businesses. I'll discuss that more later, but I must emphasize 
that the problem is particularly onerous for the U.S. regulated 
utility industry.
    The current tax law does not give companies the ability to 
efficiently bring cash generated from foreign investments back 
to the U.S.--therefore, when UtiliCorp makes a foreign 
investment, it is evaluated as a ``cash invested offshore'' 
strategy. This obviously does not provide the best answer to 
the U.S. economy, or to our shareholders.
    I thought it also might be helpful if I could provide some 
context by offering a closer look at how one U.S. utility 
company views the emerging reality of the global energy 
marketplace. For it is the rigorous demands of this marketplace 
that are pointing to the fault lines in our tax rules which 
impair the otherwise strong competitive instincts of American 
companies.
    UtiliCorp has been pursuing investments overseas since 1987 
first in Canada, and later in Great Britain, New Zealand and 
Australia. To date we have invested $1.4 billion in 
international projects and plan to seek additional 
opportunities. We're currently taking steps to participate on 
the European Continent as the markets in those countries open 
to competition.
    Driving all this is the creation of a new global energy 
industry that is creating immense global opportunities for 
American companies willing to change the way they think and do 
business.
    It's very clear to us at UtiliCorp that if we and the U.S. 
economy are going to continue to be successful competitors, all 
of our people, policies, systems, processes and tools will have 
to adapt to reflect the best-of-class global standards that are 
shaping this new industry. Global markets are developing, 
customers are becoming available, and the competitive instincts 
of American business are creating a sense of urgency to capture 
those customers.
    In fact, in an industry not typified in the past by 
venturing much beyond the monopoly-protected confines of highly 
regulated U.S. turf, we were one of the first--if not the 
first--to begin more than a decade ago to prepare for this new 
reality by exploring overseas markets as pathways to growth and 
greater opportunities for our shareholders and employees.
    Achievement of these goals means UtiliCorp has to reinvent 
itself nearly every day, changing those things under our 
control to meet the demands of a constantly churning global 
marketplace, or coming here to Washington as I am today, to 
point to changes needed on matters beyond the control of the 
private sector.
    The global need for energy is poised for explosive growth. 
Throughout the world, one third of humanity does not even have 
access to energy as we know it. As many as two billion people 
still meet their daily energy requirements by burning wood or 
cow dung. Some 80% of energy used around the world is not 
renewable.
    So, the challenge that needs to be recognized by companies, 
governments and markets is that in order to meet these growing 
energy needs they must dramatically alter the way they do 
business. In the U.S., we need to adopt a philosophy of growth 
based on rational tax policies that enhance rather than impede 
the deployment of capital in order to create competition and 
develop emerging markets.
    We must also continue to develop energy supply and 
efficient delivery system while pushing the boundaries to make 
renewable energy sources more economical and commercially 
viable as American companies move forward.
    There are, of course, many places around the globe that 
don't have anything near the kind of energy infrastructure that 
would support a thriving competitive market, and American 
companies can capitalize on that. On the other end of the 
spectrum, there are a number of ``gold plated'' infrastructures 
out there, constructed when cost-plus regulation was a reality, 
that need to be simplified to take advantage of today's market.
    Huge amounts of capital will be required to take advantage 
of these emerging opportunities. Unfortunately, outdated U.S. 
tax laws act as a strong disincentive, literally trapping 
American corporate funds in foreign countries where they cannot 
be efficiently utilized.
    When U.S. companies doing business overseas prepare their 
returns under present law, tax on foreign income is paid in the 
foreign country and again in the U.S. but without full credit. 
That's double taxation, pure and simple.
    Many of our foreign competitors have no such burden. Their 
profits from U.S. investments are free to go home to strengthen 
operations on their own turf, or to fund other international 
ventures, possibly even including additional U.S. acquisitions. 
As an American CEO, I'd love to have that choice. As it is, we 
have but one choice--to leave such funds overseas or take the 
double tax hit.
    UtiliCorp has closely examined a number of investment 
opportunities in Portugal, the United Kingdom, South America, 
Canada and other parts of the world. In cases where we were 
competing against foreign buyers with tax laws more favorable 
than our own, it has been impossible to compete.
    In some respects, the concerns I've raised would apply to 
many U.S. corporations doing business internationally, but my 
operating arena the utility industry is especially hurt by 
existing interest allocation rules. The current interest 
apportionment formula harms an industry such as mine because a 
disproportionate amount of U.S. interest is allocated to 
foreign source income, thereby reducing or eliminating the 
foreign tax credit and creating the double tax.
    Contributing factors include:
     U.S. utility assets are older and more fully 
depreciated than our foreign assets. Since interest is 
allocated based on the ratio of foreign assets to total assets, 
and foreign assets would be newer and less depreciated, an 
increased amount of interest is allocated to foreign source 
income which reduces the foreign tax credit and creates the 
double tax situation.
     U.S. utility assets are amortized using 
accelerated depreciation rules, while foreign assets are 
amortized using slower straight-line depreciation rules which 
again creates a disproportionately higher foreign asset base. 
This increases the amount of interest allocated to foreign 
income and further compounds the problem.
     Utilities are capital-intensive businesses holding 
long-lived assets and they tend to be more highly leveraged 
than companies in other industries. The greater the leverage, 
the greater the interest expense, thus creating a larger pool 
of interest to be allocated. This factor, coupled with the 
preceding points, causes an increased amount of interest to be 
allocated to foreign source income, thereby decreasing the 
foreign tax credit.
     Foreign utility companies generally are not 
subject to the same regulatory restrictions as U.S. utility 
companies in making foreign investments, thus creating a 
serious competitive disadvantage. U.S. tax law should not 
further compound this problem.
     Because the era of opportunity for U.S. investment 
in foreign utilities is relatively new, a federal tax stumbling 
block to exploitation of investment opportunities by U.S. 
utilities today will have long-lasting effects on our future 
competitiveness in foreign markets.
     Because of the inability to transport electricity 
or gas over long distances, particularly over the ocean, U.S. 
utilities must establish a taxable presence where the utility 
customers reside. This means that U.S. utilities generally do 
not have the ability to generate a low-tax foreign income to 
offset the disadvantage caused by the interest allocation 
rules. By contrast manufacturing, transportation, and 
communications industries generally can make cross-border sales 
and thereby generate low tax foreign source income.
     U.S. utility companies generally are not able to 
generate low-tax foreign source income through licensing of 
intangibles offshore, such as intellectual property. For 
example, utilities generally own little or no intellectual 
property, trademarks, trade names, and so on.
    The proposed solution we'd like you to consider eliminates 
double taxation by changing the allocation rules to take into 
account foreign interest in the interest allocations formula. 
As I have stated, we believe the solution should be available 
to all U.S. companies eligible for the foreign tax credit. 
However, Mr. Chairman we understand there may be revenue 
constraints and if it is not possible to enact this with an 
immediate effective date, we hope you will consider a phased-in 
approach, a phase-in across all American industries with an 
initial focus on those most negatively impacted.
    To sum up, Mr. Chairman, for our industry the market's 
expectations are a lot tougher today. In times past, in that 
earlier model in which we operated, we would just deliver safe, 
reliable, energy in our local monopoly territories--that was 
it. We could go home. Job done. Not so any more. That's just 
entry-level performance, and a far cry from global best-of-
class.
    To achieve that distinction we must consistently, each and 
every day, strive for the opportunity to reach and serve the 
global customer and make that customer more comfortable at home 
and more efficient in the workplace. That means we have to go 
beyond just delivering the energy. We have to understand our 
customers far deeper and better than we ever have before and 
make significant investments overseas and in the improved 
products and services the global customer base needs, expects 
and deserves.
    If American companies don't do it, our foreign counterparts 
will. That's what competition is all about. The companies--and 
countries--that make this fundamental shift will thrive and 
grow at the leading edge of these global changes. The ones that 
do not will be swept aside to tumble in the wake of the 
leaders.
    The people who run utilities and other companies overseas 
are savvy international business people. They realize that to 
be effective players on the global energy stage they've got to 
have a solid presence in the U.S. marketplace, the most 
advanced and lucrative in the world.
    And one of the reasons our market is so attractive is that 
perhaps its most valuable asset is the skills and knowledge 
embedded in the experience of the Americans we employ. We don't 
export jobs, Mr. Chairman--but we do export that knowledge. 
It's a tremendously valuable commodity.
    Mr. Chairman, American know-how, capital and muscle have 
built a truly ``First Tier'' energy system that's the envy of 
the world. That's why foreign investors already are moving 
aggressively to buy U.S. utilities, such as the acquisition of 
PacifiCorp by Scottish Power and the U.K.'s National Grid 
acquisition of New England Electric System.
    Earlier this month when approving the Scottish Power and 
National Grid acquisitions, FERC Chairman James Hoecker said 
the deals, and I quote, ``illustrate(s) how attractive U.S. 
utility assets are to international markets.''
    But I hope you understand that I am not advocating 
protectionism. I am not asking for a bailout or special breaks 
or loop-holes. All I am seeking are straightforward tax rules 
that recognize this new global marketplace and help to provide 
an equitable solution for American companies and the U.S. 
economy.
    There should be no question that U.S. enterprise knows how 
to compete, but it is absolutely vital that our government act 
to let us play to our strengths. If you don't, then the U.S. 
utility industry, which presently occupies the First Tier among 
the world's utilities, could quickly be relegated to a position 
on the second or third tier behind our foreign competitors.
    U.S. tax policy should not unduly disadvantage U.S. 
companies in their efforts to expand internationally. We 
respectfully request relief from the double taxation we 
presently face under the existing interest allocation rules, 
which create an impediment to the ability of American 
enterprise to compete.
    Acting now to sweep these tax impediments aside before a 
crisis develops is vastly preferable to coming back later to 
shore things up after the damage to the U.S. economy and U.S. 
companies is done.
    Thank you for this opportunity to appear before you, Mr. 
Chairman. Now, I'd be pleased to address whatever questions you 
or the Committee may have.

                                


    Chairman Archer. Mr. Green, thank you.
    Our next witness is Mr. John Loffredo. Mr. Loffredo, we are 
happy to have you with us. If you will identify yourself for 
the record, you may proceed.

  STATEMENT OF JOHN L. LOFFREDO, VICE PRESIDENT AND CHIEF TAX 
                 COUNSEL, DAIMLERCHRYSLER CORP.

    Mr. Loffredo. Thank you. My name is John Loffredo, and I am 
vice president and chief tax counsel for DaimlerChrysler Corp., 
the U.S. arm of DaimlerChrysler A.G. The merger of Chrysler 
Corp. and Mercedes Benz was a marriage of two global 
manufacturing companies, one with its core operations in North 
America and the other headquartered in Europe with operations 
around the world. I thought I would share with you today some 
of the tax considerations, just some of them, that went into 
determining whether the new company should be a U.S. company or 
a foreign company.
    Both companies, Chrysler and Daimler Benz, knew that after 
the merger, these companies would continue to pay their fair 
share of taxes to the countries in which they operated. 
Therefore, the merger would not reduce or eliminate the 
company's taxes in the United States or Germany on operations 
in those countries. However, the new company was concerned that 
it only pay tax to the country where the income was earned and 
not a second time on dividends repatriated from its foreign 
operations. And, second, it would be subject to immediate 
taxation on normal, active business income earned outside the 
country of incorporation.
    There was a clear, distinct choice to be made between the 
U.S. tax laws and those of most acceptable foreign countries. 
Management chose a company organized under the laws of Germany. 
The German tax system is based on the territorial theory. By 
contrast, the U.S. tax system follows a philosophy of taxing 
the worldwide income of a U.S. company while allowing tax 
credits for taxes paid to foreign governments.
    At the time of the merger, the German Territorial Tax 
System allowed qualified dividends received from foreign 
subsidiaries to be tax-free in Germany. Recent tax law changes 
in Germany now tax 15 percent of the dividends received from 
these companies. When DaimlerChrysler Corporation earns income 
in the United States and it elects to dividend some of its 
aftertax earnings from the United States to Germany, less a 5 
percent withholding tax, these dividends are now taxed in 
Germany at 3.5 percent. Therefore, we have a degree of 
certainty as to the amount of tax that will be paid on the U.S. 
operations of DaimlerChrysler.
    However, under the U.S. worldwide tax system, a U.S. parent 
company receiving dividends from its foreign affiliates does 
not have this certainty. The U.S. company must include the 
dividends and correspondent foreign taxes paid in its U.S. 
taxable income. Under certain restrictions put into the U.S. 
tax law over the past several decades, the U.S. taxpayer may 
never know beforehand whether these dividends will or will not 
be taxed by the United States. The result could be taxation of 
at least a portion of the earnings twice by two different 
countries.
    Why does a U.S. company have a problem utilizing all its 
foreign tax credits so that foreign source income is only taxed 
once? The main reason for this problem is that the U.S. company 
has to apportion many of its domestic business expenses, 
especially interest, against its foreign source income, thus, 
reducing the amount of foreign income that may be taken into 
account in meeting the limitation. This would create unused 
foreign tax credits.
    In DaimlerChrysler Corporation's case, if it were the 
parent of the new company, more than 50 percent of its interest 
expense incurred in the United States to finance a sale or 
lease of a vehicle in the United States would have been 
apportioned to foreign source income. This would have certainly 
resulted in double taxation of significant amounts of 
repatriated foreign earnings. Just for an example, if we sold a 
Dodge pick-up in Texas and incurred $1,000 of interest expense 
in our finance company, $500 of that interest would have been 
allocated to foreign source income.
    There are other U.S. tax rules that also came into our 
decision. The treatment of foreign finance subsidiaries, which 
was corrected on a year to year basis, would not be a problem 
under German tax laws. Investment income earned by foreign 
subsidiaries would not be taxed by the German company. And 
foreign-based company sales where we manufacture in one 
company, sell it to a distribution company in a second country 
and then sell on to a third company, that had the potential of 
being taxed in the United States.
    Finally, by becoming a subsidiary of a German company, 
DaimlerChrysler Corporation has minimized the possibility of 
paying additional tax--not taxes--on our foreign operation. 
This should help the U.S. operation of the company to continue 
to compete on a global scale. However, there are many U.S. 
companies which have foreign operations and they are put at a 
competitive disadvantage in the global economy because of the 
U.S. tax rules on their foreign operation.
    Thank you.
    [The prepared statement follows:]

Statement of John L. Loffredo, Vice President and Chief Tax Counsel, 
DaimlerChrysler Corporation

    My name is John Loffredo, and I am Vice President and Chief 
Tax Counsel for DaimlerChrysler Corporation, the U.S. arm of 
DaimlerChrysler. The merger of Chrysler Corporation and Daimler 
Benz A.G. was a marriage of two global manufacturing companies, 
one with its core operations in North America and the other 
headquartered in Europe, with operations around the world. 
However, the U.S. tax system puts global companies at a 
decisive disadvantage. This issue became a major concern and 
when the time came to choose whether the new company should be 
a U.S. company or a foreign company, Management chose a company 
organized under the laws of Germany.
    Generally, the German tax system is based on a 
``Territorial'' theory. By contrast, the U.S. tax system 
follows the philosophy of taxing the worldwide income of a U.S. 
company while allowing tax credits for taxes paid to foreign 
governments. In theory, it is possible for both systems to 
result in the same tax being imposed on a company whether they 
are U.S. or German. However, in practice this does NOT happen.
    Before I go further, I want to make it clear that the 
former Daimler Benz has been a good corporate citizen in the 
U.S. and has paid all taxes believed legally due on its U.S. 
operations. The same is true for the former Chrysler 
Corporation. In addition, Daimler and Chrysler will continue to 
be subject to the U.S. tax laws on their U.S. operations and 
will continue to pay their fair share of U.S. taxes. However, 
what we did not want to happen as part of this merger was to 
increase the company's tax burden by subjecting to U.S. tax 
Daimler Benz's non-U.S. operations that were NEVER subject to 
U.S. tax laws in the past.
    As mentioned, the main reason that Germany's tax system on 
global corporations is preferable to the U.S. is the 
``Territorial'' nature of their tax system. What does this mean 
from a practical standpoint?
                1. Worldwide vs. Territorial Tax System
    As of the date of our merger, the German Territorial Tax 
System exempted qualified dividends received from foreign 
subsidiaries from taxation . (Recent German law changes now tax 
15% of such dividends). When DaimlerChrysler Corporation earns 
income in the U.S. it may elect to dividend some of its after-
tax earnings from the U.S. to Germany, (less a 5% withholding 
tax). Before 1999 these dividends were not subject to German 
income tax but now 15% of the dividend is taxed (resulting in a 
3.5% German tax on the gross dividend before U.S. tax).
    However, under the U.S.'s worldwide tax system a U.S. 
parent company receiving dividends from its foreign affiliates 
must include the dividends and corresponding foreign taxes paid 
in its U.S. taxable income. Then it must determine the U.S. tax 
on those dividends. The U.S. company may be able to offset the 
U.S. tax on that income if it can meet certain limitations and 
utilize the foreign tax credits generated by these foreign 
subsidiaries. If the foreign tax rate is the same or higher 
than the U.S. tax rate, the foreign tax credits should, in 
theory, offset the U.S. tax on those dividends. If this 
occurred, the result would be the same in the U.S. as it is 
under the German Territorial System. That is, no further U.S. 
corporate tax would be imposed and the earnings will have been 
taxed by only one country. However, under restrictions put in 
the U.S. tax laws over the past several decades, this 
theoretical result is typically NOT achieved and, in many 
cases, the U.S. taxpayer can NEVER fully utilize all of the 
foreign taxes paid by its subsidiaries to offset the U.S. tax 
on foreign earnings. The result is taxation of at least a 
portion of the earnings twice, by two countries.
    Under these circumstances, the German Territorial Tax 
System provides a greater degree of certainty for the new 
DaimlerChrysler company that corporate income earned outside of 
the country of incorporation for the parent will only be taxed 
once. (Although as of January 1, 1999 dividends remitted to 
Germany will be subject to the new tax equivalent of 3.5% of 
the gross dividend before U.S. tax).
    Why does a U.S. company have a problem utilizing all its 
foreign tax credits so that foreign source income is only taxed 
once? The main reason for this problem is that a U.S. company 
has to apportion many of its domestic business expenses 
(especially interest expense) against its foreign source 
income, thus reducing the amount of foreign income that may be 
taken into account in meeting the limitation. This would create 
unused foreign tax credits.
                 2. Apportionment of Business Expenses
    The U.S. tax system requires certain domestic company's 
business expenses to be apportioned to foreign source income 
for purposes of determining the amount of foreign tax credits 
that may be claimed. This apportionment of expenses has the 
effect of reducing the amount of a taxpayer's foreign source 
income. The result is a taxpayer does not have sufficient 
foreign source income to utilize all of its foreign tax 
credits. In effect, this apportionment of expenses to foreign 
source income results in an amount of foreign income equal to 
the apportioned expenses being taxed in the U.S. with NO credit 
offset. This amount of income is thus subjected to tax twice, 
once by the foreign country and again by the U.S.
    The expense apportioned to foreign source income that 
creates the most difficulty to a company like DaimlerChrysler, 
and to many other U.S. companies, is interest expense, which 
must be apportioned on the basis of the location of an 
affiliated group's assets. Since interest is apportioned on an 
asset basis, it is apportioned to foreign source income 
categories whether or not the foreign affiliates have current 
income subject to U.S. taxation (e.g., dividends that are paid 
from a foreign subsidiary).
    DaimlerChrysler has a large affiliated finance company in 
the U.S. whose primary business purpose is to provide financing 
to Chrysler dealers and customers who buy Chrysler products in 
the U.S. However, under the U.S. tax laws, DaimlerChrysler must 
apportion its U.S. affiliated group's interest expense between 
its U.S. income and its worldwide income. Had the former 
Chrysler Corporation become the parent company of the merged 
group, substantially over 50% of the value of the assets of the 
combined companies would have been located outside of the 
United States. This would have meant that more than 50% of the 
U.S. affiliated group's interest would have been apportioned to 
foreign source income. This would have decreased the amount of 
foreign source income that was eligible for offset by the 
foreign tax credit. In effect, U.S. tax would have to be paid 
on the amount of foreign source income equal to the expenses 
allocated to that income, and that would have been quite a 
large number.
    For example, let's examine what would happen where the 
German company is a subsidiary of the U.S. Company. Assume 
DaimlerChrysler Corporation sold one vehicle in the U.S. and 
made $1,000 of net taxable income on the sale. 
DaimlerChrysler's finance subsidiary financed the sale of the 
vehicle and that company incurred $100 of interest expense. 
Also, in that year, the former Daimler Benz AG earned $100, 
paid $50 in tax to the German tax authorities, and remitted a 
$50 dividend to the DaimlerChrysler parent company in the U.S.
    Let's assume that 50% of DaimlerChrysler Corporation's 
assets were foreign. Therefore, 50% of the interest expense or 
$50 is allocated to foreign source income. Of DaimlerChrysler 
Corporation's total income subject to U.S. tax of $1,100 only 
$100 is foreign source income ($50 dividend plus $50 gross-up 
for German taxes). Under the method used to calculate foreign 
tax credits in the U.S., the $100 in foreign source income is 
reduced by the $50 U.S. interest expense apportioned to foreign 
source income. This results in net foreign source income of 
$50. The U.S. tax on that amount is $17.50 which is the maximum 
amount of credit that may be claimed on the $100 of German 
income. Therefore on the $100 earnings in Germany, 67.5% would 
be paid in taxes (50 in Germany; 17.5 in the U.S.). That is, a 
portion of the German income will have been taxed twice.
    With DaimlerChrysler A.G. as the parent company, if its 
U.S. subsidiary earned $100 of income from U.S. sources, that 
income would have been subject to a tax at the 35% U.S. rate. A 
subsequent dividend to Germany would be subject to an 
additional 5% U.S. withholding tax and then the new German tax 
(equivalent to 3.5% of the $100 earned from U.S. sources) for a 
total effective tax of around 44%, rather than 67.5%.
    In addition to the apportionment of expenses problem, there 
were three other areas of concern to DaimlerChrysler under the 
laws in the U.S. for taxation of foreign subsidiaries of U.S. 
companies:
        (A) foreign finance subsidiaries;
        (B) incidental investment income earned by foreign operating 
        subsidiaries; and
        (C) foreign base company sales income.
    A. Foreign Finance Subsidiaries--Prior to 1997, foreign 
subsidiaries of U.S. companies who were carrying on an active 
finance business (borrowing and lending) in a foreign location 
had to be concerned that these operations were subject to U.S. 
tax on their earnings even though not distributed to the U.S. 
parent. The problem has been alleviated by recent legislation 
that has given taxpayers temporary relief to exclude such 
active business income from U.S. taxation. The German tax 
system would NOT tax such an active business. DaimlerChrysler 
Corporation, which continues to own active finance companies in 
Canada and Mexico, strongly supports this rule which allows 
active foreign finance company income to be exempt from U.S. 
taxation until remitted to the U.S. and urges that it be made 
permanent.
    B. Incidental Investment Income Earned by Foreign Operating 
Subsidiaries--The U.S. will tax in the year earned passive 
foreign income (interest) if the tax rate in the foreign 
country is less than 90% of the U.S. tax rate or less than 
31.5%. The Germans, on the other hand, will not tax incidental 
income (interest on working capital) earned at an active 
operating company. However, both the German's and the U.S. have 
similar rules when it comes to taxing foreign sourced passive 
income where such income is in a tax haven country. In Germany, 
the income is taxed immediately if it is not subject to a 30% 
tax rate in the country where it is earned and, as mentioned 
before, the U.S. rule is that such income must be taxed at a 
31.5% tax rate to avoid immediate U.S. taxation.
    C. Foreign Base Company Sales Income--DaimlerChrysler is in 
the business of selling vehicles worldwide. Let us assume 
DaimlerChrysler A.G., a German company, establishes a regional 
distribution center in the United Kingdom as a staging area for 
the sale of right-hand drive vehicles worldwide. Vehicles 
manufactured in Germany are sold to the distribution center in 
the U.K., and then on to a third country. The income earned by 
the U.K. distribution center would be taxed in the U.K. (and 
not Germany until a dividend was eventually paid to Germany in 
which case the new tax on 15% of the dividend would apply).
    Now assume that DaimlerChrysler, a U.S. company, sent 
vehicles manufactured by its German subsidiary to the U.K. 
center. The vehicles in the U.K. will be sold throughout the 
world. Under U.S. tax laws the income earned by the U.K. 
distribution center on vehicles shipped to other countries 
would be taxed immediately in the U.S. The reason for this is 
because the new U.K. tax rate of 30% is less than 90% of the 
U.S. tax rate. In the above two scenarios there is no 
difference in operation for the DaimlerChrysler group, only a 
difference in tax results. The only change in facts is the 
country of incorporation of the parent company. The U.S. 
company is placed at a decisive disadvantage.
    In the above three circumstances, the foreign source income 
included in U.S. taxable income is reportable in the year the 
income is earned by the foreign company. This is the case 
whether or not the income is repatriated to the U.S. or whether 
or not the U.S. taxpayer is in a net U.S. taxable income or 
loss position for the year. Because of the ``basket'' rules 
adopted in 1986, many taxpayers with losses may be in a 
position of including this income in their tax base but they 
cannot offset the tax on this income with current foreign tax 
credits. In these cases, the chance for double taxation on the 
foreign source income increases.
    As can be seen from above, DaimlerChrysler Corporation, now 
a subsidiary of a German company, has minimized the possibility 
of paying ADDITIONAL tax (NOT TAXES) on its foreign operations. 
This should help the operations of the company to continue to 
compete on a global scale. However, there are many U.S. 
companies which have foreign operations and they are put at a 
competitive disadvantage in the global economy, just because 
they are competing against companies who do not have to follow 
the way the U.S. tax system taxes foreign operations.
    [The Report, Entitled ``THE NFTC FOREIGN INCOME PROJECT: 
INTERNATIONAL TAX POLICY FOR THE 21ST CENTURY,'' dated March 
25, 1999, is being retained in the Committee files.]

                                


    Chairman Archer. Thank you, Mr. Loffredo.
    Our next witness is Mr. Lipner. Mr. Lipner, if you will 
identify yourself for the record, you may proceed.

  STATEMENT OF ALAN J. LIPNER, SENIOR VICE PRESIDENT, TAXES, 
          AMERICAN EXPRESS COMPANY, NEW YORK, NEW YORK

    Mr. Lipner. Good morning, Mr. Chairman and Members of the 
Committee. My name is Al Lipner. I am the senior vice president 
and chief tax officer of American Express Co. I am pleased to 
have this opportunity to testify on the effect the U.S. tax 
rules have on the international competitiveness of our 
business.
    American Express has had a strong international business 
presence for more than a century and well before the Sixteenth 
amendment to the Constitution was ratified and the Federal 
income tax was first enacted. American Express offers products 
and services in some 200 countries and territories around the 
world. We offer American Express cards issued in 45 different 
currencies throughout the world. Our major competitors are 
overseas banks and other financial institutions that are 
incorporated and have headquarters outside the United States.
    Before 1987, the Subpart F rules permitted U.S. tax to be 
deferred on income derived in the active conduct of banking or 
financing business until that income was distributed to a U.S. 
shareholder. In repealing deferral for active financing income, 
Congress focused on U.S.-controlled firms operating in tax 
havens. What Congress ignored was that the majority of U.S.-
controlled banks, finance companies, and insurance companies 
operate overseas through a substantial presence in key markets 
rather than as tax haven paper companies.
    While U.S. taxes might appear to be imposed at a relatively 
moderate nominal rate compared to the rates imposed by foreign 
countries, in practice U.S. taxes frequently exceed the 
effective tax rate due to more generous foreign country tax 
rules. When U.S.-owned firms are subject to a higher tax burden 
than their foreign competitors, this can significantly affect 
how much to invest in business development, how products are 
priced, and even whether or not to continue an investment or 
continue a business in a foreign market. Such factors have 
influenced some of my company's business decisions.
    American Express purchased a Swiss bank in 1983. Its 
business operations were exclusively outside the United States 
and its customers were not U.S. persons. Its effective tax rate 
was 9 percent but was increased to 40 percent in 1987 when the 
U.S. Subpart F rules made its earnings subject to U.S. tax. Our 
subsidiaries thus became subject to a much higher tax rate than 
our foreign competitors solely because of U.S. ownership. We 
disposed of our controlling interest in the Swiss bank in 1990.
    We considered purchasing a United Kingdom life insurance 
company. Although its nominal tax rate was about 34 percent, we 
were faced with the prospect of a tax rate of over 200 percent 
because of the inability to defer U.S. tax on profits and the 
disparities between the tax base under U.S. and foreign tax 
rules. We did not go forward with the purchase.
    Congress has recently made significant progress in 
addressing some of these concerns by restoring deferral on 
certain active foreign financial services income. These new tax 
rules have significantly recognized that finance companies, 
other than banks, are eligible for deferral in appropriate 
cases. Unfortunately, the new tax rules expire at the end of 
this year. We hope Congress will enact a longer-term solution, 
rather than a 1-year extension of the current rules, since our 
business planning and investment decisions require a stable set 
of rules without the uncertainty presented by year-to-year 
changes.
    Turning to the foreign tax credit, the present basket rules 
often make arbitrary distinctions between certain types of 
income earned in an integrated business. For American Express, 
a noteworthy example concerns our travel business, which the 
regulations consider to be separate from and not incidental to 
our card and Travelers Cheque activities. As a result, a 
typical transaction with a single customer handled by a single 
American Express employee in an American Express Travel office 
overseas is considered to give rise to income and related taxes 
in two separate foreign credit baskets.
    We appreciate the introduction earlier this month of H.R. 
2018, the international tax simplification bill, presented by 
Representatives Houghton and Levin.
    In conclusion, I would like to thank the Chairman and the 
Committee for their interest in addressing the impact of U.S. 
tax rules on international competitiveness. The business 
activities of American Express in key locations of the United 
States, including New York, Minneapolis, Phoenix, and Fort 
Lauderdale, serve our global operations and not just the U.S. 
market. Assuring a strong competitive position of our business 
overseas has a clear and positive effect on U.S. business and 
the U.S. employment base of American Express.
    Thank you, Mr. Chairman.
    [The prepared statement follows:]

Statement of Alan J. Lipner, Senior Vice President, Taxes, American 
Express Company, New York, New York

    Good morning, Mr. Chairman and Members of the Committee. My 
name is Alan J. Lipner, Senior Vice President--Taxes of 
American Express Company. I am pleased to have this opportunity 
to testify on the effect U.S. tax rules have on the 
international competitiveness of our business. In addition to 
my oral remarks today, I have prepared a written statement 
that, with your permission, I would like to have entered into 
the official record of today's hearing.
    As the chief tax officer of one of the world's leading 
financial services companies, I am well aware of the profound 
impact tax issues have on our business. In my role as Chairman 
of the Board of The Tax Council and through other groups such 
as the National Foreign Trade Council, I have discussed tax 
issues of this nature with several of my counterparts at other 
major U.S. companies. My testimony today will not focus in 
detail on the technical tax rules. Instead, I will try to 
illustrate how those tax rules can have an impact upon how our 
business and other U.S. businesses compete against those whose 
headquarters are outside the United States.
    American Express has a long history of doing business 
outside the United States. This is well known by anyone who has 
traveled overseas and bought or cashed an American Express 
Travelers Cheque or used an American Express Card to charge a 
purchase. In fact, American Express has had a strong 
international business presence for more than a century--or 
well before the 16th Amendment to the Constitution was ratified 
and the Federal income tax was first enacted.
    American Express began in 1850 as a shipping company that 
transported currency and other valuable items swiftly and 
safely to their destinations. A sizeable foreign exchange and 
foreign remittance business developed in the late 19th century 
as a service for new Americans and laid the groundwork for the 
Company's eventual major role in the international financial 
arena.
    A great step in the company's international expansion came 
with the introduction in 1891 of the American Express Travelers 
Cheque. This revolutionary financial instrument, with its now 
familiar signature and countersignature, allowed travelers to 
obtain access to funds without the inconvenience of letters of 
credit that could be honored only within normal banking hours 
at specified correspondent banks in a very time consuming 
process. The international business expansion that followed led 
to the establishment of a chain of American Express offices--or 
``homes away from home''--in key cities throughout the world 
around the turn of the century.
    Today, American Express offers its products and services in 
some 200 countries and territories around the world. As in the 
early days of its international business, the company continues 
to serve U.S. customers whose personal or business affairs 
require our financial services to be available wherever they 
need them. Over the years, our business has expanded to focus 
also upon non-U.S. customers. This is illustrated by the fact 
that American Express Cards are now issued in 45 different 
currencies around the world. Our major competitors overseas are 
banks and other financial institutions that are incorporated 
and have their headquarters outside the United States.
    The two major features of U.S tax rules that affect our 
international operations are the Subpart F rules and the 
foreign tax credit. Both these areas were modified 
substantially in 1986 in ways that adversely affected both the 
burdens of tax compliance and our competitive position vis-a-
vis non-U.S. financial services firms.
    Before 1987, the Subpart F rules permitted U.S. tax to be 
deferred on income derived in the active conduct of a banking 
or financing business until that income was distributed to a 
U.S. shareholder. In repealing deferral for active financing 
income, Congress focused on U.S.-controlled firms operating in 
tax havens and earnings that were manipulated for tax reasons. 
What Congress ignored was that the majority of U.S.-controlled 
banks, finance and insurance companies operate overseas through 
a substantial presence in key markets rather than as tax haven 
``paper'' companies. These firms compete head-to-head with 
foreign-controlled companies whose home countries do not impose 
tax on unremitted, reinvested earnings. Also ignored was the 
impact of foreign banking or insurance regulations that often 
require these businesses to be operated by a locally 
incorporated subsidiary subject to local regulatory control.
    While U.S taxes might appear to be imposed at a relatively 
moderate nominal rate compared to the rates imposed by foreign 
countries, in practice U.S. taxes frequently exceed the 
effective foreign tax rate due to more generous foreign rules 
for such items as bad debt deductions or certain preferential 
income. When U.S-owned firms are subject to a higher tax burden 
than their foreign competitors, this can obviously affect such 
factors as how much to invest in business development, how 
products are priced and even whether or not to invest or 
continue to do business in a foreign market. Such tax factors 
have influenced some of my company's business decisions:

          American Express purchased a Swiss bank in 1983. Its business 
        operations were exclusively outside the U.S. and its customers 
        were not U.S. persons. Its effective tax rate of about 9% 
        increased to 40% in 1987 when the changes in the Subpart F 
        rules made its earnings subject to U.S. tax. Our subsidiary 
        thus became subject to a much higher tax rate than our foreign 
        competitors solely because of its U.S. ownership. We disposed 
        of our controlling interest in the Swiss bank in 1990.
          We considered purchasing a U.K. life insurance company. 
        Although its nominal local tax rate was about 34%, we were 
        faced with the prospect of an effective tax rate of over 200% 
        because of our inability to defer U.S. tax on its profits and 
        disparities between the tax base under U.S. and foreign tax 
        rules. We did not go forward with the purchase.

    Congress has recently made significant progress in 
addressing some of these concerns by restoring deferral of U.S. 
tax on certain active foreign financial services income. These 
new rules have specifically recognized that finance companies 
other than banks are eligible for deferral in appropriate 
cases. Unfortunately, the new rules expire at the end of this 
year. We hope Congress will enact a longer-term solution rather 
than a mere one-year extension of the current rules since our 
business planning and investment decisions require a stable set 
of rules without the uncertainty presented by year-to-year 
changes. We appreciate that a substantial number of the members 
of this committee have co-sponsored H.R. 681, legislation 
introduced by Representatives McCrery and Neal to provide 
greater certainty.
    Turning to the foreign tax credit, the present separate 
limitation or ``basket'' rules often make arbitrary 
distinctions between certain types of income earned in an 
integrated business. For American Express, a noteworthy example 
concerns our Travel business, which the tax regulations 
consider to be separate from and not incidental to our Card and 
Travelers Cheque activities. As a result, a typical transaction 
with a single customer handled by a single employee in an 
American Express Travel office overseas is considered to give 
rise to income (and related taxes) in two separate foreign tax 
credit baskets. Another example is the so-called ``high 
withholding tax interest'' basket, which was intended to curb 
cross-border loans that were not economically sound on a pre-
tax basis. By discouraging cross-border lending by U.S. 
financial institutions, the tax rules have given foreign-
controlled lenders a tax-based competitive advantage in 
financing developing economies around the world. A third 
example is the separate basket for ``joint ventures'' or 
foreign corporations with between 10% and 50% ownership by U.S. 
firms. We support proposals to accelerate a repeal of these 
rules that inhibit U.S. firms from expanding business overseas 
by investing in strategic alliances with foreign partners.
    Another area of concern to American Express is the excise 
tax on the purchase of frequent flyer mileage awards from 
airlines. Some have interpreted this tax to apply not only to 
frequent flyer points to be awarded to U.S. customers, but also 
to any points purchased anywhere in the world, from any 
airline, and for any customer, if there is a mere possibility 
that the points could be used to obtain an airline ticket to or 
from the U.S. Since foreign governments and companies have 
objected to this extraterritorial reach of the U.S. excise tax, 
the practical effect is that, absent rigorous global 
enforcement, the tax burden will fall only upon U.S. companies 
doing business overseas and the customers of U.S.-based 
airlines.
    We appreciate the introduction earlier this month of H.R. 
2018, the international tax simplification bill, by 
Representatives Houghton and Levin. This bill would address 
several of the problems I have highlighted above and would help 
simplify our complicated international tax rules and encourage 
competitiveness.
    In conclusion, I would like to thank the Chairman and the 
Committee for their interest in addressing the impact of U.S. 
tax rules on international competitiveness. The business 
activities American Express conducts at its key locations in 
the United States, including New York, Minneapolis, Phoenix and 
Fort Lauderdale, serve our global operations and not just the 
U.S. market. Assuring a strong competitive position for our 
business overseas has a clear positive effect on our U.S. 
business and employment base. In addition, ensuring a strong 
position for the financial services sector reinforces a 
competitive strength for the U.S. economy as a whole, as 
indicated by the positive contribution the service sector makes 
to our overall balance of payments situation.
    I would be pleased to respond to any questions the Chairman 
or Members of the Committee may have.

                                


    Chairman Archer. Thank you, Mr. Lipner.
    Our next witness is Ms. Stiles. We are happy to have you 
here and welcome. You may proceed.

   STATEMENT OF SALLY A. STILES, INTERNATIONAL TAX MANAGER, 
               CATERPILLAR INC., PEORIA, ILLINOIS

    Ms. Stiles. Good morning, Mr. Chairman, Members of the 
Committee. I am Sally Stiles. I am an international tax manager 
for Caterpillar. It is a pleasure to be here this morning and 
to have the opportunity to talk with you about international 
taxation.
    For those of you not entirely familiar with Caterpillar, 
let me begin with a few facts about the company. We are the 
world's largest manufacturer of constructing and mining 
equipment, natural gas and diesel engines, and industrial 
turbines.
    We also own and operate subsidiaries that handle financing, 
insurance, leasing, and logistics services. We employ more than 
40,000 employees in the United States and more than 65,000 
employees worldwide. We posted sales last year of nearly $21 
billion, including $6 billion in exports from the United 
States. These export sales directly support 15,000 U.S. jobs at 
our CAT facilities and an additional 30,000 jobs with our U.S. 
suppliers.
    Mr. Chairman, Caterpillar applauds your efforts to reduce 
trade and tax barriers that U.S. companies face on a daily 
basis. We wholeheartedly agree with you that many of our tax 
policies don't reflect the current competitive environment 
facing companies like Caterpillar. International tax policies 
implemented in the sixties, and continually expanded in the 
years since, have not kept pace with the global marketplace.
    The cross border emphasis embodied in the U.S. anti-
deferral rules is rapidly becoming obsolete in a world where 
the marketplace is no longer defined by country borders. The 
dramatic events unfolding in Europe are certainly the most 
convincing evidence of the changing marketplace. As the world 
recognizes the European Union as a single marketplace, so, too, 
should the U.S. tax law.
    Mr. Chairman, we support your efforts to preserve two very 
important provisions in the current Tax Code. The Export Source 
Rule and the Foreign Sales Corporation provisions are 
critically important to U.S. exporters. These provisions and 
the recent decision to include active finance company income in 
the deferral rules have helped place U.S. companies on a more 
level playingfield with their foreign competitors. We strongly 
support permanent extension of the active finance provision.
    Let me briefly explain to you why this provision is so 
important to Caterpillar.
    Purchasing high value goods, like Caterpillar equipment, 
generally entails more than simply writing a check. Mr. 
Chairman, you have in front of you a model which represents the 
little brother to our largest mining shovels that are 
manufactured exclusively in our Joliet, Illinois facility. This 
mammoth equipment generally costs in excess of $1 million per 
unit. And let's bear in mind, many of our customers buy in 
fleets.
    Caterpillar Financial Services Corporation and its 
subsidiaries offer competitive leasing and purchasing programs 
to all our customers, including the nearly 50 percent who are 
not in the United States.
    Until the recent change in the U.S. tax law providing 
deferral for active finance income, the foreign source income 
generated from our foreign financing business was taxable in 
the United States on a current basis. Many of our foreign 
competitors are able to offer flexible financing programs to 
assist in the purchase of their competitive equipment without 
this additional home-country tax burden. The active finance 
exception has allowed us to remain competitive in these 
programs, but we run the risk of losing what we gained if we 
backtrack now.
    If we are to maintain our primary philosophy of build it 
here and sell it there, we need a modern tax policy that is 
consistent with our global focus. U.S. tax rules must allow us 
to be competitive bidders when opportunities arise rather than 
placing us at an immediate disadvantage.
    Several Members of this Committee have been instrumental in 
proposing and helping to enact simplification measures to our 
international tax system. We encourage those efforts to 
continue. The compliance cost associated with the incredibly 
complex U.S. international tax rules are enormous.
    Let's keep our eye on the long-term benefits to the U.S. 
economy, ensuring U.S. companies remain globally competitive, 
recognizing and responding to the tax-related challenges of new 
technologies and new markets. By working together, we can 
assure our future generations an opportunity to participate in 
world markets, instead of apologizing for lost opportunities.
    I will be happy to answer any questions at the appropriate 
time. Thank you, Mr. Chairman.
    [The prepared statement follows:]

Statement of Sally A. Stiles, International Tax Manager, Caterpiller 
Inc., Peoria, Illinois

    Good morning Mr. Chairman and members of the Committee, I 
am Sally Stiles, International Tax Manager for Caterpillar Inc. 
It's a pleasure to be here and to have the opportunity to talk 
with you about international taxation.
    For those of you not entirely familiar with Caterpillar, 
let me begin with some facts about the company. We are the 
world's largest manufacturer of construction and mining 
equipment, natural gas and diesel engines, and industrial 
turbines.
    We also own and operate subsidiaries that handle financing, 
insurance, leasing programs, countertrade and logistics 
services. We employ 65,000 employees worldwide and posted sales 
last year of nearly $21 billion, including $6 billion in 
exports from the United States. These export sales directly 
support 15,000 U.S. jobs and an additional 30,000 jobs with our 
U.S. suppliers.
    Mr. Chairman, Caterpillar applauds your efforts to reduce 
trade and tax barriers that U.S. companies face on a daily 
basis. We wholeheartedly agree with you that many of our tax 
policies don't reflect the current competitive environment 
facing companies like Caterpillar. Tax policies implemented in 
the 1960's and continually expanded in the years since have not 
kept pace with the global marketplace.
    The cross border emphasis embodied in the U.S. anti-
deferral rules is rapidly becoming obsolete in a world where 
the marketplace is no longer defined by country borders. The 
dramatic events unfolding in Europe are certainly the most 
convincing evidence of the changing marketplace. As the world 
recognizes the European Union as a single marketplace so too 
should the U.S. tax laws.
    Mr. Chairman we support your efforts to preserve two very 
important features of the current tax code. The Export Source 
Rule and the Foreign Sales Corporation provisions are 
critically important to U.S. exporters. These provisions and 
the recent decision to include active finance company income in 
the deferral rules have helped place U.S. companies on a more 
level playing field with their foreign competitors. We strongly 
support permanent extension of the active finance provision.
    Let me briefly explain why this provision is so important 
to Caterpillar.
    Purchasing high value goods like Caterpillar equipment 
generally entails more than simply writing a check. The model 
you have in front of you represents the little brother of our 
largest mining shovels that are manufactured exclusively in our 
Joliet Illinois facility. This mammoth equipment generally 
costs in excess of one million dollars per unit ... and let's 
bear in mind many customers buy in fleets.
    Caterpillar Financial Services Corporation and its 
subsidiaries offer competitive leasing and purchasing programs 
to all our customers--including the nearly fifty percent who 
are not in the United States.
    Until the recent change to U.S. tax law providing deferral 
for active finance income, the foreign source income generated 
from our foreign financing business was taxable in the United 
States on a current basis. Many of our foreign competitors are 
able to offer flexible financing programs to assist in the 
purchase of their competitive equipment without this additional 
home-country tax burden. The active finance exception has 
allowed us to remain competitive in these programs, but we run 
the risk of losing what we've gained if we backtrack now.
    If we are to maintain our primary philosophy of ``build it 
here and sell it there,'' we need a modern tax policy that is 
consistent with our global focus. U.S. tax rules must allow us 
to be competitive bidders when opportunities arise rather than 
placing us at an immediate disadvantage.
    Several members of this Committee have been instrumental in 
proposing and helping to enact simplification measures to our 
international tax system. We encourage those efforts to 
continue. The compliance costs associated with the incredibly 
complex U.S. international tax rules are enormous.
    Let's keep our eyes on the long-term benefits to the U.S. 
economy, ensuring U.S. companies remain globally competitive, 
recognizing and responding to the tax-related challenges of new 
technologies and new markets. By working together, we can 
assure future generations of Americans an opportunity to 
participate in world markets--instead of apologizing for lost 
possibilities.
    As stated in the discussion above, the U.S. anti-deferral 
rules must be reformed if U.S. companies are to fully 
participate in world markets. The Foreign Base Company Income 
rules and the Foreign Personal Holding Company Income rules 
make it impossible for U.S. companies to enjoy the same 
economies of centralized operations that are available to their 
foreign competitors. Under current U.S. rules, the cross border 
transactions that are inherent in centralized operations such 
as treasury centers, distribution operations, marketing and 
``back office'' service centers are all currently taxable in 
the United States. Income associated with these centralized 
operations is clearly active business income and should not be 
subject to current U.S. taxation.
    The Foreign Tax Credit Limitation calculation is another 
area of the international tax law that is very much in need of 
reform. The rules dictating the segregation of income into the 
various baskets have become so overly complicated that 
compliance efforts are not only costly but also error prone. 
Acceleration of the provisions allowing look-thru treatment for 
dividends of Non-controlled Section 902 Corporations and 
extension of the allowable period for foreign tax credit 
carryforwards are measures that, if adopted, would provide some 
relief in this area.
    The expense allocation and apportionment rules are no less 
complicated and burdensome than the income sourcing rules. In 
particular, the interest expense apportionment rules are not 
only a complex administrative burden but also unfairly penalize 
U.S. multinational companies with U.S. financial subsidiaries. 
Under current rules interest expense may not be netted against 
interest income and must be apportioned on the asset method. 
For U.S. companies with foreign subsidiaries a significant 
portion of this interest expense will be apportioned to foreign 
source income in spite of the fact that the expense was 
incurred solely to fund U.S. financial transactions.
    The volume of information that must be collected from 
foreign locations to comply with the U.S. informational 
reporting requirements has become a tremendous burden on U.S. 
multinational companies. Adopting US GAAP accounting for the 
determination of Earnings and Profits for both informational 
and Subpart F calculations would greatly simplify this process.

                                


    Chairman Archer. Thank you, Ms. Stiles.
    Our last witness on this panel is Mr. Finnerty, welcome. 
You may proceed.

STATEMENT OF PETER J. FINNERTY, VICE PRESIDENT, PUBLIC AFFAIRS, 
 SEA-LAND SERVICE, INC., AND VICE PRESIDENT, MARITIME AFFAIRS, 
              CSX CORPORATION, RICHMOND, VIRGINIA

    Mr. Finnerty. Thank you very much, Mr. Chairman and Members 
of the Committee. I am Peter Finnerty, Vice President, Public 
Affairs, Sea-Land Service. And I am very appreciative of the 
opportunity to testify today on the significant adverse impact 
of U.S. tax rules on the international competitiveness of the 
United States Merchant Marine and some proposed solutions.
    Sea-Land is the largest ocean carrier in the United States, 
with a global fleet of about 100 container ships serving 120 
ports in 80 countries. Thirty-five of our ships are registered 
in the United States. Our inter-modal network operates with 
about 220,000 freight containers, port terminals, extensive 
computer and communications technology on five continents. It 
is a highly capital intensive business.
    As set forth in my full statement, U.S.-flag carriers are 
proud of our record of innovation. Sea-Land invented 
containerization in 1956 when the initial voyage sailed from 
New York to Houston, Texas. In the years since, however, the 
U.S.-flag fleet has been struggling under a heavy tax burden 
whereas foreign nations purposely do not tax their 
international shipping activities so they will be more 
competitive on the high seas.
    The U.S. tax burden takes many forms. In addition to income 
tax and various fees, there is the alternative minimum tax and 
the very onerous 50 percent duty on U.S.-flag vessel 
maintenance and repair.
    The administration now proposes to impose an added $1 
billion a year in harbor dredging taxes. U.S. ocean carriers 
have testified, seeking relief from the heavy tax burden in the 
past. I testified before this Committee in 1980 on this same 
point. John Snow, our chairman of CSX Corp., our parent 
company, and John Lillie, then chairman of American President 
Companies, testified in 1993 before the Senate. And again in 
1995, U.S.-flag carriers stressed that the tax gap between us 
and our foreign-flag competitors is large.
    H.R. 2159, introduced June 10, 1999, by Congressman McCrery 
and cosponsored by Congressmen Herger, Jefferson, and 
Abercrombie, proposes a number of beneficial changes to the 
Capital Construction Fund to increase its effectiveness in 
helping U.S.-flag vessel operators to generate private 
investment capital for new U.S.-flag ships and operating 
equipment. The U.S.-flag maritime industry strongly supports 
this measure, and we urge its early approval by the Committee.
    And I would like to submit a letter to that extent for the 
record.
    [The information had not been received at the time of 
printing.]
    Mr. Finnerty. The Capital Construction Fund changes would 
include a broadening of the scope of U.S.-flag vessels 
``eligible'' to make deposits into a CCF. U.S.-flag vessels 
operated in the ocean-going domestic trade and in trade between 
foreign ports would be included as qualified vessels. And 
containers and trailers which are part of the complement of an 
``eligible'' vessel could be purchased with CCF funds. 
Qualified withdrawals from a CCF account for vessels would 
continue to be limited to U.S.-flag vessels built in the United 
States. A very important change would allow a CCF fund-holder 
the right to elect a deposit into a CCF of all or a portion of 
the amount that would otherwise be payable to the Secretary of 
the Treasury as a duty on foreign repairs to U.S.-flag vessels 
imposed by section 466 of the Tariff Act of 1930.
    These tax improvements would benefit the same U.S.-flag 
ships that the Department of Defense relies upon for support of 
the Armed Forces in such contingencies as Vietnam and Desert 
Storm.
    The economic and national security of our country depend on 
this Nation's ability to guarantee the flow of goods in 
international commerce through U.S. ports. It is critical that 
the Committee approve H.R. 2159 to ensure future 
competitiveness of the U.S. Flag Merchant Marine.
    Thank you.
    [The prepared statement follows:]

Statement of Peter J. Finnerty, Vice President, Public Affairs, Sea-
Land Service, Inc., and Vice President, Maritime Affairs, CSX 
Corporation, Richmond, Virginia

                               Key Points

     By increasing the economic cost of new vessels for 
U.S. shipowners, U.S. tax rules have hindered the development 
of a United States-flag commercial merchant fleet in the 
foreign trades of sufficient size and capacity to maintain its 
share of U.S. international oceanborne trade over the last half 
of the 20th Century. As U.S. waterborne imports and exports 
increased five-fold, the share of that trade carried on United 
States-flag ships dropped from 60 percent (in 1947) to less 
than 3 percent (1997).
     This competitive handicap can be directly 
attributed to U.S. tax rules--not the competitiveness of the 
U.S. industry itself. During this period, technology and 
logistics innovations developed by the U.S. industry virtually 
revolutionized international shipping, and in every segment of 
the fleet today's U.S.-flag vessels are highly efficient and 
fully competitive with their foreign counterparts. For example, 
the U.S. liner industry today carries 25 percent more cargo 
than 30 years ago with 70 percent fewer ships.
     Nor is this a question of U.S. ship acquisition--
United States-flag ships in the international trades can be 
purchased on the same international shipbuilding market as 
ships of our foreign competitors. The key difference is that 
because of U.S. tax rules, American shipowners must purchase 
those ships with after-tax dollars whereas foreign operators 
generally can do so with pre-tax funds. As a result, American 
shipowners face a 35 percent economic disadvantage before a 
ship even hits the water.
     Other aspects of U.S. tax rules have a similar 
impact on the availability of operating revenues for investment 
in new ships. On average, our new ships would pay about $1 
million a year more in taxes, per ship, than our foreign 
competitors. Moreover, even in our unprofitable years, we 
remain subject to the Alternative Minimum Tax. If a United 
States-flag carrier and a foreign carrier each earns $10 
million in operating revenues, after national taxes are 
applied, the foreign carrier still has $10 million available to 
reinvest, while the American carrier has only $6.5 million.
     H.R. 2159, the ``United States-Flag Merchant 
Marine Revitalization Act of 1999,'' now before this Committee, 
proposes key changes to U.S.-flag tax rules to increase the 
international competitiveness of U.S.-flag shipping companies 
in international oceanborne trade. If enacted, these changes 
would make the existing Capital Construction Fund program a 
much more effective means of generating private investment 
capital for new ships and equipments for the United States-Flag 
Merchant Fleet.

                               Statement

    Mr. Chairman and Members of the Committee: Good morning my 
name is Peter Finnerty, Vice President of Public Affairs for 
Sea-Land Service, Inc. and of Maritime Affairs for CSX 
Corporation, Sea-Land's corporate parent.\1\ I am pleased to 
appear before the Committee today to discuss the impact of U.S. 
tax rules on the international competitiveness of the United 
States maritime industry and to stress the importance of 
proposed changes to those rules as embodied in H.R. 2159, the 
United States-Flag Merchant Marine Act of 1999, now pending 
before this Committee.
---------------------------------------------------------------------------
    \1\ Disclosure required under Truth in Testimony Rule: Sea-Land 
Service, Inc. contracts with the United States Government under the 
Maritime Security Act of 1996, 46 U.S.C. 652 et seq., and for 
oceanborne transportation services under 10 U.S.C. 2631 and 46 U.S.C. 
901.
---------------------------------------------------------------------------
                            I. Introduction
    The ability of the American shipowner competing in 
international shipping markets to build and operate ships on a 
comparable economic basis as our foreign competitors is vital 
to the competitiveness of the U.S.-flag industry. And tax rules 
are key to that equation. The U.S. tax environment under which 
we must compete--but from which our foreign competitors are 
largely exempt--impacts both our day to day operating 
competitiveness and our ability to acquire new or replacement 
tonnage for our fleets.
    The problem is not that these rules make it impossible for 
us to compete in international shipping. Make no mistake about 
it--today's United States-flag commercial fleet operating in 
the foreign trades is highly competitive and more than capable 
of out-performing our foreign-flag rivals in head-to-head 
competition on a level competitive playing field. For example, 
we carry as much cargo today as 40 years ago, but with fewer 
ships than at any point in our history.
    The problem with U.S. tax rules, however, is that they 
force us to play catch-up from the very day we first contract 
to build a new ship. Even though we can build our ships in the 
same shipyards as our foreign competitors, for roughly the same 
delivered contract price, by and large our foreign competitors 
can purchase those ships with pre-tax dollars whereas under 
U.S. tax law the majority of our investment must come from 
post-tax dollars. Thus, we have to out-perform our competitors 
on the operating side just to catch-up economically.
    Moreover, those same U.S. tax rules make it more difficult 
for us to compete economically in daily operations. For 
example, many of our competitors are based in countries whose 
tax regimes exempt earnings of national flag ships operated in 
international commerce from taxation altogether, whereas United 
States-flag operators are subject to U.S. tax law for all such 
revenues. Thus, not only can our foreign competitors invest 
pre-tax dollars in new ships, but the tax rules under which 
they operate leave them more of such revenues with which to 
make those purchases. Similarly, if one of our ships and one of 
their ships go into the same foreign shipyard to receive the 
same repairs at the same contract cost, our repairs end up 
costing us 50 percent more due to U.S. tax rules that impose a 
50 percent ad valorem duty on such repairs.
    The cumulative effect of the economic penalties imposed on 
United States-flag shipping companies by U.S. tax rules over 
the last 50 years is clear. Immediately following the end of 
WWII, United States-flag ships carried almost 60 percent of 
U.S. oceanborne commerce moving in international trade (by 
tonnage). Today that figure is less than 3 percent.\2\ Yet 
today's American ships are more efficient than ever--in the 
liner trades, for example, compared to 25 years ago, United 
States-flag ships carry 25-35 percent more cargo with 70-80 
percent fewer vessels.
---------------------------------------------------------------------------
    \2\ U.S. Department of Transportation, Maritime Administration, 
MARAD 98, at 49. The range in numbers results from variations in the 
categories of vessels counted for those trades across this period of 
time.
---------------------------------------------------------------------------
    Why then has the percentage of cargoes carried by U.S.-flag 
ships in foreign trades declined so precipitously? Why are more 
than 97 out of every 100 tons of cargo entering or leaving a 
U.S. port in international commerce moving on foreign-flag 
ships? The answer is not that the U.S. fleet is inefficient--it 
is not--or that American companies simply cannot compete in 
international shipping. The answer is that even though the 
amount of cargo carried by American ships has remained 
unchanged for virtually the last 40 years, U.S. trade has 
increased almost five-fold over that same period--and virtually 
all of the increase is being carried by foreign-flag ships.
    Operating under U.S. tax rules, the U.S.-flag fleet 
modernized and led the world in the introduction of new 
technologies that revolutionized international shipping. But at 
the same time, it failed to grow. Conversely, encouraged by 
their own, more favorable tax regimes, foreign shipping 
companies adopted the American companies' new technologies, 
invested in increasing numbers of modern, well-built ships 
(using tax-exempt dollars), grew in both vessel and total fleet 
capacity, and now dominate U.S. international waterborne 
commerce.
    Following a brief introduction to Sea-Land and to the 
present state of the U.S.-flag industry, my testimony today 
will focus on two points:
     The impact of existing tax rules on the economic 
competitiveness of U.S.-flag ships and shipping companies in the 
foreign trades; and
     Proposed solutions to two aspects of that impact:

           Investment in new ships; and
           Repairs in non-U.S. shipyards.

    In closing, I will also briefly address the role a portion 
of these proposed changes would play in the future 
modernization of the U.S.-flag fleet operating in the non-
contiguous trades with the U.S. mainland, trades in which Sea-
Land also operates. While not in direct competition with 
foreign shipping, the ability of U.S. carriers in those trades 
to replace existing tonnage with new ships as we enter the 21st 
Century in as cost-efficient a manner as possible will play an 
important role in our ability to continue to provide American 
shippers in those trades with the same safe, reliable and cost 
effective service as today.
                  II. Introduction to Sea-Land Service
    Sea-Land Service, Inc., headquartered in Charlotte, NC, is 
a worldwide leader in container shipping transportation and 
related trade services. Sea-Land operates a fleet of about 100 
containerships under both United States and foreign flags and 
approximately 220,000 containers. Placed end-to-end, this 
equates to a solid line of containers stretching from 
Washington, DC to somewhere between St. Louis, MO and Denver, 
CO (depending on whether they are 20- or 40-foot units). Sea-
Land's ships serve 120 ports in 80 countries and territories.
                     III. The U.S.-Flag Fleet Today
    In recent years, there has been much debate over the 
declining numbers of oceangoing U.S.-flag ships operating in 
the foreign trades. Those numbers, however, tell only a part of 
the story. It is important to look beyond the declining number 
of vessels in this part of the U.S.-flag fleet to assess its 
present state.\3\ For example, between 1965 and 1995, the U.S.-
flag oceangoing fleet decreased by 62 percent based on the 
numbers of vessels, but increased its total cargo carrying 
capacity by 15 percent. Moreover, productivity in that fleet--
as measured by output (tons carried) per seagoing employee--
increased at an annual rate (16 percent) that was 8 times the 
productivity gains being achieved by American business as a 
whole during the same period! Clearly American ships and crews 
can be competitive in international shipping markets.
---------------------------------------------------------------------------
    \3\ Indeed, on the domestic side, where all vessels operate under 
the same tax rules, the United States-flag fleet has more than doubled 
in size (based on the same size vessel as discussed in the text) and 
tripled in productivity. Today, that fleet includes almost 1,900 such 
large commercial vessels (compared to only 861 in 1965) and carries 
over 1 billion tons cargo annually.
---------------------------------------------------------------------------
    The U.S.-flag dry cargo liner fleet provides a textbook 
example of increased productivity during this period. The 
Shipping Act of 1984 affirmed the longstanding U.S. policy of 
permitting U.S. carriers to participate in liner conferences on 
the same basis as foreign carriers that was first enacted in 
the Shipping Act, 1916. Under the stable investment climate 
created by those Acts, U.S. liner carriers became world leaders 
in the industry through technological development and marketing 
innovation. As containerships replaced breakbulks in the liner 
trades, the number of U.S.-flag vessels in the international 
liner trades declined, but the cargo carrying capacity of the 
U.S. liner fleet actually grew substantially. When non-liner 
vessels are excluded from the analysis of the U.S.-flag foreign 
trade fleet shown above and only the U.S.-flag liner fleet is 
considered--which is the portion of the fleet most affected by 
the Shipping Act--it becomes clear that to a great extent the 
changes in the size and composition of that fleet over the past 
20 years represent a continuing process of downsizing and 
modernizing.
    In 1975, for example, the total U.S. liner fleet (foreign 
and domestic trades) numbered 278 ships (compared to its 
current size of roughly 138 ships), but the 1975 fleet included 
142 older, general cargo (or ``breakbulk'') vessels that were 
rapidly becoming commercially obsolete as a result of the 
general shift to containers for non-bulk dry cargo shipments. 
By 1995, the general cargo side of the liner fleet had dropped 
from 142 to just 16 ships--simply because that type of ship was 
no longer commercially viable. In contrast, although the number 
of intermodal vessels \4\ (primarily containerships) in the 
U.S. liner fleet declined slightly between 1975 and 1995 (from 
136 to 122 ships or by roughly 10 percent), the total 
deadweight tonnage, or cargo carrying capacity, of that part of 
the fleet actually increased by 35 percent as new, larger, 
faster vessels replaced the early, smaller classes of 
containerships.
---------------------------------------------------------------------------
    \4\ The term intermodal refers to transportation in the course of 
which the goods or passengers being carried transfer from one mode to 
another (e.g., from truck to railcar to oceangoing vessel). While this 
term can be used to describe virtually all modern transportation except 
trips in private automobiles, its use here is limited to referring to 
the movement of containerized goods or of wheeled vehicles (e.g., truck 
trailers) employing either containerships, roll-on/roll-off ships, or 
barges designed for those purposes whether operating separately or when 
carried on specially designed larger ``LASH'' ships. The remaining 
categories of waterborne freight transportation are bulk (cargo loaded 
``without mark or count'') employing ships or barges described same 
term and general or breakbulk, which refers to cargoes loaded as 
individual items on board a ship or barge also described using that 
term, a practice generally no longer employed in much of the maritime 
industry.
---------------------------------------------------------------------------
    This modernization process continued throughout the decade 
following the 1984 Shipping Act. Between 1984 and 1994, the 
number of intermodal ships in the U.S.-flag foreign trading 
liner fleet declined slightly (down 7 percent from 74 to 69 
ships), but the deadweight tonnage of that same fleet increased 
by 19 percent over the same decade. The 69 ships in 1994 
carried 25 percent more total cargo tonnage in international 
trade than did all 218 ships in the U.S. foreign trading fleet 
in 1975. Put simply, today's U.S.-flag foreign trade liner 
fleet carries 25 percent more cargoes in a year with almost 70 
percent fewer ships. Thus, as these figures show, while its 
numbers may be less, the U.S.-flag liner fleet in the foreign 
trades today is substantially stronger and more productive than 
it was in 1975.
            IV. Impact of U.S. Tax Rules on Competitiveness
    If United States-flag ships and their American crews 
individually have been able to successfully compete in 
international trade for cargoes up to the amounts carried by 
U.S. ships historically over the last 30-40 years, why have 
U.S. shipping companies, or the United States-flag fleet 
overall, been largely unable to compete effectively for cargoes 
beyond that amount? The answer simply is in large part due to 
the impact of U.S. tax rules on the competitiveness of those 
American companies in international commerce.

A. Impact of U.S. Tax Rules

    In recent years, American shipping companies have testified 
before Congress on numerous occasions detailing challenges 
faced by then in the international shipping market. And 
Congress has responded over the years, most recently with the 
Ocean Shipping Reform Act of 1998, which entered into effect 
this last May 1st. Indeed, the heightened competition in 
international liner shipping services that will occur as a 
result of that Act further highlight the need for Congress to 
address the tax rules applicable to the U.S.-flag shipping 
industry.
    In 1993, for example, John Snow, the Chairman of CSX 
Corporation, and John Lillie, then Chairman of American 
President Companies, testified before the Merchant Marine 
Subcommittee of the Senate Committee on Commerce, Science and 
Transportation, that the tax difference between a U.S.-flag and 
a foreign-flag vessel amounted to an estimated $1 million 
annually for their companies per vessel.\5\
---------------------------------------------------------------------------
    \5\ Hearing before the Merchant Marine Subcommittee of the U.S. 
Senate Committee on Commerce, Science and Transportation, on the 
``Implications of the U.S. Government's Decision Not to Support a U.S.-
Flag Fleet,'' August 5, 1993.
---------------------------------------------------------------------------
    Two years later, in a Joint Statement submitted to the same 
committee, a group of U.S.-flag carriers again addressed the 
tax issue in the following manner:
    The Tax Gap Between Us and Our Competitors Is Large. U.S.-
based liner companies are subject to significantly higher taxes 
than their foreign-based counterparts. In testimony two years 
ago before this Committee, APL and Sea-Land submitted data 
showing that, as a result of shipping income tax exemptions, 
deferral devices, and accelerated depreciation, many of our 
foreign competitors pay virtually no income taxes (neither do 
their crews under many foreign tax regimes). Yet here at home, 
even in our unprofitable years, we are subject to the 
Alternative Minimum Tax. Consequently, U.S.-flag operators must 
earn more in the marketplace than their competitors in order to 
earn the same amount for reinvestment or distribution to 
shareholders. For example, if a U.S.-flag carrier and a 
foreign-flag carrier each earn $10 million, the foreign-flag 
carrier generally has $10 million left after applying national 
income taxes. The U.S.-flag carrier has only $6.5 million 
(applying a 35 percent Federal corporate rate and ignoring any 
State income tax considerations.\6\
---------------------------------------------------------------------------
    \6\ Hearing before the Merchant Marine Subcommittee of the U.S. 
Senate Committee on Commerce, Science and Transportation, supporting 
``Prompt Enactment of Authorizing and Appropriations Legislation to 
Revitalize the United States-Flag Liner Fleet,'' July 26, 1995.

At that time, the carriers stated they were not before the 
committee to seek maritime tax reform legislation, but 
acknowledged that such legislation ``would be a great help.''
    Also in 1993, the General Accounting Office (``GAO'') 
conducted a study that found the commercial maritime industry 
had been assessed $11.9 billion in taxes during fiscal year 
1991. GAO identified 12 federal agencies as levying a total of 
117 diverse assessments on the industry, 92 of which are 
specific to and paid only by the maritime industry. Such taxes 
included the Harbor Maintenance Tax (since repealed for exports 
only), vessel entry processing fees, the vessel tonnage tax, 
and an inland waterways fuel tax. These agencies included:

           Animal and Plant Health Inspection Service
           Coast Guard
           Customs Service
           Federal Communications Commission
           Internal Revenue Service
           Surface Transportation Board
           Maritime Administration
           National Oceanic and Atmospheric Administration
           Panama Canal Commission
           St. Lawrence Seaway Development Corporation

    Since the 1993 study, additional taxes have been imposed. 
For example, the U.S. Coast Guard is now charging fees for a 
number of services it provides, including fees for vessel 
inspections (which it requires to be made), licensing and 
documentation of vessels, as well as fees charged to mariners 
for individual licenses and documentation. Moreover, the 105th 
Congress rejected an effort by the Office of Management and 
Budget to tax only commercial vessel operators for navigational 
assistance services, such as buoy placement and maintenance, 
vessel traffic services, and radio and satellite navigation 
systems.

B. Cumulative Impact on Competitiveness

    The following graph illustrates the cumulative effect of 
these disparate economic conditions over the last 50 years. As 
noted above, immediately following the end of WWII, United 
States-flag ships carried almost 60 percent of U.S. oceanborne 
commerce moving in international trade (by tonnage). Today that 
figure is less than 3 percent.\7\ As U.S. trade grew, U.S.-flag 
shipping companies continued to compete effectively for 
generally the same amounts of cargo as over the last 40 years. 
Foreign-flag shipping companies, on the other hand, were able 
to take advantage of the favorable investment climates created 
by their national tax regimes to purchase large numbers of new 
ships, capturing virtually all of the growth in the U.S. 
market.
---------------------------------------------------------------------------
    \7\ U.S. Department of Transportation, Maritime Administration, 
MARAD 98, at 49. The range in numbers results from variations in the 
categories of vessels counted for those trades across this period of 
time.
[GRAPHIC] [TIFF OMITTED] T6775.001


---------------------------------------------------------------------------
C. Opportunity Cost on Competitiveness

    The preceding graph also illustrates the opportunity cost 
of U.S. tax rules on the United States-flag merchant fleet, 
particularly as those rules have limited the ability of 
American shipowners to purchase on a competitive basis the new 
vessels needed to expand the U.S.-flag fleet as required to 
capture ongoing growth in U.S. oceanborne trade, or, indeed, to 
even maintain existing market shares. This is amply 
demonstrated by the following example.
    In 1965, the overall share of U.S. international trade 
moving on U.S.-flag ships on a tonnage basis was 7.5 percent 
(compared to 3.0 percent today). As the following table 
illustrates, had U.S. shipowners been able to invest in new 
tonnage as U.S. trade grew over the last 30 years--as did the 
foreign shipowners whose ships now carry those cargoes--today's 
United States-flag foreign-trading fleet could be almost 3 
times its present size.

                          Impact of Lost Opportunity on U.S.-Flag Foreign Trading Fleet
----------------------------------------------------------------------------------------------------------------
                                                                                                       Notional
                                                                            Projected                Ships Based
                           Segment                             1965 U.S.-      1997      No. Ships        on
                                                               Flag Share    Tonnage       (1997)     Projected
                                                                                                       Tonnage
----------------------------------------------------------------------------------------------------------------
Dry Bulk....................................................         4.8%       19.6 M            8           20
Liner.......................................................        22.8%       29.2 M           59          157
Tanker......................................................         5.5%       24.1 M           13           33
  Total Ships...............................................                                     80          210
----------------------------------------------------------------------------------------------------------------

                 V. Proposed Changes to U.S. Tax Rules
    Today, the Capital Construction Fund (``;CCF'') provides 
the primary means under the U.S. Tax Code for a U.S.-flag 
shipowner to accumulate capital to invest in new ships on a 
basis that even remotely approaches the economic benefits 
available to our foreign competitors under their national tax 
regimes. As illustrated above, while the U.S. system has 
enabled the U.S. fleet overall to stay even with its foreign 
competition in terms of the amount of cargo historically 
carried by U.S. ships in international commerce, it has failed 
to provide a basis for growth. As a result, the U.S.-flag fleet 
continues to lose market share to foreign ships and operators.
    H.R. 2159, the ``United States-Flag Merchant Marine 
Revitalization Act of 1999,'' introduced June 10, 1999, by 
Representative McCrery and co-sponsored by Representatives 
Herger, Jefferson, and Abercrombie, and referred to this 
Committee, proposes a number of changes to the CCF and the tax 
treatment accorded funds deposited therein to increase its 
effectiveness in helping to generate private investment capital 
for new United States-flag ships and operating equipment. We 
strongly support this measure and urge its prompt consideration 
by the Committee and its early enactment.

A. Capital Construction Fund

    The Capital Construction Fund (or ``CCF'') Program set 
forth is section 607 of the Merchant Marine Act of 1936 and 
Section 7518 of the Internal Revenue Code of 1986 is designed 
to provide competitive tax treatment to U.S.-flag vessel 
operators and to encourage construction, reconstruction and 
acquisition in United States shipyards of new vessels for the 
U.S.-flag foreign, domestic non-contiguous, Great Lakes, and 
fisheries fleets. Under the CCF, maritime and fisheries 
operators enter into binding contracts with the federal 
government which allow them to defer U.S. income tax on certain 
funds to be used for an approved shipbuilding program. The 
deferred tax is then recouped by the U.S. Treasury through 
reduced depreciation as the tax basis of a vessel purchased 
with CCF funds is reduced to compensate for the tax deferral.
    Under CCF, an operator is permitted to deposit into a CCF 
account revenues derived from the operation in the covered 
trades of an ``eligible'' vessel and to use those deposits for 
purchase of a new ``qualified'' vessel built in a U.S. 
shipyard. While the proposed changes will not alter this basic 
equation, they will reduce the competitive handicap of these 
U.S. tax rules by expanding the definitions of such vessels and 
how CCF funds are treated under the Code.

B. Proposed Changes

    The purpose of the proposed changes is to revitalize the 
international competitiveness of the United States-flag 
merchant marine. This is accomplished by providing a tax 
environment which, as compared with current U.S. tax rules, 
more closely approximates the favorable tax environments 
provided by other maritime nations to their national flag 
merchant fleets. Absent the proposed tax reforms, U.S.-flag 
carriers will continue to face a formidable tax cost 
disadvantage against foreign flag carriers who pay little or no 
tax in their home countries. Moreover, U.S. operators in the 
domestic oceangoing coastwise and noncontiguous trades would be 
encouraged to invest in construction of new or replacement 
vessels for those trades in U.S. shipyards, with increased 
benefits to the American shippers served by those trades and 
the U.S. economy generally.
    The proposed changes to the CCF and how CCF funds are 
treated under existing U.S. tax rules include the following:
     Modernize the scope of vessels covered by the CCF 
regime by including foreign-built, U.S.-flag vessels as 
eligible vessels for purposes of CCF deposits. Additionally, 
U.S.-flag vessels operated in the oceangoing domestic trade and 
in trade between foreign ports are to be included within the 
definition of qualified vessels for purposes of purchases using 
CCF. Moreover, containers and trailers that are part of the 
complement of a qualified vessel would become eligible for CCF 
purchase. Qualified withdrawals from a CCF account for vessels, 
however, would continue to be limited to U.S.-flag ships built 
in U.S. shipyards.
     Allow CCF withdrawals to be used to fund the 
principal amount of a lease of qualified vessels or containers 
if the lease is for a period of at least five years. This 
recognizes the widespread use of leasing as a modern financing 
technique for vessel acquisition, a change that has occurred 
since the original enactment of CCF.
     Allow fundholders the right to elect deposit into 
a CCF all or a portion of the amount that would otherwise be 
payable to the Secretary of the Treasury as a duty on foreign 
repairs to U.S.-flag vessels imposed by section 466 of the 
Tariff Act of 1930 (19 U.S.C. 1466)(``ad valorem duty'').
     Allow fundholders the flexibility to exceed the 
normal cap for deposits into the CCF during a taxable year 
where such excess results from an audit adjustment for a prior 
tax year which increases the deposit cap for that year. The 
excess that may be deposited equals only the amount which could 
have been deposited under the cap for that year, less the 
amount actually deposited.
     Broadens the category of investments into which 
CCF account funds can be invested. Thus, a CCF could invest not 
only in ``interest bearing securities'' but also in ``other 
income producing assets (including accounts receivable)'' so 
long as the Secretary of Transportation approves the 
investment.
     As applicable, would make conforming changes to 
the Merchant Marine Act of 1936, the Internal Revenue Code, and 
other provisions of U.S. law needed to accomplish the foregoing 
changes.
            VI. Benefit for Coastwise/Non-Contiguous Trades
    As noted, the proposed changes would affect not only United 
States-flag ships operated in the foreign trades, but would 
provide similar benefits to ships in the oceangoing domestic 
coastwise, the non-contiguous, and the Great Lakes trades of 
the United States. In these latter cases, the issue is not so 
much the impact of U.S. tax rules on the international 
competitiveness of those ships themselves--inasmuch as they do 
not compete directly with foreign ships--but rather on the 
competitiveness of the American industries and local U.S. 
economies dependent on such shipping in domestic commerce.
    The greater the efficiency and cost effectiveness of those 
segments of the U.S.-flag fleet in transporting domestic goods 
to market or to loading ports for foreign trade, the more 
competitive those industries can be in the global marketplace. 
The ability to build new, more modern ships for those trades--
as provided under the proposed changes--will be an important 
factor in ensuring continued improvements in service and 
lowered costs for American shippers.
                         VII. Summary & Closing
    For the last half-century, U.S. tax rules have hindered the 
international competitiveness of the United States-flag 
commercial merchant fleet in the foreign trades. Faced with 
competition from foreign-flag ships granted favorable tax 
treatment by their national states, U.S. ships and shipping 
companies have seen the share of U.S. international oceanborne 
commerce carried by U.S.-flag ships decline steadily over this 
period, despite a five-fold increase in such trade. As U.S. 
trade grew, foreign shipping companies were able to invest in 
newer, more numerous ships, using tax-free funds, while U.S. 
shipowners were generally limited to using primarily after-tax 
dollars for such investments.
    Even where U.S. programs like CCF existed, their limited 
scope made it possible for U.S. companies to replace existing 
ships with newer ships, but not to expand their fleets to 
compete for new cargoes. As a result, foreign ships now 
dominate U.S. international trade. The economic and national 
security of the United States depend on this Nation's continued 
ability to guarantee the flow of goods in international 
commerce through U.S. ports. Where, as here, U.S. tax rules 
have hindered the competitiveness of the U.S.-flag shipping 
industry, it is critical for Congress to act to ensure future 
competitiveness.

                                


    Chairman Archer. The Chair is grateful to each of you 
because you are the epitome of what we are trying to focus on 
today. I am, as I mentioned in my preliminary remarks, 
extremely concerned about what our Tax Code does to reduce our 
competitiveness in the global marketplace, which is going to be 
absolutely vital to every working American in the next century, 
perhaps one of the most vital things facing the future of every 
working American in the next century. Particularly as we look 
at the extra burden on workers as a result of the demographic 
changes that are looming with the baby-boomer retirement and 
two workers for every retiree instead of three. We are going to 
have to increase productivity. We are going to have to increase 
savings. We are going to have to increase competitiveness in 
the global marketplace.
    Frankly, I do not think we can stop in simply improving 
competitiveness. I think we need to give you, each of you, an 
advantage. I happened to be strongly enough American to where I 
do not think a level playingfield is what we should shoot for. 
I think we should shoot for giving you an advantage to overcome 
and replace the disadvantage that you have all spoken to that 
we have under the current law. Now whether we can achieve it 
ultimately is going to be a very, very long, difficult journey. 
In the meantime, we need to think about how we can immediately 
improve the current law, at least to some degree that will 
significantly help you in the near-term.
    I was very interested, Mr. Loffredo, in your comments 
because what we are seeing, it seems to me, is the advent of a 
new chemistry that is beginning to develop in the world and 
that is the merger of larger corporations across country 
boundaries. That again is part of what we have got to expect 
more and more of in an inter-related world marketplace. Your 
company, Chrysler, has merged with Daimler, and I notice that 
it is not ChryslerDaimler, it is DaimlerChrysler. I wonder if 
our Tax Code were changed whether it would perhaps not be 
ChryslerDaimler or if perhaps the headquarters, the home 
office, the controlling corporation would be U.S. instead of 
German. Can you tell us what role, what impact the different 
Tax Codes had on the ultimate decision of the boards of 
directors in determining whether the resulting corporation 
would be German or whether it would be U.S.?
    Mr. Loffredo. Taxes were one of several issues that 
determined the location and corporation--the country of 
incorporation. The point that should be made is the fact the 
United States never had a chance. There is no major foreign 
operation that would voluntarily submit itself to the U.S. 
international tax system. The way the structure is now, whether 
taxes was a controlling factor or just one of many, we never 
had the opportunity to broach the question because the tax 
system kept us from having any arguments to say it should be a 
U.S. company. So, basically, I can't tell you taxes was the 
reason. There were a lot of legal reasons, a lot of political 
reasons in Germany. But I can tell you the U.S. tax system did 
not give me any weapons to fight to make it a U.S. company.
    Chairman Archer. What sort of advice did the boards of 
directors receive from their tax experts on both sides of the 
Atlantic relative to what the resulting corporation should be?
    Mr. Loffredo. Once it was determined that the U.S. laws 
were not the proper place from a tax standpoint, and this means 
a lot because one of the major disadvantages of not being a 
U.S. company is that you are not treated the same way on the 
New York Stock Exchange and Standard & Poors. So you don't take 
such a decision lightly here. By giving up the U.S. corporate 
format, we were taken out of the Standard & Poors 500 and our 
stock suffered greatly.
    But there were many reasons, there were legal, there were 
political, there were tax. But after we got through the point 
as to whether or not that we knew we could not be a U.S. 
company, we looked around Europe or the rest of the world as to 
what type of company we should be. We looked to The Netherlands 
and we looked to some of the tax havens. And then the German 
tax laws came in strongly to support the fact that it should be 
a German company because if you look at the German tax laws, 
even though they at that time they probably had an effective 
tax rate of 52 percent, which is significantly higher than 
ours, 45 of that being a Federal tax rate, when a German 
company pays a dividend to a German shareholder, they receive 
15 percent of those 45 percent points back. And then the 
integrated tax system in Germany comes to play. So, in effect, 
a German company is not a taxpayer when it has a German 
shareholder because the shareholder would get the credit for 
the corporate tax. So the integrated system favored a German 
company.
    And, as you can see over the past year or so since the 
merger, we started out with 44 percent U.S. shareholders and we 
are down to around 25 percent shareholders. The attractiveness 
of this investment in Europe is growing. I can't say taxes was 
the major decisionmaker, but definitely I had no arguments from 
a U.S. standpoint to fight for it.
    Chairman Archer. Well, you testified that by becoming a 
German company, your corporation was able to save 23.5 percent.
    Mr. Loffredo. That is an example of--if we were comparing 
being a U.S. parent company and a German company on dividends 
coming into the parent. If the dividends came from Germany to 
the United States----
    Chairman Archer. Sure.
    Mr. Loffredo [continuing]. We would be unable to use the 
credits, our rate would have been significantly higher. Going 
into Germany, we know that the tax on U.S. dividends will be 
about 40, 41 percent. But, again, in any decision you make in 
business, taxes is just one of many that you do. It is not the 
controlling decision.
    Chairman Archer. Well, certainly, that would be the case. 
You examine government regulation, you examine all types of 
things, but so many of the other things, we do not have much 
opportunity to change.
    Mr. Loffredo. Right. No, I agree.
    Chairman Archer. If the United States had no income tax and 
derived all of its revenue from a border adjustable consumption 
tax, would you have been able to make a strong recommendation 
to the board that they should emerge as a U.S. corporation?
    Mr. Loffredo. I think my position would have been greatly 
enhanced because then I would have had the argument that any 
dividends coming into the United States would have been free of 
tax because we would have basically then been a similar 
territorial system like the German system is now. Plus, as you 
know, I have spent a lot of time over the last 15 years looking 
at border adjustable type taxes and with the advent--well, with 
the sale of close to 2 million Chrysler vehicles in the United 
States, Chrysler Jeeps and Dodges and Plymouths, and the sale 
of 200,000 Mercedes Benz in the United States, a third of those 
coming now from Alabama, I think it would have given me a 
strong argument for the United States being the seat of the 
corporation. Whether that would have changed the minds of the 
Daimler people, I can't say.
    Chairman Archer. Well, I understand that you are to some 
degree limited in your position with the corporation today in 
what you can say publicly before the Committee, and I do 
appreciate what testimony you have given to us. Let me simply 
say to all of you that Princeton Economics did a survey of 
major foreign corporations in Europe and Japan and asked them 
this question: If the United States abolished its income tax 
and raised its revenue in the form of a sales tax, what impact 
would that have on your decisions? The responses were that 80 
percent said they would build their new factories in the United 
States and export from the United States. Twenty percent said 
they would move their international headquarters to the United 
States.
    What we are seeing in reverse, as a result of our Tax Code, 
is DaimlerChrysler headquartered in Germany. I am not opposed 
to all of this inter-relationship, but in the long-term, it is 
certainly going to push ideas, concepts, purchases and the 
operation of the company more toward a consideration of the 
Germans than the United States. We have seen that happen with 
Bankers Trust, which is now Deutsche Bank of Germany because of 
our Tax Code. We have seen it happen with Amoco and now with 
Arco, which are now British corporations. If our Tax Code were 
different, there is no doubt in my mind that all of them would 
be U.S. corporations. Even though it is not the total factor in 
decisions, it is a massive factor in decisions.
    So I am delighted to hear the testimony from you today that 
conveys to this Committee the need to do something about the 
way that we prejudicially tax foreign source income and to get 
American moving again, not just to compete but to win the 
battle of the global marketplace in the next century.
    So I thank you very much. I am sure other members would 
like to inquire.
    Mr. McCrery.
    Mr. McCrery. Thank you, Mr. Chairman. You spoke about 
competitiveness and there is one item that was brought up by 
this panel that to me just sticks out, not in the Tax Code but 
in our duty structure, as being uncompetitive or putting our 
American ocean carriers in a very uncompetitive position and 
that is the duty on foreign repairs. This Committee repealed 
that duty 2 years ago only to lose it in conference because of 
some other considerations.
    But, Mr. Finnerty, so that the Members of this Committee 
will fully understand what happens, let me just describe a 
situation and you tell me if this is correct. If there is an 
American vessel leaving port in the United States carrying 
goods for export and it sails across the Atlantic, goes over to 
Europe, dumps its goods--not dumps, puts its goods into port 
for export, and then it has a mechanical problem, something 
goes wrong with the ship. And you got to have it fixed at a 
repair facility in Europe. Tell us what happens duty-wise when 
you have to make that repair overseas?
    Mr. Finnerty. Mr. McCrery, the law provides that after we 
pay the bill overseas, whether it be in Asia or Europe, when we 
call at the first port in the United States with that U.S.-flag 
vessel, we then owe the U.S. Government 50 percent of that 
bill. This does not apply to the foreign-flag vessels that we 
operate. And it does not apply to the foreign-flag vessels that 
are operated by all of our other competitors overseas. It only 
applies to U.S.-flag ships.
    Mr. McCrery. So that repair costs you 50 percent more than 
it otherwise would because of the duty imposed by the U.S. 
Government?
    Mr. Finnerty. That is correct.
    Mr. McCrery. Mr. Chairman, that, to me, is one of the more 
ridiculous provisions of our law that I have ever heard. And I 
hope this Committee once again will repeal that. But in lieu of 
repealing, the American-flag vessels have come up with an 
innovative way to turn that duty to the advantage of American 
shipyards. They are willing to allow that duty to continue to 
be imposed if they have the option of putting that 50 percent 
duty, rather than into the Treasury, into something that is 
already set up, the Capital Construction Fund, which would 
enable them to use that money at some point to build new ships 
in American shipyards. So it kind of creates at least a partial 
win-win for the industry. They still have to pay the 50 percent 
penalty, but at least the money would go into a ship 
construction fund that would have to be spent at shipyards here 
in the United States.
    So, Mr. Chairman, I hope this Committee will give 
consideration to that approach if we do not just repeal that 
duty altogether.
    Thank you.
    Chairman Archer. Does any other member have any questions? 
Mr. Rangel?
    Mr. Rangel. Thank you. Mr. Loffredo, you had indicated that 
tax liability was one of the major factors in determining where 
you would have your headquarters, but the chairman was 
suggesting the abolishment of the entire Tax Code and 
substituting it with a national sales tax. What impact would 
that have had on the decision that your company made?
    Mr. Loffredo. It would have at least given me the 
opportunity to present the case that a U.S. quarters should 
be--or a U.S. corporation should be the parent of the Daimler 
Group because one of the concerns of double taxation in the 
United States would have gone away, and we would be certain 
that the only tax we would pay would be on the products sold in 
the United States. And so at least I would have had an argument 
to go forward. Under the current system, I had no way--I mean 
as a tax director, it was very good to be able to give advice 
saying, ``Don't be a U.S. company.'' But as an American, that 
was very difficult advice to give our management that you don't 
want to end up being an American company. All kinds of 
companies are trying to flip out of the United States, and we 
have an opportunity to do it. And so from a tax standpoint, 
this advice is being given everyday. But it shouldn't be the 
advice that a U.S. citizen should give.
    Mr. Rangel. But tax relief or simplification or abolishment 
of the double taxation, any of these things could have provided 
you with a more favorable tax climate in the United States. The 
chairman read parts of a report from Princeton, which sounds so 
exciting. It suggests that if we just ``abolished the Tax Code 
as we know it,'' then you wouldn't have any decision to make. 
You would just bounce your firm right over here.
    Mr. Loffredo. As you know, our partner was Daimler Benz, 
which is the largest manufacturer in Germany. So political 
decisions could have outweighed any tax decisions as to where 
the location of that facility would be. I can say from a tax 
standpoint, I could defend a U.S. corporation very well and 
probably from an investment standpoint because it would have 
been still in the Standard & Poors and still a normal stock on 
the New York Stock Exchange. But the political aspects of that, 
as you know are sometimes beyond my control.
    Mr. Rangel. What you are saying is that if we make it more 
favorable, it's a factor and----
    Mr. Loffredo. Right.
    Mr. Rangel. And you have to weigh everything. Then you make 
a decision. But you certainly are not prepared to say that if 
we abolished the Tax Code you would be here.
    How about the rest of you in terms of this approach that 
the chairman has suggested just wipe the Tax Code out, pull it 
up by the roots, start all over, go into a universal sales tax 
system, and get all you guys back here in the United States? Is 
there anyone who believes that this would really bring you all 
back home where you belong? Do you think it would be a 
tremendous advantage to be able to say that you are a U.S. 
firm, you are tax-free, you will be more productive, and if it 
is possible, you will help the economy improve to an even 
higher standard than the President's gotten it? You don't seem 
as nearly as excited about this as my chairman. How about you, 
Mr. Finnerty?
    Mr. Finnerty. Well, Mr. Rangel, I will defer to my 
colleagues on the specifics, but I can tell you of what I know 
of that proposal, it would have a very dramatic and beneficial 
impact on the U.S. economy. My own company does business 
primarily outside the United States with our ships, so it would 
not have as immediate an impact on us. But in terms of our 
customers that would be producing the exports from the United 
States, it would be a very powerful engine.
    Mr. Rangel. Let me ask this before the red light goes on. 
We know that taxes play an important role in deciding where you 
are going to set up your headquarters. What about the 
competency of your staff and the education of our workers and 
the transfer of technology? Do you find that United States 
workers are competitive with workers in other parts of the 
country with regards to your company needs? Are we in pretty 
good shape?
    Mr. Loffredo. I would just make a point. Whether you are a 
U.S. company or a German company, it really doesn't dictate 
where you have to set up your physical location for your 
headquarters. At the current time, we have two headquarters 
within the DaimlerChrysler Group. We have a headquarters in 
Auburn Hills and we have a headquarters in Stuttgart. And it 
doesn't mean that eventually we may not have a headquarters in 
London or in New York to really be more of a holding company. 
So the country of incorporation doesn't have to dictate where 
you put your headquarters.
    Mr. Rangel. No, I am asking though whether the 
sophistication or the training of the employees, would that not 
be a factor too as to where you would place yourselves?
    Mr. Loffredo. But it may not be a factor as to what country 
of incorporation you are in. It just may be where you have your 
offices.
    Mr. Green. I can tell you in the emerging global energy 
industry that with the American workers and the skill of 
knowledge that we have in this country is unquestionably in the 
top-tier around the world. And that is really where we are 
coming from and having that capability to transfer that 
knowledge and skills. And I say knowledge and skills because we 
are an industry that cannot export jobs. We have to have a 
taxable presence with the other customers. So it is teaching 
that knowledge and that skill that we have learned in this 
country around the world. And to have that opportunity is what 
we are after. This has only been going on since about 1987. So 
it is a new situation in the global energy industry. And what 
we are talking about is foreign companies owning energy 
infrastructures, the very key driver to economies around the 
world. And for Americans to have the chance to be a part of 
that vital piece of other economies is very important. At the 
same time, we want to be able to protect our own economy and 
who owns our energy infrastructure here. So it is a very 
serious, important situation for us.
    Mr. Rangel. Thank you, Mr. Chairman.
    Chairman Archer. Does any other Member have questions?
    Mr. Levin.
    Mr. Levin. Just briefly, a couple of comments. Mr. 
Chairman, I think the discussion about the impact of our tax 
system on our competitiveness needs to be undertaken seriously 
and openly and with open-mindedness. I hope we will bring the 
same spirit when we talk about trade legislation and be willing 
to look at new ideas and also have the same sensitivity to the 
impact on U.S.--on American productiveness and production.
    I take it the answer on the sales tax would be affected to 
some extent by the amount of the sales tax. I would think that 
my friend from Chrysler would be the first to acknowledge that 
that has some impact.
    Let me just say, Mr. Chairman, it is important that we talk 
about the basic system, and I think you will agree, we also 
need to continue to focus on changes that we might make in the 
present system. For example, the discussion of active finance 
income. I hope we will continue to think about that because 
that is one item that has some cost to it in our bill. And 
unless there is substantial support for it, it isn't likely to 
be continued on a long-term basis.
    I also want to join with Mr. McCrery in urging we do take a 
look at 2159 to try to solve that dilemma.
    Thank you, Mr. Chairman.
    Chairman Archer. Thank you, Mr. Levin. The Chair recognizes 
Mr. Weller and then Mr. McDermott.
    Mr. Weller. Thank you, Mr. Chairman. And I would like to 
direct my question to Ms. Stiles of Caterpillar. And, of 
course, in my conversations with your company, you employ 
almost 8,000 workers in the district that I represent in the 
south suburbs and rural areas that I represent. And you folks 
make a lot of these. And this is a fraction of the size of the 
actual equipment that is produced. But very clearly, 
Caterpillar has always indicated how important global trade is 
in our conversations. And I just wonder can you tell me what 
percent of the product you produce is sold overseas today?
    Ms. Stiles. I believe we are at 49 percent of our sales are 
overseas.
    Mr. Weller. And that area, is it growing?
    Ms. Stiles. It has grown in the past years. I think we are 
actually down a percent maybe last year from 50 percent.
    Mr. Weller. Is your chief competitor a U.S. company?
    Ms. Stiles. We do not regard our chief competitor as a U.S. 
company. I would say more that it is a Japanese Co., Kamutzu, 
would be I believe one of--it is spread a bit between Japanese, 
Korean, and, of course, we do have competitors in the United 
States. But especially on that large equipment, like you have 
sitting there, it would not be a U.S. company, no.
    Mr. Weller. You mention that the deferral for finance, 
active finance income helps you provide a more level 
playingfield when you are competing with the Japanese and the 
Koreans and the others in the global market. Can you elaborate 
on why this is the case? Why that deferral for active finance 
income helps put you on a more level playingfield?
    Ms. Stiles. Certainly. As I discussed earlier, given the 
average price of Caterpillar equipment, the majority of our 
sales are very closely tied to the ability to provide an 
attractive financing package to our customers. We have found at 
Caterpillar, we maintain a very close relationship with our 
customers, not only for the machine and the servicing and sale 
of the machine but also for the financing.
    In order to do this in international settings, we have to 
compete with our foreign competitors based on the local tax law 
because most of our foreign competitors will not be subject to 
an additional incremental tax in their home country. Now when 
we absorb those costs, which we must if we are going to offer 
the same type of financing packages that they do, over the 
course of billions and billions of sales transactions, this 
becomes a very significant cost for Caterpillar. If, on the 
other hand, we find that we simply cannot offer the same type 
of package, due to the incremental tax costs facing our 
companies, we risk not only losing the finance transaction, but 
we risk losing the sale of the equipment, which is basically 
the reason we have a finance company is to sell CAT equipment.
    Mr. Weller. So the loss of your ability to offer finance 
income would severely hamper your ability to compete with the 
foreign competition?
    Ms. Stiles. That is correct.
    Mr. Weller. The last two hearings on international 
simplification, including the one this past week, they have 
disclosed there are major problems with the United States 
treatment of foreign tax credits. And I was wondering what you 
would recommend to remedy this problem?
    Ms. Stiles. Well, there are several things, two of which we 
would recommend highly are included in the current legislation, 
the extension of the carry-forward period for foreign tax 
credits and the acceleration of the provisions related to the 
902 non-controlled foreign corporations. But in addition to 
that, there are several places where it is noted we need a 
study of allocation of interest expense and apportionment.
    I would go a little further than that in that I don't know 
of a company that the interest expense apportionment rules are 
not having a very detrimental effect on them for a variety of 
different reasons. In our case, we have a U.S.-captive 
financial company. And because of the interest expense that is 
incurred by that company, we feel we are unfairly penalized 
with that expense because a very large portion of that is 
apportioned to foreign assets under the current rules. This 
expense is incurred solely to fund U.S. transactions. It should 
be consolidated within that financial company.
    Also, the basket rules have become so complex that they are 
not only costly procedures but error prone. We have to devote 
an entire staff of people for 8 to 10 weeks to calculate one 
number on our tax return, the foreign tax credit limitation.
    And while I am on the simplification, the use of U.S. gap 
earnings and profits, I think would go very far in the eyes of 
most companies to simplifying this process, and I believe 
making it a more accurate process than what we have now.
    Mr. Weller. OK, thank you. I see my time has expired. Thank 
you, Mr. Chairman.
    Chairman Archer. The Chair recognizes Mr. McDermott.
    Mr. McDermott. Thank you, Mr. Chairman. As one of the non-
tax lawyers on this Committee, I have a question. Mr. Loffredo, 
you talk about the Germans are territorial. Are they talking 
Germany or they talking the common market?
    Mr. Loffredo. No, worldwide. Prior to this recent law 
change, any dividends received by a German company from a 
foreign subsidiary would not have been taxed in Germany. It is 
not only the common market.
    Mr. McDermott. It is the whole world?
    Mr. Loffredo. Our dividends from the United States to them 
would have also gone in tax free.
    Mr. McDermott. And explain to me, just trying to understand 
historically why this happened, why are we in the position that 
we are that makes an American company say, ``Gee, we would be 
better to be registered in Germany.'' Explain what are the--how 
did that happen?
    Mr. Loffredo. I think it began, as the chairman started the 
hearings with in 1962, with the beginning of Subpart F and the 
evolution of that over the last 35 or 37 years making it more 
and more difficult for U.S. companies to utilize their foreign 
tax credits. And once you make it more difficult to utilize 
foreign tax credits, which are taxes paid by our foreign 
subsidiaries, you are then subjecting to yourself to a double 
taxation in the United States when you bring the funds home.
    Mr. McDermott. But in other words, the Congress kind of 
used a sledge hammer to deal with the Cayman Islands, or 
wherever the tax havens were, and they hit the rest of you?
    Mr. Loffredo. Right, the abuses were out there and there 
were definitely abuses out there. But when they went after the 
abuses, they brought in the normal business transactions also.
    Mr. McDermott. Do you think it is possible to divide the 
baby here and deal with legitimate foreign operations and the 
kind of tax haven operations of the Caymans?
    Mr. Loffredo. I question whether whatever law comes up, I 
think someone would be able to find a way around it.
    Mr. McDermott. Guys as smart as you could find a way around 
it, right?
    Mr. Loffredo. Yes, a decision has to be made whether or not 
you are going to maybe set a rule, you are going to tax all 
foreign income at 35 percent. If you proved you paid it 
someplace else, then you don't pay any more into the United 
States. If you didn't pay it someplace else, then you pay it to 
the United States. I mean something that arbitrary may have to 
be the only way to do it. But any rule you try to create will 
just create a 1,000 tax lawyers getting around it.
    Mr. McDermott. In other words, trying to devise a rule that 
defines a paper corporation?
    Mr. Loffredo. Right.
    Mr. McDermott. Is pretty difficult?
    Mr. Loffredo. Pretty difficult.
    Mr. McDermott. I have a second question for Mr. Finnerty. 
My understanding that your taxation, when you say when you tie 
up in an American port, you have to pay 50 percent of the cost 
of the repair. That is a trade law. That is not an income tax 
law, is that correct?
    Mr. Finnerty. It is a customs duty, Mr. McDermott. It is 
not an income tax, it is a customs duty.
    Mr. McDermott. So the chairman's idea of taking out the 
income tax, that really wouldn't do anything for what you are 
talking about because you are not taxed?
    Mr. Finnerty. No, not on that particular piece. But the 
balance of my discussion about the Capital Construction Fund, 
which is a tax deferral account, does relate to income.
    Mr. McDermott. OK, thank you. The other question I have for 
the panel really is a question of what you are saying here 
today is the tax laws are slanted the wrong way and we want to 
slant them the other way. There must be some reason why your 
companies stay here or don't--for instance, Caterpillar, why 
don't you go find some small equipment manufacturer somewhere 
overseas and do what DaimlerChrysler did? Why don't you do 
that? What makes you stay here?
    Ms. Stiles. Well, in the first place, for Caterpillar to 
move would be a very expensive proposition. Our plants are not 
easily moveable. We have to sink three stories into the ground 
just to lift our equipment, and we have a manufacturing base 
right now whereby 70 percent of our assets are in the United 
States. We would like to keep it that way.
    Mr. McDermott. But that is true for Chrysler, too? They did 
that. They didn't move any of their plants. They just simply 
moved the headquarters people and the tax people and changed 
the line on the door that said a German company?
    Mr. Loffredo. There is a rule in the tax law currently that 
says if you basically flip out to a foreign jurisdiction and 
re-incorporate, unless you meet certain tests, which we met in 
our merger, your shareholders are subject to tax on the gain. 
So there is some control on becoming a non-U.S. company 
currently in the tax law. If Chrysler were larger than Daimler, 
we would have had the potential of a U.S. tax problem if we 
became a German company. But in our tax situation, Daimler was 
larger than Chrysler.
    Mr. McDermott. So Caterpillar's real problem is that they 
are too big?
    Mr. Loffredo. Right.
    Mr. McDermott. They can't find anybody bigger than them to 
join with?
    Mr. Loffredo. But one of the things I have noticed is you 
can start doing a pyramid scheme because we have come from $60 
billion, well, let's say they were $80 billion when they 
acquired us, and we were $60. And now we are maybe $140 billion 
company. And now we can look at a Caterpillar where you could 
almost pyramid your way out.
    Mr. McDermott. Thank you, Mr. Chairman. I don't think I 
understand everything yet.
    Chairman Archer. Does any other member wish to inquire? The 
Chair would like to comment briefly to your inquiry, Mr. 
McDermott. If we went to the simplified 35 percent of foreign 
source income tax, you would still have to define foreign 
source income. You can not avoid that. You can not simplify it 
because you are inevitably coming back and having to change 
what is and what is not income and no two economists agree on 
what is or is not income. That is the problem. Your testimony 
today for the most part, if we could get this change in the 
Code, we would not be at this great disadvantage. Then you 
start to examine how you make these changes and it is the most 
complex part of the Tax Code that we have.
    I would like to ask each one of you what disadvantages are 
present in deciding between remaining a U.S. corporation 
compared to being a foreign corporation other than the Tax 
Code?
    Mr. Green. I will speak for the utility industry. That 
really is the primary disadvantage, quite frankly. Here we have 
the energy system that is the envy of the world, the skill and 
knowledge and the workers, and what we are seeing is the 
globalization of an industry that has only been going on for 10 
or 12 years. So really getting Americans competitive in this 
industry is to preempt the event that we simply can't be 
competitive.
    Chairman Archer. Does any one want to cite other aspects of 
being in the United States where you are at a disadvantage 
other than the Tax Code?
    Mr. Loffredo. May I just--two things I have noticed is that 
first of all, the reaction to Wall Street has been negative, 
the fact that we are not a U.S. company any longer, which is 
really critical in a lot of respects. Second, from a personal 
standpoint, the morale of U.S. employees I think has been a 
negative.
    Chairman Archer. You think there is higher morale of 
employees in other countries than there is in the United 
States?
    Mr. Loffredo. No, I think there was higher morale at 
Chrysler when we were a U.S. company.
    Chairman Archer. OK. So you have not cited any other 
inherent disadvantage to being in the United States other than 
the Tax Code?
    Mr. Loffredo. And Wall Street.
    Chairman Archer. And Wall Street. Let me make sure I 
understand this. In other words, U.S. corporations are at a 
disadvantage to foreign corporations because of Wall Street?
    Mr. Loffredo. No, no, I'm sorry. Tax Code, but a 
disadvantage of being a foreign corporation is that you are no 
longer allowed certain rights on Wall Street.
    Chairman Archer. OK. So that is an advantage to being in 
the U.S.?
    Mr. Loffredo. Yes.
    Chairman Archer. OK. I am asking you to cite any other 
disadvantage to being in the U.S. other than the Tax Code? The 
reason I do that is because of the inference in other questions 
that the Tax Code is only a small factor and all these other 
factors are things that have to be considered. If the Tax Code 
is the only negative factor in being a U.S. corporation, then 
clearly it is of major significance because all of these 
decisions are made at the margin. We could not see, for 
example, up until the last five to 10 years, what is happening 
now with DaimlerChrysler, Banker's Trust, Deutsche, Case, 
foreign corporation, Amoco, Arco, foreign corporations taking 
over. This is a new phenomenon in an inter-related world 
marketplace. It is clear that it is driven by the Tax Code. It 
is clear that it will continue into the next century when the 
conditions are at the margin where the Tax Code will make that 
determination.
    That is not in the best interest of the United States of 
America. God help us if we do not do something about this. It 
is the single biggest thing we can do to help in this regard 
unless you think of something else, it is a disadvantage in the 
United States where we ought to help on that.
    Mr. Watkins. Mr. Chairman?
    Chairman Archer.
    Mr. Watkins.
    Mr. Watkins. I think the point is well-taken that you are 
making. And I think we are, in all respect, we are dealing with 
tax individuals here and I would like them to broaden their 
thinking just a little because you are right on the tax policy. 
And one of the reasons why I came back to Congress was we need 
to have a 21st century globally competitive economy in the 
United States allowing us to be competitive around the world. 
In all respects, tax policy is on your mind. That is a major 
problem, and we have got to address that.
    But there are three areas that I have studied, and tax 
policy, yes. Second, regulatory. And I guarantee you talk to 
other people in your company and the regulator policies are 
affecting big time. Third, litigation, product liability, other 
things we put right here in this country. Those are some of the 
things that also have to be addressed if we are going to be 
competitive companies around the world. But tax policy I know 
is the issue right today. But I think we need to talk to other 
people in our corporations because those two things are putting 
an overburden of about 15 percent on a lot of our products.
    Chairman Archer. Thank you very much for testifying today, 
and I hope that all of you realize that I am not coming down on 
any of you in my enthusiasm for trying to do something to help 
you to be more competitive in the world marketplace in the next 
century. If we do not change the Tax Code, we are driving jobs 
out of this country. We are reducing our capability to compete. 
We are reducing our ability to export. We are undermining the 
ability of workers in this country to earn more in the next 
century. Those are major items I think we need to attend to.
    I do want to ask one specific question, relative to 
interest allocation, which has come up a couple of times. Would 
the Senate 86 proposal basically remedy this problem if we were 
to adopt it in the tax bill this year?
    Mr. Green. That wouldn't take care of our problems. I think 
that that is a very good bill, and we need to work with that. 
But there are two issues with that, one the 80 percent 
ownership requirement. In the energy industry and the 
privatization going on around the world, many times the 
privatization is less than 50 percent. So we would fall out of 
that qualification. The second piece of it that we would like 
to work with them on deals with changing the measuring of the 
assets to a fair market value or a tax book value. That, again, 
becomes misleading for a utility that has depreciated long-
lived assets and really exacerbates the problem we have with 
the interest allocation formula. But on the whole, it is a bill 
that we think is a good one, and we would like to work with it 
to see if we can get our solution inside that.
    Chairman Archer. Do you think from your expert counsel on 
this very complicated issue, that we can improve the Senate 86 
approach without losing significant additional revenue, which 
may make it prohibitive in the Tax Code?
    Mr. Green. That certainly is our intent, understanding that 
we are very sensitive to that revenue estimate. At the same 
time, I would also like to encourage looking at this at a 
phased-in approach perhaps, to maybe spread that a little bit 
more and at least start the action to change in this area.
    Chairman Archer. Well, we most definitely will need to do 
that. Whatever tax relief bill that we propose will have very 
little revenue to use in the first couple of years. So whatever 
we establish as tax policy for the future, all of it is will be 
phased in with a few exceptions. Then expanded as the wedge 
grows out. That is a generic format that we will need to 
follow.
    Again, thank you very much. We appreciate your testimony. 
You are excused, and we will get ready to hear our next panel.
    The Chair announces that, at the conclusion of the next 
panel, we will recess today for lunch. I hope we can do that no 
later than 12:15 and come back at 1.
    Gentlemen, welcome. We are ready to hear your testimony. 
Dr. Hubbard, if you would lead off, we would appreciate it. 
Again, if you will keep your oral testimony to within 5 
minutes, we would appreciate it. Your entire written statement 
will be printed in the record. Identify yourself before you 
proceed.

       STATEMENT OF R. GLENN HUBBARD, PH.D., RUSSELL L. 
 CARSON PROFESSOR OF ECONOMICS AND FINANCE, GRADUATE SCHOOL OF 
BUSINESS, COLUMBIA UNIVERSITY, NEW YORK, NEW YORK, AND RESEARCH 
            DIRECTOR, INTERNATIONAL TAX POLICY FORUM

    Mr. Hubbard. Thank you, Mr. Chairman, Mr. Rangel, Members 
of the Committee. I am Glenn Hubbard, a professor of economics 
at Columbia and research director of the International Tax 
Policy Forum. The Forum is a diverse group of U.S.-based 
multinationals that sponsors economic research and policy 
education about international tax policy.
    Racing against the red light, I only want to make three 
points and focus on the last two of those. First, U.S. 
multinationals make quite significant contributions to the U.S. 
economy. Second, following up on the points raised by the last 
panel, tax policy matters a lot for a range of investment 
decisions of multinationals. And, third, the current anti-
competitive U.S. tax policy toward multinationals can lead to 
runaway headquarters with significant potential losses in 
national well-being.
    I will not dwell on the role that U.S. multinationals play 
in our economy. It is in my written testimony, and I am sure 
other members of the panel will emphasize it. But I think it is 
important to note that the United States has a significant 
interest in ensuring that its tax rules do not hinder the 
competitiveness of U.S. multinationals.
    Tax policy matters a lot. Unfortunately, the discussion 
here often centers on an academic debate between economic 
efficiency and competitiveness. On the one hand, the United 
States has traditionally advocated so-called capital export 
neutrality, which is a long economic-sounding phrase simply 
stating that a resident should pay the same rate of tax whether 
an investment is made at home or abroad. This sounds simple. 
The idea is not to bias the location of investment, and the 
hope is to promote worldwide economic efficiency.
    From a competitiveness perspective, on the other hand, the 
United States has actually become one of the least attractive 
countries in which to locate the headquarters of a 
multinational. This reflects restrictions on the use of foreign 
tax credits, strong anti-deferral rules, and the lack of 
integration of the corporate individual income tax systems.
    Why should we care? U.S. companies can compete successfully 
against foreign firms only if they are adequately efficient to 
overcome this artificially imposed tax disadvantage.
    More important, this academic debate about efficiency 
versus competitiveness is actually based on a false choice. 
First, the United States has not, and probably will not, follow 
the capital export neutrality doctrine that it espouses. 
Implementation of capital export neutrality requires not just 
eliminating deferral, which is often talked about before you, 
but the granting of an unlimited foreign tax credit. Moreover, 
worldwide efficiency, economists' holy grail, emerges only if 
all countries simultaneously embrace the doctrine, a rather 
unlikely outcome. It is an old lesson in economics that going 
only part of a way toward an efficient outcome seldom makes us 
better off.
    Second, the models used to support the conclusion of 
capital export neutrality abstract from many important features 
of the real world, including imperfect competition. Economists 
who study multinationals outside of the tax area stress those 
features as absolutely critical for understanding 
multinationals.
    In a recent paper, Michael Devereux and I find that using 
realistic assumptions about strategic competition, deferral of 
U.S. taxation on foreign-source income can actually increase 
the well-being of U.S. residents.
    What are the bottom lines of U.S. multinationals? A 
continuation of the current emphasis of U.S. tax policy could 
lead to a decline in the share of multinational income earned 
by companies headquartered here. It is not just academic. We 
have been hearing it all morning. In several recent high-
profile mergers among United States and European 
multinationals, including BP-Amoco, Daimler-
Chrysler, and Deutsche Bank Bankers' Trust, a merged entity is 
chosen to be a foreign headquartered company.
    More important, looking down the road, future investments 
made by these companies outside the United States are not 
likely to be made through U.S. subsidiaries since tax on those 
operations could be removed from the U.S. corporate tax system 
by simply making them through the foreign parent. To be blunt, 
while some have suggested that reductions in the U.S. tax on 
foreign-source income could lead to the movement of 
manufacturing operations outside the U.S., so-called runaway 
plants, the far more likely scenario for you to consider is 
that a non-competitive U.S. tax system might lead to runaway 
headquarters, an increase in the foreign control of U.S. 
assets. Bottom line: U.S. tax rules can significantly alter the 
ability of U.S. multinationals to compete successfully around 
the world and ultimately at home.
    On behalf of the International Tax Policy Forum, I urge 
you, Mr. Chairman and Members of the Committee, to review 
carefully the U.S. international tax system in order to root 
out the major impediments limiting U.S. multinationals' ability 
to compete globally with foreign-based multinationals.
    [The prepared statement follows:]

Statement of R. Glenn Hubbard, Ph.D., Russell L. Carson Professor of 
Economics and Finance, Graduate School of Business, Columbia 
University, New York, New York, and Research Director, International 
Tax Policy Forum

                            I. Introduction
    I am R. Glenn Hubbard, Russell L. Carson, Professor of 
Economics and Finance, Graduate School of Business, Columbia 
University. I am testifying today on behalf of the 
International Tax Policy Forum, of which I am the research 
director. Founded in 1992, the International Tax Policy Forum 
is a diverse group of U.S.-based multinationals, including 
manufacturing, service, energy, financial service, and 
technology companies. The Forum sponsors research and education 
regarding the U.S. taxation of income from cross-border 
investments. As a matter of policy, the Forum refrains from 
taking positions on legislative proposals. John M. Samuels, 
Vice President and Senior Counsel for Tax Policy and Planning 
of General Electric, is chairman of the Forum. 
PricewaterhouseCoopers LLP acts as consultant to the Forum. A 
list of member companies is attached as Appendix A of this 
testimony.
    The Forum welcomes the opportunity to testify today on the 
effect of U.S. tax rules on the international competitiveness 
of U.S. companies. Increasingly, the markets for our companies 
have become global, and our competitors are foreign-based 
companies operating under tax rules that are often much more 
favorable than our own.
    The existing U.S. tax law governing the activities of 
multinational companies has been developed in a patchwork 
fashion over many years. In many instances, current law creates 
barriers that harm the competitiveness of U.S. companies. These 
rules also are horribly complex both for U.S. multinational 
companies to comply with and for the Internal Revenue Service 
to administer. That is why the Forum believes it is important 
for this Committee to review the current U.S. international tax 
rules with a view to reducing complexity and removing 
impediments to U.S. international competitiveness.
  II. The Role of U.S. Multinational Corporations in the U.S. Economy
    The primary motivation for U.S. multinationals to operate 
abroad is to compete better in foreign markets, not domestic 
markets. Investment abroad is required to provide services that 
cannot be exported, to obtain access to natural resources, and 
to provide goods that are costly to export due to 
transportation costs, tariffs, and local content requirements. 
More than one-half of all foreign affiliates of U.S. 
multinationals are in the service sector, including 
distribution, marketing, and servicing U.S. exports.\1\ Foreign 
investment allows U.S. multinationals to compete more 
effectively around the world, ultimately increasing employment 
and wages of U.S. workers.
---------------------------------------------------------------------------
    \1\ Matthew Slaughter, Global Investments, American Returns. 
Mainstay III: A Report on the Domestic Contributions of American 
Companies with Global Operations, Emergency Committee for American 
Trade (1998).

---------------------------------------------------------------------------
A. Exports

    Much research has shown that U.S. operations abroad produce 
a net trade surplus for the United States. Foreign affiliates 
of U.S. companies rely heavily on exports from the United 
States. Foreign affiliates of U.S. multinationals purchased 
just under $200 billion of merchandise exports from the United 
States in 1996. Additional exports by U.S. multinationals to 
unaffiliated foreign customers accounted for an additional $213 
billion in merchandise exports. Altogether, exports by U.S. 
multinationals were $407 billion in 1996--or 65 percent of all 
U.S. merchandise exports.\2\
---------------------------------------------------------------------------
    \2\ National Foreign Trade Council, The NFTC Foreign Income 
Project: International Tax Policy for the 21st Century, chapter 6 
(1999).
---------------------------------------------------------------------------
    A recent study by the Organization for Economic Cooperation 
and Development complements other academic research in finding 
that each dollar of outward foreign direct investment is 
associated with $2.00 of additional exports and an increase in 
the bilateral trade surplus of $1.70.\3\
---------------------------------------------------------------------------
    \3\ OECD, Open Markets Matter: The Benefits of Trade and Investment 
Liberalization, p. 50 (1998).

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B. U.S. Employment

    Foreign investment by U.S. multinationals generates sales 
in foreign markets that generally could not be achieved by 
producing goods entirely at home and exporting them. The 
strategy used by U.S multinationals of using foreign affiliates 
in coordination with domestic operations to produce goods 
allows U.S. multinationals to compete effectively around the 
world while still generating significant U.S. exports. These 
U.S. exports result in additional employment of U.S. workers at 
higher than average wage rates.\4\
---------------------------------------------------------------------------
    \4\ Mark Doms and Bradford Jensen, Comparing Wages, Skills, and 
Productivity between Domestic and Foreign-Owned Manufacturing 
Establishments in the United States, mimeo. (October 1996).
---------------------------------------------------------------------------
    A number of studies find investment abroad generates 
additional employment at home through an increase in the 
domestic operations of U.S. multinationals. As noted by 
Professors David Riker and Lael Brainard:

          The fundamental empirical result is that the labor demand of 
        U.S. multinationals is linked internationally at the firm 
        level, presumably through trade in intermediate and final 
        goods, and this link results in complementarity rather than 
        competition between employers in industrialized and developing 
        countries.\5\
---------------------------------------------------------------------------
    \5\ David Riker and Lael Brainard, U.S. Multinationals and 
Competition from Low Wage Countries, National Bureau of Economic 
Research Working Paper no. 5959 (1997).

    This relationship between foreign operations and domestic 
employment was also noted by the Council of Economic Advisers 
---------------------------------------------------------------------------
in the 1991 Economic Report of the President:

          In most cases, if U.S. multinationals did not establish 
        affiliates abroad to produce for the local market, they would 
        be too distant to have an effective presence in that market. In 
        addition, companies from other countries would either establish 
        such facilities or increase exports to that market. In effect, 
        it is not really possible to sustain exports to such markets in 
        the long run. On a net basis, it is highly doubtful that U.S. 
        direct investment abroad reduces U.S. exports or displaces U.S. 
        jobs. Indeed, U.S. direct investment abroad stimulates U.S. 
        companies to be more competitive internationally, which can 
        generate U.S. exports and jobs. Equally important, U.S. direct 
        investment abroad allows U.S. firms to allocate their resources 
        more efficiently, thus creating healthier domestic operations, 
        which, in turn, tend to create jobs.\6\
---------------------------------------------------------------------------
    \6\ Council of Economic Advisers, Economic Report of the President, 
p. 259 (1991).
---------------------------------------------------------------------------
C. U.S. Research and Development

    Foreign direct investment allows U.S. companies to take advantage 
of their scientific expertise, increasing their return on firm-specific 
assets, including patents, skills, and technologies. Professor Robert 
Lipsey notes that the ability to make use of these firm-specific assets 
through foreign direct investment provides an incentive to increase 
investment in activities that generate this know-how, such as research 
and development.\7\
---------------------------------------------------------------------------
    \7\ Robert Lipsey, ``Outward Direct Investment and the U.S. 
Economy,'' in The Effects of Taxation on Multinational Corporations, p. 
30 (1995).
---------------------------------------------------------------------------
    Among U.S. multinationals, total research and development in 1996 
amounted to $113 billion, of which $99 billion (88 percent) was 
performed in the United States.\8\ Such research and development allows 
the United States to maintain its competitive advantage in business and 
be unrivaled as the world leader in scientific and technological know-
how.
---------------------------------------------------------------------------
    \8\ U.S. Department of Commerce, Survey of Current Business 
(September 1998).

---------------------------------------------------------------------------
D. Summary

    U.S. multinationals provide significant contributions to the U.S. 
economy through:
     A strong reliance on U.S.-provided goods in both domestic 
and foreign operations;
     Additional domestic employment of employees at above 
average wages; and
     Critical domestic investments in equipment, technology, 
and research and development.
    As a result, the United States has a significant interest in 
insuring that its tax rules do not hinder the competitiveness of U.S. 
multinationals.
         III. Tax Policy and U.S. International Competitiveness
    The increasing integration of the world economies has 
magnified the impact of U.S. tax rules on the international 
competitiveness of U.S. multinationals. Foreign markets 
represent an increasing fraction of the growth opportunities 
for U.S. businesses. At the same time, competition from 
multinationals headquartered outside of the United States is 
becoming greater. As an example of this heightened worldwide 
competition, between 1960 and 1996 the number of the world's 20 
largest corporations headquartered in the United States 
declined from 18 to just 8.

A. Why Tax Policy Matters

    With the increasing globalization of the world economies, 
it has become critical for U.S. businesses to compete 
internationally if they wish to remain competitive at home. If 
U.S. businesses are to succeed in the global economy, they will 
need a U.S. tax system that permits them to compete effectively 
against foreign-based companies. This requires that U.S. 
international tax rules not place U.S.-headquartered 
multinationals at a competitive disadvantage in foreign 
markets.
    From an income tax perspective, the United States has 
become one of the least attractive industrial countries in 
which to locate the headquarters of a multinational 
corporation. This is because there are several major respects 
in which U.S. tax law differs from that of most of our trading 
partners.
    First, about half of the OECD countries have a territorial 
tax system (either by statute or treaty), under which a parent 
company is not subject to tax on the active income earned by a 
foreign subsidiary.\9\ By contrast, the United States taxes 
income earned through a foreign corporation when it is 
repatriated or deemed to be repatriated under various ``anti-
deferral'' rules in the tax code.
---------------------------------------------------------------------------
    \9\ Organization for Economic Cooperation and Development, Taxing 
Profits in a Global Economy (1991).
---------------------------------------------------------------------------
    Second, even among countries that tax income on a worldwide 
basis, the active business income of a foreign subsidiary is 
generally not subject to tax before it is remitted to the 
parent.\10\ This differs from the U.S treatment of foreign base 
company sales and service income, and certain other types of 
active business income, which are subject to current U.S. tax 
even if such income is reinvested abroad.\11\
---------------------------------------------------------------------------
    \10\ Organization for Economic Cooperation and Development, 
Controlled Foreign Company Legislation (1996).
    \11\ Foreign source income relating to active financing income was 
taxed on a current basis until the 1997 Act. Such income presently is 
exempted from current taxation, although this exemption is slated to 
expire on December 31, 1999.
---------------------------------------------------------------------------
    Third, other countries with worldwide tax systems have 
fewer restrictions on the use of foreign tax credits than does 
the United States. The United States, on the other hand, has a 
variety of rules that limit the crediting of foreign taxes. 
Such rules include: the use of multiple ``baskets,'' 
restrictions imposed by the alternative minimum tax, the 
apportionment of interest and certain other deductions against 
foreign source income, and the attribution to a foreign 
subsidiary of a larger measure of income for U.S. purposes 
(``earnings and profits'') than is used by other countries.\12\ 
These rules can result in the incomplete crediting of foreign 
taxes and, as a result, the double taxation of foreign source 
income earned by U.S. multinational corporations.
---------------------------------------------------------------------------
    \12\ Price Waterhouse LLP, Taxation of U.S. Corporations Doing 
Business Abroad: U.S. Rules and Competitiveness Issues, Financial 
Executives Research Foundation (1996).
---------------------------------------------------------------------------
    Fourth, among the OECD countries, the United States, the 
Netherlands, and Switzerland are the only countries that fail 
to provide some form of integration of the corporate and 
individual income tax systems.\13\ This integration is provided 
by the major trading partners of the United States in order to 
reduce or eliminate the extent to which corporate income is 
double taxed by recognizing that dividends are paid to 
shareholders from income previously taxed at the corporate 
level.
---------------------------------------------------------------------------
    \13\ Sijbren Cnossen, Reform and Harmonization of Company Tax 
Systems in the European Union, mimeo., Erasmus University (1996).
---------------------------------------------------------------------------
    The net effect of these tax differences is that a U.S. 
multinational operating through a foreign subsidiary frequently 
pays a greater share of its income in foreign and U.S. tax than 
does a similar foreign subsidiary owned by a competing 
multinational company headquartered outside of the United 
States.\14\ This makes it more expensive for U.S. companies to 
operate abroad than their foreign-based competitors. In such 
circumstances, U.S. companies can only successfully compete 
against foreign-based multinationals if they are sufficiently 
more efficient than the competition to overcome this 
artificially imposed tax disadvantage.
---------------------------------------------------------------------------
    \14\ Organization for Economic Cooperation and Development, Taxing 
Profits in a Global Economy (1991).

---------------------------------------------------------------------------
B. Capital Export Neutrality

    While concerns for competitiveness require a U.S. 
multinational operating in a foreign country to pay the same 
tax as a foreign-based multinational operating in that country, 
another efficiency concern is frequently proffered to support 
taxing a U.S. investor equally whether the investment is made 
at home or abroad. This latter notion is referred to as 
``capital export neutrality.'' Capital export neutrality seeks 
to ensure that a resident of a given country pays the same rate 
of tax whether the investment is made at home or abroad. In 
general terms, capital export neutrality is thought to not bias 
the location of investment from the investor's perspective. 
Capital export neutrality requires that all foreign source 
income be taxed on a current basis by the home country and that 
the home country provides an unlimited foreign tax credit for 
all taxes paid.
    The principles of competitiveness and capital export 
neutrality necessarily conflict whenever effective tax rates 
differ across countries. U.S. international tax policy has 
frequently wrestled with the tradeoffs between these two 
principles. In a recent speech, Treasury Assistant Secretary of 
Tax Policy, Donald Lubick, noted the tradeoff between these 
principles.\15\
---------------------------------------------------------------------------
    \15\ Donald C. Lubick, Treasury Assistant Secretary of Tax Policy, 
Speech before the George Washington University/IRS Institute (December 
11, 1998).
---------------------------------------------------------------------------
    The Internal Revenue Service issuance last year of Notice 
98-11, in which the IRS announced that Treasury would issue 
regulations to prevent the use of certain ``hybrid branch'' 
arrangements deemed contrary to the policies and rules of 
Subpart F, demonstrated the Treasury's concern for capital 
export neutrality.\16\ The hybrid branch arrangements targeted 
by this Notice reduced foreign taxes, not U.S. taxes. Indeed, 
the use of these arrangements can only serve to increase total 
U.S. tax paid by U.S. multinationals since aggregate foreign 
tax credits would be reduced.
---------------------------------------------------------------------------
    \16\ Regulations that would have created subpart F income with 
respect to such transactions were proposed in March 1998, but their 
withdrawal was subsequently announced by Notice 98-35. Notice 98-35 
expresses the intention to re-issue similar rules.
---------------------------------------------------------------------------
    The debate regarding the principles of competitiveness and 
capital export neutrality dates back at least to 1961, when 
President Kennedy proposed the current taxation of all foreign 
source income earned by foreign subsidiaries of U.S. companies 
(except in developing countries). The legislation ultimately 
enacted in 1962, however, put traditional concerns of 
competitiveness ahead of the Kennedy Administration's concerns 
for capital export neutrality.\17\
---------------------------------------------------------------------------
    \17\ See National Foreign Trade Council, The NFTC Foreign Income 
Project: International Tax Policy for the 21st Century, chapter 2 
(1999).

---------------------------------------------------------------------------
C. Does Capital Export Neutrality Promote Efficiency?

    The theoretical model in which capital export neutrality 
results in worldwide efficiency in the allocation of capital 
resources is a fairly simple model. In its simplest form, 
savings in every country is in fixed supply and is not 
responsive to market opportunities. As a result, each dollar of 
foreign direct investment by a domestic resident results in one 
less dollar of domestic investment. The model makes a number of 
simplifications, but, even so, capital export neutrality leads 
to worldwide efficiency only if all countries follow a tax 
system imposing capital export neutrality. As noted earlier, in 
practice a substantial number of the major trading partners of 
the United States--half of the OECD--exempt active foreign 
source income from taxation. In such a case, an attempt by the 
United States to maintain capital export neutrality does not 
necessarily improve either worldwide efficiency or U.S. well-
being. A well-known economic theorem shows that when there is 
more than one departure from economic efficiency, correcting 
only one of them may not be an improvement.18 Unilateral 
imposition of capital export neutrality by the United States 
may fail to advance both worldwide efficiency and U.S. national 
well-being.
---------------------------------------------------------------------------
    \18\ R.G. Lipsey and K. Lancaster, ``The General Theory of the 
Second Best,'' Review of Economic Studies, pp. 11-32 (1956-57).
---------------------------------------------------------------------------
    The simple model supporting capital export neutrality fails 
to consider a number of real-world features that significantly 
affect the tax policy conclusions one should draw regarding the 
tax principles that promote worldwide efficiency and U.S. well-
being. For example, the model fails to consider that 
competition among multinational corporations takes place in a 
strategic environment where companies can increase their income 
by achieving economies of scale. In work co-authored with 
Michael Devereux, we show that, when these assumptions are 
relaxed, deferral of home-country taxation on foreign source 
income can increase the well-being of domestic residents 
relative to a system of current inclusion of foreign 
earnings.\19\
---------------------------------------------------------------------------
    \19\ Michael P. Devereux and R. Glenn Hubbard, ``Taxing 
Multinationals,'' mimeo. (January 1999).
---------------------------------------------------------------------------
    The simple model supporting capital export neutrality also 
fails to consider the possibility that foreign direct 
investment is complementary to domestic investment--rather than 
a substitute for domestic investment. As discussed earlier, a 
number of economic studies find that, at the firm level, 
foreign direct investment results in an increase in exports 
from the home country to foreign subsidiaries.
    Another important example of the simple model's failings is 
that it ignores the possibility that domestic residents can 
transfer their savings abroad through portfolio investment as 
an alternative to foreign direct investment. As recently as 
1980, portfolio investment abroad by U.S. investors was only 
about one-sixth the size of U.S. direct investment abroad. By 
1997, however, portfolio investment abroad was 40 percent 
larger than U.S. direct investment abroad.\20\ If U.S. tax law 
disadvantages U.S. multinationals, U.S. investors today have 
the opportunity to direct their savings to portfolio investment 
in foreign multinationals, the foreign investments of which are 
not subject to U.S. corporate income tax.
---------------------------------------------------------------------------
    \20\ U.S. Department of Commerce, Survey of Current Business (July 
1998).
---------------------------------------------------------------------------
    For these reasons, contemporary economic analysis offers 
little reason to believe that unilateral adoption of the 
principle of capital export neutrality can improve either 
worldwide efficiency or U.S. well-being.

D. Implications for U.S. Multinationals

    As noted earlier, from a tax perspective the United States 
is one of the least favorable industrial countries in which a 
multinational corporation can locate. Over time, these U.S. tax 
rules could lead to a reduction in the share of multinational 
income earned by companies headquartered in the United States. 
This decline in the importance of U.S. multinationals should be 
a concern for the very real loss in economic opportunities such 
a decline would bring about for American workers and their 
families.
    Professor Laura Tyson, former Chair of the Council of 
Economic Advisers and former Director of the National Economic 
Council, points out a number of political, strategic, and 
economic reasons why maintaining a high share of U.S. control 
over global assets remains in the national interest.\21\ These 
include:
---------------------------------------------------------------------------
    \21\ Laura D'Andrea Tyson, ``They Are Not Us: Why American 
Ownership Still Matters,'' American Prospect (Winter 1991).
---------------------------------------------------------------------------
     U.S. multinationals locate over 70 percent of 
their assets and employment in the United States;
     U.S. multinationals invest more per employee and 
pay more per employee at home than abroad in both developed and 
developing countries; and
     U.S. multinationals perform the overwhelming 
majority of their research and development at home.
    If the United States wishes to attract and retain high-end 
jobs, the U.S. tax system must not discourage multinationals 
from establishing their headquarters here.
    In several recent high-profile mergers among U.S. and 
European multinational corporations (including AEGON-
Transamerica, BP-Amoco, Daimler-Chrysler, Deutsche Bank-Bankers 
Trust, and Vodafone-AirTouch) the merged entity has chosen to 
be a foreign-headquartered company. In recent testimony before 
the Senate Finance Committee, DaimlerChrysler's vice president 
and chief tax counsel specifically implicated the overly 
burdensome U.S. international tax regime as a key factor in the 
merged firm's decision to be a German-headquartered 
company.\22\ Future investments made by these companies outside 
of the United States are unlikely to be made through the U.S. 
subsidiary since tax on these operations can be permanently 
removed from the U.S. corporate income tax system by instead 
making them through the foreign parent.
---------------------------------------------------------------------------
    \22\ John L. Loffredo, ``Testimony before the Senate Finance 
Committee'' (March 11, 1999).
---------------------------------------------------------------------------
    As I pointed out earlier, portfolio investment offers still 
another, perhaps less visible, route by which foreign-owned 
multinationals can expand at the expense of U.S. 
multinationals. If U.S. multinationals cannot profitably expand 
abroad due to unfavorable U.S. tax rules, foreign-owned 
multinationals will attract the investment dollars of U.S. 
investors. Individuals purchasing shares of foreign companies--
either through mutual funds or directly through shares listed 
on U.S. and foreign exchanges--can generally ensure that their 
investments escape the U.S. corporate income tax on foreign 
subsidiary earnings.
    While some have suggested that reductions in the U.S. tax 
on foreign source income could lead to a movement of 
manufacturing operations out of the United States (``runaway 
plants''), a far more likely scenario is that a noncompetitive 
U.S. tax system will lead to ``runaway headquarters''--a 
migration of multinational headquarters outside the United 
States and an increase in the foreign control of corporate 
assets.
    The decline in the market share of multinationals 
headquartered in the United States has important implications 
for the well-being of the U.S. economy. High-paying 
manufacturing jobs and high-paying executive jobs are lost with 
the movement of these headquarters. Research and development 
may be shifted abroad, in addition to jobs in high-paying 
service industries, such as finance, associated with 
headquarters' activities. Further, foreign-based multinationals 
operating in the United States rely significantly more on 
inputs and supplies produced offshore than do U.S.-owned 
companies. At the same time, the channeling of new investment 
outside of the United States through foreign subsidiaries owned 
by the foreign parent results in the generation of income 
completely outside of the U.S. tax system. A desire to tax 
foreign source income at rates higher than those of our 
competitors may ultimately insure that that there is little 
income left to tax.
                            IV. Conclusions
    In summary, U.S. tax rules can have a significant impact on 
the ability of U.S. multinationals to compete successfully 
around the world and, ultimately, at home. On behalf of the 
International Tax Policy Forum, I urge that this Committee 
carefully review the U.S. international tax system with a view 
to removing impediments that limit the ability of U.S. 
multinationals to compete globally on the same terms as 
foreign-based multinationals. Such reforms would enhance the 
well-being of American families and allow the United States to 
retain its world economic leadership position into the 21st 
century.

                                

Appendix International Tax Policy Forum Member Companies.

American Express Company

America Online, Inc.

Associates First Capital Corporation

Bank of America

Bristol-Myers Squibb Company

Caterpillar Inc.

CIGNA Corporation

Cisco Systems, Inc.

Citigroup

Dow Chemical Company

Eastman Kodak Company

Emerson Electric Co.

Enron Corporation

Exxon Corporation

Ford Motor Company

General Electric Co.

General Motors Corporation

Georgia-Pacific Corporation

Goodyear Tire & Rubber Company

Hewlett-Packard Company

Honeywell, Inc.

IBM Corporation

ITT Industries, Inc.

Johnson & Johnson, Inc.

Merrill Lynch & Co., Inc.

Microsoft Corporation

Morgan Stanley, Dean Witter & Co.

PepsiCo, Inc.

Philip Morris Companies, Inc.

Premark International, Inc.

The Procter & Gamble Company

The Prudential Insurance Company

Tenneco, Inc.

Tupperware Corporation

United Technologies Corporation

Warner-Lambert Company


                                


    Chairman Archer. Thank you, Dr. Hubbard.
    The next witness is Mr. Murray. Welcome, and you may 
proceed.

  STATEMENT OF FRED F. MURRAY, VICE PRESIDENT FOR TAX POLICY, 
              NATIONAL FOREIGN TRADE COUNCIL, INC.

    Mr. Murray. Thank you, Mr. Chairman. Good morning and good 
morning to the distinguished Members of the Committee. My name 
is Fred Murray. I am Vice President for Tax Policy for the 
National Foreign Trade Council. With me today are Mr. Phil 
Morrison, director of the International Tax Services Group in 
the Washington national office of Deloitte & Touche and 
formerly International Tax Counsel at the Treasury. And also, 
Mr. Peter Merrill, director of the National Economic Consulting 
practice at Pricewaterhouse-
Coopers in their Washington national office, and who was 
formerly chief economist for the Joint Committee on Taxation.
    Our testimony relates to the Foreign Income Project of the 
National Foreign Trade Council. My written statement and a copy 
of our report is before you in your packets.
    In addition to the three of us, the Project has been 
drafted and reviewed by more than 50 distinguished 
professionals, former Treasury and IRS officials, including 
Assistant Secretaries and Deputy Assistant Secretaries for Tax 
Policy, International Tax Counsels, a Commissioner of Internal 
Revenue, and other distinguished lawyers and economists, 
corresponding professionals from Hill offices, and, finally, 
distinguished lawyers, accountants, and economists from some of 
America's most prominent companies, professional firms, and 
universities.
    The NFTC is an association of businesses with some 550 
members founded in 1914. Most of the largest U.S. manufacturing 
companies and most of the 50 largest U.S. banks are Council 
members, accounting for at least 70 percent of all U.S. non-
agricultural exports and 70 percent of U.S. private foreign 
investment.
    In 1997, the NFTC launched this project in response to 
growing concerns about the disparity between U.S. trade policy 
and U.S. tax policy. Foreign competition faced by U.S.-based 
businesses has greatly intensified in recent years. The 
globalization of business has also greatly accelerated. We 
believe it is important to pause to look at these changes and 
at their implications.
    We focus our study on the last 40 or so years because in 
1962, Congress made major changes in our international tax 
system in enacting Subpart F. Subpart F was shaped in a global 
economic environment that has changed almost beyond recognition 
as the 20th century comes to a close. The gold standard has 
been abandoned. The exchange rate of the dollar is no longer 
fixed. The United States is now the largest importer of 
capital, with foreign investment in U.S. assets exceeding U.S. 
investment in foreign assets by over $100 billion per year.
    Our current rules, to the extent they were enacted for more 
than revenue considerations, are often based on economic 
underpinnings that no longer apply. Mr. Merrill will elaborate 
on these issues in his remarks.
    Our study today leads us to several broad conclusions:
    United States-based companies are much more dependent on 
global markets for a significant share of their sales and 
profits, and, hence, have plentiful non-tax reasons for 
establishing foreign operations.
    United States-based companies are now far less dominant in 
global markets, and, hence, more adversely affected by the 
competitive disadvantage of incurring current home country 
taxes with respect to income that in the hands of a non-U.S.-
based competitor is subject only to local taxation.
    Changes in U.S. tax law in recent decades have on balance 
increased the taxation of foreign income. And, as Mr. Morrison 
will discuss in a greater detail, we have also concluded that 
U.S. taxation of foreign income is far more complex and 
burdensome than that of other significant trading nations and 
far more complex and burdensome than what is required by 
appropriate tax policy. We have tried to lead other countries 
to our position, but none have followed us to where we are.
    United States tax laws impose rules that are different in 
important respects than those imposed by many other nations 
upon their companies. Other countries also tax the worldwide 
income of their nationals and companies doing business outside 
their territories. But such systems are generally less complex, 
and provide for deferral subject to less significant 
limitations. Importantly, many have territorial systems of 
taxation and/or border adjustable VAT systems.
    The U.S. foreign tax credit system is very complex, 
particularly in the computation of applicable limitations under 
section 904. Systems imposed by other countries are in all 
cases less punitive. The current U.S. international tax system 
contains many anomalies that make little sense when considered 
in the context of the matters we discussed today, and that 
create many ``heads, I win, tails, you lose,'' scenarios that 
are difficult to justify on a principled basis. One of those 
that has been noted a number of times today is the allocation 
of interest expense between domestic and foreign subsidiaries 
for the purpose of determining the foreign tax credit 
limitation.
    Finally, in a 1991 OECD study, the United States and Japan 
are tied as the least competitive G-7 countries for a 
multinational company to locate its headquarters, taking into 
account taxation at both the individual and corporate levels. 
These findings have an ominous quality, given the recent spate 
of acquisitions of large U.S.-based companies by their foreign 
competitors. In fact, of the world's 20 largest companies, 
ranked by sales in 1960, 18 were headquartered in the United 
States. By the mid-nineties, that number had dropped to eight 
and is probably less today. That trend is starkly reflected in 
the banking sector. After recent acquisitions, only two, 
CitiCorp and Chase Manhattan, of the world's largest 25 
financial services companies are headquartered in the United 
States.
    In closing, Mr. Chairman, the NFTC strongly supports H.R. 
2018, introduced by Mr. Houghton, Mr. Levin, and Mr. Johnson, 
and joined by Mr. Crane, Mr. Herger, Mr. English, and Mr. 
Matsui. We congratulate them on their efforts to make these 
amendments. They address important concerns of our companies in 
their efforts to export American products and to create jobs 
for American workers.
    And we congratulate you on holding this hearing this 
morning. That concludes my oral remarks. I will be pleased to 
answer questions.
    [The prepared statement follows:]

Statement of Fred F. Murray, Vice President for Tax Policy, National 
Foreign Trade Council, Inc.

    Mr. Chairman, and Distinguished Members of the Committee:
    My name is Fred Murray. I am Vice President for Tax Policy 
for the National Foreign Trade Council, Inc. I was formerly 
Special Counsel (Legislation) for the Internal Revenue Service, 
and before that represented taxpayers for seventeen years in 
private practice before joining the Treasury. With me today are 
Mr. Phil Morrison, Director of the International Tax Services 
Group in the Washington National Office of Deloitte & Touche 
LLP and formerly International Tax Counsel at the U.S. 
Treasury, and Mr. Peter Merrill, Director of the National 
Economic Consulting Practice at Pricewaterhouse Coopers in 
their Washington National Tax Services Office and formerly 
Chief Economist for the Joint Committee on Taxation. We intend 
to summarize for you the analysis and conclusions that have 
been reached in the ongoing National Foreign Trade Council 
Foreign Income Project. In addition to the two gentlemen here 
with me today, the project has been drafted and reviewed by 
more than fifty distinguished professionals: former Treasury 
and IRS officials including Assistant Secretaries and Deputy 
Assistant Secretaries for Tax Policy, International Tax 
Counsels, a Commissioner of Internal Revenue, and other 
distinguished lawyers and economists, corresponding 
professionals from Hill offices, and finally distinguished 
lawyers, accountants, and economists from some of America's 
most prominent companies, professional firms, and universities.
    The National Foreign Trade Council, Inc. (the ``NFTC'' or 
the ``Council'') is appreciative of the opportunity to present 
its views on the impact on international competitiveness of 
certain of the foreign provisions of the Internal Revenue Code 
of the United States.
    The NFTC is an association of businesses with some 550 
members, originally founded in 1914 with the support of 
President Woodrow Wilson and 341 business leaders from across 
the U.S. Its membership now consists primarily of U.S. firms 
engaged in all aspects of international business, trade, and 
investment. Most of the largest U.S. manufacturing companies 
and most of the 50 largest U.S. banks are Council members. 
Council members account for at least 70% of all U.S. non-
agricultural exports and 70% of U.S. private foreign 
investment. The NFTC's emphasis is to encourage policies that 
will expand U.S. exports and enhance the competitiveness of 
U.S. companies by eliminating major tax inequities and 
anomalies. International tax reform is of substantial interest 
to NFTC's membership.
    The founding of the Council was in recognition of the 
growing importance of foreign trade and investment to the 
health of the national economy. Since that time, expanding U.S. 
foreign trade and investment, and incorporating the United 
States into an increasingly integrated world economy, has 
become an even more vital concern of our nation's leaders. The 
share of U.S. corporate earnings attributable to foreign 
operations among many of our largest corporations now exceeds 
50 percent of their total earnings. Even this fact in and of 
itself does not convey the full importance of exports to our 
economy and to American-based jobs, because it does not address 
the additional fact that many of our smaller and medium-sized 
businesses do not consider themselves to be exporters although 
much of their product is supplied as inventory or components to 
other U.S.-based companies who do export. Foreign trade is 
fundamental to our economic growth and our future standard of 
living. Although the U.S. economy is still the largest economy 
in the world, its growth rate represents a mature market for 
many of our companies. As such, U.S. employers must export in 
order to expand the U.S. economy by taking full advantage of 
the opportunities in overseas markets.
  The Council Believes That We Must Re-evaluate Current International 
                              Tax Policies
    United States policy in regard to trade matters has been 
broadly expansionist for many years, but its tax policy has not 
followed suit.
    The foreign competition faced by U.S.-based companies has 
intensified as the globalization of business has accelerated. 
At the same time, U.S.-based multinationals increasingly voice 
their conviction that the Internal Revenue Code places them at 
a competitive disadvantage in relation to multinationals based 
in other countries. In 1997, the NFTC launched an international 
tax policy review project, at least partly in response to this 
growing chorus of concern. The project is presently divided 
into two parts, the first dealing with the United States' anti-
deferral regime, subpart F, the second dealing with the foreign 
tax credit. The two parts are in turn divided into two phases. 
In both, an analytical report examining the legal, economic and 
tax policy aspects of the U.S. rules will be followed by 
legislative and policy recommendations based on the analytical 
report.
    On March 25, 1999, the NFTC published a report analyzing 
the competitive impact on U.S.-based companies of the rules 
under subpart F of the tax code, which accelerate the U.S. 
taxation of income earned by foreign affiliates.\1\ The data 
and analysis presented in Part One support several significant 
conclusions:
---------------------------------------------------------------------------
    \1\ The NFTC Foreign Income Project: International Tax Policy for 
the 21st Century; Part One: A Reconsideration of Subpart F (hereinafter 
referred to as ``Part One'' or ``the Report'').
---------------------------------------------------------------------------
     Since the enactment of subpart F more than 35 
years ago, the development of a global economy has 
substantially eroded the rules' economic policy rationale.
     The breadth of subpart F exceeds the international 
norms for such rules, adversely affecting the competitiveness 
of U.S.-based companies by subjecting their cross-border 
operations to a heavier tax burden than that borne by their 
principal foreign-based competitors.
     Most importantly, subpart F applies too broadly to 
various categories of income that arise in the course of active 
foreign business operations, and should thus be substantially 
narrowed.
    Our present testimony is in part based upon the findings 
described in the Report.
Fundamental Changes in the Economic Underpinnings of Our International 
                               Tax System
    The compromise embodied in a significant portion of our 
present international tax system was shaped in the global 
economic environment of the early 1960s--a world economy that 
has changed almost beyond recognition as the 20th century draws 
to a close.
    In the decades since subpart F was enacted in 1962, the 
global economy has grown more rapidly than the U.S. economy. By 
almost every measure--income, exports, or cross-border 
investment--U.S.-based companies today represent a smaller 
share of the global market. At the same time, U.S.-based 
companies have become increasingly dependent on foreign markets 
for continued growth and prosperity. Over the last three 
decades, sales and income from foreign subsidiaries have 
increased much more rapidly than sales and income from domestic 
operations. To compete successfully both at home and abroad, 
U.S.-based companies have adopted global sourcing and 
distribution channels, as have their competitors.
    Changes introduced since 1962 in subpart F and other 
important rules in our international tax system have imposed 
current U.S. taxation on ever-larger categories of active 
foreign income. These two incompatible trends -decreasing U.S. 
dominance in global markets set against increasing U.S. 
taxation of CFC income--are not claimed to have any necessary 
causal relation. However, they strongly suggest that re-
evaluation of the balance of policies that underlie our rules 
is long overdue.
    Because economic arguments advanced against the backdrop of 
the 1962 economy are the foundation upon which subpart F was 
erected, the balance that was struck in 1962 may no longer be 
appropriate. The same is true for other provisions of our 
international tax system that were constructed with far 
different bases in mind.
    Accordingly, with U.S.-based companies less dominant in 
foreign markets, but at the same time more dependent on those 
markets, U.S. international tax rules that are out of step with 
those of other major industrial countries are more likely to 
hamper the competitiveness of U.S. multinationals than was the 
case in the 1960s. The growing economic integration among 
nations -especially the formation of common markets and free 
trade areas -raises questions about the appropriateness of U.S. 
tax rules regarding ``base'' companies that transact business 
across national borders with affiliates. Finally, the eclipsing 
of foreign direct investment by portfolio investment calls into 
question the importance of tax policy focused on foreign direct 
investment for purposes of achieving an efficient global 
allocation of capital.
    We will discuss these issues in greater detail in the 
balance of my testimony and in that of my colleagues.
               Where We Came From and Where We Are Today
    In 1962, the Kennedy Administration proposed to subject the 
earnings of U.S. controlled foreign corporations (CFCs) to 
current U.S. taxation. At this time, the dollar was tied to the 
gold standard, and the United States was the world's largest 
capital exporter. These capital exports drained Treasury's gold 
reserves, and made it more difficult for the Administration to 
stimulate the economy. Thus, the proposed repeal of deferral of 
tax on the foreign income of U.S. multinationals was intended 
by Treasury Secretary Douglas Dillon to serve as a form of 
capital control, reducing the outflow of U.S. investment 
abroad.

The 1962 Legislation

    Some commentators have taken the view that subpart F as 
enacted in 1962 reflected a compromise between two competing 
tax policy goals. Treasury itself has recently described 
subpart F as enforcing a balance between the goal of 
maintaining the competitiveness of U.S. business, on the one 
hand, and on the other of maintaining neutrality as between the 
taxation of domestic and foreign business (capital export 
neutrality \2\). The compromise between competitiveness and 
neutrality that was struck in 1962 has been seriously disrupted 
by the legal and economic changes of nearly four decades.
---------------------------------------------------------------------------
    \2\ ``Capital export neutrality'' is a term used to describe a 
situation in which tax considerations will play no part in influencing 
a decision to invest in another country.
---------------------------------------------------------------------------
    The United States has never enacted an international tax 
regime that makes capital export neutrality its principal goal 
with respect to the taxation of business income. Indeed, during 
the period 1918-1928, the formative era for U.S. tax policy 
regarding international business income, the United States 
ceded primary taxing jurisdiction over active business income 
to the country of source.\3\ Rules were formulated to protect 
the ability of the United States to collect tax on U.S.-source 
income, and the foreign tax credit was introduced allowing U.S. 
income tax to be imposed whenever the foreign country where the 
income was sourced failed to tax the income. The dominant 
purpose of the U.S. international tax system put in place 
then--a system that still governs U.S. taxation of 
international income--was to eliminate the double taxation of 
business income earned abroad by U.S. taxpayers, which had been 
imposed under the taxing regime enacted at the inception of the 
income tax.\4\
---------------------------------------------------------------------------
    \3\ See Michael J. Graetz & Michael O'Hear, The Original Intent of 
U.S. International Taxation, 46 Duke L.J. 1021 (1997).
    \4\ Id. The original system had allowed only a deduction for 
foreign income taxes.
---------------------------------------------------------------------------
    When the foreign tax credit was first enacted in 1918, the 
United States taxed income earned abroad by foreign 
corporations only when that income was repatriated to the 
United States. In addition to implementing the basic policy 
decision to grant source countries the principal claim to the 
taxation of business income, this ``deferral of income'' \5\ 
reflected concerns both about whether the United States had the 
legal power to tax income of foreign corporations (even if 
owned by U.S. persons) and about the practical ability of the 
United States to measure and collect tax on income earned 
abroad by a foreign corporation.\6\ Deferral of tax on active 
business income remained essentially unchanged for the next 44 
years--until 1962. The only exception to this rule was the 
result of ``foreign personal holding company'' legislation 
enacted in 1937 to curb the use of foreign corporations to hold 
income-producing assets and to sell assets with unrealized (and 
untaxed) appreciation. The foreign personal holding company 
rules tax currently certain kinds of ``passive'' income of a 
narrow class of corporations in the hands of their owners.\7\
---------------------------------------------------------------------------
    \5\ The foreign income of a foreign corporation is not ordinarily 
subject to U.S. taxation, since the United States has neither a 
residence nor a source basis for imposing tax. This applies generally 
to any foreign corporation, whether it is foreign-owned or U.S.-owned. 
This means that in the case of a U.S.-controlled foreign corporation 
(CFC), U.S. tax is normally imposed only when the CFC's foreign 
earnings are repatriated to the U.S. owners, typically in the form of a 
dividend. However, subpart F of the Code alters these general rules to 
accelerate the imposition of U.S. tax with respect to various 
categories of income earned by CFCs.
    It is common usage in international tax circles to refer to the 
normal treatment of CFC income as ``deferral'' of U.S. tax, and to 
refer to the operation of subpart F as ``denying the benefit of 
deferral.'' However, given the general jurisdictional principles that 
underlie the operation of the U.S. rules, we view that usage as 
somewhat inaccurate, since it could be read to imply that U.S. tax 
``should'' have been imposed currently in some normative sense. Given 
that the normative rule imposes no U.S. tax on the foreign income of a 
foreign person, we believe that subpart F can more accurately be 
referred to as ``accelerating'' a tax that would not be imposed until a 
later date under normal rules.
    \6\ See supra note 3.
    \7\ See I.R.C. Sec. Sec. 552 and 553.
---------------------------------------------------------------------------
    However, President Kennedy urged a reversal of this 
longstanding U.S. tax policy in 1961. The President called for 
the ``elimination of tax deferral privileges in developed 
countries and `tax haven' privileges in all countries.'' \8\ 
President Kennedy's 1961 State of the Union Address, elaborated 
on in his tax message of April 20, 1961, prompted Congressional 
consideration during 1961 and 1962 of changes in the U.S. 
taxation of controlled foreign corporations. In addressing 
broad balance of payments concerns, Kennedy announced in his 
State of the Union Address that his administration would ask 
Congress to reassess the tax provisions that favored investment 
in foreign countries over investment in the United States. The 
President, in his April tax message, urged five goals for 
revising U.S. tax policy: (1) to alleviate the U.S. balance of 
payments deficit; (2) to help modernize U.S. industry; (3) to 
stimulate growth of the economy; (4) to eliminate to the extent 
possible economic injustice; and (5) to maintain the level of 
revenues requested by President Eisenhower in his last budget.
---------------------------------------------------------------------------
    \8\ Message of the President's Tax Recommendations, April 20, 1961, 
reprinted in H.R. Doc. No. 87-140, at 6 (1961).
---------------------------------------------------------------------------
    In addition to changes in foreign income tax provisions, 
President Kennedy, in both his State of the Union Address and 
tax message, called for the introduction of an 8 percent 
investment tax credit on purchases of machinery and equipment 
to ``spur our modernization, our growth and our ability to 
compete abroad.'' \9\ Kennedy urged that this credit be limited 
to expenditures on new machinery and equipment ``located in the 
United States.'' \10\ [Emphasis added.]
---------------------------------------------------------------------------
    \9\ See H.R. Rep. No. 87-2508, at 2 (1962)(Conference Report).
    \10\ See Message of the President's Tax Recommendations (April 20, 
1961), reprinted in H.R. Doc. No. 87-140, at 4 (1961).
---------------------------------------------------------------------------
    Specifically, with regard to the taxation of foreign 
income, the President stated that ``changing conditions'' made 
continuation of the ``deferral privilege undesirable,'' and 
proposed the elimination of tax deferral in developed countries 
and in tax havens everywhere. The President stated:

          To the extent that these tax havens and other tax deferral 
        privileges result in U.S. firms investing or locating abroad 
        largely for tax reasons, the efficient allocation of 
        international resources is upset, the initial drain on our 
        already adverse balance of payments is never fully compensated, 
        and profits are retained and reinvested abroad which would 
        otherwise be invested in the United States. Certainly since the 
        post-war reconstruction of Europe and Japan has been completed, 
        there are no longer foreign policy reasons for providing tax 
        incentives for foreign investment in the economically advanced 
        countries.'' \11\
---------------------------------------------------------------------------
    \11\ Id., at 6-7.

    The Kennedy Administration's recommendations with respect 
to deferral and the investment tax credit were not neutral 
toward the location of capital.
    It is clear that neither the House nor the Senate embraced 
the Kennedy Administration's call. The President's proposal was 
rejected by the Congress, and the legislation that eventually 
passed as the Revenue Act of 1962 provided for much narrower 
constraints on deferral of the taxation of active business 
income. Congress aimed to curb tax haven abuses rather than to 
end the deferral of U.S. income tax on active business income 
in developed countries. The 1962 legislation, as ultimately 
enacted, was targeted at eliminating certain ``abuses'' 
permitted under prior law, although, the historical record is 
far from clear about exactly what the ``abuses'' were that 
Congress intended to curb.
    The abuses that the Revenue Act of 1962 sought to rectify 
changed substantially as the legislation made its way through 
the legislative process. Under President Kennedy's original 
proposal contained in his tax message of April 1961, and urged 
throughout the Congressional process by Treasury Secretary 
Dillon, any deferral of U.S. taxation constituted an abuse. An 
exception to current taxation would have been provided for (and 
limited to) investments in less developed countries, but this 
exception was explicitly grounded in foreign policy, not tax 
policy, considerations.
    Treasury's proposal of July 20, 1961, implicitly treated as 
abusive the deferral of tax on income from transactions between 
a foreign corporation and a related party outside the country 
in which the foreign corporation was organized.\12\ In the 
Senate Finance Committee hearings, Secretary Dillon singled out 
as abusive the use of foreign corporations that market their 
goods or services in third countries with the subjective intent 
of ``reducing taxes.'' \13\ The potential of transfer pricing 
abuses between related companies were a concern.
---------------------------------------------------------------------------
    \12\ Staff of the Joint Comm. on Internal Revenue Taxation, 87th 
Cong., General Explanation of Comm. Discussion Draft of Revenue Bill of 
1961, at 5 (Comm. Print 1961).
    \13\ Id.
---------------------------------------------------------------------------
    In the legislation sent to the House by the Committee on 
Ways and Means and adopted by the House, the abuse appeared to 
be the avoidance of ``taxation by the United States on what 
could ordinarily be expected to be U.S. source income.'' \14\ 
As stated above, this concern was consistent with U.S. tax 
policy dating back to the formative period of 1918-1928, and 
can be viewed, not as a change in policy, but rather as an 
application of longstanding policies to new circumstances.
---------------------------------------------------------------------------
    \14\ H.R. Rep. No. 87-1447, at 58 (1962)(Committee on Ways and 
Means, Revenue Act of 1962).
---------------------------------------------------------------------------
    It is clear, however, that Congress did not intend to 
reverse the policy of generally permitting deferral of active 
business income earned abroad. Ultimately, no clear 
Congressional understanding of exactly what constituted an 
abuse can be determined from the history of the 1962 Revenue 
Act. Indeed, the Act left determinations of abuse--at least to 
some extent--up to the Treasury on a case-by-case basis. What 
these provisions seek to do is still mysterious even today.

The Importance of Transfer Pricing Developments

    In reviewing Secretary Dillon's concerns, and the 
subsequent enactment of the base company rules, it is clear 
that the subpart F provisions were intended to be a 
``backstop'' to the then existing transfer pricing regime of 
the Code. Very significant changes have taken place in the 
field of transfer pricing administration since the 1962 
legislation, as Treasury itself has testified in recent years.
    When subpart F was enacted, the use of improper transfer 
pricing to shift income into tax haven jurisdictions was a 
major concern of Treasury and Congress. Although 
contemporaneous efforts were being made to address transfer 
pricing concerns via regulations under section 482, significant 
aspects of subpart F were specifically intended to backstop 
transfer pricing enforcement by imposing current U.S. tax on 
various forms of tax haven income, thus reducing U.S. 
taxpayers' incentives to shift income into tax havens. In 
particular, this was one of the stated reasons for the rules 
relating to foreign base company sales and services. By 
limiting the benefit of maximizing sales or services profits in 
a tax haven, these rules were intended to relieve some of the 
pressure on the still-nascent transfer pricing regime's ability 
to police the pricing of cross-border transactions.\15\
---------------------------------------------------------------------------
    \15\ Transfer pricing was not, of course, the sole or even the 
principal rationale for these rules; they were also said to be 
justified by ``anti-abuse'' notions that related to protection of the 
U.S. tax base and, in the views of some, capital export neutrality.
---------------------------------------------------------------------------
    Nearly four decades later, transfer pricing law and 
administration have undergone profound changes that call into 
serious question the continued relevance of subpart F to 
transfer pricing enforcement. Most conspicuously, based on 
legislative changes in the 1986 and 1993 tax acts, Treasury has 
promulgated detailed regulations that have drastically altered 
the transfer pricing enforcement landscape.\16\ These 
regulations clarify many areas of substantive transfer pricing 
controversy, but perhaps more importantly they implement a 
structure of reporting and penalty rules that have had a 
considerable impact on taxpayer behavior. Further, although 
audit experience with the new rules is still limited, it is 
anticipated that the widespread availability of contemporaneous 
transfer pricing documentation will markedly enhance the 
Internal Revenue Service's ability to perform effective 
transfer pricing examinations.
---------------------------------------------------------------------------
    \16\ I.R.C. Sec. Sec. 482 (last sentence) and 6662(e); Treas. Reg. 
Sec. Sec. 1.482-1 through -8 and 1.6662-6.
---------------------------------------------------------------------------
    Almost as important is the globalization of transfer 
pricing enforcement efforts; partly in response to U.S. 
initiatives in the area, and partly because of compliance 
concerns of their own, many of the United States' major trading 
partners have recently stepped up their own transfer pricing 
enforcement efforts, enhancing reporting and penalty regimes 
and increasing audit activity. As a result, the role of the 
Organisation for Economic Cooperation and Development (OECD) as 
a forum for the development of international consensus on 
transfer pricing matters has attained new prominence, with the 
United States making notable efforts to ensure that its own 
transfer pricing initiatives win international acceptance via 
the OECD.
    Accordingly, the ability of U.S. taxpayers to shift income 
into a sales base company by manipulating the pricing of 
transactions is far more circumscribed than it was when 
transfer pricing as a discipline was in its infancy. This basic 
change in the landscape, in combination with the general 
development of a global economy, suggests that transfer pricing 
considerations no longer provide much support for the base 
company sales and services rules. Indeed, treating 
international transactions through centralized sales or 
services companies as per se tax abusive ignores the current 
realities of both transfer pricing enforcement and the globally 
integrated business models demanded by the global marketplace.
                        Development of Subpart F
    A lack of clarity in the historical record of the 1962 Act 
about what constituted an abuse of tax deferral in 
international transactions has resulted in ongoing debates 
about the proper scope of subpart F that continue to this day. 
Legislation since 1962 has changed the rules for when current 
taxation is required, but has not resolved the basic debate 
that raged in 1962. Interpretations of the 1962 Act subsequent 
to its enactment have sometimes described as abusive any 
transaction where a foreign government imposes lower tax than 
would be imposed by the United States on the same transaction 
or income.\17\ This cannot be right. In 1962, Congress clearly 
rejected making capital export neutrality the linchpin of U.S. 
international tax policy. Attempting to force a strained 
interpretation of the legislation it did enact into an 
endorsement of capital export neutrality by defining anything 
that departs from capital export neutrality as an abuse 
flagrantly disregards the historical record.
---------------------------------------------------------------------------
    \17\ See Stanford G. Ross, Report on the United States Jurisdiction 
to Tax Foreign Income, 49b Stud. on Int'l Fiscal L. 184, 212 (1964).
---------------------------------------------------------------------------
    Nevertheless, in the years since 1962, subpart F has been 
the subject of numerous revisions, including substantial 
overhauls in 1975 and 1986: by the addition of new categories 
of subpart F income; by the narrowing of exceptions to subpart 
F income; and by the creation of additional anti-deferral 
regimes (i.e., the Passive Foreign Investment Company 
provisions). This constant tinkering has created both 
instability and a forbiddingly arcane web of general rules, 
exceptions, exceptions to exceptions, interactions, cross 
references, and effective dates, generating a level of 
complexity that cannot be defended. Further, while Congress has 
over the years modified the rules in ways that both tightened 
and relaxed the anti-deferral rules, it is clear that the 
overall trend has been to expand the scope of those rules. 
Particularly with the changes made in 1975 and 1986, Congress 
has brought more and more income within the net of current 
taxation, to the point where Treasury now feels justified in 
positing that current taxation is the general rule, with 
deferral permitted only as an exception.
    A review of this legislative activity makes it clear that 
U.S. international tax policy has remained largely unchanged 
for more than three decades. Legislative activity has continued 
to focus on perceived abuses of deferral (as well as the 
foreign tax credit), with relatively little consideration given 
to the changing relationship between the U.S. economy and the 
rest of the world.
                            1999 Is Not 1962
    The compromise embodied in subpart F was shaped in the 
global economic environment of the early 1960s--a world economy 
that has changed almost beyond recognition as the 20th century 
draws to a close. The gold standard was abandoned during the 
Nixon Administration, and the exchange rate of the dollar is no 
longer fixed. The United States is now the world's largest 
importer of capital, with foreign investment in U.S. assets 
exceeding U.S. investment in foreign assets by over $100 
billion per year.
    With the completion of the post-World War II economic 
recovery in Europe and Japan, the growth of an industrial 
economy in many countries in Asia and elsewhere, and the 
overall development of a global economy, U.S. dominance of 
international markets is only a memory. The competition from 
foreign-based companies in U.S. and international markets is 
far more intense today than it was in 1962.\18\ While 
competition in international markets has grown stiffer, those 
markets have simultaneously become more important to the 
prosperity of U.S.-based companies, as foreign income has come 
to constitute an increasing percentage of U.S. corporate 
earnings.
---------------------------------------------------------------------------
    \18\ Some Treasury officials have suggested that the loss of U.S. 
dominance is simply a function of the rest of the world ``catching up'' 
after the devastation of World War II. This may well be true, but it is 
also irrelevant: whatever the reasons for the loss of U.S. dominance, 
the point is that the competitive landscape is completely different 
today, so that it is high time to reconsider the competitive impact of 
legislative provisions enacted when the world was a very different 
place.
---------------------------------------------------------------------------
    The relentless tightening of the subpart F and foreign tax 
credit rules since 1962, plus the enactment of additional anti-
deferral regimes, has steadily increased the tension between 
U.S. international tax policy and the competitive demands of a 
global economy. A comparison between the policy goals of our 
international tax system and changes in the global economy is 
thus long overdue.
                   Relevant Tax Policy Considerations
    Without foreclosing the consideration of other factors, it 
should be noted that Treasury officials in recent months have 
suggested that five tax policy considerations will need to be 
taken into account in the process of reforming subpart F:

           Capital export neutrality
           Competitiveness
           Conformity with international norms
           Minimizing compliance and administrative burdens
           Meeting revenue needs in a fair manner

Capital Export Neutrality

    As explained in detail in the Report, and as further explained by 
my colleagues with me on the panel this morning, the NFTC believes that 
the historical significance of capital export neutrality (``CEN'') in 
the enactment of subpart F has come to be exaggerated by subsequent 
commentators. More importantly, the Report finds numerous reasons to 
reject CEN as a foundation of U.S. international tax policy. Briefly 
summarized, these reasons include:
     The futility of attempting to achieve globally efficient 
capital allocation by unilateral action.
     The similar futility of attempting to advance investment 
neutrality by focusing solely on direct investment, particularly in 
light of the fact that international portfolio investment now 
significantly exceeds direct investment.
     The failure of the United States itself to take CEN 
seriously as a matter of tax policy, other than in the one relatively 
narrow area of subpart F, where it appears to operate largely as a 
rationale of convenience.
     Growing criticism of CEN in current economic literature.
     The anomalousness of adopting a tax policy that encourages 
the payment of higher taxes to foreign governments.
    The fact that CEN is the wrong starting point for our international 
tax policy is particularly well illustrated by the last item. Several 
provisions of subpart F have the effect of penalizing a taxpayer that 
reduces its foreign tax burden, apparently based on the CEN principles. 
Presumably the idea is that preventing U.S. taxpayers from reducing 
foreign taxes will ensure that they do not make investment decisions 
based on the prospect of garnering a reduced rate of foreign taxation 
(while deferring U.S. taxation until repatriation). However, insisting 
that U.S. taxpayers pay full foreign tax rates when market forces 
require that they do business in another jurisdiction is a flawed 
policy from at least three perspectives. First, from the standpoint of 
the tax system, insisting on higher foreign tax payments obviously 
increases the amount of foreign taxes available to be credited against 
U.S. tax liability, thus decreasing U.S. tax collections in the long 
run. Second, from the standpoint of competitiveness, it leaves U.S.-
based companies in a worse position than their foreign-based 
competitors: the U.S. company must either pay the high local rate, or 
if it attempts to reduce that tax it will instead trigger subpart F 
taxes at the U.S. rate, while the foreign competition will reduce their 
local taxes through perfectly normal transactions such as paying 
interest on a loan from an affiliate, and trigger no home country taxes 
by doing so.\19\ Third, the belief that the level of foreign investment 
by U.S. companies will be significantly increased by the ability to 
reduce foreign taxes (while deferring U.S. taxation) is seriously 
antiquated in the context of the global economy. Such a belief may have 
been justified in the early 1960's, when the business reasons for U.S. 
companies to invest offshore were more limited. But today, when the 
principal opportunities for expansion are offered by foreign markets, 
so that U.S.-based companies derive an ever-greater proportion of their 
earnings from offshore activities, a presumption that foreign tax 
reduction will generate tax-motivated foreign investment is not merely 
out of touch with economic reality, but seriously harmful to the 
competitiveness of U.S.-based companies (as further discussed below). 
We submit that the at best highly theoretical global capital allocation 
benefits that may be achieved by subpart F's haphazard pursuit of CEN 
principles do not even come close to justifying the fiscal and 
competitive damage caused by denying U.S. companies the ability to 
reduce local taxes on the foreign businesses that are critical to their 
future prosperity and that of their workers.
---------------------------------------------------------------------------
    \19\ Local tax authorities may well scrutinize the amount of 
outbound deductible payments under transfer pricing and thin-
capitalization principles, but subject to that discipline there is 
nothing inherently objectionable about an allocation of functions and 
risks among affiliates that gives rise to a deductible payment in a 
high-tax jurisdiction. Treasury has not made a case that protection of 
the foreign tax base should in any event be a concern of the U.S. tax 
system.
---------------------------------------------------------------------------
    Accordingly, the NFTC believes that CEN is not a sound basis on 
which to build U.S. international tax policy for the coming century, 
and recommends that in redesigning subpart F it be given no greater 
weight than it has been given in the case of other major international 
provisions such as the foreign tax credit.

Competitiveness

    Accelerating the U.S. taxation of overseas operations (while 
permitting a foreign tax credit) means that a U.S.-based company will 
pay tax at the higher of the U.S. or foreign tax rate. If the local tax 
rate in the company of operation is less than the U.S. rate, this means 
that locally-based competitors will be more lightly taxed than their 
U.S.-based competition. Moreover, companies based in other countries 
will also enjoy a lighter tax burden, unless their home countries 
impose a regime that is as broad as subpart F, and none have to date 
done so. While the competitive impact of a heavier corporate tax burden 
is difficult to quantify, it is clear that a company that pays higher 
taxes suffers a disadvantage vis-a-vis its more lightly taxed 
competitors. That disadvantage may ultimately take the form of a 
decreased ability to engage in price competition, or to invest funds in 
the research and capital investment needed to build future 
profitability, or in the ability to attract capital by offering an 
attractive after-tax rate of return on investment. Whatever its 
ultimate form, however, it cannot be seriously questioned that a 
heavier corporate tax burden will harm a company's ability to 
compete.\20\
---------------------------------------------------------------------------
    \20\ Congress has previously acknowledged the connection between 
corporate tax burden and competitiveness. For example, in connection 
with the enactment of the dual consolidated loss rules under Code 
section 1503(d) as part of the Tax Reform Act of 1986 (the ``'86 
Act''), Congress observed that the ability of a foreign corporation to 
reduce its worldwide corporate tax burden through the use of a dual 
resident company enabled such corporations ``to gain an advantage in 
competing in the U.S. economy against U.S. corporations.'' Joint 
Committee on Taxation, General Explanation of the Tax Reform Act of 
1986 (the ``'86 Act General Explanation''), at 1065.
---------------------------------------------------------------------------
    Competitiveness concerns were central to the debate when subpart F 
was enacted, even at a time when U.S.-based companies dominated the 
international marketplace. This apparent dominance did not convince 
Congress that the competitive position of U.S. companies in 
international markets could be ignored. Thus, although the 
Administration originally proposed the acceleration of U.S. taxation of 
most foreign-affiliate income, that proposal was firmly rejected by 
Congress based largely on concerns about its competitive impact.\21\
---------------------------------------------------------------------------
    \21\ See Part One, Chapter 2.
---------------------------------------------------------------------------
    If competitiveness was a consideration when subpart F was enacted, 
there are compelling reasons to treat it as a far more serious concern 
today.
                  Conformity with International Norms
    As will be further developed by my colleagues on the panel 
this morning, conformity with international norms is important 
from a competitiveness standpoint, but it bears further 
emphasis here that our principal trading partners have 
consistently adopted rules that are less burdensome than 
subpart F. We do not dispute the fact that subpart F 
established a model for the taxation of offshore affiliates 
that has been imitated to a greater or lesser degree in the CFC 
legislation of many countries. But looking beyond the 
superficial observation that other countries have also enacted 
CFC rules, the detailed analysis in the Part One Report showed 
that in virtually every scenario relating to the taxation of 
active offshore operations, the United States imposes the most 
burdensome regime. Looking at any given category of income, it 
is sometimes possible to point to one or two countries whose 
rules approach the U.S. regime, but the overall trend is 
overwhelmingly clear: U.S.-based multinationals with active 
foreign business operations suffer much greater home-country 
tax burdens than their foreign-based competitors.
    The observation that the U.S. rules are out of step with 
international norms, as reflected in the consistent practices 
of our major trading partners, supports the conclusion that 
U.S.-based companies suffer a competitive detriment vis-a-vis 
their multinational competitors based in such countries as 
Germany and the United Kingdom, and that the appropriate reform 
is to limit the reach of subpart F in a manner that is more 
consistent with the international norm.
    Some commentators have suggested that the competitive 
imbalance created by dissimilar international tax rules should 
be redressed not through any amelioration of the U.S. rules, 
but rather through a broadening of comparable foreign regimes. 
As a purely logical matter the point is valid--a see-saw can be 
balanced either by pushing down the high end or pulling up the 
low one. However, the suggestion is completely impractical for 
several reasons--conformity and competitive balance are far 
more likely to be achieved through a modernization of the U.S. 
rules. For one thing, since the U.S. rules are out of step with 
the majority, from the standpoint of legislative logistics 
alone it would be far easier to achieve conforming legislation 
in the United States alone, rather than in more than a dozen 
other countries. More fundamentally, there is no particular 
reason to believe that numerous foreign sovereigns, having 
previously declined to adopt subpart F's broad taxation of 
active foreign businesses, will now suddenly have a change of 
heart and decide to follow the U.S. model.
    Further, recent OECD activities relating to ``unfair tax 
competition'' do not increase the likelihood of foreign 
conformity with subpart F's treatment of active foreign 
businesses. It is important to recognize that those activities 
relate to efforts by OECD member countries to limit the 
availability and usage of ``tax haven'' countries and regimes. 
By imposing abnormally low rates of taxation, such countries or 
regimes may be viewed as improperly reducing other countries' 
tax bases and distorting international investment decisions. 
The failure of a country to impose any type of CFC legislation 
can be viewed as offering a type of tax haven opportunity, 
since it may permit the creation of investment structures that 
avoid all taxation. Thus, the OECD has recommended that 
countries without CFC regimes ``consider'' enacting them. 
However, in encouraging countries that have no CFC rules to 
enact them, the OECD has done nothing to advance the degree of 
conformity among existing CFC regimes. Based on the materials 
that are publicly available, it does not appear that the OECD 
has sought to address the lack of conformity between the 
highly-developed CFC rules of the United States and its major 
trading partners, particularly as they affect active foreign 
business operations.
    In conclusion, the U.S. rules under subpart F are well 
outside the international mainstream, and should be conformed 
more closely to the practices of our principal trading 
partners. We emphasize that, contrary to the suggestions of 
some commentators, we advocate only that the U.S. rules be 
brought back to the norm so as to achieve competitive parity--
not that they be loosened further in an effort to confer 
competitive advantage.
            Minimizing Compliance and Administrative Burdens
    The NFTC applauds Treasury's inclusion of administrability 
among the principal tax policy goals that will be considered in 
reforming our international tax system. Subpart F includes some 
of the most complex provisions in the Code, and it imposes 
administrative burdens that in many cases appear to be 
disproportionate to the amount of revenue at stake. There are 
several sources of complexity within subpart F, including the 
following:
     The basic design and drafting of the subpart F 
regime was complex;
     That initial complexity has been exacerbated over 
the years by numerous amendments, which have created an 
increasingly arcane web of rules, exceptions, exceptions to 
exceptions, etc.; and
     The subpart F rule require coordination with 
several other regimes that are themselves forbiddingly complex, 
including in particular the foreign tax credit and its 
limitations.
    The complexity of the rules long ago reached the point that 
the ability of taxpayers to comply, and the ability of the IRS 
to verify compliance, were both placed in serious jeopardy. The 
NFTC therefore urges that administrability concerns be given 
serious weight in the process of modernizing the tax system. To 
that end, we urge that the drafters of the Code and regulations 
consider not only the legal operation of the rules, but also 
their practical implementation in terms of forms and 
recordkeeping requirements. In addition, we urge that fuller 
consideration be given to the interaction of multiple complex 
regimes; it may be possible to read section 904(d) and its 
implementing regulations and conclude that the provision can be 
understood, and it may likewise be possible to read section 954 
and its implementing regulations and conclude that that 
provision is also understandable, but when the two sets of 
rules must be read and implemented together, we submit that the 
limits of human understanding are rapidly exceeded.
                 Meeting Revenue Needs in a Fair Manner
    The final policy criterion recently mentioned by Treasury 
is fairness. While no one could quarrel with the notion of 
fairness in tax policy, what fairness means in practice is 
somewhat less clear. Our understanding is that Treasury is 
concerned about preservation of the corporate tax base: it 
would be unfair if U.S.-based multinationals could eliminate or 
significantly reduce their U.S. tax burden through the use of 
CFCs. This analysis presumably requires that a distinction be 
drawn between those cases in which it is ``fair'' to accelerate 
the U.S. taxation of foreign affiliates' income, and those in 
which it is not.
    There should be general agreement about two cases in which 
accelerated U.S. taxation is appropriate: first, where passive 
income is shifted into an offshore incorporated pocketbook, and 
second, where income is inappropriately shifted offshore 
through abusive transfer pricing. The first case is well-
addressed by the extensive subpart F rules concerning foreign 
personal holding company (``FPHC'') income, while the second 
case is addressed by extensive transfer pricing and related 
penalty rules which give the IRS ample authority to curb 
transfer pricing abuses. Thus, little needs to be done to 
advance fairness in these regards.
    Conversely, it should generally be agreed that it is not 
fair to accelerate U.S. taxation when a foreign subsidiary 
engages in genuine business activity in its foreign country. 
Unless Treasury is considering a radical redefinition of the 
scope of U.S. international taxing jurisdiction, the normal 
U.S. rules that impose U.S. tax only when income is repatriated 
should continue to be viewed as fair.
    This leaves a relatively narrow band of potential 
controversy: whether there are certain types of income that 
should be taxed currently even though they are associated with 
active foreign business operations. Subpart F currently 
identifies a number of such categories, and imposes current tax 
on them for reasons that are not always clear, but appear to be 
generally bound up with the notion of capital export 
neutrality, as advanced by Treasury at the time of the 1962 
legislation. We have already stated our view that U.S. 
international tax policy needs a firmer foundation than the 
economic theorizing that underlies CEN, and would only add here 
that CEN should be of no relevance to the definition of 
fairness in international tax policy.
    Finally, we conclude by noting that as a practical matter, 
Treasury concerns for the preservation of the corporate tax 
base and distributional equity in the U.S. tax system should 
not be exaggerated in the context of the relatively modest 
reforms that we advocate. We do not believe that the 
rationalizations of subpart F and the foreign tax credit to be 
proposed will alter historical patterns of offshore investment 
and profit repatriation (although they will improve our 
companies' ability to compete). Those patterns show that U.S. 
companies invest and operate overseas in response to market 
rather than tax considerations, that offshore operations do not 
substitute for investments in U.S. operations, that offshore 
investments in fact have a positive impact on U.S. employment, 
and that a significant percentage of offshore profits will be 
repatriated currently regardless of the applicable tax rules. 
Accordingly, while the distributional equity of the U.S. tax 
system is really not at stake here, the fairness of the system 
will be meaningfully improved by rationalizing and modernizing 
the taxation of U.S. companies that compete in the global 
marketplace.
                               Conclusion
    The NFTC believes that the tax policy criteria of 
competitiveness, administrability, and international conformity 
all support a significant modernization of our international 
tax systemat this time, and that fairness considerations are at 
worst a neutral factor. Finally, even if Congress and the 
Administration are persuaded to given continued weight to the 
policy of capital export neutrality (which we do not believe to 
be justified), the countervailing considerations are 
sufficiently powerful to justify meaningful reform.
     Improvement of the U.S. International Tax System Is Necessary
    There is general agreement that the U.S. rules for taxing 
international income are unduly complex, and in many cases, 
quite unfair. Even before this hearing was announced, a 
consensus had emerged among our members conducting business 
abroad that legislation is required to rationalize and simplify 
the international tax provisions of the U.S. tax laws. For that 
reason alone, if not for others, this effort by the Committee, 
which focuses the spotlight on U.S. international tax policy, 
is valuable and should be applauded.
    The NFTC is concerned that this and previous 
Administrations, as well as previous Congresses, have often 
turned to the international provisions of the Internal Revenue 
Code to find revenues to fund domestic priorities, in spite of 
the pernicious effects of such changes on the competitiveness 
of United States businesses in world markets. The Council is 
further concerned that such initiatives may have resulted in 
satisfaction of other short-term goals to the serious detriment 
of longer-term growth of the U.S. economy and U.S. jobs through 
foreign trade policies long consistent in both Republican and 
Democratic Administrations, including the present one.
    The provisions of Subchapter N of the Internal Revenue Code 
of 1986 impose rules on the operations of American business 
operating in the international context that are much different 
in important respects than those imposed by many other nations 
upon their companies. Some of these differences, noted in 
previous sections of this testimony, make U.S.-based business 
interests less competitive in foreign markets when compared to 
those from our most significant trading partners:
     The United States taxes worldwide income of its 
citizens and corporations who do business and derive income 
outside the territorial limits of the United States. Although 
other important trading countries also tax the worldwide income 
of their nationals and companies doing business outside their 
territories, such systems generally are less complex and 
provide for ``deferral'' subject to less significant 
limitations under their tax statutes or treaties than their 
U.S. counterparts. Importantly, many of our trading partners 
have systems that more closely approximate ``territorial'' 
systems of taxation, in which generally only income sourced in 
the jurisdiction is taxed.\22\
---------------------------------------------------------------------------
    \22\ We start from the fundamental assumption that the United 
States taxes the income of its citizens and domestic corporations on a 
worldwide basis. We do not attempt to address either the desirability 
or the implications of the adoption of a territorial system of 
taxation, an alternative that could itself be the subject of 
substantial analysis and debate. Therefore, for this analysis the 
question is stated not as whether but as when should foreign income be 
taxed.
---------------------------------------------------------------------------
     The United States has more complex rules for the 
limitation of ``deferral'' than any other major industrialized 
country. In particular, we have determined that: (1) the 
economic policy justification for the current structure of 
subpart F has been substantially eroded by the growth of a 
global economy; (2) the breadth of subpart F exceeds the 
international norms for such rules, adversely affecting the 
competitiveness of U.S.-based companies; and (3) the 
application of subpart F to various categories of income that 
arise in the course of active foreign business operations 
should be substantially narrowed.
     The U.S. foreign tax credit system is very 
complex, particularly in the computation of limitations under 
the provisions of section 904 of the Code. While the theoretic 
purity of the computations may be debatable, the significant 
administrative costs of applying and enforcing the rules by 
taxpayers and the government is not. Systems imposed by other 
countries are in all cases less complex.
     The United States has more complex rules for the 
determination of U.S. and foreign source net income than any 
other major industrialized country. In particular, this is true 
with respect to the detailed rules for the allocation and 
apportionment of deductions and expenses. In many cases, these 
rules are in conflict with those of other countries, and where 
this conflict occurs, there is significant risk of double 
taxation. In some cases, U.S. rules by themselves cause double 
taxation, as for example, in one of the more significant 
anomalies, that of the allocation and apportionment of interest 
expense.
     The current U.S. international tax system contains 
many other anomalies that make little sense when considered in 
the context of the matters we discuss today. Under present law, 
the treatment of subpart F income and the treatment of losses 
generated by subpart F-type activities are not symmetrical, 
creating many ``heads-I-win-tails-you-lose'' scenarios that are 
difficult to justify on a principled basis. Income from subpart 
F activities is always recognized currently on the U.S. tax 
return, but if those activities should instead generate losses 
they will generally be given no current U.S. tax effect. (As a 
threshold matter, we can't resist noting that this restrictive 
treatment of losses realized by CFCs, as compared with the 
treatment of losses realized by domestic affiliates, is a 
distinct departure from CEN principles, since it creates a 
genuine tax disincentive to carry out certain activities 
abroad. If the activities targeted by subpart F are carried out 
in a foreign corporation, subpart F will accelerate any income 
but defer any losses. If those activities were instead placed 
in a U.S. corporation, both income and losses would be 
recognized for U.S. tax purposes. Since the likelihood of any 
given activity's producing losses rather than income is not 
generally known at the outset, the system creates a structural 
bias in favor of U.S. investment, rather than anything 
approaching neutrality. But as we noted elsewhere, U.S. 
allegiance to CEN as a tax policy principle has been haphazard 
at best.) The rules carry this bias not only in their basic 
structure, but also in the way they apply to carryover 
restrictions, consolidation of affiliate losses, and the 
offsetting of losses among subpart F income categories.
    Similarly, other provisions in the Code apply in an 
asymmetrical way. This is true with respect to the rules 
relating to overall foreign losses. Other rules determine the 
composition of affiliated groups for the filing of consolidated 
returns and do not allow the inclusion of foreign corporations, 
except in very limited circumstances.
     The current U.S. Alternative Minimum Tax (AMT) 
system imposes numerous rules on U.S. taxpayers that seriously 
impede the competitiveness of U.S. based companies. For 
example, the U.S. AMT provides a cost recovery system that is 
inferior to that enjoyed by companies investing in our major 
competitor countries; additionally, the current AMT 90-percent 
limitation on foreign tax credit utilization imposes an unfair 
double tax on profits earned by U.S. multinational companies--
in some cases resulting in a U.S. tax on income that has been 
taxed in a foreign jurisdiction at a higher rate than the U.S. 
tax.
    As noted above, the United States system for the taxation 
of the foreign business of its citizens and companies is more 
complex than that of any of our trading partners, and perhaps 
more complex than that of any other country.
    That result is not without some merit. The United States 
has long believed in the rule of law and the self-assessment of 
taxes, and some of the complexity of its income tax results 
from efforts to more clearly define the law in order for its 
citizens and companies to apply it. Other countries may rely to 
a greater degree on government assessment and negotiation 
between taxpayer and government--traits which may lead to more 
government intervention in the affairs of its citizens, less 
even and fair application of the law among all affected 
citizens and companies, and less certainty and predictability 
of results in a given transaction. In some other cases, the 
complexity of the U.S. system may simply be ahead of 
development along similar lines in other countries--many other 
countries have adopted an income tax similar to that of the 
United States, and a number of these systems have eventually 
adopted one or more of the significant features of the U.S. 
system of taxing transnational transactions: taxation of 
foreign income, anti-deferral regimes, foreign tax credits, and 
so on. However, after careful inspection and study, and as my 
colleague will discuss in greater detail, we have concluded 
that the United States system for taxation of foreign income of 
its citizens and corporations is far more complex and 
burdensome than that of all other significant trading nations, 
and far more complex and burdensome than what is necessitated 
by appropriate tax policy.
    The reluctance of others to follow the U.S. may in part 
also be attributable to recognition that the U.S. system has 
required very significant compliance costs of both taxpayer and 
the Internal Revenue Service, particularly in the international 
area where the costs of compliance burdens are 
disproportionately higher relative to U.S. taxation of domestic 
income and to the taxation of international income by other 
countries.

          There is ample anecdotal evidence that the United States' 
        system of taxing the foreign-source income of its resident 
        multinationals is extraordinarily complex, causing the 
        companies considerable cost to comply with the system, 
        complicating long-range planning decisions, reducing the 
        accuracy of the information transmitted to the Internal Revenue 
        Service (IRS), and even endangering the competitive position of 
        U.S.-based multinational enterprises.\23\
---------------------------------------------------------------------------
    \23\ See Marsha Blumenthal and Joel B. Slemrod, ``The Compliance 
Cost of Taxing Foreign-Source Income: Its Magnitude, Determinants, and 
Policy Implications,'' in National Tax Policy in an International 
Economy: Summary of Conference Papers, (International Tax Policy Forum: 
Washington, D.C., 1994).

    Many foreign companies do not appear to face the same level 
of costs in their operations. The European Community Ruding 
Committee survey of 965 European firms found no evidence that 
compliance costs were higher for foreign source income than for 
domestic source income.\24\ Lower compliance costs and simpler 
systems that often produce a more favorable result in a given 
situation are competitive advantages afforded these foreign 
firms relative to U.S. based companies.
---------------------------------------------------------------------------
    \24\ Id.
---------------------------------------------------------------------------
    Taking into account individual as well as corporate-level 
taxes, a report by the Organization for Economic Cooperation 
and Development (OECD) finds that the cost of capital for both 
domestic (8.0 percent) and foreign investment (8.8 percent) by 
U.S.-based companies is significantly higher than the averages 
for the other G-7 countries (7.2 percent domestic and 8.0 
percent foreign). The United States and Japan are tied as the 
least competitive G-7 countries for a multinational company to 
locate its headquarters, taking into account taxation at both 
the individual and corporate levels.\25\ These findings have an 
ominous quality, given the recent spate of acquisitions of 
large U.S.-based companies by their foreign competitors.\26\ In 
fact, of the world's 20 largest companies (ranked by sales) in 
1960, 18 were headquartered in the United States. By the mid-
1990s, that number had dropped to 8.
---------------------------------------------------------------------------
    \25\ OECD, Taxing Profits in a Global Economy: Domestic and 
International Issues (1991).
    \26\ See, e.g., testimony before the Committee on Finance, U.S. 
Senate, March 11, 1999.
---------------------------------------------------------------------------
    Short of fundamental reform--a reform in which the United 
States federal income tax system is eliminated in favor of some 
other sort of system--there are many aspects of the current 
system that could be reformed and greatly improved. These 
reforms could significantly lower the cost of capital, the cost 
of administration, and therefore the cost of doing business for 
U.S.-based firms.
    In this regard, the NFTC strongly supports the 
International Tax Simplification for American Competitiveness 
Act of 1999, H.R. 2018, recently introduced by Mr. Houghton, 
and Mr. Levin, and Mr. Sam Johnson, and joined by four other 
members: Mr. Crane, Mr. Herger, Mr. English, and Mr. Matsui. We 
congratulate them on their efforts to make these amendments. 
They address important concerns of our companies in their 
efforts to export American products and create jobs for 
American workers.
    The NFTC is preparing recommendations for broader reforms 
of the Code to address the anomalies and problems noted in our 
review of the U.S. international tax system, and would enjoy 
the opportunity to do so.
                               Conclusion
    In particular, our study of the international tax system of 
the United States has led us so far to four broad conclusions:
     U.S.-based companies are now far less dominant in global 
markets, and hence more adversely affected by the competitive 
disadvantage of incurring current home-country taxes with respect to 
income that, in the hands of a non-U.S. based competitor, is subject 
only to local taxation; and
     U.S.-based companies are more dependent on global markets 
for a significant share of their sales and profits, and hence have 
plentiful non-tax reasons for establishing foreign operations.
     Changes in U.S. tax law in recent decades have on balance 
increased the taxation of foreign income.
     The U.S. international tax system is much more complex and 
burdensome than that of our trading partners.
     United States policy in regard to trade matters has been 
broadly expansionist for many years, but its tax policy has not 
followed suit.
    These two incompatible trends -decreasing U.S. dominance in 
global markets set against increasing U.S. taxation of foreign 
income -are not claimed by us to have any necessary causal 
relation. However, they strongly suggest that we must re-
evaluate the balance of policies that underlie our 
international tax system.
    Again, the Council applauds the Chairman and the Members of 
the Committee for beginning the process of reexamining of the 
international tax system of the United States. These tax 
provisions significantly affect the national welfare, and we 
believe the Congress should undertake careful modification of 
them in ways that will enhance the participation of the United 
States in the global economy of the 21st Century. We would 
enjoy the opportunity to work with you and the Committee in 
further defining both the problems and potential solutions. The 
NFTC would hope to make a contribution to this important 
business of the Committee.

                                


    Chairman Archer. Thank you, Mr. Murray.
    Mr. Morrison you may proceed.

   STATEMENT OF PHILIP D. MORRISON, PRINCIPAL AND DIRECTOR, 
WASHINGTON INTERNATIONAL TAX SERVICES GROUP, DELOITTE & TOUCHE 
  LLP.; ON BEHALF OF THE NATIONAL FOREIGN TRADE COUNCIL, INC.

    Mr. Morrison. Thank you, Mr. Chairman, distinguished 
Members of the Committee, and staff. My name is Phil Morrison. 
I am a principal with Deloitte & Touche and the director of 
Deloitte's Washington International Tax Services Group. I 
appear today on behalf of the National Foreign Trade Council.
    I am one of the co-authors of the NFTC's report on Subpart 
F, and we are currently working on a second report, as Mr. 
Murray said, on the foreign tax credit. My role with respect to 
both of these reports is a comparative law one, to compare the 
U.S. regime with the comparable regimes of our major trading 
partners, specifically Canada, France, Germany, Japan, the 
Netherlands, and the United Kingdom. It is the large 
multinational corporations from these countries that form the 
chief competition of U.S. companies when they operate abroad.
    The Subpart F comparison that we completed illustrates 
that, in many important respects, the U.S. CFC provisions in 
Subpart F are much harsher than the rules of foreign countries' 
comparable regimes. While the foreign tax credit comparison is 
still a work in progress, preliminary results indicate that the 
use of the credit, U.S. limitations on the use of the credit, 
and expense allocation provisions, particularly interest 
expense, as has been mentioned this morning several times, are 
both more complex and more likely to result in double tax than 
comparable regimes in the foreign countries surveyed. This is 
particularly true with respect either to highly leveraged 
industries or those that produce significant foreign losses 
during the startup years abroad, such as telecommunications or 
power generation.
    The 1-page table that appears at the end of my written 
testimony summarizes several of the practical examples that we 
examined in the Subpart F report. As Example 1 shows, none of 
the countries surveyed eliminates deferral for active financial 
services income received by a CFC from unrelated persons. Such 
income is universally recognized as active business income, and 
except in the United States, is not subject to the anti-
defferal regime. Thus, if the temporary active financing 
provision enacted for this year were permitted to expire at the 
end of 1999, the United States would be clearly out of step 
with international norms.
    Examples 2, 3, and 4 in the table address the situations 
where an active business CFC receives dividends, in Example 2; 
interest, in Example 3; and royalties, in Example 4, from a 
related active business CFC resident in a different country. In 
each case, the United States is the only country that always 
denies deferral.
    Example 5 deals with foreign-based company oil-related 
income, that is, income from downstream activities, such as 
refining.
    Under Subpart F, the income of the CFC always would be 
attributed to U.S. shareholders. In the other countries, oil-
related income is subject to the same rules as other types of 
active business income; only France would tax oil-related 
income.
    In Example 6, a CFC is engaged in buying and selling 
property that it does not manufacture. The property is bought 
from related parties outside the CFC's residence country and 
sold to unrelated parties, also outside the CFC's country. 
Again, because of tax disparities, Canadian, Dutch, German, and 
Japanese multinationals all have a competitive advantage over 
U.S. multinationals.
    Example 7 demonstrates that none of the countries examined 
have a section 956 surrogate. None require inclusion in income 
by a CFC shareholder for an increase in earnings invested in 
the home country of the CFC.
    These comparisons demonstrate that, due to Subpart F, U.S. 
multinationals operate at a competitive disadvantage abroad as 
compared to multinationals from our major trading partners. By 
pointing out this competitive disadvantage, and despite the 
chairman's invitation earlier, we don't mean to imply that the 
United States should inaugurate a ``race to the bottom,'' a 
race to provide the most lenient tax rules in the United 
States. The comparison does demonstrate, however, quite 
clearly, that the rest of the developed world has not joined 
the United States in a ``race to the top.'' In the 37 years 
since the enactment of Subpart F, while each jurisdiction 
studied has approached CFC issues somewhat differently, none 
has adopted a regime as harsh as Subpart F.
    The U.S. anti-deferral rules are out of step with 
international norms. The relaxation of Subpart F, even to the 
highest common denominator among other countries' regimes, let 
alone to a more moderate middle ground, would help redress the 
competitive imbalance created by Subpart F without contributing 
to the feared race to the bottom.
    While we have yet to complete our study that will be part 
of the foreign tax credit report, our preliminary work reveals 
that the U.S. credit system, again, particularly with respect 
to interest allocation and the treatment of foreign losses, is 
also out of step with international norms. It appears that this 
too contributes to a competitive disadvantage for most U.S. 
multinationals.
    Thank you very much for your attention.
    [The prepared statement follows:]

Statement of Phillip D. Morrison, Principal and Director, Washington 
International Tax Services Group, Deloitte & Touche LLP; on behalf of 
the National Foreign Trade Council, Inc.

    Mr. Chairman, distinguished Members of the Committee, and 
staff: My name is Phil Morrison. I am a Principal with Deloitte 
& Touche LLP and the Director of Deloitte's Washington 
International Tax Services Group. I appear today on behalf of 
the National Foreign Trade Council (``NFTC'').
                            I. Introduction
    I am co-author of the NFTC's report on subpart F \1\ and am 
currently working with others on an NFTC-sponsored report on 
the foreign tax credit. My role with respect to these reports 
was to compare the United States subpart F and foreign tax 
credit regimes to the comparable regimes of Canada, France, 
Germany, Japan, the Netherlands, and the United Kingdom.
---------------------------------------------------------------------------
    \1\ International Tax Policy for the 21st Century: A 
Reconsideration of Subpart F, (March 25, 1999).
---------------------------------------------------------------------------
    These countries were selected for comparison because they 
constitute, together with the United States, the countries with 
the most corporations that are among the world's largest 500 
corporations. In the aggregate, these countries are home to 412 
of the 500 largest corporations in the world,\2\ and it is 
large multinational corporations from these countries that are 
the competition for U.S. corporations that conduct business 
abroad.
---------------------------------------------------------------------------
    \2\ Based upon the Financial Times 500, The Financial Times, 
January 22, 1998.
---------------------------------------------------------------------------
    The subpart F comparison illustrates that, in many 
important respects, the U.S. controlled foreign corporation 
(CFC) provisions in subpart F are harsher than the rules in the 
foreign countries' comparable regimes.\3\ While the foreign tax 
credit comparison is still a work-in-progress, preliminary 
results indicate that the U.S. limitations on the use of the 
credit and expense allocation provisions are both more complex 
and more likely to result in double taxation than the foreign 
countries' comparable regimes. These comparisons demonstrate 
that U.S. multinationals operate at a competitive disadvantage 
abroad as compared to multinationals from these other major 
jurisdictions.
---------------------------------------------------------------------------
    \3\ For convenience, the anti-deferral regimes of all of the 
countries will be referred to as ``CFC regimes.'' The actual names of 
the particular regimes vary.
---------------------------------------------------------------------------
    By pointing out this competitive disadvantage, we do not 
mean to imply that the United States should inaugurate a ``race 
to the bottom,'' a race to provide the most lenient tax rules. 
The comparison does demonstrate, however, that the rest of the 
developed world has not joined the United States in a ``race to 
the top.'' If the rest of the developed world is not going to 
join the United States and mimic the harshness of subpart F and 
the complexity of our foreign tax credit rules, and history has 
shown that it will not, then it is incumbent upon Congress to 
carefully examine whether the resulting competitive imbalance 
is warranted for other policy reasons. Since, as the NFTC 
report demonstrates and as is summarized in the testimony of 
Messrs. Murray and Merrill, it is not, it would be sensible to 
relax the U.S. rules. This relaxation need not be a relaxation 
to the lowest common denominator but only to a more reasonable 
middle position among those adopted by our competitor 
countries.
    The unstated assumption of those who raise the spectre of a 
race to the bottom, is that any significant deviation from the 
U.S. model that exists in another country indicates that the 
other government has yielded to powerful business interests and 
has enacted tax laws that are intended to provide its home-
country based multinationals a distinct competitive advantage. 
It is seldom, if ever, acknowledged that the less stringent 
rules adopted in other countries might reflect a conscious but 
different balance of the rival policy concerns of neutrality 
and competitiveness.
    The unstated assumption is incorrect. The CFC regimes 
enacted by the countries studied, for example, all were enacted 
in response to and after several years of scrutiny of the U.S. 
subpart F regime. They reflect a careful study of the impact of 
subpart F and, in every case, include some significant 
refinements of the U.S. rules. Each regime has been in place 
long enough for each respective government to study its 
operation and to conclude whether it is either too harsh or too 
liberal. While each jurisdiction has approached CFC issues 
somewhat differently, each has adopted a regime that, in at 
least some important respects, is materially less harsh than 
subpart F.
    The proper inference to draw from this comparison is that 
the United States has tried to lead and, while many have 
followed, none has followed as far as the United States has 
gone. A relaxation of subpart F to even the highest common 
denominator among other countries' CFC regimes, let alone to a 
moderate middle ground, would help redress the competitive 
imbalance created by subpart F without contributing to a race 
to the bottom.
              II. Anti-Deferral or CFC Regimes--Generally
    Each of the countries examined in the NFTC study on subpart 
F has enacted a regime aimed at preventing taxpayers from 
obtaining deferral with respect to certain types of income of, 
or income earned by certain types of, CFCs. At the same time, 
however, each country has balanced its anti-deferral concerns 
with the need not to interfere with the ability of domestic 
taxpayers to compete in genuine business activities in 
international markets. Resolution of the conflict between these 
two policy objectives typically hinges on the definition of 
what constitutes genuine foreign business activity. Genuine 
business activity gains deferral; a lack of genuine business 
activity triggers the anti-deferral regime. As might be 
expected, the definition of genuine foreign business activity 
varies widely.
    There are two primary ways in which countries prevent what 
they consider to be improper deferral of domestic taxation of 
foreign-source income earned by CFC's. A country may end 
deferral with respect to certain types of ``tainted'' income 
that it believes should not receive deferral. This 
transactional approach is the approach taken by the United 
States, Canada, and Germany. The alternative is to deem all 
income to be tainted when a CFC meets certain criteria (such as 
having a significant amount of tainted income or being located 
in certain jurisdictions). If the CFC does not meet the 
criteria for application of the regime, deferral is allowed for 
all of the income. This jurisdiction-based approach is taken by 
France, Japan, and the United Kingdom. Both approaches provide 
exemptions and modifications that tend to minimize the 
differences between them, however. The Netherlands, through a 
participation exemption, broadly exempts foreign income of 
CFCs. While the participation exemption is denied for certain 
passive investments, liberal safe harbors preserve the 
exemption in most cases.
    Deferral is ended (and current inclusion achieved) by 
attributing either the tainted income or all income earned by 
the CFC to certain shareholders (usually those holding a 
minimum percentage ownership). Shareholders must include the 
attributed income in their own income currently. CFC regimes 
that attribute only tainted income provide for exclusions that 
remove specific types of income from classes of income that 
normally are considered to be tainted. CFC regimes that 
attribute all income provide exemptions that remove all or 
certain income from attribution under the regime.
  III. Specific Comparison of CFC Regimes with Respect to Particular 
                                 Types 
                             of Income \4\
A. Active Financial Services Income

    Prior to 1986, a CFC's active financial services income was 
treated much the same as other types of active income. From 
1986 until 1998, however, most income earned by a CFC of a U.S. 
financial services company was subject to tax when earned, 
apparently because Congress believed that deferral of such 
income provided excessive opportunities to route income through 
foreign countries to maximize tax benefits.\5\ The pre-1986 
treatment for active financial services income was temporarily 
restored in 1997,\6\ with the addition of rules to address the 
concerns that led to the repeal in 1986.
---------------------------------------------------------------------------
    \4\ In each of the examples below, it is assumed that a single 
home-country shareholder (a parent company) owns 100% of the CFC. 
Because of this, in each of the examples outlined below, the Dutch 
anti-deferral regime (exceptions from the Dutch exemption system) will 
not apply.
    \5\ Joint Committee on Taxation, General Explanation of the Tax 
Reform Act of 1986, at 966 (Comm. Print 1986).
    \6\ Pub. L. No. 105-34, Sec.  1175(a); H.R. Rep. No. 105-220, at 
639-645 (1997)(Taxpayer Relief Act of 1997, Conference Report to H.R. 
2014).
---------------------------------------------------------------------------
    The active financing income provision was revisited in 
1998, in the context of extending the provision for the 1999 
tax year. Considerable changes were again made to address 
concerns relating to income mobility. The newly crafted 
provision is narrowly drawn. Under the 1999 active financing 
provision, a financial services business must have a 
substantial number of employees carrying on substantial 
managerial and operational activities in the foreign country. 
The activities must be carried on almost exclusively with 
unrelated parties, and the income from the activities must be 
recorded on the books and records of the CFC in the country 
where the income was earned and the activities were 
performed.\7\ In addition, an active banking, financing, 
securities, or insurance business is painstakingly defined by 
statute and accompanying legislative history. The activities 
that may be taken into account in determining whether a 
business is active also are carefully delineated in the statute 
and legislative history and substantially all of the CFC's 
activities must be comprised of such activities as defined.
---------------------------------------------------------------------------
    \7\ See H.R. Rep. No. 105-825, at 921 (1998)(Conference Report to 
H.R. 4328, section 1005 of the Omnibus Consolidated and Emergency 
Supplemental Appropriations Act of 1999).
---------------------------------------------------------------------------
    As Example 1 on the attached table shows, none of the 
countries surveyed eliminates deferral for active financial 
services income received by a CFC from unrelated persons. Such 
income is universally recognized as active trade or business 
income. Thus, if the active financing provision were permitted 
to expire at the end of 1999, U.S. banks, insurers, and other 
financial services companies would find themselves at a 
significant competitive disadvantage in relation to all their 
major foreign competitors when operating outside the United 
States.
    Other major industrialized countries provide more lenient 
requirements for a CFC to be able to defer the taxation of its 
active financing income. German law merely requires that the 
income must be earned by a bank with a commercially viable 
office established in the CFC's jurisdiction and that the 
income results from transactions with customers. Germany does 
not require that the CFC conduct the activities generating the 
income or that the income come from transactions with customers 
solely in the CFC's country of incorporation. The United 
Kingdom has an even less restrictive deferral regime than 
Germany. The United Kingdom does not impose current taxation on 
CFC income as long as the CFC is engaged primarily in 
legitimate business activities primarily with unrelated 
parties.

B. Dividends, Interest, and Royalties from Active Earnings 
Received from Related Parties

    Example 2 on the attached table addresses the case where a 
CFC engaged in the active conduct of a trade or business 
receives dividends from a subsidiary CFC, incorporated in a 
different country, also engaged in the active conduct of a 
trade or business.
    For U.S. tax purposes, the dividend income would be taxed 
to (attributed to) the CFC's U.S. shareholders. There would be 
no attribution to Canadian shareholders because dividends 
received from other foreign related parties out of active 
earnings are excluded from attribution. French shareholders 
would be exempt because the CFC is engaged in an active 
business. The dividend income would not be considered to be 
tainted income in Germany provided the parent CFC's holdings in 
the subsidiary CFC are commercially related to its own excluded 
active business operations (e.g., CFC is also engaged in a 
similar manufacturing business) or if the dividends would have 
been exempt if received directly by the German corporation. 
Japanese shareholders would be exempt because the business of 
CFC is conducted primarily in its country of incorporation 
(even if business were not conducted in that country, Japanese 
shareholders would be exempt if the main business of CFC were 
wholesale, financial, shipping, or air transportation because 
it is engaged in business primarily with unrelated parties). 
U.K. shareholders would be exempt from attribution because the 
recipient CFC is principally engaged in an active business and 
the business operations of CFC are carried on principally with 
unrelated parties.
    Thus, in the case of an active business CFC that receives a 
dividend from a CFC subsidiary engaged in active business in a 
country other than the recipient CFC country, the United States 
is the only country that always attributes the income to CFC 
shareholders. While the foreign countries allow for situations 
where legitimate active businesses earn dividend income in the 
normal course of business, the United States puts its 
multinational corporations at a disadvantage by always taxing 
dividend income currently unless the extremely narrow same 
country exception applies.
    Example 3 assumes the same facts as Example 2 but deals 
with interest. Thus, in Example 3, a CFC engaged in an active 
trade or business pays interest to a parent or sister CFC in 
another country that is also engaged in an active business.
    Canadian, French, Japanese, and U.K. CFCs are allowed to 
lend money to active business subsidiaries without being 
penalized by the CFC rules. German CFCs are allowed to lend 
money to foreign active business subsidiaries as long as the 
loan is long-term and the money is borrowed by the CFC on 
foreign capital markets. U.S. multinational corporations 
generally are not able to provide a loan from a CFC engaged in 
active business with an excess of cash to a subsidiary of the 
CFC that is engaged in active business with a need for cash, 
without incurring current U.S. taxation on the interest paid 
from the subsidiary to the CFC. The only time U.S. 
multinationals are able to provide such a loan without current 
U.S. taxation is if both the CFC and the subsidiary are in the 
same country. Although income used to pay the interest is 
earned in an active foreign business by a party related to the 
U.S. multinational and the income is reinvested in an active 
foreign business, the U.S. rules still tax the income 
currently.
    Once again, U.S. multinationals are at a competitive 
disadvantage in the international marketplace. This situation, 
like the dividend example in Example 2, hamstrings U.S. 
multinationals groups from redeploying foreign earnings of 
their CFC group from jurisdiction to jurisdiction without 
triggering an end to deferral.
    Example 4 on the attached table is identical to Examples 2 
and 3 except that it deals with royalties. Royalties are paid 
by an active CFC in one country to an active CFC in another 
country.
    The Canadian CFC rules provide an exception that deems 
amounts paid to a CFC by a related foreign corporation to be 
active business income if the amount is deductible in computing 
the income of the payer corporation. Therefore, the royalty 
payments would be excluded from attribution. Income would not 
be attributed to French shareholders or Japanese shareholders 
because CFC is principally engaged in an active business 
carried on in its residence country. Germany does not consider 
royalty income to be passive tainted income provided the CFC 
has used its own research and development activities without 
the participation of German shareholders or an affiliated 
person to create the patents, trademarks, know-how, or similar 
rights from which the income is derived. U.K. shareholders 
would be exempt from attribution because CFC is principally 
engaged in an active business and the business operations of 
CFC are carried on principally with unrelated parties.
    Only members of U.S. multinational groups cannot pay 
royalties to a CFC that actively develops intangibles without 
triggering an anti-deferral regime. Even if earned in an active 
business, royalties from related parties are subpart F income. 
In each of the competitor countries' cases, such royalties are 
not tainted income or otherwise attributable to the CFC's 
shareholders.

C. Oil-Related Income

    In 1982, the United States expanded subpart F income to 
include ``foreign base company oil-related income.'' \8\ 
Congress claimed that, because of the fungible nature of oil 
and because of the complex structures involved, oil income is 
particularly suited to tax haven type operations.\9\ Under the 
changes made foreign base company oil-related income was 
defined as foreign oil-related income other than: (1) income 
derived from a source within a foreign country in connection 
with oil or gas extracted from an oil or gas well located in 
that foreign country; or (2) income from oil, gas, or a primary 
product of oil or gas that is sold by the foreign corporation 
for use or consumption within the foreign country or is loaded 
in such country on a vessel or aircraft as fuel for such vessel 
or aircraft.\10\
---------------------------------------------------------------------------
    \8\ Pub. L. No. 97-248, Sec. 212(a).
    \9\ Joint Committee on Taxation, General Explanation of the Revenue 
Provisions of the Tax Equity and Fiscal Responsibility Act of 1982, at 
72.
    \10\ I.R.C. Sec. 954(g).
---------------------------------------------------------------------------
    Example 5 compares the U.S. rules with respect to foreign 
base company oil-related income to those applicable to CFCs of 
companies incorporated in our competitor countries. Example 5 
assumes that CFC operates a refinery in country X. CFC earns 
oil-related income in X from purchasing oil extracted from a 
country other than X and sells the refined product for 
consumption outside of X. CFC's sales are primarily conducted 
with unrelated parties.
    Under subpart F, the income of CFC would be attributed to 
its U.S. shareholders. None of the other countries have singled 
out oil-related income as a type of income that should be 
tainted. In the other countries, oil-related income is subject 
to the same rules as other types of active business income. In 
this example, however, income would be attributed to French 
shareholders because CFC makes sales primarily outside the CFC 
country. In the other countries examined, the income would not 
be taxed.
    Thus, U.S.-based and French-based multinational oil 
companies are, in these circumstances, at a competitive 
disadvantage in relation to oil companies from the other 
compared countries with respect to income earned from 
downstream activities. Only for U.S. and French multinational 
oil companies will income from an active downstream business 
conducted in a subsidiary in a foreign jurisdiction be 
attributed to shareholders. In each of the other surveyed 
jurisdictions, such income would be entitled to deferral or 
exemption.

D. Base Company Sales Income

    For U.S. tax purposes, foreign base company sales income 
generally is income derived from the purchase and re-sale of 
property that is not manufactured by the CFC where either the 
seller or the buyer is related to the CFC.
    In Example 6, CFC is engaged in the buying and selling of 
personal property that it does not manufacture. The property is 
bought from related parties outside CFC's residence country and 
sold to unrelated parties outside CFC's residence country.
    The income of CFC would be attributed to U.S. shareholders. 
In Canada, CFC's income would be exempt from attribution 
because the income is earned in active business. The income 
would be attributed to French shareholders because the business 
is conducted primarily outside the CFC country. Germany's 
exemption for commercial activities does not generally apply 
when goods are acquired by the CFC from, or sold to, a related 
German party. If the goods are both purchased and sold outside 
Germany, however, the sales income is exempt, even if the goods 
are sold to a related party and the German shareholder of the 
CFC actively participates. In this example, therefore, there 
would be no attribution. To qualify for exemption from 
attribution, a Japanese sales company must conduct its business 
primarily with unrelated parties. To be conducting business 
primarily with unrelated parties for Japanese purposes, the CFC 
must either purchase more than 50 percent of its goods from 
unrelated parties or sell more than 50 percent of its goods to 
unrelated parties. The income of CFC would not be attributed to 
Japanese shareholders because more than 50 percent of the goods 
are sold to unrelated parties. A CFC controlled by U.K. 
shareholders is subject to the CFC regime and income is 
attributed to its shareholders if the main business of the CFC 
is dealing in goods for delivery to or from the United Kingdom 
or to or from related parties. The main business of the CFC is 
dealing in goods from related parties, so the income of the CFC 
would be attributed to its shareholders.
    Canadian, German, and Japanese multinationals have a 
competitive advantage over U.S. multinationals when goods 
bought from related parties outside the home and CFC countries 
are sold to unrelated parties outside the home and CFC 
countries.

E. Increase in Investment in the Home Country

    In Example 7, CFC has nothing invested in home country 
property at the beginning of the year. CFC purchases tangible 
property located in the home country for use in its business 
during the year. CFC has earnings and profits in excess of the 
value of the property.
    Under subpart F, U.S. shareholders would have to include 
the entire amount invested by the CFC in U.S. property for the 
taxable year in its income.\11\ None of the other countries 
studied have a provision that requires an inclusion in income 
by the CFC shareholders for an increase in earnings invested by 
the CFC in the home country. Canada and Germany have decided 
that, if the income earned from that property invested in the 
home country is of a type for which deferral should not be 
granted, then it is sufficient to subject the income from that 
investment to the anti-deferral regime (note that the CFC 
itself may be subject to tax in the home country because the 
income may be sourced in the home country). France, Japan, and 
the United Kingdom do not even subject the income from such 
property to tax under their anti-deferral regime, even if the 
income is of a type for which deferral should not be granted, 
if the CFC is engaged primarily in active business.
---------------------------------------------------------------------------
    \11\ I.R.C. Sec. Sec.  951(a)(1)(B), 956(a).
---------------------------------------------------------------------------
              IV. Conclusion--Anti-Deferral or CFC Regimes
    Anti-deferral or CFC regimes have been enacted in each of 
the countries studied. Most were enacted in the two decades 
following the enactment of subpart F in the United States. It 
is possible to argue that other countries, albeit slowly, have 
followed the United States' lead. But no country has followed 
our lead, even after 37 years, nearly as far as we have gone. 
The United States clearly imposes the most burdensome regime. 
Looking at any given category of income, it is sometimes 
possible to point to one or two countries whose rules approach 
the U.S. regime, but the overall trend is overwhelmingly clear: 
U.S.-based multinationals with active foreign business 
operations suffer much greater home-country tax burdens than 
their foreign-based competitors.
    The observation that the U.S. rules are out of step with 
international norms, as reflected in the consistent practices 
of our major trading partners, supports the conclusion that 
U.S.-based companies suffer a competitive disadvantage vis-a-
vis their multinational competitors based in other countries. 
The appropriate reform is to limit the reach of subpart F in a 
manner that is more consistent with the international norm.
    Some commentators have suggested that the competitive 
imbalance created by dissimilar international tax rules should 
be redressed not through any amelioration of the U.S. rules, 
but rather through a broadening of comparable foreign regimes. 
As a purely logical matter the point is valid--a see-saw can be 
balanced either by pushing down the high end or pulling up the 
low one. However, the suggestion is completely impractical for 
several reasons. For one thing, since the U.S. rules are out of 
step with the majority, from the standpoint of legislative 
logistics alone it would be far easier to achieve conforming 
legislation in the United States alone, rather than in more 
than a dozen other countries. More fundamentally, there is no 
particular reason to believe that numerous foreign sovereigns, 
having previously declined to adopt subpart F's broad taxation 
of active foreign businesses despite 37 years of the U.S. 
setting the example, will now suddenly have a change of heart 
and decide to follow the U.S. model. Clearly our competitor 
jurisdictions have studied our subpart F and chosen a somewhat 
less harsh balance between competitiveness and neutrality. It 
is unwarranted and naive to think they have made this choice 
without careful consideration or solely in an effort to 
maintain a competitive advantage for ``their'' multinationals.
    Further, recent OECD activities relating to ``unfair tax 
competition'' do not increase the likelihood of foreign 
conformity with subpart F's treatment of active foreign 
businesses. It is important to recognize that those activities 
relate to efforts by OECD member countries to limit the 
availability and usage of ``tax haven'' countries and regimes. 
The failure of a country to impose any type of CFC legislation 
can be viewed as offering a type of tax haven opportunity, 
since it may permit the creation of investment structures that 
avoid all taxation. Thus, the OECD has recommended that 
countries without any CFC regime ``consider'' enacting them. 
However, in encouraging countries that have no CFC rules to 
enact them, the OECD has in no way endorsed an effort to 
promote conformity among existing CFC regimes, let alone 
conformity with the U.S. system.
    In conclusion, the U.S. rules under subpart F are well 
outside the international mainstream, and should be conformed 
more closely to the practices of our principal trading 
partners. We emphasize that, contrary to the suggestions of 
some commentators, we advocate only that the U.S. rules be 
brought back to the norm so as to achieve competitive parity--
not that they be loosened further in an effort to confer 
competitive advantage.
                         V. Foreign Tax Credit
    As mentioned above, the NFTC foreign tax credit study is a 
work-in-progress. While I am unable to report definitive 
conclusions from the comparative law portion of that study, we 
are far enough along to make some general observations. First, 
while superficially less complex, exemption or territorial 
systems have the potential for significant complexity. Because, 
under an exemption or territorial system, foreign source income 
is exempt, sourcing rules are as important and susceptible of 
as much pressure as under a foreign tax credit system with a 
complex limitation. Similarly, because income of foreign 
subsidiaries is exempt under a territorial system, transfer 
pricing rules can come under significant pressure. Finally, 
most jurisdictions with exemption or territorial systems find 
the need to not exempt certain types of passive income. Thus, 
there may be a foreign tax credit system just for this type of 
income, as well as an anti-deferral or CFC regime.
    Second, no other country studied limits averaging between 
high-and low-tax countries with either the severity or the 
complexity of the U.S. foreign tax credit basket system. Even 
the U.K., with a juridical per item limitation mitigates the 
complexity and harshness of such a rule by permitting the 
utilization of so-called ``mixer'' companies. Other credit 
countries, such as Japan, adopt a straight-forward overall 
limitation such as the United States has had in the past.
    Third, no country studied appears to have anywhere near as 
complex an expense allocation regime, particularly with respect 
to interest, as the United States'. The U.S. interest 
allocation rules appear, based on our preliminary work, to be 
vastly more complex and unfair than the expense allocation 
rules applicable in any of the other jurisdictions.
    Finally, none of the other jurisdictions studied appear to 
have a rule such as the U.S. overall foreign loss (``OFL'') 
recapture rule. That rule, which causes U.S. multinationals 
with OFLs to recapture future foreign source income as domestic 
income, essentially eliminates the benefit of a foreign tax 
credit in industries such as telecommunications and power 
generation where significant capital outlays in early years of 
foreign operations produce significant early years losses.
    In sum, our preliminary findings show that, like subpart F, 
the U.S. foreign tax credit regime places U.S. multinationals 
at a competitive disadvantage versus multinationals from the 
other countries studied. This is particularly true with respect 
to either heavily leveraged industries or those that produce 
significant foreign losses in the early years of operation 
abroad.
                         VI. Overall Conclusion
    The U.S. subpart F and foreign tax credit regimes are both 
more complex and harsher than the comparable regimes in the six 
other countries studied. The higher administrative cost in 
dealing with this complexity, together with the higher domestic 
tax on foreign-earned income, generally places U.S. 
multinationals at a competitive disadvantage versus 
multinationals based in these other countries.
[GRAPHIC] [TIFF OMITTED] T6775.002


                                


    Chairman Archer. Thank you, Mr. Morrison.
    Our next witness is Mr. Merrill.

 STATEMENT OF PETER R. MERRILL, PRINCIPAL, WASHINGTON NATIONAL 
TAX SERVICES, AND DIRECTOR, NATIONAL ECONOMIC CONSULTING GROUP, 
PRICEWATERHOUSECOOPERS, LLP; ON BEHALF OF THE NATIONAL FOREIGN 
                      TRADE COUNCIL, INC.

    Mr. Merrill. Thank you, Mr. Chairman and the Committee, for 
the opportunity to testify before you this morning. I am 
director of the National Economic Consulting Group at 
Pricewaterhouse-
Coopers here in Washington. I am appearing today in my capacity 
as a member of the drafting group of the NFTC study on Subpart 
F.
    I would like to cover today four points. First, how has the 
global economy changed in the 37 years since Congress enacted 
the Subpart F regime? Second, is foreign investment by U.S. 
companies harmful to the domestic economy? Third, does the 
competitiveness of U.S.-headquartered companies matter for our 
national economic well-being? Fourth, how does U.S. tax policy 
affect the competitiveness of U.S. companies?
    I am going to conclude my testimony today by summarizing 
some of the results from a new study that 
PricewaterhouseCoopers has just completed, which looks at the 
question that the chairman raised in announcing the hearing, 
which is are American companies the losers in recent cross-
quarter mergers?
    In 1962 when Subpart F was enacted, the United States was 
on the gold standard, exchange rates were fixed, and the United 
States was the world's largest capital exporter. Treasury was 
concerned about keeping capital in the United States, 
preventing it from flowing out. That was one of the main 
rationales for the Subpart F regime, adopted in 1962--to keep 
the capital at home. Today, of course, the gold standard is 
gone. The dollar floats. The United States is the world's 
largest capital importer. There is obviously hardly any reason 
that we need tax legislation designed to keep the capital at 
home.
    The world has become a much more competitive place for U.S. 
multinationals. In 1967, U.S. multinationals had a 50 percent 
market share in cross-border investment. Today, they have a 25 
percent share. As Mr. Murray has mentioned, in 1960, 18 of the 
20 largest corporations in the world were headquartered in the 
United States. But, today, just eight are headquartered in the 
United States. Obviously, U.S. multinationals face much 
heightened competition compared to what they did in 1962.
    Second, does U.S. foreign direct investment abroad help or 
hurt the U.S. economy? Obviously, some have argued that U.S. 
investment abroad comes at the expense of the domestic economy. 
Under this view, Subpart F and various rules that penalize U.S. 
investment abroad are necessary to protect U.S. workers. I will 
quote to the Committee a recent study by the OECD. It is a very 
good study. It is called ``Open Markets Matter.'' The OECD 
found that domestic firms and their employees, ``generally gain 
from the freedom of businesses to invest overseas. As with 
trade, foreign direct investment generally creates net benefits 
for the host and the source countries alike.''
    A few other points about U.S. investment abroad. First, 
companies that don't invest abroad pay 5 to 15 percent lower 
wages than similar U.S. multinational companies.
    Second, U.S. multinationals account for $407 billion of 
exports in 1996. That is in two-thirds of all exports a U.S. 
multinational is involved in the export.
    Third, the OECD study that I mentioned before found that 
for each dollar of outward investment, there is an additional 
$1.70 of contribution to the trade balance, a net trade surplus 
of $1.70. U.S. multinationals certainly are a key component of 
exports.
    Companies that invest abroad invest to do so for foreign 
markets. You heard in the earlier panel, that over 90 percent 
of what U.S. companies abroad sell is destined for foreign 
markets, not the U.S. market.
    Thus, international competitiveness of U.S. multinationals 
matter for the domestic economy. Laura Tyson, former Chair of 
the Council of Economic Advisors in this administration and the 
former director of the National Economic Council said, in an 
article in the American Prospect Magazine, Yes, it is important 
to have headquarters of companies here. She pointed out that 70 
percent of the assets and jobs of U.S. multinationals are 
located in the United States and 88 percent of the R&D they 
perform is located in the United States. U.S.-headquartered 
companies overwhelmingly have U.S. leadership and they source 
the supplies for the products they make from U.S. suppliers 
predominately.
    Last, why do we think that it is important that we have a 
competitive U.S. tax policy? If the United States taxes 
foreign-source income of its multinationals more heavily than 
other countries, then ultimately the world market share of U.S. 
multinationals will decline. This can happen in a variety of 
ways. It can happen through cross-border mergers. It can happen 
because U.S. individuals invest in foreign mutual funds. The 
portfolio capital that moves to foreign-headquartered companies 
avoids the U.S. corporate tax rules.
    I would like to in the last minute call your attention to a 
recent PricewaterhouseCoopers' study. We just released this 
today. It is a summary of large U.S. cross-border mergers and 
acquisitions for 1998. We looked at all of the mergers and 
acquisitions that were completed in 1998 involving transactions 
of over $500 million. What we found--it is in the study--is 
very striking.
    We found that a net of $127 billion of U.S. assets moved 
from U.S.-headquartered companies to foreign-headquartered 
companies in 1998, that is, $127 billion moved out of U.S.-
headquartered companies. Future foreign investment by these 
companies will generate income that will not ever be taxed by 
the United States. Out to be, out of 51 transactions, 34 were 
acquisitions of U.S. companies by foreigners, only 17 were 
acquisitions of foreign companies by U.S. companies. Of the 
$175 billion of deals, there were $151 billion where foreigners 
acquired U.S. companies. Only $24 billion were U.S. acquired 
foreign companies. So you can see that clearly there is a net 
movement of $127 billion of U.S. assets out of U.S.-
headquartered companies.
    I will conclude my testimony there and take questions.
    [The prepared statement follows:]

Statement of Peter R. Merrill, Principal, Washington, National Tax 
Services, and Director, National Economic Consulting Group, 
PricewaterhouseCoopers LLP; on behalf of the National Foreign Trade 
Council, Inc.

                            I. Introduction
    I am Peter Merrill, a principal in the Washington National 
Tax Services office of PricewaterhouseCoopers LLP, and director 
of the National Economic Consulting group. I am testifying 
today as a member of the drafting group of a recent National 
Foreign Trade Council report on International Tax Policy for 
the 21st Century: A Reconsideration of Subpart F.\1\ This 
report is a comprehensive legal and economic review of the U.S. 
anti-deferral rules that have applied to U.S. multinational 
companies since they were enacted by Congress in 1962.
---------------------------------------------------------------------------
    \1\ National Foreign Trade Council, Inc. International Tax Policy 
for the 21st Century: A Reconsideration of Subpart F, March 25, 1999, 
Washington, D.C.
---------------------------------------------------------------------------
    This testimony \2\ briefly addresses four key economic 
issues that are discussed more fully in the NFTC report:
---------------------------------------------------------------------------
    \2\ This statement draws heavily on Chapter 5 and 6 and of the NFTC 
report.
---------------------------------------------------------------------------
    1. How has the global economy changed during the 37 years since 
subpart F was enacted?
    2. Is foreign investment by U.S. companies harmful to the domestic 
economy?
    3. Does the competitiveness of U.S.-headquartered companies matter 
for U.S. well being?
    4. How does U.S. tax policy affect the competitiveness of U.S. 
multinational companies?
                 II. Global Economic Change Since 1962
    In 1962, the Kennedy Administration proposed to subject the 
earnings of U.S. controlled foreign corporations to current 
U.S. taxation. At that time, the dollar was tied to the gold 
standard, exchange rates were fixed, and the United States was 
the world's largest capital exporter. These capital exports 
drained Treasury's gold reserves, and made it more difficult 
for the Administration to stimulate the economy. Thus the 
proposed repeal of deferral was intended by Treasury Secretary 
Douglas Dillon to serve as a form of capital control, reducing 
the outflow of U.S. investment abroad.
    The compromise adopted by Congress, in response to the 
Kennedy Administration's proposal, was shaped by the global 
economic environment of the early 1960s--a world economy that 
has changed almost beyond recognition as the 20th century draws 
to a close. The gold standard was abandoned during the Nixon 
Administration, and the exchange rate of the dollar is no 
longer fixed. The United States is now the world's largest 
importer of capital, with net capital outflows of over $200 
billion per year.
    National economies are becoming increasingly integrated. 
Globalization is being fueled both by technological change of 
almost unimaginable rapidity, and a worldwide reduction in 
tariff and regulatory barriers to the free flow of goods and 
capital.

Foreign Direct Investment

    In the 1960s, the United States completely dominated the 
global economy, accounting for over 50 percent of worldwide 
cross-border direct investment, and 40 percent of worldwide 
Gross Domestic Product (GDP). In 1960, of the world's 20 
largest corporations (ranked by sales), 18 were headquartered 
in the United States (see Table 1).
    Three decades later, the United States confronts far 
greater competition in global markets. As of the mid-1990s, the 
U.S. economy accounted for about 25 percent of the world's 
foreign direct investment and GDP, and just 8 of the world's 20 
largest corporations were headquartered in the United States. 
The 21,000 foreign affiliates of U.S. multinationals now 
compete with about 260,000 foreign affiliates of multinationals 
headquartered in other nations.\3\ The declining dominance of 
U.S.-headquartered multinationals is dramatically illustrated 
by the recent acquisitions of Amoco by British Petroleum, 
Chrysler by Daimler-Benz, AirTouch by Vodafone, Bankers Trust 
by Deutsche Bank, and Transamerica by AEGON. These mergers have 
the effect of converting U.S. multinationals to foreign-
headquartered companies.
---------------------------------------------------------------------------
    \3\ UNCTAD, World Investment Report, 1997.
---------------------------------------------------------------------------

Bankers Trust by Deutsche Bank, and Transamerica by AEGON. These 
mergers have the effect of converting U.S. multinationals to foreign-
headquartered companies.
[GRAPHIC] [TIFF OMITTED] T6775.003

Ironically, despite the intensified competition in world 
markets, the U.S. economy is far more dependent on foreign 
direct investment than ever before. In the 1960s, foreign 
operations averaged just 7.5 percent of U.S. corporate net 
income; by contrast, over the 1990-97 period, foreign earnings 
represented 17.7 percent of all U.S. corporate net income. A 
recent study of the Standard and Poors' 500 corporations (the 
500 largest publicly-traded U.S. corporations) finds that sales 
by foreign subsidiaries have increased from 25 percent of 
worldwide sales in 1985 to 34 percent in 1997.\4\
---------------------------------------------------------------------------
    \4\ IBES International based on Disclosure data as reported in the 
Wall Street Journal, ``U.S. Firms Global Progress is Two-Edged,'' 
August 17, 1998.
---------------------------------------------------------------------------
The U.S. Market

    In 1962, U.S. companies focused manufacturing and marketing 
strategies in the United States, which at the time was the 
largest consumer market in the world. U.S. companies generally 
could achieve economies of scale and rapid growth selling 
exclusively into the domestic market. In the early 1960's, 
foreign competition in U.S. markets was inconsequential.
    The picture is now completely changed. First, U.S. 
companies now face strong competition at home. Since 1980, the 
stock of foreign direct investment in the United States has 
increased by a factor of six (from $126 billion to $752 billion 
in 1997), and $20 of every $100 of direct cross-border 
investment flows into the United States. Foreign companies own 
approximately 14 percent of all U.S. non-bank corporate assets, 
and over 27 percent of the U.S. chemical industry.\5\ Moreover, 
imports have tripled as a share of GDP from an average of 3.2 
percent in the 1960s to an average of over 9.6 percent over the 
1990-97 period (see Table 5-1).
---------------------------------------------------------------------------
    \5\ PricewaterhouseCoopers calculations based on Department of 
Commerce and IRS data.
---------------------------------------------------------------------------
    Second, foreign markets frequently offer greater growth 
opportunities than the domestic market. For example, from 1986 
to 1997, foreign sales of S&P 500 companies grew 10 percent a 
year, compared to domestic sales growth of just 3 percent 
annually.\6\
---------------------------------------------------------------------------
    \6\ Wall Street Journal, Op. cit.
---------------------------------------------------------------------------
    From the perspective of the 1960s, there was little 
apparent reason for U.S. companies to direct resources to 
penetrating foreign markets. U.S. companies frequently could 
achieve growth and profit levels that were the envy of their 
competitors with minimal foreign operations. By contrast, in 
today's economy, competitive success frequently requires U.S. 
companies to execute global marketing and manufacturing 
strategies.

International Trade

    Over the last three decades, the U.S. share of the world's 
export market has declined. In 1960, one of every six dollars 
of world exports originated from the United States. By 1996, 
the United States supplied only one of every nine dollars of 
world export sales. Despite a 30-percent loss in world export 
market share, the U.S. economy depends on exports to a much 
greater degree. During the 1960s, only 3.2 percent of national 
income was attributable to exports, compared to 7.5 percent 
over the 1990-97 period.
    Foreign subsidiaries of U.S. companies play a critical role 
in boosting U.S. exports--by marketing, distributing, and 
finishing U.S. products in foreign markets. U.S. Commerce 
Department data show that in 1996 U.S. multinational companies 
were involved in 65 percent of all U.S. merchandise export 
sales.\7\ The importance of foreign operations also is 
indicated by the fact that U.S. industries with a high 
percentage of investment abroad are the same industries that 
export a large percentage of domestic production.\8\
---------------------------------------------------------------------------
    \7\ U.S. Bureau of Economic Analysis, Survey of Current Business, 
September 1998.
    \8\ Robert E. Lipsey, ``Outward Direct Investment and the U.S. 
Economy,'' in M. Feldstein, J. Hines, Jr., and G. Hubbard (eds.), The 
Effects of Taxation on Multinational Corporations, University of 
Chicago Press, 1995.

---------------------------------------------------------------------------
Foreign Portfolio Investment

    In 1962, policymakers would scarcely have taken note of 
cross-border flows of portfolio investment. As recently as 
1980, U.S. portfolio investment in foreign private sector 
securities amounted to only $62 billion--85 percent less than 
U.S. direct investment abroad. By 1997, U.S. portfolio 
investment abroad had increased 2,230 percent to over $1.4 
trillion--40 percent more than U.S. direct investment abroad. 
Similarly, foreign portfolio investment in U.S. private 
securities increased from $90 billion in 1980 to over $2.2 
trillion in 1997 (see Table 1).
    Institutional changes have greatly facilitated foreign 
portfolio investments, including the growth in mutual funds 
that invest in foreign securities and the listing of foreign 
corporations on U.S. exchanges. According to the New York Stock 
Exchange, the trading volume in shares of foreign firms totaled 
$485 billion in 1997, or over eight percent of total NYSE 
trading volume.\9\ Market capitalization of foreign firms 
listed on the NYSE topped $3 trillion in 1998.\10\
---------------------------------------------------------------------------
    \9\ Trading in foreign companies is primarily, but not solely, 
through depository receipts.
    \10\ NYSE, Quick Reference Sheet, and discussion with NYSE 
Research, September 1998.
---------------------------------------------------------------------------
    The Administration's 1962 proposal to terminate deferral 
for U.S. CFCs was motivated in large part by a desire to ensure 
that foreign direct investment not flow off-shore for tax 
reasons. At the time, U.S. direct investment abroad exceeded 
private portfolio investment by a factor of 6.5 to 1; thus, it 
is not surprising that the Administration focused much of its 
attention on the taxation of direct investment abroad in 1962.
    In the current economic environment, U.S. portfolio 
investors (e.g., individuals, mutual funds, pension funds, 
insurance companies, etc.) increasingly allocate capital to 
foreign-based multinational companies whose foreign investments 
are not subject U.S. corporate income tax. Under these 
circumstances, the impact of U.S. multinational corporation tax 
rules on the global allocation of capital is greatly 
attenuated.\11\
---------------------------------------------------------------------------
    \11\ See Section E of Chapter 6 of the NFTC report for a discussion 
of this issue.

---------------------------------------------------------------------------
Market Integration

    The explosive pace of economic integration has been aided 
by governments that have liberalized trade and investment 
climates. An alphabet soup of regional trade agreements has 
complemented the original multilateral agreement, GATT. In 
addition to the formation of the European Union--the world's 
largest common market--free trade agreements are creating 
increasingly integrated multinational markets. Examples include 
the European Economic Area (European Union plus remaining 
members of the European Free Trade Area), NAFTA (North 
America), ASEAN (Southeast Asia), ANZCERTA (Australia and New 
Zealand), and MERCOSUR (Latin America). Almost half of the 153 
regional trade agreements notified to the GATT or the WTO have 
been set up since 1990.\12\ Complementing these trade 
agreements are hundreds of bilateral investment treaties (BITs) 
which reduce barriers to foreign direct investment flows. 
UNCTAD reports that there has been a three-fold increase in 
BITs in the five years to 1997.\13\
---------------------------------------------------------------------------
    \12\ The Economist, October 3, 1998, p. 19.
    \13\ UNCTAD, World Investment Report, 1997.
---------------------------------------------------------------------------
    A consequence of market integration is that U.S. companies 
and their foreign competitors increasingly do not view their 
business as occurring in separate country markets, but rather 
in regional markets where national boundaries often have little 
economic significance. In this economic environment, the 
distinctions in subpart F, between economic activities 
conducted within and outside a foreign subsidiary's country of 
incorporation, have in many cases become artificial. When there 
is a high degree of economic integration between national 
markets, tax rules that treat these markets separately are as 
arbitrary as distinctions between a company's transactions with 
customers in different cities.

Conclusions

    In the decades since the enactment of subpart F in 1962, 
the global economy has grown more rapidly than the U.S. 
economy. Concomitantly, U.S. companies have confronted both the 
rise of powerful foreign competitors and the growth of market 
opportunities abroad. By almost every measure--income, exports, 
or cross-border investment--the United States today represents 
a smaller share of the global market. At the same time, U.S. 
companies have increasingly focused on foreign markets for 
continued growth and prosperity. Over the last three decades, 
sales and income from foreign subsidiaries have increased much 
more rapidly than from domestic operations. To compete 
successfully both at home and abroad, U.S. companies have 
adopted global sourcing and distribution channels, as have 
their competitors.
    These developments have a number of potential implications 
for tax policy. U.S. tax rules that are out of step with those 
of other major industrial counties are now more likely to 
hamper the competitiveness of U.S. multinationals in today's 
global economy than was the case in the 1960s.
    The growing economic integration among nations--especially 
the formation of common markets and free trade areas--raises 
questions about the appropriateness of U.S. tax rules that 
treat foreign transactions differently if they cross national 
borders than if they occur within the same country.
    The eclipsing of foreign direct investment by portfolio 
investment calls into question the ability of tax policy 
focussed on foreign direct investment to influence the global 
allocation of capital.
    The abandonment of the gold standard has eliminated balance 
of payment considerations as a rationale for using tax policy 
to discourage U.S. investment abroad. Indeed, as the world's 
largest debtor nation, tax policies that discourage U.S. 
investment abroad are obsolete.
      III. Is Foreign Investment By U.S. Companies Harmful to the 
                           Domestic Economy?
    While acknowledging the anti-competitive implications of 
subpart F, opponents of deferral frequently argue that U.S. 
direct investment abroad comes at the expense of the U.S. 
economy. From this perspective, subpart F is viewed as 
protecting the U.S. economy in general--and U.S. workers 
specifically--from the flow of U.S. investment abroad. 
Opponents of deferral often oppose free trade agreements 
because the free flow of goods across national borders, much 
like the free flow of investment, is perceived as jeopardizing 
domestic jobs.
    The data and economic studies, summarized below, however, 
support the view that outward investment is beneficial rather 
than harmful to the home country economy. As noted in a recent 
report of the Organization for Economic Cooperation and 
Development (OECD), critics of outward direct investment 
sometimes fail to look at the broader economic ramifications:

          The effects of direct investment outflows on the source 
        country, particularly on employment are sometimes still 
        regarded with some disquiet. Most concerns regarding the 
        effects of FDI [foreign direct investment] outflows may arise 
        because investment is viewed statically and without due regard 
        to the spillover effects it generates at home and abroad. In 
        fact, however, domestic firms and their employees generally 
        gain from the freedom of businesses to invest overseas. As with 
        trade, FDI generally creates net benefits for host and source 
        countries alike.\14\
---------------------------------------------------------------------------
    \14\ OECD, Open Markets Matter: The Benefits of Trade and 
Investment Liberalization, 1998, p. 49.

---------------------------------------------------------------------------
Background: Why Do U.S. Corporations Invest Abroad?

    Contrary to the image some commentators have that U.S. corporations 
set up foreign affiliates as substitutes for U.S. operations, the 
latest UN report on foreign investment finds that ``accessing markets 
will remain the principal motive for investing abroad.\15\ Tariff and 
non-tariff barriers, transportation costs, local content requirements, 
location of natural resources, location of customer facilities, and 
other factors frequently make investing abroad the only feasible option 
for successfully penetrating foreign markets. Moreover, a local 
presence generally is required for services industries such as finance, 
retail, legal, and accounting.\16\ In addition, multinational customers 
frequently prefer to deal with suppliers and service providers who have 
operations in all of the jurisdictions in which they operate. Foreign 
investment also allows U.S. parent companies to diversify risks; 
through diversification, a downturn in the home market may be offset by 
an upturn abroad.
---------------------------------------------------------------------------
    \15\ UNCTAD, World Investment Report, 1997, p. xix.
    \16\ See, OECD, Open Markets Matter: The Benefits of Trade and 
Investment Liberalization, 1998, p. 50.
---------------------------------------------------------------------------
    High-income countries provide the most lucrative opportunities for 
U.S. multinationals. As a result, government data show that the bulk of 
U.S. direct investment abroad goes to high-wage, high-income countries. 
In 1996, 81 percent of assets and 68 percent of employment were in 
high-income developed countries rather than low-wage developing 
nations.\17\ This pattern of investment is consistent with the view 
that the presence of rich consumer markets is a much more important 
explanation for U.S. investment abroad than low wages. Low wages 
typically indicate low productivity, so there is little if any 
advantage to be obtained from manufacturing in low-wage jurisdictions, 
particularly where the economic infrastructure (e.g., transportation, 
communication, electricity and water services) and legal infrastructure 
are not adequately developed.
---------------------------------------------------------------------------
    \17\ Developed countries are defined here as Europe, Canada, 
Australia, New Zealand, South Africa, Japan, Singapore, and Hong Kong. 
See, U.S. Department of Commerce, U.S. Direct Investment Abroad 
(September 1998).
---------------------------------------------------------------------------
    Further evidence for the hypothesis that U.S. direct investment 
abroad is attracted by consumer demand rather than low-cost labor 
supply is the fact that less than 10 percent of U.S.-controlled foreign 
corporation sales were exported to the United States. If U.S. 
investment abroad were motivated by the desire to substitute cheap 
foreign labor, rather than to serve foreign markets, one would expect a 
significant amount of U.S. multinational production abroad to be 
shipped back to the United States.\18\ In fact, over half of all 
foreign affiliates of U.S. companies are engaged in services and trade, 
activities that are closely tied to the customers' location.\19\
---------------------------------------------------------------------------
    \18\ See, Peter Merrill and Carol Dunahoo, ``Runaway Plant 
Legislation: Rhetoric and Reality,'' Tax Notes (July 8, 1996) pp. 221-
226 and Tax Notes International (July 15, 1996) pp. 169-174.
    \19\ Mathew Slaughter, Global Investment, American Returns, 
Emergency Committee for American Trade, 1998.
---------------------------------------------------------------------------
    If U.S. investment abroad were attracted by low wages, as critics 
contend, foreign employment and production of U.S. multinationals 
abroad would be rising in comparison to domestic employment and 
production. In fact, the output and employment of U.S.-controlled 
foreign corporations has declined as a share of domestic output and 
employment since the CFC data were first published by the Bureau of 
Economic Analysis in 1982.\20\
---------------------------------------------------------------------------
    \20\ The gross product of controlled-foreign corporations (CFCs) 
has fallen from 6.9 percent of U.S. GDP in 1982 to 6.6 percent in 1996. 
Similarly, CFC employment as fallen from 5.0 percent of U.S. domestic 
employment in 1982 to 4.9 percent in 1986.
---------------------------------------------------------------------------
    The centrality of the sales expansion function of foreign 
affiliates suggests that the operations of U.S. parent firms and their 
foreign affiliates are mutually reinforcing rather than substitutes. 
Direct investment abroad frequently leads to additional exports of 
machinery and other inputs into the manufacturing process as well as 
additional demand at home for headquarters services such as research, 
engineering, finance, etc. The parent companies of U.S. multinationals 
purchase over 90 percent of their inputs from U.S.-based suppliers.\21\
---------------------------------------------------------------------------
    \21\ Mathew Slaughter. Global Investments, American Returns 
Emergency Committee for American Trade, 1998.

---------------------------------------------------------------------------
Exports

    U.S. multinational corporations play a crucial role in U.S. foreign 
trade. As affiliates establish production and distribution facilities 
abroad, export data indicate that they source a large quantity of 
inputs from the United States. U.S. multinationals were responsible for 
$407 billion of merchandise exports in 1996 representing almost two-
thirds of all U.S. merchandise exports.
    Academic studies support the hypothesis that U.S. investment abroad 
promotes U.S. exports. For example, Prof. Robert Lipsey finds a strong 
positive relationship between manufacturing activity of foreign 
affiliates of U.S. corporations and the level of exports from the U.S. 
parent company.\22\ Similarly, a recent OECD study of 14 countries 
found that ``each dollar of outward FDI [foreign direct investment] is 
associated with $2 of additional exports and with a bilateral trade 
surplus of $1.70.\23\ These studies support the conclusion that if U.S. 
investment abroad were curtailed, U.S. exports would suffer.
---------------------------------------------------------------------------
    \22\ Robert E. Lipsey, ``Outward Direct Investment and the U.S. 
Economy,'' in M. Feldstein, J. Hines, Jr., and G. Hubbard (eds.), The 
Effects of Taxation on Multinational Corporations, University of 
Chicago Press, 1995.
    \23\ See, OECD, Open Markets Matter: The Benefits of Trade and 
Investment Liberalization, 1998, p. 50.

---------------------------------------------------------------------------
Headquarters services

    In addition to their role in increasing demand for U.S. exports, 
foreign affiliates of U.S. corporations also increase the demand for 
U.S. headquarters services such as management, research and 
development, technical expertise, finance, and advertising. These 
support activities expand as U.S. affiliates compete successfully 
abroad. For example, in 1996, nonbank U.S. multinationals performed 88 
percent of their research and development in the United States, even 
though one-third of their sales were abroad./24/
---------------------------------------------------------------------------
    \24\ U.S. Department of Commerce, Survey of Current Busines, 
(September 1998).
---------------------------------------------------------------------------
    Headquarters functions, such as R&D, finance, and management, are 
the types of activities that are prospering in the information-oriented 
economy. As such, some economists have argued that U.S. tax policy 
should seek to make the United States an attractive location for 
multinational corporations to establish their headquarters.\25\ 
Unfortunately, because of subpart F and other aspects of U.S. 
international tax rules, the United States is one of the least 
attractive jurisdictions--from a tax perspective--for a multinational 
corporation's headquarters.\26\
---------------------------------------------------------------------------
    \25\ See Gary Hufbauer, U.S. Taxation of International Income: 
Blueprint for Reform, Institute for International Economics, 1992.
    \26\ See, Price Waterhouse LLP, Taxation of U.S. Corporations Doing 
Business Abroad: U.S. Rules and Competitiveness Issues, Financial 
Executives Research Foundation, 1996.

---------------------------------------------------------------------------
U.S. Investment Abroad and U.S. Employment

    Rather than draining jobs and production from the United States, 
the economic evidence points to the opposite conclusion--U.S. 
investment abroad increases activity at home. The complementary 
relationship between the foreign and domestic operations of U.S. 
multinational corporations means that U.S. workers need not be harmed 
by U.S. investment abroad.\27\ Profs. David Riker and National Economic 
Council Deputy Director Lael Brainard find that the labor demand of 
U.S. multinationals at home and abroad are linked, with an increase in 
one supporting an increase in the other:
---------------------------------------------------------------------------
    \27\ See, OECD, Open Markets Matter: The Benefits of Trade and 
Investment Liberalization, 1998, pp. 73-76.
---------------------------------------------------------------------------
    Labor demand of U.S. multinationals is linked internationally at 
the firm level, presumably through trade in intermediate and final 
goods, and this link results in complementarity rather than competition 
between employers in industrialized and developing countries.\28\
---------------------------------------------------------------------------
    \28\ David Riker and Lael Brainard, ``U.S. Multinationals and 
competition from Low Wage Countries,'' NBER Working Paper No. 5959, 
March 1997.
---------------------------------------------------------------------------
    The foreign operations of U.S. companies also are associated with 
higher wages of U.S. workers. U.S. companies that invest overseas, on 
average, pay higher domestic wages than do purely domestic companies in 
the same industries. Profs. Mark Doms and Bradford Jensen find that 
U.S. parent companies pay higher wages to their entire workforce, and 
that the wage premium in percentage terms is greater for lower paid 
production workers than for higher paid non-production workers.\29\ 
Prof. Slaughter interprets this as evidence that U.S. parent companies 
promote a more equal distribution of income by paying higher wage 
premia to traditionally lower paid workers.\30\
---------------------------------------------------------------------------
    \29\ Mark Doms and Bradford Jensen, ``Comparing Wages, Skills, and 
Productivity Between Domestic and Foreign Owned Manufacturing 
Establishments in the United States,'' mimeo., October 1996.
    \30\ Matthew J. Slaughter, `Production Transfer Within 
Multinational Enterprises and American Wages,'' mimeo., March 1998.
---------------------------------------------------------------------------
    Investment abroad by U.S. multinationals not only is essential to 
facilitating the distribution and servicing of U.S. exports, but 
failure of U.S. multinationals to invest abroad would create an 
opportunity for foreign-headquartered competitors to increase their 
investment in and exports to foreign markets.

Returns to U.S. Investors

    U.S. shareholders in U.S. multinationals directly realize the 
benefits of the high profits and risk diversification offered by 
international operations. The pre-tax return on assets earned by U.S.-
controlled foreign corporations was almost 30 percent higher than the 
return earned on domestic corporate investment in 1995.\31\ These 
foreign profits totaled $150 billion, and accounted for about 18 
percent of all U.S. corporate profits in 1997.\32\
---------------------------------------------------------------------------
    \31\ Earnings (excluding capital gains and special charges) before 
interest and taxes as a percent of assets, as calculated by the U.S. 
Dept. of Commerce.
    \32\ U.S. Dept. of Commerce, Survey of Current Business, (August 
1998).
---------------------------------------------------------------------------
    The profits earned abroad by U.S. multinationals are part of 
national income (GNP) and are reflected in the share valuations. 
Moreover, much of the income earned abroad by foreign subsidiaries is 
distributed back to the United States. According to the most recent 
available IRS data, in 1994, distributions from the largest U.S.-
controlled foreign corporations totaled $50 billion, amounting to 67 
percent of their after-tax earnings and profits.
    Academic research has found a large premium in the returns from 
foreign investment as compared to domestic investment. Prof. Martin 
Feldstein concludes that an additional dollar of foreign direct 
investment by U.S. corporations, in present value, leads to 70 percent 
more interest and dividend receipts and U.S. tax payments than an 
additional dollar of domestic investment.\33\
---------------------------------------------------------------------------
    \33\ Martin Feldstein, ``Tax Rules and the Effect of Foreign Direct 
Investment in U.S. National Income,'' in Taxing Multinational 
Corporations, eds. Martin Feldstein, James Hines, and Glenn Hubbard, 
1995.

---------------------------------------------------------------------------
Conclusion

    Fears that U.S. investment abroad comes at the expense of output, 
income, and employment at home are not supported by data or economic 
research. Rather, the evidence strongly confirms that market access, 
rather than cheap labor, primarily motivates foreign direct investment. 
The overwhelming majority of foreign direct investment is in high-wage 
countries, and very little of the foreign output of U.S. multinationals 
is shipped back to the United States. Numerous studies have found that 
foreign investment not only produces higher returns to U.S. investors 
but also is complementary with economic activity in the United States--
leading to increased exports and high-paid research, engineering, and 
other headquarters jobs in the United States. There is no evidence that 
U.S. investment abroad has reduced employment in the United States; 
indeed, the data show that companies with investment outside the United 
States pay better wages than purely domestic companies in the same 
industries.\34\
---------------------------------------------------------------------------
    \34\ For anecdotal evidence from case studies of U.S. 
multinationals, see Mathew Slaughter, Global Investments, American 
Returns, Emergency Committee for American Trade, 1998 (Chapter V).
---------------------------------------------------------------------------
    Restricting foreign investment in an attempt to protect domestic 
employment ultimately is a self-defeating policy. Foreign companies 
will seize these investment opportunities and increase market share at 
the expense of U.S. multinationals' employment at home and abroad.
    Like international trade in goods and services, foreign direct 
investment benefits both home and host countries; thus, it is in the 
mutual interest of home and host countries to reduce barriers to the 
free flow of direct investment. In view of the recent downturn that has 
struck a number of emerging market economies, it is important to 
distinguish foreign direct investment from international portfolio 
investment. Portfolio investment, such as investment in short-term 
government and private debt obligations, can easily be withdrawn at the 
first hint of an economic reversal. By contrast, foreign direct 
investment, particularly in plant and equipment, is long-term in 
nature, and cannot easily be removed. Barriers to U.S. direct 
investment abroad not only harm the development of foreign countries, 
but also deprive the U.S. economy of the increased returns, exports, 
and wages associated with multinational investment.
IV. Does the Competitiveness of U.S.-Headquartered Companies Matter for 
                       U.S. Economic Well-Being?
    In a provocative article, former Labor Secretary Robert 
Reich argues against multinational competitiveness as a goal 
for U.S. policy.\35\ In Reich's view, where corporations happen 
to be headquartered is ``fundamentally unimportant.'' Reich 
believes U.S. policymakers should focus primarily on domestic 
investments (whether by domestic or foreign companies) and less 
on the strength of American companies.
---------------------------------------------------------------------------
    \35\ Robert Reich, ``Who is Us?'' Harvard Business Review (January-
February 1990) pp. 53-64.
---------------------------------------------------------------------------
    In response, Prof. Laura Tyson, former Chair of the Council 
of Economic Advisers and former Director of the National 
Economic Council, argues that under current conditions, the 
``competitiveness of the U.S. economy remains tightly linked to 
the competitiveness of U.S. companies.'' Tyson offers a number 
of reasons for this linkage, including: \36\
---------------------------------------------------------------------------
    \36\ Laura D'Andrea Tyson, ``They are not Us: Why American 
Ownership Still Matters,'' The American Prospect, Winter, 1991.
---------------------------------------------------------------------------
     U.S. multinationals locate over 70 percent of 
their assets and employment in the United States;
     U.S. multinationals invest more per employee and 
pay more per employee at home than abroad in both developed and 
developing countries;
     U.S. multinationals perform the overwhelming 
majority of their R&D at home;
     The leadership of U.S. multinationals is 
overwhelmingly American;
     Trade barriers frequently require U.S. companies 
to invest abroad in order to sell abroad; and
     U.S. affiliates of foreign firms rely much more 
heavily on foreign suppliers than on domestic companies.
    Tyson believes that American interests will be advanced 
through multilateral reductions in trade and investment 
barriers, and through policies that make the U.S. an attractive 
production location for high-productivity, high-wage, and 
research-intensive activities.
V. How Does U.S. International Tax Policy Affect the Competitiveness of 
                     U.S. Multinational Companies?
    If policymakers wish to attract high-end jobs to the United 
States, they must consider whether the U.S. income tax system 
makes the United States a desirable location for establishing 
and maintaining a corporate headquarters. If the U.S. corporate 
income tax is not competitive, U.S. headquartered companies can 
be expected to lose world market share with a commensurate loss 
in the U.S. share of headquarter-type jobs. While the country 
of incorporation is not necessarily where headquarters 
functions are located, there is indisputably a very high 
correlation between legal residence and headquarters 
operations.
    A number of studies have found that, compared to other 
major industrial countries, the U.S. income tax system places a 
relatively high burden on cross-border corporate 
investment.\37\ The tax burden is relatively high for two main 
reasons: (1) the U.S. international tax regime, including 
subpart F, is more restrictive than that of most other 
countries; and (2) unlike most other major industrial 
countries, the United States does not relieve the double 
taxation of corporate dividends.
---------------------------------------------------------------------------
    \37\ For an international comparison U.S. multinational tax 
competitiveness, see: Price Waterhouse LLP, Taxation of U.S. 
corporations Doing Business Abroad: U.S. Rules and Competitiveness 
Issues, Financial Executives Research Foundation, 1996 (Chapter 10).
---------------------------------------------------------------------------
    Over time, countries that place relatively high tax burdens 
on multinational corporations can expect to see a reduction in 
investment in domestic headquartered companies. This can occur 
through a loss in market share and profits that can be 
reinvested in the business. Alternatively, domestic companies 
may merge with foreign corporations in transactions that result 
in a foreign-headquartered company. Recent U.S. examples 
include the BP-Amoco, Daimler-Chrysler, Vodafone-AirTouch, 
Deutsche Bank-Bankers Trust, and AEGON-Transamerica mergers. In 
these examples, future investments outside the United States 
will most likely not be made by the U.S. merger partner, but 
instead by the foreign parent, permanently removing such 
investment from the U.S. corporate income tax net.
    Foreign-headquartered companies also can grow at the 
expense of U.S.-headquartered companies, if U.S. investors buy 
shares of foreign companies on U.S. or foreign exchanges. The 
growth in U.S. mutual funds that invest in foreign stocks is an 
illustration of this trend, as are investments in foreign firms 
listed on U.S. stock exchanges.
    While some have advocated increasing U.S. tax on the 
foreign earnings of U.S. multinationals as a way to protect 
U.S. jobs, the most likely consequence of such action will be a 
loss in the global market share of U.S. headquartered 
companies. Rather than protecting U.S. jobs, imposing a tax 
system on U.S. multinationals that is more burdensome than that 
of their foreign competitors will hamper the growth of U.S. 
companies, ultimately reducing U.S. exports, research and 
development, and high-quality American jobs.

   Summary of Large U.S. Cross-Border Mergers and Acquisitions, 1998

Introduction

    in announcing the June 30, 1999 hearing of the Committee on 
Ways and Means regarding the impact of U.S. tax rules on the 
international competitiveness of U.S. workers and businesses, 
Chairman Archer posed the following questions:

        ``Is the U.S. tax system contribution to the de-Americanization 
        of U.S. industry? Do our tax laws force U.S. companies to be 
        domiciled in foreign countries? Are we making it a foregone 
        conclusion that mergers of U.S. companies with foreign 
        companies will always leave the resulting new company 
        headquartered overseas? '' \1\

    \1\ U.S. House of Representatives, Committee on Ways and Means, 
press release no. FC-12, June 15, 1999.
---------------------------------------------------------------------------
    As an initial step towards answering these questions, this 
report summarizes data on all large cross-border mergers and 
acquisitions involving U.S. companies that were completed in 
1998. Based on these data, one can determine whether U.S. 
companies are more often the acquirer or the target (i.e., the 
acquired company) in large cross-border mergers and 
acquisitions.

Methodology

    For purposes of this study, PricewaterhouseCooper LLP (PwC) 
reviewed all mergers and acquisitions completed during 1998 as 
reported by Mergers and Acquisitions, a journal that publishes 
detailed information on all public transactions. From this 
sample, we selected all transactions that met the following 
criteria:
    1. The terms of the transaction were in excess of $500 
million;
    2. The transaction involves the acquisition of all or a 
remaining interest in the target company;
    3. The transaction crosses country borders (i.e., acquirer 
and target are headquartered in different in different 
countries); and
    4. A U.S.--headquartered company is the acquirer or the 
target.
    Information regarding the selected transactions is 
summarized in Tables 1-4, including the name and country of 
incorporation of the acquirer and the target, the target's 
business, and the terms, type, and completion due of the 
transaction.

Results

    In 1998, there were a total of 51 cross-border mergers and 
acquisitions involving U.S companies with terms in excess of 
$500 million. The total dollar value of these transactions 
exceeded $175 billion.
    Foreign acquisitions of U.S. companies far exceeded U.S. 
acquisitions of foreign companies, both in terms of the number 
of transactions and the dollar value of these transactions. For 
cross-border mergers and acquisitions exceeding $500 million in 
1998:
     Foreign companies made 34 acquisitions of U.S. 
companies, while U.S. companies made 17 acquisitions of foreign 
companies. Thus, the number of transactions that had the effect 
of moving assets from U.S.-to foreign-headquartered firms 
exceeded transactions moving assets in the opposite direction 
by $127 billion, or 529 percent in dollar terms.
     Foreign acquisitions of U.S. companies totaled 
$151 billion, while U.S. acquisitions of foreign companies 
totaled $24 billion. Thus, the number of transactions that had 
the effect of moving assets from U.S.-to foreign-foreign-
headquartered firms exceeded transactions moving assets in the 
opposite direction by $127 billion, or 529 percent in dollar 
terms.
     Foreign acquisitions of U.S. companies were 
dominated, in dollar terms, by two mega-mergers--the 
acquisition of Amoco Corp. by British Petroleum Co. PLC and the 
acquisition of Chrysler Corp. by Daimler-Benz AG. These two 
deals together represent the sale of U.S. companies valued at 
$89 billion to foreign acquirers. However, even excluding these 
two mega-mergers, transactions which had the effect of moving 
assets from U.S.-to foreign-headquartered firms exceeded 
transactions moving assets in the opposite direction by $38 
billion, or 58 percent in dollar terms.
     Transactions involving acquisitions of financial 
services companies accounted for 15 of the 51 ross-border 
deals, or 29 percent. Foreign acquisions of U.S. financial 
services companies (12 transactions totaling $11.3 billion) 
exceeded U.S. acquisitions of foreign financial services 
companies (3 transactions totaling $3.6 billion) by 300 percent 
in number, or by 214 percent in dollar terms. It should be 
noted that some of the other U.s. target companies have large 
financial services subsidiaries (e.g., Chrysler Corp.), 
although these are not included in the statistics on financial 
service mergers and acquisitions.

Conclusions

    the structuring of cross-border acquisitions reflects a 
variety of business reasons including domestic and foreign tax 
considerations. The role of tax considerations in recent 
across-border mergers and acquisitions is beyond the scope of 
this study.
    To the extent that U.S. multinational companies are subject 
to more burdensome international tax rules than their foreign-
headquarter multinationals. In particular, one would expect to 
see this result for target companies in industries where the 
disparity between U.S. and foreign tax rules is large, such as 
financial services. The data in this study show that, as a 
result of cross-border mergers and acquisitions, assets are, on 
balance moving from U.S.-to foreign-headquartered companies, 
and this trend is pronounced in the financial services industry 
(measured by the number of transactions).
    While the recent cross-border merger and acquisition data 
are consistent with the hypothesis that relatively burdensome 
U.S. tax rules are influencing the movement of assets to 
foreign-headquartered companies, they cannot be taken as proof 
of this hypothesis. More research will be necessary to measure 
the role, if any, of tax considerations.
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    Chairman Archer. Thank you, Mr. Merrill.
    Our last witness on this panel is Mr. Bouma. Welcome, you 
may proceed.

STATEMENT OF HERMANN B. BOUMA, INTERNATIONAL TAX ATTORNEY, H.B. 
                             BOUMA

    Mr. Bouma. Thank you. Thank you very much, Mr. Chairman. My 
name is Herm Bouma and I am an international tax attorney 
engaged in private practice in Washington, D.C. I appreciate 
very much the opportunity to appear before the Committee this 
morning, almost afternoon now. And I commend the Committee for 
focusing its time and energy on the international provisions of 
the Code.
    In my testimony, I would like to take a look at the forest, 
rather than the trees, and focus on the basic foundations of 
our international tax rules. I believe those foundations are 
not tied into reality and that this accounts for much of the 
arbitrariness and complexity of the current system.
    Specifically, I would like to focus on three fundamental 
issues: taxation of business entities in general, the taxation 
of U.S. versus foreign corporations, and the rules for sourcing 
income.
    With respect to the taxation of business entities, under 
the current Code, business entities are divided into two basic 
types: corporations and partnerships. As used here, the term 
partnership also includes a sole proprietorship. Radically 
different tax rules apply to corporations and to partnerships. 
Certain business entities are treated as per se corporations, 
while other business entities are permitted to choose whether 
they wish to be treated as a corporation or as a partnership. 
There is no logical reason why per se corporations are treated 
as such.
    Certainly, this treatment cannot be justified on the 
grounds that they provide limited liability to their interest 
holders or that they are so-called separate entities. Many 
business entities that are entitled to choose their 
classification also have these same characteristics. When it 
comes to the taxation of business entities, all business 
entities should be subject to only one layer of taxation and 
they should be taxed on a territorial basis.
    Assuming the Code continues to classify business entities 
as either corporations or partnerships, the next fundamental 
issue I would like to address is whether there should be any 
difference between the taxation of U.S. corporations on the one 
hand and foreign corporations on the other.
    Under present law, a corporation is considered a U.S. 
corporation, simply by being organized under the laws of the 
United States or some political subdivision thereof, such as 
Delaware. I would like to emphasize whether the company has its 
headquarters in the United States or does any business here is 
completely irrelevant to whether or not it is a U.S. 
corporation for purposes of the Internal Revenue Code.
    Incorporation in the United States does not in any way 
justify taxing a corporation on a worldwide basis. Thus, the 
United States should adopt a territorial system for 
corporations. Every corporation, whether U.S. or foreign, 
should be taxed by the United States only on its income from 
operations in the United States.
    The third fundamental issue I would like to address 
involves the rules for sourcing income as either U.S.-source or 
foreign-source income. The current Code and regulations have 
come up with a complex, arbitrary, and arcane set of rules for 
sourcing all kinds of income. Replacing these rules with an 
approach focused on permanent establishments would be a major 
step toward rationalizing and simplifying the international 
provisions.
    Under this approach, the 30 percent gross basis tax would 
apply to certain payments made by U.S. permanent establishments 
and the foreign tax credit limitation, assuming such was still 
necessary, would focus on income that is effectively connected 
with a taxpayer's foreign permanent establishment or that is 
received by the taxpayer from someone's foreign permanent 
establishment. Thus, the arbitrary and complex sourcing rules 
of the current Code could be replaced with a much more logical 
and clear-cut approach.
    Because of the arbitrariness and complexity of the current 
international provisions, it is critical that they be revised 
from the ground up so that they are tied into reality, 
rationalized and simplified, thereby eliminating the major 
burden they currently impose on the international 
competitiveness of U.S. corporations.
    Thank you, Mr. Chairman, and I would be happy to answer any 
questions the Committee might have.
    [The prepared statement follows:]

Statement of Hermann B. Bouma, International Tax Attorney, H.B. Bauma

    Mr. Chairman and distinguished Members of the Committee on 
Ways and Means:
    My name is Herm Bouma and I appreciate very much the 
opportunity to appear before the Committee this morning to 
speak on the international provisions of the Internal Revenue 
Code. I commend the Committee for focusing its time and energy 
on this very important topic. I appear before the Committee on 
my own behalf and not on behalf of any client.
    I have been an international tax attorney now for almost 20 
years, ever since I graduated from law school. Upon graduating 
from law school, I went to work with the Office of Chief 
Counsel at the Internal Revenue Service, where I worked in the 
International Branch of the Legislation and Regulations 
Division. My principal project there involved the final foreign 
tax credit regulations under sections 901 and 903. After 
fulfilling my four-year commitment there, I went into private 
practice with the Washington tax firm known as McClure & 
Trotter. I was a partner there for eight years and then left to 
establish my own practice, continuing to focus on international 
taxation. The rationalization and simplification of the 
international tax provisions is a subject I have thought about 
for a long time now.
                Reality and the International Provisions
    We international tax practitioners have a tendency to get 
bogged down among the trees (of which there are many) and 
seldom step back to view the forest as a whole. In my testimony 
I would like to look at the forest and focus on the basic 
foundational principles on which our international tax regime 
should be constructed.
    Judge Learned Hand once wrote:

          . . . In my own case the words of such an act as the Income 
        Tax . . . merely dance before my eyes in a meaningless 
        procession . . . couched in abstract terms that offer no handle 
        to seize hold of . . . [A]t times I cannot help recalling a 
        saying of William James about certain passages of Hegel: that 
        they were no doubt written with a passion of rationality; but 
        that one cannot help wondering whether to the reader they have 
        significance save that the words are strung together with 
        syntactical correctness.

Learned Hand, Thomas Walter Swan, 57 Yale L.J. 167, 169 (1947). 
Why is it that people find the Code so hard to understand? 
There are a number of reasons but one explanation is that often 
it is not tied in to reality. I believe this is the case with 
the international provisions of the Code.
    There is a huge gap between reality and those provisions. 
If the international provisions can be based on certain 
fundamental principles that are grounded in reality and that 
make sense conceptually, then the provisions will be far less 
arbitrary and far less complex. They will be easier to learn, 
both for practitioners and the IRS, and easier to apply. Even 
where a certain amount of complexity is still required, the 
complexity will be based on sound fundamental principles, and 
thus much easier to understand. Moreover, if the international 
provisions are tied in to reality and make sense, then, when 
one encounters a situation that is not directly addressed by 
the provisions, it will be much easier to determine what the 
answer should be.
    When the foundation of a structure is wealc and rickety, 
adding more to the top will not strengthen it; it will simply 
add more weight so that eventually the whole structure may 
collapse of its own weight. That is the point we are reaching 
now with the international provisions of the Code, where the 
structure has become so huge and so heavy, and yet the 
foundation is extremely weak and rickety. The whole thing is in 
danger of collapsing, collapsing in the sense that it is moving 
beyond the capacity of the IRS to administer and enforce it.
                   ``A Brief Description of Reality''
    In order to tie the international provisions in to reality, 
we first need to have a clear view of reality. Describing 
reality in somewhat broad-brush strokes, reality consists of 
God, people, and the world (which includes such things as rocks 
and trees and squirrels). People have rights and obligations, 
including financial rights and obligations, which are often 
referred to as assets and liabilities. People can hold assets 
and liabilities directly or through arrangements. Some 
arrangements for assets and liabilities are intended to 
generate income. An income-generating arrangement normally 
consists of a set of rules which governs the management of the 
assets and liabilities and the distribution of assets either to 
persons who hold interests in the arrangement or to others. 
Income-generating arrangements are of three basic types: 
business entities, trusts, and non-profit organizations.
    In focusing on the basic foundational principles on which 
our international tax regime should be constructed, I would 
like to consider three ``big-ticket'' items: the taxation of 
business entities, the taxation of U.S. versus foreign 
corporations, and the rules for sourcing income as either U.S.-
source or foreign-source.
                     Taxation of Business Entities
    Obviously, the taxation of business entities is not an 
issue that is limited to the international area. However, it 
does have major ramifications for the international area and 
thus is a foundational issue for an international tax regime.
    Worldwide there is a great variety of business entities--
they come in all different shapes and sizes. However, they have 
one thing in common--they are attempting to generate income for 
their interest holders. Under the current Code, this great 
variety of business entities is divided into two basic types, 
corporations and partnerships (including, for this purpose, 
sole proprietorships), and radically different tax regimes 
apply to each. With respect to corporations, there are two 
layers of taxation; with respect to partnerships, only one.
    Under current IRS regulations, certain business entities, 
including certain foreign business entities, are treated as per 
se corporations. All other business entities are permitted to 
choose whether they wish to be treated as a corporation or as a 
partnership for U.S. tax purposes. There is no logical reason 
why certain business entities are treated as per se 
corporations, and thus subject to an additional layer of tax.
    It is sometimes said that it is appropriate to treat 
certain corporations as per se corporations because they 
provide limited liability to their interest holders. However, 
what logical connection is there between the two? Why should 
two layers of tax apply just because the entity provides 
limited liability to its interest holders? When an interest 
holder receives a distribution of profits from an entity, the 
interest holder benefits to the same extent, whether or not it 
has limited liability. Moreover, many business entities that 
are entitled to choose whether to be treated as a corporation 
or a partnership do provide limited liability to their interest 
holders. Thus, there is nothing in the nature of limited 
liability that requires an additional layer of tax.
    An extra layer of tax is sometimes justified for per se 
corporations on the grounds that they are ``separate 
entities.'' However, the concept of ``separate entity'' is 
never defined and in fact there does not appear to be any 
definition that would apply only to per se corporations and not 
to other types of business entities also. Certainly, under 
typical business law concepts, a traditional partnership under 
state law, which may be treated as a partnership for U.S. tax 
purposes, is as much a ``separate entity'' as is a corporation 
under state law that is treated as a per se corporation for 
U.S. tax purposes. Such a partnership can sue and be sued, it 
can operate under its own name, and it can hold property in its 
own name, including real estate. Thus, it would appear to be as 
much of a ``separate entity'' as is a per se corporation. There 
is, therefore, absolutely no justification for taxing certain 
business entities as per se corporations, while permitting 
other business entities to choose how they are taxed. Until 
this can be remedied, we have a Code that at its very 
foundation makes no sense.
    Except as noted below with respect to publicly-traded 
business entities, all business entities should be taxed in the 
same way. Ideally, there should be only one layer of tax and it 
should be imposed on the business entity on a territorial 
basis. Requiring the business entity to pay the tax (rather 
than the interest holders as is currently the case under the 
Code with respect to the taxation of partnership income) would 
promote efficiency and reduce the reporting burden on the 
interest holders. If an interest holder sold its interest in 
the business entity, the business entity would be responsible 
for paying the tax on the gain (which would be withheld from 
the proceeds due to the interest holder), and adjustments to 
the entity's asset bases would be made in a manner similar to 
that provided in section 743 of the current Code. If the 
business entity were publicly-traded and an interest holder 
with a less than 10% interest sold its interest, then the 
interest holder would pay tax on the gain and there would be no 
adjustment to the asset bases of the business entity.
    Suppose, for example, a business entity (such as a large 
law firrn) has 1,000 interest holders and conducts business in 
five countries. Under the current Code, if one of those 
countries is the United States and the business entity is 
treated as a partnership for U.S. tax purposes, then each of 
the 1,000 interest holders is required to file a U.S. tax 
return because the business entity is engaged in the conduct of 
a trade or business in the United States. However, the tax 
obligation should be imposed on the business entity, not the 
interest holders. Thus, instead of 5,000 returns being required 
(assuming the other four countries also required a return from 
each interest holder), only five returns would be necessary 
(assuming all five countries adopted the approach of imposing 
the tax obligation on the business entity).
    An alternative approach would be to treat all non-publicly-
traded business entities as partnerships are treated under the 
current Code. Thus, there would be only one layer of tax but 
the income would be taxed through to the interest holders. If a 
business entity were publicly-traded, it would be taxed as 
discussed above under the ideal approach. Thus, there would be 
only one layer of tax, but it would be imposed on the business 
entity (except in the case of gain on the sale of an interest 
by a less than 10% interest holder).
    Thus, when it comes to the taxation of business entities, 
the only distinguishing characteristic should be whether or not 
they are publicly-traded, not whether or not they provide 
limited liability or are ``separate entities''.
               Taxation of U.S. vs. Foreign Corporations
    If the Code continues to characterize business entities as 
either corporations or partnerships and continues to subject 
them to different tax regimes, the next ``big-ticket'' item is 
whether there should be any difference between the taxation of 
U. S. corporations as opposed to foreign corporations. Under 
present law, a U.S. corporation is taxed by the United States 
on its worldwide income, whereas a foreign corporation is taxed 
by the United States only on certain U.S.-source income and on 
income that is effectively connected with the conduct of a 
trade or business in the United States.
    It is important to understand what makes a corporation a 
U.S. corporation or a foreign corporation for this purpose. 
What makes the difference is a simple piece of paper, a paper 
indicating whether the corporation has been organized under the 
laws of the United States or a political subdivision thereof, 
such as Delaware, or under the laws of a foreign jurisdiction, 
such as the Cayman Islands. The location of the corporation's 
headquarters, of most of its business operations, of most of 
its property, where it first started business, and the 
residency of most of its shareholders are all completely 
irrelevant for this purpose. What matters is a simple piece of 
paper. Thus, a corporation can be a U.S. corporation even if it 
has no operations or property in the United States, and no 
shareholders that are residents of the United States. 
Similarly, a corporation can be a foreign corporation even if 
it:s headquarters and most of its operations and property are 
in the United States, and all of its shareholders are residents 
of the United States.
    Incorporation in the United States does not provide any 
benefits that justify taxing a U.S. corporation on a worldwide 
basis. In fact, given the many rules and regulations that apply 
to U.S. corporations outside the tax area, one could argue that 
incorporation in the United States is actually a detriment, 
particularly when there are many other locations in the world 
that have favorable corporate laws. Thus, incorporation in the 
United States does not in any way justify taxing a corporation 
on a worldwide basis. A corporation primarily benefits from the 
countries in which it earns income, not from the country in 
which it happens to be incorporated.
    On March 11, 1999, Mr. Robert Perlman, Vice President for 
Tax, Licensing & Customs for Intel Corporation, testified 
before the Senate linance Committee concerning the 
international provisions of the Code. Mr. Perlman stated that 
if Intel had it to do all over again, it would incorporate as a 
foreign corporation, not as a U.S. corporation. Some members 
ofthe Committee took offense at this statement and considered 
it unpatriotic. In addition, they pointed out all of the 
benefits of doing business in the United States, including an 
educated labor force, little regulation, and a stable 
government, and they expressed skepticism that a company would 
move its operations offshore in order to secure better tax 
benefits. However, this reaction to Mr. Perlman's statement 
reflected a basic misunderstanding of what it means, under the 
Code, to be a U.S. corporation or a foreign corporation.
    Mr. Perlman said that if Intel had it to do all over again, 
it would incorporate in the Cayman Islands rather than the 
United States. All that this would mean is that Intel would 
have a piece of paper saying it was incorporated under the laws 
of the Cayman Islands. Everything else about Intel's 
operations, including its U.S. operations, would be exactly the 
same. Intel would still have its headquarters in the United 
States, and it would have just as many factories in the United 
States, just as much research in the United States, and just as 
many salesmen in the United States. The only difference is that 
Intel would have a piece of paper saying it was incorporated in 
the Cayman Islands and this would make all the diSerence in the 
world taxwise. It would not be subject to the infamous Subpart 
F regime, and in fact all of its income from foreign operations 
would be completely free of U.S. tax.
    Start-up companies are now being wisely advised to 
incorporate in a foreign jurisdiction in order to avoid the 
onerous rules of the U.S. tax regime, including worldwide 
taxation and Subpart F. However, many companies which 
incorporated as U. S. corporations many years ago are stuck 
with the onerous U.S. tax regime because the ``toll charge'' 
under section 367(a) precludes a foreign reincorporation. It is 
simply unfair for a corporation to now suffer inordinately 
under the U.S. tax regime just because it made the unfortunate 
decision, 50 or 100 years ago, to be incorporated in the United 
States.
    In a recent article, Professor Reuven S. Avi-Yonah, an 
assistant professor at Harvard Law School, stated that ``it 
does not seem to make sense to rely so much on formalities such 
as which country an entity is incorporated in.'' Reuven S. Avi-
Yonah, Tax Competition and Multinational Competitiveness: The 
New Balance of Subpart F, Tax Notes International, April 19, 
1999, p. 1575, fn 45. Although Professor Avi-Yonah made this 
statement in reference to controlled foreign corporations, it 
certainly applies to the taxation of U.S. corporations also. It 
is ironic that, while the IRS struggles to tax transactions 
based on their substance and not their forrn, in this major way 
the Code elevates form over substance.
    It is extremely important, therefore, that all corporations 
be treated the same, whether they are incorporated in the 
United States or outside the United States. This means that the 
United States should adopt a territorial system with respect to 
the taxation of corporations; every corporation, whether U.S. 
or foreign, should be taxed only on its income from operations 
in the United States.
                           The Sourcing Rules
    The third ``big-ticket'' item that I would like to address 
involves the sourcing rules. The current Code operates on the 
assumption that every item of income is either U.S.-source or 
foreign-source. The use of the term ``source'' is misleading 
because it gives the impression that there is a quarry of 
income in each country and one simply determines whether an 
item of income came from a quarry in the United States or from 
a quarry in a foreign country. However, the matter is not that 
simple. Income, which is an increase in value, is not a 
physical object, and thus, by its very nature, does not have a 
geographical location. Therefore, one cannot source income 
simply by determining the geographical location from which it 
came.
    Given this conundrum, the Code and regulations have come up 
with a complex, arbitrary, and arcane set of rules for sourcing 
all kinds of income. Depending on the type of income that is 
involved, these rules look at such factors as the residence, 
citizenship, place of incorporation, or place of business of 
the payor, the residence, citizenship, place of incorporation, 
or place of business of the payee, and the place where services 
were performed, where negotiations took place, where property 
was at the time title to the property passed, where property is 
used, where property is manufactured using certain 
manufacturing intangibles, and where property is marketed using 
certain marketing intangibles.
    Supposedly, the intent of these rules is to identify the 
country whose economy is most closely connected with the 
particular item of income. However, in fact the result has been 
a hodge-podge of extremely arbitrary rules that in many cases 
make no sense. For example, income from the performance of 
services is sourced to the country where the services were 
performed. Thus, if I hire Tom Clancy to write a novel and he 
spends three weeks on a beach in France writing it, the amount 
I pay him will be foreign-source income, even though it is 
extremely difficult to see how this income might have its 
``source'' in France.
    Given the arbitrariness and complexity of these rules, one 
is led to ask the question, are these rules really necessary? 
In fact they are not, and eliminating them would be a major 
step towards rationalizing and simplifying the international 
provisions of the Code.
    Under the Code, the sourcing rules are generally used for 
three purposes: (1) to deterrnine the effectively-connected 
income of a foreign person that is engaged in the conduct of a 
trade or business in the United States; (2) to determine the 
income of a foreign person that is subject to a U.S. tax of 30% 
on a gross basis (certain ``U.S.-source'' income that is not 
effectively connected with the conduct of a trade or business 
in the United States); and (3) to detertnine ``foreign-source'' 
income for purposes of the limitation on the foreign tax credit 
for U. S. persons.
    With respect to the determination of the effectively-
connected income of a foreign person, such income can be 
determined by focusing direcl.ly on the business activities 
being carried on in the United States and by determining what 
income those activities give rise to. Although this 
determination would not always be easy, the approach would be 
much more direct and much easier to understand. There certainly 
is no need to first ``source'' income before determining 
whether a particular business activity has given rise to it.
    With respect to the determination of the income of a 
foreign person that is subject to a U.S. tax of 30% on a gross 
basis, the sourcing rules are not needed for this purpose 
either. Such income could be defined as income paid by a 
perrnanent establishment in the United States to a foreign 
person, provided the income is not effectively connected with 
the conduct of a trade or business by the foreign person in the 
United States. This approach would also be more direct and 
easier to understand.
    With respect to the deterrnination of the foreign tax 
credit limitation for U.S persons, clearly the sourcing rules 
would not be necessary if no foreign tax credit were given. 
Such would be the case with respect to business entities if the 
United States taxed every business entity, whether U.S. or 
foreign, only on the portion of its worldwide income that is 
allocable to a permanent establishment (or establishments) that 
the business entity has in the United States. Since income that 
is allocable to foreign permanent establishments would not be 
taxed by the United States, there would be no need to provide a 
foreign tax credit. If the United States had a 30% gross basis 
tax for payments made by U.S. permanent establishments to 
foreign persons, then the United States would need to allow a 
foreign tax credit with respect to payments received by a U.S. 
permanent establishment from a foreign permanent establishment 
(since, in the eyes of the United States, those payments could 
rightfully be subject to a gross basis tax by the country of 
the foreign permanent establishment).
    Even if the United States did not adopt a territorial 
system, it still would not be necessary to retain the current 
sourcing rules in order to determine the foreign tax credit 
limitation of a U.S. person. The limitation could be determined 
by adding together all the income of a U.S. person that is 
allocable to foreign permanent establishments of the U.S. 
person or that is received by the U.S. person from foreign 
permanent establishments (whether or not belonging to the U.S. 
person). This approach would not only be easier to apply but 
would also make sense conceptually because the foreign tax 
credit limitation would be based on the income of a U.S. person 
that foreign countries would tax if they applied the rules of 
the United States for taxing foreign persons. Under the current 
Code, there is often a disconnect between the amount of a U.S. 
person's foreign-source income for purposes of the foreign tax 
credit limitation and the amount of income foreign countries 
would tax if they applied to the U.S. person the rules applied 
by the United States to foreign persons.
    Thus, the arbitrary and complex sourcing rules of the 
current Code could be replaced with much more clear-cut, 
logical approach.
                               Conclusion
    There is a fundamental disconnect between reality and the 
international provisions of the current Code, and this 
disconnect accounts for the arbitrariness and complexity of 
those provisions. Because ofthis arbitrariness and complexity, 
U.S. corporations are subject to both a much higher tax burden 
and a much higher compliance burden than are many of their 
foreign competitors. It is critical that the international 
provisions be revised from the ground up, so that they are tied 
in to reality, rationalized, and simplified, thereby 
eliminating the current burden on the international 
competitiveness of U.S. corporations.

                                


    Chairman Archer. Thank you, Mr. Bouma.
    Does any member wish to inquire of this panel?
    [No response.]
    If not, we appreciate your testimony, and we thank you for 
the opportunity to consider it as we move ahead in developing 
this tax package.
    The Committee will stand in recess until one o'clock so 
everybody can get some lunch, and then we will hear from our 
last panel.
    [Whereupon, the Committee recessed to reconvene at 1 p.m., 
the same day.]
    Chairman Archer. The Chair apologizes to our next panel of 
witnesses for keeping you waiting for an extra 20 minutes. We 
will be pleased to receive your testimony. Mr. Conway, if you 
would lead off, please, sir.

   STATEMENT OF KEVIN CONWAY, VICE PRESIDENT, TAXES, UNITED 
   TECHNOLOGIES CORPORATION, HARTFORD, CONNECTICUT, AND VICE 
  CHAIRMAN, SUBCOMMITTEE ON INTERNATIONAL TAXATION, NATIONAL 
                  ASSOCIATION OF MANUFACTURERS

    Mr. Conway. Thank you, Mr. Chairman. Members of the 
Committee, my name is Kevin Conway. I am the vice president of 
taxes at United Technologies Corp. I am here today on behalf of 
the National Association of Manufacturers.
    NAM is the oldest and largest multi-industry trade 
association in the U.S. NAM's 14,000 members include 10,000 
small and medium-sized companies and over 300 member 
associations who represent manufacturers in every State. NAM 
has long advocated international tax simplification to improve 
the international competitiveness of U.S. companies. NAM 
strongly supports the provisions of H.R. 2018.
    I will focus my testimony on four areas of particular 
concern. At United Technologies, the Otis Elevator Co. competes 
in the global marketplace in the elevator service industry. 
There are approximately 6 million elevators in the world that 
are available to service. Over 5 million of those are located 
outside the United States. So what this means is that 80 
percent of that market is outside the United States.
    In order for us to compete in that marketplace, we often 
have to operate through corporate joint ventures. In order to 
penetrate markets or expand in existing markets, we are 
required to have partners and joint ventures. Very often, our 
partners will want to retain at least a 50 percent ownership in 
that venture. The result is that we often find ourselves in the 
10/50 basket. What that means is that if the local income tax 
rate is greater than the 35 percent U.S. rate, if we have 
dividends from that 10/50 company, we will have excess credits 
that we will never use.
    In the same year, we have 10/50 company operations in 
countries where the local rate is below the 35-percent rate. In 
that case, when we take dividends back, we have excess 
limitation that we will never use. Clearly, we think the 10/50 
rule results in us being non-competitive and it is time that it 
be repealed. The 1997 Act recognized that and it repealed the 
10/50 basket. Unfortunately, there was a complex transition 
rule which delayed the effective date of the repeal. And NAM 
urges that the effective date be accelerated to the current 
time.
    The second area I want to talk about is the provision which 
applies in the case of a taxpayer who is subject to the AMT, 
the alternative minimum tax regime. That provision essentially 
says that if you have foreign tax credits, you are subject to a 
90 percent limitation. You can use the foreign tax credits, but 
you can only reduce your liability up to 90 percent. We don't 
believe that the AMT tax regime makes any sense. We think it 
makes even less sense to have this 90 percent limitation. So we 
urge that the rules be changed and that AMT taxpayers, just 
like regular taxpayers, be permitted to use their foreign tax 
credits to offset their tax liability.
    The third area I would like to talk about is exports. 
Exports are critical to the growth of U.S. jobs, U.S. 
companies, and the U.S. economy. In 1998, United Technologies 
had export sales of more than $4 billion. Those were products 
that were manufactured in the United States and sold abroad. We 
have two important provisions in the Internal Revenue Code 
dealing with exports. The first provision is the foreign sales 
corporation provision. We also have the export source rule 
under section 863. They are both important export incentives 
and should be maintained.
    However, the FSC rules have a provision which essentially 
provides that the FSC benefit is reduced by 50 percent in the 
case of export sales of military or Defense products. This 
provision was enacted back in 1976 on the theory that military 
products weren't subject to competition. We know that is not 
the case today. The competition from Europe is stiff on these 
types of products and there is no reason why military products 
should be treated differently than commercial products. So that 
limitation should be repealed.
    Finally, I would like to urge the Committee and Congress to 
act on the legislation which would continue to ensure the 
confidentiality of financial information which is submitted or 
generated as part of an advance pricing agreement. The APA 
program, I think, is one example we can all point to of a 
program that has really worked well for the IRS, for taxpayers, 
and foreign countries. It has enabled us to resolve 
intercompany pricing issues to avoid audits and tax 
controversies. And the issue we have before us is if this 
information is not treated as confidential and it becomes 
disclosed, there will be a significant chilling effect on the 
use of the APA program, and we don't think that that is 
appropriate.
    I would like to thank the chairman and the Committee for 
the progress that you have made in the international tax area 
and urge that H.R. 2018 be adopted. Thank you.
    [The prepared statement follows:]

Statement of Kevin Conway, Vice President, Taxes, United Technologies 
Corporation, Hartford, Connecticut, and Vice Chairman, Subcommittee on 
International Taxation, National Association of Manufacturers

                            I. Introduction
    Chairman Archer, members of the committee, my name is Kevin 
Conway. I am the vice president of taxes for United 
Technologies Corporation. I thank you for this opportunity to 
testify on behalf of the National Association of Manufacturers 
(NAM). The National Association of Manufacturers--``18 million 
people who make things in America''--is the nation's largest 
and oldest multi-industry trade association. The NAM represents 
14,000 members (including 10,000 small and mid-sized companies) 
and 350 member associations serving manufacturers and employees 
in every industrial sector and all 50 states. Headquartered in 
Washington, D.C., the NAM has 11 additional offices across the 
country.
    The NAM has long advocated international tax 
simplification, which would greatly improve the international 
competitiveness of U.S. manufacturers and the U.S. economy 
overall. There are many opportunities to improve the 
international provisions of the Internal Revenue Code (IRC), 
and the NAM strongly supports H.R. 2018, the ``International 
Tax Simplification for American Competitiveness Act of 1999,'' 
by Representatives Houghton (R-31st NY) and Levin (D-12th MI). 
However, due to time constraints and more extensive coverage of 
several important issues by other members of this panel, I will 
confine my remarks to four particular areas of concern: (1) 
look-through for 10/50 companies; (2) the 90 percent limitation 
on foreign tax credits applicable to companies in AMT status; 
(3) advance pricing agreement (APA) disclosure; and (4) the 50 
percent limitation on foreign sales corporation (FSC) benefits 
applicable to defense exports.
                  II. Look-Through for 10/50 Companies
    Until 1997, a separate foreign tax credit (FTC) limitation 
(i.e., a separate ``basket'') computation was required for 
dividends received from each ``noncontrolled Section 902 
corporation.'' A ``noncontrolled Section 902 corporation'' is a 
foreign corporation that satisfies the stock ownership 
requirements of IRC section 902(a), yet is not a controlled 
foreign corporation (CFC) under IRC section 957(a). More simply 
stated, these are companies in which U.S. shareholders own at 
least 10, but no more than 50, percent of the foreign 
corporation, hence the name ``10/50 company.''
    This rule imposed a tremendous compliance burden on 
multinationals by requiring extensive, separate bookkeeping. 
Additionally, it severely constrained the ability of U.S.-based 
multinationals to use their FTCs in the most efficient manner 
to alleviate double taxation. Only foreign taxes directly 
associated with a 10/50 company's dividends could be credited 
against the U.S. tax on that 10/50 company's income, i.e., 
excess FTCs from other sources could not offset FTC shortfalls 
of 10/50 companies, and excess FTCs generated by 10/50 
companies could not offset shortages incurred by other 
companies, even other 10/50 companies. This is a deviation from 
the general rules, which allow ``look-through'' treatment, as 
in the case of CFC dividends. Furthermore, there is no tax 
accounting or policy reason for differentiating between income 
earned by noncontrolled corporations versus CFCs.
    Look-through rules allow dividend income to be re-
characterized in accordance with the underlying sources of the 
payor corporation's income. Thus, dividends associated with 
overall limitation income would be eligible for inclusion in 
the overall limitation income basket. Under the rules in place 
before 1998, however, taxpayers were not allowed to ``look-
through'' dividends received from 10/50 companies, even though 
10/50 company dividends are generally derived from overall 
limitation income and would otherwise be eligible for inclusion 
in the overall limitation income basket under the look-through 
rules.
    The 1997 Tax Relief Act corrected this inequity by 
eliminating separate baskets for 10/50 companies. Instead, 10/
50 companies are treated just like CFCs, and taxpayers can 
utilize look-through rules for re-characterizing dividend 
income in accordance with the underlying sources of the payor 
corporation's income. The 1997 act, however, did not make the 
change effective for such dividends unless they were received 
after the year 2003 and, even then, required two sets of rules 
to apply for dividends from earnings and profits (E&P) 
generated before the year 2003, and dividends from E&P 
accumulated after the year 2002.
    The ongoing requirement to use two sets of rules on 
dividends before the year 2003 has been a concern of taxpayers, 
members of Congress, and the Administration. Thus, to address 
the complexity created by this much-delayed effective date, the 
Administration has, as part of both its FY1999 and FY2000 
budget proposals, recommended accelerating the effective date 
of the 1997 Tax Act change. The proposal would apply the look-
through rules to all dividends received in tax years after 
1998, no matter when the E&P constituting the makeup of the 
dividend was accumulated.
    This change would result in a tremendous reduction in 
complexity and compliance burdens for U.S. multinationals doing 
business overseas through foreign joint ventures. It would also 
reduce the competitive bias against U.S. participation in such 
ventures by placing U.S. companies on a much more level playing 
field from a corporate tax standpoint. Finally, this proposal 
epitomizes the favored policy goal of simplicity in the tax 
laws and will go a long way toward helping the U.S. economy by 
strengthening the competitive position of U.S.-based 
multinationals.
          III. Foreign Tax Credit Limitations on AMT Companies
    A multinational corporation with a U.S. parent and foreign 
subsidiaries can be double taxed on income earned by its 
foreign subsidiaries when the income is repatriated to the U.S. 
parent as a dividend. The U.S. government, recognizing that 
these multiple levels of tax hurt the competitiveness of U.S. 
corporations, alleviates this multiple tax burden by allowing 
the U.S. company foreign tax credits (FTCs) for the income 
taxes paid to foreign governments. These credits are allowed 
for taxes paid by subsidiaries on dividends which are 
distributed to the U.S. parent. Foreign tax credits are dollar-
for-dollar credits that offset U.S. tax liability. However, the 
number of these credits that can actually be used to offset the 
U.S. parent tax liability is determined by whether the parent 
corporation has regular tax liability or alternative minimum 
tax (AMT) liability.
    Under a regular tax computation, the U.S. parent company 
can use foreign tax credits to offset 100 percent of its U.S. 
tax liability on the dividends it receives from the foreign 
subsidiary. However, a similar company in AMT status would not 
be permitted to alleviate all of its double taxation. The 
resulting multiple taxation occurs because of a provision added 
to the tax code as part of the Tax Reform Act of 1986, 
providing that only 90 percent of the amount of AMT liability 
can be offset by foreign tax credits.
    The intent of this limitation was to ensure that a U.S. 
corporation that earned U.S.-source income and was profitable 
on its U.S. operations from a book perspective would incur a 
minimum amount of U.S. taxes. In operation, however, U.S. 
corporations that have a substantial amount of foreign source 
income relative to their U.S.-source income or that have 
taxable losses on their U.S. operations are forced to pay U.S. 
taxes on income already heavily taxed outside the United 
States. This result contravenes the very purpose for which 
foreign tax credits were created.
    AMT liability by its very nature actually represents a 
prepaid double taxation. Because AMT is a prepayment of taxes, 
the law allows corporations to accumulate credits for AMT taxes 
that have been paid.
    Theoretically, these credits can ultimately be used when 
the corporation is no longer in AMT status and has fully 
utilized all other available credits such as foreign tax 
credits and research and development credits. In reality, a 
corporation that has substantial U.S.-source losses over a 
number of years or that has substantially more foreign source 
income than U.S. source income may never actually recover the 
taxes it prepaid. In this regard, the provision operates in a 
punitive manner not anticipated when the provision was enacted.
             IV. Advance Pricing Agreement (APA) Disclosure
    The Advance Pricing Agreement (APA) program of the Internal 
Revenue Service (IRS) began in 1991 as an innovative way for 
taxpayers, the IRS, and foreign tax agencies to avoid costly 
litigation and uncertainty over international transfer 
pricing--i.e., the appropriate arm's length price for sales, 
services, licenses and other transactions between related 
parties. The program has been extremely successful and is often 
cited as a model for how the IRS should interact with 
taxpayers. From the beginning of the program, the IRS assured 
taxpayers, Congress, and foreign governments that any 
information ``received or generated'' by the IRS during the APA 
process was ``subject to the confidentiality requirements of 
Sec. 6103.'' (See Rev. Proc. 91-22 and Rev. Proc. 96-53). 
Indeed, written assurances of confidentiality have often been 
included in the APA itself. However, in January of this year, 
as a concession in a lawsuit seeking public disclosure brought 
by the Bureau of National Affairs (BNA), the IRS unexpectedly 
reversed its long-standing policy and notified taxpayers that 
APAs are subject to disclosure under IRC Sec. 6110--which 
requires disclosure of any IRS ``written determination.'' 
Regardless of the outcome of the pending lawsuit, the IRS is 
proceeding with redaction and release of APAs (now scheduled 
for October 1999) in contravention of both its own prior 
assurances of confidentiality to taxpayers and the express 
intent of Congress (in 1993) that Sec. 6103 protects APAs from 
disclosure.
    First of all, APAs are not ``written determinations'' under 
IRC Sec. 6110. In 1976, when Congress enacted Sec. 6110 to 
allow disclosure of written determinations, negotiated taxpayer 
agreements, such as closing agreements, were specifically 
excluded because ``a negotiated settlement . . . as such, does 
not necessarily represent the IRS view of the law.'' (S. Rep. 
No. 938, 94th Cong. 2d Sess. 306-7 (1976); H.R. Rep. No. 658, 
94th Cong., 2d Sess. 316 (1976)). APAs are not written 
determinations (such as private letter rulings) that are 
unilaterally issued to the taxpayer by the IRS and consist of 
facts, law and the application of the law to the facts. Rather, 
APAs are customized, binding, written contracts that determine 
specific tax results and are carefully negotiated between the 
taxpayer and the IRS, like closing agreements, which are not 
subject to disclosure (Id). APAs are highly factual in nature, 
making a fact-intensive economic determination, not a legal 
one.
    Second, APAs are protected return information under IRC 
Sec. 6103. In 1993, when Congress amended Sec. 6103 to add 
Sec. 6103(l)(14), which permits disclosure of certain return 
information to the Customs Service, the Congress expressly 
exempted APAs from such disclosure. This was done because APAs 
were viewed as return information in the first instance. The 
legislative history states: ``The effectiveness of the APA 
program relies on voluntary disclosure of sensitive information 
to the Internal Revenue Service; accordingly, information 
submitted or generated in the APA negotiating process should 
remain confidential.'' See H.R. Report. No. 103-361, Vol. I, at 
104 (1993). Treasury regulations implementing this provision 
also expressly describe APAs as ``return information.'' See 
Treas. Reg. 301.6103(l)(14)-1(d). Public disclosure of APAs is 
contrary to congressional intent and Treasury's own 
regulations.
    Third, redaction of APAs under IRC Sec. 6110 will strain 
IRS and taxpayer resources. Prior to release of any APAs under 
Sec. 6110, the IRS will be required to redact any identifying 
taxpayer information. In addition, the ``background files'' 
will be subject to disclosure under IRC Sec. 6110(b)(2). These 
background files are voluminous and contain highly sensitive 
proprietary data that will have to be reviewed and redacted. 
Redaction, especially of these background files, will strain 
the resources of the IRS and be yet another cost, and likely 
deterrent, for taxpayers participating in the APA program
    Ironically, release and redaction of APAs under IRC 
Sec. 6110 will create costly disputes and litigation. The APA 
program was instituted specifically to curtail audit disputes 
and litigation over transfer pricing, but the redaction process 
required under IRC Sec. 6110 allows taxpayers and third parties 
to challenge proposed redactions in court, creating a 
significant risk of even more disputes and litigation. Disputes 
will arise not only between the taxpayer and the IRS over what 
should be redacted, but also between the taxpayer and third 
parties seeking disclosure, and over what is or is not a 
background file. Release and/or redaction of APAs and the 
background files would be disastrous for both the IRS and the 
taxpayer, as well as for our treaty partners.
    Furthermore, confidentiality is essential to protect 
taxpayer privacy and to assure continuation of the APA program. 
The APA program has worked because taxpayers have trusted the 
IRS and agreed to voluntarily submit sensitive pricing 
information to the IRS in advance of an audit--based on a 
promise of confidentiality. Release and redaction of APAs and 
background files would be a betrayal of taxpayers who 
voluntarily submitted sensitive information in the past and a 
significant deterrent to taxpayers contemplating participation 
in the APA program in the future. In addition, an increasing 
number of APAs are bilateral or multi-lateral involving foreign 
tax authorities and making confidentiality even more important. 
Our treaty partners are very concerned about possible breach of 
the promise of confidentiality in the APA program. If taxpayers 
cannot obtain bilateral APAs because foreign tax authorities 
refuse to participate, many taxpayers may decide not to pursue 
an APA at all. IRS's concession has jeopardized the APA 
program, which has been such a successful tool in helping the 
IRS and taxpayers resolve difficult factual issues without 
litigation.
    Finally, disclosure of APAs could jeopardize the 
confidentiality of competent authority proceedings and U.S. 
relationships with foreign governments. When a taxpayer's 
income is potentially subject to tax by both the United States 
and a foreign jurisdiction, the IRS can enter into a 
negotiation with the foreign ``competent authority'' to 
determine how much tax should be paid to each jurisdiction. 
These Competent Authority proceedings are confidential under 
our tax treaties. Although these proceedings involve the 
elimination of any type of double taxation, they often resolve 
double taxation problems arising from transfer pricing 
disputes--just like bilateral APAs. If APAs are subject to 
disclosure, there is a real risk Competent Authority 
proceedings could also be disclosed. Any suggestion that 
Competent Authority proceedings should be subject to disclosure 
would be viewed with tremendous concern by our treaty partners 
and could seriously impair our ability to resolve claims 
regarding double taxation in the future.
    Congress should promptly confirm that APAs are protected 
taxpayer information under IRC Sec. 6103 and not subject to 
disclosure under IRC Sec. 6110. Congressional action is needed 
to prevent the IRS from breaching its solemn assurances to 
taxpayers, the Congress, and foreign governments that these 
agreements are confidential taxpayer information. Failure to 
take immediate action in this regard will severely cripple, if 
not destroy, the APA program.
    V. Foreign Sales Corporation (FSC) Benefits for Defense Exports
    The Internal Revenue Code allows U.S. companies to 
establish foreign sales corporations (FSCs), under which they 
can exempt from U.S. taxation a portion of their earnings from 
foreign sales. This provision is designed to help U.S. firms 
compete against foreign companies relying more on value-added 
taxes (VATs) than on corporate income taxes. When products are 
exported from such countries, the VAT is rebated, effectively 
lowering their prices. U.S. companies, in contrast, must charge 
relatively higher prices in order to obtain a reasonable net 
profit after taxes have been paid. By permitting a share of the 
profits derived from exports to be excluded from corporate 
income taxes, the FSC in effect allows companies to compete 
with foreign firms that pay less tax.
    In 1976, Congress reduced the Domestic International Sales 
Corporation (DISC) tax benefits for defense products to 50 
percent, while retaining the full benefit for all other 
products. The limitation on military sales, currently contained 
in IRC Sec. 923(a)(5), was continued when Congress enacted the 
FSC (which replaced the DISC) in 1984. The rationale for this 
discriminatory treatment--that U.S. defense exporters faced 
little competition--no longer exists. Regardless of the 
veracity of that premise 25 years ago, today military exports 
are subject to fierce international competition in every area. 
In the mid-1970s, roughly half of all the nations purchasing 
defense products benefited from U.S. military assistance. 
Today, U.S. military assistance has been sharply curtailed and 
is essentially limited to two countries. European and other 
countries are developing export promotion projects to counter 
the industrial impact of their own declining domestic defense 
budgets and are becoming more competitive internationally. In 
addition, a number of Western purchasers of defense equipment 
now view Russia and other former Soviet Union countries as 
acceptable suppliers, further increasing the global 
competition.
    Circumstances have changed dramatically since the tax 
limitation for defense exports was enacted in 1976. Total U.S. 
defense exports and worldwide defense sales have both decreased 
significantly. Over the past 15 years, the U.S. defense 
industry has experienced spending reductions unlike any other 
sector of the economy. During the Cold War, defense spending 
averaged around 10 percent of U.S. Gross Domestic Product, 
hitting a peak of 14 percent during the Korean War in the early 
1950s and gradually dropping to 6-7 percent in the late 1980s. 
That figure has now sunk to 3 percent of GDP and is projected 
to go even lower, to 2.8 percent, by Fiscal Year (FY) 2001.
    Since FY85 the defense budget has shrunk from 27.9 percent 
of the federal budget to 14.8 percent in FY99. As a percentage 
of the discretionary portion of the U.S. Government budget, 
defense has slid from 63.9 percent to 45.8 percent over the 
same time. Moreover, the share of the defense budget spent on 
the development and purchase of equipment--Research, 
Development, Test and Evaluation (RDT&E) and procurement--has 
contracted. Whereas procurement was 32.2 percent and RDT&E 10.7 
percent of the defense budget in FY85--for a total of 42.9 
percent; those proportions are now 18.5 percent and 13.9 
percent, respectively--for a total of 32.4 percent.
    Obviously, statistics such as these are indicative that the 
U.S. defense industry has lost much of its economic robustness. 
This is additionally evidenced by massive consolidation and job 
loss in the defense industry. Of the top 20 defense contractors 
in 1990, two-thirds of the companies have merged, been sold or 
spun off, and hundreds of thousands of jobs have been 
eliminated in the industry.
    Budget issues are always a concern to lawmakers. The Joint 
Tax Committee estimates that extending the full FSC benefit to 
defense exports will likely cost about $340 million over five 
years. However, this expense is justified by both overriding 
policy concerns and sound tax policy. With the sharp decline in 
the defense budget over the past 15 years, exports of defense 
products have become ever more critical to maintaining a viable 
U.S. defense industrial base. Key U.S. defense programs rely on 
international sales to keep production lines open and to reduce 
unit costs. Repeal will benefit not only the large 
manufacturers of military hardware, but also the smaller 
munitions manufacturers, whose products are particularly 
sensitive to price fluctuations.
    The recent decision to transfer jurisdiction of commercial 
satellites from the Commerce Department to the State Department 
illustrates the fickleness of Section 923(a)(5). When the 
Commerce Department regulated the export of commercial 
satellites, the satellite manufacturers received the full FSC 
benefit. Since the Congress transferred export control 
jurisdiction to the State Department, the identical satellites, 
manufactured in the same facility, by the same hard-working 
employees, no longer receive the same tax benefit. Because 
these satellites are now classified as munitions, their FSC 
benefit has been cut in half. This result demonstrates the 
inequity of singling out one class of products for different 
tax treatment than every other product manufactured in America.
    The Cox Committee, recognizing the absurdity of the 
situation, recommended that the Congress take action to correct 
this inequity as it applies to satellites. The Administration 
has agreed with this recommendation. Section 303 would not only 
correct the satellite problem, but would also change the law so 
that all U.S. exports are treated the same under the FSC.
    Repeal of Section 923(a)(5) of the tax code does not alter 
U.S. export licensing policy. Military sales will continue to 
be subject to the license requirements of the Arms Export 
Control Act. Exporters will be able to take advantage of the 
FSC only after the U.S. Government has determined that a sale 
is in the national interest.
    Decisions on whether to allow a defense export sale should 
continue to be made on foreign policy grounds. However, once a 
decision has been made that an export is consistent with those 
interests, our government should encourage that such orders are 
filled by U.S. companies and workers, not by our foreign 
competitors. Discriminating against these sales in the tax code 
puts our defense industry at great disadvantage and makes no 
sense. Removing this provision of the tax code will further our 
foreign policy objectives by making defense products more 
competitive in the international market.
                             VI. Conclusion
    In conclusion, the NAM has long advocated overhaul of the 
overly complex and arcane international tax provisions in the 
Internal Revenue Code and complete repeal of the punitive 
alternative minimum tax (AMT). While the opportunities for 
improvement in the code are numerous, the NAM strongly endorses 
H.R. 2018, the ``International Tax Simplification for American 
Competitiveness Act of 1999,'' and the simplification 
provisions therein as a significant step toward improving the 
competitiveness of U.S.-based manufacturers. However, we would 
also urge the committee to address the impending disclosure by 
IRS of advance pricing agreements (APAs) by clarifying their 
status as return information under I.R.C. Sec. 6103.
    With only about four percent of the world's population 
residing in the United States, international trade is no longer 
a luxury but necessary to the survival and growth of U.S.-based 
manufacturers. While U.S. negotiators have actively pursued an 
increasing number of trade agreements to improve access to 
overseas markets, a major impediment to trade sits in our own 
backyard, namely the U.S. tax code. The NAM thanks the 
Committee on Ways and Means for recognizing the barriers our 
tax code imposes and the decreased competitiveness that 
results. Hearings such as this one are the first step to 
achieving significant reform. Thank you for scheduling this 
hearing to address these important issues and for allowing me 
to testify today on the NAM's behalf.

                                


    Chairman Archer. Thank you, Mr. Conway. Mr. Mogenson, you 
may proceed.

  STATEMENT OF HARVEY B. MOGENSON, MANAGING DIRECTOR, MORGAN 
   STANLEY DEAN WITTER & CO.; ON BEHALF OF THE COALITION OF 
                       SERVICE INDUSTRIES

    Mr. Mogenson. Mr. Chairman, Members of the Committee, my 
name is Harvey Mogenson. I am a managing director at Morgan 
Stanley Dean Witter responsible for international tax matters 
for the company. Morgan Stanley Dean Witter is a global 
financial services firm and a market leader in securities, 
asset management, and credit and transaction services. We have 
offices in New York, London, Tokyo, Hong Kong, and all of the 
other principal financial centers around the world.
    However, today I am testifying on behalf of the Coalition 
of Services Industries, CSI. CSI was established in 1982 to 
create greater awareness of the major role services industry 
play in our national economy, to promote the expansion of 
business opportunities abroad for U.S. services, and to 
encourage the U.S. leadership in attaining a fair and 
competitive global marketplace. CSI represents a broad array of 
U.S. service industries, including financial, 
telecommunications, professional, travel, transportation, 
information, and information technology sectors.
    I would like to thank you, Mr. Chairman, for holding this 
important meeting today regarding the U.S. tax rules and their 
impact on the competitiveness of U.S. corporations doing 
business abroad. I also want to thank Mr. Houghton and Mr. 
Levin and other Members of the Ways and Means Committee and 
members who have joined them in introducing H.R. 2018, the 
International Tax Simplification For American Competitiveness 
Act of 1999. And also I would like to thank Mr. McCrery and Mr. 
Neal for the work that they are doing in this area.
    Although my limited grey hair belies the fact, I have been 
practicing international tax for 18 years. I can personally 
attest that the U.S. international tax laws are complex, 
cumbersome, and can stifle competitiveness of U.S. companies 
doing business abroad. Because of this, international tax 
reform is a critical element of an effective U.S. tax and trade 
policy.
    While U.S. trade policy has concentrated on opening world 
markets to U.S. companies, particularly in the service sector, 
the U.S. tax policy has not always moved in the same direction. 
As trade policy moves into the 21st century, it seems our 
international tax policy still reflects the business 
environment of the sixties, as elaborated on by the previous 
panel in citing the statistics regarding the segments of our 
economy at that time. That is why we strongly support the 
provisions of the Houghton-Levin Simplification bill. Further, 
as part of that bill, CSI believes that the active financing 
exception to subpart F for financial services companies active 
business foreign earnings should be extended with other 
expiring provisions for as long as possible.
    To understand how important the U.S. tax laws are to 
companies operating abroad, perhaps I will elaborate on why 
U.S. firms and financial service companies in particular go 
overseas in the first place. As the world economy has been 
increasingly global in nature, the need to secure new markets 
for U.S. corporations has intensified. As those companies, who 
are our clients, expand overseas, the financial services firms 
have had to go and do the same thing in order to support the 
global expansion of those companies. In essence, financial 
services companies are in the foreign markets initially because 
that is where our customers are. Thus, as our customers have 
become global, we have had to also become global rather than 
lose that business to our global competitors.
    Also, the U.S. financial markets are mature and it is 
anticipated that much of the growth in the financial services 
industry will come in foreign marketplaces as they open up to 
the type of development that we have seen in the U.S. financial 
services marketplace.
    Many financial service companies have also had a local 
presence abroad because we are heavily regulated and required 
to conduct business through local companies. For example, 
insurance and reinsurance companies, like securities dealers--
my company--are required to maintain significant levels of 
capital with minimum solvency thresholds in order to be 
licensed to operate in the foreign jurisdiction. In addition, 
these regulated companies are subject to stringent regulation 
that constrains the movement of capital, regardless of whether 
such income has or has not been subject to U.S. taxation.
    Most global services firms, therefore, including Morgan 
Stanley Dean Witter, have operated through locally incorporated 
and regulated affiliates in the major commercial centers.
    As a way of background to the legislative approach to 
active financing exception, I would just like to say that in 
1986, Congress repealed the active financing exception because 
of the concerns over active and passive income. In 1997 and 
1998, those concerns were revisited and a compromise was 
crafted to focus on the active activities of financial services 
firms that do conduct substantial activities in the home 
country. Active financial services, as we have heard, is 
recognized by our major trading partners as active business 
income. Thus, if the current law provision were permitted to 
expire at the end of this year, U.S. financial services 
companies would find themselves at a significant competitive 
disadvantage vis-a-vis all of our major competitors operating 
outside the United States.
    Also, because the active financing exception is currently 
temporary, it denies U.S. companies of a certainty their 
foreign competitors have. I will conclude my remarks there.
    [The prepared statement follows:]

Statement of Harvey B. Mogenson, Managing Director, Morgan Stanley Dean 
Witter & Co.; on behalf of the Coalition of Service Industries

                              Introduction
    Mr. Chairman and distinguished Members of the Committee:
    My name is Harvey Mogenson, I am a Managing Director at 
Morgan Stanley Dean Witter & Co. (MSDW). MSDW is a global 
financial services firm and a market leader in securities, 
asset management, and credit and transaction services. The Firm 
has offices in New York, London, Tokyo, Hong Kong and other 
principal financial centers around the world and has 456 
securities branch offices throughout the United States. I am 
testifying today on behalf of the Coalition of Services 
Industries (CSI). CSI was established in 1982 to create greater 
awareness of the major role services industries play in our 
national economy; promote the expansion of business 
opportunities abroad for U.S. services, and encourage U.S. 
leadership in attaining a fair and competitive global 
marketplace. CSI represents a broad array of U.S. service 
industries including the financial, telecommunications, 
professional, travel, transportation, information and 
information technology sectors.
    I want to thank you, Mr. Chairman for holding this 
important hearing on the impact U.S. tax rules have on the 
competitiveness of U.S. corporations doing business abroad. I 
also want to thank Mssrs. Houghton and Levin and the other Ways 
& Means Committee Members who have joined them in introducing 
H.R. 2018, the International Tax Simplification for American 
Competitiveness Act of 1999.
    U.S. international tax laws are complex, cumbersome, and 
can stifle the competitiveness of U.S. companies doing business 
overseas. Because of this, international tax reform is a 
critical element of an effective U.S. trade policy. While U.S. 
trade policy has concentrated on opening world markets to U.S. 
companies, our tax policy has not always moved in the same 
direction. As trade policy moves into the 21st Century, it 
seems our international tax policy still reflects the business 
environment of the '60s. That is why we strongly support the 
provisions in the Houghton-Levin Simplification bill. And, as 
part of that bill, CSI believes that the active financing 
exception to subpart F for financial services companies' active 
business foreign earnings should be extended with the other 
expiring provisions for as long as possible.
           Why Financial Services Companies Operate Overseas
    To understand how important U.S. international tax laws are 
to companies operating abroad, it may be useful to elaborate on 
why U.S. firms, and financial services companies in particular, 
go overseas in the first place.
    As the world economy has become increasingly global in 
nature, the need to secure new markets for U.S. corporations 
has intensified. As those companies expand overseas, financial 
services firms have had to do the same in order to support that 
global expansion and to stake out new markets for themselves. 
In essence, financial services companies are in foreign markets 
because that is where our customers are (both domestic and 
foreign). Thus, as our customers have become more global, we 
have also become global rather than lose the business to our 
global competitors. Also, the U.S. financial markets are mature 
and much of the growth in the industry will come in foreign 
markets as they open up to the type of development we have seen 
in the US financial services market-place.
    You will hear today from manufacturing companies such as 
United Technologies, which owns Otis Elevator Company. Otis 
maintains a presence overseas in order to service and maintain 
the elevators they sell around the world. In much the same way 
financial services companies, be they banks, securities, 
finance or insurance companies, need to have a local presence 
to market, service and maintain financial services to their 
customers. As with other non-financial companies that need to 
be close to their customers because of the proximity to raw 
materials and other inputs, financial services companies need 
access to the local debt and financial markets to facilitate 
their lending and securities activities. In most cases, such 
access provides us with lower cost of funds and protection 
against currency fluctuations.
    Many financial services companies also have a local 
presence because they are heavily regulated businesses and 
foreign rules dictate that they conduct business through local 
companies. In the case of insurance and reinsurance companies, 
they are required to maintain significant levels of capital 
with minimum solvency thresholds in order to be licensed in a 
foreign jurisdiction. In addition, insurers are subject to 
stringent regulation that constrain the movement of capital.
    Most global securities firms, including Morgan Stanley Dean 
Witter, have locally incorporated and regulated affiliates in 
the major commercial centers within Europe (London, Frankfurt, 
Paris, Milan) and Asia (Tokyo, Hong Kong, Singapore, Sydney). 
Because each jurisdiction asserts full regulatory control for 
activities within its country, local subsidiaries are used to 
avoid overlapping regulatory supervision.
          Legislative Background on Active Financing Exception
    When subpart F was first enacted in 1962, the original 
intent was to provide deferral for foreign operating income, 
and require current U.S. taxation of foreign income of U.S. 
multinational corporations that was passive in nature. The 1962 
law was careful not to subject active financial services 
business income to current taxation through a series of 
detailed carve-outs. In particular, dividends, interest and 
certain gains derived in the active conduct of a banking, 
financing, or similar business, or derived by an insurance 
company on investments of unearned premiums or certain reserves 
were specifically excluded from current taxation if such income 
was earned from activities with unrelated parties.
    In 1986, Congress repealed deferral of controlled foreign 
corporation's active financial services business income in 
response to concerns about the difficulty in distinguishing 
between active and passive income. In 1997, the 1986 rules were 
revisited, and an exception to the subpart F rules was added 
for the active income of U.S. based financial services 
companies, along with rules to ensure that the exception would 
not be available for passive income. The active financing 
income provision was revised in 1998, in the context of 
extending the provision for the 1999 tax year, and changes were 
made to focus the provision on active overseas financial 
services businesses that perform substantial activities in 
their home country.
    Active financial services income is recognized by our major 
trading partners as active trade or business income. Thus, if 
the current law provision were permitted to expire at the end 
of this year, U.S. financial services companies would find 
themselves at a significant competitive disadvantage vis-a-vis 
all their major foreign competitors when operating outside the 
United States. In addition, because the U.S. active financing 
exception is currently temporary, it denies U.S. companies the 
certainty their foreign competitors have. The need for 
certainty in this area cannot be overstated. U.S. financial 
services institutions need to know the tax consequences of 
their business operations, especially since many client 
transactions may be multiple year commitments or arrangements.
    A comparative review of current U.S. law with the laws of 
foreign countries conducted by the National Foreign Trade 
Council, Inc.\1\ shows that the United States imposes a 
stricter anti-deferral policy on U.S.-based financial services 
companies than Canada, France, Germany, Japan and The 
Netherlands. None of the countries listed eliminates deferral 
for active financial services income. For example, ``German law 
merely requires that the income must be earned by a bank with a 
commercially viable office established in the CFC's 
jurisdiction and that the income results from transactions with 
customers. Germany does not require that the CFC conduct the 
activities generating the income or that the income come from 
transactions with customers solely in the CFC's country of 
incorporation. The United Kingdom has an even less restrictive 
deferral regime than Germany. The United Kingdom does not 
impose current taxation on CFC income as long as the CFC is 
engaged primarily in legitimate business activities primarily 
with unrelated parties. In sum, current U.S. treatment of CFC 
active financing income is more restrictive than the treatment 
afforded such CFC income by many of the United States' 
competitors.'' \2\
---------------------------------------------------------------------------
    \1\ The NFTC Foreign Income Project: International Tax Policy For 
The 21st Century A Report and Analysis Prepared by the National Foreign 
Trade Council, Inc.
    \2\ The NFTC Foreign Income Project. International Tax Policy For 
The 21st Century p 4-11.
---------------------------------------------------------------------------
The Active Financing Exception is Essential to the Competitive Position 
  of American Financial Services Industries in the Global Marketplace
    The financial services sector is one of the fast growing 
components of the U.S. trade in services surplus (which is 
expected to exceed $80 billion this year). It is therefore in 
the economic interest of the United States that the Congress 
act to maintain a tax structure that does not hinder the 
competitive efforts of the U.S. financial services industry. 
While the economic research is continuing, there seems to be a 
growing awareness of the benefits to the U.S. economy of strong 
U.S.-based global companies. And, certainly in the case of a 
financial services company like MSDW, our global reach has 
allowed us to be a stronger competitor and more successful 
within the U.S.
    The growing interdependence of world financial markets has 
highlighted the urgent need to rationalize U.S. tax rules that 
undermine the ability of American financial services industries 
to compete in the international arena. From a tax policy 
perspective, financial services businesses should be eligible 
for the same U.S. tax treatment of worldwide income as that of 
manufacturing and other non-financial businesses. The 
inequitable treatment of financial services industries under 
prior law jeopardizes the international expansion and 
competitiveness of U.S.-based financial services companies, 
including finance and credit entities, commercial banks, 
securities firms, insurance, and reinsurance companies.
    This active financing provision is particularly important 
today as the U.S. financial services industry is the global 
leader and plays a pivotal role in maintaining confidence in 
the international marketplace. Also, recently concluded trade 
negotiations have opened new foreign markets for this industry, 
and it is essential that our tax laws complement this trade 
liberalization effort. We hope the Congress will not allow the 
tax code to revert to penalizing U.S.-based companies upon the 
expiration of the temporary provision this year.
   The Active Financing Exception Should be Extended for as Long as 
                                Possible
    According to the floor statement of Mr. Houghton during the 
debate on the Conference Report of the Tax Act of 1997, the 
fact that the original active financing exception would sunset 
after one year was ``a function of revenue concerns, not doubts 
as to its substantive merit.'' \3\ Indeed, even in the course 
of subjecting this provision to a presidential line-item veto, 
the Clinton Administration acknowledged, and continues to 
acknowledge that the ``primary purpose of the provision was 
proper.'' \4\
---------------------------------------------------------------------------
    \3\ Congressional Record, July 31, 1997.
    \4\ White House Statement, August 11, 1997.
---------------------------------------------------------------------------
    Understanding that revenue constraints can impact U.S. tax 
policy considerations, extending the provision for as long as 
possible would greatly enhance the competitive position of the 
U.S. financial services industry as they compete in the global 
marketplace. Otherwise, the international growth of American 
finance and credit companies, banks, securities firms, 
insurance and reinsurance companies will continue to be 
impaired by an on-again, off-again system of annual extensions 
that does not allow for certainty.
                               Conclusion
    On behalf of the entire U.S. financial services industry 
and the Coalition of Services Industries, I want to thank you 
Mr. Chairman and Members of the Committee for your efforts to 
improve the international rules that affect not only the 
financial services industry but all U.S. corporations operating 
overseas. We urge the Committee to support H.R. 2018 which 
would provide a more consistent, equitable and stable 
international tax regime for the U.S. financial services 
industry.

                                


    Chairman Archer. Thank you, Mr. Mogenson. I am sure all the 
witnesses hear those buzzers, which mean that we are being 
summoned to vote on the floor of the House. We have 10 more 
minutes before we have to be over there. We will proceed for at 
least one more witness and then we will have to recess and 
vote. Two votes will be taken so it will be a while before we 
get back. Mr. Chip, you may proceed.

    STATEMENT OF WILLIAM W. CHIP, CHAIRMAN, TAX COMMITTEE, 
 EUROPEAN-AMERICAN BUSINESS COUNCIL, AND PRINCIPAL, DELOITTE & 
                           TOUCHE LLP

    Mr. Chip. Thank you, Mr. Chairman. I am an international 
tax lawyer. I have been practicing for 20 years. I am 
testifying today for the European-American Business Council. 
The Council is an alliance of U.S. companies that have 
operations in Europe and European companies that have 
operations in the United States. Our membership has a lot of 
experience in the relative impact of the U.S. tax rules 
compared to foreign tax rules.
    Mr. Chairman, I would agree with you that--what you said 
this morning--that if we were to replace our income tax system 
with a sales tax system that raised the same amount of revenue, 
that would almost certainly confer a significant competitive 
advantage on the United States. One reason it would is because 
most of our competitors have income tax systems that, while 
more competitive than ours, are not completely competitive.
    Understanding what makes a competitive tax system and why 
ours is not is actually not that hard. I think in an ideal 
system, each country would tax the business income locally 
generated at a rate sufficient to pay for roads and education 
and other things needed to make that a desirable place to do 
business. And the income would not be taxed again until it was 
distributed to the individual owners of the enterprise to pay 
for things that their resident country needed to make it a safe 
and pleasant place to live.
    The reason the U.S. tax system is uncompetitive is very 
simple. Between the time the income is earned overseas and 
distributed to the U.S. owners or the foreign owners, we impose 
an extra level of tax at the U.S. corporate level when that 
income is brought back to the United States to be distributed 
to shareholders or invested in the United States. For example, 
if we pay a lower rate of tax in Ireland on operations there, 
the United States will impose a tax in the United States equal 
to the difference between the United States and the foreign tax 
rate.
    What if a foreign operation had lower electricity charges? 
What if we imposed a charge at the U.S. level on the difference 
between U.S. electricity rates and foreign electricity rates 
and the difference between U.S. labor rates. It is not that 
hard to understand why the income tax system makes U.S. 
companies uncompetitive.
    This innate uncompetitive feature of the U.S. tax law has 
been with us from the beginning and has been exacerbated, 
rather than created, by Subpart F, which requires that this 
extra level of corporate tax be imposed in many cases even if 
the income has not been brought back to the United States.
    In particular, I would like to focus on the foreign base 
company rules, which provide that if a foreign subsidiary of a 
U.S. company conducts sales and services activities outside the 
country where it is incorporated, the income from that activity 
is immediately taxed by the United States at whatever the U.S. 
rate is over the local rate. This is a problem for U.S. 
companies everywhere, but it is particularly a problem for us 
in the European Union.
    The European Union is a single marketplace. You can be a 
successful global business without having an operation in 
Nigeria or Thailand, but you cannot be a global competitor 
unless you have a substantial, profitable, cutting-edge 
operation in the European Union. U.S. companies are fiercely 
competing with European companies to reorganize themselves and 
structure themselves to take advantage of the common market 
there. The Subpart F rules which treat an operation that is 
incorporated in one EU country, but takes place in another EU 
country, as, in effect, tax-shelter income that must 
immediately be taxed by the United States, is a very serious 
impediment to the rationalization of U.S. business in the 
European Union.
    That is why we are, of course, very grateful that Mr. 
Houghton and Mr. Levin in their bill have asked for a study to 
identify the consequences of this and to propose solutions. I 
would say that the business community, almost since Subpart F 
was enacted, have been complaining and pointing out to the 
Congress the tremendous competitive disadvantage they suffer in 
structuring their European operations and taking advantage of 
European economic integration that this rule has imposed upon 
them.
    So, in closing, I would like to thank the chairman for 
calling these hearings. This is a very important subject. I am 
also very interested in the United States staying on top and I 
hate to see our rules pushing us in any other direction.
    [The prepared statement follows:]

Statement of William W. Chip, Chairman, Tax Committee, European-
American Business Council, and Principal, Deloitte & Touche LLP

    My name is Bill Chip. I am a principal in Deloitte & 
Touche, an international tax, accounting, and business 
consulting firm. I have been engaged in international tax 
practice for 20 years.
    I am testifying today as Chairman of the Tax Committee of 
the European-American Business Council (EABC). The EABC is an 
alliance of 85 multinational enterprises with headquarters in 
the United States and Europe. A list of EABC members is 
attached. Because the EABC membership includes both US 
companies with European operations and European companies with 
U.S. operations, the EABC brings a unique but practical 
perspective on how the U.S. international tax rules impact the 
competitiveness of U.S. companies operating in the European 
Union (EU)--the world's largest marketplace.
    The points I would like to make today may be summarized as 
follows:
    1. U.S. international tax rules foster tax neutrality 
between U.S. companies, but not between U.S. companies and 
foreign companies.
    2. In order for U.S.-parented companies to be truly 
competitive in a globalized economy, the U.S. should not impose 
a corporate income tax on income from foreign operations.
    3. The enhanced power of the IRS to police transfer pricing 
has eliminated the most important rationale for the subpart F 
rules, which should therefore be relaxed.
    4. The anticompetitive flaws in the U.S. system cannot be 
fully corrected without attending to other problems, such as 
the taxation of dividends with no credit for corporate-level 
taxes.
    5. Certain changes are urgently needed pending more 
fundamental reforms: (1) the EU should be treated as a single 
country under the subpart F rules; (2) the U.S. should agree to 
binding arbitration of transfer pricing disputes; and (3) the 
rules for allocating interest between U.S. and foreign income 
should be made economically realistic.
    6. Many problems faced by U.S. companies operating 
internationally cannot be resolved by U.S. tax policy alone, 
and the U.S. should take the lead in erecting an international 
tax system that does not impede cross-border business activity.
    The EABC welcomes the Chairman's interest in reforming this 
country's international tax rules. Those rules have always had 
a negative impact on the ability of U.S. companies to compete 
overseas. However, this anticompetitive impact has been masked 
during most of this century by several U.S. business 
advantages, including the world's largest domestic economy as a 
base, a commanding technological lead in many industries, and 
sanctuary from the destruction of two world wars. However, 50 
years of peace and the rapid spread of new technologies have 
leveled these advantages and exposed the anticompetitive thrust 
of our international tax regime.
    I would go so far as to say that the U.S. rules with 
respect to income produced overseas were written without any 
regard whatsoever for their impact on competitiveness. Their 
goal instead was to ensure that any income controlled by a U.S. 
person was eventually subject to U.S. tax. Thus, income of 
foreign subsidiaries is taxed at the full U.S. corporate rate 
when distributed to the U.S. parent (with a credit for any 
foreign income taxes) and then taxed again (with no credit for 
either U.S. or foreign income taxes) when distributed to the 
U.S. shareholders. The imposition of U.S. tax is accelerated 
when foreign earnings are redeployed from one foreign 
subsidiary to another and also, under subpart F, when the 
foreign income is one of the many types that Congress feared 
could otherwise be ``sheltered'' in a ``tax haven.''
    These rules do have the effect of neutralizing the impact 
of foreign taxes on competition between U.S. companies. Because 
all foreign earnings must eventually bear the full U.S. tax 
rate, a U.S. company that produces in a low-tax foreign 
jurisdiction enjoys at most a temporary tax advantage over one 
that produces in the U.S.. Likewise, because all earnings of 
U.S. companies eventually bear the same U.S. corporate tax 
rate, the presence or absence of a shareholder-level credit for 
corporate taxes is immaterial in a shareholder's decision to 
invest in one U.S. company rather than in another.
    In contrast, the U.S. tax system does not neutralize the 
impact of taxes on competition between U.S. and foreign 
companies. At the shareholder level, the absence of a credit 
for corporate-level taxes favors investments in low-taxed 
foreign companies over their U.S. equivalents. At the corporate 
level, if the costs of producing a product, including tax 
costs, are lower in a foreign country such as Ireland than they 
are in the U.S., our free trade rules will likely result in 
U.S. customers purchasing the Irish product rather than the 
equivalent U.S. product. However, if a U.S. owner of an Irish 
enterprise must also pay the excess of U.S. over the Irish tax 
rate, then the Irish enterprise will likely end up being owned 
by a foreign company whose home country does not tax the Irish 
earnings, taxes them later, or provides a more liberal foreign 
tax credit.
    These competitive disadvantages are aggravated by business 
globalization. Owing to the internationalization of capital 
markets, an ever-larger percentage of U.S. shareholders are 
able and willing to invest in foreign corporations and mutual 
funds, impairing the ability of U.S. companies to raise capital 
for their overseas operations even in the U.S. capital markets. 
The electronic revolution in communications and computing has 
also globalized the economic production process. Economic 
output is increasingly the consequence of coordinated activity 
in a number of different countries, expanding the range of 
products impacted by anticompetitive tax rules. If the Irish 
enterprise in the foregoing example is an integral part of a 
global activity, U.S. companies may lose the opportunity to 
sell, not only the Irish product, but also any integral U.S. 
products.
    The U.S. system leads to very anomalous results. Consider a 
U.S. company with a German and Irish subsidiary, then consider 
three identical companies, except that the U.S. and Irish 
companies are subsidiaries of the German company. The U.S. 
would never dream of trying to tax the income of the Irish 
subsidiary in the second case, but in the first case insists on 
taxing it when the income is repatriated, if not sooner. There 
is no reason why this should be so. Most countries, like the 
U.S., have a progressive income tax for individuals and, above 
a certain level, a virtually flat income tax for corporations. 
That being the case, there is a reason for imposing 
shareholder-level taxes on dividends received from local and 
foreign corporations (although there should be a credit for 
taxes paid at the corporate level). There is no reason for 
imposing a local corporate tax on foreign earnings as they make 
their way from the foreign subsidiary to the ultimate 
individual shareholders.
    Nowhere is the anti-competitive burden imposed by U.S. tax 
rules more evident and damaging than in the application of the 
U.S. ``subpart F'' rules to U.S.-owned enterprises in the EU. 
The subpart F rules were intended to prevent U.S. companies 
from avoiding U.S. taxes by sheltering mobile income in ``tax 
havens.'' The impact of these rules is exacerbated by the fact 
that since 1986 any country with an effective tax rate not more 
than 90% of the U.S. rate is effectively treated as a tax 
haven. Even the United Kingdom, an industrialized welfare state 
with a modern tax system, is treated as a tax haven by subpart 
F because its 30% corporate rate is only 86% of the U.S. 
corporate rate. (If the U.S. corporate tax rate when subpart F 
was enacted were the benchmark, the U.S. today would itself be 
considered a tax haven.)
    Because Congress perceived that selling and services were 
relatively mobile activities that could be separated from 
manufacturing and located in tax havens, the ``foreign base 
company'' rules of subpart F immediately tax income earned by 
U.S.-controlled foreign corporations from sales or services to 
related companies in other jurisdictions. Consider the impact 
of this rule on a U.S. company that already has operations in 
several EU countries but wishes to rationalize those operations 
in order to take advantage of the single market. Such a company 
may find it most efficient to locate personnel or facilities 
used in certain sales and service activities in a single 
location or at least to manage them from a single location. 
While a number of factors will affect the choice of location, 
all enterprises, whether U.S.-owned or EU-owned, will favor 
those locations that impose the lowest EU tax burden on the 
activity. However, if the enterprise is U.S.-owned, the subpart 
F rules may eliminate any locational tax efficiency by 
immediately imposing an income tax effectively equal to the 
excess of the U.S. tax rate over the local tax rate. Thus, U.S. 
companies are penalized for setting up their EU operations in 
the manner that minimizes their EU tax burden (even though 
reduction of EU income taxes will increase the U.S. taxes 
collected when the earnings are repatriated). It makes as 
little sense for the U.S. to penalize its companies in this way 
as it would for the EU to impose a special tax on European 
companies that based their U.S. sales and service activities in 
the U.S. States that imposed the least tax on those activities.
    The subpart F rules were enacted mostly out of concern that 
certain types of income could readily be shifted into ``tax 
havens.'' However, the term tax haven is misleading. Taxes are 
only one of many costs that enter into the production process 
and into the decision where to conduct a particular activity. 
Some countries have low taxes, but others have low labor or 
energy costs or a favorable climate or location. If an 
enterprise is actually conducted in a low-tax jurisdiction, it 
is anticompetitive for the U.S. to impose (let alone 
accelerate) corporate taxes on the income properly attributable 
to that enterprise, just as it would be anticompetitive to 
impose a charge equal to any excess of U.S. over foreign labor 
or energy costs. The imposition of taxes or other charges that 
offset the competitive advantage of the foreign enterprise will 
simply cause the enterprise to be owned by a non-U.S. 
competitor that does not have subpart F rules.
    When subpart F was enacted, Congress seemed to be concerned 
that U.S. companies might arbitrarily attribute excessive 
amounts of income to their low-taxed foreign operations. 
Whether or not such concern was warranted then, it is not 
warranted now. Since 1994 U.S. companies have been subject to 
draconian penalties on any substantial failure to price their 
international transactions at arm's length. Moreover, most of 
our competitors, and even less developed countries such as 
Mexico and Brazil, have followed suit and greatly enhanced 
their enforcement of the arm's length standard. Having endowed 
the IRS with ``weapons of mass destruction'' in the field of 
transfer pricing, Congress can now afford to retire much of the 
obsolete subpart F armory.
    I would be remiss not to acknowledge that the globalization 
of business poses important challenges to tax administrators in 
the U.S. and elsewhere. Ever greater shares of the nation's 
income derives from cross-border activity, while ever 
increasing integration of cross-border activity makes it harder 
to determining the source of business income. The IRS and most 
foreign tax authorities are well aware of these challenges and 
are working to surmount them. Indeed, the enhanced attention to 
transfer pricing is one of the more important and obvious 
responses to the globalization challenge.
    The efforts of the U.S. and other countries to ensure 
receipt of their ``fair share'' of global tax revenues through 
transfer pricing enforcement points also to a need for 
increased international cooperation. For example, each country 
is likely to view arm's length transfer pricing as the pricing 
that maximizes the amount of local income. Hence the need for 
international mechanisms which ensure that the calculation of 
national incomes under national transfer pricing policies does 
not add up to more than 100% of a company's global income. 
Unfortunately, although all tax treaties provide a mechanism 
for reaching agreement on transfer pricing, very few require 
that the countries actually reach agreement, meaning there is 
no guarantee against double taxation. Even more unfortunately, 
the U.S. is opposing such requirements. For example, while the 
EU countries have entered into a convention that requires 
arbitration of international transfer pricing disputes, the 
U.S. has declined to exchange the notes that would effectuate 
the arbitration clauses of the few U.S. tax treaties that have 
them. For that reason the EABC strongly recommends that the 
U.S. enter into negotiations with the EU members states to 
extend the principles of the EU convention to transfer pricing 
disputes between the U.S. and EU members.
    International cooperation does not mean that tax rates 
should be harmonized or even that the calculation of taxable 
income should be harmonized. In fact, unharmonized tax rates 
are a good thing, because tax competition is a useful 
counterweight to the many pressures on government to increase 
taxes and spending. For that reason the EABC shares many of the 
concerns outlined in the response of the Business and Industry 
Advisory Committee (BIAC) to the report on ``Harmful Tax 
Competition'' by the Organization for Economic Cooperation and 
Development (OECD). There is genuine alarm within the business 
community that some OECD members are responding in an 
anticompetitive way to the challenges of globalization. Rather 
than working cooperatively to construct an international tax 
system that ensures income is properly attributed to the 
jurisdiction where it originates and not taxed more than once, 
some countries seem more interested in maximizing the reach of 
their tax jurisdiction and capturing any income under the 
control of companies that are headquartered locally. The 
efforts of the present U.S. Administration to expand the scope 
of subpart F by regulation and legislation reflect such an 
approach and should be rejected by the Congress.
    I am worried about a deep and growing divide between the 
business community and the tax authorities in many 
industrialized countries on how to manage the fiscal challenges 
of business globalization. At the EABC's recent Transatlantic 
Tax Conference, officials of the U.S., EU, and OECD discussed 
``harmful tax competition'' and other current issues with tax 
leaders from BIAC and from leading U.S. and EU business 
organizations. EU business was as frustrated with the inability 
of the EU member states to eliminate obstacles to cross-border 
business integration and dividend/royalty payments as was U.S. 
business with IRS Notices 98-11 and 98-35. All business 
representatives were concerned that the OECD seemed less intent 
on eliminating tax obstacles to an efficient international 
economy than on attempting to freeze in place existing revenue 
sources.
    The EABC welcomes attention by the U.S. Congress to how the 
U.S. tax system impacts business decisionmaking and is ready to 
work with your Committee to identify urgently needed reforms.

                                

Members of the European-American Business Council

ABB

ABN Amro Bank

AgrEvo

Airbus Industrie

AirTouch Communications Inc.

Akin, Gump, Strauss, Hauer & Feld

Akzo Nobel Inc.

Andersen Worldwide

Astra Pharmaceutical Products Inc.

AT&T

BASF Corporation

BAT Industries

Bell Atlantic Inc.

Bell South Corporation

BMW (US) Holding Corporation

BP America, Inc.

BT North America, Inc.

Cable & Wireless

Chubb Corporation

Citicorp/Citibank

Cleary, Gottlieb, Steen & Hamilton

Compagnie Financiere de CIC et de l'Union Europeenne

Credit Suisse

DaimlerChrysler

Deloitte & Touche LLP

DIHC

Dun & Bradstreet Corporation

Eastman Kodak Company

ED&F Man Inc.

EDS Corporation

Ericsson Corporation

Finmeccanica

Ford Motor Company

Gibson, Dunn & Crutcher

Glaxo Inc.

IBM Corporation

ICI Americas Inc.

ING Capital Holding Corporation

Investor International

Koninklijke Hoogovens NV

Linklaters & Paines

Lucent Technologies

MCI Communications Corporation

Merrill Lynch & Company, Inc.

Michelin Tire Corporation

Monsanto Company

Morgan Stanley & Co.

Nestle USA, Inc.

Nokia Telecommunications Inc.

Nortel Networks

Novartis

Novo Nordisk of North America

Pechiney Corporation

Pfizer International Inc.

Philips Electronics North America

Pirelli

Powell, Goldstein, Frazer & Murphy

Procter & Gamble

Price Waterhouse LLP

Rabobank Nederland

Rolls-Royce North America Inc.

SAAB AB

Sara Lee Corporation

SBC Communications Inc.

Siegel & Gale

Siemens Corporation

Skandia

Skanska AB

SKF AB

SmithKline Beecham

Sulzer Inc.

Tetra Laval Group

Tractebel Energy Marketing

Unilever United States, Inc.

US Filter

Veba Corporation

VNU Business Information Svcs., Inc.

Volkswagen

Volvo Corporation

White Consolidated, Inc.

Xerox Corporation

Zeneca Inc.


                                


    Chairman Archer. Thank you, Mr. Chip. With the indulgence 
of the other witnesses, we are going to have to go across the 
street and vote. There will also be another 5-minute vote. It 
will probably be somewhere between 10 and 15 minutes before we 
get back. The Committee will stand in recess until then.
    [Recess.]
    Chairman Archer. The Committee will come to order. Mr. 
Laitinen, would you give us your testimony?

    STATEMENT OF WILLIAM H. LAITINEN, ASSISTANT GENERAL TAX 
     COUNSEL, GENERAL MOTORS CORPORATION, DETROIT, MICHIGAN

    Mr. Laitinen. Thank you, Mr. Chairman. My name is Bill 
Laitinen. I am Assistant General Tax Counsel for General Motors 
Corporation.
    I am testifying today on behalf of a coalition of U.S. 
multinational companies that are severely penalized by a 
particular aspect of the U.S. tax law affecting international 
operations, that is, the rules regarding the allocation of 
interest expense between U.S. source and foreign source income 
for purposes of determining the foreign tax credits a U.S. 
taxpayer may claim for taxes it pays to a foreign country.
    I would like to express our appreciation to the Chairman 
and the Members of the Committee for holding this hearing and 
for the opportunity to testify on the vitally important issue 
of the impact of U.S. tax rules on the international 
competitiveness of U.S. workers and businesses. Also, I would 
like to commend Representative Houghton and Representative 
Levin on the introduction of their important international 
simplification bill.
    My testimony today will focus exclusively on the distortive 
and anti-competitive impact of the current interest allocation 
rules and the pressing need to reform these rules.
    The United States taxes U.S. persons on their worldwide 
income, but allows a credit against U.S. tax for foreign taxes 
paid on income earned abroad. In order to determine the foreign 
tax credits that may be claimed, taxpayers must allocate 
expenses between U.S. source and foreign source income. Special 
rules enacted in the Tax Reform Act of 1986 require that U.S. 
interest expense be allocated to a U.S. multinational group's 
investment and its foreign subsidiaries. Although the rules 
purport to reflect a principle of fungibility of money, in 
fact, they ignore the interest expense actually incurred by the 
foreign subsidiaries. This one-way street approach to 
fungibility is a gross economic distortion.
    The interest allocation rules cause a disproportionate 
amount of U.S. interest expense to be allocated to foreign 
source income. This overallocation of U.S. interest expense 
reduces the group's capacity to claim foreign tax credits for 
the taxes it pays to foreign countries. Of course, the U.S. 
interest expense so allocated is not deductible for foreign tax 
purposes and, therefore, does not result in any reduction in 
the foreign taxes a multinational group actually pays. Thus, 
the ultimate distortion caused by the interest allocation rules 
is the double-taxation of foreign income earned by the U.S. 
multinational group.
    This double-taxation represents a significant cost for U.S. 
multinationals, a cost not borne by their foreign competitors. 
This increased cost makes it more difficult for U.S. 
multinationals to compete in the global marketplace. When a 
U.S. multinational considers a foreign expansion or 
acquisition, it must factor into its projections the double 
taxation caused by the interest allocation rules. A foreign 
competitor considering the same expansion or acquisition can do 
so without this added cost.
    Not only do the interest allocation rules impose a cost 
that makes it more difficult for U.S. multinationals to compete 
in overseas markets, the rules actually put U.S. multinationals 
at a competitive disadvantage in making U.S. investments. When 
a U.S. multinational incurs debt to make an additional 
investment in the United States, a portion of the interest 
expense on that debt is allocated to foreign source income. In 
effect, the U.S. multinational is denied a current deduction 
for that portion of the interest expense.
    A foreign corporation that makes the same investment in the 
United States will not be impacted by these interest allocation 
rules. Thus the foreign corporation making an investment in the 
United States will face lower costs than a U.S. multinational 
making the same investment in this country. Under the interest 
allocation rules, U.S. multinationals can't even compete on a 
level playingfield when they are the home team.
    There is no tax policy rationale that supports the 
distortion caused by the current rules. The interest allocation 
rules must be reformed to eliminate these distortions. First, 
the interest allocation rules should take into account all the 
interest expense incurred by the multinational group, that is, 
both United States and foreign interest expense. Second, debt 
incurred by a subsidiary member of the group based on its own 
credit should be allocated separately, taking into account only 
the assets of that member and its subsidiaries. Finally, 
financial services entities, which borrow on their own credit 
rather than that of the group, should be treated as a separate 
group.
    These important reforms to the interest allocation rules 
are embodied in H.R. 2270, which was introduced recently by 
Representative Portman and Representative Matsui. The interest 
allocation rules reflected in H.R. 2270 eliminate the 
distortions caused by the current rules, thereby allowing the 
foreign tax credit to achieve its fundamental purpose, which is 
to eliminate double taxation of income earned abroad.
    In closing, I respectfully urge the Committee to enact the 
reforms reflected in H.R. 2270. Reform of the interest 
allocation rules is critical to ensuring the ability of U.S. 
multinationals to compete with their foreign counterparts, both 
abroad and in the United States. Thank you.
    [The prepared statement follows:]

Statement of William H. Laitinen, Assistant General Tax Counsel, 
General Motors Corporation, Detroit, Michigan

                            I. Introduction
    General Motors Corporation appreciates the opportunity to 
testify before the House Ways and Means Committee on 
competitiveness issues raised by the international provisions 
of the U.S. tax laws. Our testimony is submitted on behalf of a 
coalition of U.S.-based multinational companies that are 
severely penalized by a particular aspect of the international 
provisions of the U.S. tax laws: the rules regarding the 
allocation of interest expense between U.S.-source and foreign-
source income for purposes of determining the foreign tax 
credit a U.S. taxpayer may claim for foreign taxes it pays. Our 
testimony specifically focuses on the distortive and anti-
competitive impact of the present-law interest allocation 
rules, which were enacted with the Tax Reform Act of 1986, and 
the pressing need for reform of these rules.
    The present-law interest allocation rules penalize U.S. 
multinationals by artificially restricting the foreign tax 
credits they may claim. By improperly denying a credit for 
foreign taxes paid by U.S. multinationals on the income they 
earn abroad, the rules result in double taxation of such 
income. This double taxation is contrary to fundamental 
principles of international taxation and imposes on U.S.-based 
multinationals a significant cost that is not borne by their 
competitors.
    We respectfully urge the Ways and Means Committee to 
consider legislation to reform the interest allocation rules. 
Such reforms are embodied in H.R. 2270, which was introduced 
recently by Representative Portman and Representative Matsui. 
As we explain in this testimony, interest allocation reform is 
necessary in order to reflect the fundamental tax policy goal 
of avoiding double taxation and to eliminate the competitive 
disadvantage at which the present-law interest allocation rules 
place U.S.-based multinationals.
               II. Present-Law Interest Allocation Rules
    The United States taxes its corporations, citizens and 
residents on their worldwide income, without regard to whether 
such income is earned in the United States or abroad. In order 
to avoid having the same dollar of income subjected to tax both 
by the United States and by the country in which it is earned, 
the United States allows U.S. persons to claim a credit against 
U.S. taxes for the foreign taxes paid with respect to foreign-
source income. The U.S. tax laws have allowed such a foreign 
tax credit since the Revenue Act of 1918.
    The purpose of preventing double taxation requires allowing 
foreign taxes paid by a U.S. person as a credit against the 
potential U.S. tax liability with respect to the income earned 
by such person abroad. However, foreign taxes are not allowed 
as a credit against the U.S. tax liability with respect to 
income earned in the United States. Accordingly, the foreign 
tax credit limitation applies to limit the use of such credits 
to offset only the U.S. tax on foreign-source income and not 
the U.S. tax on U.S.-source income.
    In order to compute the foreign tax credit limitation, the 
U.S. taxpayer must determine its taxable income from foreign 
sources. This determination requires the allocation and 
apportionment of expenses and other deductions between U.S.-
source gross income and foreign-source gross income. Deductions 
that are allocated to foreign-source income for U.S. tax 
purposes have the effect of reducing the taxpayer's foreign tax 
credit limitation, thus reducing the amount of foreign taxes 
that may be used to offset the taxpayer's potential U.S. tax on 
income earned from foreign sources.
    Special rules enacted with the Tax Reform Act of 1986 apply 
for purposes of determining the allocation of interest expense 
between U.S.-source income and foreign-source income. Interest 
expense generally is allocated based on the relative amounts of 
U.S. assets and foreign assets. The rules enacted with the 1986 
Act generally require that interest expense be allocated by 
treating all the U.S. members of an affiliated group of 
corporations as a single corporation. Accordingly, the interest 
allocation computation is done by taking into account all the 
interest expense incurred by all the U.S. members of the group 
on a group-wide basis. Moreover, such interest expense is 
allocated based on the aggregate amounts of U.S. and foreign 
assets of all such U.S. members of the affiliated group on a 
group-wide basis.
    Under the 1986 Act provisions, the group for interest 
allocation purposes includes only the U.S. corporations in a 
multinational group of corporations and does not include 
foreign corporations that are part of the same multinational 
group. Under this approach, the interest expense incurred by 
the foreign subsidiaries in the multinational group is not 
taken into account in the allocation determination. Moreover, 
the assets of the foreign subsidiaries are not taken into 
account in determining the aggregate U.S. and foreign assets of 
the group. Rather, the stock of the foreign subsidiaries is 
treated as a foreign asset held by the group for purposes of 
allocating the interest expense of the U.S. members of the 
group between U.S. and foreign assets.
    Special rules apply to certain banks that are members of 
the affiliated group. Under these rules, banks are not included 
in the group for interest allocation purposes. Instead, such 
banks are treated as a separate group and the interest 
allocation rules are applied separately to such group.
    In addition, the regulations apply more specific tracing 
rules to allocate interest expense in certain situations. A 
tracing approach applies to the allocation of interest expense 
incurred with respect to certain nonrecourse indebtedness. Such 
an approach also applies to the allocation of interest expense 
incurred in connection with certain integrated financial 
transactions.
        III. Impact of the Present-Law Interest Allocation Rules
    The present-law interest allocation rules purport to 
reflect a principle of fungi-
bility of money, with interest expense treated as attributable 
to all the activities and assets of the U.S. members of a group 
regardless of the specific purpose for which the debt is 
incurred. However, the approach adopted with the 1986 Act does 
not truly reflect the fungibility principle because it applies 
fungibility only in one direction. Under this approach, the 
interest expense incurred by the U.S. members of an affiliated 
group is treated as funding all the activities and assets of 
such group, including the activities and assets of the foreign 
corporations in the same multinational group. However, in this 
calculation, the interest expense actually incurred by the 
foreign corporations in the group is ignored. Thus, under the 
present-law interest allocation rules, the interest expense 
incurred by the foreign corporations in a multinational group 
is not recognized as funding either the foreign corporation's 
own activities and assets or any of the activities and assets 
of other group members. This one-way street approach to 
fungibility is a gross economic distortion.
    The distortive impact of the present-law interest 
allocation rules can be illustrated with a simple example. 
Consider a U.S. parent with a single foreign subsidiary. The 
two corporations are of equal size and are equally leveraged. 
Thus, the total assets of the two corporations are equal and 
the interest expense incurred by the two corporations is equal. 
The U.S. parent's assets (other than the stock of the foreign 
subsidiary) are all U.S. assets and the foreign subsidiary's 
assets are all foreign assets. Under the present-law interest 
allocation rules, only the interest expense of the U.S. parent 
would be taken into account. This interest expense is allocated 
based on only the U.S. parent's assets, taking into account the 
stock of the foreign subsidiary as a foreign asset of the U.S. 
parent. Thus, in this case, one-half of the U.S. parent's 
assets are U.S. assets and one-half are foreign assets. 
Accordingly, one-half of the U.S. parent's interest expense is 
allocated to the foreign assets (i.e., the stock of the foreign 
subsidiary). However, the foreign subsidiary itself has 
incurred interest expense equal to that of the U.S. parent and 
representing a leverage ratio equal to that of the U.S. parent. 
From an economic perspective, none of the U.S. parent's 
interest expense in this example should be treated as 
supporting the activities or assets of the foreign subsidiary. 
The allocation of a portion of the U.S. parent's interest 
expense to foreign assets represents a double-counting of the 
interest expense that is treated as relating to foreign assets. 
Indeed, in this case, three-quarters of the group's interest 
expense (i.e., one-half of the U.S. parent's interest expense 
plus all of the foreign subsidiary's interest expense which is 
disregarded under the interest allocation rules) effectively is 
treated as relating to the foreign subsidiary, even though its 
assets represent only one-half of the group's assets. There is 
absolutely no economic basis for this result -it is an obvious 
distortion.
    By disregarding the interest expense of the foreign members 
of a multinational group, the approach reflected in the 
present-law interest allocation rules causes a disproportionate 
amount of U.S. interest expense to be allocated to the foreign 
assets of the group. This over-allocation of U.S. interest 
expense to foreign assets has the effect of reducing the amount 
of the multinational group's income that is treated as foreign-
source income for U.S. tax purposes, which in turn reduces the 
group's foreign tax credit limitation. This reduction in the 
foreign tax credit limitation has the effect of reducing the 
amount of the group's foreign taxes that can be used to offset 
its potential U.S. tax liability on its foreign-source income. 
Of course, the U.S. interest expense that is allocated to 
foreign assets under the interest allocation rules is not 
deductible for foreign tax purposes and therefore such 
allocation does not result in any reduction in the foreign 
taxes the multinational group actually pays. The allocation 
merely reduces the amount of such taxes paid that may be used 
as a credit against the potential U.S. tax liability with 
respect to the same foreign-source income. Thus, the ultimate 
result of the distortion caused by the present-law interest 
allocation rules is double taxation of the foreign income 
earned by the U.S. multinational group.
    The double taxation that results from the present-law 
interest allocation rules represents a significant cost for 
U.S.-based multinationals, a cost not borne by their foreign 
competitors. This increased cost makes it more difficult for 
U.S. multinationals to compete in the global marketplace. When 
a U.S. multinational considers a foreign expansion or 
acquisition, it must factor into its projections the fact that 
the additional foreign asset will result in an additional 
allocation to foreign-source income of the interest expense 
incurred by the multinational group in the United States. An 
additional allocation will result as the expansion or 
acquisition generates earnings even if the expansion or 
acquisition is fully supported by borrowing incurred outside 
the United States. The resulting additional allocation of U.S. 
interest expense will exacerbate the double taxation to which 
the U.S.-based multinational is subject. A foreign-based 
corporation considering the same expansion or acquisition can 
do so without this cost that arises from the distortion in the 
U.S. tax rules.
    Not only do the interest allocation rules impose a cost 
that makes it more difficult for U.S. multinationals to compete 
with their foreign counterparts with respect to foreign 
operations, the rules actually operate to put U.S. 
multinationals at a competitive disadvantage with respect to 
investments in the United States. This impact of the interest 
allocation rules is especially troubling. When a U.S.-based 
multinational makes an additional investment in the United 
States and finances that investment with debt, a portion of the 
interest expense incurred with respect to that debt is treated 
as relating to its foreign subsidiaries, even if the foreign 
subsidiaries are themselves leveraged to the same extent as the 
U.S. members of the group. Thus, the U.S. multinational 
effectively is denied a deduction for a portion of the interest 
expense on the additional debt incurred to fund the U.S. 
acquisition. A foreign corporation that makes the same 
acquisition in the United States and finances it with the same 
amount of debt will not be impacted by these interest 
allocation rules and will be entitled to a deduction for U.S. 
tax purposes for the full amount of the interest expense 
related to the acquisition. Thus, the foreign corporation 
considering an investment in the United States will face lower 
costs than a U.S.-based multinational considering the same 
investment in the United States.
          IV. Proposed Reform of the Interest Allocation Rules
    The interest allocation rules enacted with the Tax Reform 
Act of 1986 were intended to eliminate the potential for 
manipulation that arose under the then-applicable separate 
company approach to interest allocation. The 1986 Act rules 
requiring interest to be allocated on a group basis addressed 
that concern. However, by drawing the line for interest 
allocation at the water's-edge and ignoring the interest 
expense incurred by the foreign members of a U.S. multinational 
group, the present-law rules create a fundamental distortion. 
There is no tax policy rationale that supports the distortion 
caused by the present-law rules. The interest allocation rules 
must be reformed to eliminate these distortions and to reflect 
a defensible result from a tax policy perspective. Eliminating 
such distortions will remove a significant barrier to the 
competitiveness of U.S. multinationals in the global 
marketplace.
    First, interest expense should be allocated consistent with 
the actual economics of the debt structure of the U.S. 
multinational group. In order to accurately reflect the 
principle of fungibility, such principle must be applied on a 
worldwide basis. Under a worldwide fungibility approach, the 
foreign-source income of the U.S. multinational group generally 
would be determined by allocating all interest expense of the 
worldwide affiliated group on a group-wide basis. The interest 
allocation computation would take into account both the 
interest expense of the foreign members of the affiliated group 
and the assets of such members. Interest expense incurred by a 
foreign subsidiary thus would reduce the amount of the U.S. 
interest expense that would be allocated to foreign-source 
income. This approach would eliminate the double-counting of 
the amount of interest expense treated as the cost of holding 
the assets of a foreign subsidiary that occurs under the 
present-law rules.
    Moreover, interest expense should be more specifically 
allocated where the debt does not fund the entire multinational 
group. In other words, the principle of fungibility should be 
applied to a smaller group of companies in cases where the debt 
is incurred by (and based on the credit of) a member other than 
the common parent. While debt incurred by one lower-tier member 
of an affiliated group may be viewed as funding the assets and 
activities of that corporation and its subsidiaries, such debt 
does not fund the assets and activities of other members of the 
group (such as the parent or sister corporations of the 
borrowing corporation). Thus, it is appropriate to permit the 
interest expense associated with such debt to be allocated 
based solely on the assets of the subgroup of corporations that 
consists of the borrower and its subsidiaries.
    Finally, it is appropriate to separate financial services 
entities -which tend to have debt structures that are very 
different from the other members of an affiliated group -for 
purposes of the allocation of interest. This treatment of 
financial services entities as a separate subgroup is 
consistent with the present-law rule treating banks as a 
separate subgroup. However, this expansion of the present-law 
bank rule recognizes that such treatment should encompass all 
financial services entities rather than only entities regulated 
as banks.
    These important reforms to the interest allocation rules 
are embodied in H.R. 2270, the Interest Allocation Reform Act, 
which was introduced recently by Representative Portman and 
Representative Matsui. The interest allocation rules reflected 
in H.R. 2270 eliminate the distortions caused by the present-
law rules, facilitating the operation of the foreign tax credit 
to eliminate double taxation of income earned abroad. Enactment 
of the reforms reflected in H.R. 2270 is critical to ensuring 
the ability of U.S.-based multinationals to compete with their 
foreign counterparts, both with respect to operations abroad 
and with respect to operations in the United States.
                 V. Technical Explanation of H.R. 2270
    A detailed technical explanation of the provisions of H.R. 
2270 is set forth below.

In General

    H.R. 2270 would modify the present-law interest allocation 
rules of section 864(e) that were enacted by the Tax Reform Act 
of 1986. Under the bill's modifications, interest expense 
generally would be allocated by applying the principle of 
fungibility to the taxpayer's worldwide affiliated group 
(rather than to just the U.S. affiliated group). In addition, 
under special rules, interest expense incurred by a lower-tier 
U.S. member of an affiliated group could be allocated by 
applying the principle of fungibility to the subgroup 
consisting of the borrower and its direct and indirect 
subsidiaries. H.R. 2270 also would allow members engaged in the 
active conduct of a financial services business to be treated 
as a separate group. Finally, the bill would provide specific 
regulatory authority for the direct allocation of interest 
expense in other circumstances where such tracing is 
appropriate.
    Under H.R. 2270, a taxpayer would be able to make a one-
time election to apply the modified rules reflected in the bill 
rather than the interest allocation rules of present law. Such 
election would be required to be made for the taxpayer's first 
taxable year to which the bill is applicable and for which it 
is a member of an affiliated group, and could be revoked only 
with IRS consent. Such election, if made, would apply to all 
the members of the affiliated group.
    H.R. 2270 generally is not intended to modify the 
interpretive guidance contained in the regulations under the 
present-law interest allocation rules that is relevant to the 
rules reflected in the bill, and such guidance is intended to 
continue to be applicable.

Worldwide Fungibility

    Under H.R. 2270, the taxable income of an affiliated group 
from sources outside the United States generally would be 
determined by allocating and apportioning all interest expense 
of the worldwide affiliated group on a group-wide basis. For 
this purpose, the worldwide affiliated group would include not 
only the U.S. members of the affiliated group, but also the 
foreign corporations that would be eligible to be included in a 
consolidated return if they were not foreign. Both the interest 
expense and the assets of all members of the worldwide 
affiliated group would be taken into account for purposes of 
the allocation and apportionment of interest expense. 
Accordingly, interest expense incurred by a foreign subsidiary 
would be taken into account in determining the initial 
allocation and apportionment of interest expense to foreign-
source income. The interest expense incurred by the foreign 
subsidiaries would not be deductible on the U.S. consolidated 
return. Accordingly, the amount of interest expense allocated 
to foreign-source income on the U.S. consolidated return would 
be reduced (but not below zero) by the amount of interest 
expense incurred by the foreign members of the worldwide group, 
to the extent that such interest would be allocated to foreign 
sources if these rules were applied separately to a group 
consisting of just the foreign members of the worldwide 
affiliated group. As under the present-law rules for affiliated 
groups, debt between members of the worldwide affiliated group, 
and stockholdings in group members, would be eliminated for 
purposes of determining total interest expense of the worldwide 
affiliated group, computing asset ratios, and computing the 
reduction in the allocation to foreign-source income for 
interest expense incurred by a foreign member.
    As under the present-law rules, taxpayers would be required 
to allocate and apportion interest expense on the basis of 
assets (rather than gross income). Because foreign members 
would be included in the worldwide affiliated group, the 
computation would take into account the assets of such foreign 
members (rather than the stock in such foreign members). For 
purposes of applying this asset method, as under the present-
law rules, if members of the worldwide affiliated group hold at 
least 10 percent (by vote) of the stock of a corporation (U.S. 
or foreign) that is not a member of such group, the adjusted 
basis in such stock would be increased by the earnings and 
profits that are attributable to such stock and that are 
accumulated during the period that the members hold such stock. 
Similarly, the adjusted basis in such stock would be reduced by 
any deficit in earnings and profits that is attributable to 
such stock and that arose during such period. However, unlike 
under the present-law rules, these basis adjustment rules would 
not be applicable to the stock of the foreign members of the 
expanded affiliated group (because such members would be 
included in the group for interest allocation purposes).
    Under H.R. 2270, interest expense would be allocated and 
apportioned based on the assets of the expanded affiliated 
group. For interest allocation purposes, the affiliated group 
would be determined under section 1504 but would include life 
insurance companies without regard to whether such companies 
are covered by an election under section 1504(c)(2) to include 
them in the affiliated group under section 1504. This 
definition of affiliated group would be the starting point for 
the expanded affiliated group. In addition, the expanded 
affiliated group would include section 936 companies (which are 
included in the group for interest allocation purposes under 
present law). The expanded affiliated group also would include 
foreign corporations that would be included in the affiliated 
group under section 1504 if they were domestic corporations; 
consistent with the present-law exclusion of DISCs from the 
affiliated group, FSCs would not be included in the expanded 
affiliated group.

Subgroup Election

    H.R. 2270 also provides a special method for the allocation 
and apportionment of interest expense with respect to certain 
debt incurred by members of an affiliated group below the top 
tier. Under this method, interest expense attributable to 
qualified debt incurred by a U.S. member of an affiliated group 
could be allocated and apportioned by looking just to the 
subgroup consisting of the borrower and its direct and indirect 
subsidiaries (including foreign subsidiaries). Debt would 
qualify for this purpose if it is a borrowing from an unrelated 
person that is not guaranteed or otherwise directly supported 
by any other corporation within the worldwide affiliated group 
(other than another member of such subgroup). Debt that does 
not qualify because of such a guarantee (or other direct 
support) would be treated as debt of the guarantor (or, if the 
guarantor is not in the same chain of corporations as the 
borrower, as debt of the common parent of the guarantor and the 
borrower). If this subgroup method is elected by any member of 
an affiliated group, it would be required to be applied to the 
interest expense attributable to all qualified debt of all U.S. 
members of the group.
    When this subgroup method is used, certain transfers from 
one U.S. member of the affiliated group to another would be 
treated as reducing the amount of qualified debt. If a U.S. 
member with qualified debt makes dividend or other 
distributions in a taxable year to another member of the 
affiliated group that exceed the greater of its average annual 
dividend (as a percentage of current earnings and profits) 
during the five preceding years or 25 percent of its average 
annual earnings and profits for such period, an amount of its 
qualified debt equal to such excess would be recharacterized as 
nonqualified. A similar rule would apply to the extent that a 
U.S. member with qualified debt deals with a related party on a 
basis that is not arm's length. Interest attributable to any 
debt that is recharacterized as nonqualified would be allocated 
and apportioned by looking to the entire worldwide affiliated 
group (rather than to the subgroup).
    If this subgroup method is used, an equalization rule would 
apply to the allocation and apportionment of interest expense 
of members of the affiliated group that is attributable to 
nonqualified debt. Such interest expense would be allocated and 
apportioned first to foreign sources to the extent necessary to 
achieve (to the extent possible) the allocation and 
apportionment that would have resulted had the subgroup method 
not been applied.

Financial Services Group Election

    Under H.R. 2270, a modified and expanded version of the 
special bank group rule of present law would apply. Under this 
election, the allocation and apportionment of interest expense 
could be determined separately for the subgroup of the expanded 
affiliated group that consists solely of members that are 
predominantly engaged in the active conduct of a banking, 
insurance, financing or similar business. For this purpose, the 
determination of whether a member is predominantly so engaged 
would be made under rules similar to the rules of section 
904(d)(2)(C) and the regulations thereunder (relating to the 
determination of income in the financial services basket for 
foreign tax credit purposes). Accordingly, a member would be 
considered to be predominantly engaged in the active conduct of 
a banking, insurance, financing, or similar business if at 
least 80 percent of its gross income is active financing income 
as described in Treas. Reg. sec. 1. 904-4(e)(2). As under the 
subgroup rule, certain transfers of funds from a U.S. member of 
the financial services group to another member of the 
affiliated group that is not a member of the financial services 
group would reduce the interest expense that is allocated and 
apportioned based on the financial services group. Also as 
under the subgroup rule, if elected, this rule would apply to 
all members that are considered to be predominantly engaged in 
the active conduct of a banking, insurance, financing, or 
similar business.
                             IV. Conclusion
    The present-law interest allocation rules operate to deny 
U.S. multinationals foreign tax credits for the taxes they pay 
to foreign jurisdictions. The rules thus subject U.S. 
multinationals to double taxation of their income earned 
abroad. This double taxation represents a burden on U.S.-based 
multinationals that hinders their ability to compete against 
their foreign counterparts. Indeed, the distortions caused by 
the interest allocation rules impose a substantial cost that 
affects the ability of U.S.-based multinationals to compete 
against foreign companies both with respect to foreign 
operations and with respect to their operations in the United 
States.
    H.R. 2270 would reform the interest allocation rules to 
eliminate these rules. The interest allocation rules reflected 
in H.R. 2270 represent sound tax policy and are consistent with 
the goal of eliminating double taxation. Such rules would allow 
the foreign tax credit limitation to operate properly. We 
respectfully urge the Congress to enact the reforms reflected 
in H.R. 2270 in order to eliminate the unfair, anti-
competitive, and indefensible burden that the present-law 
interest allocation rules have imposed on U.S. multinationals 
for the last thirteen years.

                                


    Chairman Archer. Thank you, Mr. Laitinen. Mr. Hamod, you 
may proceed.

   STATEMENT OF DAVID HAMOD, EXECUTIVE DIRECTOR, SECTION 911 
                           COALITION

    Mr. Hamod. Thank you, Mr. Chairman, for the opportunity to 
testify today. My name is David Hamod, and I serve as the 
Executive Director of the section 911 Coalition. Our Coalition 
consists of business organizations, non-profit entities, and 
companies that have come together in recent years to call 
attention to the importance of the Section 911 foreign earned 
income exclusion. The Coalition has some 75 members, including 
representatives of the more than 75 American chambers of 
commerce around the world and nearly 550 American and 
international schools abroad.
    On a personal note, Mr. Chairman, Americans around the 
world want to thank you for your consistent support for 
American communities overseas. No one in Congress during the 
past two decades has been a more outspoken advocate for, or 
more tenacious defender of, the foreign earned income exclusion 
and the jobs that it helps to create here in the United States.
    Mr. Chairman, if I were to take this 23-page testimony and 
boil it down to just a few words, they would be these: 
Americans abroad = U.S. exports = U.S. jobs. Any businessowner 
will tell you that to generate business, you have got to put 
your sales people into the field. Experience shows that 
Americans abroad are the best salesmen and best saleswomen for 
U.S. goods and services overseas. They drive U.S. exports, 
which, in turn, generate U.S. jobs. We know that Americans 
abroad buy American, sell American, specify American, hire 
American, and create other business opportunities for Americans 
overseas.
    Despite the obvious importance of employing Americans 
overseas, U.S. tax policy puts American workers abroad and 
their employers at a significant competitive disadvantage. The 
United States is the only major industrial country in the world 
that taxes on the basis of citizenship rather than residence. 
Because this U.S. tax policy is out of step with the rest of 
the world, American workers are significantly more expensive to 
hire than are comparably qualified foreign nationals. As a 
result, the trend worldwide is to replace American workers with 
less expensive third-country nationals, particularly Europeans.
    In the continuing battle for international market share, 
Section 911 has proved to be one of the most important weapons 
in America's trade arsenal because this exclusion: (1) makes 
U.S. citizens working overseas more competitive with foreign 
nationals, who pay no tax on their overseas earned income; (2) 
makes American companies more competitive in their bids on 
overseas projects; and, (3) helps to put Americans into the 
field overseas where they promote U.S. goods and services and 
create hundreds of thousands of jobs here in the United States.
    In 1995, the section 911 Coalition commissioned two 
independent studies that reinforced the long-held view that 
section 911 is especially important to the little guy overseas: 
small and medium-sized companies, American educators, clergy, 
NGOs and others. Summaries of these studies are attached to 
this testimony, but two key points bear repeating this 
afternoon. First, nearly two-thirds of small and large 
companies said their competitive advantage would improve if the 
exclusion were increased from $70,000 to at least $100,000 back 
in 1995.
    Second, without Section 911, there would be a decline in 
U.S. exports of almost 2 percent. This translates into $8.7 
billion in lost exports and a loss of upward of 150,000 direct 
U.S.-based jobs. These figures do not include service-related 
jobs or indirect employment, which would probably double the 
number of jobs lost.
    Mr. Chairman, I have good news and I have bad news. First, 
the good news is that 2 years ago, under your leadership, the 
Ways and Means Committee and Congress helped to temporarily 
shore up Section 911 through the Taxpayer Relief Act of 1997.
    The bad news, as this chart illustrates, is that the 
Section 911 exclusion continues to lose ground. According to 
Pricewaterhouse-
Coopers, the 1999 exclusion amount in real dollars is 45 
percent below its level in 1983, when the exclusion topped out 
at $80,000. The real value of the exclusion is projected to 
continue falling after 1999 and is expected to stabilize in the 
year 2007 at approximately $65,150 in 1999 dollars.
    Looked at from a purchasing power point of view, the value 
of the exclusion will have plummeted in real dollars from 
$134,197 back in 1983 to $65,150 in 2007, a devastating loss of 
nearly $70,000 in 1999 dollars. The exclusion was $80,000 in 
1983; it will again be $80,000 in 2008, 25 years later. And as 
we all know, Mr. Chairman, $80,000 today doesn't buy what it 
did a quarter-century ago.
    In the long-run, Congress should remove the limitation on 
the Section 911 exclusion. But in the short-term, the Coalition 
is proposing an interim step designed to restore value to the 
exclusion that has been eroded over the years as a result of 
inflation. We recommend that the foreign earned income 
exclusion be adjusted, beginning in calendar year 2000, to 
compensate for the effects of inflation since 1983, when the 
exclusion was frozen at $80,000. This indexation would help to 
stop the deterioration of Section 911 and it would also be 
consistent with the inflation adjustments made in many other 
dollar amounts in the individual income tax system.
    In conclusion, Mr. Chairman, as you yourself have said, our 
work is not yet done. We hope that the Committee will look 
favorably upon our proposal. It represents a small investment 
that we believe will position the United States to compete in 
the 21st century and yield billions of dollars worth of 
dividends to the U.S. economy in the years ahead. Thank you, 
Mr. Chairman, for the opportunity to testify today.
    [The prepared statement follows:]

Statement of David Hamod, Executive Director, Section 911 Coalition

    Thank you, Mr. Chairman, for the opportunity to testify 
today. My name is David Hamod, and I serve as Executive 
Director of the Section 911 Coalition. Our coalition consists 
of business organizations, non-profit entities, and companies 
that have come together in recent years to call attention to 
the importance of the Section 911 foreign earned income 
exclusion. The Coalition has some 75 members, including 
representatives of more than 75 American chambers of commerce 
overseas and nearly 550 American and international schools 
abroad. (A list of Section 911 Coalition members is attached to 
this testimony as Appendix A.)
    In recent years, the stock market notwithstanding, exports 
have been the most impressive engine of growth for America's 
economy. It goes without saying that exports don't just happen 
by themselves. Independent studies and raw statistical data 
show a direct correlation between the number of Americans 
working overseas and the level of U.S. exports. Any business 
owner will tell you that to generate business, you've got to 
put your sales people in the field. Experience shows that 
Americans abroad are the best salesmen and saleswomen for U.S. 
goods and services overseas. The bottom line, Mr. Chairman, is 
this:

Americans Abroad = U.S. Exports = U.S. Jobs.

    In the ongoing battle for international market share, the 
Section 911 exclusion has proved to be one of the most 
important weapons in America's trade arsenal. By helping to 
maintain U.S. citizens ``in the field'' around the world, where 
they promote America's national interests on a daily basis, 
Section 911 has had a direct impact on the competitiveness of 
American workers and U.S. companies operating in foreign 
markets.
    Two years ago, the Ways and Means Committee responded very 
positively to an initiative by Americans worldwide to increase 
the foreign earned income exclusion. Under your leadership, Mr. 
Chairman, the Committee (and ultimately, Congress) increased 
Section 911 by $2,000 per year, leveling off at $80,000 in 
calendar year 2002. Beginning in calendar year 2008, the 
$80,000 exclusion will also be adjusted for inflation for 2008 
and subsequent years.
    We are very grateful for this increase, which has helped to 
shore up temporarily the backsliding that the foreign earned 
income exclusion has experienced for more than a decade. But as 
you have said yourself, Mr. Chairman, our work is not yet done. 
The changes of two years ago represent an important step in the 
right direction, but U.S. companies overseas and American 
workers abroad must continue to make their case to Congress to 
level the international business playing field for the United 
States.
    Even with the positive changes enacted under the Taxpayer 
Relief Act of 1997, the Section 911 exclusion continues to lose 
ground. According to Pricewaterhouse-
Coopers LLP, the 1999 exclusion amount, in real dollars, is 45 
percent below its level in 1983 ($80,000 in nominal dollars and 
$134,197 in 1999 dollars), following passage of the Economic 
Recovery Tax Act of 1981. The real value of the exclusion is 
projected to continue falling after 1999 and is expected to 
stabilize in the year 2007 at approximately $65,150 in 1999 
dollars. Looked at from a ``purchasing power'' point of view, 
the value of the exclusion will have plummeted in real dollars 
from $134,197 (1983) to $65,150 (2007), a devastating loss of 
nearly $70,000 in 1999 dollars. Under these circumstances, Mr. 
Chairman, the Section 911 Coalition is very concerned about 
``locking in'' indexation of the exclusion at an unacceptable 
level from the year 2008 onwards. (A copy of the June 28, 1999 
report by PricewaterhouseCoopers LLP--The Effect of Inflation 
on the Foreign Earned Income Exclusion Amount--is attached to 
this testimony as Appendix B.)
    Ideally, Congress should remove the limitations on the 
Section 911 exclusion in order to give American workers an 
equal footing in the global marketplace. None of America's 
major trade competitors tax foreign earned income, and the U.S. 
should also move to an unlimited exclusion. (The only countries 
that tax on the basis of citizenship rather than residence, 
like the United States, appear to be Bulgaria, Gabon, Honduras, 
Indonesia, Jamaica, Kenya, Korea, Philippines, Senegal, and 
Zambia.) Reinstating the unlimited exclusion today would be a 
forward-looking measure and would do more to move the United 
States toward a consistent foreign trade surplus than would 
many other proposals under consideration by Congress.
    We realize, however, that removing the cap on the foreign 
earned income exclusion may not be possible at a time when 
Congress is grappling with so many major budgetary 
considerations. This is especially true because under the 
current revenue estimating procedure, the unlimited exclusion, 
in the short-term, would somewhat curtail tax revenues. Our 
Coalition would argue, however, that in the medium-term and 
long-term, net revenue gains would be substantial and would 
more than compensate for short-term losses.
    With this in mind, Mr. Chairman, the Section 911 Coalition 
proposes an interim measure for the Committee's consideration. 
This step is designed to restore value to the exclusion that 
has been eroded over the years as a result of inflation.
    We propose that the foreign earned income exclusion be 
adjusted, beginning in calendar year 2000, to compensate for 
the effects of inflation since 1983, when the Deficit Reduction 
Act of 1984 froze the exclusion at $80,000. This indexation 
would help to stop the deterioration of Section 911, and it 
would also be consistent with the inflation adjustments made in 
many other dollar amounts in the individual income tax system--
the standard deduction, personal exemption, tax bracket 
amounts, earned income credit, phase-out of itemized deductions 
and personal exemptions, and so on.
    Enactment of this measure would represent an important step 
forward for U.S. companies and American workers overseas. Our 
Coalition believes that by making American workers more 
affordable in the global marketplace, Congress would pave the 
way for more U.S. citizens overseas to buy American, sell 
American, specify American, hire American, and create 
opportunities for other Americans abroad. In short, this 
measure represents a relatively small investment that will 
position the United States to compete in the twenty-first 
century and yield billions of dollars worth of dividends to the 
U.S. economy in the years ahead.
                    1. Section 911: The Big Picture
    Section 911 provides for a foreign earned income exclusion 
of up to $74,000 annually to Americans working overseas, 
thereby assisting them to compete against comparably qualified 
non-Americans (who pay no taxes on income earned abroad). A 
U.S. citizen or resident alien whose tax home is outside the 
United States and who is a bona fide resident of a foreign 
country or who is present in a foreign country for 11 months 
out of 12 (330 days in any 365 day period) may exclude from 
gross income up to $74,000 per year of foreign earned income, 
plus a housing cost amount.
    The foreign earned income exclusion has been part of the 
Internal Revenue Code since 1926, when it was unlimited for 
bona fide residents of a foreign country. (For a short history 
of the foreign earned income exclusion, see Appendix C.) 
Congress enacted the exclusion more than 70 years ago in an 
effort to ``encourage citizens to go abroad and to place them 
in an equal position with citizens of other countries going 
abroad who are not taxed by their own countries.'' (Senate 
Report No. 781, 82nd Congress, 1st Session, 1951, pp. 52-53.)
    America's trade competitors realized long ago that 
encouraging their citizens to work overseas has a pronounced, 
salutary impact on their domestic economies. Sending their 
workers abroad has become an integral part of these nations' 
export strategies. To facilitate this ``export'' of their 
citizens (and thus the export of products and services), other 
governments do not tax their citizens on the money they make 
while working abroad. This makes these citizens extremely 
competitive in foreign markets.
    U.S. Government tax policies, by contrast, have generally 
discouraged Americans from working abroad. Alone among the 
world's industrialized nations, the United States still taxes 
its citizens on the basis of citizenship rather than residence. 
Further, overseas Americans must also pay U.S. income tax on 
benefits, allowances, and overseas adjustments. The practical 
effects of this tax policy are clear: Americans overseas are at 
a significant competitive disadvantage and are being priced out 
of foreign markets because prospective employers must provide 
more income to compensate American workers for these additional 
tax burdens.
    Overseas employers are faced with a choice: They must pay 
an American worker more than they would pay other comparably 
qualified nationals (so that the American may keep a comparable 
after-tax income) or they must utilize a tax equalization 
program to keep the employee whole for his or her additional 
tax burden. Both approaches involve additional costs to the 
employer--a burden that many employers are unwilling to accept 
even if the American worker is more productive and has better 
professional qualifications than the competition.
    For those companies that have a tax equalization program in 
place, where the company pays any actual taxes for its overseas 
employees, the Section 911 exclusion helps to mitigate the tax 
burden mentioned above--thereby cutting company costs and 
enabling it to be more competitive abroad. For companies that 
do not utilize a tax equalization program--and most small and 
medium-sized companies working overseas fall into this 
category--the Section 911 exclusion is most helpful to the 
employee, who is responsible for paying his own taxes. The 
current exclusion helps to make a difference in both cases, but 
the difference may still not be substantial enough to enable an 
American worker overseas to defend his or her job against 
foreign nationals.
    The cost of hiring or maintaining an American worker is 
inordinately high because non-salary, quality-of-life items 
must be included in the worker's taxable income, often adding 
as much as 50 -100 percent of base pay. Such ``income'' 
includes reimbursement for the cost of children's schooling, 
cost-of-living allowances, home leave, emergency travel, and 
other necessary and often expensive aspects of living overseas. 
Because so many overseas contracts today are decided on the 
basis of cost, and when companies' profit margins grow tighter 
and tighter, many employers (including American employers) 
simply aren't prepared to cover the additional tax burden to 
``Hire American.''
    A Section 911 Coalition member offered this case in point:

          A large American company recently won a multi-billion dollar, 
        multi-year overseas contract to supply telecommunications 
        equipment and services. The U.S.-based company would prefer to 
        have Americans heading its overseas operations but, because the 
        U.S. tax system effectively prices Americans out of the 
        international job market, the company tends to hire Europeans 
        instead. The President of this company's international 
        operations is British, and his Vice President is Dutch. Not 
        surprisingly, the Human Resources Director, who answers to the 
        Vice President, is also from Holland. He has hired 
        approximately 2,000 technical employees for this project, most 
        of whom are Dutch. In addition, Volvos were purchased instead 
        of U.S.-made vehicles because they are considered ``more 
        suitable'' for the technical employees. If the U.S. tax system 
        were more like those of America's trade competitors, who 
        maintain an unlimited foreign earned income exclusion, most of 
        these 2,000+ jobs would have gone to Americans rather than 
        Europeans, and a large number of American cars would have been 
        exported and purchased instead of Volvos.

    Section 911 is important because it makes a substantial 
difference in our nation's efforts to compete on the 
international business playing field. Without this exclusion, 
there is good reason to believe that many thousands of 
Americans currently overseas would be priced out of the global 
marketplace. This would be a devastating blow to America's 
national interests because Americans abroad:

           Direct business and jobs to the United States;
           Carry America's culture and business ethic to other 
        nations;
           Specify and purchase U.S. goods and services for 
        overseas projects;
           Set standards and shape ideas that guide future 
        policies in the development of infrastructures and economies 
        overseas.

    In addition, for U.S. companies to continue expanding their 
market share worldwide, they must think and act globally. To 
stay competitive internationally, American managers need the 
kind of ``hands on'' experience that can only be gained by 
living and working abroad. In recent years, for example, two of 
the traditional Big Three automobile companies promoted their 
CEOs directly from European positions to corporate 
headquarters. This clearly demonstrates recognition by these 
companies of the role that international experience plays in 
their economic futures.
    In short, Mr. Chairman, Section 911 helps to protect 
against replacement of Americans abroad by third country 
nationals who pay no taxes at all on their overseas income. 
Given the tens of thousands of overseas business opportunities 
that are of interest to U.S. companies and U.S.-based 
institutions each year, increasing the Section 911 exclusion 
stands to make a substantial difference for American influence 
abroad, U.S. exports, U.S. jobs, and overall American 
competitiveness.
                   2. Who Benefits from Section 911?
    The loss of U.S. market share and the cutback in American 
jobs overseas represent a setback for American competitiveness. 
However, this tells only part of the story. The other part, of 
more immediate concern here at home, is the impact felt in 
communities all across the United States as jobs created or 
sustained by exports would disappear.
    All Americans abroad, whatever their background, are 
helping to fuel the economy in the United States. By securing 
employment overseas, they free up jobs for other Americans back 
home, thereby reducing unemployment. They also support the 
American economy by repatriating much of their overseas 
earnings back to the United States. Most important of all, 
perhaps, Americans working overseas serve as the front-line 
marketing and sales force for U.S. exports. Unless all 
Americans support competitiveness through exports, our nation's 
trade deficit will surely continue. I noted earlier that 
exports are the engine of growth for the U.S. economy, and it 
is generally accepted that small and medium-sized companies 
provide the fuel for this engine. When the engine of growth is 
stalled out by constrictive U.S. tax laws that are no longer 
appropriate, Americans everywhere pay the price.
    For years, supporters of Section 911 have emphasized that 
the exclusion is especially important to small and medium-sized 
companies operating in overseas markets. ``Real world'' 
experience has borne out that:
    (1) Small companies, when trying to gain a foothold 
overseas, are more likely than large companies (many with an 
established overseas presence already) to draw on U.S.-based 
personnel to penetrate foreign markets.
    (2) Small and medium-sized companies, because they lack the 
world-class name recognition that might provide them with open 
access to foreign customers, traditionally rely very heavily on 
Americans overseas to specify and purchase their products.
    (3) Small and medium-sized companies are, by necessity, 
much more sensitive to individual cost elements and the 
financial bottom line. Without the $74,000 Section 911 
exclusion to help make overseas Americans more competitive with 
foreign nationals, relatively few of these small and medium-
sized companies would be able to hire Americans to fill 
overseas slots.
    In 1995, the Section 911 Coalition commissioned two 
independent studies to look at the impact of the foreign earned 
income exclusion on U.S. business. (A one-page summary of each 
study is attached to this testimony as Appendices D and E.) One 
study was conducted by Price Waterhouse LLP (Economic Analysis 
of the Foreign Earned Income Exclusion), while the other was 
undertaken by professors at The Johns Hopkins University School 
of Advanced International Studies--SAIS (The Importance of 
Section 911 for U.S. International Competitiveness). Both 
studies reinforced the long-held view that Section 911 is 
especially important to the ``little guy'' trying to do 
business overseas. (This also applies to American schools 
abroad, whose efforts to provide educational services overseas 
have played an instrumental role in promoting an American 
lifestyle and U.S. products.) The studies indicated that:
     For small and medium-sized companies (0-500 
employees), elimination of the Section 911 exclusion would have 
a significant impact on the ability of American workers abroad 
to keep their jobs. In a survey conducted by the SAIS 
professors for the Section 911 Coalition, nearly two-thirds (64 
percent) of small and medium-sized respondents said elimination 
of Section 911 would result in a ``moderate'' change (6 to 25 
percent) or a ``major'' change (above 25 percent) in their 
ability to retain American employees overseas. (In the same 
survey, 70 percent of large companies said elimination of 
Section 911 would result in some job loss change, and 38 
percent said this change would be a moderate or major change.)
     For small and medium-sized companies, elimination 
of Section 911 would have an even greater impact on prospective 
U.S. citizen hires that would be lost or substituted with 
foreign nationals. Eighty-five percent of these companies said 
elimination of Section 911 would result in a moderate or major 
change in their future hiring practices. (For small and medium-
sized companies responding to the survey, 32 percent of their 
total overseas employees are U.S. nationals.) Fifty-four 
percent of the large companies said elimination of Section 911 
would result in a moderate or major change in their future 
hiring practices.
     For small and medium-sized companies, elimination 
of Section 911 would have a substantial impact on these 
companies' abilities to secure projects or compete abroad. 
Eighty-two percent of these companies said the loss of this 
exclusion would result in a moderate or major change in their 
ability to secure projects or compete abroad. (The equivalent 
number for large companies was 64 percent.)
     For small and large companies alike, there was 
widespread agreement that increasing the exclusion from $70,000 
(in 1995) to $100,000 would have a substantive impact on their 
ability to secure projects. Sixty-five percent of respondents 
said their competitive advantage would improve, with 38 percent 
stating that the improvement would be moderate or major.
     For small and medium-sized companies, U.S. 
nationals employed abroad are far more likely to source their 
imports of goods and services from the United States. Eighty-
nine percent of these companies said there is a tendency to 
source American, with 76 percent stating that this is a ``large 
tendency.'' (The equivalent number for large companies was 77 
percent and 46 percent, respectively. This is especially 
meaningful because U.S. multinational corporations accounted in 
1995 for 58 percent of U.S. exports and that almost half of 
that trade was between parent companies and affiliates, 
according to the March 1995 ``Survey of Current Business.'') 
Seventy-seven percent of all respondents (small and large) made 
it clear that U.S. citizens abroad ``Buy American'' and that 
more than two-thirds of these found a ``large tendency'' to 
source U.S. goods and services.
     With regard to compensation levels, the benefits 
of Section 911 are more important for lower-paid Americans 
abroad (such as employees of small companies, educators, NGOs 
and non-profit organizations) than for higher-paid Americans 
abroad. If Section 911 had been eliminated in 1993, employers 
would have needed to increase compensation by 12.7 percent to 
protect the after-tax income of U.S. expatriates at the lower 
end of the income scale (base pay of $12,720 per year). At the 
other end of the scale, for those with a base pay of $152,640 
per year, compensation would have needed to increase by an 
average of only 6.8 percent.
    This latter finding reinforces a 1993 U.S. Treasury 
Department study which noted that Section 911 is an important 
mechanism for mitigating the tax liability of lower income 
taxpayers working abroad. (U.S. Department of the Treasury, 
Taxation of Americans Working Overseas--Operation of the 
Foreign Earned Income Exclusion in 1987, January 1993.) These 
facts do not support the negative ``spin'' that some would put 
on the foreign earned income exclusion--the wrongheaded 
suggestion that the exclusion benefits only the so-called 
corporate ``fat cats.''
    It is also important to note, however, that more senior 
(and consequently more expensive) managers working overseas 
tend to be best positioned to benefit the U.S. economy most. 
The senior managers are more likely to influence the buying and 
hiring decisions of their company, and they are also more 
likely to assist other U.S. companies trying to do business 
abroad. In addition, they are the ones most apt to gain the 
international experience required by future senior executives 
for American companies looking to compete successfully in the 
increasingly global economy.
    Nevertheless, it is often very difficult to persuade key 
employees to adjust their career paths and family situations by 
leaving corporate headquarters and the United States. And from 
the companies' perspective, despite the many advantages of 
hiring American peak performers to head overseas offices, 
current tax policies tend to make this option prohibitively 
expensive.
                3. Nuts and Bolts: How Section 911 Works
    The cost of hiring an American varies widely around the 
world depending on such factors as local housing costs, local 
standards of living, availability of schools and recreation 
facilities, remoteness and hardships, and so forth. 
Nevertheless, it may be instructive to look at a typical 
example of how the foreign earned income exclusion works. The 
American Business Council of the Gulf Countries, an Executive 
Committee member of the Section 911 Coalition, provided the 
following example.

          The cost for a grade school student to attend the American 
        School in Dubai is approximately $10,000 per year--not for an 
        exclusive private school, but for the only American curriculum 
        school there. If an employer reimburses this cost for two 
        children, the employee has an additional $20,000 of imputed 
        taxable ``income.'' This places an additional tax burden on the 
        individual of up to $8,000.
          If the employer chooses to make the reimbursement of this 
        schooling cost tax-neutral to the employee, the total 
        reimbursement cost to the company could exceed $33,000 
        (including the compounding effect of tax reimbursements, which 
        are also considered taxable ``income'' to the employee). This 
        represents a $13,000 (65 percent) additional cost to the 
        company to provide education for the American employee's 
        children (compared to providing the same education for children 
        of a comparable European employee)--simply because of U.S. tax 
        policy.
          If the employer provides an annual trip back to the United 
        States for home leave for the employee and family (spouse and 
        two children), the employee has an additional $10,000 or more 
        of taxable ``income.'' Emergency and sympathy travel generate 
        taxable income; cost of living adjustments are considered 
        taxable income; hardship allowances are taxable income; tax 
        reimbursement is taxable income.

    In other words, as this typical example shows, taxable 
compensation that does not represent either ``perks'' or 
disposable income to the employee typically absorbs a very 
large part of the current $74,000 exclusion. This is a burden 
borne solely by Americans, significantly hampering their 
ability to compete in the international arena.
    The National Constructors Association, another member of 
the Coalition's Executive Committee, asked one of its member 
companies in recent years to compare the annual costs of 
employing an engineer with and without the benefit of Section 
911. The results of this comparison are striking:


----------------------------------------------------------------------------------------------------------------
                                                                                           Saudi
                                                            Hong Kong   United Kingdom     Arabia       Chile
----------------------------------------------------------------------------------------------------------------
Engineer's Base Pay......................................     $112,800        $100,000     $121,824     $100,000
Tax Cost to Company with 911  Exclusion..................      $11,743         $34,275      $11,433       $4,843
Tax Cost to Company without 911  Exclusion...............     $103,513         $51,151      $66,019      $27,413
Increased Tax Cost to Company............................      $91,770        $16,876*      $54,586     $22,570*
----------------------------------------------------------------------------------------------------------------
* In high tax countries, these savings may not be typical but may be realized in certain dual-contract
  situations. It should also be noted that the tax burden shown above includes taxes on allowances.

    While the Section 911 exclusion is particularly helpful in 
low-tax foreign jurisdictions like Saudi Arabia and Hong Kong, 
it can also make a very substantial difference in those nations 
with relatively high levels of individual income tax. Filings 
of Internal Revenue Service Form 2555 provide an adequate 
measure of those Americans abroad utilizing the Section 911 
exclusion. According to IRS figures, nearly two-thirds (61.8 
percent) of Forms 2555 filed in 1987 were submitted by 
Americans in just 15 nations. (Internal Revenue Service, SOI 
Bulletin, Winter 1992-93, p. 86.) The vast majority of these 
nations--led by Germany and the United Kingdom, with Canada and 
Japan not far behind--are considered relatively high-tax 
jurisdictions. This was consistent with the 1995 Price 
Waterhouse LLP findings which note that, absent Section 911, 
required compensation would increase by an average of 8.6 
percent in Australia, 8.0 percent in Japan, 5.4 percent in 
Switzerland, 4.5 percent in France, 3.3 percent in Canada, and 
3.1 percent in Germany (In Economic Analysis of the Foreign 
Earned Income Exclusion, Price Waterhouse LLP calculated the 
average change in compensation required if Section 911 were 
repealed for all expatriates at all income levels in each of 
the 15 nations.)
    According to the Price Waterhouse LLP study, Section 911 
can be beneficial in high-tax countries for a number of often 
overlooked reasons, including:

           Countries with very high statutory rates may have 
        generous deductions and exclusions that result in relatively 
        low tax liability, particularly for taxpayers at modest income 
        levels;
           International assignments often begin or end at mid-
        year, resulting in little foreign income tax liability in the 
        year of assignment and/or return;
           Unlike the foreign tax credit, Section 911 may cause 
        U.S. source income of Americans working abroad to be taxed in 
        lower U.S. income tax brackets.

    In short, no matter where in the world U.S. companies and 
American citizens work, the Section 911 exclusion can make a 
substantial difference for U.S. competitiveness.
       4. Voices from Abroad: Americans Speak Out on Section 911
    By their very presence overseas, U.S. citizens help to 
promote America's national interests. This is true of all 
Americans abroad--whether they are representatives of major 
U.S. corporations, cultural or religious institutions, service 
providers, educators, entrepreneurs, heads of charitable 
organizations, or homemakers. Americans abroad foster a 
positive image of the United States throughout the world while 
also contributing to our nation's economic and cultural well-
being at home.
    Based on 1995 survey feedback received by professors at The 
Johns Hopkins University (SAIS), Americans who use the foreign 
earned income exclusion come from all walks of life and can be 
found in all parts of the globe. From these expatriates' 
comments, a sampling of which are provided below, it is also 
clear that Section 911 makes a substantial difference in the 
lives of Americans abroad.

          ``When I first arrived here, Americans from our firm in the 
        U.S. totaled 90 percent of our professional staff. As time 
        progressed, because of the high cost of the tax equalization 
        program, we first changed to hiring local Americans [those not 
        recruited from the United States] and some foreign nationals. 
        Each year as the cost of Americans increased (the reduction to 
        $70,000 exclusion really hurt) we have slowly reduced our 
        American percentage to today's 28 percent. These professionals 
        not only 'buy American' for our company needs, but as 
        consultants to local businesses also recommend American 
        products to foreign companies. Without U.S. taxes overseas, we 
        would double the number of Americans employed.''

          ``In 1988 when I joined [Company X] our U.S. imports were 0. 
        Since starting our major import program in 1991 we are now 
        (1994) importing over 120 containers of U.S. product annually 
        plus air freight delivery of U.S. produce and beef on a weekly 
        basis.''

          ``Without the tax exclusion, we would not be able to attract 
        U.S. citizens to work at our school and they would be replaced 
        by locally hired Mexican nationals. U.S. textbooks and supplies 
        would probably be discontinued and Spanish materials would be 
        used in their place.''

          ``It becomes very obvious to me around October of each year 
        when the physicians submit their budget requests to me how 
        nationality affects one's thinking. The American (or American 
        trained) physicians will request U.S. manufactured supplies, 
        equipment and pharmaceutical items. Likewise the Germans, 
        British and French physicians request those that they are more 
        familiar with.''

          ``As we are strictly tuition based, an increase in personnel 
        costs is directly reflected in the cost of tuition. In the past 
        we have chosen to hire less expensive teachers from other 
        countries. If we raise tuition, many companies will not send 
        families to Korea. American businesses need a high quality 
        school in Seoul in order to convince their best people to come. 
        Were we to lose our Section 911 it would have a serious impact 
        on the competitiveness of other American businesses in Korea.''

          ``If the exclusion is lost, the company will probably lose 
        the American management it prides itself on and turn to Saudis 
        or British nationals. If this happens, the odds of Americans 
        ever working for this company again will be nil.''
          ``Under [President] Carter, the tax exclusion was eliminated, 
        U.S. companies pulled out of many foreign locations (or greatly 
        reduced their expatriate contingent) and U.S. overseas schools 
        suffered tremendous enrollment/revenue losses. The losses were 
        compensated by increasing host country populations in the 
        schools, an effect which is still felt today, particularly in 
        Latin America.''

          ``We constantly hear it clearly stated by business people 
        here that they would not be here if they did not have access to 
        an American educational program. During the last draw down of 
        the exclusion in the late seventies, the availability of 
        teachers willing to come overseas to work dropped 
        significantly. They saw no advantage to being overseas.''

          ``Elimination of the Section 911 exclusion and even the 
        current limitation dictates that we recruit on a cost-effective 
        basis; i.e., lower cost nationalities due to tax advantages. 
        This will be particularly true for our smelter project in 
        [country X] which requires an expatriate staff of about 185. 
        Projections are that between 60-80 percent will be TCNs [third-
        country nationals].''

          ``Administering an overseas school in 1980 in Bangladesh when 
        the foreign earned income exclusion was taken away, I observed 
        first hand the impact on American business, especially on the 
        construction industry. I was building a new school at the time 
        for $4,000,000, half of which was financed by the U.S. 
        government. There were 2 bidders: a U.S. company and a Korean 
        company. The Americans lost the contract on price, and the 
        difference was the tax on U.S. personnel! . . . It was proven 
        back then that abolishing the 911 exemption cost money: it 
        didn't gain a dime. Have we learned nothing from experience? ''

    The Section 911 Coalition believes that having Americans 
overseas is not just helpful, it is essential. In effect, 
taxation of foreign earned income amounts to a shortsighted, 
indirect tax on U.S. exports and American culture. This is a 
debilitating and entirely self-inflicted wound--a policy which 
discriminates against America's companies, U.S. workers, and 
American educational institutions abroad.
               5. Tax Policy Implications of Section 911
    The concept of a foreign earned income exclusion has been 
part of U.S. tax law for more than 70 years. During that time, 
the exclusion has undergone a number of configurations. The 
debate over whether to increase Section 911, decrease Section 
911, or maintain it at current levels centers on an evaluation 
of basic tax policy rationale for and implications of such an 
exclusion.
    The results of the 1995 Price Waterhouse LLP study suggest 
that the traditional standards for evaluating income tax 
provisions--fairness and economic efficiency--justify exclusion 
of the portion of foreign earned income attributable to the 
additional costs of living abroad. The Section 911 exclusion is 
an approximate method for meeting the equity and efficiency 
standards and also satisfies a third tax policy objective: 
simplicity.
    Fairness--Price Waterhouse LLP noted that the concept of 
``ability to pay'' taxes is inherently subjective, but that it 
has generally been recognized that an individual's costs 
associated with earning income reduce the ability to pay taxes 
and should be deducted. By this logic, individuals on 
international assignment should not be taxed on that part of 
their compensation which reasonably reflects the added costs of 
working abroad (extra housing costs, the education of children, 
home leave, cost-of-living adjustments, etc.).
    Economic Efficiency--This standard dictates that the tax 
law not interfere with the efficient allocation of resources. 
Economic efficiency suggests that in foreign markets, American 
workers should be allowed to compete according to prevailing 
rules. Absent Section 911, Price Waterhouse LLP found, the tax 
law would frequently discourage U.S. companies from hiring 
Americans in overseas positions, causing foreign nationals to 
be hired even where Americans would, but for taxes, be 
preferred.
    Simplicity--By all accounts, the Section 911 exclusion 
simplifies deductions revolving around doing business overseas, 
especially when compared to the 1978 rules that the current 
exclusion replaced.
    Three additional tax policy standards are often used to 
evaluate U.S. tax provisions that affect international income: 
competitiveness, harmonization, and protection of the U.S. tax 
base. Once again, Price Waterhouse LLP found that the Section 
911 exclusion clearly meets these standards.
    International competitiveness--This standard requires that 
U.S. capital and labor employed in foreign markets bear the 
same tax burden as foreign capital and labor in those markets. 
Price Waterhouse LLP noted that for Americans abroad,

          ``the competitiveness standard would be achieved if the 
        United States excluded all foreign earned income without the 
        $70,000 limitation in present law. In this way, Americans 
        working abroad would be subject only to foreign income taxes on 
        their foreign earned income in exactly the same manner as 
        foreign workers are taxed.''

    Harmonization--Price Waterhouse LLP pointed out that 
Section 911 provides a ``glaring example of the failure on the 
part of the United States to harmonize with international tax 
practice. As noted by the General Accounting Office, the United 
States is the only major industrial power that taxes its 
individuals on the basis of citizenship rather than residence. 
In today's global economy . . . the failure of the United 
States to harmonize the tax treatment of expatriate workers 
means that U.S. citizens are more expensive to employ abroad 
than citizens of many other industrial nations. In summary, the 
principle of tax harmonization strongly argues for complete 
exclusion of foreign earned income'' as was the case in the 
United States during the period 1926-1952.
    Protecting the U.S. Tax Base--This standard is intended to 
prevent U.S. source income from escaping the income tax net. 
The Section 911 exclusion does not undermine the U.S. tax base 
because the exclusion has been carefully designed to prevent 
U.S. source income from escaping U.S. taxation.
    In summary, according to the Price Waterhouse LLP study, 
``an unlimited foreign earned income exclusion would be 
consistent with the international tax policy standards of 
competitiveness, preservation of the U.S. tax base, and 
harmonization. Thus it would be appropriate to lift the . . . 
cap on the foreign earned income exclusion to better achieve 
these tax policy objectives.''
  6. Conclusion: Increasing Section 911 = Increasing Business and Jobs
    As I noted at the outset of my remarks today, Americans 
Abroad = U.S. Exports = U.S. Jobs. Perhaps more than any other 
provision of law, Section 911 helps to put U.S. citizens ``in 
the field'' around the world where they buy American, sell 
American, specify American, hire American, and create 
opportunities for other Americans. As such, Section 911 has a 
direct impact on the competitiveness of American workers and 
U.S. companies operating in foreign markets--a substantial 
growth area for the United States as we move into the twenty-
first century.
    To help place America on a more level footing with our 
trade competitors, the Section 911 Coalition encourages 
Congress to adjust the foreign earned income exclusion, 
beginning in calendar year 2000, to compensate for the effects 
of inflation since 1983, when the exclusion was frozen at 
$80,000. This will not make American workers and companies as 
competitive as an unlimited exclusion would, but it is 
certainly an important step in the right direction. U.S.-based 
jobs are on the line, especially for small and medium-sized 
businesses, and we look forward to an opportunity to work with 
the Ways and Means Committee to strengthen Section 911 -an 
unheralded but vital part of the U.S. tax code.
    Thank you, Mr. Chairman, for the opportunity to testify 
today. I would be pleased to answer any questions that you or 
the Committee might have.

                                


APPENDIX A

Section 911 Coalition Members

American Business Council of the Gulf Countries
American Citizens Abroad
American Consulting Engineers Council
American Express
American Institute of Architects
American International School of Budapest
Asia Pacific Council of American Chambers of Commerce
Ass'n of American Chambers of Commerce in Latin America
Association of Americans Resident Overseas
BDM International, Inc.
Baker Hughes, Inc.
Bechtel Group, Inc.
Booz-Allen & Hamilton Arabia
Brown and Root/Halliburton
COLSA International
CRSS--Metcalf & Eddy Joint Venture
Caltex Petroleum Corporation
Caterpillar, Inc.
Chicago Bridge & Iron Company
Chrysler Technologies Corp.--Middle East Ltd.
Coalition for Employment through Exports, Inc.
Coopers & Lybrand L.L.P.
Culligan Italiana SpA
Cummins Engine Company, Inc.
Deloitte & Touche LLP
Democrats Abroad
Dillingham Construction International, Inc.
Dresser Industries, Inc.
Economic Strategy Institute Employee Relocation Council
European Council of American Chambers of Commerce
FMC Arabia Ltd.
Federated League of Americans Around the Globe
Federation of American Women's Clubs Overseas
Fluor Corporation
Foster Wheeler
Hoechst Celanese Corporation
Hughes Saudi Arabia Ltd.
Intercom International Consultants
Int'l Engineering & Construction Industries Council
International School of Islamabad
International School of Tanganyika
International Schools Services
J.A. Jones Construction
John Brown Constructors
Juraid & Company
Lockheed Middle East Services
Loral Corporation
M.W. Kellogg Company
Mansour General Dynamics Ltd.
McDonnell Douglas Middle East Ltd.
Middle East Policy Council
National Constructors Association
Occidental Petroleum Corporation
Oracle Corporation
Parsons Brinckerhoff
Parsons Corporation
Republicans Abroad
Saudi American Bank
Saudi Arabian International School--Dhahran
Saudi Arabian International School--Riyadh
Science Applications International Corporation
Small Business Exporters Association
Sogerep, Ltd.
Stafford & Paulsworth
Stone & Webster, Inc.
U.S. Chamber of Commerce
United Technologies
Unocal Corporation
Verdala International Schools
Vinnell Corporation--Saudi Arabia
Vinnell Corporation--U.S.A.
Westinghouse Electric Corporation
World Federation of Americans Abroad

                                


APPENDIX B

The Effect of Inflation on the Foreign Earned Income Exclusion Amount

                              Introduction
    This report updates information on the effect of inflation 
on the real value of the foreign earned income exclusion 
amount, which was originally included in an October 1995 report 
(entitled Economic Analysis of the Foreign Earned Income 
Exclusion) prepared by Price Waterhouse LLP for The Section 911 
Coalition.
    Under the provisions of Section 911 of the Internal Revenue 
Code, a U.S. citizen or resident alien whose tax home is 
outside the United States, and who meets a foreign residence or 
foreign presence test, may exclude from gross income in 1999 up 
to $74,000 per year of foreign earned income plus a housing 
cost amount. Historically, the principal rationale for the 
exclusion has been to make the tax treatment of Americans 
working abroad more competitive with that of foreign nationals 
and, thereby, to promote exports of U.S. goods and services.
             History of the Foreign Earned Income Exclusion
    The foreign earned income exclusion originally was enacted 
in 1926 to help promote U.S. exports. From 1926 to 1952, the 
exclusion was unlimited, corresponding to the present day 
practice of other major industrial countries. From 1953 to 
1977, the exclusion was limited to $20,000 per year; however, 
for Americans working abroad for more than three years, the 
exclusion was increased to $35,000 from 1962 to 1964 and 
subsequently reduced to $25,000 from 1965 to 1977.
    In 1978, the Foreign Earned Income Act replaced the Section 
911 exclusion with Section 913, a series of deductions for 
certain excess costs of living abroad.
    The Economic Recovery Tax Act of 1981 restored Section 911 
and increased the exclusion to $75,000 in 1982 with scheduled 
increases to $95,000 in 1986. The legislative history indicates 
that Congress was concerned that the rules enacted in 1978 made 
it more expensive to hire Americans abroad compared to foreign 
nationals, reduced U.S. exports, rendered the United States 
less competitive abroad, and due to the complexity, the new 
rules required many Americans employed abroad to use 
professional tax preparers.
    Among a number of other deficit reduction measures, the 
Deficit Reduction Act of 1984 delayed the scheduled increases 
in the foreign earned income exclusion, freezing the benefit at 
$80,000 through 1987. The Tax Reform Act of 1986 reduced the 
exclusion to $70,000 beginning in 1987. The exclusion remained 
at this level through 1997.
                              Present Law
    The Taxpayer Relief Act of 1997 increased the $70,000 
exclusion to $80,000 in increments of $2,000 beginning in 1998. 
The following table shows the exclusion amounts specified by 
the Act.

           Table 1.--Present Law Section 911 Exclusion Amounts
------------------------------------------------------------------------
               Calendar Year                      Exclusion Amount
------------------------------------------------------------------------
1998......................................  $72,000
1999......................................  $74,000
2000......................................  $76,000
2001......................................  $78,000
2002-2007.................................  $80,000
2008 and thereafter.......................  $80,000 adjusted for
                                             inflation
------------------------------------------------------------------------

    As noted in the table, beginning in 2008 the $80,000 
exclusion for foreign earned income will be adjusted for 
inflation. Thus, for any calendar year after 2007, the 
exclusion amount will be equal to $80,000 times the cost-of-
living adjustment for that calendar year. The cost-of-living 
adjustment will be calculated using the methodology that 
adjusts the income brackets in the tax rate schedules (Section 
1(f)(3) of the Internal Revenue Code). The Consumer Price Index 
for all urban consumers (CPI-U) that is published by the 
Department of Labor will be used to determine the adjustment. 
Specifically, the cost-of-living adjustment for a calendar year 
will equal the CPI-U for the preceding calendar year divided by 
the CPI-U for calendar year 2006 (the base year). The Internal 
Revenue Code further specifies that, in making this 
calculation, the CPI-U for a calendar year is to be calculated 
as the average of the CPI-U as of the close of the 12-month 
period ending on August 31 of such calendar year. Finally, the 
Taxpayer Relief Act of 1997 stipulates that if the adjusted 
exclusion amount is not a multiple of $100, then it is to be 
rounded to the next lowest multiple of $100.
    For this report, we have estimated the inflation-adjusted 
exclusion amounts for 2008 and 2009 to be $82,000 and $84,200, 
respectively. These estimates assume that the CPI-U will 
increase by 2.6 percent annually beginning in calendar year 
2000. This assumption is based on the Congressional Budget 
Office's (CBO) most recent published economic projections (The 
Economic and Budget Outlook: Fiscal Years 2000-2009, January 
1999, Table 1.4).
                          Effect of Inflation
    Figure 1 shows the exclusion amount in both nominal and 
real (1999) dollars. The nominal dollar line shows the 
exclusion amounts specified by legislation. The effect of the 
Taxpayer Relief Act of 1997 is shown starting in 1998 when the 
exclusion amount begins to increase in $2,000 increments from 
the $70,000 amount established by the Tax Reform Act of 1986. 
In 2002, the exclusion amount reaches $80,000 and remains at 
that level until 2008 when the exclusion amount begins to be 
adjusted for inflation.
    As illustrated in Figure 1, the real value of the exclusion 
has dropped substantially. In real 1999 dollars, the 1999 
exclusion amount of $74,000 is 45 percent below its level in 
1983 ($134,197 in 1999 dollars) when the nominal dollar amount 
of the exclusion ($80,000) reached its highest level after the 
1981 Act.
    Figure 1 also shows that the real value of the exemption is 
projected to continue to fall after 1999, even though the 
Taxpayer Relief Act of 1997 eventually will raise the exclusion 
amount to $80,000.
    The provision to adjust the exclusion amount for inflation 
will stabilize the real value of the exclusion amount beginning 
in 2008. Based on the CBO's projection that consumer prices 
will be 2.5 percent higher in 1999 than they were in 1998 and 
that annual price increases will amount to 2.6 percent 
thereafter, the value of the exclusion amount will stabilize at 
approximately $65,150 in 1999 dollars--an amount that is 12 
percent below the current exclusion amount in real terms and 51 
percent below the 1983 peak as measured in 1999 dollars.
                               Conclusion
    Since the Section 911 exclusion amount has not been 
automatically indexed for inflation in the way that the 
Internal Revenue Code adjusts the income tax tables and other 
dollar amounts, the real value of the exclusion has dropped 
substantially. If the $80,000 exclusion that was in effect in 
1983 had been continually adjusted for inflation, the exclusion 
would be approximately $134,000 in 1999. Based on current CBO 
projections of inflation, the exclusion amount in the year 2000 
would be nearly $138,000.
[GRAPHIC] [TIFF OMITTED] T6775.004


                                


APPENDIX C

The Foreign Earned Income Exclusion

                            A Short History
    The foreign earned income exclusion has been part of the 
Internal Revenue Code since 1926, when it was unlimited for 
bona fide residents of a foreign country. Congress enacted the 
exclusion more than 70 years ago in an effort to ``encourage 
citizens to go abroad and to place them in an equal position 
with citizens of other countries going abroad who are not taxed 
by their own countries.'' (Senate Report No. 781, 82nd 
Congress, 1st Session, 1951, pp. 52-53.)
    Limiting the foreign earned income exclusion is a concept 
that goes back to 1953, when Congress first capped the 
exclusion. In the immediate aftermath of World War II, there 
may have been a good reason for limiting the exclusion. 
However, times have changed dramatically since the 1950s, when 
the U.S. economy was a global colossus with no serious 
competition, and U.S. tax policy has not kept pace with the 
changing times.
    In 1978, the Foreign Earned Income Act replaced the 
exclusion with a series of deductions for certain expenses 
associated with living abroad (former Section 913). American 
workers and U.S. companies in overseas markets were hit hard by 
the 1978 amendments and lost considerable overseas market share 
as a result. Recognizing this, Congress in 1981 restored the 
flat earned income exclusion (Section 911) at $75,000 per year 
for 1982 with scheduled increases to $95,000 in 1986. Noting 
that the rules enacted in 1978 reduced exports, Congress in 
1981 ``was concerned with the increasing competitive pressures 
that American businesses faced abroad. The Congress decided 
that in view of the nation's continuing trade deficits, it is 
important to allow Americans working overseas to contribute to 
the effort to keep American business competitive'' through 
Section 911. (Joint Committee on Taxation, General Explanation 
of the Economic Recovery Tax Act of 1981, JCS-71-81, December 
29, 1981, p. 43.)
    The exclusion was revisited in 1984 and 1986. The Deficit 
Reduction Act of 1984 delayed the scheduled increases in the 
exclusion, freezing the benefit at $80,000 (the 1983 benefit 
level) through 1987. The Tax Reform Act of 1986 reduced the 
exclusion to $70,000, and it remained at that level through 
1997. The Taxpayer Relief Act of 1997 increased the $70,000 
exclusion to $80,000 in increments of $2,000 per year, 
beginning in 1998. In addition, beginning in the year 2008, the 
$80,000 exclusion will be adjusted for inflation.
    Because the exclusion has not been adjusted for inflation 
over the years, its real value has dropped substantially. 
According to a June 28, 1999 report by PricewaterhouseCoopers 
LLP, the 1999 exclusion amount, in real dollars, is 45 percent 
below its level in 1983, following passage of the Economic 
Recovery Tax Act of 1981. (The exclusion in 1983 was $80,000 in 
nominal dollars and $134,197 in 1999 dollars.) If the $80,000 
exclusion that was in effect in 1983 had been continually 
adjusted for inflation, the exclusion would be approximately 
$134,000 in 1999, rising to nearly $138,000 in the year 2000.
    The real value of the exclusion is projected to continue 
falling after 1999 and is expected to stabilize in the year 
2007 at approximately $65,150 in 1999 dollars. Looked at from a 
``purchasing power'' point of view, the value of the exclusion 
will have plummeted in real dollars from $134,197 (1983) to 
$65,150 (2007)--a devastating loss of nearly $70,000 in 1999 
dollars.

           *         *         *         *         *

    Many Members of Congress serving today were not witness to 
the extensive Congressional debates which resulted in the 
enactment of the exclusion in 1981. As a result, this short 
history should provide some insights into why the exclusion 
came about, why it provides a return to the U.S. economy that 
far exceeds its estimated revenue losses, and why the Section 
911 exclusion has such an impact on U.S. business 
competitiveness overseas.
    In the 1970s, in an effort to move away from the foreign 
earned income exclusion, Congress took steps that proved to be 
disastrous. The Tax Reform Act of 1976 generally reduced the 
exclusion to $15,000 per year. While this cut in the exclusion 
did not take effect in the end, it nevertheless had a 
``chilling'' effect on U.S. companies' efforts to send American 
workers abroad. A 1978 General Accounting Office (GAO) survey 
of 183 U.S. companies found that more than 80 percent of these 
companies felt that reducing the exclusion along the lines of 
the 1976 Act would result in a reduction of U.S. exports by at 
least five percent. (U.S. GAO, Impact on Trade of Changes in 
Taxation of U.S. Citizens Employed Overseas, ID-78-13, February 
21, 1978.)
    Two years after the 1976 Act, the situation went from bad 
to worse. The Foreign Earned Income Act of 1978 repealed the 
foreign earned income exclusion and put in its place Section 
913, composed of five factors: (1) A cost-of-living deduction 
based on the differential between U.S. and overseas costs of 
living; (2) A housing deduction; (3) A deduction for schooling 
expenses where a U.S.-type school was not within a reasonable 
commuting distance; (4) A travel expense deduction for an 
annual round-trip visit to the United States; 5) A deduction 
for work in a hardship area.
    The 1978 Act, compared to prior law, represented a 23 
percent reduction in the tax benefit of the exclusion. To 
determine the impact of this reduction, the GAO conducted a 
survey in 1980 of 33 key firms in four industries. The GAO 
found that additional costs attributable to the 1978 Act was a 
primary reason why these firms had decreased their employment 
of Americans abroad. The numbers decreased absolutely from 1979 
to 1980 in three of the industries and, during the period 1976 
to 1980, the relative number of Americans abroad dropped 
compared to third country nationals. (U.S. GAO, American 
Employment Abroad Discouraged by U.S. Income Tax Laws, ID-81-
29, February 27, 1981.)
    As a result of these findings, the 1981 GAO report produced 
the following recommendation:

          ``We believe that the Congress should consider placing 
        Americans working abroad on an income tax basis comparable with 
        that of citizens of competitor countries who generally are not 
        taxed on their foreign earned income.''

    The GAO went on to say that ``complete exclusion or a 
limited but generous exclusion of foreign earned income for 
qualifying taxpayers . . . would establish a basis of taxation 
comparable with that of competitor countries and, at the same 
time, be relatively simple to administer.''
    Findings in a 1980 report by Chase Econometrics provided 
more evidence of the dangers for U.S. competitiveness of 
restricting the foreign earned income exclusion. As a result of 
the changes in 1976 and 1978, Chase noted, a significant number 
of Americans working overseas would be forced to return home. 
Chase determined that a ten percent drop in Americans overseas 
would lead to a five percent drop in U.S. exports. The study 
went on to say that the ``drop in U.S. income due to a five 
percent drop in real exports will raise domestic unemployment 
by 80,000 [persons] and reduce federal receipts on personal and 
corporate income taxes by more than $6 billion, many times the 
value of increased taxes on overseas workers.'' (Chase 
Econometrics, Economic Impact of Changing Taxation of U.S. 
Workers Overseas, June 1980, p. 2.)
    The U.S. & Overseas Tax Fairness Committee, an ad hoc group 
established in the late 1970s to defend the foreign earned 
income exclusion, noted in 1980 that ``of all the current U.S. 
disincentives that discourage trade, none is easier to 
eliminate than the U.S. practices of taxing foreign earned 
income . . . and none will produce faster or more substantial 
results for our balance of trade.'' In an effort to show what 
damage the 1976 and 1978 Acts had done as of 1980, the 
Committee cited the example of the U.S. construction and 
engineering industry operating in the Middle East. American 
companies in this sector ``had over ten percent of the 
construction volume in the Middle East four years ago and now 
has less than two percent--almost entirely due to the current 
U.S. tax treatment of overseas Americans,'' the Committee 
noted, ``and industry is finding it very difficult to recapture 
its former standing.'' (U.S. & Overseas Tax Fairness Committee, 
Press Release, June 16, 1980.)

           *         *         *         *         *

    The message is as clear today as it was in 1980: Changes in 
the foreign earned income exclusion generate a substantial and 
direct impact--positive or negative--on the ability of U.S. 
companies and American workers to compete in overseas markets.

                                


APPENDIX D

Highlights of the Price Waterhouse Study

      ``Economic Analysis of the Foreign Earned Income Exclusion''
    Price Waterhouse LLP, in a study prepared in 1995 for the 
Section 911 Coalition, found that:
     The U.S. is the only major industrial country that 
does not completely exempt from taxation the foreign earned 
income of its citizens working abroad.
     Because the Section 911 exclusion is not adjusted 
for inflation, its real value has dropped by 43 percent since 
1982. If the exclusion had been adjusted for inflation since it 
was set at $70,000 in 1987, the exclusion would rise to over 
$111,000 in the year 2000. If the exclusion is not indexed for 
inflation soon, its value will continue to decline.
     Without the Section 911 exclusion, compensation 
levels for Americans abroad would need to increase by an 
average of 7.19 percent to preserve after-tax income. Section 
911 was shown to provide benefits in both low tax and high tax 
nations. Moreover, the exclusion represents a larger share of 
the compensation of low income than of high income Americans 
working abroad.
     A 7.19 percent increase in required compensation 
would result in a 2.83 percent decrease in Americans working 
abroad. Without Section 911, U.S. exports would decline by 1.89 
percent or $8.7 billion. This translates into a loss of 
approximately 143,000 U.S.-based jobs. [N.B.-These figures do 
not include service-related jobs or indirect employment, which 
would likely double the number of jobs lost.]
     From a tax policy standpoint, the 911 exclusion 
meets the traditional standards for evaluating income tax 
provisions: Fairness--Absent Section 911, Americans working 
abroad would pay much higher taxes than U.S.-based workers with 
the same base pay. Economic efficiency--Absent 911, U.S. tax 
law would discourage U.S. companies from hiring Americans in 
overseas positions, causing foreign nationals to be hired even 
where Americans would, but for taxes, be preferred. 
Simplicity--The current structure of Section 911 was 
specifically enacted by Congress in 1981 in reaction to the 
unmanageable complexity of the rules enacted in 1978.
     Section 911 also adheres to three additional tax 
policy standards often used to evaluate provisions that affect 
international income: Competitiveness--The competitiveness 
standard, that U.S. capital and labor employed in foreign 
markets bear the same tax burden as foreign capital and labor 
in those markets, would be achieved if the U.S. excluded all 
foreign earned income (without the current cap). Protecting the 
U.S. tax base--Section 911 applies only to income that is 
earned abroad for activities that are performed abroad by 
individuals who are not residents of the USA. Harmonization--
True harmonization with other nations would require an 
unlimited exclusion, as was in effect in the USA from 1926 to 
1952.

                                


APPENDIX E

Section 911 Survey Results are in

Survey Finds Exclusion is Especially Important to Small & Medium-Sized 
                               Companies
    The Section 911 Coalition has announced the findings of its 
``American Competitiveness Survey.'' With nearly 150 companies 
and associations responding to the survey, it represents the 
largest and most broad-based Section 911 survey ever conducted.
    The six-page survey examined the importance of the $70,000 
foreign earned income exclusion (under Section 911 of the U.S. 
Tax Code) and its impact on America's global competitiveness. A 
report prepared by economists at the Johns Hopkins University 
School of Advanced International Studies, Drs. Charles Pearson 
and James Riedel, found that:
     The Section 911 exclusion is especially important 
to small and medium-sized firms (including International and 
American schools abroad), which are at least ten times more 
dependent on Section 911 than are the large firms that were 
surveyed. Eighty-two percent of small and medium-sized firms 
said that a loss of the exclusion would result in a moderate (6 
to 25 percent) or major (above 25 percent) change in their 
ability to compete abroad.
     Nearly two-thirds (65 percent) of respondents felt 
that their ability to secure projects and compete abroad would 
be improved if the exclusion ($70,000 in 1995) were raised to 
$100,000--a long-standing position of Americans resident 
overseas.
     Americans abroad showed a strong tendency to 
source goods and services produced in the United States. 
Seventy-seven percent of respondents said that nationality has 
an effect on sourcing decisions. Among small and medium-sized 
firms, the number is even higher: 89 percent said their 
American expatriate employees prefer to Buy American.
     Compensation costs are significant in determining 
whether or not to hire U.S. nationals overseas, and the Section 
911 exclusion is important in holding down compensation costs. 
Eighty percent of respondents said elimination of Section 911 
would have a moderate or major negative effect on compensation 
costs, with 66 percent saying elimination of the exclusion 
would have an important negative impact on future hiring 
practices.
    The survey results strongly suggest that the Section 911 
exclusion plays a key role in America's competitiveness and the 
creation of U.S. jobs through exports. For further information, 
please contact the Section 911 Coalition.

                                


    Chairman Archer. Thank you, Mr. Hamod. Mr. Dean, you may 
proceed.

STATEMENT OF WARREN L. DEAN, JR., PARTNER, THOMPSON COBURN LLP, 
        AND REPRESENTATIVE, SUBPART F SHIPPING COALITION

    Mr. Dean. Good afternoon, Chairman Archer, and 
distinguished Members of the Committee. On behalf of the 
Subpart F Shipping Coalition, I commend the Committee for 
examining U.S. international tax policy and its impact on 
competitiveness in the U.S. economy.
    The Subpart F Shipping Coalition is a group of U.S.-
controlled foreign-flag shipping companies that are adversely 
affected by U.S. international tax policy. They strongly 
support the Shaw-Jefferson bill, H.R. 265, the Shipping Income 
Reform Act of 1999, which is pending before the Committee.
    Mr. Chairman, I represent the interests of transportation 
companies engaged in foreign commerce. For the last 10 years, I 
have also been an adjunct professor in international 
transportation law in the graduate program of Georgetown 
University Law Center. I have taught and written extensively on 
the affects of U.S. tax and regulatory policy on the 
competitiveness of U.S. enterprise.
    To make a long story short, Mr. Chairman, if the United 
States wants a shipping presence of any kind, U.S. or foreign 
flag in its foreign commerce, then the application of Subpart F 
to shipping income has got to go. It is just that simple. 
Subpart F's affect on the economy is essentially threefold. It 
erodes the competitiveness of the shipping industry. It effects 
the results of the worldwide consolidation affecting shipping. 
And it has an adverse affect on U.S. exports that are carried 
by that shipping.
    Prior to the inclusion of shipping income in Subpart F in 
1975, the United States owned approximately 25 percent of the 
world fleet. That number has declined to 5 percent today and is 
continuing to fall fast. As U.S.-controlled investment in 
shipping has declined, so has sealift capability and the 
Treasury revenues from that income.
    The National Foreign Trade Council's recently completed 
study entitled ``The NFTC Foreign Income Project International 
Tax Policy for the 21st Century'' confirms those findings. The 
study showed that the U.S.-controlled foreign fleet cannot 
afford to compete effectively in an international market 
against trading partners that have adopted tax policies and 
incentives to support their international shipping industries.
    Last, the purpose of the inclusion of shipping income in 
Subpart F has not been achieved. Shipping industry tax revenues 
decreased from approximately $90 million in the year before 
1975 (that's $250 million in today's dollars) that resulted 
from the voluntary repatriation of dividends from that income--
to less than $50 million today.
    Further, the application of Subpart F to shipping income 
has affected the trend in worldwide consolidation in 
transportation industries. To survive in increasingly 
competitive international markets, transportation enterprises, 
like American President Lines, must be able to expand their 
operations, often through combinations with other carriers. 
Assuming a suitable foreign flag carrier can be identified, the 
only question then is the form of the merged entity, whether 
the U.S. carrier is the acquired or the acquiring company. That 
decision should be a marketplace decision, even though there 
are compelling national interests at stake in preserving U.S. 
control over U.S. flag shipping.
    Subpart F's application to foreign-based shipping income of 
companies like American President Lines ensures that the 
surviving company cannot be a U.S. taxpayer. If the foreign 
corporation acquires American President Lines and rationalizes 
its operations, none of its foreign flag vessels will be 
subject to U.S. taxation. If, on the other hand, American 
President Lines were to acquire a foreign company, all of the 
foreign flag vessels of the combined enterprise would be 
subject to current U.S. taxes. In cases like the acquisition of 
American President Lines or the acquisition of Lykes Steamship 
Co. by a Canadian corporation, those cases demonstrate that 
Subpart F substantially harms the competitiveness of U.S.-owned 
foreign-flag shipping, fails to raise revenues, and it 
adversely affects the national security, and it costs American 
workers their jobs.
    The last thing I want to address is the impact of this tax 
on our exports. Sir Walter Raleigh once observed that whoever 
commanded the sea commanded the trade of the world and, hence, 
the world itself. Subpart F has cost American jobs and export 
opportunities in related industries as a result of our 
declining presence in world shipping. U.S. owned and controlled 
transportation companies are much more likely to identify and 
promote export opportunities for both related and unrelated 
U.S. manufacturers and their employees. The fact of the matter 
is that if we act like isolationists on tax policy, it should 
be no surprise that the American public is going to turn 
isolationist on trade policy and reject further liberalization.
    Mr. Chairman, we live in the global marketplace with 
formidable challenges and opportunities. Americans, I believe, 
are prepared to embrace those challenges, provided Washington 
doesn't get in the way. We have seen too many Americans 
recently lose their job in shipping and other important 
industries just because poorly conceived tax policies 
inadvertently dictate that they would lose in this era of 
worldwide consolidation. In this regard, I refer you to the 
compelling statement of Crowley American Transport submitted to 
this Committee on June 24, 1999. If we want to be competitive 
in world commerce, we must start here in Washington. Thank you, 
Mr. Chairman.
    [The prepared statement follows:]

Statement of Warren L. Dean, Jr., Partner, Thompson Coburn LLP, and 
Representative, Subpart F Shipping Coalition

    Good morning, Chairman Archer and distinguished Members of 
the Committee. On behalf of the Subpart F Shipping Coalition, I 
commend the Committee for examining U.S. international tax 
policy and its impact on the competitiveness of the U.S. 
economy. The coalition appreciates the opportunity to appear 
before you today.
    The Subpart F Shipping Coalition is a group of U.S.-
controlled foreign-flag shipping companies that are adversely 
affected by U.S. international taxation policy. Our members 
include General Ore International Corporation Limited, Seaboard 
Marine (a wholly-owned subsidiary of Seaboard Corporation), and 
Tropical Shipping (a wholly-owned subsidiary of NICOR, Inc.). 
Our members support the Shaw-Jefferson bill, H.R. 265, which is 
pending before the Committee, and they are submitting 
statements on the record in support of that legislation.
    Mr. Chairman, I chair the Transportation Group at Thompson 
Coburn LLP and represent the interests of transportation 
companies engaged in foreign commerce. For the last ten years I 
have also been an Adjunct Professor of International 
Transportation Law in the Graduate Program of Georgetown 
University Law Center. I have taught and written extensively on 
the effects of U.S. tax and regulatory policy on the 
competitiveness of U.S. enterprise. My statement will, 
therefore, be general and policy-oriented.
    At the outset, let me clarify one very important point. 
Amending Subpart F to reinstate the deferral of foreign-base 
company shipping income will not adversely affect the 
competitive position of the remaining subsidized U.S.-flag 
shipping companies that operate in our foreign commerce. In 
fact, as reflected in written statements submitted to this 
Committee, it would substantially improve their ability to 
compete in foreign commerce, since they also operate foreign-
flag vessels.
    In sum, if the United States wants a shipping industry of 
any kind--U.S.-flag or foreign-flag--then the application of 
Subpart F has got to go. It is just that simple.

           *         *         *         *         *

    My testimony focuses on three key issues that are of great 
concern to U.S. shipping companies and U.S. manufacturers and 
exporters. First, I will discuss the impact of U.S. 
international tax policies on the competitiveness of the U.S. 
shipping industry. Next, I will describe how the shipping 
industry's worldwide consolidation has exacerbated this 
decline. And finally, my testimony will describe the impact 
that this decline in U.S. shipping capability is having on U.S. 
exports.
             Competitiveness of the U.S. Shipping Industry
    International shipping is a highly competitive industry. 
Foreign-flag operators that are relatively unburdened by direct 
or indirect national taxes determine its rate structure. Most 
maritime nations, including those in the European Union, have 
adopted tax policies that ensure that their operators are able 
to compete with ships operated under flags of convenience. The 
United States has taken no such action. Instead, in response to 
the liberalization of international shipping taxes by the 
world's great shipping nations, it has increased its taxes. As 
a result, the United States is no longer a major force in 
international shipping.
    Of course, the tax I am referring to is Subpart F of the 
Internal Revenue Code, which imposes taxes on U.S.-owned 
businesses abroad as if they were operating in the United 
States. Before Subpart F was extended to shipping--it was 
extended partially in 1975 and fully in 1986--American citizens 
and corporations owned or controlled more than 25 percent of 
the world's fleet. Now that figure has slipped to less than 5 
percent, and is falling fast. As U.S.-controlled investment in 
shipping has declined, so have U.S. sealift capability and U.S. 
Treasury revenues from shipping. This anti-competitive tax 
regime has also reduced new ship acquisition by U.S.-controlled 
companies, and it has resulted in U.S. owners becoming minority 
participants in vessels they once owned and operated.
    The National Foreign Trade Council's recently completed 
study, titled ``The NFTC Foreign Income Project: International 
Tax Policy for the 21st Century,'' confirms these findings. The 
study showed that the U.S.-controlled foreign fleet cannot 
afford to compete effectively in the international market 
against trading partners that have adopted tax policies and 
incentives to support their international shipping industries.
    Let me give you an example. Assume an American-controlled 
shipping company needs, for competitive purposes, to offer 
service between Indonesia and Japan. U.S.-flag services by a 
U.S. corporation is not an option. The expense of flying crews 
back and forth alone would be prohibitive. Subpart F, the 
purpose of which is to prevent tax-motivated earnings through 
foreign corporations, reaches this transportation service and 
taxes it more onerously than it would tax U.S.-flag service--
even though this transportation is not within any rational 
definition of U.S. commerce. There is no legitimate tax policy 
foundation for this absurd result.
    Sadly, the U.S. government has gained nothing from 
extending Subpart F to shipping income. While the tax imposed 
upon this industry was originally designed to generate 
revenues, it has cost the U.S. Treasury millions of dollars. 
Shipping industry tax revenues have decreased from 
approximately $90 million a year before 1975 ($250 million in 
today's dollars) to less than $50 million today.
                        Worldwide Consolidation
    The marketplace for transportation services is increasingly 
global, as international trade responds to the liberalization 
of commerce under new multilateral trade agreements. In 
response, the ocean shipping industry has been consolidating to 
take advantage of worldwide service networks. These actions are 
not unique to ocean shipping. The international airline 
industry is experiencing a comparable evolution.
    This worldwide consolidation is leaving the United States 
with significantly diminished shipping capacity, due in large 
part to U.S. international tax policy. Take, for example, 
American President Lines, one of the premier U.S.-flag 
operators for nearly 150 years with terminal and transportation 
facilities on the West Coast that are extraordinarily valuable, 
both economically and militarily. It is also one of the major 
participants in the Maritime Security Program. American 
President Lines relies in part on its foreign-flag fleet to 
compete on a global basis.
    To survive in the increasingly competitive international 
markets, transportation enterprises like American President 
Lines must be able to expand their operations, often through 
combinations with other carriers. Assuming a suitable foreign-
flag carrier can be identified, the only question then is the 
form of the merged entity, i.e., whether the U.S. carrier is 
the acquired or the acquiring company. That decision should be 
a marketplace decision, even though there are national 
interests at stake in preserving U.S. control over subsidized 
U.S.-flag operators.
    Subpart F's application to the foreign-base company 
shipping income of companies like American President Lines 
ensures that the surviving company cannot be a U.S. taxpayer. 
If a foreign corporation acquires American President Lines and 
rationalizes its operations, none of its foreign-flag vessels 
will be subject to U.S. taxation. If American President Lines 
were to acquire a foreign company, on the other hand, all of 
the foreign-flag vessels of the combined enterprise would be 
subject to U.S. taxes.
    In fact, Neptune Orient Lines, a Singapore corporation, 
acquired American President Lines. As a result, American 
President Lines' foreign-flag operations are effectively exempt 
from U.S. taxation. (Singapore does not tax the shipping income 
of its nationals, whether from Singaporean or non-Singaporean 
vessels.) The U.S. government has lost in terms of both a 
potential dividend revenue base and the realization of its 
taxpayer-subsidized national security objectives.
    If our tax laws had been more competitive--meaning the 
United States had maintained a policy to allow vessels to 
compete in the tax-free environment that determines the rate 
structure for international shipping--American President Lines 
might have acquired Neptune Orient Lines instead. Examples like 
American President Lines, or the acquisition of Lykes Steamship 
Co. by a Canadian corporation, demonstrate that Subpart F 
substantially harms the competitiveness of U.S.-owned foreign-
flag shipping, fails to raise revenue to the U.S. Treasury, 
adversely affects U.S. national security, and costs American 
workers their jobs.
                              U.S. Exports
    Sir Walter Raleigh once observed that whoever commanded the 
sea commanded the trade of the world and hence the world 
itself. More recently, Tom Clancy wrote a novel describing a 
world eventually dominated by a third-world nation that gained 
control of ocean shipping. Simply put, our tax laws effectively 
prohibit Americans from owning and operating the shipping 
companies that carry the world's commerce. This means lost tax 
revenue, diminished presence in international markets, and an 
increased threat to the nation's economic security.
    Subpart F has cost Americans jobs and export opportunities 
in related industries as well. As the once significant U.S.-
owned fleet expatriated to remain competitive, related 
industries, including insurance brokers, ship management 
companies, surveyors, ship brokers, technical consultants, and 
many others who provided services to the maritime industry, 
followed. Further, Subpart F's application to shipping 
adversely affects the export opportunities of U.S. enterprises. 
U.S.-owned and controlled transportation companies are much 
more likely to identify and promote export opportunities for 
both related and unrelated U.S. manufacturers and their 
employees. They are also more likely to offer jobs to American 
citizens, such as ships' officers, who are not already employed 
on U.S.-flag shipping. That's how real economic opportunities 
for Americans are developed and marketed in a global economy.
    If we act like isolationists on tax policy, it should be no 
surprise that the American public may turn isolationist on 
trade policy by rejecting further liberalization of 
international trade.
                               Conclusion
    The Subpart F Shipping Coalition urges the Committee to 
level the playing field so that U.S.-shipping companies can 
once again be viable competitors in the international market. 
We encourage the Committee to approve H.R. 265, sponsored by 
Congressmen Shaw and Jefferson. It would restore the 
competitive opportunities for U.S.-controlled foreign-flag 
corporations by excluding shipping income from Subpart F. Under 
the proposed legislation, taxes would be deferred, not 
exempted, and would eventually be paid into the U.S. Treasury 
when repatriated.
    Mr. Chairman, we live in a global marketplace, with 
formidable challenges and opportunities. Americans, I believe, 
are prepared to embrace those challenges--provided Washington 
doesn't get in the way. We have seen too many Americans 
recently lose their jobs in shipping, and other important 
industries, just because poorly conceived tax policies 
inadvertently dictated that they would lose in this era of 
worldwide consolidation. In this regard, I refer you to the 
compelling statement of Crowley American Transport, Inc. 
submitted to this Committee on June 24, 1999. If we want to be 
competitive in world commerce, we must start here in 
Washington.
    If Subpart F is not amended, companies like the ones I am 
representing today will eventually be forced out of business or 
driven into partnerships with foreign companies, having been 
weakened over the years by unnecessary tax obligations. We look 
forward to working with you and the Ways and Means Committee to 
address this important issue.

                                


    Chairman Archer. Thank you, Mr. Dean. Mr. Houghton.
    Mr. Houghton. Thank you very much, Mr. Chairman. Yes, I 
would like to ask two or three different questions and whoever 
would like to respond, I would appreciate that. If you were to 
take a look--and you probably have been here through some of 
the other testimony--at all the testimonies that have been 
given, concentrating on various aspects of the tax law, what is 
the number one change you would make in the United States 
international tax laws? If you could pick one thing?
    Mr. Laitinen. Well, I have, obviously, testified on the 
interest allocation rule and I think that is one of the most 
egregious examples.
    Mr. Houghton. It is important, but is it the most 
important?
    Mr. Laitinen. Yes, sir. I believe so.
    Mr. Houghton. You are a good advocate for your cause. Does 
anybody else have a comment?
    Mr. Conway. Mr. Houghton, I would like to suggest that I 
think the most important change would be if we looked at an 
alternative, maybe a territorial system. I think the foreign 
tax credit system that we put in place when we enacted the 
income tax system was designed to be a de facto territorial 
system. We pay tax in the United States and we pay tax outside 
the United States, but we get a full credit when we brought the 
money back and we were taxed. And I think what has happened is 
over the past 25 years since I have been involved in taxes, we 
have chipped away at that foreign tax credit system and 
introduced tremendous complexities.
    So I think the most important change we could make is to 
really reconsider what kind of a system we want to have. Half 
of the OECD member countries have territorial systems, and I 
think we ought to look at that alternative. So I think that 
would be the most important change.
    Mr. Houghton. Well, now, Mr. Chip, didn't you--I wasn't 
here for your testimony, but I read it. Didn't you talk a 
little bit about that in terms of the European Union as one 
basket?
    Mr. Chip. Yes, sir. I would have to agree, though, with my 
colleague from General Motors. If you asked the business 
community at large the one thing, assuming we kept our basic 
system, that they find the most unconstructive are the interest 
allocation rules. Although I would say that for those companies 
that operate in Europe--and I think any company that wants to 
be a global business nowadays has to have a strong European 
presence--being able to treat the European Union as a single 
country so that it would be possible to incorporate your 
business in one of those countries and not be treated as 
engaged in tax haven operations simply because you then had 
activities in other parts of the European Union would be very 
important.
    But all of these problems--and I have to agree with what 
was said before--all of these issues would go away if we had a 
territorial tax system that accepted that the country where the 
business actually is conducted should have the only right to 
tax that business income to pay for business infrastructure and 
the United States should tax the income only when it is 
distributed to U.S. individual shareholders to pay for the 
things that they need in the country where they reside.
    Short of moving to a territorial system, which is really 
the answer, I would have to agree that the interest allocation 
rules are probably the biggest problem for U.S. business, but I 
would put the problems we have rationalizing our business in 
the European Union as a close second.
    Mr. Dean. Congressman.
    Mr. Houghton. Yes.
    Mr. Dean. Congressman, I would like to add one thing. The 
problems we are discussing are all symptomatic of a broader 
problem. The Tax Code is being gamed in the application of 
these rules to collect revenue in circumstances where it is 
simply not appropriate. We have to take a fundamentally careful 
look at the way we apply these rules to make sure that 
enterprises are not punished solely because they are owned and 
controlled by our own citizens. It is a truly pathetic irony 
that we are in a situation now where American owned enterprises 
are being punished by their own government precisely because of 
the nationality of their ownership.
    That is the case of Subpart F. That is the case of the 
interest allocation expense. And it is the case of the foreign 
tax credit as well.
    Mr. Houghton. Well, I think it is very helpful to be able 
to listen to people like yourselves because I have a feeling 
that business is far ahead of government in this respect. In 
the old days, businesses used to have export agreements, 
licensing agreements; what was made overseas was for them and 
what was made here was for us. And, of course, that is 
absolutely out now. And we obviously have got to bring up our 
tax laws to recognize that.
    Now let me just ask you one other question. Mr. Levin and I 
have proposed a tax simplification bill. Are there any other 
issues--I don't know if you have seen this--are there any other 
issues we should get into that we haven't touched on? Not that 
we can put them in now, but thinking ahead for another session?
    Mr. Chip. As some of the other witnesses have said, in 
addition to studying some of these micro issues, I would hope 
that Congress would give serious consideration to studying 
moving to a fully territorial system. Short of moving to a pure 
sales tax system, which probably would be more competitive than 
our competitors since they have income tax systems, would at 
least give us the most competitive income tax system possible.
    Most of our competitors come much closer to the most 
competitive income tax system that you can have if you are 
going to have that kind of system. And I think it would be 
worthwhile for--but it is not something that you can do very 
simply. And I would be fooling you if I pretended that it is. 
Among other things, you have to get into the issue of the 
double taxation of shareholders. When we distribute corporate 
income to shareholders, they don't get a credit for the taxes 
paid by the company. Most of our competitors--at least, a lot 
of our competitors--do have an integrated tax system.
    So you can't really isolate even the international area. 
You have to look very deeply into the system, and I think that 
now is as good a time to get started as any.
    Mr. Mogenson. I think that what you are hearing is various 
themes all of which kind of come back to a similar concept 
which is give the freedom for U.S. multinationals to compete on 
a foreign marketplace, you know, on equal footing with the 
competitors that are not United States based. The notion that 
the U.S. rules should extend globally is what is causing the 
handicap.
    I can tell you that I sit daily and deal with transactions 
which are entirely foreign-to-foreign transactions that are 
being proposed or conducted by our foreign affiliates and need 
to overlay the U.S. rules on top of that, whereas a similarly 
situated foreign bank or foreign securities firm merely has to 
focus on what are the U.K. rules or what are the German rules 
in that particular situation. And I come back to the common 
theme of saying let the foreign transactions or foreign 
business opportunities stand in that marketplace and don't 
extend the U.S. rules into there, whether it be compliance or 
substantive.
    Mr. Houghton. Well, thanks very much. Thank you, Mr. 
Chairman.
    Mr. Hamod. Congressman, if I may be an advocate for Section 
911 very briefly. I don't believe it is in the bill now, but we 
hope you will give it serious consideration. One of the things 
that impresses me most about Section 911 is its remarkable 
versatility. It helps large companies, it helps small 
companies. It helps big wage earners, it helps small wage 
earners. It helps in high-tax nations, it helps in low-tax 
nations. In fact, as far as we can tell, the only folks it 
doesn't help is the competition, and that's the way it should 
be. Thank you.
    Chairman Archer. Amo, you have asked some very excellent 
questions and it has piqued my interest to follow up a little 
bit.
    What, if we went to a purely territorial system, would you 
recommend as the best way to implement that? Simply not to tax 
foreign-source income or find a way to give a tax credit for 
foreign-source income?
    Mr. Conway. Mr. Chairman, I think we really should 
seriously look at a system which would exempt foreign income 
from tax. We operate in 180 countries and if you read our 
annual report, you will see that we pay a lot of taxes both in 
the United States and outside the United States. The minute 
that you have a foreign tax credit system, it introduces 
tremendous complication. Every time we go to make an 
acquisition and we compete for acquisitions with non-U.S. 
companies, we find ourselves doing an analysis and coming out 
on the short end of the stick because of these rules.
    We have learned in business that the best way to simplify a 
process is, many times, to eliminate a process. If we can, we 
should eliminate the foreign tax credit system. Our main goal 
is to increase our net income. If our taxes go up, that is OK. 
We don't mind paying taxes as long as our profits go up at the 
same time. So I think the point is that American companies 
would be in a much more competitive position. We would still be 
paying taxes. And, in the end, I think we would wind up winning 
the global competition.
    Chairman Archer. With all of the capabilities today and 
with the enormous intricate interrelationship between companies 
operating all over the world would there not be some opening 
for gaming of the system so that you would be able to transfer 
your domestic income to become foreign income to where it would 
not be taxed? Depending again upon the level of taxation in the 
country in which you were operating, would not transfer pricing 
methods and other methods, be an attractive nuisance to 
encourage a gaming of the system?
    Mr. Conway. I think there would be issues, but I think, 
given the sophistication in technology and information, we 
ought to take a serious look at a territorial system. I think 
those issues could be addressed just by defining the source 
rules and could be dealt with that way. What we find in our 
businesses is that we are generating income where the customers 
are. And I gave the example of the Otis Elevator Co. We have to 
operate where the elevators are in order to earn the income. 
And it is pretty clear what the source of income is in that 
case. When we are manufacturing and selling, then, you know, 
there are some issues because we cross borders with an export 
sale.
    But I think it would be worthwhile to seriously study those 
issues. I think we would be far ahead in trying to craft some 
reasonable rules. There will always be people who will game the 
rules. But I think we could craft rules that could cover the 
vast majority of companies, and I don't think we would 
necessarily jeopardize our revenue base.
    Mr. Chip. Mr. Chairman, those transfer pricing issues you 
alluded to are present in the current system because we still 
allow a certain amount of deferral of foreign income and there 
is an advantage to a U.S. company today to try to allocate as 
much income as possible to its lowest taxed subsidiaries. For 
that matter, that problem would exist in a sales tax system. 
And a concern about that, I think, was one of the main reasons 
subpart F was enacted in the first place and, indeed, it is one 
the main reasons for not having a territorial system.
    But I think we need to take account that the Congress has 
amended the Internal Revenue Code to provide the Internal 
Revenue Service with very powerful tools in the transfer 
pricing area, including very severe penalties for transfer 
pricing violations. And most of our competitor countries have 
followed our lead in that area so that the likelihood that a 
large company could successfully achieve an irrational shifting 
of large amounts of income, even under the current system let 
alone under an exemption system, is not nearly as severe as 
perhaps it may have been perceived to be 30 years ago and 
should not really stand in the way of moving to any other 
system, because the problem will exist under all systems. It is 
not limited to any one system.
    Mr. Mogenson. That is right, Mr. Chairman. When you 
contemplate a new system, you are correct that you would have 
to craft rules that would maintain the integrity of the U.S. 
tax base and the U.S. income that is earned here. That means 
that you would have to accurately define foreign-source income 
that is going to be exempted as under a territorial system and 
you must define the deductions or the expenses that relate to 
the income that you are not taxing.
    However, following up on the transfer pricing point, at 
least you would deal with transfer pricing in a very detailed 
way when the United States is one side of the transaction where 
it is in or out of the United States, but you have taken off 
the table the multitude of foreign-to-foreign transactions as 
far as applying the U.S. rules to them.
    Chairman Archer. Well, I can see that there would still be 
complexities with the IRS requiring an awful lot of compliance 
types of administrative red tape for you to be sure that, 
quote, we are not in some way taking domestic income and 
putting it into foreign income through all of the various 
methods that would be possible to a clever individual who knows 
how to work the intricacies and the sophistication that is 
available today. I do wonder why you say the sales tax would 
bring the same thing, because in the sales tax, you would have 
no recordkeeping for income whatsoever.
    Mr. Chip. Well, you do have the issue of inputs coming into 
the United States and items going out.
    Chairman Archer. Now if you just had a retail sales tax, 
you would not have any question of input coming into the United 
States.
    Mr. Chip. Well, not if you are thinking of a Customs system 
where you apportion the tax depending on the value-added or the 
value of the product. There will always be a question of what 
the real value is when it is being passed from a related to an 
unrelated person.
    Chairman Archer. Not with a retail sales tax, Mr. Chip. 
With a retail sales tax it would be all collected at the point 
of sale irrespective of how much came into the country through 
imports or how much was domestically produced. There would be 
no records for an income tax that would have to be kept. 
Transfer pricing or any other manipulation through some 
sophisticated system of interrelationship between two different 
countries would not be questioned. You eliminate all of that.
    Mr. Chip. Yes, Mr. Chairman, a purely retail sales tax that 
applied exclusively to transactions between businesses and 
unrelated customers would, you are correct, not have those 
problems.
    Chairman Archer. Well, I just wanted to make that clear, 
because you said you would have the same problem with the sales 
tax but you would not have the same problem in a sales tax.
    Mr. Chip. Many of the alternatives to the income tax system 
that have been considered, including value-added taxes and 
other taxes do have those problems, but, I agree that a purely 
retail sales would not have that problem.
    Chairman Archer. OK. Because your statement was even with 
the sales tax, you would have the same problem and that is not 
accurate relative to a retail sale tax.
    Mr. Chip. Not a retail sales tax.
    Chairman Archer. OK. OK. All right. Well, I hope I live 
long enough to where we can see an elimination of all the extra 
complexities that an income tax inevitably seems to put on us. 
The sad thing about an income tax is that we can talk about how 
we are going to simplify it, but I have been through many 
efforts to simplify the income tax and each time we attempt to 
simplify it, we make it more complex.
    1986 was the great simplification Act, and we added many 
new complexities that were not present prior to 1986. In fact, 
I was sitting right here at the time of the debate on the 1986 
Act and my friend Jimmy Baker, who was then Secretary of the 
Treasury, who I grew up with in Houston was testifying. He was 
presenting Treasury II, which was a 500-page summary of their 
proposal for tax reform, entitled Fairness, Growth, and 
Simplicity.
    I had scanned through it the night before, which was the 
only time we had available. I came to the foreign-source income 
provision section and read with incredulity what was in their 
own summary. In their own summary. It said the current system 
is extremely complex and very difficult to administer and our 
proposal will make it more complex. I read that to him and I 
said how can you entitle this Fairness, Growth, and Simplicity 
and he smiled and said that is why we put simplicity third in 
the order of things. [Laughter.]
    Then the Congress made it worse.
    So I have about lost confidence that we can simplify the 
income tax. We will get into that at another time.
    Are there any other questions? Mr. Portman.
    Mr. Portman. Mr. Chairman, that is a perfect segue because, 
as you know, it was the 1986 Act that you looked at that made 
these interest allocation rules so complicated and it really 
puts us here.
    Chairman Archer. By the way, I ended up leading the 
opposition to that bill, I want all of you to know. I am on 
record.
    Mr. Portman. Yes. But I also would say that even 
eliminating the corporate income tax and instituting a business 
sales tax, which could be called a VAT tax, whether it is 
subtraction or a credit method, would avoid many of these 
problems of allocation of income. It would create new problems, 
but I would venture to say they would not be nearly as complex 
for you all and ultimately for the American consumer as the 
current income tax system.
    But let me get back to reality for a second to what we 
might be able to do in the short-term on interest allocation. 
The Houghton-Levin bill, I think, is wonderful and Mr. Houghton 
and Mr. Levin are to be commended for rolling up their sleeves 
and getting into this international area at all. It is an area 
only less attractive to most members than the pension laws that 
we are trying to get into as well. But they deserve a lot of 
credit. They have a study, as you know, on the interest 
allocation rules. And then there is this additional legislation 
that I just dropped in recently with Mr. Matsui that tries to 
get at some of the points that were raised both in this panel 
and in the previous panel on interest allocation.
    And I just have a couple of follow-up questions to see 
whether we can maybe better identify some of the problems. And 
then, perhaps, talk about ways in which that legislation could 
be altered to make it more broadly applicable to some of the 
companies including, I listened to Mr. Green's testimony 
earlier, to UtiliCorp. He had some concerns, I think, about 
applicability to some companies, perhaps focusing on the 80 
percent rule. Maybe lowering that 80 percent to some smaller 
percentage.
    But if I could start with asking you, Mr. Laitinen, about 
your question regarding U.S. investment. You basically said 
that the home team is disadvantaged even on the home court, in 
so many words. And if you could follow through on that a little 
bit and explain why, for instance, a foreign car manufacturer, 
as compared to a GM, would be at an advantage.
    And I guess this relates also to the fact that all of your 
competitors probably live under a different tax system. So we 
know with some certainty how they are going to be taxed, which 
would be on the U.S. system, to the extent they are investing 
in the United States. Whereas our tax system would have 
interest allocated that is U.S. domestic interest allocated to 
foreign sources and therefore would put us at a disadvantage. 
Could you explain that?
    Mr. Laitinen. Well, basically, interest on U.S. debt 
incurred by a U.S. multinational to invest in the United States 
is subject to these interest allocation rules, whereas a 
foreign-based company with a subsidiary in the United States 
that borrows funds here to make a similar investment in the 
United States is not subject to those rules because that U.S. 
subsidiary of the foreign company is not going to have foreign 
assets to allocate interest to.
    An example, if I could give one, would be in the late 
1980s, when GM borrowed funds in the United States to build a 
Saturn Corporation plant in Spring Hill, Tennessee. And a 
portion of the interest expense on the debt was allocated to 
foreign-source income and, in effect, a current deduction was 
lost for part of that interest expense. But, by way of 
contrast, about the same time, Nissan built a plant down the 
road in Smyrna, Tennessee. As a foreign-based competitor, they 
weren't subject to the interest allocation rules on any 
borrowings they might have had for that plant. That is the type 
of thing that can happen again.
    Mr. Portman. So they got the full deduction on their 
interest that they borrowed for their expansion, whereas GM did 
not because some of that was allocated to foreign-source.
    Mr. Laitinen. Right. I use that as an example. I don't know 
their actual facts as to their borrowings and so on, but----
    Mr. Portman. Yes. Well, you don't know about their 
borrowings, necessarily, but we do know enough about the tax 
system in Japan or in Germany or in any of the other EU 
countries to know with some certainty that they would have been 
subject to a different set of rules.
    Mr. Laitinen. Right, but, in effect, the U.S.-based 
multinational investing in the United States is at a 
competitive disadvantage. That is why I was saying that it is 
not a level playing field, even in our home turf.
    Mr. Portman. Right. The other question I have which I 
raised a second ago was do you all have any thoughts as to how 
the legislation that we introduced, H.R. 2270, might be altered 
to make it more applicable to more companies? I mentioned the 
percentage of foreign ownership, for instance. Any thoughts of 
any of the panelists? Mr. Laitinen, anybody?
    Mr. Laitinen. Well, the percentage of affiliation is 80 
percent in your bill and it could be lowered to 50 percent. The 
CFC rule, for example, could be used for what foreign 
affiliates you take into account. I mean, that would be a way 
of broadening it. Also, there is a subgroup rule in the bill 
which we think is important. Under your bill, as I understand 
it, a company could elect to stay in the current law or elect 
worldwide fungibility with the subgroup election also. If that 
subgroup election were made available under current law, again, 
it would provide some additional flexibility.
    I mean, there are ways to broaden the bill slightly and 
still maintain the two important points of worldwide 
fungibility and subgroup elections, which are, as you know, the 
key points in your bill.
    Mr. Portman. Well, again, we appreciate your help and 
giving us advice on that. I will say that any change, 
obviously, has an impact on revenue. At least those two changes 
you mentioned would, I believe, raise an issue as to the 
revenue impact. But I think we have made some progress through 
Mr. Houghton's legislation and if we can get some interest 
allocation relief as well, it seems to me from what we have 
heard today, that will be a major help to U.S. companies trying 
to compete worldwide. Thank you, Mr. Chairman.
    Chairman Archer. I am constrained to ask whether there is 
any coalition of overseas companies that has been put together 
to try to determine the best way to do the interest allocation 
change. I understand that different businesses are affected 
differently, based on how we make the change. The 1986 Senate 
proposal, for example, does not help a lot of businesses. I 
wonder if there has been any effort to get the business 
community together to make a recommendation. I see Mr. Murray 
raising his hand in the audience out there. [Laughter.]
    Mr. Portman. National Foreign Tax Council.
    Chairman Archer. Well, we would appreciate the input of any 
one with practical experience on how we to make the best 
possible choice to remove this barrier to our competitiveness 
overseas. I think Mr. Portman's questions were very well-taken.
    Let me quickly ask you this and then excuse you and move 
on. If we were to get a pure territorial system, would most of 
the research that your corporations do be brought back to the 
United States? There would be no incentive to do it overseas if 
you are not. By reducing your foreign-source income, you would 
not be helping yourself in your bottom line net. However, if 
you brought it here and you take a deduction against your 
domestic income, then it seems to me it would be very 
attractive for you to start bringing your research activities, 
whatever they might be, back to the United States of America. 
Am I correct in that?
    Mr. Conway. Mr. Chairman, I think you are correct. If you 
are potentially adversely impacted by the foreign tax credit 
rules in the R&D allocation, it absolutely would make sense to 
move the R&D back because, you know, it would absolutely 
neutral from a tax standpoint and, quite frankly, I think for 
most companies, most of the R&D is done in the United States 
anyway. This is where the technology base is and to the extent 
that we not only get a deduction, but we get an R&D credit here 
as well, which has been extended--in fact, it has been approved 
with the alternative research credit--more and more countries 
are enacting R&D incentives.
    There are now 16 major countries which have R&D incentives. 
So I think a territorial system would provide an incentive to 
do more R&D here.
    Chairman Archer. OK. Thank you very much. Are there any 
other questions by members? Thank you very much. Your input has 
been very helpful to us. The Committee will be adjourned.
    [Whereupon, at 2:42 p.m., the hearing was adjourned.]
    [Submissions for the record to follow:]

Statement of LaBrenda Garrett-Nelson, Ad Hoc Coalition of Finance and 
Credit Companies, and Washington Counsel, P.C.

    Both H.R. 681 (introduced by Reps. McCrery and Neal) and 
Section 101 of the International Tax Simplification for 
American Competitiveness Act of 1999 (H.R. 2018, introduced by 
Reps. Houghton and Levin) highlight the need to extend the 
provision that grants active financial services companies an 
exception from subpart F. In light of the growing 
interdependence and integration of world financial markets, 
coupled with the international expansion of U.S.-based 
financial services entities, the foreign activities of the 
financial services industry should be eligible for deferral on 
terms comparable to that of manufacturing and other non-
financial businesses. This statement was prepared on behalf of 
an ad hoc coalition of leading finance and credit companies 
whose activities fall within the catch-all concept of a 
``financing or similar business.''
    The ad hoc coalition of finance and credit companies 
includes entities providing a full range of financing, leasing, 
and credit services to consumers and other unrelated 
businesses, including the financing of third-party purchases of 
products manufactured by affiliates (collectively referred to 
as ``Finance and Credit Companies''). This statement describes 
(1) the ordinary business transactions conducted by Finance and 
Credit Companies, including information regarding the unique 
role these companies play in expanding U.S. international 
trade, and (2) the importance of the active financing exception 
to subpart F to the international competitiveness of these 
companies.
   I. The International Operations of U.S.-Based Finance and Credit 
                               Companies
A. Finance and Credit Companies Conduct Active Financial 
Services Businesses.

    Finance and Credit Companies are financial intermediaries 
that borrow to engage in all the activities in which banks 
customarily engage when issuing and servicing a loan or 
entering into other financial transactions. Indeed, many 
countries (e.g., Germany, Austria, and France) actually require 
that such a company be chartered as a regulated bank. For 
example, one member of the ad hoc group has a European Finance 
and Credit Company that is regulated by the Bank of England 
and, under the European Union (``EU'') Second Banking 
Coordination Directive, operates in branch form in Austria, 
France, and a number of other EU jurisdictions. The principal 
difference between a typical bank and a Finance and Credit 
Company is that banks normally borrow through retail or other 
forms of regulated deposits, while Finance and Credit Companies 
borrow from the public market through commercial paper or other 
publicly issued debt instruments. In some cases, Finance and 
Credit Companies operating as regulated banks are required to 
take deposits, although they may not rely on such deposits as a 
primary source of funding. In every important respect, Finance 
and Credit Companies compete directly with banks to provide 
loan and lease financing to retail and wholesale consumers.

B. A Finance and Credit Company's Activities Include A Full 
Range Of Financial Services.

    The active financial services income derived by a Finance 
and Credit Company includes income from financing purchases 
from third parties; making personal, mortgage, industrial or 
other loans; factoring; providing credit card services; and 
hedging interest rate and currency risks with respect to active 
financial services income. As an alternative to traditional 
lending, leasing has developed into a common means of financing 
acquisitions of fixed assets, and is growing at double digit 
rates in international markets. These activities include a full 
range of financial services across a broad customer base and 
can be summarized as follows:
     Specialized Financing--Loans and leases for major 
capital assets, including aircraft, industrial facilities and 
equipment and energy-related facilities; commercial and 
residential real estate loans and investments; loans to and 
investments in management buyouts and corporate 
recapitalizations.
     Consumer Services--Private label and bank credit 
card loans; merchant acquisition, card issuance, and financing 
of card receivables; time sales and revolving credit and 
inventory financing for retail merchants; auto leasing and 
lending and inventory financing; and mortgage servicing.
     Equipment Management--Leases, loans and asset 
management services for portfolios of commercial and 
transportation equipment, including aircraft, trailers, auto 
fleets, modular space units, railroad rolling stock, data 
processing equipment, telecommunications equipment, ocean-going 
containers, and satellites.
     Mid-Market Financing--Loans and financing and 
operating leases for middle-market customers, including 
manufacturers, vendors, distributors, and end-users, for a 
variety of equipment, such as computers, data processing 
equipment, medical and diagnostic equipment, and equipment used 
in construction, manufacturing, office applications, and 
telecommunications activities.
    Each of the financial services described above is widely 
and routinely offered by foreign-owned finance companies in 
direct competition with Finance and Credit Companies.

C. Finance and Credit Companies Are Located In The Major 
Markets In Which They Conduct Business And Compete Head-on 
Against ``Name Brand'' Local Competitors.

    Finance and Credit Companies provide services to foreign 
customers or U.S. customers conducting business in foreign 
markets. The customer base for Finance and Credit Companies is 
widely dispersed; indeed, a large Finance and Credit Company 
may have a single customer that itself operates in numerous 
jurisdictions. As explained more fully below, rather than 
operating out of regional, financial centers (such as London or 
Hong Kong), Finance and Credit Companies must operate in a 
large number of countries to compete effectively for 
international business and provide local financing support for 
foreign offices of U.S. multinational vendors. One Finance and 
Credit Company affiliated with a U.S auto maker, for example, 
provide services to customers in Australia, India, Korea, 
Germany, the U.K., France, Italy, Belgium, China, Japan, 
Indonesia, Mexico, and Brazil, among other countries. Another 
member of the ad hoc coalition conducts business through 
Finance and Credit Companies in virtually all the major 
European countries, in addition to maintaining headquarters in 
Hong Kong, Europe, India, Japan, and Mexico. Yet another member 
of the ad hoc coalition currently has offices that provide 
local leasing and financing products in 22 countries.
    Finance and Credit Companies are legally established, 
capitalized, operated, and managed locally, as either branches 
or separate entities, for the business, regulatory, and legal 
reasons outlined below:
    1. Marketing and supervising loans and leases generally 
require a local presence. The provision of financial services 
to foreign consumers requires a Finance and Credit Company to 
have a substantial local presence--to establish and maintain a 
``brand name,'' develop a marketing network, and provide pre-
market and after-market services to customers. A Finance and 
Credit Company must be close to its customers to keep abreast 
of local business conditions and competitive practices. Finance 
and Credit Companies analyze the creditworthiness of potential 
customers, administer and collect loans, process payments, and 
borrow money to fund loans. Inevitably, some customers have 
trouble meeting obligations. Such cases demand a local presence 
to work with customers to ensure payment and, where necessary, 
to terminate the contract and repossess the asset securing the 
obligation. These active functions require local employees to 
insure the proper execution of the Finance and Credit Company's 
core business activities--indeed, a single member of the ad hoc 
group has approximately 15,000 employees in Europe. From a 
business perspective, it would be almost impossible to perform 
these functions outside a country of operation and still 
generate a reasonable return on the investment. ``Paper 
companies'' acting through computer networks would not serve 
these local business requirements.
    In certain cases, a business operation and the employees 
whose efforts support that operation may be in separate, same-
country affiliates for local business or regulatory reasons. 
For example, in some Latin American jurisdictions where profit 
sharing is mandatory, servicing operations and financing 
operations may be conducted through separate entities. Even in 
these situations, the active businesses of the Finance and 
Credit Companies are conducted by local employees.
    2. Like other financial services entities, a Finance and 
Credit Company requires access to the debt markets to finance 
its lending activities, and borrowing in local markets often 
affords a lower cost of funds. Small Finance and Credit 
Companies, in particular, may borrow a substantial percentage 
of their funding requirements from local banks. Funding in a 
local currency reduces the risk of economic loss due to 
exchange rate fluctuations, and often mitigates the imposition 
of foreign withholding taxes on interest paid across borders. 
Alternatively, a Finance and Credit Company may access a 
capital market in a third foreign country, because of limited 
available capital in the local market--Australian dollar 
borrowings are often done outside Australia for this reason. 
The latter mode of borrowing might also be used in a country 
whose government is running a large deficit, thus ``soaking 
up'' available local investment. A Finance and Credit Company 
may also rely for funding on its U.S. parent company, which 
issues debt and on-lends to affiliates (with hedging to address 
foreign exchange risks).
    3. In many cases, consumer protection laws require a local 
presence. Finance and Credit Companies must have access to 
credit records that are maintained locally. Many countries, 
however, prohibit the transmission of consumer lending 
information across national borders. Additionally, under 
``door-step selling directives,'' other countries preclude 
direct marketing of loans unless the lender has a legal 
presence.
    4. Banking or currency regulations may also dictate a local 
presence. Finance and Credit Companies must have the ability to 
process local payments and--where necessary--take appropriate 
action to collect a loan or repossess collateral. Foreign 
regulation or laws regarding secured transactions often require 
U.S. companies to conduct business through local companies with 
an active presence. For example, as noted above, French law 
generally compels entities extending credit to conduct their 
operations through a regulated ``banque'' approved by the 
French central bank. Other jurisdictions, such as Spain and 
Portugal, require retail lending to be performed by a regulated 
entity that need not be a full-fledged bank. In addition, 
various central banks preclude movements of their local 
currencies across borders. In such cases, a Finance and Credit 
Company's local presence (in the form of either a branch or a 
separate entity) is necessary for the execution of its core 
activities of lending, collecting, and funding.
    EU directives allow a regulated bank headquartered in one 
EU jurisdiction to have branch offices in another EU 
jurisdiction, with the ``home'' country exercising the majority 
of the bank regulation. Thus, for example, one Finance and 
Credit Company in Europe operates in branch form, engaging in 
cross-jurisdictional business in the economically integrated 
countries that comprise the EU. The purpose of this branch 
structure is to consolidate European assets into one 
corporation to achieve increased borrowing power within the EU, 
as well as limit the number of governmental agencies with 
primary regulatory authority over the business.

D. Finance and Credit Companies Play A Critical Role In 
Supporting International Trade Opportunities

    As U.S. manufacturers and distributors expand their sales 
activities and operations around the world, it is critical that 
U.S. tax policy be coordinated with U.S. trade objectives, to 
allow U.S. companies to operate on a level playing field with 
their foreign competitors. One of the important tools available 
to U.S. manufacturers and distributors in seeking to expand 
foreign sales is the support of Finance and Credit Companies 
providing international leasing and financing services. U.S. 
tax policy should not hamper efforts to provide financing 
support for product sales.
    U.S. manufacturers, in particular, include the availability 
of financing services offered by Finance and Credit Companies 
as an integral component of the manufacturer's sales promotion 
in foreign markets. For related manufacturing or other 
businesses to compete effectively, Finance and Credit Companies 
establish local country financial operations to support the 
business. As an example, the Finance and Credit Company 
affiliate of a U.S. auto maker establishes its operations where 
the parent company's sales operations are located, in order to 
provide marketing support.
    In supporting the international sales growth of U.S. 
manufacturers and distributors in developed markets, Finance 
and Credit Companies are themselves forced into competition 
with foreign-owned companies offering the same or similar 
leasing and financing services. To the extent Finance and 
Credit Companies are competitively disadvantaged by U.S. tax 
policy, U.S. manufacturers and distributors either are 
prevented from competing with their counterparts or must seek 
leasing and financing support from foreign-owned companies 
operating outside the United States.
      II. The Need to Continue the Subpart F Exception for Active 
                            Financing Income
A. Legislative Background

    When deferral for active financial services income was 
repealed in 1986, the Congress was concerned about the 
potential for abuse by taxpayers routing passive or mobile 
income through tax havens. At that time. the U.S. financial 
services industry was almost entirely domestic, and so little 
thought was given to the appropriateness of applying the 1986 
Act provisions to income earned by the conduct of an active 
business. The subsequent international expansion of the U.S. 
financial services industry created a need to modernize Subpart 
F by enacting corrective legislation.
    The Taxpayer Relief Act of 1997 introduced a temporary 
(one-year) Subpart F exception for active financing income, and 
1998 legislation revised and extended this provision for an 
additional year. The financial services industry continues to 
seek a more permanent Subpart F exception for active financing 
income.
    But for the Active financing exception, current law would 
discriminate against the U.S. financial services industry by 
imposing a current U.S. tax on interest, rentals, dividends 
etc., derived in the conduct of an active trade or business 
through a controlled foreign corporation. From a tax policy 
perspective, a financial services business should be eligible 
for the same U.S. tax treatment of worldwide income as that of 
manufacturing and other non-financial businesses.

B. The Active Financing Exception is Necessary To Allow U.S. 
Financial Services Companies To Compete Effectively In Foreign 
Markets

    U.S. financial services entities engaged in business in a 
foreign country would be disadvantaged if the active financing 
exception were allowed to expire (and the United States thereby 
accelerated the taxation of their active financing income).
    To take a simplified example, consider a case where a 
Finance and Credit Company establishes a U.K. subsidiary to 
compete for business in London. London is a major financial 
center, and U.S.-based companies compete not only against U.K. 
companies but also against financial services entities from 
other countries. For example, Deutsche Bank is a German 
financial institution that competes against U.S. Finance and 
Credit Companies. Like many other countries in which the parent 
companies of major financial institutions are organized, 
Germany generally refrains from taxing the active financing 
income earned by its foreign subsidiaries. Thus, a Deutsche 
Bank subsidiary established in London defers the German tax on 
its U.K. earnings, paying tax on a current basis only to the 
U.K.
    The application of Subpart F to the facts of the above 
example would place the U.S. company at a significant 
competitive disadvantage in any third country having a lower 
effective tax rate (or a narrower current tax base) than the 
United States (because the U.S. company would pay a residual 
U.S. tax in addition to the foreign income tax). The 
acceleration of U.S. tax under Subpart F would run counter to 
that of many other industrialized countries, including France, 
Germany, the United Kingdom, and Japan.\1\ All four of these 
countries, for example, impose current taxation on foreign-
source financial services income only when that income is 
earned in tax haven countries with unusually low rates of tax.
---------------------------------------------------------------------------
    \1\ For detailed analyses of other countries' approaches to anti-
deferral policy with respect to active financing income, see ``The NFTC 
Foreign Income Project: International Tax Policy for the 21st 
Century,'' Chapter 4 (March 25, 1999).
---------------------------------------------------------------------------
    In view of the relatively low profit margins in the 
international financing markets, tax costs might have to be 
passed on to customers in the form of higher financing rates. 
Obviously, foreign customers could avoid higher financing costs 
by obtaining financing from a foreign-controlled finance 
company that is not burdened by current home-country taxation, 
or--in the case of Finance and Credit Companies financing 
third-party purchases of an affiliate's product--purchasing the 
product from a foreign manufacturer offering a lower all-in 
cost. The active financing exception advances international 
competitiveness by insuring that financial services companies 
are taxed in a manner that is consistent with their foreign 
competitors--consistent with the legislative history of Subpart 
F and the long-standing tax policy goal of striking a 
reasonable balance that preserves the ability of U.S. 
businesses to compete abroad.
  III. The Definition of a Finance Company Under the Active Financing 
 Exception to Subpart F was Carefully Crafted to Limit Application of 
                 the Exception to Bona Fide Businesses
    The 1998 legislation introduced a statutory definition of a 
``lending or finance business'' for purposes of the active 
financing exception to subpart F. A lending or finance business 
is defined to include very specific activities:

          (i) making loans;
          (ii) purchasing or discounting accounts receivable, notes, or 
        installment obligations;
          (iii) engaging in leasing;
          (iv) issuing letters of credit or providing guarantees;
          (v) providing charge or credit services; or
          (vi) rendering related services to an affiliated corporation 
        that is so engaged.

A. A Finance Company Must Satisfy a Two-pronged Test to be 
Eligible to Qualify any Income for the Active Financing 
Exception.

    1. Predominantly Engaged Test.--Under a rule that applies 
to all financial services companies, a finance company must 
first satisfy the requirement that it be ``predominantly 
engaged'' in a banking, financing, or similar business. To 
satisfy the ``predominantly engaged'' test, a finance company 
must derive more than 70 percent of its gross income from the 
active and regular conduct of a lending or finance business (as 
defined above) from transactions with unrelated ``customers.''
    2. Substantial Activity Test.--Even if a finance company is 
``predominantly engaged,'' as in the case of all financial 
services companies, it will flunk the test of eligibility 
unless it conducts ``substantial activity with respect to its 
business. The ``substantial activity'' test, as fleshed out in 
the committee report, is a facts-and-circumstances test (e.g., 
overall size, the amount of revenues and expense, the number of 
employees, and the amount of property owned). In any event, 
however, the legislative history prescribes a ``substantially 
all'' test that requires a finance company to ``conduct 
substantially all of the activities necessary for the 
generation of income''--a test that cannot be met by the 
performance of back-office activities.

B. Once Eligibility is Established, Additional Requirements 
Must be Satisfied Before Income From Particular Transactions 
Can be Qualified Under the Active Financing Exception.

    As listed in the relevant committee report, there are only 
21 types of activities that generate income eligible for the 
active financing exception. In addition, an eligible Finance 
and Credit Company cannot qualify any income under the 
exception unless the income meets four, additional statutory 
requirements that apply to all financial services businesses:
    1. The Exception Is Limited to Active Business Income.--
First, the income must be ``derived by'' the finance company in 
the active conduct of a banking, financing or similar business. 
This test, alone, would preclude application of the active 
financing exception to the incorporated pocketbook of a high 
net worth individual or a pool of offshore passive assets.
    2. Prohibition on Transactions With U.S. Customers.--
Secondly, the income must be derived from one or more 
transactions with customers located in a country other than the 
United States.
    3. Substantial Activities.--Substantially all of the 
activities'' in connection with a particular transaction must 
be conducted directly by the finance company in its home 
country.
    4. Activities Sufficient For a Foreign Country To Assert 
Taxing Jurisdiction.--The income must be ``treated as earned'' 
by the Finance and Credit Company--i.e., subject to tax--for 
purposes of the tax laws of its home country.

C. In any Event, a Finance Company Cannot Qualify any Income 
Under the Active Financing Exception Unless it meets an 
Additional 30-Percent Home Country Test.

    Under a ``nexus'' test applicable to Finance and Credit 
Companies (but not banks or securities firms with respect to 
which government regulation satisfies the nexus requirement), a 
company must derive more than 30 percent of its separate gross 
income from transactions with unrelated customers in its home 
country. This rule makes it highly unlikely that taxpayers 
could locate a finance company in a tax haven and qualify for 
the active financing exception, because tax havens are unlikely 
to provide a customer base that would support the transactions 
required to meet the 30-percent home country test. Even if such 
a well-populated tax haven could be found, the ability to 
qualify income would be self-limiting (in terms of absolute 
dollars) by the dollar-value of transactions that could be 
derived from unrelated, home-country customers.
                               Conclusion
    We urge the Congress to extend the provision that grants 
active financial services companies an exception from subpart 
F. Without this legislation, the current law provision that 
keeps the U.S. financial services industry on an equal footing 
with foreign-based competitors will expire at the end of this 
year. Moreover, this legislation will afford America's 
financial services industry parity with other segments of the 
U.S. economy.

                                


Statement of Larry Bossidy, AlliedSignal, and The Business Roundtable

    I am Larry Bossidy, Chairman and CEO of AlliedSignal and 
Chairman of the Fiscal Policy Task Force of The Business 
Roundtable. I am submitting this statement for the record to 
express the views of The Business Roundtable on the corporate 
tax component of the 1999 tax reduction bill. The Business 
Roundtable is an association of chief executive officers of 
leading corporations with a combined workforce of more than 10 
million employees in the United States.
    As the Committee designs a tax cut to return the budget 
surplus to taxpayers, we urge that you allocate the tax cut 
between corporate and individual taxpayers as their tax 
collections have jointly contributed to the budget surplus. 
Specifically, we urge the Committee to reduce corporate income 
taxes by $1 for every $4 that it cuts from individual income 
taxes, as this $1 to $4 ratio reflects the collection of income 
tax over the current economic expansion from 1992. Thus, if a 
tax bill is structured around income tax cuts of $778 billion, 
the 10-year target for corporate income tax reduction would be 
approximately $156 billion. Such a corporate tax cut would 
stimulate savings, investment, economic growth and job 
creation.
    In the United States, corporations employ more people, pay 
more wages, fund more research, invest in more plant and 
equipment, and support more employee benefits than any other 
type of business. We also pay more federal income tax. 
Therefore, one of our main public policy interests is how taxes 
are affecting corporations in their central economic role as 
engines pulling the national economy.
    From that perspective, we urge the Committee to reduce the 
corporate income tax. Corporate funds that are not diverted to 
taxes can go into building the economy and underwriting 
prosperity in future years. The old saying is true: the time to 
invest is when you have it. The condition of the federal 
budget, itself a beneficiary of economic growth, makes 
corporate tax reduction feasible. Corporate tax reduction, in 
turn, can help sustain a strong recovery.
    As shown in the accompanying table, the proposed 1-to-4 tax 
cut ratio reflects the collection of federal income taxes since 
the U.S. economy began its solid, long period of growth in 
1992. Following the 1-to-4 guideline for the corporate 
component of the tax bill will----

          Be equitable, because the budget surplus will be paid back to 
        taxpayers in the same proportion as it is being created.
          Preserve the balance between individual and corporate income 
        taxes that has prevailed during our sustained prosperity, and
          Assure that some portion of the tax bill will make a 
        contribution to continuing economic growth and job creation.

    The Roundtable believes that the corporate portion of the 
tax-cut bill should center around reducing corporate income tax 
rates. A rate reduction is the fairest and simplest way to cut 
business taxes. It would benefit corporations of all sizes. It 
would put funds into play to compete for economic projects that 
have the best prospects for creating value and stimulating 
growth. The alternative is for the government to pick business 
winners based on politics and thus dilute the beneficial impact 
of a business tax reduction. As you know, the top corporate tax 
rate was raised from 34 percent to 35 percent in 1993 solely 
for deficit reduction, which is now an obsolete rationale. A 
two-percentage-point rate cut might be phased in--one point 
early in the 10-year planning period and another point later--
to fit the time pattern of cuts that Congress has defined.
    We are also interested in other aspects of corporate taxes, 
such as simplification of international tax rules, a permanent 
R&E credit, and repeal of the corporate AMT.
    The international provisions of the U.S. tax law represent 
a significant barrier to the competitiveness of U.S. companies 
in the global marketplace. The U.S. tax regime imposes costs on 
the foreign operations of U.S.-based multinationals that are 
not borne by our foreign competitors. With the ever-increasing 
globalization of the economy, there is a great need for 
fundamental reform of the U.S. international tax rules. U.S. 
companies must be able to compete abroad on equal terms if we 
are to compete successfully at home.
    The International Tax Simplification for American 
Competitiveness bill, introduced recently by Representative 
Houghton and Representative Levin and supported by many Members 
of the Committee, addresses many of the needed reforms. Of 
particular significance is the request that the Treasury 
Department study the interest expense allocation rules. The 
present-law rules severely penalize U.S.-based multinationals 
by artificially restricting their ability to claim foreign tax 
credits for the taxes they pay to foreign countries, thereby 
subjecting them to double taxation. The interest allocation 
rules must be reformed to eliminate the distortions that cause 
this double taxation and to eliminate the competitive 
disadvantage at which the present-law rules place U.S. 
multinationals.
    The Tax Reform Act of 1997 included the prospective repeal 
of a rule enacted in 1986 that restricted the ability of U.S. 
companies to claim foreign tax credits for foreign taxes paid 
by less-than-majority owned foreign subsidiaries; the 
international simplification bill enhances this important 
simplification by accelerating the repeal of this rule. In 
addition, the bill would provide more appropriate tax treatment 
for the sale by a foreign subsidiary of an interest in a 
partnership.
    In addition to these simplification measures, another 
particularly important provision is the permanent extension of 
the subpart F exception for active financial services income. 
This provision is essential to allowing the U.S. financial 
services industry compete with their foreign counterparts.
    These are just a few of the most pressing issues that need 
to be addressed in the U.S. international tax rules. We commend 
the Committee for its attention to these critical issues and 
look forward to working with the Committee to achieve the 
necessary reforms.
    We will make our tax directors available to your staff with 
information and comments in these and other areas if that would 
be helpful to your Committee.

  Federal Income Tax Collections During the Current Economic Expansion,
                                1992-1998
                [By fiscal year, in billions of dollars]
------------------------------------------------------------------------
                                                             Individual/
          Fiscal year            Individual     Corporate     Corporate
                                Income Taxes  Income Taxes      Ratio
------------------------------------------------------------------------
1992..........................        476.0         100.3           4.7
1993..........................        509.7         117.5           4.3
1994..........................        543.1         140.4           3.9
1995..........................        590.2         157.0           3.8
1996..........................        656.4         171.8           3.8
1997..........................        737.5         182.3           4.0
1998..........................        828.6         188.7           4.4
  Total.......................      4,341.4       1,058.0           4.1
------------------------------------------------------------------------

                                


Statement of the American Bankers Association

    The American Bankers Association (ABA) is pleased to have 
an opportunity to submit this statement for the record on the 
impact of U.S. tax rules on international competitiveness.
    The ABA brings together all elements of the banking 
community to best represent the interests of this rapidly 
changing industry. Its membership--which includes community, 
regional, and money center banks and holding companies, as well 
as savings associations, trust companies, savings banks and 
thrifts--makes ABA the largest banking trade association in the 
country.
    As technology and expanding trade opportunities change the 
global market place, financial institutions have had to make 
rapid adjustments in order to remain competitive with foreign 
financial entities. With respect to the international 
operations of U.S.-based financial institutions, the tax law 
has not kept pace with technological advances and changes in 
the global economy.
    The ABA supports the enactment of legislation that would 
simplify the international tax law and that would assist, 
rather than hinder, U.S. financial institutions' global 
competitiveness. We agree with the observation that we can't 
afford a tax system that fails to keep pace with fundamental 
changes in the global economy or that creates barriers that 
place U.S. financial services companies at a competitive 
disadvantage. In that regard, the ABA would like to commend 
Representatives Amo Houghton (R-NY) and Sander Levin (D-MI) for 
the introduction of H.R. 2018, the International Tax 
Simplification for American Competitiveness Act of 1999. H.R. 
2018 contains a number of important provisions that would do 
much to update U.S. international tax law and promote global 
competitiveness in the financial services industry. We would 
also like to commend Representatives Jim McCrery (R-LA) and 
Richard Neal (D-MA) for the introduction of H.R. 681, which 
would permanently extend the active financing exception to 
subpart F.
    This statement will address a number of proposals currently 
under consideration, many of which have been included in H.R. 
2018 and H.R. 681.
  Permanent Extension for Subpart F Active Financing Income Exception
    Prior to 1987, subpart F allowed deferral of U.S. tax on 
income derived in the active conduct of a banking business 
until the income was distributed to a U.S. shareholder. In 
1986, Congress repealed the provisions put in place to ensure 
that a controlled foreign corporation's active financial 
services business income would not be subject to current tax in 
response to concerns about the potential for taxpayers to route 
passive or mobile income through tax havens.
    In 1997, Congress added an exception to the subpart F rules 
for the active income of U.S.-based financial services 
companies. The 1986 rules were modified for a number of 
reasons. An important reason was the fact that many U.S. 
financial services companies found that the existing rules 
imposed a competitive barrier in comparison to the home-country 
rules of many foreign-based financial services companies. 
Moreover, the logic of the subpart F regime was flawed, given 
that most other U.S. businesses were not subject to similar 
subpart F restrictions on their active trade or business 
income. The 1997 Taxpayer Relief Act added rules to address 
concerns that the provision would be available to shelter 
passive operations from U.S. tax. Due primarily to revenue 
constraints, the exception was made effective for only one 
year. In 1998, the provision was extended and modified for the 
1999 tax year.
    Thus, under current law, the active business income of U.S. 
financial institutions is subject to tax only when that income 
is distributed back to the U.S. This temporary exception to 
subpart F will expire in 1999, ending deferral of financial 
services income and placing financial institutions on a more 
uneven playing field vis-a-vis domestic manufacturing companies 
and global competitors.
    Generally, active financial services income is generally 
recognized as active trade or business income. Thus, if the 
current-law provision were permitted to expire at the end of 
this year, U.S. financial services companies would find 
themselves at a significant competitive disadvantage vis-a-vis 
major foreign competitors when operating outside the United 
States. In addition, because the U.S. active financing 
exception is currently temporary, it denies U.S. companies the 
certainty their foreign competitors have. The need for 
certainty in this area is important to U.S. companies. They 
need to know the tax consequences of their business operations, 
which are generally evaluated on a multi-year basis.
    Failure to extend the active financing exception this year 
would countermine legislative efforts to promote 
competitiveness and simplification. Moreover, the tax structure 
would revert to a regime that inequitably penalizes 
international financial institutions, as the National Foreign 
Trade Council's report on subpart F \1\ indicates.
---------------------------------------------------------------------------
    \1\ International Tax Policy for the 21st Century: A 
Reconsideration of Subpart F (March 25, 1999). In that report, the NFTC 
concluded that the development of a global economy has substantially 
eroded subpart F's policy rationale; that subpart F subjects U.S.-based 
companies cross border operations to a heavier tax burden than that 
borne by their foreign-based competitors; and that subpart F applies 
too broadly to various categories of income that arise in the course of 
active foreign business operations, and should be substantially 
narrowed.
---------------------------------------------------------------------------
    The ABA supports the permanent extension of the active 
financing exception to the subpart F for financial services 
companies.
  Simplify the Foreign Tax Credit Limitation for Dividends from 10/50 
                               Companies
    The foreign tax credit rules impose a separate foreign tax 
credit limitation (separate baskets) for companies in which 
U.S. shareholders own at least 10 but no more than 50, percent 
of the foreign corporation. The old law 10/50 rule imposed an 
unreasonable level of complexity, which Congress sought to 
correct in the 1997 Tax Relief Act by eliminating the separate 
baskets for 10/50 companies using a ``look through'' rule. 
However, the 1997 Act change is not effective until after year 
2002, and itself imposes an additional set of complex rules.
    The ABA supports the proposal to accelerate the effective 
date of the 1997 Act change to apply the look-through rules to 
all dividends received in tax years after December 31, 1998, 
irrespective of when the earnings constituting the makeup of 
the dividend were accumulated. Such change would dramatically 
reduce tax credit complexity and the administrative burdens on 
financial institutions doing business internationally. It would 
also help level the playing field with respect to global 
competitors.
  Subpart F Earnings and Profits Determined under Generally Accepted 
                      Accounting Principles (GAAP)
    The ABA supports the proposal to determine the subpart F 
earnings and profits of foreign subsidiaries under GAAP. Under 
current rules, determining the earnings and profits of foreign 
subsidiaries for subpart F purposes may comprise as many as 
five steps involving a series of complex and time-consuming 
computations. For example, the process would start with the 
local books of account of the foreign subsidiary, continuing 
through a series of complicated accounting and tax adjustments 
to the parent institution. On audit, each of the steps would 
have to be explained and justified to IRS agents. We agree with 
the proposition offered by certain witnesses at this hearing 
that using GAAP to determine earnings and profits would provide 
equally reliable figures at a fraction of the time and cost to 
the institution. In this connection, we point out that H.R. 
2018 contains such a provision, which we urge you to consider.
    Treatment of Certain Dividends of Regulated Investment Companies
    The ABA supports legislation that would exempt from U.S. 
withholding tax certain dividends distributed by a U.S. mutual 
fund to non-resident alien individuals.
    The U.S. mutual fund industry has established a favorable 
global reputation for providing professional portfolio 
management as well as significant shareholder safeguards. 
However, current law hinders foreign individual investment in 
U.S. mutual funds in that the law does not extend the exemption 
from U.S. withholding tax on capital gains and interest income 
in investment portfolios to such funds. In particular, interest 
income and short-term capital gains, which otherwise would be 
exempt from U.S. withholding tax when received by foreign 
investors directly or through a foreign fund, are subject to 
U.S. withholding tax as ``dividends'' when distributed by a 
U.S. fund to its investors.
    We note that H.R. 2018 contains a provision that would 
exempt such dividends from U.S. withholding tax. This change 
would help U.S. firms compete with foreign-based companies in 
attracting investments and we commend it to you for your 
consideration.
                               Conclusion
    We appreciate having this opportunity to present our views 
on these issues. We look forward to working with you in the 
further development of solutions to our above-mentioned 
concerns.
    [By permission of the Chairman]

                                


Statement of Hon. Bill Alexander, American Citizens Abroad (ACA), 
Geneva, Switzerland

    Mr. Chairman, Members of the Committee: Let me thank you 
for the great pleasure of having this opportunity to submit a 
written statement. The subject that you are addressing is a 
worthy one and also a challenging and perplexing one. It is a 
subject that has been of particular interest to me for many 
years, including the twenty-four years while I served in this 
body representing my constituents in the First Congressional 
District of Arkansas.
    My District is one of the major rice growing areas of the 
United States. Having open and fair access to world markets is 
of great concern to my former constituents. To better 
understand their challenges, and to better serve their 
interests, I helped organize the House Export Caucus. Later, 
because of active involvement in issues of trade and 
competitiveness, I had the privilege of serving on the 
President's Export Council during the Carter Administration. 
Through contacts with American business and labor leaders, I 
began to understand even more clearly how the laws we enact, 
with what we believe to be a very justifiable and noble purpose 
in mind, can have very important unintended consequences in 
other areas that are also vital to the health and welfare of 
all Americans. It is in this conflict between noble and 
justifiable aims, and their related unintended consequences, 
that leads to the necessity to continually revisit questions 
such as the one we are addressing here again today.
    While serving on the Export Caucus and the President's 
Export Council, I had the opportunity to meet with leaders of a 
number of organizations which have been created by Americans 
living abroad, whose daily lives are touched by the laws and 
regulations of the United States and, in particular, those laws 
and regulations that alter the nature of their competitive 
standing in the marketplaces of the world.
    One of these organizations, American Citizens Abroad (ACA), 
has been forceful and eloquent in articulating the concerns of 
this expatriate community. For more than twenty years they have 
been writing reports, drafting legislation, and proposing other 
forms of appropriate redress for the grievances that they feel 
are causing harm not only to themselves but also to all 
Americans. It is my privilege today to be speaking on behalf of 
ACA, one of the strongest and clearest voices of the more than 
3 million U.S. citizens who live and work abroad.
    Addressing the specific topic of this hearing, we ask: 
``Are the tax laws of the United States having an impact on the 
competitiveness of American goods and services in world 
markets?''
    There is another equally important and often overlooked 
question. Are U.S. tax laws making it difficult for U.S. 
citizens to live and work abroad in competition for jobs and as 
entrepreneurs with citizens of other countries?
    The quick answer to both of these questions is quite 
simple. Yes, the tax laws are having an impact and it is highly 
negative.
    It is negative principally because the United States is the 
only country that has seen fit to extend its domestic tax laws 
to embrace the income of its citizens living and working away 
from home. This extra-territorial reach of domestic legislation 
into foreign markets fundamentally distorts the economic rules 
of the game and tilts the playing field. Competitors in the 
marketplaces of the world compete by two sets of rules and two 
cost structures. One applies to Americans, the other applies to 
everyone else.
    What the United States did in unilaterally distorting the 
competitive environment to the detriment of its expatriate 
citizens did not pass unnoticed. Shortly after the United 
States started to impose domestic taxation on its overseas 
citizens in 1962, the major developed countries of the world, 
meeting under the auspices of the Organization for Economic 
Cooperation and Development (OECD), took up this very question 
of how citizens living away from home should be treated from a 
taxation point of view. The OECD members decided that a common 
set of standard rules applying to all participants in the same 
market should be the norm. The OECD drafted, therefore, a model 
bi-lateral tax treaty that defines the tax status of citizens 
living away from their home countries. This bi-lateral tax 
treaty takes as its fundamental premise that workers should 
have a unique tax liability to be defined by the country in 
which the individual is residing after a certain minimum period 
of time. Double taxation is considered not only unfair but also 
detrimental to efficient trading. The OECD model proposes 
taxation of individuals that is predictable, consistent and 
applies equally to everyone in the same geographical market.
    When the United States negotiates tax treaties, it also 
uses the OECD model as a base. Then, however, it unilaterally 
adds additional language that states boldly that the 
protections in these treaties against double taxation will not 
apply to U.S. citizens! In other words, bi-lateral tax treaties 
negotiated by the United States that ensure competitive 
equality to foreign citizens living and working in the United 
States, at the same time guarantee competitive inequality and 
extra competitive handicaps to Americans living and working 
abroad. That, surely, is an incomprehensible trade policy.
    Does this really make a difference? Does imposing an 
additional tax burden on overseas Americans really have any 
impact on the ability of the United States to export American 
goods and services?
    When I was serving on President Carter's Export Council in 
1979, we set up a special task force to look into these and 
related questions on the impact of American taxation on trade. 
Our analysis was convincing and our conclusions were 
unambiguous. The taxation of overseas Americans was costing the 
United States billions of dollars in lost trade, and tens of 
thousands of export-related jobs each year. We recommended 
twenty years ago that the United States stop taxing Americans 
living and working abroad so that they might once again enjoy a 
level playing field throughout the world.
    How has the situation changed since then? We have a lot of 
anecdotal evidence to suggest that it hasn't improved very 
much. I regret very much that more concrete official 
statistical and analytical data is still lacking on this 
subject. I would have welcomed the chance to comment on any 
studies of the cost-benefit analysis of the taxation of 
overseas Americans carried out recently by at least one 
responsible agency of the U.S. Government. Unfortunately, no 
such studies seem to be available.
    How do we explain that the U.S. Commerce Department 
prepares an annual assessment of barriers to trade imposed by 
other countries, but has never shown any similar curiosity 
concerning the barriers we impose on ourselves?
    How do we explain the anomaly of the aggressive efforts of 
the Office of the Special Trade Representative, ardently 
negotiating at the WTO and with foreign governments to open up 
foreign markets for U.S. origin goods and services, but never 
negotiating internally within the U.S. Government to eliminate 
the impediments that we ourselves have erected to the 
exploitation of these new market opportunities by our own 
citizens?
    In the absence of any such official information on this 
subject, I asked ACA to prepare the table that is attached to 
my statement. This shows the evolution of the Gross Domestic 
Product (GDP) of the United States since 1960, before the 
taxation of overseas Americans began, right up through the end 
of 1998. It also shows the evolution of imports, exports and 
the balance of trade since then.
    This table shows that when the law introducing expatriate 
taxation was first enacted, trade was still a very modest 
percentage of GDP, and the United States was enjoying a small 
trade surplus. Not long thereafter, when the tax bite was 
starting to be felt abroad, trade grew to play a more important 
role in our domestic economy and a trade deficit began to 
appear. Trade as a percentage of GDP increased from less than 
10% in 1962 to almost 25% in 1998. At the same time, the United 
States began to generate and accumulate the world's largest and 
most chronic trade deficit, which grew to 2% of GDP in 1998 
alone.
    Taking an international comparative perspective, are the 
practices of the United States really that different from those 
of other countries? One of the founders of ACA looked 
specifically at this question. He carried out a study a few 
years ago comparing the way the major trading nations of the 
world treat their citizens living and working in foreign 
countries, and discovered that taxation was only one of the 
areas where the practices of the United States differed 
fundamentally from the practices of our competitors. 
Citizenship of children born abroad, access to social security 
programs, health care, educational benefits, and myriad other 
issues are all areas where other countries are usually much 
more generous than the United States. These are additional 
dimensions of the competitive advantage enjoyed by non-
Americans. Sadly, the United States comes last in two 
categories. It imposes heavier burdens and grants fewer 
benefits than almost every other major trading nation.
    Does it make a difference when it is more expensive and 
bureaucratically burdensome for an American expatriate than an 
expatriate of another country? Let's put the question a 
different way. Would we ever consciously send our armed forces 
abroad to fight in foreign conflicts with severe competitive 
military handicaps compared with our adversaries? If not, why 
do we feel so complacent and have such a different attitude 
toward our overseas Americans who have to compete in the 
equally ferocious trade battles?
    How specifically does the U.S. taxation of overseas 
Americans create a handicap? Let me give a few brief examples.
    If Americans have to pay taxes to two countries on the same 
income, and if both countries define income, and taxes, 
differently, there will inevitably be income that is taxed more 
than once. Many taxes paid abroad are not recognized as tax 
eligible for credit under U.S. tax rules because the tax is 
novel and not used the same way in the USA. Even in the case of 
credit given for some foreign income taxes paid abroad, the 
United States has moved recently to reduce the value of this 
credit by applying the Alternative Minimum Tax to the foreign 
earned income exclusion. In other words, today there is a 
mandatory minimum amount of double tax that has to be paid on 
certain incomes, even if that income has already been fully 
taxed at the same rate by another country!
    The extra tax paid abroad obviously has to come from 
somewhere. Either the American expatriate taxpayer then has to 
live with a lower take-home pay than colleagues of other 
nationalities earning the same gross income, or the employer 
will have to make up the difference. In many multinational 
companies, the practice in recent years has been for equal 
take-home pay for equal work for all expatriate employees of 
any nationality. Thus, the employer has to endure an extra 
expense for every U.S. citizen on the payroll. Ask, as I have 
done, whether corporations overseas are less inclined to hire 
Americans than people of other nationalities and the answers 
are usually clear and unambiguous. Americans are less likely to 
be hired because they are more expensive. The net difference in 
cost is a payment that has to be made to the U.S. government 
for the privilege of having an American on the payroll. And, 
because of the way the repayment of the extra tax is made, the 
burden grows larger every year. So even if an American is hired 
to work abroad, the extra cost for an expatriate American keeps 
getting larger and larger. This is another incentive to reduce 
the American expatriate staff.
    Even more perplexing and competitively debilitating is the 
exquisite complexity of the U.S. tax laws as they apply to 
Americans living and working abroad. Because they are so hard 
to understand, many Americans are forced to have recourse to 
expensive tax and legal consultants and can end up paying even 
more in service charges to correctly fill out their tax returns 
than they end up paying in tax. The competitive handicap then 
becomes double. Not only is the tax a burden, but the cost of 
complying with the complexity of the tax compounds the burden.
    Finally, Mr. Chairman, we should be paying much more 
attention to the competitive handicap that our tax laws create 
for American entrepreneurs overseas, especially those who are 
willing to set up a small business in remote parts of the 
world. The costs associated with the filling out of forms and 
filing returns for small entrepreneurial controlled foreign 
corporations are a very heavy disincentive. The only way many 
such businesses could survive is by simply ignoring the current 
law and risking the consequences. Yet who better than an 
American entrepreneur should be encouraged to go abroad, set up 
an innovative new business, and manifest the virtues and 
benefits of the liberal democratic political and economic 
system we have found to be so propitious to our welfare and way 
of life at home.
    In other words, does it really make sense for the United 
States to spend billions of dollars each year of taxpayer money 
on aid projects in developing countries when, without any cost 
to the United States, we could simply turn loose our American 
entrepreneurs and wish them well? If we would get rid of the 
expense and complexity of our current tax laws as a 
disincentive to our entrepreneurs, I believe we could much more 
effectively help developing countries become much more 
prosperous, and at a much lower cost to the American taxpayer.
    My concern about the importance of overseas Americans to 
the long term economic health and vitality of our country 
motivated me to introduce legislation to end the taxation of 
Americans overseas. The last bill, which I introduced in 1992 
(102nd Congress HR 4562), was co-sponsored by my good friend 
Congressman Ben Gilman, now the Chairman of the House Committee 
on International Relations.
    In summary, my conviction is that changing the tax laws of 
the United States would have a dramatic and material impact on 
the ability of Americans to compete in foreign markets. I 
believe that this would encourage many more Americans to live 
and work abroad, to set up small businesses abroad, and be a 
powerful contribution toward a more safe and prosperous world.
    It is noteworthy that overseas Americans have never asked 
the U.S. Government for special competitive favors abroad. Are 
they really asking for too much when they request the right to 
be able to compete on a more level playing field? I think not.
    My hope, therefore, Mr. Chairman, is that you and your 
colleagues will agree that giving overseas Americans a fair and 
equal chance to compete abroad is not only good for them, but 
good for us all. Amending the tax laws of the United States 
would have a positive impact on the international 
competitiveness of our country and its citizens at home and 
abroad.
    Thank you.
    [GRAPHIC] [TIFF OMITTED] T6775.005
    
                                


Statement of the American Petroleum Institute

                            I. Introduction
    This statement is submitted by the American Petroleum 
Institute (API) for the June 30, 1999 Ways and Means hearing on 
the impact of U.S. tax rules on the international 
competitiveness of U.S. workers and businesses. API represents 
approximately 300 companies involved in all aspects of the oil 
and gas industry, including exploration, production, 
transportation, refining and marketing.

Significance of Foreign Operations for U.S. Oil Companies

    While U.S. petroleum reserves are depleting, federal and 
state government policies increase restrictions on exploration 
for, and development of, new deposits. To stay in business, 
U.S. petroleum companies must find new reserves overseas. This 
is at a time when U.S. oil industry is losing its leadership 
position because of the shrinking advantages over its foreign 
competition from U.S. technology and investment capital.
    The loss of ground by U.S. oil companies relative to their 
foreign competitors is alarming. In 1974, 6 of the 10 largest 
oil companies in the world, and 4 of the top 5, were U.S.-
based. In 1995, only 5 of the top 10 companies, and 2 of the 
top 5, were U.S.-based. According to a recent API study for the 
period of 1985 to 1995, foreign production by U.S. companies 
increased by 300,000 barrels/day. Nevertheless, that was not 
enough to offset the declines in U.S. production, so that U.S. 
companies' total global production during that period actually 
declined. Over that same period, production by similarly sized 
foreign oil companies other than those from OPEC countries 
expanded nearly 60%.

U.S. Tax Policy Adversely Affects Competitiveness

    A major factor in the decline in U.S. companies' relative 
share in global production is U.S. international tax policy. 
U.S. tax rules impose a substantial economic burden on U.S. 
companies not faced by their foreign competition. This is 
because the U.S. tax regime exposes U.S. multinational 
companies to double taxation (that is, the payment of tax on 
foreign source income to both the host country and to the U.S.) 
and to taxation before repatriation of profits. Moreover, 
complexities of the U.S. tax rules result in significant 
compliance costs not faced by foreign competitors. As a result, 
U.S. companies may be forced to forego foreign investment 
altogether based on projected after-tax rates of return, or 
they may be preempted in bids for overseas investments by their 
foreign competitors.
    Since the early sixties, U.S. tax policy has been driven by 
the goal of capital export neutrality which purports to remove 
any tax advantages of foreign investment by equalizing the tax 
burden for U.S. and foreign investments. A continuing adherence 
to this policy ignores that the allocation of investment 
capital is no longer controlled by multi-national corporations 
alone but is increasingly influenced by portfolio investors, 
reflecting the development of a global capital market. Thus, 
tax policy no longer exerts the same control over domestic vs. 
foreign investment by U.S. corporations as in the past, but may 
affect whether U.S. residents invest through U.S. or foreign 
corporations.

Foreign Investment Strengthens the U.S. Economy

    U.S. tax policy with respect to foreign source income, 
although intending to tax the return on foreign and domestic 
investment the same, has developed a demonstrable bias against 
foreign operations. This policy was based on the postulate that 
foreign investment by U.S. business loses jobs and capital for 
the domestic market. This is not empirically demonstrable. More 
importantly, this ineffective policy, as a relict of a past 
era, conflicts with global integration and removal of trade 
barriers.
    With the entry into the information age, foreign investment 
by U.S. companies must no longer be viewed in the context of a 
Runaway Plant problem, but as creating new opportunities for 
U.S. employment in management and support functions as well as 
the export of products and technology. Moreover, for U.S. oil 
companies the location of opportunities for investment is 
dictated by subterraneous geological history. It is merely a 
question of whether the U.S. company or its foreign competitor 
will have the opportunity of the investment in the oil and gas 
project. But in case of a failure of the U.S. company to obtain 
the business opportunity, it is not at all certain that the 
freed up capital be invested in the U.S. First of all, there 
may be a lack of comparable domestic investment opportunities. 
Secondly, the U.S. portfolio investor, who ultimately controls 
the available capital, may shift his investment to a foreign 
competitor who has access to more profitable projects.
    Foreign investment by a U.S. oil company has significant 
benefits. A persistent, strong foreign presence of U.S. oil 
companies maintains foreign employment of U.S. personnel and 
utilization of U.S. technology in foreign markets and maintains 
domestic employment in activities which support those 
companies' foreign operations. The U.S. oil and gas industry 
directly employs almost 60,000 Americans in the U.S. in jobs 
directly dependent on these companies' international 
operations. Over 140,000 additional Americans are employed in 
the U.S. by U.S. suppliers to the industry's foreign 
operations. An additional 150,000 Americans are employed in the 
U.S. supporting those working for the oil companies and their 
suppliers. Thus, over 350,000 Americans owe their jobs to the 
international success of the U.S. oil and gas industry.
    As distinguished from tax policy, U.S. trade policy 
supports foreign investment by U.S. oil companies. Examples are 
the encouragement to U.S. participation in the oil field of the 
Caspian Sea countries which was praised by the Administration 
as fostering the political independence of those newly formed 
nations, as well as securing new sources of oil to Western 
nations, still too heavily dependent on Middle-East imports.
    The opening of the countries of the former Soviet-Union to 
foreign capital and the privatization of energy in portions of 
Latin America, Asia and Africa--all offer the potential for 
unprecedented opportunity in meeting the challenges of 
supplying fuel to a rapidly growing world economy. In each of 
these frontiers, U.S. companies are poised to participate 
actively. However, if U.S. companies cannot compete because 
they operate under comparatively disadvantageous home country 
tax rules, foreign resources will instead be produced by 
foreign competitors, with little or no benefit to the U.S. 
economy, U.S. companies, or American workers.

The Goal of Capital Export Neutrality Overshot

    Tax Code provisions that are driven by capital export 
neutrality often violate their theoretical underpinning. As we 
will discuss below, the fractioning of the foreign tax credit 
(FTC) basket, the income sourcing and deduction allocation 
rules, the imposition of U.S. concepts in testing the income 
tax character of a foreign tax,\1\ the limited excess credit 
carryover, and the transfer pricing criteria, all can result in 
double taxation, clearly in violation of capital export 
neutrality. Similarly, where the foreign tax is higher, there 
is no reduction of the U.S. tax and the foreign investment 
bears more tax as compared to the domestic opportunity, failing 
to assure export neutrality.
---------------------------------------------------------------------------
    \1\ In other words, the arrogated preemption of the foreign 
sovereign's choice of how to exercise its power to tax.

---------------------------------------------------------------------------
Hearing Promises Correction in Priorities of U.S. tax policy

    We welcome this Hearing as a recognition of the need of an 
overhaul of the taxation of foreign source income that is 
driven by a reformulated U.S. tax policy with multinational 
competitiveness \2\ as primary criterion.
---------------------------------------------------------------------------
    \2\ By the JCT defined as ``the ability of U.S. multinationals 
(firms headquartered in the United States that operate abroad) that 
locate production facilities overseas to compete in foreign markets. . 
. . This definition of competitiveness focuses on the after-tax returns 
to investments in production facilities abroad.'' E.g., JCS-6-91, at 8 
(1991).
---------------------------------------------------------------------------
    In the past, revenue raising in and of itself was 
paramount. One will recall that in the last hours of the 
deliberations of the Tax Reform Act of 1986 it was the taxation 
of foreign source income that was used as a source of 
additional revenue. To further illustrate, the Treasury 
Department's January 1993 interim report on ``International Tax 
Reform'' lists simplification as primary objective, followed by 
administrability, consistency, economic efficiency, and (only 
last) ``competitiveness.'' The Committee's focus on what should 
be the primary criterion of a sound tax policy for the taxation 
of foreign source income will assure that tax policy will fall 
into step with a modern trade policy.
    The international competitiveness of U.S. firms must become 
the primary criterion for U.S. taxation of foreign source. This 
will agree with U.S. foreign trade policy for the new global 
market place which. Efforts must continue to level the playing 
field as regards home country taxation. Such efforts should 
include considerations of whether the time has come for the 
introduction of a territorial system of taxation by the United 
States.
    A realignment of the present system with today's global 
market place will contribute to a strengthening of the foreign 
presence of U.S. oil companies which assures not only 
employment of U.S. personnel both abroad and in domestic 
support functions, but also exports of equipment and supplies 
from the U.S. for use in the foreign operations.

Passage of The International Tax Simplification for American 
Competitiveness Act of 1999, H.R. 2018 Would be a Significant 
Step Towards Leveling the Playing Field in the Global Market 
Place

    The proposed International Tax Simplification for American 
Competitiveness Act of 1999, H.R. 2018, goes a long way toward 
simplifying the current U.S. international tax rules and 
removing some of the inequities in the existing system. As 
reflected in our subsequent discussion, of particular interest 
to our members are: the repeal of compliance costly Code 
Section 907 additional separate limitation on Foreign Oil and 
Gas Extraction Income (FOGEI) as obsolete because of the 
numerous cross-crediting limitations under the FTC basket rules 
and the all industry encompassing dual capacity taxpayer 
regulations (Sec. 208); the acceleration of the repeal of the 
separate FTC limitation for dividends received from 
noncontrolled 10/50 companies (Sec. 204); the recognition of 
the need to treat the European Union as one country under the 
subpart F rules (Sec. 102); the introduction of symmetry 
through the adoption of an overall domestic loss recapture 
(Sec. 202); the look-through for sales of partnership interests 
(Sec. 107); the extension of look-through rules to interest, 
rents, and royalties from a noncontrolled Section 902 
corporation or a noncontrolled foreign partnership (Sec. 205); 
the repeal of the 10% limitation on the use of FTCs under the 
Alternative Minimum Tax (AMT)(Sec. 207); the option to 
determine subpart F E&P under generally accepted accounting 
principles (Sec. 104); the exception of foreign operations of 
foreign persons from the uniform capitalization rules (UNICAP) 
(Sec. 302); the clarification that income solely from pipeline 
transportation through a foreign country is not subject to 
subpart F (Sec. 105); the extension of the FTC carryforward to 
ten years (Sec. 201) and the change of the ordering rules so 
that carryover credits are deemed to be used first (Sec. 206); 
and the recognition of the need to correct the distorting and 
complex interest allocation rules (Sec. 309).
    Our statement comments in more detail on these provisions. 
We also highlight other aspects of current law which affect our 
members' international competitiveness due to potential double 
taxation, the taxation of controlled foreign corporations' 
(CFC) earnings before repatriation, and the disproportionate 
compliance costs. We suggest relief from these problems which 
should have no or little revenue effects.
     II. How U.S. Tax Rules Place U.S. Companies at a Competitive 
                 Disadvantage in the Global Marketplace
Foreign Tax Credit and Deferral as Corollaries of World Wide 
Taxation

    One of the most serious risks to foreign operations by 
multinational firms is their vulnerability to double taxation. 
Two approaches have been adopted to remedy this problem: 
worldwide taxation with a credit for taxes paid to foreign 
governments, and territorial taxation which limits a home 
country's taxation of its citizens to income generated within 
its national boundaries.
    The U.S. taxes domestic corporations on worldwide income. 
That is, U.S. companies are subject to the same U.S. tax 
liability whether that income is earned at home or abroad. As a 
complement to world-wide taxation, the FTC is, of course, 
designed to prevent double taxation. Furthermore, world-wide 
income should be taxed only when realized by the subjects of 
U.S. taxation, i.e., U.S. citizens (including U.S. 
corporations) and resident aliens. Legislative and 
administrative changes within the last several decades have 
severely diluted and emasculated these tenets.

The Flawed Foreign Tax Credit Regime

    Although the U.S. allows a credit against a company's U.S. 
tax liability for taxes paid to foreign governments, the FTC 
does not fully protect U.S. companies against double taxation, 
placing U.S. companies at a competitive disadvantage. In 
addition, the FTC will not assure export neutrality where the 
host country imposes a higher tax than the U.S. tax because 
there is no refund of the excess tax burden.
    But even where the host country tax is equal to or lower 
than the U.S., many of the FTC rules prevent export neutrality 
because they subject US corporations to double taxation. As 
discussed, these restrictive features include the rules on (1) 
creditability of foreign taxes which impose U.S. income tax 
criteria on foreign tax regimes; (2) limited credit carryover 
periods which do not take into account the differences in 
income and deduction recognition timing under the host country 
rules; (3) the numerous FTC baskets; (4) transfer pricing; (5) 
sourcing of income; (6) allocation of deductions; (6) transfer 
pricing; (7) and loss of deferral which inhibits effective tax 
credit management.
    Many of our trading partners limit home country tax of 
their citizens to income generated within their national 
boundaries. Foreign competitors based in territorial taxation 
countries still enjoy a benefit even where the host country tax 
is lower than the U.S. tax and the above mentioned distorting 
effects do not come into play.
    For example, when income earned abroad by a U.S. company is 
subject to a foreign income tax rate that is less than the U.S. 
rate, then U.S. companies are subjected to a tax burden (to the 
U.S.) not borne by foreign competition from a country with 
territorial taxation:


------------------------------------------------------------------------
                                                        Competitor from
                                        U.S.-based        territorial
                                         company          system  home
                                                            country
------------------------------------------------------------------------
Income from Host Country..........                100                100
Host country tax at 25%...........                 25                 25
Take home.........................                 75                 75
Home country taxable income.......                100                  0
U.S. tax at 35%...................                 35
FTC...............................                 25
Residual U.S. tax.................                 10
After Tax Income..................                 65                 75
Competitor's Higher Return........                                 15.4%
------------------------------------------------------------------------

U.S. Shareholders are Taxed on Deemed Dividends

    As originally adopted, world-wide taxation by the U.S. was 
intended to capture the income of citizens and residents. 
However, driven by a concern that US taxpayers could keep 
movable passive income in CFCs outside the US taxation, anti-
deferral rules were adopted which tax the U.S. shareholder 
before it realizes certain earnings of its CFC. Despite this 
``movable passive income'' rationale for the subpart F regime, 
anti-deferral rules were extended to certain operating income 
despite the fact that such earnings were not received by the 
shareholder and may have been reinvested by the CFC in active 
business operations.
                  III. Relief from Major Adverse Rules
A. Defects in the Foreign Tax Credit Regime

    Foreign Tax Credit Separate Basket Rules. Foreign taxes can 
be utilized as a credit only up to the amount of U.S. tax on 
foreign source income. Thus, an overall limitation on currently 
usable FTC's is computed by taking the ratio of foreign source 
income to worldwide taxable income and multiplying this by the 
tentative U.S. tax on worldwide income. The FTC separate basket 
rules further limit the allowable FTC. The overall FTC 
limitation must be computed separately for more than nine 
separate categories, or baskets, of foreign source income. 
Thus, U.S. tax rules force taxpayers in the active conduct of a 
trade or business to divide their active business income into 
multiple baskets, with the concomitant inability to cross 
credit. U.S. companies are often unable to make up for 
differences in timing and the mutations of the income/expense 
profiles, etc., of the tax regimes of the host countries. 
Because the separate basket rules increase the likelihood that 
a U.S. company will owe residual U.S. tax on foreign source 
income, they further widen the gap between the U.S. companies' 
and their competitors' home countries tax systems, to the 
disadvantage of U.S. businesses.
    Foreign taxes on active business income should be available 
for cross credit. We must return to the roots of the FTC and 
allow full credit against U.S. taxes on foreign business income 
for all foreign taxes and not limit their use through the 
imposition of a schedular system. Any undesirable shielding of 
U.S. tax on offshore passive income can be prevented by one 
separate passive basket.
    Foreign Oil and Gas Extraction Income and Foreign Oil 
Related Income. Code Section 907. In the computation of the 
overall FTC limitation foreign oil and gas income falls into 
the general limitation basket. But before this limitation for 
general operating income, foreign income taxes on foreign oil 
and gas income have to clear the additional tax credit hurdle 
of Code Section 907.
    Section 907 limits the utilization of foreign income taxes 
on FOGEI to that income times the current U.S. corporate income 
tax rate. The excess credits may be carried back two years and 
carried forward five years, with the creditability limitation 
of Section 907 being applicable for each such year. Section 907 
also authorizes Treasury to provide in regulations that a 
purported income tax on foreign oil related income (FORI) is 
not creditable but only deductible to the extent such income 
tax on FORI is materially greater than the amount of tax 
imposed on income other than FORI or FOGEI. FORI is income 
derived from the foreign refining, transportation, and 
distribution, of oil and gas and its primary products. 
Furthermore, Section 907 provides that, if the taxpayer has an 
overall foreign extraction loss in a year that reduces non-
extraction income, a corresponding amount of FOGEI in a 
subsequent year has to be re-characterized as income which is 
not FOGEI.
    Section 907 was originally enacted in 1975 in reaction to 
the first oil crisis and out of a concern that the high oil and 
gas production taxes paid to host countries might be in part 
the economic equivalent of ground rents or royalties. Unlike 
the U.S. and some Canadian provinces, mineral rights in other 
countries vest in the foreign sovereign, which then grants 
exploitation rights. Because of this identity of the grantor of 
the mineral rights and the taxing sovereign, the high tax rates 
imposed on oil and gas profits have become subject to scrutiny 
whether this government take is in part payment for the grant 
of ``a specific economic benefit'' from the mineral 
exploitation rights.
    Congress intended for the FOGEI and FORI rules to purport 
to identify the tax component of payments by U.S. oil companies 
to foreign governments. The goal was to limit the FTC to that 
amount of the foreign government's ``take'' which was perceived 
to be a tax payment vs. a royalty as payment for the production 
privilege. But even the so identified creditable tax component 
should be not be used to shield the U.S. tax on certain low 
taxed other foreign income, such as shipping.
    These concerns have been adequately addressed in subsequent 
administrative rulemaking and legislation. After several years 
of discussion and drafting, Treasury completed in 1983 the 
``dual capacity taxpayer rules'' of the FTC regulations which 
set forth a methodology for determining how much of an income 
tax payment to a foreign government will not be creditable 
because it is a payment for a specific economic benefit. Such a 
benefit could, of course, also be derived from the grant of oil 
and gas exploration and development rights. These regulations 
have worked well for both IRS and taxpayers in various 
businesses (e.g., foreign government contractors), including 
the oil and gas industry. In addition, the multiple separate 
basket rules were enacted in 1986, restricting taxpayers from 
offsetting excess FTC's from high-taxed income against taxes 
due on low-tax categories of income.
    Since 907 has been rendered obsolete since the function of 
Section 907 is now fully covered by the FTC baskets of the 1986 
Act and the ``dual capacity taxpayer regulations'' under Code 
Section 901. Furthermore, the Section 907 limitation has raised 
little, if any, additional tax revenue because excess FOGEI 
taxes would not have been needed to offset U.S. tax on other 
foreign source income. Nevertheless, oil and gas companies 
continue to be subject to burdensome compliance work. Each 
year, they must separate FOGEI from FORI and the foreign taxes 
associated with each category. These are time consuming and 
work intensive analyses, which have to be replicated on audit. 
Section 907 should be repealed as obsolete [Sec. 208 of The 
International Tax Simplification for American Competitiveness 
Act of 1999] which would promote simplicity and efficiency of 
tax compliance and audit.
    Dividends Received from 10/50 Companies. The 1997 Tax Act 
repealed the separate basket rules for dividends received from 
10/50 companies, effective after the year 2002. A separate FTC 
basket will be required for post-2002 dividends received from 
pre-2003 earnings. Because of these limitations, U.S. companies 
will continue to forego in many cases foreign projects through 
noncontrolled 10/50 corporations. Accordingly, the repeal will 
remove significant complexity and compliance costs for 
taxpayers and foster their global competitiveness.
    The repeal of the separate limitation basket requirement 
with respect to dividends received from 10/50 companies 
therefore should be accelerated. In addition, the requirement 
of maintaining a separate limitation basket for dividends 
received from E&P accumulated before the repeal should be 
eliminated [see Sec. 204 of The International Tax 
Simplification for American Competitiveness Act of 1999].
    Look-through Treatment for Sale of Partnership Interests. 
The distributive share of partnership income of an at least 10% 
partner of a foreign partnership brings with it all tax 
attributes, including the FTC basket classification. By 
contrast, the gain on the sale of a partnership interest falls 
into the passive income FTC category. A 1988 amendment to Code 
Section 954 characterizes the gain on the disposition of a 
foreign partnership as Foreign Personal Holding Company Income 
(FPHCI) which is referenced in the passive income definition of 
the FTC categories.
    The passive income categorization is particularly 
burdensome for the oil and gas industry. Because of frequent 
inability to secure 100% of the mineral interest from foreign 
governments, the business strategy to spread the risk of 
exploration by participating in several projects instead of 
``putting all the eggs into one basket,'' or because of capital 
restraints, U.S. companies typically find themselves as joint 
venturers in foreign exploration projects. Unless there is an 
election-out under the Joint Operating Agreement, the venture 
will be a partnership for U.S. purposes. Under current rules 
the gain from the sale of such venture participation would be 
passive income even though it is the disposition of an interest 
in business operations whose venue was not chosen for tax 
reasons but because of nature's placement of the natural 
resource.
    The 1988 amendment conflicts with the aggregate theory of 
partnership taxation. It is generally applied in foreign income 
taxation with respect to the effect of partner level 
transactions. Furthermore, there is no rationale for treating 
the disposition gain different from the income distribution. 
Both are realizations of values generated in the partnership 
and differ only in the form of realization.
    Economically, any gain on the sale of the partnership 
interest is attributable to the value of the partnership 
assets. If the partnership sold the assets, the FTC categories 
for such income would flow through to the partner. The same 
rule should apply if the partner by selling its partnership 
interest sells the equivalent of its undivided interest in the 
partnership assets [See Section 107 of The International Tax 
Simplification for American Competitiveness Act of 1999 which 
removes the gain on disposition of a partnership interest from 
passive income not only for purposes of the FTC basket rules 
but also from FPHCI]. It is not only inequitable but also 
counterintuitive for the legal form of the value realization to 
control the FTC basket characterization.
    Look-through Treatment for Interest, Rents, and Royalties 
With Respect To Non-Controlled Foreign Corporations and 
Partnerships. U.S. companies are often unable, due to 
government restrictions or operational considerations, to 
acquire controlling interests in foreign corporate joint 
ventures. To align their position with general participation 
situations in foreign projects, they also should be granted the 
look-through treatment for interest, rents and royalties 
received from foreign joint ventures as in the case of 
distributions from a CFC.
    Current tax rules also require that payments of interest, 
rents and royalties from noncontrolled foreign partnerships 
(i.e., foreign partnerships owned between 10 and 50% by U.S. 
owners) must be treated as separate basket income to the joint 
venture partners. Again, as in the case of corporate joint 
ventures, look-through treatment should be extended to these 
business entities. This would abolish distinctions in treatment 
of distributions that are based on participation percentages 
which may be beyond the control of the U.S. taxpayer [See 
Section 205 of The International Tax Simplification for 
American Competitiveness Act of 1999].
    Recapture of Overall Domestic Losses. When in a tax year 
foreign source losses reduce U.S. source income (overall 
foreign loss or OFL), this perceived beneficial domestic 
taxation effect has to be ``recaptured'' by resourcing foreign 
source income in a subsequent tax year as domestic source. Of 
course, this re-characterization reduces the ratio of foreign 
source income to total income, which in turn reduces the ratio 
of tentative U.S. tax which can be offset against foreign 
taxes. However, if foreign source income is reduced by U.S. 
source losses, there is no parallel system of ``recapture.'' 
Taxpayers are not allowed to recover or recapture foreign 
source income that was lost due to a domestic loss. The U.S. 
losses thus can give rise to excess FTC's which, due to the FTC 
carryover restrictions, may expire unused. Only a corresponding 
re-characterization of future domestic income as foreign source 
income will reduce the risk that FTC carryovers do not expire 
unused [See Section 202 of The International Tax Simplification 
for American Competitiveness Act of 1999].
    Foreign Tax Credit Carryover Rules. The utilization of 
income taxes paid to foreign countries as FTC is limited to the 
U.S. tax that is owed on the foreign source income. Thus, an 
overall limitation on currently usable FTC's is computed by 
taking the ratio of foreign source income to worldwide taxable 
income and multiplying this by the tentative U.S. tax on 
worldwide income. The excess FTC's can be carried back to the 
two preceding taxable years, or to the five succeeding taxable 
years, subject in each of those years to the same overall 
limitation. If the credits are not used within this time frame, 
they expire.
    Because of the ever increasing limitations on the use of 
FTC's, coupled with the differences in income recognition 
between foreign and U.S. tax rules, excess credit positions are 
frequent. Present law's short seven year carryover (2-year 
carryback and 5-year carryforward) period easily results in 
credits being lost, most likely resulting in double taxation.
    As a modernization step, clearly within the long-standing 
policy of not taxing the same income twice, the carryover 
periods for excess FTCs should be extended, in accordance with 
the rationale of the much longer period allowed for net 
operating loss utilization [See Section 201 of The 
International Tax Simplification for American Competitiveness 
Act of 1999 which extends the carryforward to 10 years and Sec. 
206 assuring first use of carryover credits].
    Allocation of Interest Expense. Current law requires the 
interest expense of all U.S. members of an affiliated group to 
be apportioned to all domestic and foreign income, based on 
assets. The current rules deny U.S. multinationals the full 
U.S. tax benefit from the interest incurred to finance their 
U.S. operations. For example, if a domestically operating 
member of a U.S. tax consolidation with foreign operations 
incurs interest to finance the acquisition of new environmental 
protection equipment, a portion of the interest will be 
allocated against foreign source income of the group and 
therefore become ineffective in reducing U.S. tax. A U.S. 
subsidiary of a foreign corporation (or a U.S. corporation--or 
affiliated group--without foreign operations) would not suffer 
a comparable detriment.
    Unless allocation based on fair market value of assets is 
elected, allocations of interest expense according to the 
adjusted tax bases of assets allocate too much interest to 
foreign assets. For U.S. tax purposes, foreign assets generally 
have higher adjusted bases than similar domestic assets because 
domestic assets are eligible for accelerated depreciation while 
foreign-sited assets are assigned a longer life and limited to 
straight-line depreciation. For purposes of the allocation, the 
E&P of a CFC is added to the stock basis. Since the E&P 
reflects the slower depreciation, the interest allocated 
against foreign source income is disproportionately high.
    Rules similar to the Senate version of interest allocation 
in the Tax Reform Act of 1986 would alleviate the current anti-
competitive results. In addition to the domestic consolidated 
group, the allocation group would include all companies that 
would be eligible for U.S. tax consolidation but for being 
foreign corporations. The interest allocated to foreign source 
income under this worldwide taxpayer rule would be reduced by 
the interest that would be allocable to foreign source income 
from the foreign corporations if treated as separate group. 
Second, as an exception to the ``one taxpayer'' rule, ``stand 
alone'' subsidiaries could elect to allocate interest on 
certain qualifying debt on a mini-group basis, i.e., looking 
only to the assets of that subsidiary, including stock.
    Furthermore, taxpayers should be allowed to elect to use 
the E&P bases of assets, rather than the adjusted tax bases, 
for purposes of allocating interest expense. Use of E&P basis 
would produce a fair result because the E&P rules are similar 
to the rules now in effect for determining the tax bases of 
foreign assets [See H.R. 2270 introduced by Messrs. Portman and 
Matsui as the Interest Allocation Reform Act].
    Foreign Tax Credit Limitation under the Alternative Minimum 
Tax. U.S. tax rules prohibit the use of FTC's to reduce the 
tentative minimum tax (AMT) to less than 10% of the tax before 
the FTC (AMT FTC Cap). Excess credits are eligible for 
carryover under the same carryover rules discussed above. The 
AMT FTC Cap was part of a general floor for the use of net 
operating loss (NOL) and investment tax credit (ITC) 
carryovers. But the FTC serves a function distinct and 
different from NOLs or the ITCs, the other tax attributes whose 
utilization is limited for AMT purposes.
    The NOL carryover rules are designed to overcome any 
hardships resulting from the annual accounting concept. The ITC 
is a tax benefit designed to foster investment in productive 
capital. Both provisions developed only over time and do not 
have the systematic cogency of the FTC. As the logical and 
systematic result of the U.S. claiming worldwide taxing 
jurisdiction over U.S. corporations, the FTC has been a fixture 
of the U.S. tax system since 1918. Concurrently with the 
adoption of worldwide taxing jurisdiction, the U.S. ceded 
primary taxing jurisdiction to the host country. To deny a full 
offset of AMT with FTC violates this principle of secondary 
U.S. taxation of foreign source income.
    The AMT's rationale to assure U.S. tax payments on economic 
income is inappropriate with respect to foreign source economic 
income if the result is double taxation. While the AMT 
envisions acceleration of tax payments which otherwise would 
become due in the future (only deferred because of preferences 
or tax attributes like NOL and ITC), the availability of FTC's 
reflects that an appropriate tax already has been exacted from 
the taxpayer. To the extent of FTC's, there is no economic 
income which escapes taxation. Accordingly, the AMT FTC Cap 
should be repealed [See Section 207 of The International Tax 
Simplification for American Competitiveness Act of 1999].
    Repeal Code Section 901(j) which Denies Foreign Tax Credit 
with Respect to Countries Supporting Terrorism, Etc. The global 
political landscape has changed considerably since the 
enactment of this provision in 1986. Not only are 
confrontational polarizations into opposing power centers 
fading, so is terrorism as means of international politics. 
Barriers have come down so fast that the establishment of 
diplomatic relations cannot keep up with global integration.
    The retention of this provision merely hinders business 
developments because of the lag in establishing full diplomatic 
relations.
    State Tax Allocation to Foreign Income. Pursuant to a 
statutory grant of general rulemaking authority, Treasury has 
issued regulations requiring the allocation of State income 
taxes or income based franchise taxes to foreign source income 
if taxable income determined under State law exceeds Federal 
taxable income. Because of the often substantial variances 
between these two tax bases, U.S. taxpayers may be subject to 
double taxation because foreign taxes attributable to the 
foreign income that is eliminated by the misallocation of State 
taxes will not offset U.S. tax on worldwide income. State 
income taxes are a cost of doing business in a particular State 
and generally have nothing to do with a U.S. taxpayer's foreign 
operations; they should affect only income generated from 
activities within the State. From a technical standpoint, the 
allocation rule is defective because it compares State taxable 
income with Federal taxable income; the respective regimes may 
differ substantially as to inclusiveness and timing. This 
misallocation therefore should be abolished.
    Overreaching Treasury Regulations on Dual Consolidated 
Losses. IRC Section 1503(d) was designed to forestall a 
perceived abuse where a U.S. affiliate's net operating loss was 
not only deducted against the income of another U.S. company 
but under a foreign tax regime also reduced the income of a 
foreign affiliate. That Section authorizes regulations to 
except U.S. corporations from this loss disallowance to the 
extent the losses do not offset the income of another foreign 
corporation under the foreign tax law. Treasury has issued a 
regulation pursuant to which practically every foreign business 
operation of a U.S. corporation jeopardizes the deduction of a 
loss from the foreign venture for the U.S. tax consolidation 
unless unreasonable administrative undertakings are stipulated. 
For example, a U.S. consolidated return corporation with 
foreign nexus, including a mere interest in a foreign 
partnership, can use a loss in computing consolidated return 
income only if it enters into a burdensome agreement with the 
IRS which requires continuous monitoring and in many cases 
annual reporting. In light of the burdensome and overreaching 
administrative rule, the statute should limit loss disallowance 
to the targeted abuse and preempt the current regulatory 
overkill.

B. Relief from Shareholders' Current Taxation of CFC Earnings

    Repeal the Byzantine High-Tax Kick-Out. According to FTC 
basket rules, otherwise passive income is not included in the 
passive FTC basket if it is subject to a foreign tax rate in 
excess of the U.S. rate. The implementing regulations impose a 
regime that defies a brief summary.
    These labyrinthine rules add enormous complexity. The 
computation of sub-groups and sub-baskets, together with the 
various sets of rules for determining the amount of tax on a 
particular type of income, impose inordinate burdens on the 
foreign and domestic tax personnel of U.S. multi-national 
corporations.
    The primary reason for the separate passive income basket 
is the perceived easy mobility into low tax jurisdiction. If 
this goal is not realized, there is no reason to mingle passive 
income with operating income, because the underlying 
characteristic of mobility and its passive character remains. 
``Once passive income, always passive income.'' Accordingly, 
the ``high-tax kick-out'' should be repealed.
    E&P for Sub-part F Should be Based on GAAP Financial 
Statements. Under current rules, for the taxation of the US 
shareholder, E&P of foreign corporations have to be determined 
according to US tax accounting rules. The accounting personnel 
and accounting systems of foreign subsidiaries typically do not 
allow simple adjustments to US tax books. Proposed regulations 
under Code S964 recognize the unrealistic nature of such a 
requirement and grant relief from most book to tax adjustment. 
Unfortunately, this relief--because of a perceived lack of 
statutory authority--does not extend to the determination of 
E&P in connection with computing whether or not there is a 
deemed distribution of subpart F income that may have been 
realized by the CFC.
    Nevertheless, the reasons for the dispensation from the 
book to tax adjustments under the proposed Section 964 
regulations apply equally in connection with subpart F. Without 
extension of the relief to the E&P computation for subpart F 
purposes, the Section 964 relief is meaningless. Because of the 
possibility that a CFC may realize income of the type that may 
give rise to subpart F income it has to track its E&P under 
current rules according to US tax accounting principles.
    A uniform recognition of financial statements of CFCs for 
all purposes of the taxation of its US shareholders would 
remove an unnecessary, costly compliance feature [See Section 
104 of The International Tax Simplification for American 
Competitiveness Act of 1999].
    Anti-Deferral Rules Should Not Be Applied To Pipeline 
Transportation. Under Code Section 954(g), a CFC's foreign base 
company oil related income (FBCORI, i.e., a CFC's FORI derived 
other than in a country of extraction or consumption) includes 
pipeline transportation income. In the past such income was 
typically derived as integral part of downstream oil and gas 
operation (processing, refining, and marketing).
    Large pipeline projects through non-producing countries 
without further processing are a recent phenomenon. The 
original ratio legis behind the FBCORI category does not apply 
to such pipeline transportation. The location is not subject to 
tax consideration but is controlled by the most feasible 
connection between production site and intended naval 
transshipping or consumption point, taking into account 
construction and maintenance cost, as well as political 
considerations.
    Accordingly, income from carrying oil and gas in a pipeline 
through a country should be excepted from FBCORI [See Section 
105 of The International Tax Simplification for American 
Competitiveness Act of 1999].
    Treat European Community as Single Country. In recognition 
of economic realities, all countries comprising the European 
Community (EC) should be treated as a single country for 
purposes of the subpart F rules on foreign base company sales 
income and foreign base company service income. Where the 
perceived taint of tax arbitrage through cross-border 
transactions is missing, US tax rules except what would 
otherwise be subpart F income if derived from transactions 
within the CFC's country of incorporation. The same rationale 
should applies in excepting transactions to the unified market 
of the EC nations, representing customs and monetary unity with 
the goal of tax harmonization. This would be an important step 
in the reduction of the disadvantage CFCs experience in the 
common market vis a vis their EC based competitors.
    The recognition of the EC as one country should also apply 
to the ``same country'' exception FBCORI. Without such 
modification, the EC's recognition as one country would not 
carry over into refining, distribution, and marketing of oil 
and gas as well as their primary products. For example, a CFC's 
sale in Germany of gasoline from its refinery in The 
Netherlands would continue to be tainted, even though the 
transaction takes place within the borders of what now is 
recognized as one economy [The problem is recognized in the 
study commissioned under Section 102 of The International Tax 
Simplification for American Competitiveness Act of 1999].
          IV. Provisions Common to FTC and Anti-Deferral Rules
Exempt Foreign Operations of Foreign Persons from the Uniform 
Capitalization Rules

    The Uniform Capitalization Rules (UNICAP) of Code Section 
263A are designed to assure that (1) all production cost are 
capitalized and (2) the same rules apply to the production 
activities of all industries. Perceived tax accounting 
differences among industries and activities were seen as 
unwelcome factors in resource allocation and structural 
alignments. Moreover, it was argued that a better matching of 
income and expenses would also prevent unwarranted deferral of 
income taxes.
    The application of UNICAP to foreign operations of foreign 
persons was not a concern of Congress. It has been the 
Service's failure to exercise its regulatory discretion which 
still subjects foreign operations of foreign persons to UNICAP.
    An exemption from UNICAP would bring simplicity. It would 
not violate equity. Any attempt to equalize tax postures of 
foreign persons with respect to foreign operations is futile 
because of the ever changing tax regimes in the host countries. 
Because of excess FTCs it would be revenue neutral. Because of 
a relief from compliance cost, the exemption would promote 
competitiveness [See Section 302 of The International Tax 
Simplification for American Competitiveness Act of 1999].
                             V. Conclusions
    The risk of double taxation presented (1) by restrictions 
on the use of FTC and (2) by the current taxation to the U.S. 
shareholder of certain CFC income regardless of distribution, 
continues to adversely affect the ability of U.S. businesses to 
compete worldwide. The complexity of the U.S. tax rules 
obfuscate tax planning and introduce often substantial risks, 
hindering effective capital investment. Simplification, removal 
of inequitable and ineffective rules, and alignment with 
today's global economy would encourage compliance, facilitate 
the free flow of capital, and improve the competitive position 
of U.S. multinational concerns. The passage of The 
International Tax Simplification for American Competitiveness 
Act of 1999 would go a long way to the realization of these 
goals.

                                


Statement of Rod Paige, Council of the Great City Schools, and 
Superintendent of Houston Public Schools

    Mr. Chairman, Congressman Rangel, and members of the Ways 
and Means Committee, I am Rod Paige, Superintendent of the 
Houston Public Schools. I am submitting testimony regarding the 
significant need for major federal school infrastructure aid on 
behalf the Houston Public Schools and the Council of the Great 
City Schools, the coalition of some fifty of the largest 
central city school districts of the nation.
    It has been five years since the General Accounting 
Office's study of school infrastructure needs garnered national 
attention. To the surprise of many, the school infrastructure 
inadequacies were found to be nearly universal, though not 
unexpectedly more severe in urban schools. A $112 billion 
backlog of serious infrastructure needs was identified back in 
1994. But despite the efforts of some states, and school 
districts like Houston committing significant resources to 
address our most severe facility problems, the remainder of the 
$112 billion historic backlog still remains. In fact, the wave 
of new school enrollments from the so-called ``baby boom echo'' 
have lifted the estimated national school infrastructure needs 
to approximately $200 billion as this century comes to a close.
    Houston is very proud that our voters elected to finance a 
$678 million bond authority in 1998 by a 73% to 27% vote. I 
believe that this represents a renewed vote of confidence in 
our public schools after a narrow defeat of a previous bond 
authority in 1996. However, even though Houston will be 
spending over $1/2 billion in the next 3 years, we have not 
addressed the full range of our school facility needs. Our 
facilities staff projects the need for over $800 million in 
additional funds to meet our current requirements. In fact, 
during a review of needs before our bond election, we estimated 
that unless we are able to address our needs in deferred 
maintenance and renovations, in 10 years time the cost to 
repair the schools would approach replacement value. At that 
time, it is unlikely we would ever catch up with the problem. 
Infrastructure problems if not addressed in a timely manner, 
may be the most serious facilities problem facing large urban 
district now and certainly in the future.
    The State of Texas has done little to assist districts such 
as Houston over the years. Although the State does have an 
education fund which is used to help obtain higher bond 
ratings, little money has been put into the big districts for 
facilities. While we are continuing to work for the full 
inclusion of facilities funding into the State's school funding 
laws and some movement in that direction occurred this year, I 
see little hope that the State will soon come to our aid in any 
significant manner.
    In order to address the massive national school facility 
needs, substantial participation is critical not only from our 
local public schools, but also from our state and our national 
governments. A $200 billion gap cannot be closed without a 
significant financial commitment from all levels. The Houston 
Public Schools and the Council of the Great City Schools, 
therefore, support a major federal investment to close a 
sizable portion of this national school facilities gap.
    It also is essential to optimize the volume and the 
timeliness of school construction and renovation generated by 
each federal aid dollar, and that the communities with the 
highest concentrations of poor are assured of receiving the 
greatest amount of assistance.
    There are a variety of school infrastructure assistance 
bills pending before both houses of the Congress. I would like 
to address a few of these legislative proposals using Houston 
as an example:
          Tax Subsidized, Zero Interest School Facility Bonds
    There are a number of tax-subsidized, zero-interest school 
facility bond proposals pending in both houses of Congress with 
the major difference found primarily in the distribution 
formulas of the tax subsidizes. Cong. Rangel's H.R. 1660, Cong. 
Johnson's H.R. 1760, and Sen. Lautenberg's S. 223, each provide 
tax credits in lieu of interest income to the holders of 
qualified school facility bonds, thus allowing school districts 
to pay back these infrastructure bonds without the normally 
associated interest costs of such financing. This mechanism 
could cut the cost of school construction financing by nearly 
half. Both H.R. 1660 and S. 223 would ensure that the school 
districts with the largest number of low-income children would 
receive a substantial benefit from these tax incentives. 
Houston would be authorized to issue $240 million under H.R. 
1660 and $168 million under S. 223 in these bonds. H.R 1760 
would leave allocations for Houston and other school districts 
with the highest numbers of poor children in the nation to the 
political whims of their states--an historically inequitable 
position. The tax credit mechanism in these three bills would 
have a five-year federal budget impact of approximately $3.5 
billion, but would leverage approximately $25 billion in school 
construction and renovation.
                    Arbitrage Spend-down Flexibility
    There are also a number of legislative proposals, including 
Cong. Goodling's H.R. 2, Cong. Dunn's H.R. 1084, and Sen. 
Graham's S. 526, which would extend the spend-down restrictions 
on safe harbor arbitrage income from two years to four years, 
and would increase the small issuer exception to $15 or $20 
million. These arbitrage flexibility proposals would have a 
five-year federal budget impact of approximately $1.4 billion. 
Using our recent $678 million Houston bond issue as an example, 
under current market conditions 28 basis points are being 
realized by investing our unexpended funds. Therefore, the 
maximum annual benefit for Houston on a $678 million issue 
would be about $1.9 million in arbitrage.
       Tax Exempt Private Activity Bonds for School Construction
    Another legislative proposal, included in Sen. Graham's S. 
526, is the proposed use of tax exempt private activity bonds 
for school construction purposes. A new $10 per capita volume 
limit would be authorized for each state to allow private 
entities to finance the development of schools through these 
tax-exempt instruments. This private activity bond proposal 
would have a five-year federal budget impact of approximately 
$1.2 billion. Though the allocation of these tax-exempt bonds 
would be at the discretion of the state, Houston could issue 
nearly $20 million in bonds, if the state allotted us our per 
capita share of the state's allotment. Operationally, the 
school district would lease the school facility from the 
private developer until the bond was paid, and then the school 
would be turned over to the school district. Unfortunately, 
most school districts would have to make lease payments out of 
their operating budgets, thus diluting available funds for 
teacher compensation, instructional materials, computers, and 
even facility maintenance. Based on market conditions, we would 
expect lease payments to be at higher rates than would 
traditional bonds. The amount of the school lease payments 
appears to be at the discretion of the private developers.
    Obviously, Houston would be glad to accept all the school 
infrastructure assistance that Congress can provide. But 
realistically all of these legislative proposals cannot be 
enacted with limited federal resources. Therefore, Congress 
should spend its federal budget resources as efficiently and 
effectively as possible--in effect securing the most school 
construction for the buck. From our analysis, H.R 1660 would 
subsidize $240 million of school construction bonds for Houston 
at a cost of five-year $3.5 billion to the federal treasury. At 
one-third to two-fifths of the costs to the Treasury, neither 
arbitrage reform nor private activity bonds would provide one-
tenth of this level of school facility aid. Qualified school 
facility bonds, in our opinion, represent the approach to 
federal aid that will have a truly consequential impact on 
meeting the infrastructure needs of Houston and other large 
urban high poverty districts. Under a similar H.R. 1776, 
Houston would not be assured of receiving any assistance at 
all, as the state would have total discretion over the 
allocation of this federal assistance--a major weakness from 
out perspective.

    Mr. Chairman, there is a clear link between proper school 
facilities and improved educational achievement. How can we 
hold our children accountable for educational progress, if 
their local, state and national leaders are not providing them 
with modern schools and the tools needed for success? Thank you 
for focusing the attention of the Committee on this issue 
during the hearing process. It is encouraging that the 
Committee is looking at the school facility needs of the 
nation. On behalf of the Houston Public Schools and our 
colleagues in the other Great City Schools, I urge the 
Committee to include in the upcoming tax bill at least $3 to $4 
billion in immediate subsidies that will leverage $25 to $30 
billion in new school infrastructure improvements. Thank you 
for the opportunity to submit testimony for the Committee 
hearing record.
                                


                               Crowley Maritime Corporation
                                    Washington, D.C., 20004
                                                      June 24, 1999
Hon. Bill Archer, Chairman,
House Ways & Means Committee
Washington, DC.

Re: June 30 Hearing on International Tax Rules--Statement of Crowley 
        Maritime Corporation

    Dear Chairman Archer:

    Crowley Maritime Corp. (Crowley) commends the Chairman and 
committee for holding this hearing, and appreciates the 
opportunity to submit this statement on the subject of 
international tax rules. Our statement consists of this letter 
and the attached presentation on ``Shipping Income Tax Reform'' 
given last September at the national meeting of the Propeller 
Club of the United States. We hope soon to provide a 
supplemental statement updating some of the information in the 
attached presentation.
    We have also discussed these issues with others who will be 
submitting oral testimony at the hearing, including Mr. Peter 
Finnerty of Sea-Land Service, Inc., and Prof. Warren Dean. We 
anticipate general agreement with their testimony, and submit 
this separate statement only because of the importance of these 
issues and the urgency with which they need to be addressed.
    By way of background, Crowley (headquartered in Oakland) is 
the second-largest American shipping company. Crowley 
subsidiary Crowley American Transport, Inc. (CATI) (based in 
Jacksonville) is a major regional liner operator, offering the 
most comprehensive container services to Latin America. Other 
operating subsidiaries include Crowley Marine Services, Inc., a 
diversified marine contractor, Crowley Petroleum Transport, 
Inc. (both based in Seattle), and Crowley Marine Transport, 
Inc. (based in Houston).
    As discussed in the attached presentation, tax reform 
legislation is urgently needed to level the playing field for 
American carriers competing against foreign carriers, and to 
provide an environment in which American citizens will maintain 
and expand their investments in the maritime industry. 
According to Journal of Commerce PIERS data, nine of the top 
ten liner shipping companies carrying America's imports and 
exports are foreign carriers (eight of which are based in 
Asia). Moreover, according to Maritime Administration data, the 
U.S. flag liner companies' share of the U.S. import-export 
market fell by about 50% between 1990 and 1996. As others have 
demonstrated, American citizen control of the world's 
commercial fleet fell by about 80% between 1975 (the last year 
in which American carriers were taxed about the same as foreign 
carriers) and 1996.
    It must be emphasized that the decline of America's 
shipping companies has nothing to do with any comparative 
advantage foreign carriers have over American carriers. In 
fact, given nondiscriminatory government policies, and 
recognizing that American carriers are based in the world's 
largest trading nation, American carriers likely would have an 
inherent competitive advantage over foreign-based carriers if 
the market for international shipping services were totally 
free of government influence.
    As we all know, however, many governments subsidize 
shipping in a wide variety of ways and for many reasons. 
American subsidies over the past quarter-century, for good and 
sufficient reasons, have been focussed on maintaining a fleet 
of US-flag vessels. Subsidies would not be needed for American 
shipping companies (as distinct from their US-flag fleets) 
except for the fact that foreign governments, through income 
tax policy, subsidize their shipping companies. An internal 
Crowley study shows that, in 1996, American carriers paid more 
than 45% of their profits in income taxes, while foreign 
carriers received a net tax credit of about 2%.
    This huge disparity in bottom line earnings goes a long way 
in explaining why it is that American carriers have sold out to 
foreign competitors. Given their inherent competitive advantage 
over foreign carriers, the loss of American shipping companies 
reflects the utter failure of American tax policy in the 
international arena. Thousands of high-paying jobs have been 
lost, jobs that should, in a free market, go to Americans. Our 
nation's security has been harmed as the amount and reliability 
of sealift available for military contingencies is reduced. Our 
economic security is degraded as foreign firms exert total 
control over the movement of our imports and exports.
    Legislation that takes important steps toward correcting 
this tax disadvantage has been introduced. As a matter of sound 
tax policy, and to address clear threats to our nation's 
military and economic security, we strongly urge that it be 
enacted as quickly as possible.
            Respectfully Submitted,
                                         Michael G. Roberts
                               Vice President, Government Relations

Shipping Income Tax Reform

    Good morning and thank you for including me in this 
discussion of legislation affecting the maritime industry. Two 
years ago last week, at the end of the 104th Congress, we 
celebrated passage of the Maritime Security Act. The MSP saved 
what was surely one of the most endangered species existing in 
the world's oceans--American mariners sailing on commercial 
ships in international trades. With the clock running out on 
the existing government support programs, enactment of MSP was 
essential--in the words of Congressman Herb Bateman, a matter 
of the very survival of the American mariner in international 
trade. The entire maritime industry--liner carriers, non-liner 
carriers, unions, shipbuilders, ports--the entire industry 
pulled together and pushed MSP through Congress despite long 
odds. While MSP needs to be expanded and made permanent, its 
passage has helped assure the survival of a critical part of 
the American maritime industry.
    We are now confronted, as we move toward the 106th 
Congress, with the threatened extinction of another critical 
part of our industry--the American shipping company operating 
in international trade. According to the U.S. Maritime 
Administration, American liner carriers' share of the market 
for moving U.S. import and export cargoes fell by almost half 
between 1990 and 1996, from over 17% of the market in 1990, to 
less than 9% in 1996. As the first slide shows, that's a huge 
and precipitous drop, an exodus that starts from an already 
unacceptably low level of U.S. carrier participation. Let me 
add that, while this slide focuses on liner cargoes, I 
understand that U.S. carriers' share of non-liner cargoes is 
even more dismal--in the one to three percent range.
    We can assess the strength of American shipping companies 
not only on the basis of our share of the cargo market, but 
also based on the vessel capacity we own or operate. With this 
group I don't need to go into the number of U.S. flag vessels 
remaining. We know the U.S. flag fleet operated in 
international trades has been in long term decline. It is 
approaching the 47 ships in the MSP, and it will likely expand 
only if and when the government decides to expand MSP.
    Slide 2 shows the decline in U.S. controlled tonnage flying 
foreign flags of convenience. And let me at this point touch on 
the issue of U.S. carriers operating foreign flags of 
convenience vessels. We all want to see as many ships as 
possible flying the U.S. flag and manned by U.S. crews. That's 
one of the central purposes of this organization. But unless 
and until we are able to eliminate the huge cost advantages 
available to flag of convenience vessels, we have to fully 
reconcile ourselves, as most of us have, to the fact that U.S. 
carriers must have the same ability to operate flag of 
convenience vessels as do our foreign competitors. To the 
extent we limit or condition U.S. carriers' rights in this 
regard (and not also limit or condition foreign carriers' 
rights), we don't stop or reduce flag of convenience shipping 
one bit. We simply shift it to foreign carriers instead of U.S. 
shipping companies. And U.S. shipping companies become more and 
more irrelevant.
    This is not in any way meant as an endorsement of flag of 
convenience shipping. On the contrary, I thoroughly and 
completely agree that flag of convenience shipping fosters a 
``culture of evasion'' that hurts the entire industry. David 
Cockroft, one of the leaders of the International Transport 
Workers Federation, was a little more blunt when he said the 
system ``stinks,'' and I agree with that, too.
    But as we all know, we have tried for decades to come up 
with a way to stop foreign flags of convenience, and as this 
chart shows, all we've succeeded in doing is to take Americans 
out of the business while flag of convenience shipping 
continues to grow. In 1975, U.S. carriers owned about 22 
million of the 85 million gross registered tons in the world 
flag of convenience fleet. This accounted for about 26% of the 
world fleet. By 1996, the world flag of convenience fleet had 
almost tripled, to 241 million tons, while U.S. carrier 
ownership fell almost in half. The next slide shows what this 
means on a percentage basis, as American carriers' share of 
that fleet fell in 1996 to one-fifth the level it was in 1975.
    So it's not a pretty picture, whether you look at cargo 
flows or vessel ownership. America, the world's largest trading 
nation, is almost a non-factor in the business of transporting 
its imports and exports.
    Let me take a few minutes to talk now about why it is we 
have seen such a stark decline in the American shipping 
industry, and then get into what we might consider doing about 
it. First, let's be clear as to what is not the cause of our 
decline. It is not because we are incompetent. Looking at the 
liner sector, Sea-Land is the largest container shipping 
company serving the United States. Not the most profitable, but 
the biggest. Crowley is not the most profitable nor the 
biggest, but it is big and has consistently been rated the 
``Best of the Best'' of the world's shipping companies. Lest 
this seem too much like a plug, APL has for many years been one 
of the world's strongest container lines, and other American 
shipping companies have been similarly well-managed. Even our 
biggest detractor, Rob Quartel, has conceded that Americans are 
the best in the world at this business.
    So I'm pleased to report that we're not stupid and 
incompetent. And I don't believe the decline of our industry 
results from a comparative cost advantage that foreign carriers 
enjoy over U.S. carriers. Certainly in the liner sector, most 
costs are simply not affected by the nationality of the 
shipping company. With respect to vessel costs, which account 
for about one-fifth of total costs, American carriers operating 
U.S. flag MSP ships or foreign flag charters can be fully cost 
competitive. The remaining portion of liner operating costs, 
consisting of administration and overhead, does vary by 
nationality of the carrier, according to living costs in the 
area where these services are provided. But with headquarters 
located in places like Jacksonville or Charlotte, American 
carriers actually have a cost advantage over foreign carriers 
operating out of Tokyo or Hong Kong or London.
    So what is the problem, why is the American shipping 
industry internationally in such a state of decline if not 
because of incompetence or cost disadvantages? The answer, as a 
matter of simple logic, must be profitability. The prices we 
charge keep going down, revenues are inadequate and returns, or 
profitability, is unacceptably low. This next slide, from 
Mercer Management, shows operating margins for the liner 
shipping industry compared to the operating margins for 
companies included in the Standard & Poors 500. As you can see, 
profits for the 24 liner shipping companies surveyed 
consistently averaged between one-third and one-half of the 
average profits earned by S&P 500 companies.
    The unprofitability of the international liner industry can 
be traced, at least in substantial part, to two factors. First 
is overcapacity, which is attributable in part to the cyclical 
nature of the business, but also to the fact that governments 
love to subsidize the building of ships. Too many ships are 
built not because of market demand for transportation services, 
but because of the desire primarily of foreign governments to 
put their people to work building ships. Those of us in the 
ship operating business are left to deal with this mess and try 
to make a living with too much capacity in our markets. 
Hopefully, the OECD Shipbuilding Agreement or something like it 
will be implemented so that capacity in the shipping business 
can settle back toward a more rational, market-based level.
    Another reason for unprofitability, at least in the liner 
sector, is a hyper-competitive market structure. Having 15 or 
20 shipping companies doing the same thing in the same markets 
is not efficient nor conducive to rational business decision 
making, especially when some of the state-owned competitors are 
not fully motivated to making decent profits. Industry 
consolidation may be painful, but it is needed and is likely, 
particularly given the imminent enactment of the Ocean Shipping 
Reform Act. Consolidation, we hope, will eventually produce a 
more stable market structure and better profit margins.
    These factors help explain why the industry as a whole is 
not profitable, but not why it is apparently less profitable 
for American carriers than for foreign carriers. Why is it, 
then, that foreign carriers are growing while American carriers 
decline if foreign carriers (1) have no cost advantage, (2) 
have no quality advantage, and (3) foreign investors apparently 
have the same incentive as Americans to seek higher investment 
returns elsewhere? Who can say for sure, but the one factor 
that we can readily identify and that goes a long way in 
explaining this mystery, is income taxes. To be clear, I'm 
talking about income taxes, below-the-line taxes assessed after 
all the costs and above-the-line tax benefits--accelerated 
depreciation, generous deductions, etc.,--are taken out of the 
revenues. American carriers pay income tax at a base rate of 
36%. Most foreign carriers pay little or no income tax. The 
next slide is an analysis we've done in-house using the actual 
financial statements of nine liner carriers--three American, 
six foreign. While a larger sample of financial statements 
needs to be analyzed, even this small sample absolutely 
illustrates the point. On average, the foreign carriers sampled 
got a net tax credit in 1996, while American carriers paid over 
45% of their profits to Uncle Sam. In 1997, it was about 7% 
foreign income tax liability versus 43% for the Americans.
    What this all means is that, if the industry has an average 
profit margin of say 6%, the effective rate of return for 
foreign investors may range from 8% to 11% depending on foreign 
income tax rates. Considering that some companies in some years 
do much better than 6%, it's not a bad return if you're a 
foreign carrier paying no income tax. Certainly, the incentive 
for foreign investors to leave the industry is much less than 
for American investors. In short, it is the income tax 
disadvantage, more than any other factor that I can identify, 
that explains the current condition of the American shipping 
industry. In fact, I understand that income tax liability 
played a crucial--perhaps decisive--role in the decision to 
merge APL into NOL instead of the other way around.
    We've got to fix this problem, and there are any number of 
ways to do it. Most of the attention has centered around 
restoring Subpart F tax deferral, which until 1986 provided a 
means for American carriers to defer their income tax liability 
on shipping income earned using foreign flag vessels. 
Congressmen Shaw and Jefferson have introduced legislation that 
would restore the Subpart F exemption, but improve on it by 
allowing tax deferred money to be invested in U.S. flag 
shipping. Their bill has broad but not unanimous support within 
the industry. A variation on this approach would not just allow 
tax deferred money to be reinvested in U.S. flag shipping, but 
require such reinvestment as a condition for receiving tax 
deferral on some or all of the foreign flag earnings. Still 
another approach would not involve Subpart F at all, but would 
simply adjust the income tax rates of American shipping 
companies engaged exclusively in international trade to match 
the average tax rates of our foreign competitors.
    I'm not here today to suggest a specific solution to the 
problem. But I would like to do two things. First, is to 
express the hope that the top leadership of the maritime 
industry--primarily seagoing unions and shipping companies--
will commit to make a concentrated effort over the next several 
months until we find a solution to this problem. It took a long 
time, but the entire industry eventually came together over MSP 
and we got a program that has helped insure the survival of 
American mariners. We need to make the same commitment to 
assure the survival of American shipping companies, and I am 
hopeful and optimistic that we will.
    Secondly, I'd like to suggest at least a couple of 
principles that would help guide our work. There are 
undoubtedly others, but the two that come to my mind are as 
follows:
    First, ``Foreign income tax advantages harm all American 
shipping companies in international trade, and must be 
addressed on an industry wide basis.'' We simply cannot afford 
to lose time while companies or unions jockey for advantage 
against one another over this issue. If we succeed in fixing 
the problem, the pie will grow maybe a lot and everyone's 
sustainable, long-term benefit will far exceed what might be 
gained or lost by attempting to rig the system. Let's not beat 
each other up, but let's be fair and work together for tax 
equity.
    Secondly, ``The solution to this problem must avoid placing 
burdens on American carriers that are not faced by their 
foreign competitors.'' This is the whole point of the exercise. 
If we don't stick to that very basic and obvious and important 
principle, we run a real risk of getting nowhere, or passing 
legislation that will accomplish nothing, and see the final 
loss of what's left of our industry.
    Thank you very much for your attention, and I'd be happy to 
hear your comments and answer your questions.
    [Charts are being retained in committee filed.]

                                


                                          Ernst & Young LLP
                                    Washington, D.C., 20036
                                                       July 7, 1999
Hon. Bill Archer, Chairman
House Committee on Ways and Means
Washington, D.C.
    Dear Mr. Chairman:

    We are pleased have an opportunity to share with the Committee on 
Ways and Means our views on an issue of vital importance to high 
technology businesses--the tax rules regarding bona fide research and 
development (``R&D'') cost sharing arrangements. We are concerned that 
recent interpretations of the R&D cost sharing rules by the Internal 
Revenue Service (``IRS'') will make leading edge U.S. based companies 
less competitive than their foreign counterparts and, in some cases, 
will have the effect of encouraging such companies to relocate R&D 
activities outside the United States. We request that this letter be 
made part of the formal record of the Committee's June 30, 1999, 
hearing to examine the effect of U.S. tax rules on the competitiveness 
of U.S. businesses as well as ``. . . the policies (tax or otherwise) 
our international tax rules ought to reflect and implement.''

                               Background

    The proper allocation of income resulting from research and 
development activities, and the derivation of benefit from the 
use of valuable intangible property developed from those 
activities, has been a continuing source of controversy between 
the IRS and taxpayers, especially when an affiliate of a U.S. 
multinational company is using the intangible property in a low 
tax jurisdiction. Prior to 1984, the IRS had adopted an 
administrative ruling position that allowed intangible property 
developed in the U.S. to be transferred in a tax-free 
transaction under Internal Revenue Code (``IRC'') section 367 
to a foreign affiliate of a U.S. taxpayer provided that the 
intangible property was not used to create products destined 
for the U.S. market. In 1984, Congress ended this practice by 
enacting section 367(d), which requires arm's length taxable 
compensation on intercompany transfers of intangible property.
    As part of the Tax Reform Act of 1986, Congress amended 
section 482 by adding a sentence that provides, ``In the case 
of any transfer (or license) of intangible property . . . , the 
income with respect to such transfer or license shall be 
commensurate with the income attributable to the intangible.'' 
The legislative history to this provision indicated that by 
enacting the ``commensurate with income'' provision, Congress 
did not intend to prohibit use of bona fide R&D cost-sharing 
agreements, provided that such agreements were structured 
consistently with the intent of the provision.
    Under a cost sharing agreement, related parties agree in 
advance to share the financial risk (i.e., the costs) of R&D 
activities in return for agreed-upon rights to exploit any 
intangible property developed as a result of the R&D. Cost 
sharing payments received by a U.S. party conducting R&D reduce 
the deductible amount of R&D expense, while cost sharing 
payments made by a U.S. taxpayer are a deductible expense. A 
U.S. multi-national company conducting R&D in the U.S. that is 
a party to a cost sharing arrangement with a foreign affiliate 
gives up the right to current R&D deductions to the extent of 
the cost sharing payment. In return, the foreign affiliate 
attains the right to exploit any valuable intangible property 
created without further payment (other than its annual 
obligation to fund additional R&D under the cost sharing 
agreement).
    The 1989 Treasury/IRS White Paper on Transfer Pricing and 
the 1996 cost sharing regulations enunciated several principles 
that ought to be taken into account if a cost sharing 
arrangement was to meet the criteria of the commensurate with 
income provision. These principles included the following:
     Costs of R&D should be shared proportionately 
based upon expected benefits to be earned by the participants.
     Costs should include direct and indirect operating 
expenses attributable to the covered R&D.
     Provisions should be made in the arrangement to 
account for material changes in actual benefits from expected 
benefits.
     Participants entering into a cost sharing 
arrangement should pay an arm's length amount for preexisting 
and in process R&D (a ``buy in'') that may take the form of a 
declining arm's length royalty.
    Subsequent to enactment of the ``commensurate with income'' 
provision, the IRS engaged in a series of litigation 
challenging transfers of intangible property with limited 
success. These cases have involved such industries and products 
as contact lenses, medical equipment, semiconductors and 
computer disk drives.\1\ The IRS's typical position in these 
cases is to limit the profitability of the offshore affiliate 
to a limited function contract manufacturer's profit and to 
ignore the fact that arm's length parties who make substantial 
investments to exploit technologies created by another expect 
to receive a reasonable share of the profits to be earned from 
exploiting the intangible property.
---------------------------------------------------------------------------
    \1\ Bausch & Lomb (contact lenses); Perkin Elmer (medical 
equipment); National Semiconductor (semiconductors); Seagate (disk 
drives).
---------------------------------------------------------------------------
    In order to avoid the costs \2\ and risks inherent in 
licensing intangible property for which no exact comparable 
licensing transactions exist, many taxpayers have entered into 
cost sharing agreements. Until recently, most taxpayers 
believed that these agreements would be respected as bona fide 
by the IRS provided there was a reasonable buy-in payment and 
that U.S. Generally Accepted Accounting Principles (``GAAP'') 
R&D expenses were shared based upon reasonably expected 
benefits of the R&D activity the costs of which were being 
shared.
---------------------------------------------------------------------------
    \2\ The recent IRS ``Report on the Application and Administration 
of Section 482 ``estimates IRS litigation costs in two recent cases at 
$4.6 million and $2.1 million. Taxpayer costs were much higher.
---------------------------------------------------------------------------
                               The Issue
    The IRS National Office has recently advanced two new 
positions for evaluating bona fide cost sharing arrangements 
that have the effect of making the tax cost of such 
arrangements so high that they are uneconomical for U.S. 
technology-intensive companies. These positions are that:
     Costs to be shared should include stock option 
``expense'' attributed to R&D activities.
     A buy-in payment should be measured either by the 
taxpayer's total market capitalization less the value of its 
book assets or by reference to premiums in value over book 
assets in recent M & A transactions.
             Why the IRS's Positions are Unwise Tax Policy
     The IRS's positions are technically insupportable 
and conflict with the legislative support for cost sharing.
    Congress recognized in the 1986 Tax Reform Act that bona 
fide R&D cost sharing arrangements should be available as an 
alternative to licensing under the commensurate with income 
standard. The abuse that Congress sought to eliminate in the 
1986 Act (and in 1984) was that technology developed in the 
U.S. was being transferred outside the U.S. for no 
consideration to the U.S. developer. However, Congress neither 
prohibited transfers of intangible property outside the U.S., 
nor did it outlaw the availability of cost sharing 
arrangements.
    No party at arm's length would enter into a technology 
development (cost sharing) arrangement where it was required to 
buy into the agreement by paying a share of the U.S. 
developer's market capitalization. In addition, at any moment, 
in-time market capitalization of an individual company is 
profoundly affected by the intrinsic volatility of the overall 
market; the market's view of the industry and the company's 
overall competitive position within that industry; and the 
anticipated long-term earnings power of the company which 
extends far beyond the useful life of its current technology or 
other intangibles. Thus, market capitalization value is not a 
good benchmark upon which to base a buy-in payment. 
Furthermore, accounting goodwill created in an acquisition is 
as much a measurement of post-merger synergy of the two 
companies as it is a measure of the intangibles of the acquired 
company.
    R&D cost sharing is not an uncommon risk sharing 
arrangement between unrelated joint parties, especially in 
technology-driven industries. We have never observed an 
instance in which unrelated parties have agreed to cost share 
the compensation element (i.e., the difference between the fair 
market value of the stock and the exercise price) of stock 
options attributable to R&D employees, nor do we think 
unrelated parties would even consider sharing such an 
unpredictable, non-cash expense. Thus, we believe that the 
IRS's position on stock option expense as it relates to cost 
sharing is non-arm's length.
     These positions will lead to double taxation of 
U.S. multinationals.
    In our experience, the conventional arm's length methods, 
all of which are based on varying degrees of comparability in 
third-party transactions, are still the international norm for 
settling cross-border disputes regarding intercompany 
compensation for the use of intangibles. Market capitalization 
for intangibles is clearly unconventional. As a result, a U.S. 
government position based on market capitalization values will 
lead to irreconcilable differences in competent authority 
proceedings resulting in higher incidents of double taxation of 
U.S. multinationals.
    In a similar vein, the treatment of stock option exercises 
varies by country. For example, the spread between the fair 
market value of the option and the exercise price in not the 
measure of compensation in all countries, nor is the employee's 
exercise the event which gives rise to the compensation in all 
countries. Accordingly, even in the unlikely event that a 
foreign country can be persuaded that arm's length parties 
would incorporate a stock option additive into a cost sharing 
equation, it is unlikely that the foreign country would agree 
on the U.S. definition of the timing or amount. Thus, this 
stock option position, if pursued by the IRS, will also 
inevitably lead to double taxation of U.S. multinationals.
     These positions may encourage U.S. companies to 
move R&D out of the U.S.
    Simply put, U.S. multinationals just could not afford the 
tax cost of licensing or transferring intangibles to affiliates 
if today's market capitalization values became a proxy for the 
required arm's length consideration. A U.S. tax-induced 
limitation on the deployment of intangibles will undoubtedly 
hurt U.S. competitiveness. It may, in fact, encourage U.S. 
multinationals to move their R&D activities outside the U.S. 
where the resulting intangibles can be exploited in a far more 
tax effective manner. Many tax have jurisdictions already offer 
significant incentives to locate R&D in their countries; the 
IRS position will add to those existing incentives.
    Compensation for qualified U.S. engineers is already among 
the highest in the world. Stock options have become a common 
incentive for attracting and retaining U.S. engineers in this 
highly competitive market place. Clearly, the tax deductible 
portion of the stock option spread defrays some of the high 
compensation costs for U.S. engineers. If the deduction is lost 
because it is required to be charged to cost sharing foreign 
affiliates, the defrayal is lost as well. Absent this much 
needed defrayal, U.S. multinationals may establish R&D 
operations outside the U.S., staffed with lower cost 
engineering talent.
     These positions are an indirect attempt by the IRS 
to eliminate deferral contrary to Congressional intent.
    Since 1962, Congress has recognized that U.S. 
multinationals should be allowed to defer U.S. tax on active 
business income earned by affiliates outside the U.S. until 
such income is repatriated in the form of dividends. Rather 
than undertake a direct challenge to deferral, as the IRS and 
Treasury attempted in Notices 98-11 and 98-35, the IRS's recent 
adoption of these positions is a back door attack on deferral. 
By imposing excessive charges on foreign affiliates for buy-in 
and cost sharing payments, the IRS intends that there will be 
little or no profit to defer or repatriate.

Why Congress Should Act Now

    Cost sharing arrangements are used by some of the most 
innovative and dynamic growth companies in the U.S. The active 
business profits generated by foreign affiliates of these 
companies are used to fund overseas expansion. Many of these 
companies are global leaders in their fields. Under the old IRS 
``contract manufacturer'' position and its new cost sharing 
position, the IRS would subject all or nearly all of the active 
business profits of these foreign operations to a ``toll 
charge'' of current U.S. taxability. The abuse that Congress 
sought to end in 1984 and 1986 was the tax-free transfer 
overseas of intangible property developed in the U.S., not to 
end deferral for active profits earned outside the U.S. after 
payment to the U.S. of a fair amount for developing the 
intangible property.
    Under typical IRS dispute resolution procedures, issues 
like these can take 5-12 years to resolve. While the issues 
remain in dispute, taxpayers will be required to incur 
substantial administrative costs and outside adviser fees to 
defend against the IRS's claims.\3\ In addition, these claims 
cause substantial financial uncertainty for companies since IRS 
agents often demand several times the amounts they 
realistically expect to obtain.\4\ Taxpayers use cost sharing 
arrangements to avoid the uncertainties inherent in the 
``commensurate with income'' standard applicable to licenses. 
Years of uncertainty and inefficiency could be avoided if 
Congress would move now to establish some objective criteria 
for cost sharing arrangements.
---------------------------------------------------------------------------
    \3\The recent IRS Report on Section 482 states that IRS costs for 
resolving two recent transfer pricing litigation were $4.6 million and 
$2.1 million while costs to resolve comlex Advance pricing Agreements 
averaged $72,000.
    \4\ According to the IRS report, since 1994, the average amount of 
Section 482 adjustments proposed by IRS examiners sustained by Appeals 
was 27%. In the recent litiigation with DHL, the IRS Notice of 
Deficiency asserted a value in excess of $500 million for the 
transferred trademark and trade name, which value was reduced by IRS to 
around $300 million at trial, of which the Tax court sustained an 
adjustment of $100 million.
---------------------------------------------------------------------------
    Our Recommendations. We believe that Congress should:
     Clarify the cost sharing rules to limit buy-in 
payments and cost sharing payments to amounts that unrelated 
parties dealing at arm's length would pay. We believe that 
actual transfers of reasonably comparable intangible property 
are a proper reference point for buy-in payments and that 
direct and indirect R&D expenses as determined under GAAP are a 
good reference point for defining R&D costs to be shared.
     Consider whether the ``commensurate with income'' 
provision is serving its intended purpose or whether, as 
interpreted by the IRS it is being used as a device to end 
legitimate deferral of U.S. tax by U. S. multinationals.
    These views and recommendations are based on our nearly 50 
years of collective experience with Ernst & Young LLP providing 
tax advice to many of the leading U.S. biomedical and high-tech 
firms that operate on a worldwide basis. Should you wish, we 
would be happy to meet with you or your staff to discuss these 
important issues. We can be contacted through Donna Steele 
Flynn in Ernst & Young LLP's Tax Legislative Services group in 
Washington at 202-327-6664.
            Sincerely,
                                                Peter Kloet
                                          Michael F. Patton
                                                 John Wills

                                


Statement of the Financial Executive Institute, Morristown, NJ

    Chairman Bill Archer and Members of the House Ways and 
Means Committee:
    The Financial Executives Institute (``FEI'') Committee on 
Taxation appreciates this opportunity to present its views on 
the impact of U.S. tax rules on international competitiveness.
    FEI is a professional association comprising 14,000 senior 
financial executives for over 8,000 major companies throughout 
the United States. The Tax Committee represents the views of 
the senior tax officers from over 30 of the nation's largest 
corporations.
    At the outset, FEI would like to thank you, Mr. Chairman, 
for your support of H.R. 2018, the International Tax 
Simplification for American Competitiveness Act of 1999, 
recently introduced by Mr. Houghton and Mr. Levin. This 
legislation builds on your previous successful efforts to keep 
step with the rapid globalization of the economy by simplifying 
and rationalizing the international provisions of the Internal 
Revenue Code (the ``Code'').
                      Taxation in a Global Economy
    The U.S. international tax regime reflects a balance 
between two important, but sometimes conflicting, goals: 
neutrality and competitiveness. The U.S. generally tries to 
raise revenue in a neutral manner that does not discriminate in 
favor of one investment over another. At the same time, the 
U.S. seeks to raise revenue in a way that does not hinder, and 
where possible helps, the competitiveness of the American 
economy, its firms and its workers.
    The current balance between neutrality and competitiveness 
was struck almost four decades ago during the Kennedy 
Administration. At the time, the rest of the world was still in 
large measure trying to rebuild from the social, physical and 
political devastation of World War II. The United States was a 
comparative economic giant, accounting for 50 percent of 
worldwide foreign direct investment and 40 percent of worldwide 
GDP. Under these circumstances, policymakers were more 
concerned with the impact of tax law on the location decisions 
of U.S. firms--i.e., neutrality--than on the effect of tax law 
on the competitiveness of those firms.
    Accordingly, the Code taxes U.S. taxpayers on their 
worldwide income, with a tax credit for taxes paid to foreign 
jurisdictions. In theory, this approach ensures that a given 
investment by a U.S. firm will experience roughly the same 
level of taxation regardless of location. The Code takes 
competitiveness concerns into account by deferring tax on the 
active income of foreign subsidiaries of U.S. firms until the 
income is repatriated. This ensures that active subsidiaries 
are not more heavily taxed currently than their non-U.S. 
competitors down the street. Over the years, this deferral has 
been increasingly limited as competitiveness has taken a back 
seat to concerns about tax avoidance by U.S. taxpayers.
    Today, the global economic landscape looks very different 
than it did during the Kennedy Administration. Europe, Japan 
and a host of other nations have emerged as tough competitors. 
Revolutions in transportation, telecommunications and 
information technology mean that firms increasingly compete 
head-to-head on a global basis. As a result, the U.S. is 
fighting harder than ever to maintain its share, now down to 
about 25 percent, of the world's foreign direct investment and 
GDP, and many U.S. firms now focus as much or more on fast-
growing overseas markets as on the mature U.S. market.
    The U.S. needs to adapt its international tax regime to 
this new reality. It is no longer acceptable merely to strive 
to treat U.S. taxpayers or their investments in a neutral 
manner. We must also consider how their competitors from other 
nations are taxed by their host governments. For example, while 
the United States continues to tax its taxpayers on a worldwide 
basis, many of our trading partners tend to tax their 
businesses on a ``territorial'' basis in which only income 
earned (``sourced'') in the home jurisdiction is subject to 
taxation. Even countries which tax on a worldwide basis do so 
with far fewer limitations and less complex rules on deferral, 
the foreign tax credit and the allocation and apportionment of 
income, deductions and expenses between domestic and foreign 
sources.
                    Making America More Competitive
    With your leadership, Mr. Chairman, Congress in recent 
years has taken some positive steps to reform the international 
tax rules and make America more competitive. Among the 
important changes: eliminating the PFIC/CFC overlap, 
simplifying the 10/50 basket, applying the FSC regime to 
software, repealing section 956A, and extending deferral to 
active financing income.
    H.R. 2018 includes many of the necessary next steps for 
reform. FEI strongly endorses this legislation and associates 
itself with the testimony of the National Foreign Trade Council 
with respect to specific provisions of the bill.
    For example, FEI strongly supports the provision in H.R. 
2018 that seeks to treat the European Union as a single 
country. The European Union created a single market in 1992 and 
a single currency, the euro, in 1999. Yet U.S. international 
tax rules still treat the EU as 15 separate countries. This has 
made it difficult for U.S. companies to consolidate their EU 
operations and take advantage of the new economies of scale. 
Over time, our European competitors, who do not face such 
obstacles to consolidation, will gain a competitive advantage.
    Another example is the provision that would accelerate the 
effective date for ``look-through'' treatment in applying the 
foreign tax credit baskets to dividends from 10/50 companies. 
The 1997 tax law allows such look-through treatment for 
dividends paid out of earnings and profits accumulated in 
taxable years beginning after December 31, 2002. This means 
U.S. corporate taxpayers face an unnecessary tax cost until 
2003.
                       Threats to Competitiveness
    Notwithstanding these positive developments, there have 
been some ominous clouds on the international tax horizon. The 
Treasury Department early last year issued guidance on so-
called ``hybrid entities'' that would have substantially 
hindered the ability of U.S. companies to compete abroad 
(Notice 98-11). Although the original ``hybrid'' rules were 
withdrawn and we understand that the subsequent notice (Notice 
98-35) is being reconsidered, Treasury has given every 
indication that it will continue to push neutrality concerns 
over competitiveness. (e.g., seeking limits on deferral and 
promoting the OECD effort on ``harmful tax competition''). 
These and other proposals to amend the Code in ways that 
threaten U.S. competitiveness take us in precisely the opposite 
direction from where we need to go in the global economy.
    Consider the effort by some to further limit deferral. 
Under current law, ten percent or greater U.S. shareholders of 
a controlled foreign corporation (``CFC'') generally are not 
taxed on their proportionate share of the CFC's operating 
earnings until those earnings are actually paid in the form of 
a dividend. Thus, U.S. tax on the CFC's earnings generally is 
``deferred'' until an actual dividend payment to the parent 
company, just as tax is ``deferred'' when an individual holds 
shares in a company until such time as the company actually 
pays a dividend to the individual. However, under Subpart F of 
the Code, deferral is denied--so that tax is accelerated--on 
certain types of CFC income.
    Subpart F was originally enacted in 1962 to curb the 
ability of U.S. companies to allocate income and/or assets to 
low-tax jurisdictions for tax avoidance purposes. Today, it is 
virtually impossible under the Section 482 transfer pricing and 
other rules to allocate income in this manner. Indeed, the 
acceleration of tax on shareholders of CFC operations has no 
counterpart in the tax laws of our foreign trading partners.\1\ 
Nevertheless, Subpart F remains in the Code, putting U.S. 
companies at a disadvantage. In many instances, Subpart F 
results in the taxation of income that may never be realized--
perhaps because of the existence in a foreign country of 
exchange or other restrictions on profit distributions, 
reinvestment requirements of the business, devaluation of 
foreign currencies, subsequent operating losses, expropriation, 
and the like--by the U.S. shareholder.
---------------------------------------------------------------------------
    \1\ For example, according to a 1990 ``White Paper'' submitted by 
the International Competition Subcommittee of the American Bar 
Association Section of Taxation to congressional tax writing 
committees, countries such as France, Germany, Japan, and The 
Netherlands do not tax domestic parents on the earnings of their 
foreign marketing subsidiaries until such earnings are repatriated.
---------------------------------------------------------------------------
    Other problems posed by the acceleration of tax under 
Subpart F and similar proposals include:
     Acceleration of tax may lessen the likelihood or 
totally prevent U.S. companies from investing in developing 
countries by vitiating tax incentives offered by such countries 
to attract investment. This result would be counter to U.S. 
foreign policy objectives by opening the door to foreign 
competitors who would likely order components and other 
products from their own suppliers rather than from U.S. 
suppliers. Moreover, any reduced tax costs procured by these 
foreign competitors would likely be protected under tax 
sparing-type provisions of tax treaties that are typically 
agreed to by other nations, although not by the U.S. Treasury.
     Subpart F adversely affects companies attempting 
to cope with difficult exchange control and customs issues, 
frequently encountered in developing countries. The risks of 
controlled currencies and adverse customs results can be 
avoided if the U.S. multinational sells into the country 
through a controlled subsidiary incorporated in another 
country. However, the current Subpart F regime results in loss 
of deferral. Non-U.S. competitors are not faced with this 
additional cost.
     It may result in double taxation in those 
countries which permit more rapid recovery of investment than 
the U.S., because the U.S. tax would precede the foreign 
creditable income tax by several years and the carryback period 
may be inadequate. Moreover, even if a longer carryback period 
were enacted, the acceleration of the U.S. tax would be a 
serious competitive disadvantage vis-a-vis foreign-owned 
competition.
     It would discriminate against shareholders of U.S. 
companies with foreign operations, as contrasted with domestic 
companies doing business only in the U.S., by accelerating the 
tax on unrealized income. This is poor policy because U.S. 
multinational companies have been and continue to be 
responsible for significant employment in the U.S. economy, 
much of which is generated by their foreign investments.
     It could harm the U.S. balance of payments. 
Earnings remitted to the U.S. have exceeded U.S. foreign direct 
investment and have been the most important single positive 
contribution to the U.S. balance of payments. The ability to 
freely reinvest earnings in foreign operations results in 
strengthening those operations and assuring the future 
repatriation of earnings. Accelerating tax on CFCs would 
greatly erode this advantage.
    Acceleration of tax on CFCs is often justified by the 
belief that U.S. jobs will somehow be preserved if foreign 
subsidiaries are taxed currently. However, in reality, foreign 
operations of U.S. multinationals create rather than displace 
U.S. jobs, while also supporting our balance of payments and 
increasing U.S. exports. Foreign subsidiaries of U.S. companies 
play a critical role in boosting U.S. exports by marketing, 
distributing, and finishing American-made products in foreign 
markets. In 1996, U.S. multinational companies were involved in 
an astounding 65 percent of all U.S. merchandise export sales. 
And studies have shown that these exports support higher wage 
jobs in the United States.
    U.S. firms establish operations abroad because of market 
requirements or marketing opportunities. For example, it is 
self-evident that those who seek natural resources must develop 
them in the geographical locations where they are found, or 
that those who provide time-sensitive information technology 
products and services must have a local presence. In addition, 
as a practical matter, local conditions normally dictate that 
U.S. corporations manufacture in the foreign country in order 
to enjoy foreign business opportunities. This process works in 
reverse: it has now become commonplace for foreign companies 
like BMW, Honda, Mercedes, and Toyota to set up manufacturing 
operations in the U.S. to serve the U.S. market. It is not just 
multinationals that benefit from trade. Many small and medium-
sized businesses in the U.S. either export themselves or supply 
goods and services to other export companies.
    Moreover, CFCs generally are not in competition with U.S. 
manufacturing operations but rather with foreign-owned and 
foreign-based manufacturers. A very small percentage (less than 
10% in 1994) of the total sales of American-owned foreign 
manufacturing subsidiaries are made to the U.S. Most imports 
come from sources other than foreign affiliates of U.S. firms. 
Therefore, a decrease in foreign investment by U.S. companies 
would not result in an increase in U.S. investment, primarily 
because foreign investments are undertaken not as an 
alternative to domestic investment, but to supplement such 
investment.
    Indeed, there is a positive relationship between investment 
abroad and domestic expansion. Leading U.S. corporations 
operating both in the U.S. and abroad have expanded their U.S. 
employment, their domestic sales, their investments in the 
U.S., and their exports from the U.S. at substantially faster 
rates than industry generally. In a 1998 study entitled 
``Mainstay III: A Report on the Domestic Contributions of 
American Companies with Global Operations,'' and an earlier 
study from 1993 entitled ``Mainstay II: A New Account of the 
Critical Role of U.S. Multinational Companies in the U.S. 
Economy,'' the Emergency Committee for American Trade 
(``ECAT'') documented the importance to the U.S. economy of 
U.S. based multinational companies. The studies found that 
investments abroad by U.S. multinational companies provide a 
platform for the growth of exports and create jobs in the 
United States. (The full studies are available from The 
Emergency Committee for American Trade, 1211 Connecticut 
Avenue, Washington, DC 20036, phone (202) 659-5147).
    Proposals to accelerate tax through the repeal of 
``deferral'' are in marked contrast and conflict with over 50 
years of bipartisan trade policy. The U.S. has long been 
committed to the removal of trade barriers and the promotion of 
international investment, most recently through the NAFTA and 
WTO agreements. Moreover, because of their political and 
strategic importance, foreign investments by U.S. companies 
have often been supported by the U.S. government. For example, 
participation by U.S. oil companies in the development of the 
Tengiz oil field in Kazakhstan has been praised as fostering 
the political independence of that newly formed nation, as well 
as securing new sources of oil to Western nations, which are 
still heavily dependent on Middle Eastern imports.
                               Conclusion
    Current U.S. international tax rules create many 
impediments that cause severe competitive disadvantages for 
U.S. based multinationals. By contrast, the tax systems of 
other countries actually encourage our foreign-based 
competitors to be more competitive. It is time for Congress to 
improve our system to allow U.S. companies to compete more 
effectively, and to reject proposals that would create new 
impediments making it even more difficult and in some cases 
impossible to succeed in today's global business environment.
    We thank you for the opportunity to provide our comments on 
this extremely important issue.

                                


Statement of Warren Thompson, Director of Tax, Frank Russell Company, 
Tacoma, WA

    My name is Warren Thompson; I am the Director of Tax for 
Frank Russell Company. The testimony offered herein presents 
Russell's experience concerning the manner in which current US 
tax law seriously impedes the growth potential of the US mutual 
fund industry. In addition, we would like to register our 
support of H.R. 2430, the Investment Competitiveness Act of 
1999. H.R. 2430 is sensible and long overdue legislation that 
is critical if the US mutual fund industry is to become an 
attractive investment alternative for global investors. The 
Frank Russell Company strongly supports this legislation and 
commends the bill's sponsors, Representatives Crane, Dunn, and 
McDermott for their efforts to address this issue.
    The Frank Russell Company, headquartered in Tacoma, 
Washington, is recognized as one of the premier global money 
managers and pension consulting firms in the world, providing 
investment strategy consulting worldwide to such institutional 
investors as GM, IBM, AT&T, XEROX, Boeing, UAL, Unilever, 
Shell, Monsanto, and others. From nine offices worldwide, 
Russell advises clients on over $1 trillion of investment 
assets and manages over $50 billion in funds, including mutual 
funds (otherwise known as regulated investment companies or 
``RICs''), common trust funds, commingled employee benefit 
funds, and private investment partnerships. In addition, 
Russell conducts research on nearly 2000 investment managers in 
more than twenty countries.
    We have found, from our experience around the world, that 
the US mutual fund industry is the most technologically 
advanced in the world and, therefore, the most efficient in 
delivering services to clients. However, research of the 
current practices of global investment managers shows that 
global institutional investors and managers use US mutual funds 
very sparingly. One of the principle reasons they do not use US 
mutual funds is the withholding tax on dividends and short-term 
capital gains imposed under current US tax law.
    As the Committee is already well aware, current US tax laws 
have, in many cases, failed to kept pace with our increasingly 
dynamic and competitive US and global market, often to the 
detriment of US companies. In the case of the US mutual fund 
industry, current US law blocks US-based mutual funds from 
competing for international investment dollars by making it 
virtually impossible for US mutual funds to sell their products 
outside the United States. As a direct result, US mutual fund 
companies are forced outside the United States to simply sell 
their products and compete with foreign funds that are not 
subject to similar withholding taxes.
                           Current Tax Rules
    Income earned by a mutual fund is comprised of four 
elements: (1) interest; (2) short-term capital gains; (3) long-
term capital gains; and (4) dividends. Of these four, 
generally, only dividend income is subject to withholding tax.
    Under current law, when the income earned by a mutual fund 
is distributed, the interest income and short-term capital 
gains income are converted into dividend income, effectively 
re-characterizing the principal earnings of the mutual fund as 
dividend income. When received by a foreign investor, this 
``dividend income'' is subject to a 30 percent withholding tax. 
Tax treaties may reduce this rate to 15 percent or less for 
residents of certain treaty countries. Nonetheless, this tax 
significantly reduces the attractiveness of US-based mutual 
funds to foreign investors.

Interest Income

    The Deficit Reduction Act of 1984 generally repealed the 30 
percent withholding tax for portfolio interest paid to foreign 
investors on obligations issued after July 18, 1984. Tax 
treaties between the United States and a number of foreign 
countries also exempt interest paid to foreign investors from 
the withholding tax.
    For a US mutual fund, however, interest income is 
characterized as dividend income when it is distributed. The 
portfolio interest exemption and reduced treaty rates, 
therefore, do not apply and all such income is subject to 
withholding tax when received by foreign investors.

Short-term capital gains

    A US mutual fund must also characterize short-term capital 
gains as ordinary income dividends, making such income subject 
to withholding tax when received by foreign investors. In 
direct contrast, if a foreign investor invests directly in US 
securities, through a unit-trust, partnership, or foreign 
mutual fund, such short-term capital gain income is not be 
subject to withholding tax.
  Current US Tax Law Creates a Major Impediment to Foreign Investment
    We have found, in our discussions with potential investors 
throughout the world, that the first fund of choice for a 
foreign investor is one based in its own country. The second 
choice, all other things being equal, typically is investment 
in US funds, for the following reasons:
     The US system of regulation is unparalleled in its 
commitment to investor protector.
     The US fund system uses the most advanced 
investment management technology, including the best accounting 
and recordkeeping knowledge and expertise.
     The US mutual fund industry has by far the best 
marketing and client servicing capabilities.
    Until 1980, US-based institutional investors had very few, 
if any, investments outside the United States. Today, these 
funds invest 15 percent or more of their assets in overseas 
equity and debt instruments. Similarly, institutional investors 
in foreign countries, such as those in the United Kingdom, 
Japan, and Switzerland are also increasing their investments 
outside their home country. These investors include insurance 
companies, banks, trusts, pension funds, reinsurance pools, 
central banks, and government entities.
    The US withholding tax, however, provides a strong 
disincentive for foreign investors for two reasons--it 
effectively imposes an export tax on the US mutual fund 
industry, making US based funds less attractive from a pricing 
standpoint; and it creates an administrative burden.
    Large, institutional investors have a broad choice of 
investment vehicles worldwide. It has been our experience that 
these investors will not hesitate to move investment assets 
wherever necessary to obtain the highest after-tax yield 
available at their particular risk-tolerance level. The US 
withholding rate of 30 percent reduces yields for US mutual 
funds to levels substantially below world market rates, thus 
creating a significant impediment to US investment managers 
selling their funds outside the US.
    While some foreign investors may be entitled to a refund of 
the withholding tax paid (under tax treaty provisions), the 
administrative burden and the loss of use of the funds (for 
periods of time frequently in excess of a year) outweigh the 
expected yields. Thus, the foreign investment in US securities 
is achieved through other means.
    Foreign investors can avoid the withholding tax by 
investing directly in US securities. However, our experience is 
that foreign investors, particularly institutional investors, 
prefer to employ highly experienced professional investment 
managers to diversify their investments overseas through the 
use of ``pooled'' vehicles. Recently, Russell conducted a 
survey of its potential investment clients in Europe. We 
learned that, in general, those investors prefer a pooled 
vehicle such as a mutual fund for their global investment 
strategies. This is no surprise. Pooled investments represent 
the most efficient way to diversify a portfolio across multiple 
markets and among several currencies. However, because the US 
tax code imposes a tax penalty in the form of the 30 percent 
withholding tax, those investors generally go elsewhere to 
access the global markets.
    This has resulted in the dramatic increase in institutional 
funds located in such tax-favored jurisdictions as Luxembourg, 
Ireland, Bermuda, and the Cayman Islands. Many of the funds 
created in these jurisdictions invest in US securities. 
Foreign-based institutional investors find these funds 
attractive because their investments are not subject to the US 
withholding tax.
     US Mutual Fund Companies Must Locate Outside the US in Order 
                               to Compete
    The 30 percent withholding tax imposed on US mutual funds 
can be totally avoided by establishing funds outside the US. 
Since interest and capital gains earned directly (i.e. without 
being ``converted'' into dividends) generally are not subject 
to US withholding tax, funds based outside the US are not 
subject to the same 30 percent cut that is imposed on funds 
located inside the US. US mutual fund companies, therefore, 
routinely set up ``clone'' or ``mirror'' funds of their US-
based funds outside US borders. This is currently the only way 
US funds can effectively avoid the 30 percent tax and compete 
for foreign investment dollars.
    Frank Russell Company, along with many other US mutual fund 
companies, would prefer not to have to set up operations 
outside the US to make their products attractive to foreign 
investors. Keeping these operations at home would allow US 
companies to benefit from their existing operations and 
systems. It would also allow us to avoid additional taxation 
and expenses associated with locating in foreign countries and 
it would allow us to develop jobs at home rather than abroad.
    Russell's experience in Canada exemplifies this point and 
the impact of the US withholding tax.

Russell's Experience

    In 1992, Russell entered into an arrangement to provide a 
series of investment funds to be marketed to the individual 
retirement account market in Canada by a Canadian brokerage. 
The US withholding tax made Russell's existing US mutual funds 
unattractive investment vehicles for Canadian investors.
    Russell was thus forced to create a new Canadian-based 
family of funds (that are essentially ``clones'' of existing 
Russell US-based mutual funds), solely for the purpose of 
providing a tax efficient pooled investment vehicle to Canadian 
investors who wish to invest a substantial portion of their 
retirement portfolio in US securities. These funds became fully 
operational in January 1993, and grew to over $100 million 
(Canadian) in assets in less then six months. They have since 
grown to over $2 billion in assets.
    One reason these funds are so successful is because, 
increasingly, foreign investors are attracted to Russell's 
``multi-style, multi-manager'' investment approach. This 
investment approach is particularly attractive to investors 
with a long-term asset/liability management focus, such as 
pension funds, individual retirement plans, and insurance 
pools. In using the investment technology it has developed over 
the last 25 years advising some of the world's largest 
investment pools, Russell is regarded as possessing cutting 
edge global investment technology. This proprietary technology 
and ``know-how'' represents a quantum leap over other 
investment products available in the global market.
    Yet, these funds--managed in Canada but substantially 
invested in US securities--employ Canadian accounting, 
custodial, trustee, and recordkeeping services and pay 
investment management fees to select Canadian investment 
managers. Russell's Canadian affiliate pays Canadian corporate 
income tax on its earnings from this operation.
    It is worth noting at this point that several foreign 
jurisdictions have enacted ``magnet'' legislation to attract 
the pooled investment business to their countries. Ireland is a 
recent example of this trend, having enacted legislation to 
permit pure ``pass-through'' treatment for funds located there, 
and significantly lowering the income tax rate for investment 
management firms that conduct funds operations in Dublin. Such 
foreign legislation thus creates a double incentive to locate 
US funds businesses off shore.
         H.R. 2430, The Investment Competitiveness Act of 1999
    If H.R. 2430 had been in place at the time Russell was 
organizing its funds in Canada, there would have been no need 
for Russell to create a separate set of ``clone'' funds in 
Canada.
    In general, H.R. 2430 effectively removes the 30 percent 
penalty imposed on US mutual funds by allowing interest and 
short-term capital gains income to retain their original 
character when distributed to a foreign shareholder. Rather 
than being converted to dividend income subject to the 30 
percent withholding tax, interest earned by a US mutual fund 
would flow through to foreign shareholders as interest income. 
Likewise, short-term capital gains income would flow through as 
short-term capital gains income. This would permit US mutual 
funds to sell their investment products to investors outside 
the US without the withholding tax impediment.
                  Policy Issues Relating to H.R. 2430
    Competitive Considerations. US mutual funds, such as those 
sponsored by Frank Russell Company, should be placed on a level 
playing field with foreign mutual funds. The international 
funds business is highly competitive and marked by very narrow 
profit margins. Often, mere basis points (hundredths of a 
percentage point) separate the bidders for institutional 
investment business. The US fund industry, if allowed to 
compete on level ground with foreign funds, could employ its 
production efficiencies and cutting edge technology to 
attracting significant foreign capital. Under current US tax 
law, companies like Frank Russell cannot compete, and the 
foreign investment dollar is left to a foreign fund, with 
little or no direct benefit accruing to the United States.
    Neutrality of Tax Law In Investment Decisions. Foreign 
investment in US securities may be accomplished in several 
ways: directly, or indirectly, through foreign or US vehicles. 
Current US tax law favors direct investment or indirect 
investment through foreign funds. Effectively, US tax law 
compels a particular investment approach by foreign investors, 
which denies US mutual funds access to the market. We do not 
believe sound tax policy is served by the current tax 
structure. Tax law should be neutral with respect to its impact 
on investment decisions. We believe that such tax neutrality 
would permit taxpayers such as Frank Russell Company the 
ability to fully benefit from the technological and strategic 
advantage we have worked hard to develop over the years.
    Application of the 1984 Act. In the Deficit Reduction Act 
of 1984, Congress exempted from US withholding tax certain 
payments to foreign direct investors and exempted investments 
in the underlying obligations from US estate tax. Congress 
enacted these provisions to promote capital formation and 
substantial economic growth in the United States. This bill 
would continue to foster capital formation and economic growth 
by providing wider access for US mutual funds to the billions 
of foreign investment dollars currently lodged in foreign 
mutual funds.
                               Conclusion
    During the last decade, the US mutual fund industry has 
become one of the fastest growing segments of the US financial 
services industry. US mutual fund assets now total over $2 
trillion. Such a thriving domestic industry must be allowed to 
flourish on an international level as well. Yet, the current 
tax environment prevents this industry from exporting its 
product. H.R. 2430 would create a worldwide market for US 
mutual funds, thus unleashing additional flows of international 
capital into US investments. For the Frank Russell Company, 
H.R. 2430 adjusts US tax law to reflect today's dynamic, 
international financial services market. It is legislation that 
it critically important from both a business and policy 
prospective.

                                


Statement of M. David Blecher, Principal, Hewitt Associates, LLC

                              Introduction
    Hewitt Associates is a global management consulting firm 
specializing in human resource solutions, with 10,000 
associates worldwide, and 73 offices in 34 different countries, 
including 27 offices across the U.S. We have been recognized by 
Business Insurance magazine as the largest U.S. benefits 
consulting firm and the second-largest benefits consulting firm 
worldwide. Our clients include over 75 percent of Fortune 500 
companies.
    Our primary business falls into three main areas:
     Strategy, design, and implementation of human 
resources, benefits, and compensation programs both 
domestically and globally.
     Financial and performance management of programs 
including actuarial services, cost quality, employee 
satisfaction, measurement, and analysis for all retirement and 
health-related benefits.
     Ongoing administration of programs including 
outsourced delivery. For example, we manage all aspects of 
employee benefits plan administration, including coordination 
with third parties (e.g., individual health plans) and improve 
customer service for employee benefits plan participants.
    Both in our capacity as a global employer and in our 
capacity as a consultant to companies with international 
interests, we have, over time, become aware of various problems 
with U.S. tax laws, problems caused in some instances by the 
contents of the laws and in other instances by the way the laws 
are enforced.
    Some of our concerns have been ably addressed in the 
materials filed by witnesses at the June 30 hearing. 
Specifically, we endorse the need to correct problems created 
by subpart F, section 911, the foreign tax credit rules, and 
the alternative minimum tax, and we generally support the 
current efforts to reform these areas of the law. Some of the 
items that we have found especially troublesome are listed, 
without discussion, as ``Other Important Items'' toward the end 
of this statement.
    Rather than use up our limited space in reiterating 
arguments that have already been cogently made, we would like 
to focus on some specific problems that, as far as we are 
aware, have not been raised before the Committee. These relate 
to the effect of tax rules on individuals rather than 
corporations. In their way, they contribute toward the 
reduction in global competitiveness of U.S. companies.
                                Summary
    In our current age of increasing globalization, U.S. 
companies more than ever before need employees with 
international experience. Increasingly, this need is no longer 
confined to corporate executives, but is felt at a much broader 
level than formerly. Features of the tax code and its 
application, however, militate against the transfer of 
employees overseas; indeed, they encourage companies to operate 
abroad employing non-U.S. employees. We believe that the effect 
of this is to impair the competitiveness of companies in the 
United States.
    The problem stems from the requirements of the Internal 
Revenue Code relating to individuals living and working outside 
the United States. In addition to substantive rules that we 
would consider anti-competitive, the Code's provisions are 
complicated and make compliance difficult. The complicated tax 
law, lengthy forms, and cost to individuals and companies for 
tax preparation services encourages companies to eliminate U.S. 
employees from the candidate pool when considering 
international assignments. The converse is true, too; we have 
seen U.S. employees refuse overseas assignments because of 
their complicated and unpleasant tax implications. Without 
international work and living experiences, U.S. employees will 
become less competitive in the global workforce.
    Topics that illustrate the problems we perceive are the 
complex tax filing requirements, the tax-related costs 
typically borne by U.S. employers (and, if not the employer, 
then the U.S. employees), and the rules relating to retirement 
benefits for expatriate employees; each of these we discuss 
briefly below. While these issues may not in themselves cause a 
company to take such drastic action as establishing 
headquarters outside the U.S., they do contribute to overall 
anti-competitiveness and could be addressed without major 
overhaul of the Internal Revenue Code.
           Recommendations for Further Study by the Committee
    Our suggestions of areas for further study by the Committee 
with respect to the taxation of individuals include:
    1. Review tax forms such as Forms 673, 2555, 5471, and W-4, 
with a view to reducing their complexity or even eliminating 
forms where administrative costs outweigh the benefits of the 
information contained in the forms.
    2. Consider legislation under which the U.S. would enable 
expatriate employees participating in foreign retirement plans 
to be treated for U.S. income tax purposes as if the employees 
were participating in U.S. qualified plans, provided the 
foreign plans are genuine retirement plans and are qualified 
under the laws of the host country. Tax-deferred rollovers or 
transfer of distributions from foreign retirement plans to U.S. 
plans should be included in any such rules.
    3. Consider negotiating tax treaty provisions that would 
prevent expatriate employees from being taxed in the host 
country when they continue to accrue benefits under U.S. plans 
while on assignment in the host country.
    4. Explore ways of encouraging states to adopt uniform 
provisions for the consistent tax treatment of individuals on 
international assignments.
    In addition, we suggest the Committee consider addressing 
the items listed as ``Other Important Items'' toward the end of 
this statement pertaining to both business and individual 
taxation.
                          Filing Requirements
    The filing requirements for expatriates have been made 
somewhat simpler in recent years. Form 2555EZ, on which a 
taxpayer claims relief under the foreign earned income 
exclusion of Code section 911, is more straightforward than the 
standard Form 2555, although the bookkeeping requirements to 
complete the form are substantial--the taxpayer must carefully 
track when he is in and out of the U.S., and what he was doing 
when he was in each location (work versus personal time)--and 
the ``EZ'' form cannot be used if the taxpayer also wishes to 
claim the foreign housing exclusion.
    In addition to tracking travel and work days, the employee 
must complete Form 673, Statement for Claiming Benefits 
Provided by Section 911 of the Internal Revenue Code. This form 
provides written documentation to the employer that the 
employee is eligible for the section 911 exclusions, and 
provides the amounts by which income may be reduced before 
withholding is necessary. The employee may also need to 
complete a revised Form W-4 to take into account the foreign 
tax credit or a statement indicating that the employee is 
subject to tax withholdings in the host country, so that no 
federal withholding is necessary. Both Form 673 and Form W-4 
are difficult to understand and complete; the average taxpayer 
is unable to complete either form without professional 
assistance.
    The U.S. filing complexity is eclipsed only by the various 
states' requirements for residents on international 
assignments. Much of the difficulty of state tax filings would 
be eliminated if unnecessary federal filing requirements were 
curtailed or if the states could agree on a uniform approach to 
the taxation of employees on international assignments.
                           Tax-Related Costs
    Many U.S. taxpayers on international assignments are paying 
some income tax required by the U.S. tax code even though they 
did not earn the income in the U.S. Because the majority of 
U.S. multinational companies have a policy of tax-equalization 
(the employees will pay only as much in taxes as they would 
have paid had they remained at home), this cost is borne by 
U.S. corporations. On top of the tax cost, we must consider the 
cost to administer payroll (calculating appropriate 
withholdings, reviewing documentation for payroll, etc.) and 
the cost of tax return preparation services relating to 
employees' overseas employment.
    In our professional experience, we have seen companies 
decide not to transfer U.S. citizens or residents because of 
the additional costs and complexities involved. If they are to 
continue to succeed in the global economy, U.S. companies need 
employees with international experience. In short, the U.S. tax 
code may adversely affect the competitiveness of U.S. companies 
by making international assignments prohibitively expensive and 
complicated.
                           Retirement Income
(a) U.S. Plans v. Foreign Plans

    The U.S. system of taxing its citizens and residents on 
their worldwide income has some adverse effects in the area of 
retirement benefits. For example, if a company transfers a U.S. 
citizen abroad, the expatriate employee may continue to be 
covered in his or her U.S. retirement plans (commonly the case 
where the employee is transferred for a relatively short-term 
assignment) or the employee may cease participation in U.S. 
plans and, instead, become a member of one or more plans in the 
host country. These two scenarios have different tax results:
    (1) Continued participation in U.S. plans. Under current 
law, if the expatriate employee continues to participate in 
U.S. plans, the U.S. tax treatment will be essentially the same 
as if he or she were still in the U.S. Specifically, 
contributions on the employee's behalf to, and benefits under, 
U.S. qualified plans will not normally be taxable to the 
employee until he or she receives a distribution of benefits 
from the plans. The problem for U.S. expatriate employees is 
that the employee may well find that the host country is 
subjecting the employee to taxation on his or her U.S. 
benefits, such as 401(k) deferrals or benefit accruals under a 
pension plan, on the basis that they represent income with a 
host-country source and that U.S. plans do not qualify for 
favorable tax treatment under the host country's laws.
    When this occurs, U.S. law may afford the employee a 
foreign tax credit to offset those taxes, but the way the 
foreign tax credit works, it will not always operate to fully 
avoid double taxation of the individual.
    (2) Participation in host country plans. If an expatriate 
employee participates in retirement plans in the host country, 
the employee may escape current taxation in the host country if 
those plans are qualified for favorable tax treatment in that 
country. From the U.S. perspective, however, it is close to 
certain that the foreign plans will not contain all the 
provisions needed for them to be qualified in the U.S. To the 
extent, therefore, that an expatriate's overseas accruals are 
vested, the U.S. will subject the individual to current rather 
than deferred taxation of the benefits. This gives rise to 
complicated tax calculations when the individual eventually 
retires, having already been taxed on the overseas benefit and 
being likely taxed by the host country at the time of payout.
    It would be much simpler, and should involve no significant 
(if any) loss of revenue if the U.S. and foreign countries 
could work out a system of reciprocity under which an 
expatriate participating in tax-qualified retirement plans in 
the host country could have the home country deem the host 
country plans to be tax-qualified in this situation.
    This kind of arrangement is not unprecedented. The income 
tax treaty between the U.S. and Canada contains a provision 
(Article XVIII, section 7) that enables expatriate employees 
(e.g., U.S. citizens working in Canada and participating in 
Canadian retirement plans) to defer the taxation of retirement 
income in the home country until the time the employee actually 
receives a distribution of that income.
    In addition, in the United Kingdom, the Inland Revenue 
(without reciprocity from the U.S.) has a procedure under which 
U.S. retirement plans can be submitted for ``corresponding 
approval'' under U.K. law. In order to obtain such approval, a 
plan need not demonstrate that it complies with all the 
requirements for a U.K. ``approved scheme.''
    We believe that the U.S. should seriously consider 
establishing similar procedures under which the Internal 
Revenue Service could deem foreign retirement plans to be 
qualified for purposes of deferring taxation of U.S. citizens 
and residents.

(b) Rollovers and Transfers of Benefits.

    Under current rules, benefits from a nonqualified 
retirement plan cannot be rolled over or transferred to a 
qualified retirement plan without jeopardizing the 
qualification of the latter plan. As virtually no foreign plans 
are qualified for U.S. purposes, this effectively precludes an 
employee who is transferring to (or back to) the United States 
from transferring any benefits he or she may have received from 
a qualified foreign plan to the U.S. qualified retirement plans 
in which the employee participates. Such transfers, if 
permitted, would facilitate the transfer of needed employees to 
the U.S. This would, however, require careful investigation and 
might be best handled through reciprocal arrangements in income 
tax treaties.
    The coordination of retirement benefits for mobile 
employees is a complicated topic. We do not claim to have all 
the answers. We do believe, however, that it is an issue that 
will affect the competitiveness of U.S. companies, particularly 
as other regions of the world tackle this issue. We follow with 
interest the movement in the European Union toward pan-European 
pensions and the ability of workers to move among European 
countries without adversely affecting their pensions. While 
Europe has not yet achieved these goals, there are forces 
committed to their achievement. If and when this happens, 
companies may have one more reason to site operations in Europe 
rather than the United States. With this in mind, we believe 
that the U.S. should pay serious attention to the tax problems 
confronting U.S. citizens and residents working abroad.
                         Other Important Items
    Additional items that we, in our experience, would classify 
as anti-competitive from a U.S. perspective include:

           the complexity of the foreign tax credit rules, 
        which place an undue administrative burden on U.S. taxpayers;
           the alternative minimum tax;
           the inequity of the rules under which unused foreign 
        tax credits can be carried forward only five years and backward 
        only one year, while overall foreign losses (which operate to 
        reduce the credits) are carried forward without limit;
           lack of a ``deemed paid'' foreign tax credit for 
        non-corporate taxpayers, with the result that U.S. corporations 
        can take a U.S. tax credit for foreign taxes paid directly by 
        corporate subsidiaries, while non-corporate U.S. taxpayers 
        (such as partnerships) are denied such a credit;
           the mind-numbingly complex deemed dividend rules 
        (e.g., under Subpart F), which are effectively tax traps for 
        the unwary; and
           the requirement to file costly and extremely 
        burdensome annual ``Information Returns'' (e.g., Form 5471) for 
        certain foreign corporate and partnership subsidiaries--forms, 
        in our view, of which the cost to taxpayers far outweighs the 
        benefit of their contents to the government.
                               Conclusion
    We thank the Committee for giving us the opportunity to 
express our views on this subject. We would be happy to work 
with the Committee in further understanding the ramification of 
the issues discussed in this statement.

                                


Statement of Timothy A. Brown, President, International Organization of 
Masters, Mates & Pilots, Linthicum, MD and Lawrence H. O'Toole, 
President, Marine Engineers' Beneficial Association

    Mr. Chairman and Members of the Committee: On behalf of the 
International Organization of Masters, Mates & Pilots (MM&P) 
and the Marine Engineers' Beneficial Association (MEBA), we 
thank you for the opportunity to submit this statement 
specifically addressing our proposal to make section 911 of the 
Internal Revenue Code applicable to certain American merchant 
mariners. The MM&P primarily represents Masters and Licensed 
Deck Officers working aboard commercial vessels operating in 
our nation's foreign and domestic shipping trades. The MEBA 
primarily represents Licensed Engineers working aboard 
commercial vessels also operating in our nation's foreign and 
domestic shipping trades.
    We would first like to emphasize our support for the views 
presented at the June 30 hearing by Mr. Peter Finnerty, Vice 
President for SeaLand Service, Inc., in support of H.R. 2159, 
the ``United States-flag Merchant Marine Revitalization Act of 
1999.'' We agree wholeheartedly that changes to the existing 
Capital Construction Fund as embodied in H.R. 2159 will help 
increase the competitiveness of the United States-flag merchant 
marine by facilitating the accumulation of capital necessary 
for the construction of new, modern commercial vessels in 
American shipyards for operation under the United States-flag. 
We similarly urge its favorable consideration by the Committee.
    At the same time, we believe it is equally important that 
Congress examine ways to increase the employment of American 
merchant mariners aboard commercial vessels in the foreign and 
international trades. We are convinced that extending the same 
foreign earned income exclusion available to other American 
workers to American mariners working aboard commercial vessels 
operating outside the United States will help American merchant 
mariners compete more equally with comparably qualified non-
American mariners for these jobs.
    As the Committee is well aware, under section 911 of the 
Internal Revenue Code, American citizens employed outside the 
United States may exclude from their gross income for Federal 
income tax purposes up to $74,000 of their foreign-earned 
income. American merchant mariners, working aboard United 
States-flag or foreign flag commercial vessels in the foreign 
or international trades, are not qualified to take advantage of 
the foreign earned income exclusion primarily because they are 
not deemed to be working in a foreign country as defined in 
Internal Revenue Service regulations.
    We strongly believe that changing the definition of 
``foreign country'' and altering the ``foreign residence'' test 
for merchant mariners to better reflect the true nature of 
their employment, and making section 911 applicable to merchant 
mariners, will be consistent with the important purposes and 
objectives of the foreign earned income exclusion.
    Clearly, one of the primary goals of section 911 is to 
promote America's national interests through the employment of 
American citizens outside the United States. Ensuring that the 
United States has a sufficient number of loyal, trained 
American merchant mariners to crew the government-owned and 
private vessels needed during war or other national or 
international emergency is a key component of America's sealift 
capability. Making section 911 applicable to merchant mariners, 
and increasing the opportunity for Americans to compete for 
employment on commercial vessels, will augment America's 
available seapower force. As in the case of other Americans 
seeking employment in the international marketplace, it is 
extremely difficult for American mariners, who are subject to 
the full range of American tax law, to secure employment 
opportunities outside the United States.
    Similarly, extending section 911 to American mariners will 
have a direct and positive impact, not only on the ability of 
Americans to secure employment on foreign vessels, but also on 
American companies operating vessels in the international 
shipping arena. Presently, vessel owners must pay an American 
mariner more than they would pay mariners from other nations so 
that American mariners may retain a comparable after-tax 
income. All too often, in the maritime industry as in other 
industries, the employer is unwilling to pay this premium, even 
when the American mariner is more qualified, more professional 
and more productive than his foreign counterparts.
    Today, privately-owned United States-flag commercial 
vessels are forced to compete for cargoes in an environment 
largely dominated by heavily subsidized and foreign state-owned 
fleets, and fleets registered in tax-haven countries, such as 
Liberia, Honduras, and Vanuatu. These fleets have significant 
economic and tax advantages as compared to American shipping 
companies. In reality, some of these discrepancies will 
continue to exist for the foreseeable future. For example, 
American companies extend health and welfare benefits that 
foreign governments rather than foreign companies provide to 
their nationals, and Americans are subject to a wide range of 
U.S. government-imposed rules and regulations generally not 
applicable to their foreign competitors. Extending section 911 
to American mariners is one thing that Congress can do so that 
it will no longer mean an economic penalty or burden if a 
vessel operator--American or foreign--chooses to employ 
American mariners.
    Today, despite the efforts of our organizations and other 
maritime labor organizations, American mariners are at a 
significant competitive disadvantage and are being priced out 
of their foreign markets--employment on commercial vessels 
operating outside the United States in the foreign or 
international trades--because prospective employers must 
provide more income to American mariners to compensate them for 
the tax burden that is not faced by foreign mariners.
    We would point out that other nations are pursuing changes 
in their tax laws to increase employment opportunities for 
their merchant mariners. It has been reported that the 
Government of Ireland has decided to make concessions in its 
taxation of seafarers to make it more attractive to use Irish 
seafarers on Irish vessels and that a draft Government of India 
shipping policy includes, among other things, a proposal to 
provide ``income tax exemptions for Indian seafarers, to 
attract talent to the field.''
    Similarly, both Great Britain and Germany announced at the 
end of 1998 that they were each exploring a variety of tax-
related measures and incentives, including those relating to 
their merchant mariners, in order to revitalize their fleets 
and increase employment for their nationals. Germany is 
specifically addressing whether they can attract more young 
Germans to seafaring jobs by further exempting from taxes a 
portion of the wages of new seafarers.
    Indeed, it is also worth noting that some foreign nations 
have already exempted their mariners from their national income 
tax, including Cyprus, Denmark, the Netherlands, Norway, and 
Spain.
    We believe that Congress can help achieve the dual 
objective of enhancing the competitiveness of United States-
flag commercial vessels operating in international and foreign 
commerce, and increasing the opportunity for American merchant 
mariners to secure employment aboard foreign and American 
commercial vessels. We recommend that Congress make section 911 
applicable to American mariners working aboard either a United 
States-flag commercial vessel or aboard a vessel documented 
under the laws of a foreign country, to the extent the income 
earned by the American mariner is attributable to employment 
performed outside the territorial waters of the United States.
    We thank you and your Committee for your consideration of 
this proposal and we stand ready to provide whatever additional 
information you or your staff may require.

                                


Statement of the Interstate Natural Gas Association of America

    The Interstate Natural Gas Association of America 
(``INGAA'') is a non-profit national trade association that 
represents virtually all of the major interstate natural gas 
transmission companies operating in the United States. These 
companies handle over 90 percent of all natural gas transported 
and sold in interstate commerce. INGAA's United States members 
are regulated by the Federal Energy Regulatory Commission 
pursuant to the Natural Gas Act, 15 U.S.C. Sec. Sec. 717-717w, 
and the Natural Gas Policy Act of 1978, 15 U.S.C. 
Sec. Sec. 3301-3432.
    In recent years a number of INGAA's members have become 
engaged in the design, construction, engineering, ownership and 
operation of major pipeline and power plant projects outside 
the United States. Investments are made in these foreign 
projects generally by foreign subsidiaries of the U.S. 
companies. These projects, which are highly capital-intensive, 
often involve construction of a natural gas pipeline and 
related facilities to transport gas from its point of 
extraction within one or more foreign countries for industrial 
uses, gas distribution and to electric generating facilities 
for use as fuel in the generation of power. The pipeline 
construction project may include the electric generating plant, 
and in some cases may also include an interest in the gas wells 
which provide the gas supply. The gas being transported in the 
pipeline may or may not be owned by the pipeline owner. Most of 
these projects are being undertaken in countries in Latin 
America, such as Argentina, Bolivia and Chile, in countries in 
Asia, such as India, Oman, and Abu Dhabi and in less developed 
countries in other parts of the world.
    Generally, large energy projects are awarded through a 
bidding process. The bidding is highly competitive, and the 
economics of such projects are extremely tax sensitive. In many 
cases, the country or countries where the project is based 
impose substantial taxes on the project. U.S. tax law currently 
disadvantages U.S. companies vis-a-vis their foreign 
competitors, including particularly those based in Canada, 
Australia, or Europe.
    In announcing this hearing, Chairman Archer stated: ``I 
strongly believe that our tax rules must help, rather than 
hinder, the competitiveness of American businesses.'' INGAA 
urges Congress to reform the taxation of foreign oil and gas 
income to eliminate the clear inequities of current law as 
applicable to foreign pipeline projects. It is INGAA's position 
that the ownership and operation of gas pipelines and other 
immovable assets in foreign countries as described herein 
should never result in Subpart F income, whether or not the 
activities occur in a country where the gas was extracted or 
consumed, and whether or not the controlled foreign corporation 
takes title to the gas being transported, because these 
activities do not produce income which is passive or 
manipulable. Accordingly, we urge the Committee to support H.R. 
1127, introduced by Representatives McCrery and Watkins, which 
clarifies the treatment of pipeline transportation income, and 
section 105 of H.R. 2018, ``International Tax Simplification 
for American Competitiveness Act of 1999,'' introduced by 
Representatives Houghton and Levin. Both bills would exclude 
income from the transportation of oil and gas by pipeline from 
subpart F income. Companion bills in the Senate, S. 1116 
introduced by Senator Nickles and section 105 of S. 1164 
introduced by Senators Hatch and Baucus, would similarly 
exclude active oil and gas pipeline income from subpart F 
income. At a minimum, current law should be amended: (i) to 
apply both the current law ``consumption'' and ``extraction'' 
exceptions to subpart F treatment in the same manner, i.e., 
their application should not be dependent upon whether the 
controlled foreign corporation takes title to the gas it is 
transporting; and (ii) to apply the high-tax exception to 
foreign base company income to foreign base company oil related 
income.
    Moreover, the Administration's proposal to revise the tax 
treatment of foreign oil and gas income (the ``Proposal'') 
should be rejected. The Proposal would, if enacted, exacerbate 
the current law bias against INGAA members in competing for 
these projects, and would drastically affect the economics of 
projects already undertaken. Accordingly, INGAA also urges 
Congress to reject the Proposal.
    This statement describes current law, illustrates the 
inequity of current law to INGAA members, and then further 
illustrates how the Proposal would greatly exacerbate this 
inequity.
        I. U.S. Taxation of Foreign Pipelines Under Current Law
A. Subpart F

    Under the Subpart F rules, U.S. ``10 percent shareholders'' 
\1\ of a ``controlled foreign corporation'' (``CFC'') \2\ are 
subject to U.S. tax currently on their proportionate shares of 
``Subpart F income'' earned by the CFC, whether or not it is 
distributed to the U.S. shareholders.\3\ Included among the 
categories of Subpart F income is ``foreign base company oil 
related income.'' \4\ Foreign base company oil related income 
is income derived outside the United States from the processing 
of minerals extracted from oil or gas wells into their primary 
products; the transportation, distribution or sale of such 
mineral or primary products; the disposition of assets used in 
a trade or business involving the foregoing; or the performance 
of any related services.
---------------------------------------------------------------------------
    \1\ See section 951(b).
    \2\ See section 957(a).
    \3\ Section 951(a).
    \4\ See section 954(g).
---------------------------------------------------------------------------
    There are two significant exceptions to the foreign base 
oil related income class:
    1. The extraction exception: income, including income from 
operating a pipeline, derived from a source within a foreign 
country in connection with oil or gas which was extracted by 
any person from a well located in such foreign country is not 
treated as foreign base company oil related income; \5\ and
---------------------------------------------------------------------------
    \5\ Section 954(g)(1)(A).
---------------------------------------------------------------------------
    2. The consumption exception: income, including income from 
operating a pipeline, derived from a source within a foreign 
country in connection with oil or gas (or a primary product 
thereof) which is sold by the CFC or a related person for use 
or consumption within the foreign country is not foreign base 
company oil related income.\6\
---------------------------------------------------------------------------
    \6\ Section 954(g)(1)(B).
---------------------------------------------------------------------------
    In addition, there is a general exception for CFCs which do 
not produce 1,000 barrels per day of foreign crude oil and 
natural gas.\7\ This exception, however, often is not available 
because for this purpose all related persons are aggregated, 
and many significant investors in natural gas pipelines and 
power projects around the world own foreign production which 
exceeds 1,000 barrels per day. Indeed, this limited exception 
is particularly non-competitive as it applies to production in 
Canada.
---------------------------------------------------------------------------
    \7\ Section 954(g)(2).
---------------------------------------------------------------------------
    All types of foreign base company income except foreign oil 
related income may be excluded from current taxation under 
Subpart F if the income is subject to an effective rate of 
local income tax greater than 90 percent of the U.S. corporate 
rate.\8\ No reason is given in the legislative history as to 
why this high tax exception is not applicable to foreign oil 
related income.
---------------------------------------------------------------------------
    \8\Section 954(b)(4).
---------------------------------------------------------------------------
    The Subpart F taxation of foreign oil related income was 
enacted in the Tax Equity and Fiscal Responsibility Act of 1982 
(``TEFRA''), P.L. 97-248, September 3, 1982. The legislative 
history explaining the tax policy rationale for the Subpart F 
treatment of foreign oil and gas income is as follows:

          [B]ecause of the fungible nature of oil and because of the 
        complex structures involved, oil income is particularly suited 
        to tax haven type operations.

    S. Rep. No. 494, 97th Cong., 2d Sess. 150 (1982).
    The only other reference made in the legislative history of 
TEFRA to any reason for including foreign oil related income in 
Subpart F is the general statement of the Finance Committee 
that ``the petroleum companies have paid little or no U.S. tax 
on their foreign subsidiaries' operations despite their 
extremely high revenue.'' Id. Accordingly, Subpart F taxation 
was imposed on all foreign oil related income without analysis 
of whether such income fit the criteria of Subpart F, i.e., was 
passive in nature or moveable. Income from the ownership and 
operation of foreign gas pipelines is neither passive or 
moveable. Moreover, it is unlikely that such income could have 
been a target of TEFRA because INGAA members only began 
building pipelines outside the United States in the 1990s.
    As described above, CFCs owned by INGAA members participate 
in large foreign projects which typically involve the 
construction and operation of gas pipelines and related 
facilities, sometimes include the participation in power 
plants, and occasionally also include investment in gas wells. 
These are all active business activities which have become 
common only in recent years. This foreign income of CFCs owned 
by INGAA members is no more ``particularly suited to tax haven 
operations'' (as the Senate Finance Committee Report states) 
than is any foreign manufacturing or processing activity 
conducted by a CFC, such as the manufacture of consumer or 
industrial goods. Surely it is not possible to ``manipulate'' 
income earned by a CFC from operating a gas pipeline 
permanently installed in a particular foreign country.
    Most U.S. bidders have generally only won projects where 
either the ``extraction'' or ``consumption'' exceptions to 
Subpart F treatment applied. If a pipeline project does not 
qualify for one of these exceptions to Subpart F it is unlikely 
that a U.S. bidder could successfully win a bid for that 
project against foreign competitors. Indeed, such a U.S. bidder 
is at a competitive disadvantage even for projects with local 
income taxes higher than the U.S. corporate rate because the 
Subpart F exception for high-tax income does not apply.
    Moreover, the exceptions to Subpart F for foreign oil 
related income apply irrationally. Consider the example where 
gas is extracted and processed by persons unrelated to the CFC 
in country A. The CFC constructs a pipeline from country A 
through country B and into country C where the gas is delivered 
to a power plant. Assume that the CFC receives $100 for 
transportation of the gas in each of countries A, B, and C, and 
that each country imposes tax on the CFC of $35. The U.S. 
taxation of the $300 of income is as follows:
    Country A--The $100 is not subpart F income because the 
extraction exception applies--the income is derived from 
country A where the gas was extracted.
    Country B--The $100 is Subpart F income, currently taxed in 
United States because the income is not earned either in a 
country where the gas was extracted (Country A) or consumed 
(Country C).
    Country C--The $100 is Subpart F income if the CFC does not 
own the gas but instead charges a tariff for transportation. 
However, if the CFC takes title to the gas and sells it in 
country C, the consumption exception applies and the $100 is 
not Subpart F income.
    As a matter of tax policy, different tax treatment of each 
separate $100 of income cannot be justified. None of this $300 
of income should be Subpart F income because it is not passive 
or moveable. Moreover, because, as explained below, INGAA 
members are frequently in an excess foreign tax credit 
position, there are many instances in which a foreign tax 
credit is not available to offset the current U.S. tax on 
subpart F income from the operation of foreign pipelines by a 
CFC, with the result that international double taxation occurs.

B. Foreign Tax Credit

    U.S. persons are subject to U.S. income tax on their 
worldwide income. To eliminate international double taxation, 
i.e., the taxation of the same income by more than one tax 
authority, the United States allows a credit against the U.S. 
tax on foreign source income for foreign income taxes paid.\9\ 
The amount of credits that a taxpayer may claim for foreign 
taxes paid is subject to a limitation intended to prevent 
taxpayers from using foreign tax credits to offset U.S. tax on 
U.S. source income.\10\ The foreign tax credit limitation is 
calculated separately for specific categories of income.\11\ 
Generally speaking, the foreign income activities conducted by 
INGAA members, such as operating pipelines to transport natural 
gas in foreign countries, produce ``active basket'' (sometimes 
referred to as ``general basket'') foreign source income. 
Income from the extraction of oil and gas is also generally 
``active basket'' income, although foreign oil and gas 
extraction income taxes are creditable only to the extent that 
they do not exceed 35 percent of the extraction income.\12\
---------------------------------------------------------------------------
    \9\ Section 901(a).
    \10\ Section 904(a).
    \11\ Section 904(d).
    \12\ Section 907.
---------------------------------------------------------------------------
    The ``separate basket'' approach of current law was 
instituted in the Tax Reform Act of 1986. In 1986 Congress 
expressed a concern that the overall foreign tax credit 
limitation permitted a ``cross crediting'' or averaging of 
taxes so that high foreign taxes on one stream of income could 
be offset against U.S. tax otherwise due on only lightly taxed 
foreign income. Nevertheless, in 1986 Congress endorsed the 
overall limitation as being ``consistent with the integrated 
nature of U.S. multi-national operations abroad,'' and 
therefore concluded that averaging credits for taxes paid on 
active income earned anywhere in the world should generally be 
allowed to continue.\13\ Congress limited the cross crediting 
of foreign taxes when it would ``distort the purpose of the 
foreign tax credit limitation.'' \14\ For example, one 
identified concern was the use of portfolio investments in 
stock in publicly-traded companies, which could quickly and 
easily be made in foreign countries rather than in the United 
States. In order to limit the opportunities for cross-
crediting, Congress added additional baskets for income that 
frequently either bore little foreign tax or abnormally high 
foreign tax, or was readily manipulable as to source. The 
baskets enacted in 1986 included passive income, financial 
services income, shipping income, high withholding tax 
interest, and dividends from non-controlled section 902 
corporations.\15\
---------------------------------------------------------------------------
    \13\ General Explanation of the Tax Reform Act of 1986, 99th Cong., 
2d Sess. 862 (1986) (``1986 Blue Book'').
    \14\ Id.
    \15\ H.R. Conf. Rep. No. 841, 99th Cong., 2d Sess. 564-66 (1986).
---------------------------------------------------------------------------
    Current law, which treats all income from the 
transportation of natural gas through a foreign pipeline as 
active basket income, is clearly the correct result. INGAA 
members, however, are frequently in an excess foreign tax 
credit position because of the substantial interest expense on 
debt incurred to finance domestic capital expenditures which is 
apportioned to foreign source income, reducing the numerator of 
the foreign tax credit limitation which in turn reduces the 
amount of the foreign tax credit. Thus, as a practical matter 
it is difficult for a U.S. pipeline company to obtain foreign 
tax credits with respect to the income earned from its foreign 
operations.\16\ Such companies, however, should not be 
precluded from using available credits.
---------------------------------------------------------------------------
    \16\ In the example described above, although the $200 of income 
frm Countries B and C would be subject to U.S. tax under Subpart F, it 
is unlikely that the $70 of foreign income taxes paid to Countries B 
and C would be available as a foreign tax credit to offset the U.S. tax 
on such income. As a result, there would be international double 
taxation of the $200 of income.
---------------------------------------------------------------------------
                   II. The Administration's Proposal
    On February 1, 1999, the Administration put forth the 
Proposal which would result in a substantial change in the 
taxation of foreign oil and gas income. The Proposal would 
treat all foreign income taxes paid by a CFC relating to oil 
and gas income, including income from the transportation of gas 
through a pipeline, as being subject to a separate foreign tax 
credit limitation instead of being included as part of the 
``general basket'' of active income.
    In the General Explanation of the Proposal, the Treasury 
Department does not articulate any reason for creating a 
separate basket for foreign oil and gas income under the 
foreign tax credit limitation. In its ``Description of Revenue 
Provisions Contained in the President's Fiscal Year 2000 Budget 
Proposal,'' issued February 22, 1999, the Staff of the Joint 
Committee on Taxation stated that the proposal ``may provide 
some simplification by eliminating issues that arise under 
present law in distinguishing between income that qualifies as 
extraction income and income that qualifies as oil related 
income.'' \17\
---------------------------------------------------------------------------
    \17\ Staff of the Jt. Com. on Tax., 106th Cong., 1st Sess., 
Description of Revenue Provisions Contained in the President's Fiscal 
Year 2000 Budget Proposal, 310 (Comm. Print 1999).
---------------------------------------------------------------------------
    The policy rationale of simplification does not apply to 
pipeline companies, which do not have extraction income. 
Accordingly, there is no policy justification for separating 
foreign oil and gas transportation income from other active 
income for purposes of the foreign tax credit limitation. 
Moreover, separating foreign oil and gas income into a separate 
foreign tax credit limitation basket would be contrary to the 
general principle of the separate basket regime enacted by 
Congress in 1986 that all active business income should be 
included in one foreign tax credit limitation basket to enable 
the cross-crediting of all taxes on such income.\18\
---------------------------------------------------------------------------
    \18\ Shipping and financial services income, which are both active 
income, were subjected to separate basket treatment in 1986, either 
because the income ``frequently'' bore little foreign tax or abnormally 
high foreign tax or was manipulable as to source. 1986 Blue Book at 
863-64. The income from operating foreign gas pipelines is not more 
frequently subject to either abnormally high or low foreign tax than 
manufacturing income, nor is it manipulable as to source.
---------------------------------------------------------------------------
    The Proposal would materially harm U.S. businesses, 
affecting U.S. jobs and U.S. competitiveness in the global 
economy. The effect of the Proposal would be to limit further 
the amount of foreign tax credits available to INGAA members 
and preclude most U.S. investors from successfully bidding for 
the capital-intensive foreign pipeline projects. This would 
significantly hinder a thriving business currently available to 
INGAA members. This business creates a demand for U.S. jobs, 
particularly engineering and support services. Elimination of 
most U.S. pipeline companies from participating in foreign 
pipeline projects seems to INGAA to be wholly counterproductive 
and misguided tax policy which would cost U.S. jobs.
    In addition, the Proposal would apply to projects already 
completed and in operation. U.S. investors would therefore 
realize returns different from their economic projections, with 
materially adverse financial statement impacts. In short, 
enactment of the Proposal would create profound economic harm 
for INGAA members with foreign pipeline activities.
                          III. Recommendations
A. Reform the Subpart F Taxation of Foreign Oil-Related Income 
As It Applies to Gas Pipelines

    Current law includes all foreign oil related income in 
Subpart F income. It is INGAA's position that the ownership and 
operation of gas pipelines and other immovable assets in 
foreign countries as described herein should never result in 
Subpart F income, whether or not the activities occur in a 
country where the gas was extracted or consumed, and whether or 
not the CFC takes title to the gas being transported, because 
these activities do not produce income which is passive or 
manipulable. Accordingly, we urge the Committee to support H.R. 
1127, introduced by Representatives McCrery and Watkins which 
clarifies the treatment of pipeline transportation income, and 
section 105 of H.R. 2018, ``International Tax Simplification 
for American Competitiveness Act of 1999'' introduced by 
Representatives Houghton and Levin. Both bills would exclude 
income from the transportation of oil and gas by pipeline from 
subpart F income. At a minimum, (i) the consumption exception 
should be amended to apply in the same manner as the extraction 
exception, i.e., its application should not be dependent upon 
whether the CFC takes title to the gas it is transporting, and 
(ii) the high-tax exception to foreign base company income 
should be amended so that it applies to foreign base company 
oil related income as it does to all other foreign base company 
income.

B. Reject the Administration Proposal

    The Proposal should be rejected. As applied to foreign gas 
pipelines, there is no tax policy justification for the 
Proposal. It is inconsistent with the separate basket approach 
of current law and would preclude most U.S. investors from 
successfully bidding for the capital-intensive foreign pipeline 
projects. It also could result in a substantial ``tax 
increase'' for INGAA members that own foreign gas pipelines.

           *         *         *         *         *

    INGAA appreciates the opportunity to provide this statement 
and would be pleased to furnish any information requested by 
the Committee.

                                


Statement of the Investment Company Institute

    The Investment Company Institute (the ``Institute'') \1\ 
urges the Committee to enhance the international 
competitiveness of U.S. mutual funds, treated for federal tax 
purposes as ``regulated investment companies'' or ``RICs,'' by 
enacting legislation that would treat certain interest income 
and short-term capital gains as exempt from U.S. withholding 
tax when distributed by U.S. funds to foreign investors.\2\ The 
proposed change merely would provide foreign investors in U.S. 
funds with the same treatment available today when comparable 
investments are made either directly or through foreign funds.
---------------------------------------------------------------------------
    \1\ The Investment Company Institute is the national association of 
the American investment company industry. Its membership includes 7,576 
open-end investment companies (``mutual funds''), 479 closed-end 
investment companies and 8 sponsors of unit investment trusts. Its 
mutual fund members have assets of about $5.860 trillion, accounting 
for approximately 95% of total industry assets, and have over 73 
million individual shareholders.
    \2\ The U.S. statutory withholding tax rate imposed on non-exempt 
income paid to foreign investors is 30 percent. U.S. income tax 
treaties typically reduce the withholding tax rate to 15 percent.
---------------------------------------------------------------------------

             I. The U.S. Fund Industry is the Global Leader

    Individuals around the world increasingly are turning to 
mutual funds to meet their diverse investment needs. Worldwide 
mutual fund assets have increased from $2.4 trillion at the end 
of 1990 to $7.6 trillion as of September 30, 1998. This growth 
in mutual fund assets is expected to continue as the middle 
class continues to expand around the world and baby boomers 
enter their peak savings years.
    U.S. mutual funds offer numerous advantages. Foreign 
investors may buy U.S. funds for professional portfolio 
management, diversification and liquidity. Investor confidence 
in our funds is strong because of the significant shareholder 
safeguards provided by the U.S. securities laws. Investors also 
value the convenient shareholder services provided by U.S. 
funds.
    Nevertheless, while the U.S. fund industry is the global 
leader, foreign investment in U.S. funds is low. Today, less 
than one percent of all U.S. fund assets are held by non-U.S. 
investors.

       II. U.S. Tax Policy Encourages Foreign Investment in the 
                          U.S. Capital Markets

    Pursuant to U.S. tax policy designed to encourage foreign 
portfolio investment \3\ in the U.S. capital markets, U.S. tax 
law provides foreign investors with several U.S. withholding 
tax exemptions. U.S. withholding tax generally does not apply, 
for example, to capital gains realized by foreign investors on 
their portfolio investments in U.S. debt and equity securities. 
Likewise, U.S. withholding tax generally does not apply to U.S. 
source interest paid to foreign investors with respect to 
``portfolio interest obligations'' and certain other debt 
instruments. Consequently, foreign portfolio investment in U.S. 
debt instruments generally is exempt from U.S. withholding tax; 
with respect to portfolio investment in U.S. equity securities, 
U.S. withholding tax generally is imposed only on dividends.
---------------------------------------------------------------------------
    \3\ ``Portfolio investment'' typically refers to a less than 10 
percent interest in the debt or equity securities of an issuer, which 
interest is not ``effectively'' connected to a U.S. trade or business 
of the investor.
---------------------------------------------------------------------------

  III. U.S. Tax Law, However, Inadvertently Encourages Foreigners to 
                  Prefer Foreign Funds Over U.S. Funds

    Regrettably, the incentives to encourage foreign portfolio 
investment are of only limited applicability when investments 
in U.S. securities are made through a U.S. fund. Under U.S. tax 
law, a U.S. fund's distributions are treated as ``dividends'' 
subject to U.S. withholding tax unless a special 
``designation'' provision allows the fund to ``flow through'' 
the character of its income to investors. Of importance to 
foreign investors, a U.S. fund may designate a distribution of 
long-term gain to its shareholders as a ``capital gain 
dividend'' exempt from U.S. withholding tax.
    For certain other types of distributions, however, foreign 
investors are placed at a U.S. tax disadvantage. In particular, 
interest income and short-term capital gains, which otherwise 
would be exempt from U.S. withholding tax when received by 
foreign investors either directly or through a foreign fund, 
are subject to U.S. withholding tax when distributed by a U.S. 
fund to these investors.

IV. Congress Should Enact Legislation Eliminating U.S. Tax Barriers to 
                    Foreign Investment In U.S. Funds

    The Institute urges the Committee to support the enactment 
of H.R. 2430,\4\ which generally would permit all U.S. funds to 
preserve, for withholding tax purposes, the character of short-
term gains and interest income distributed to foreign 
investors.\5\
---------------------------------------------------------------------------
    \4\ Introduced by Representatives Crane, Dunn and McDermott as the 
``Investment Competitiveness Act of 1999.''
    \5\ The taxation of U.S. investors in U.S. funds would not be 
affected by these proposals.
---------------------------------------------------------------------------
    For these purposes, U.S.-source interest and foreign-source 
interest that is free from foreign withholding tax under the 
domestic tax laws of the source country (such as interest from 
``Eurobonds'' \6\ would be eligible for flow-through treatment. 
The legislation, however, would deny flow-through treatment for 
interest from any foreign bond on which the source-country tax 
rate is reduced pursuant to a tax treaty with the United 
States.
---------------------------------------------------------------------------
    \6\ ``Eurobonds'' are corporate or government bonds denominated in 
a currency other than the national currency of the issuer, including 
U.S. dollars. Eurobonds are an important source of capital for 
multinational companies.
---------------------------------------------------------------------------
    The Institute fully supports H.R. 2430 because it would 
eliminate the U.S. withholding tax barrier to foreign 
investment in U.S. funds, while containing appropriate 
safeguards to ensure that (1) flow-through treatment applies 
only to interest income and gains that would be exempt from 
U.S. withholding tax if received by a foreign investor directly 
or through a foreign fund and (2) foreign investors cannot 
avoid otherwise-applicable foreign tax by investing in U.S. 
funds that qualify for treaty benefits under the U.S. income 
tax treaty network.

           *         *         *         *         *

    The Institute urges the enactment of legislation to make 
the full panoply of U.S. funds--equity, balanced and bond 
funds--available to foreign investors without adverse U.S. 
withholding tax treatment. Absent this change, foreign 
investors seeking to enter the U.S. capital markets or obtain 
access to U.S. professional portfolio management will continue 
to have a significant U.S. tax incentive not to invest in U.S. 
funds.

                                


                      Joint Venture: Silicon Valley Network
                           San Jose, California, 95113-1605
                                                       July 6, 1999
A.L. Singleton, Chief of Staff,
Committee on Ways and Means
U.S. House of Representatives
Washington, DC.

Re: Hearing on the Impact of U.S. Tax Rules on International 
        Competitiveness

    The following comments are being submitted on behalf of 
Joint Venture: Silicon Valley Network. Joint Venture: Silicon 
Valley Network is a non-profit dynamic model for regional 
rejuvenation. Our vision is to build a sustainable community 
collaborating to compete globally. Joint Venture brings people 
together from business, government, education, and the 
community to identify and act on regional issues affecting 
economic vitality and quality of life.\1\
---------------------------------------------------------------------------
    \1\ This letter represents the collective views of the Tax Policy 
Group within the Council on Tax & Fiscal Policy of Joint Venture: 
Silicon Valley Network (described on the last page of this letter), and 
not necessarily the views of any individual member of the Tax Policy 
Group. This letter is a summary of a larger Tax Policy Group position 
paper on International Tax Reform, which is expected to be published 
soon. The primary draftsperson of this letter was William C. Barrett 
(Applied Materials, Inc.). The ideas expressed in this letter represent 
the joint efforts of the following members of the Tax Policy Group: Jim 
Cigler (PricewaterhouseCoopers, LLP), Harry Cox (Aspec Technology 
Corporation), Randy George (Adaptec Corporation), Dan Kostenhauder 
(Hewlett Packard, Inc.), Larry Langdon (Hewlett Packard, Inc.), Suzanne 
Luttman (Santa Clara University), Annette Nellen (San Jose State 
University), Sandra Olsen (Solectron Corporation), and Don Scott 
(Oracle Corporation).
---------------------------------------------------------------------------

                The Importance of the Global Marketplace

    In order for companies in the high-tech sector to thrive, 
including those in Silicon Valley, they must expand their 
business outside the United States. One critical reason for 
developing worldwide markets is to spread large R&D and other 
developmental costs over the largest possible product base in 
order to keep prices low in a highly competitive global 
economy. Perhaps the most important message that Congress can 
give businesses in the United States is through the tax 
provisions relating to the treatment of international 
operations of U.S.-based companies. Congress can encourage or 
discourage the expansion of U.S. companies outside the United 
States. Congressional action will make a great deal of 
difference with regard to whether U.S. businesses will thrive 
in the 21st century. Tax policy needs to be formulated on a 
long-term basis and it needs to encourage U.S. businesses, 
especially those in the high-tech sector, to expand outside the 
United States. Any efforts to modify international tax rules 
should consider how tax policy--can support trade policy, 
international competitiveness, simplification, and the reality 
that today's global economy is not the one that existed when 
some of these international rules were created years ago.

                  U.S. Tax Policy is U.S. Trade Policy

    Tax policy should not impede trade policy. To that end, 
changes in U.S. tax policy should consider global tax trends, 
such as converging corporate income tax rates, and strive for 
reducing complexity. Converging corporate income tax rates 
around the world make a strong case for territorial-based tax 
systems, which reduce complexity. U.S. tax policy should 
encourage ``headquarters'' activities, such as research and 
development and non-commodity manufacturing, that will in turn 
produce higher profits in the future and higher U.S. wages. If 
changes to the current international tax rules are made without 
full consideration of all factors of today's global economy, 
economic growth in the United States could be adversely 
affected. Finally, U.S. international tax reform should occur 
within the context of global business and economic trends with 
a goal of designing tax policy that does not impede trade 
policy or is inconsistent with tax trends around the world.

                          Economic Tax Models

    An appropriate starting point to understanding 
international taxation related to foreign transactions is to 
compare the current U.S. system to classic economic tax models. 
There are two classic economic models in the area of foreign 
taxation: capital export neutrality (CEN) and capital import 
neutrality (CIN).
    The CEN concept holds that an item of income, regardless of 
where it is earned, should bear a global rate of tax equivalent 
to the home country tax rate. As applied in the U.S., the CEN 
model allows a foreign tax credit to a U.S. corporation facing 
U.S. taxation on it's worldwide income in order to reduce the 
risk of double taxation of the foreign earnings. Under the CEN 
model, tax rates are equivalent for investors residing in the 
same country.
    Under a CIN model, tax rates are equivalent for all 
investment located in the same country. If such a model were 
used in the U.S., foreign income would not be taxed in the 
United States in the year in which it is earned or when 
received as a dividend. Territorial-based tax systems (e.g., 
The Netherlands and France) are patterned after the CIN concept 
where a country only taxes income earned within its borders. 
Under CIN, income would be allocated between U.S. and foreign 
operations based on functions and risks performed in the 
respective geographic locations.
    The U.S. tax system is a hybrid approach with 
characteristics of both the classic CEN and CIN models. Except 
for certain proscribed activities (e.g., subpart F), the U.S. 
tax system is best described as a system based on deferral, 
where income earned offshore in a separate legal entity is not 
taxed until distributed (paid as a dividend of the foreign 
earnings) back to the U.S. The U.S. hybrid system includes 
incentives to encourage U.S.-based research, manufacturing, and 
export.
    Numerous studies exist that debate the relative merits of 
the CEN vs. CIN economic models.\2\ However, fewer studies 
exist that debate the [practical] distinctions between the two 
models. Practical considerations would include the following:
---------------------------------------------------------------------------
    \2\ For example, Overview of Present-Law Rules and Economic Issues 
in International Taxation, Joint Committee on Taxation, March 9, 1999, 
JCX-13-99.
---------------------------------------------------------------------------
    1. Global tax rates around the world for major trading 
partners are converging.\3\ This global tax trend leads to the 
conclusion that, net of foreign tax credit, the U.S. government 
gains little by taxing foreign earnings.
---------------------------------------------------------------------------
    \3\ For example, see Jeffrey Owens, ``Emerging Issues in Tax 
Reform: The Perspective of an International Bureaucrat,'' Tax Notes 
International, December 22, 1997. Nominal tax rates tend to converge 
around 30-40%.
---------------------------------------------------------------------------
    2. Studies have shown that the amount of foreign taxes paid 
by U.S. multinationals are matched closely with the amount of 
foreign tax credit claimed on their U.S. returns.\4\ Therefore, 
the amount of U.S. tax revenue generated by taxing foreign 
earned income may be insignificant. In the interest of 
simplicity, the extremely complex provisions in the Internal 
Revenue Code that trigger 'deemed' income inclusions make 
little sense.
---------------------------------------------------------------------------
    \4\ In an article written by Sarah Nutter, Assistant Professor at 
George Mason University, and attached to the 1997 IRS Statistics of 
Income Bulletin, Prof. Nutter points out that U.S. multinationals paid 
$23.7 billion of foreign taxes in 1993 and claimed $22.9 billion of 
foreign tax credits (see Tax Notes International, January 12, 1998, p. 
89). The $600 million differential raises interesting observations, 
which seem to lead to the conclusion that the U.S. fiscal gains little 
by taxing foreign earned income of U.S. multinationals. For example, if 
the assumption is made that the $600 million differential are taxes 
associated with `low-tax' offshore earnings (e.g., 10% tax rate 
earnings), the base income `deferred' offshore would be $6 billion. The 
tax rate differential between the 10% and 35% U.S. tax rate would lead 
one to the conclusion that only $1.5 billion tax was deferred by U.S. 
multinationals. If these conclusions are correct, Congress should 
seriously question whether it makes sense to retain unnecessarily 
complex provisions of the U.S. Tax Code, such as subpart F, that tax 
these foreign earnings. Eliminating subpart F provisions of the Code, 
with the possible exception for incorporation of `offshore pocket 
books', or adopting a `territorial' based tax system are equally 
compelling and would eliminate unnecessary complication without 
sacrificing significant tax revenue.
---------------------------------------------------------------------------
    3. Global mergers involving U.S. companies (e.g., Daimler/
Chrysler) are becoming more common. Integration of the global 
marketplace and financial markets portends of an increase in 
these global mergers. These mergers provide an opportunity for 
the parties to re-evaluate their global tax structure and as a 
result, U.S. companies may have the opportunity to create a 
`territorial' tax base for U.S. operations when the foreign 
party becomes the parent company of the newly merged global 
operation. Again, policy makers should seriously re-evaluate 
whether the taxation of foreign earned income makes any sense 
(1) when a territorial tax base is possible through global 
restructuring, and (2) under our worldwide-based taxation 
system with a foreign tax credit operating in a world with 
converging corporate tax rates.
    4. The IRS and the U.S. Treasury adopted extensive transfer 
pricing regulations, and Congress enacted related penalty 
provisions, in 1993. Foreign governments in turn have adopted 
many of the concepts in these U.S. regulations. In addition, 
the `Advanced Pricing Agreement' program has been used 
extensively by U.S. multinationals and the IRS where the IRS 
and U.S. multinational agree prospectively to transfer pricing 
methodologies. Consistency in global transfer pricing practices 
portends of more efficient transfer pricing audit resolution. 
These very significant developments to proper allocation of 
cross-border income eliminate many of the concerns the Kennedy 
administration had in 1962 when subpart F, and other anti-
deferral provisions, were enacted.
    These practical observations lead to a very compelling 
argument that when there are minimal [practical] distinctions 
between CEN, CIN, or the U.S. hybrid method, the U.S. 
government should align international tax reform with a model 
that is the easiest to administer. From a U.S. tax revenue 
perspective, it matters little whether foreign earned income is 
taxed at all in the United States when U.S. tax on this income 
is offset by foreign tax credits that on average, are very 
close to the U.S. statutory tax rate. Repealing anti-deferral 
provisions in the U.S. tax code would be a tremendous tax 
simplification step with minimal downside tax revenue loss. 
Aspiring towards international tax simplification is an 
attainable pursuit in this increasingly integrated global 
economy and convergence of tax rates around the world.

                  Global Economic and Business Trends

    The Brookings Institution analyzed the impact that trade 
barriers have on trade balance and export-related jobs.\5\ The 
report concludes that trade barriers increase the cost of an 
exported product and, as a result, reduce the number of high-
paying jobs in export-related industries. Therefore, it stands 
to reason that by reducing trade barriers, U.S. companies are 
able to support a higher wage base and focus on new product 
innovation that accompanies these higher-paying and export-
related jobs. Extending the Brookings report logic, U.S. tax 
policy that increases the tax cost of export-related products 
will suppress high wage U.S. export-related jobs.
---------------------------------------------------------------------------
    \5\ Globaphobia: The Wrong Debate Over Trade Policy, by Robert Z. 
Lawrence and Robert E. Litan, September 1997, http://www.brook.edu/
comm/policybriefs/pbO24/pb24.htm.  The Brookings report states that 
export related jobs on average pay 15% more than the average U.S. wage. 
The Bank of Montreal published a survey (Trade And Investment In The 
Americas, Survey of North American Businesses, Bank of Montreal/Harris 
Bank) revealing that after implementation of NAFTA, 47% of all North 
American businesses have gained employees while another 41% employ 
about the same number of employees. Only 11% of the surveyed firms lost 
employees. Further, the Hudson Institute has published a sequel to its 
study Workforce 2000 that reinforces many of these conclusions 
(Workforce 2020, Work and Workers in the 21st Century, Hudson 
Institute, Indianapolis Indiana, 1997).
---------------------------------------------------------------------------
    Global business consolidation is a trend seen across 
numerous industries. This trend hints of a more subtle 
evolution which is the consolidation of core ``headquarters'' 
functions. Core ``headquarters'' functions encompass research 
and development; centralized corporate functions, such as 
office of the Chief Executive Officer wherein global policy 
setting occurs for multinationals; and non-commodity 
manufacturing related to new product development. These 
functions are primary profit drivers for a multinational 
company and are critical to product innovation.\6\ For many 
companies, there is one centralized headquarters location. 
Understanding the ``headquarters'' relationship is important in 
developing tax policy because a tax policy that encourages 
locating these functions in the U.S. will reap a higher U.S. 
profit base, higher wages, a stronger local economy, and future 
U.S. innovation that perpetuates the cycle.
---------------------------------------------------------------------------
    \6\ Gary Hufbauer, U.S. Taxation of International Income, Blueprint 
for Reform, Institute for International Economics, October 1992, 
characterizes ``headquarters'' activities as ``incubators of human 
capital.'' ``Non-commodity manufacturing'' is used in this context to 
distinguish between lower profit ``commodity'' manufacturing. In an 
increasingly global marketplace, sound business governance dictates 
that to remain competitive in selling commodity products, business must 
seek lower cost production sites, leaving higher profit and higher 
paying wage jobs associated with ``non-commodity'' high-tech products 
in the United States.
---------------------------------------------------------------------------

         Calls to Abolish ``Corporate Welfare'' Miss the Point

    ``Anti-deferral'' legislation (e.g., ``runaway plant'' type 
legislation) is popular within protectionist camps.\7\ The 
concern from these groups is that when U.S. multinational 
corporations invest in offshore manufacturing locations it is 
being done solely to reduce U.S. labor costs. The protectionist 
fears are largely unfounded considering the global trends 
discussed above and should be resisted. Multinationals will 
locate major income-producing functions (i.e., ``headquarters'' 
functions) where they can achieve the highest rate of return in 
terms of both human capability and financial return on 
investment and it is these ``headquarters'' functions that 
attract economic income. Concerns about losing low-wage/low-
tech jobs misinterpret global trends and the factors that 
promote economic growth and improve wages in the United States.
---------------------------------------------------------------------------
    \7\ See for example, S. 1597 as proposed by Senator John Dorgan (R-
S. Dakota.) in March 1996 and Amendment No. 5223 (Sept. 11, 1996). S. 
1597 would have taxed offshore income associated with the sale of goods 
back into the U.S. The Asian economic crisis has heightened concerns 
from economists and business leaders that politicians may respond to 
price reductions with protectionist legislation which might in turn 
lead to deterioration of the global economy (see for example Wall 
Street Journal, January 5, 1998, editorial page).
---------------------------------------------------------------------------
    The ongoing debate about whether to further restrict 
deferral is engaged in by parties that view the world from 
different perspectives. There are those who believe that 
eliminating deferral for the foreign earnings of U.S.-based 
companies while the foreign earnings of foreign-based 
competitors obtain the advantages of tax-sparing treaties or 
territorial tax systems puts U.S. companies at a major 
competitive disadvantage that works to the detriment of the 
entire U.S. economy. On the other side are those who focus on 
the potential loss of U.S. manufacturing jobs that could occur 
because U.S. companies would be attracted to foreign, low-tax 
jurisdictions.
    Perhaps the most interesting way to think of these 
alternative views is through the prism of trade policy. The 
U.S. has been a leader since the middle of this century in 
dropping barriers to the free flow of goods and services across 
international boundaries. It is generally recognized that such 
a liberal trade policy has provided great economic benefits to 
all the countries of the world, including the Unites States. In 
the same vein, it is likely that allowing capital to flow more 
freely across borders will have a beneficial impact on U.S. and 
global economies. If some of the proposed anti-deferral 
legislation were adopted, the United States would be the first 
major country to eliminate deferral of income from active 
business activity. This would make U.S. companies less 
competitive without providing significant offsetting benefits.

                          Contact Information

    Any questions on our comments should be directed to either 
Bill Barrett, Chair of the Tax Policy Group's International Tax 
Reform Subcommittee at (408) 235-4389 or barrett--
[email protected], or Annette Nellen, Chair of the Tax Policy 
Group, at (408) 924-3508 or [email protected].
            Sincerely,
                                              Larry Langdon
                          Vice President: Tax, Licensing, & Customs
                                                    Hewlett Packard
                        Co-Chairs, Council on Tax and Fiscal Policy

                                                Jane Decker
                                            Deputy County Executive
                                              County of Santa Clara

    Joint Venture: Silicon Valley Network (www.jointventure.org) is a 
non-profit dynamic model for regional rejuvenation. Our vision is to 
build a sustainable community collaborating to compete globally. Joint 
Venture brings people together from business, government, education, 
and the community to identify and act on regional issues affecting 
economic vitality and quality of life. One of OUI initiatives is the 
Council on Tax and Fiscal Policy.
    Council on Tax & Fiscal Policy and the Tax Policy Group: The 
mission of the Council on Tax and Fiscal Policy is to bring together 
Silicon Valley's public and private sectors to identify common tax and 
fiscal needs and to work for mutually beneficial policy change at the 
regional, state, and federal levels. The Council champions reform by 
crafting legislation, supporting legislation, conducting special 
analysis, and serving as an educational forum. The Council's Tax Policy 
Group consists of individuals from high tech industry, government, and 
academia who analyze various state and federal tax rules and proposals 
to consider the impact to local governments and high tech industries. 
The Group's current work encompasses international tax reform, worker 
classification, R&D incentives, major federal tax reform, incentives 
for donations of technology to K-14, and sales tax issues of electronic 
commerce. The Group works to promote better understanding of tax and 
fiscal issues of significance to the Silicon Valley economy, through 
distribution of its reports and quarterly tax and fiscal newsletter, 
sponsorship of seminars and discussion forums, and submission of 
testimony to legislators and tax administrators.

                                


                                   NEU Holdings Corporation
                                        Whippany, NJ, 07981
                                                      June 28, 1999
The Honorable Bill Archer, Chairman
Committee on Ways and Means
U.S. House of Representatives
Washington, DC.

Re: Hearing on International Tax Rules, June 30, 1999

    Dear Representatives Archer and Rangel:

    We greatly appreciate your efforts to examine the United States' 
international tax policy and its impact on U.S.-controlled shipping 
companies. Your attention to this matter, as well as the Shaw-Jefferson 
bill, H.R. 265, which is pending before the Committee, are the first 
vital steps toward strengthening the U.S.-controlled foreign-flag 
shipping industry and restoring the United States' competitive 
opportunities internationally.
    General Ore International Corporation Limited (GOIC Ltd.) is one of 
the largest American-controlled industrial shippers of iron ore and 
liquid petroleum products in world markets, and it is one of the last 
corporations, privately-owned by U.S. citizens, that operates foreign-
flag vessels. Nevertheless, GOIC Ltd. is a very small operator compared 
to its international competitors.
    Our continued success is dependent upon our ability to compete 
fairly and openly in the international market. However, burdensome U.S. 
tax policies have hindered our ability to compete. Shipping income 
earned by GOIC Ltd. is subject to taxation under Subpart F of the 
Internal Revenue Code regardless of whether that income is reinvested 
in the business.
    Subpart F, enacted in 1962, imposes taxes on certain U.S.-owned 
businesses operating abroad that are more onerous than if those 
businesses were operating in the United States. As originally enacted, 
U.S.-controlled foreign shipping companies were not subject to Subpart 
F and were taxed no differently than their competitors--their earnings 
were not taxed until they were repatriated. In 1975, this changed. 
Congress amended Subpart F to limit the deferral of foreign flag 
shipping income so that income not reinvested into shipping operations 
was taxed currently. As a result, the industry and the tax revenues it 
produced began to decline.
    In 1986, Congress eliminated the deferral for reinvested income. 
Now the income from the U.S.-controlled foreign fleet is subject to 
U.S. tax whether or not those revenues are realized. This places 
companies like ours at a competitive disadvantage relative to our 
competitors, which are not subject to these taxes. Further, the United 
States cannot compete effectively in international markets with its 
major trading partners that have adopted tax policies and incentives to 
support their international shipping industries and, through them, 
their exports.
    Extending Subpart F to shipping income has devastated the U.S.-
controlled foreign shipping industry. Before 1975, U.S.-owned foreign-
flag shipping companies controlled 25 percent of the world's fleet. 
Because of the tax burdens imposed by Subpart F, that number has 
declined to less than 5 percent today. This anti-competitive tax regime 
has reduced new ship acquisition, and it has resulted in U.S. owners 
becoming minority owners in the vessels they once owned and operated.
    The U.S. government has gained nothing from extending Subpart F to 
shipping income. While the tax imposed upon this industry was 
originally designed to generate revenues, it has cost the U.S. Treasury 
millions of dollars. Please see the enclosed analysis by KPMG Company. 
In addition, U.S. national security is eroding with the declining 
sealift capability.
    The U.S. Congress must take action to restore the industry's 
competitive opportunities with its foreign trading partners. We 
encourage the Ways and Means Committee to move H.R. 265 through the 
House. Under the proposed legislation, taxes would be deferred, not 
exempted, and would be paid into the U.S. Treasury when repatriated. 
The bill allows growth in the U.S.-controlled fleet and restores the 
ability of U.S citizens to be active competitors in the global market. 
Without immediate action, the United States risks losing the few 
remaining U.S.-controlled shipping companies to countries whosetax laws 
are more favorable.
    Thank you for your attention to this matter. We look forward to 
working with you and the Ways and Means Committee to address this 
important issue. If you or your staff would like any additional 
information, please contact my Washington counsel, Warren L. Dean of 
Thompson Coburn LLP, at (202) 508-1004.
            Very truly yours,
                                             Richard W. Neu
    [Attachment is being retained in Committee files.]

                                


                                       Seaboard Corporation
                                      Washington, DC, 20006
                                                      July 7, 1999.
Hon. Bill Archer, Chairman,
House Ways & Means Committee,
Washington, DC

Re: June 30, 1999 Committee Hearing on the Impact of U.S. Tax Rules on 
        International Competitiveness

    Dear Chairman Archer:

    Seaboard Marine commends the Chairman and Committee for 
holding its recent hearing on the international tax regime. We 
appreciate the opportunity to submit this statement regarding 
critical changes that are necessary in the U.S. tax code. 
Seaboard is in agreement with the testimony that Prof. Warren 
Dean provided June 30 on behalf of the Subpart F Shipping 
Coalition, of which we are part, and provides this separate 
statement because of the urgency and significance of these 
issues.
    Seaboard Marine, based in Miami, is a wholly-owned 
subsidiary of Seaboard Corporation. It is one of the few 
remaining U.S.-owned shipping lines. Our company is one of the 
nation's premier carriers to the Carribean Basin, Central 
America and the west coast of South America. Additionally, 
Seaboard Marine is the largest carrier operating out of the 
Port of Miami, the world's leading shipping port to the 
Carribean Basin and Central America.
    Seaboard Marine competes internationally with carriers from 
around the world. Our ability to compete, however, is 
significantly hampered because of oppressive and repressive 
U.S. tax and regulatory policy. These rules and regulations 
favor foreign shippers at the expense of the U.S. maritime 
industry, creating a lopsided playing field. The imposition of 
punitive taxes on U.S.-owned international shipping companies 
has decimated the maritime industry. Specifically, the current 
provisions of Subpart F of the Internal Revenue Code have made 
it virtually impossible for Seaboard Marine and other U.S.-
owned shipping companies to remain competitive in the global 
marketplace.
    As one of the last remaining U.S.-owned shipping lines, we 
urge the Committee to approve H.R. 265, sponsored by 
Congressmen Clay Shaw (R-Fla.) and William Jefferson. (D-La.) 
This proposed legislation would restore the competitive 
opportunities for U.S.-controlled foreign-flag corporations by 
excluding shipping income from Subpart F of the Internal 
Revenue Code. Under H.R. 265, taxes would be deferred, not 
exempted, and would eventually be paid into the U.S. Treasury 
when repatriated. If the current provisions of Subpart F are 
not amended and corrected, the American maritime industry faces 
extinction.
    Besides employing more than 500 U.S. citizens and 
generating revenues in excess of $300 million, Seaboard Marine 
tangentially affects the employment of thousands of other 
American workers who are necessary to the inherent capital-
intensive nature of the marine shipping industry. These 
ancillary businesses include trucking, warehousing, banking and 
manufacturing industries, and freight forwarders. Moreover, the 
vast portion of the capital assets that Seaboard Marine 
utilizes in its business are produced in the United States, 
such as flat racks, refrigeration equipment, chassis and 
forklifts. For Seaboard Marine, the loss of Subpart F 
protection has meant not only decreased revenues, but also a 
disincentive to reinvest and expand.
    If this disincentive were eliminated, the industries upon 
which the maritime industry depends for goods and services also 
would benefit. Finally, Seaboard Marine provides a critical 
trade link to key countries in Latin America, such as 
Guatemala, Honduras, El Salvador, Nicaragua and the Dominican 
Republic. For these countries, the United States is the 
principal source of trade, of which Seaboard Marine plays a 
major role. The U.S.' ability to maintain its dominance in this 
important trade zone will be enhanced by the reinstitution of 
Subpart F protections for our industry.
    Besides the specific implications for Seaboard Marine, the 
ramifications of current Subpart F provisions are far-reaching 
for the U.S. maritime industry. It is not incorrect or an 
exaggeration to say that the American maritime industry faces 
extinction if the current provisions of Subpart F are not 
amended and corrected.
    Alarmingly, the U.S.-controlled fleet has declined from 
representing more than twenty-five (25) percent of the world 
fleet in 1975, when Subpart F was first altered, to less than 
five (5) percent today. American carriers' share of the market 
of the U.S. import/export cargoes fell by half between 1990 and 
1996, according to the U.S. Maritime Administration. Equally 
striking is that in 1975, U.S. carriers owned nearly 22 million 
of the 85 million gross registered tonnage in the world flag-
of-convenience fleet. This accounted to approximately 26 
percent of the world fleet. By 1996, however, the world-flag-
of-convenience fleet had almost tripled, to 241 million tons, 
while U.S. carrier ownership fell almost by half.
    The downfall of the American shipping industry is directly 
attributable to the devastating income tax burden that the U.S. 
government imposes upon it. American carriers pay income tax at 
a base rate of 36 percent. Most foreign carriers, however, pay 
little or no income tax.
    A study conducted by Crowley Maritime Corp., which also 
submitted a statement to the Committee regarding its June 30 
hearing, illustrates the disparity of the tax ramifications 
between U.S. and foreign shippers. The Crowley study found that 
on average, the foreign carriers sampled received a net tax 
credit in 1996, while American carriers sampled paid more than 
45 percent of their profits to the U.S. government in taxes in 
1996; 43 percent in 1997.
    With this tax disparity in mind, there is little wonder why 
the American shipping industry is struggling for survival.
    Before the protection of Subpart F was stripped away, the 
once-proud U.S.-owned fleet controlled a quarter of the world's 
fleet. Hundreds of millions of dollars were generated in annual 
tax revenues as a result of the voluntary repatriation of 
earnings. The associated infrastructure generated billions of 
additional dollars of taxable economic activity. After the 1975 
alteration to Subpart F, the once significant U.S.-owned fleet 
was forced to expatriate to remain competitive. Related 
industries, such as insurance brokerage, ship management, 
surveying, chartering, technical consultancies, etc., who 
serviced the maritime industry, followed.
    Conversely, foreign shippers have taken advantage of a 
favorable tax regime both in the U.S. and abroad. This has a 
given them a great advantage and thus a stranglehold on the 
industry. Consequently, the economic leadership of the United 
States in this critical sector of the economy has been lost. 
This has been painfully demonstrated and made obvious by recent 
international maritime transactions.
    In 1997, for example, the American President Lines, a 
bastion of the American maritime industry for more than 100 
years, was sold to Neptune Orient Lines Ltd. of Singapore. 
Shortly thereafter, Lykes Steamship Company, another prominent 
old-line shipper, sold its assets to Canadian Pacific Ltd. In 
short, these venerable lines fell into foreign hands because of 
the repressive and noncompetitive tax burdens the U.S. 
government placed on the lines' American owners.
    The elimination of the exclusion for shipping income from 
Subpart F of the Internal Revenue Code is thus illogical. The 
current provisions of Subpart F do not achieve the objective 
for which they were created. This repressive tax burden has not 
generated the tax revenues which were expected. Instead of 
increasing the tax revenue from the 1975 level of slightly more 
than $200 million to a projected revenue of almost $800 million 
in 1998, the revenue has, in fact, plummeted to (approx.) a 
meager $50 million.
    The decline of the maritime industry has additionally 
weakened the national defense, threatened existing maritime 
jobs and prevented the creation of new job opportunities. 
America's national defense is weakened because the military has 
historically relied upon the U.S. fleet to meet its marine 
transportation requirements. We must now depend upon ships 
under foreign ownership.
    The current provisions of Subpart F threaten thousands of 
U.S. maritime jobs, and prevent the creation of countless 
others because of the disincentive for American investment or 
reinvestment in shipping enterprises. Relieving the onerous 
burden that Subpart F presently imposes on the U.S. maritime 
industry not only would secure existing American jobs, but 
would no doubt be conducive to the creation of new job 
opportunities.
    As one of the last surviving players in the American 
maritime industry, Seaboard Marine urges you to give close and 
careful scrutiny to the ramifications of H.R. 265. Without the 
repeal of the repressive provisions of the current Subpart F 
legislation, the extinction of the U.S. maritime industry is 
inevitable.
    Seaboard Marine appreciates the opportunity to contribute 
to this vital tax debate. Our industry has been made to suffer 
by repressive taxation. It is time to halt and correct this 
crippling of a vital American industry.
            Sincerely,
                                              Ralph L. Moss
                                       Director, Government Affairs

                                


Statement of the Section 904(g) Coalition

    Mr. Chairman, the Section 904(g) Coalition commends you for 
holding this hearing on the impact of U.S. tax rules on the 
international competitiveness of U.S. businesses. Foreign 
competition faced by U.S. businesses has intensified with the 
acceleration of globalization. Over the years, Congress has 
revised the Internal Revenue Code to address the expanding 
activities of U.S. businesses in overseas markets. 
Unfortunately, a number of those revisions have negatively 
impacted the ability of U.S. businesses to compete in the 
global marketplace. One such provision, Section 904(g), enacted 
as part of the Deficit Reduction Act of 1984, can result in 
double taxation of income earned by a foreign subsidiary of a 
U.S. company. This testimony describes the situation in which 
double taxation can arise under Section 904(g) and proposes a 
narrow amendment to prevent such a result.
                             1. Background
    The members of the Section 904(g) Coalition are fully 
integrated U.S.-based multinational companies that engage 
directly and through domestic and foreign subsidiary 
corporations in the discovery, development, manufacture, 
marketing and sale of products. The foreign subsidiaries 
manufacture finished products from materials supplied by the 
U.S. parent company (``Parent'') or other affiliates, and 
market, sell and distribute such products in their local 
markets. A number of these foreign subsidiaries also conduct 
research and development activities locally through their own 
research staffs, while others may fund research by third 
parties or affiliates on their behalf or pursuant to bona-fide 
cost sharing agreements within or outside their home countries. 
These foreign subsidiaries are incorporated in developed 
countries with which the U.S. has a tax treaty. All locally 
funded research and development expenses are deducted in their 
home country, foreign tax returns and expensed for local 
statutory accounting purposes. Consequently, worldwide patent 
rights that result from these efforts and expenses are owned by 
the foreign subsidiary.
    Quite often the foreign patent owner does not have a 
manufacturing plant. The decision about where to locate such a 
plant is based on a variety of business, legal and political 
considerations. Building a manufacturing plant often requires a 
very significant investment in capital, and approval of the 
local government is often required for the siting, design and 
construction of the plant. In addition, manufacturing often 
involves specialized manufacturing know-how that the subsidiary 
may not possess. The foreign subsidiary would also need to 
recruit and train a manufacturing work force, which could 
require a significant investment of time, expense and 
management effort. In many cases, even if the subsidiary were 
willing to expend the time, expense and effort to acquire this 
capability itself, it could not construct a new manufacturing 
plant in time to meet the anticipated launch date for a 
particular product.
    For these reasons, worldwide patent rights owned by a 
foreign subsidiary (``Licensor'') may be licensed at an arm's-
length royalty rate to another affiliate (``Licensee'') that 
already owns and operates a manufacturing plant and has the 
capacity and know-how to manufacture the patented product.
                2. Internal Revenue Code Section 904(g)
    Under Code section 861 (a)(4) of the Internal Revenue Code 
(``Code''), royalties received for the use of a patent in the U.S. are 
U.S. source income. As a result, royalties paid by Licensee to Licensor 
for sales of product in the U.S. will generally be considered U.S. 
source income to Licensor. Moreover, under Code section 904(g), when 
Licensor pays an actual or deemed dividend to Parent, the dividend will 
be U.S. source income to the extent Licensor's earnings and profits are 
attributable to the U.S. source royalties. Any such dividend paid by 
Licensor will carry foreign tax credits at rates that may equal or 
exceed the U.S. statutory rate, but none of the royalty component of 
the dividend will be foreign source income.
    Alternatively, Section 904(g)(10) would permit Parent to avoid 
Section 904(g) resourcing if such resourcing would be inconsistent with 
an income tax treaty between the U.S. and Licensor's country of 
residence. Two requirements must be satisfied for Section 904(g)(10) to 
apply: (i) the treaty must give the foreign jurisdiction the right to 
tax dividends paid by Licensor to Parent (notwithstanding the 
dividend's domestic source under U.S. law), and (ii) the treaty must 
contain a special source rule that treats dividends that Licensor's 
jurisdiction may tax as arising in Licensor's jurisdiction for U.S. 
foreign tax credit purposes (see, e.g., Article 23 of the U.S.-UK 
Income Tax Treaty). Section 904(g)(10) relief, therefore, is contingent 
on the right of Licensor's country to impose withholding tax on 
dividends paid to Parent, rather than its right under the treaty to tax 
Licensor on its U.S. source income. Thus, for example, if the new U.S.-
UK treaty (now under renegotiation) should no longer permit the U.K. to 
tax dividends paid to Parent (or, alternatively, no longer contain a 
special sourcing rule), Section 904(g)(10) relief would be unavailable 
even though Licensor has paid full U.K. corporate income tax on its 
royalty income. Loss of Section 904(g)(10) relief is a very real 
possibility in the U.K. because dividend withholding tax may be 
entirely eliminated under U.K. internal law. Moreover, resourcing 
provisions are now contained in only a limited number of treaties 
(perhaps a dozen), and United States treaty policy has generally been 
to reserve for the U. S. the right to apply Section 904(g) in post-
enactment treaties (see, e.g. Treasury Department Explanation to 
Article 25 of the new U.S.-Luxembourg treaty). As newer treaties 
supersede older treaties, Section 904(g)(10) relief will become 
increasingly rare. Section 904(g)(10) also requires that the dividend 
income attributable to the resourced royalty be placed in a separate 
foreign tax credit limitation basket.\1\
---------------------------------------------------------------------------
    \1\ Section 904(g)(10) is further limited where Parent has dividend 
income under Subpart F by requiring treaty protection at each level of 
ownership where there are intermediary holding companies. Section 
904(g)(10)B.
---------------------------------------------------------------------------
    Thus, the choices available to Parent under current law are: (1) to 
rely on the possibility of cross-crediting all the foreign income taxes 
in the five-year carry-forward period in its general limitation basket, 
or (2) to choose the benefits of a treaty, where available, and credit 
foreign taxes paid up to the effective U.S. tax rate but permanently 
lose the ability to credit local taxes in excess of the U.S. rate.\2\ 
If the product is generating substantial U.S. royalty income that is 
subject to tax in the foreign jurisdiction, it is extremely unlikely 
that Parent would be able to cross-credit the foreign taxes in its 
general limitation basket. Thus, either choice will result in serious 
double taxation for Parent. The separate basket approach also unfairly 
prevents a taxpayer from using other available credits to satisfy any 
residual U.S. tax liability on U S. source royalties taxed at a foreign 
rate below the U.S. statutory rate.
---------------------------------------------------------------------------
    \2\ In practice the capacity to credit taxes within a separate 
904(g)(10) basket will be limited to rates below the U.S. statutory 
rate because of the allocation of expenses under Reg. Sec. 1.861-8.
---------------------------------------------------------------------------
    As discussed below, the Coalition believes, based on the 
legislative history of Code section 904(g), that Congress did not 
intend this result. Conceding for purposes of argument that Congress 
did intend when it enacted Section 904(g) in 1984 that dividends paid 
by Licensor to Parent be treated as U.S. source income to the extent 
Licensor's earnings and profits were attributable to U.S. source 
royalties, evolving foreign business requirements during the 
intervening 14 years and the need for U.S. companies to compete in 
foreign markets should cause Congress to revisit and revise subsection 
(g).
                         3. Legislative History
    The legislative history to the Deficit Reduction Act of 
1984 (``the 1984 Act'') expresses concern that, under existing 
law, a corporation could receive U.S. source income and 
subsequently repatriate the income as foreign source by flowing 
the income through an intermediate foreign corporation. By thus 
inflating foreign source income, U.S. companies with excess 
foreign tax credits could reduce U.S. tax on what would 
otherwise be U.S. source income and thus distort the foreign 
tax credit limitation. Congress also wanted to eliminate any 
competitive advantage to U.S. taxpayers that exported capital 
to be invested in the United States to foreign subsidiaries 
rather than investing it directly. Joint Committee Print, H.R. 
4170, 98th Congress, Public Law 98-369, pp. 346-54.
    Examples in the Joint Committee Print make it clear that 
the abuse Congress was targeting was the conversion of U.S. 
source income to foreign source income by routing the income 
through a foreign subsidiary set up for that purpose: where, in 
other words, there was no business reason for the activities in 
question to be carried on by a foreign subsidiary instead of a 
U.S. subsidiary or the U.S. parent itself, and the primary 
reason for the establishment of a foreign subsidiary was tax 
avoidance. The example given by the Joint Committee is a 
foreign insurance subsidiary of a U.S. company that earns all 
its income from insuring U.S. risks of U.S. companies and 
distributes its profits to its parent as foreign source income.
       4. Application Of Code Section 904(g) Appears Contrary To 
                          Congressional Intent
    As discussed above, Congress had two concerns when it 
enacted Code section 904(g) in 1984: the export of capital and 
the manipulation of the foreign tax credit. Neither of these 
concerns applies to the activities of Licensor in the 
circumstances described above.
    First, there is no export of capital involved in the 
ownership and commercialization of product by a foreign 
subsidiary where the patent is either discovered in the foreign 
jurisdiction and/or funded from Licensor's local business 
profits,\3\ and all the R&D expenses are deducted in its local 
tax return. In these circumstances, no U.S. capital is 
exported, directly or indirectly, to Licensor for the discovery 
and development of the product. The patent rights to the 
product are clearly the property of Licensor, and Licensor 
therefore has no choice but to report the full profits from 
exploiting the patent in its local tax return. In any event, 
Code section 367(d), also enacted in 1984, put an end to the 
practice of transferring appreciated intangibles from a U.S. 
parent to a foreign subsidiary in a tax-free exchange. Under 
Code section 367(d), the intangible is treated as having been 
transferred in exchange for a royalty or other payment 
commensurate with the income earned on the intangible. Since 
the royalty would be U.S.-source if the intangible were used in 
the U.S., the outbound transfer would no longer result in 
either a deferral of income or a conversion of income from U.S. 
to foreign source.
---------------------------------------------------------------------------
    \3\ A formula can be developed to assure that funds expended for 
R&D were derived from Licensor's own profits rather than from capital 
contributions made by Parent.
---------------------------------------------------------------------------
    Second, there is no manipulation of the foreign tax credit. 
If Licensor had manufactured the product itself, Licensor's 
income from sales of product into the U.S. would be foreign 
source income. Because Licensor has no manufacturing plant, it 
will license worldwide patent rights to an affiliate that does 
have such a plant in return for an arm's length royalty. Thus, 
the decision to license to an affiliate is made for sound 
business reasons. Moreover, all of Licensor's income, including 
royalties, is subject to full local taxation in its 
jurisdiction of residence. Even if Parent had a choice about 
where to report the income from exploiting the patent, it could 
not obtain a foreign tax credit benefit by routing U.S. source 
income through a full tax-paying foreign jurisdiction. On the 
contrary, Parent's foreign tax credit capacity is reduced to 
the extent it incurs local tax in excess of the U.S. tax rate. 
Because the Licensor that the Coalition is focused upon is 
incorporated and residing in a developed country with which the 
U.S. has a tax treaty, there is little or no opportunity for 
manipulation of the foreign tax credit rules.
    Finally, it appears that Code section 904(g) would apply 
even if Licensor had actually imported capital into the U.S. by 
manufacturing product and selling it in the U.S. through a U.S. 
branch--a structure clearly not designed either to export 
capital or distort the foreign tax credit limitation. In that 
case, Licensor would be subject to a 35% U.S. federal tax on 
its income, plus a 5% branch profits tax. Licensor would also 
be subject to full local income tax less a credit for U.S. 
taxes incurred. A dividend from Licensor under these 
circumstances would likewise be subject to Code section 904(g), 
and, thus, a pro rata portion would be U.S. source income. 
Consequently, Parent would face the same foreign tax credit 
problem discussed above.
    In sum, Parent has not attempted to transfer a U.S. asset 
or business to a foreign jurisdiction to convert U.S. source 
income into foreign source income. The capital to create the 
asset is of foreign origin, all R&D expenses are deducted in 
Licensor's local tax return, and Parent has never owned the 
asset. The foreign subsidiary that owns the patent is 
incorporated and residing in a country with which the U. S. has 
a tax treaty. The foreign tax jurisdiction, moreover, has very 
reasonable expectations that any profit resulting from 
commercialization of the patent will be subject to full income 
taxation in that jurisdiction. U.S. tax policy actually 
endorses this expectation through income tax treaties by ceding 
primary taxing jurisdiction to that other country on royalty 
income that is U.S. source income under Section 861 principles. 
There is no valid U.S. tax policy objective in these 
circumstances for limiting utilization of foreign tax credits 
under Section 904(g).
 5. Evolving Foreign Business Conditions Necessitate Modifications to 
                             Section 904(g)
    There is language in the attached Joint Committee Print to 
the effect that Congress intended to preserve full U.S. tax on 
U.S. source income earned by foreign subsidiaries of U.S. 
corporations upon repatriation to the U.S. regardless of the 
rate of tax paid by the foreign subsidiary on the income.\4\ 
Thus, the Committee Print appears to reflect U.S. tax policy 
concern even where the U.S. source income is subject to high 
rates of foreign taxes, the cost of which the taxpayer then 
seeks to shift to the U.S. government through the foreign tax 
credit mechanism. The Coalition believes, however, as discussed 
earlier, that Congress was principally concerned with 
situations where the high rate of local tax results from the 
U.S. parent company having either transferred a U.S. source-
income-generating-asset to the foreign subsidiary or having 
allowed the subsidiary to conduct business in the U.S., rather 
than engaging in the U.S. business activity itself.
---------------------------------------------------------------------------
    \4\ See page 348 of the Joint Committee Print which states that: 
``The [pre 1984] source rules arguably allowed the circumvention of the 
foreign tax credit limitation. The creation of foreign income that 
either attracted high foreign taxes directly or absorbed foreign tax 
credits that arose from unrelated high-taxed foreign income passed the 
cost of high foreign taxes from the U.S. taxpayer to the U.S. 
government. The [Deficit Reduction] Act [of 1984] prevents that result 
by its general rule that ensures full U.S. tax when U.S. source income 
flows through a U.S.-owned foreign corporation.''
---------------------------------------------------------------------------
    Clearly, Congress was not focused on a foreign subsidiary 
that was developing worldwide patent rights to a product and 
would eventually license such patent to another foreign 
affiliate. In today's global economy, U.S. parent companies are 
increasingly designating foreign subsidiaries as centers to 
undertake a portion of their research. These decisions are 
dictated by business necessity in today's international 
business climate. Increasingly, foreign governments are looking 
for strengthened local business ties as a prerequisite for 
important local business opportunities. These may include 
enhanced patent protection under local law, expedited review of 
new product applications, and pricing decisions in countries 
where these decisions are controlled largely by local 
governments.
    The increased ``nexus'' local governments are more 
increasingly focused on is the funding of research costs for 
particular products. This requirement is based on the 
expectation that increased R&D will lead to the recruiting of 
local scientists and ultimate ownership of worldwide patent 
rights if the research efforts should prove successful. It is 
imperative that U.S. companies be free to compete with their 
foreign counterparts in meeting these local business 
requirements without subjecting themselves to the potential 
risk of future double taxation. The Coalition believes that 
this result is clearly inconsistent with broader goals of U.S. 
tax policy.
   6. Code Section 904(a) Discourages Repatriation, Resulting In Net 
                              Revenue Loss
    Because repatriation of earnings could put Parent in an 
excess foreign tax credit position, Licensor could reasonably 
decide not to pay a dividend to Parent. Retaining earnings in 
the foreign jurisdiction would defer the repatriation of local 
tax credits. Profits from reinvested capital would be subject 
to tax in the foreign jurisdiction but not in the U.S., with a 
corresponding loss of U.S. tax revenue. The loser in this 
scenario is the U.S. government because capital imports are 
diminished, and profits from reinvested capital are subject 
only to foreign tax, not to U.S. tax.
                           7. Recommendation
    It is recommended that Code section 904(g) be amended to 
prevent its application when the owner who has funded 
development of a patent or other intangible receives a royalty 
or other income from exploiting an intangible and such income 
is subject to tax in a country with which the U.S. has an 
income tax treaty, which treaty permits the foreign country to 
tax such U.S. source income. The fact that the United States 
has entered into an income tax treaty with that other country 
is indicative that a tax haven jurisdiction is not being 
availed of and foreign tax credit manipulation is not involved 
(compare, e.g., Bermuda captive insurance or finance 
companies). The royalty income would, in any event, be subject 
to U.S. tax under subpart F if it is taxed at a rate that is 
less than 90% of the U.S. rate. See Section 954(b)(4).
    The Coalition believes that if Code section 904(g) is 
amended as suggested above, there will be no additional export 
of capital from the U.S. or manipulation of the-U.S. foreign 
tax credit rules.
    [Attachment is being retained in Committee files.]

                                


                                                Tax Council
                                      Washington, DC, 20005
                                                       July 7, 1999
The Honorable Bill Archer, Chairman
Committee on Ways and Means
U.S. House of Representatives
Washington, D.C.
    Dear Mr. Chairman:

    On June 30, 1999 the Ways & Means Committee held a hearing 
on the Impact of U.S. Tax Rules on International 
Competitiveness. The Tax Council commends you and the other 
members of the committee for scheduling the hearing on this 
issue which is so important to American workers and businesses.
    In addition to Representatives Houghton and Levin, you 
heard from 16 outstanding private sector witnesses who possess 
an unprecedented amount of expertise and knowledge regarding 
taxes and international business. All of the witnesses 
presented convincing and well thought out statements that 
justify the urgent need to reform and simplify the U.S. 
international tax laws. Over half of the witnesses you called 
to testify represent members of The Tax Council and we would 
like to state for the record that we, as an association, 
strongly support their collective call for international tax 
reform.
    In particular, we support the provisions in H.R. 2018 that 
would accelerate the effective date for look-through treatment 
in applying the foreign tax credit baskets to dividends from 
10/50 companies; repeal Section 907 with its excessively 
burdensome record keeping requirements; apply look-through 
rules on sales of foreign partnerships; and provide a permanent 
subpart F exemption for active financing income. In addition, 
we recommend the recently proposed legislation that would treat 
Advance Pricing Agreements as confidential return information. 
These provisions would help to simplify the tax code and assist 
U.S. companies to compete more effectively against foreign-
based competitors.
    The Tax Council is a nonprofit association that has been in 
existence since 1966 and has 110 major companies and businesses 
as members. In addition to providing an ongoing forum for the 
discussion of important tax policy questions, it supports 
efforts to assure that all federal tax laws are based on sound 
tax and budget policies.
    The Tax Council, which has been actively involved in the 
debate on international tax reform for a long time, urges the 
Committee to move as quickly as possible on the recommendations 
that were presented during this hearing. If we can be of any 
assistance, please do not hesitate to call upon us.
            Sincerely,
                                          Roger J. LeMaster
                                                 Executive Director

                                


                                          Tropical Shipping
                              Riviera Beach, FL, 33404-6902
                                                       July 6, 1999
A.L. Singleton, Chief of Staff
Committee on Ways and Means
U.S. House of Representatives
Washington, D.C.

Re: June 30, 1999 Committee Hearing on Impact of U.S. Tax Rules on 
        International Competitiveness

    Dear Mr. Singleton:

    The current U.S. international tax regime is contributing 
to the de-Americanization of U.S. industry because the U.S. 
owned fleet is being forced to expatriate to remain 
competitive. An unintended result of the 1986 and 1975 tax law 
changes has been the near complete removal of U.S. investment 
from the Ocean Shipping industry leaving the cargo trades of 
the United States almost entirely in the hands of foreign owned 
and foreign controlled shipping companies. Overall, U.S. 
ownership of the world fleet has declined from 25% of world 
tonnage in 1975 when Congress enacted the first tax code change 
affecting shipping, to less than 5% today!
    This unintended consequence has profound implications for 
the United States, as international trade and commerce of goods 
have historically been influenced by the national interests of 
the country of ultimate ship ownership.
    Tropical Shipping is a U.S.-owned container shipping 
company (CFC) with a business focus on serving ports of call in 
the Caribbean, the only region in the world in which the United 
States has a balance of trade surplus. The exports to this 
region create numerous jobs throughout the U.S. agricultural 
and manufacturing sectors as well as our own company's 
employment of over 500 people in the United States.
    The existence of the U.S. balance of trade surplus with the 
Caribbean is no coincidence. This region is the last area in 
the world where U.S. owned shipping companies dominate the 
carriage of general cargo and this contributes to the success 
and promotion of U.S. exports. Our company, and our U.S. owned 
competitors, are active every day, putting Caribbean buyers in 
touch with U.S. exporters which is beneficial for Tropical 
Shipping's long term interests.
    Our tax laws force U.S. companies to become acquired by 
foreigners because their countries have adopted tax policies to 
ensure that their international shipping industry is 
competitive in world markets. Our foreign-owned competitors 
have a great advantage in their accumulation of capital, as 
they are not taxed on a current basis and generally only pay 
tax when the dividends are repatriated. It is inevitable that 
mergers of U.S. companies with foreign companies will leave the 
resulting new company headquartered overseas. Examples of this 
are found in the decrease of the U.S. controlled fleet and the 
foreign acquisition of American President Lines and Lykes 
Steamship Co. Because of the adverse consequences resulting 
under the current U.S. international tax system, U.S. shipping 
companies are being forced out of the growing world market for 
the carriage of cargo.
    Buying and operating ships is capital intensive. U.S. 
owners in this capital intensive and very competitive shipping 
industry, have sold out, gone out of business, and not invested 
in shipping because they just cannot compete due to the 
unintended consequences of the U.S. international tax regime. 
It is simply this regime that places U.S. owners at a distinct 
disadvantage in the global commerce of ocean transportation. 
U.S. owners can compete in all other respects.
    In the containerized shipping industry, U.S. owned 
participation in the carriage of U.S. trade has steadily 
declined to an all time low of 14.2% of the container trade in 
1998. The decline is not in the economic interest of the United 
States and weakens U.S. exports contributing to fewer U.S. 
based jobs. It will be a sad day indeed if all the ocean 
commerce created in the growing market of the Americas as a 
result of NAFTA and the FTAA ends up benefiting foreign owners 
with no chance for U.S. investors to participate.
    Please correct the tax code so that the U.S. will increase 
their global competitiveness, expand and stabilize itself in 
the international shipping industry and strengthen U.S. exports 
which would result in more U.S. based jobs. H.R. 265, 
introduced by Congressman Shaw and co-sponsored by Congressman 
Jefferson, is an important response to this problem.
            Sincerely yours,
                                            Richard Murrell
                                                 President and CEO.

                                


Statement of LaBrenda Garrett-Nelson, and Robert J. Leonard, Washington 
Counsel, P.C.

    Washington Counsel, P.C. is a law firm based in the 
District of Columbia that represents a variety of clients on 
tax legislative and policy issues.
                              Introduction
    The provisions that make up the U.S. international tax 
regime rank among the most complex provisions in the Code. This 
statement discusses section 308 of the International Tax 
Simplification for American Competitiveness Act of 1999 (H.R. 
2018, introduced by Reps. Houghton and Levin), a proposal to 
reduce complexity in this area by repealing the little used 
regime for export trade corporations (``ETCs''). The ETC rules 
were enacted in 1962 to provide a special export incentive in 
the form of deferral of U.S. tax on export trade income. The 
rationale for the proposed repeal is that the special regime 
for ETCs was, effectively, repealed by the 1986 enactment of 
the passive foreign investment company (``PFIC'') rules. At the 
same time, the proposal would provide appropriate (and 
prospective) transition relief for ETCs that were caught in a 
bind created by enactment of the PFIC regime.

I. The Overlap Between the ETC Regime and the PFIC Rules 
Effectively Nullified the ETC Rules For Many Corporations

    Although the PFIC rules were originally targeted at foreign 
mutual funds, the Congress has recognized that the scope of the 
PFIC statute was too broad. Thus, for example, the Taxpayer 
Relief Act of 1997 eliminated the overlap between the PFIC 
rules and the subpart F regime for controlled foreign 
corporations. Similarly, in the 1996 Small Business Jobs 
Protection Act, the Congress enacted a technical correction to 
clarify that an ETC is excluded from the definition of a PFIC.
    The 1996 technical correction came too late, however, for 
ETCs that took the reasonable step of making ``protective'' 
distributions during the ten-year period between the creation 
of the uncertainty caused by enactment of the PFIC regime and 
the passage of the 1996 technical correction. Although U.S. tax 
on distributed earnings would have been deferred but for the 
ETC/PFIC overlap, these ETCs made distributions out of 
necessity to protect against the accumulation of large 
potential tax liabilities under the PFIC rules. Thus, the PFIC 
rules, in effect, repealed the ETC regime.

II. Congressional Precedents for Providing Transition Relief 
for ETCs

    The proposal would simplify the foreign provisions of the 
tax code by repealing the ETC regime. When the Congress enacted 
the Domestic International Sales Company (``DISC'') rules in 
1971, and again when those rules were replaced with the Foreign 
Sales Corporation (``FSC'') rules in 1984, existing ETCs were 
authorized to remain in operation. Moreover, ETCs that chose to 
terminate pursuant to the 1984 enactment of the FSC regime were 
permitted to repatriate their undistributed export trade income 
as nontaxable previously taxed income (or ``PTI'').
    The Proposal also provides a mechanism for providing 
prospective relief to ETCs that were caught in the bind created 
by the PFIC rules. Consistent with the transition rule made 
available in the 1984 FSC legislation, the proposal would grant 
prospective relief to ETCs that made protective distributions 
after the 1986 enactment of the PFIC rules. Essentially, future 
(actual or deemed) distributions would be treated as derived 
from PTI, to the extent that pre-enactment distributions of 
export trade income were included in a U.S. shareholder's gross 
income as a dividend. Note that the proposed transition relief 
would provide only ``rough justice,'' because taxes have 
already been paid but the proposed relief will occur over time.
                               Conclusion
    Repeal of the ETC provisions would greatly simplify the 
international tax provisions of the Code, but such a repeal 
should be accompanied by relief for ETCs that were caught in 
the bind created by the PFIC rules.

                                


                                         Youngstein & Gould
                                            London W1M 5FQ,
                                                      June 25, 1999
Ways and Means Committee
United States House of Representatives
Washington, D.C.
    Dear Sirs:

    In connection with hearings which are to be held this 
Wednesday, June 30, 1999, I enclose a letter by me on 11th 
December 1998 to the U.K. Inland Revenue and U.S. Treasury 
Department (the ``Letter'') in connection with negotiations 
which commenced early this year to modernize the US/UK income 
tax treaty. The points made there are highly relevant to any 
inquiry into the effect of U.S. tax law on the international 
competitiveness of U.S. workers who are working in countries 
which also impose worldwide taxation of income (e.g. the OECD 
countries).
    As the Letter illustrates, U.S. citizens who are resident 
for tax purposes in another jurisdiction which imposes 
worldwide income taxation tend to be subject to the harshest 
aspects of the U.S. and foreign taxation systems without the 
benefit of either system's tax incentives/reliefs (tax exempt 
pensions, reduced taxation of capital gains, etc. etc.). The 
result is that such individuals pay much higher tax than either 
U.S. citizens who remain in the U.S. or non U.S. citizens 
resident in the same foreign jurisdiction, as well as being 
subject to exponentially greater compliance burdens. The effect 
is nothing less than economic ``second class citizenship.''
    The Letter notes that a solution to the most severe aspects 
of this problem would be simply to eliminate the ``saving 
clause'' which is inserted by the Treasury Department as a 
matter of rote in all U.S. double tax treaties, providing that 
U.S. citizens resident in the other treaty jurisdictions may 
not claim relief from U.S. tax under such treaties. It is 
unclear that the policy for inclusion of the saving clause in 
the U.S. treaties has ever been clearly considered, and 
certainly not by the House of Representatives which is not 
involved in the treaty process. As noted in the Letter, it is 
fallacious to argue that the saving clause is an extension of 
the policy of the U.S. to tax its citizens regardless of 
residence.
    Also as noted in the Letter, the inclusion of the saving 
clause in treaties implies a level of responsibility of the 
Treasury Department to recommend and Congress to adopt domestic 
taxation provisions for U.S. citizens resident abroad which 
mitigate the harsh consequences of the denial of treaty relief, 
yet neither the Treasury Department nor Congress appear to 
appreciate that this responsibility exists. Clearly it has not 
been fulfilled.
    The position of U.S. citizens resident in other countries 
imposing worldwide taxation deserves your urgent attention. It 
would undoubtedly improve the morale of expatriate Americans if 
your Committee would acknowledge the problems which exist and 
assume responsibility for developing and implementing a 
solution.
            Yours sincerely,
                                           Jeffrey L. Gould

                                         Youngstein & Gould
                                            London W1M 5FQ,
                                                      Dec. 11, 1998
Bob Wightman Esq
Inland Revenue International Division
London WC2R 1HH

Joseph H Guttentag Esq.
Deputy Assistant Secretary (International Tax Affairs)
U.S. Treasury Department
Washington, D.C.
    Dear Mr. Wightman and Mr. Guttentag:

    I understand from our tax publications that the Inland 
Revenue and IRS have announced plans to modernise the UK/US 
double taxation convention for income taxes.
                             I. Background
    A. As a U.S. lawyer who has practised in London for the 
past 20 years, specializing in taxation matters, I have had 
occasion to advise on many aspects of the current treaty. I am 
aware of many areas where ``modernization'' is certainly 
required, to take into account developments in the domestic 
taxation rules and commercial environments of the two countries 
since the present treaty was agreed. I would like to focus on 
one area in which I am aware of a desperate need for a more 
sensible approach, namely the taxation by the U.S. of its 
citizens who are resident in the U.K. without affording the 
benefit of ``dual resident relief'' provided, for example, in 
the OECD Model Income Tax Treaty.
    B. As indicated below, the effect of the present treaty is 
a sort of ``second class citizenship'' for U.S. Expatriates 
resident in the U.K., who are unable to lead a fiscally 
``normal'' life because they have to face the harshest aspects 
of both the U.K. and the U.S. systems without the mitigating 
effects of the reliefs offered in either country.
                         II. The Problem Areas
    A. The fact that the U.S. imposes taxation of the worldwide 
income of its nationals, regardless of residence, raise unique 
problems particularly for U.S. citizens who are resident in 
countries like the U.K. which impose their own worldwide 
taxation. The ``International'' solution to such problems, as 
exemplified by the OECD Model Income Tax Treaty, is found in 
the ``dual resident'' provisions under which in cases of an 
individual who is fiscally resident in both treaty countries, 
the country with the greater claim to imposing worldwide 
taxation is accorded the status of the country of residence for 
treaty purposes while the other country may impose worldwide 
taxation but subject to the reliefs given under the treaty. The 
U.S. rejects this solution in the case of its nationals 
residing overseas (``U.S. Expatriates'') through requiring the 
inclusion in its double taxation treaties of ``saving clauses'' 
reserving to the U.S. the right to tax its nationals without 
regard to treaty reliefs.
    B. Unfortunately, the U.S. domestic tax law offers nothing 
for U.S. Expatriates who are subject to worldwide taxation in 
another country to take the place of dual resident treaty 
relief. As a result, the only protection against double 
taxation of such U.S. Expatriates rests in claiming foreign 
credits. Relief from double taxation by way of credit or 
exemption is a feature of the domestic tax law in virtually 
every other OECD country as well, but such relief clearly has 
been considered inadequate to deal with the problems of 
worldwide double taxation, as evidenced by the almost uniform 
inclusion of ``dual resident'' provisions in treaties between 
OECD countries
    C. The sometimes Draconian consequences to U.S. Expatriates 
of the U.S. approach are proof of the wisdom of the OECD 
approach. With only the foreign tax credit to rely upon, U.S. 
Expatriates residing in the U.K. are unable to obtain any 
benefit from tax-favored transactions in either country because 
of inconsistency in approach. For example:
    1. While the U.S. offers a rate of capital gains tax which 
is one-half that of the U.K., the U.S. taxes capital gains 
which are exempt under U.K. rules, such as the annual exemption 
from U.K. capital gains tax, gain from the disposal of a 
principal residence and gain which would qualify for U.K. 
retirement relief. The U.S. Expatriate who is resident in the 
U.K. must pay U.K. capital gains tax at the U.K.'s higher rate 
on those gains which are not exempt, and U.S. capital gains tax 
at the U.S.'s lower rate on gains which are exempt from the 
U.K. capital gains tax. Thus the U.S. Expatriate obtains the 
benefit of neither system's taxation of capital gains.
    The difference in tax treatment of gain from the sale of a 
residence is exacerbated by an unenlightened U.S. tax policy 
regarding currency gains and losses realized on foreign 
currency (e.g. pound sterling) mortgages.
    2. The U.S. and U.K. rules for tax-deferred pension and 
profit sharing plans are similar, but each impose different 
specific requirements as a result of which no U.K. exempt 
approved pension scheme will meet U.S. requirements for a 
qualified plan, and vice-versa. The U.K. at least offers the 
possibility of ``corresponding relief'' for certain U.K. 
residents who are covered by U.S. plans, but the vast majority 
of U.S. Expatriates who are resident in the U.K. are unable to 
avail themselves of such relief.
    U.S. Expatriates participating in U.K. pension plans may be 
liable to U.S. tax not only on employer contributions but also 
on a pro rata share of any income and gain realized in the 
pension fund. As this income is not liable to tax in the U.K., 
no credits for U.K. tax are available to offset the U.S. 
liability, while on the other hand when benefits are received, 
they will be largely tax-free in the U.S. (having already been 
taxed) while U.K. tax will then be due. The result is that in 
the extremely important area of pension planning U.S. 
Expatriates uniquely are unable to benefit from tax deferred 
pensions and are likely to suffer true double taxation if they 
are so ill-advised as to participate in a U.K. exempt approved 
scheme.
    3. Tax incentives for charitable giving differ between the 
U.S. and U.K. and it is difficult to get them to match.
    D. A similar problem has arisen from proliferation of U.S. 
anti-avoidance legislation, which is frequently focussed on 
overseas activities of U.S. taxpayers but always from the point 
of view of preventing avoidance by U.S. resident taxpayers. In 
fact, it is U.S. Expatriates who are most often affected by 
these rules, and in ways not intended by Congress.
    1. For example, the ``passive foreign investment company'' 
(``PFIC'') rules penalize minority investment in foreign 
companies which are organized to earn passive income. To 
prevent the last scintilla of avoidance, the term PFIC is so 
broadly defined as to include many purely active commercial 
ventures. Similarly, very restrictive tax credit provisions are 
embodied in the PFIC rules, which are inconsistent with the 
principles of double taxation relief as contained in Article 23 
of the present UK/US treaty. The result is that U.S. 
Expatriates who are resident in U.K. are subject to anti-
avoidance rules when making investments in U.K. companies in 
circumstances where there is no tax avoidance, resulting both 
in punitive rates of U.S. tax and denial of effective relief 
for U.K. taxation imposed on the same income/gain, i.e. true 
double taxation.
    2. Other U.S. anti-avoidance provisions such as the 
``controlled foreign corporation'' rules may result in 
attribution of income of a foreign entity to a U.S. Expatriate 
prior to the time when that income would be taxed to him in the 
U.K., creating a potential mismatch of credits and, once again, 
the possibility of true double taxation.
    3. A further problem of certain anti-avoidance rules both 
in the U.K. and the U.S. is the attribution of income to 
someone other than he who has earned it. The frequent result 
will be that income is taxed to one person by the U.K. and to 
another by the U.S., so that once again the foreign tax credit 
becomes an inadequate shield against double taxation.
    E. Many of the above problems would be avoided if a U.S. 
Expatriate residing in the U.K. were able to claim relief from 
the U.S. taxation under the US/UK double tax treaty.
                           III. The Solution
    A. The most comprehensive solution to these problems would 
be to eliminate the saving clause from the new US/UK income tax 
treaty. A U.S. Expatriate resident in the U.K. and eligible for 
relief from U.S. tax under the new treaty would, for the most 
part, be able to plan his affairs on the basis of being liable 
to tax on his income only in the U.K. and therefore have the 
same possibility as any other U.K. resident to mitigate his tax 
liability through adoption of acceptable forms of planning such 
as pensions. It is true that, because of the absence of a 
provision which deals with capital gain, the present treaty 
would not afford U.S. Expatriates relief from inconsistent 
treatment of capital gains even if there were no saving clause. 
However, the U.S.'s unilateral approach to treaty claims by 
U.S. resident aliens (pursuant to Treasury Regulations Section 
301.7701 (b) -7) would satisfactorily address this problem.
    B. It therefore seems to me high time for the IRS to 
reexamine the wisdom of incorporating the saving clause into 
its treaties. So far as I am aware, the saving clause has no 
congressional sanction. Presumably, the rationale for requiring 
the saving clause is to serve the U.S. policy of taxing its 
citizens on a worldwide basis, but there is no reason why this 
policy should be any stronger than U.S. policy of taxing its 
resident aliens on a worldwide basis, yet resident aliens are 
freely able to claim the benefit of ``dual resident'' 
provisions of U.S. treaties when applicable. The difficulties 
faced by a U.S. Expatriate residing in a country like the U.K. 
amply demonstrate that the U.S. has not taken responsibility in 
the drafting of its domestic legislation for the impact of the 
saving clause on such individuals.
    C. Another reason to reconsider the saving clause is that, 
in practice, the saving clause operates to the disadvantage of 
the U.S.'s treaty partners. Although typically (as in present 
US/UK treaty) the saving clause is drafted so as to afford 
either treaty partner the ability to tax its own nationals as 
if the treaty had not come into effect, it is only the U.S. 
which reaps a fiscal benefit from the saving clause because:

          1. the U.S. is the only country which impose worldwide 
        taxation of its nationals; and
          2. in those cases where a country such as the U.K. could 
        avail itself of the saving clause to deny treaty relief (i.e. 
        in relation to claims of U.K. nationals resident in the U.S.), 
        in practice it does not do so, either because it is not geared 
        to enforce a ``one-off'' provision which is inconsistent with 
        its normal treaty obligations or for cultural reasons.

    D. If the Treasury Department is not persuaded that it 
should take a fresh look at this issue, an alternative which 
certainly should be considered is a series of specific treaty 
provisions to deal with specific problems (e.g. pensions, 
capital gains, charitable contributions). This is less than 
ideal, both because of the difficulty of drafting all the 
provisions that ought to be included and because of the risk of 
rapid obsolescence. Nonetheless, ``half a loaf'' would be far 
better than none.
                             IV. Conclusion
    It would be a very positive development if the re-
negotiation of theUS/UK income tax treaty could pave the way 
for a more considered treatment of U.S. Expatriates in future 
treaty negotiations (or indeed, unilateral relief through U.S. 
domestic legislation wholly or partly overriding saving clauses 
in existing U.S. treaties).
    I would be very interested in assisting the Inland Revenue 
and /or the IRS during the course of these discussions, both in 
relation to the problem of U.S. Expatriates and generally. 
Please do not hesitate to contact me if I may be of service.
            Yours sincerely,
                                           Jeffrey L. Gould

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