[House Hearing, 112 Congress]
[From the U.S. Government Publishing Office]




 
                    WAYS AND MEANS INTERNATIONAL TAX
                        REFORM DISCUSSION DRAFT

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

                                HEARING

                               before the

                SUBCOMMITTEE ON SELECT REVENUE MEASURES

                                 of the

                      COMMITTEE ON WAYS AND MEANS
                     U.S. HOUSE OF REPRESENTATIVES

                      ONE HUNDRED TWELFTH CONGRESS

                             FIRST SESSION

                               __________

                           NOVEMBER 17, 2011

                               __________

                          Serial No. 112-SRM5

                               __________

         Printed for the use of the Committee on Ways and Means


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                      COMMITTEE ON WAYS AND MEANS
                SUBCOMMITTEE ON SELECT REVENUE MEASURES

                   PATRICK J. TIBERI, Ohio, Chairman

PETER J. ROSKAM, Illinois            RICHARD E. NEAL, Massachusetts
ERIK PAULSEN, Minnesota              MIKE THOMPSON, California
RICK BERG, North Dakota              JOHN B. LARSON, Connecticut
CHARLES W. BOUSTANY, JR., Louisiana  SHELLEY BERKLEY, Nevada
KENNY MARCHANT, Texas
JIM GERLACH, Pennsylvania

                       Jon Traub, Staff Director

                  Janice Mays, Minority Staff Director


                            C O N T E N T S

                               __________
                                                                   Page

Advisory of November 17, 2012 announcing the hearing.............     2

                               WITNESSES

Mr. John L. Harrington, Partner, SNR Denton......................     5
    Testimony....................................................     7
Mr. Tim Tuerff, Partner, Deloitte Tax LLP........................    18
    Testimony....................................................    20
Mr. David G. Noren, Partner, McDermott, Will & Emery.............    34
    Testimony....................................................    36
Mr. Paul W. Oosterhuis, Partner, Skadden, Arps, Slate, Meagher & 
  Flom LLP & Affiliates..........................................    44
    Testimony....................................................    46
Dr. Martin A. Sullivan, Contributing Editor, Tax Analysts, 
  Alexandria, VA.................................................    66
    Testimony....................................................    68

                    MEMBER QUESTIONS FOR THE RECORD

Mr. John L. Harrington...........................................    97
Mr. David G. Noren...............................................    99
Mr. Paul W. Oosterhuis...........................................   100

                   PUBLIC SUBMISSIONS FOR THE RECORD

Business Roundtable..............................................   103
Carrix Inc.......................................................   114
Center for Fiscal Equity.........................................   118
Jeffery M Kadet..................................................   123
RATE Coalition...................................................   155
U.S. Chamber Of Commerce.........................................   158


        WAYS AND MEANS INTERNATIONAL TAX REFORM DISCUSSION DRAFT

                              ----------                              


                      THURSDAY, NOVEMBER 17, 2012

                     U.S. House of Representatives,
                               Committee on Ways and Means,
                                                    Washington, DC.
    The subcommittee met, pursuant to notice, at 10:00 a.m., in 
Room 1100, Longworth House Office Building, the Honorable 
Patrick Tiberi [chairman of the subcommittee] presiding.
    [The advisory of the hearing follows:]

HEARING ADVISORY FROM THE COMMITTEE ON WAYS AND MEANS

 Chairman Tiberi Announces Hearing on Ways and Means International Tax 
                        Reform Discussion Draft

November 26, 2011

    Congressman Pat Tiberi (R-OH), Chairman of the Subcommittee on 
Select Revenue Measures, today announced that the Subcommittee will 
hold a hearing on the international tax reform discussion draft 
released on October 26, 2011 by the Committee on Ways and Means. The 
Committee released the discussion draft to solicit feedback on the 
details of the corporate rate cut and participation exemption (i.e., 
territorial) system that the Committee hopes to include as part of 
comprehensive tax reform. The hearing will take place on Thursday, 
November 17, 2011, in Room 1100 of the Longworth House Office Building 
at 10:00 A.M.
      
    In view of the limited time available to hear witnesses, oral 
testimony at this hearing will be from invited witnesses only. However, 
any individual or organization not scheduled for an oral appearance may 
submit a written statement for consideration by the Committee and for 
inclusion in the printed record of the hearing. A list of invited 
witnesses will follow.
      

BACKGROUND:

      
    As part of its pursuit of comprehensive tax reform, the House Ways 
and Means Committee (``the Committee'') released on October 26, 2011, a 
discussion draft of one discrete component of broader tax reform 
legislation: a participation exemption for certain foreign-source 
income (sometimes referred to as a ``territorial'' system). The 
Committee released this draft because it views the participation 
exemption as a fundamental change in the way the United States taxes 
cross-border activity, and in the interests of transparency seeks 
feedback from a broad range of stakeholders, taxpayers, practitioners, 
economists, and members of the general public on how to improve this 
proposed set of rules.
      
    The discussion draft is intended to be revenue neutral in and of 
itself when considered as part of comprehensive tax reform legislation 
that reduces the corporate tax rate to 25 percent. In addition to the 
exemption and other simplifications, the draft includes a number of 
options intended to prevent U.S. base erosion from activities such as 
overleveraging and income-shifting. Ways and Means Committee Chairman 
Dave Camp (R-MI) asked Chairman Tiberi to schedule a hearing on this 
discussion draft to begin to gather analysis from outside experts on 
the details of the draft.
      
    In announcing the hearing, Chairman Tiberi said, ``The Members of 
the Ways and Means Committee worked hard to produce a draft proposal 
that encourages investment and job creation here in the U.S. while 
addressing concerns about potential erosion of the U.S. tax base 
through creative tax planning. Having said that, we want to ensure the 
plan carefully considers the potential impact on American businesses 
and workers, and we welcome feedback from the public on how to refine 
and improve the draft proposal.''
      

FOCUS OF THE HEARING:

      
    The hearing will focus on the Ways and Means discussion draft 
released on October 26, 2011. For purposes of this hearing, the 
Subcommittee is particularly interested in comments and analysis of the 
basic architecture of the draft exemption system, including the scope 
of the 95 percent exemption for certain dividends and capital gains, 
the treatment of different forms of entities and ownership structures, 
and the transition rule applied to pre-effective date earnings. The 
hearing also will review the various options for protecting the U.S. 
tax base, both with respect to thin capitalization rules and income-
shifting through the location of intangible property and similar means.
      

DETAILS FOR SUBMISSION OF WRITTEN COMMENTS:

      
    Please Note: Any person(s) and/or organization(s) wishing to submit 
written comments for the hearing record must follow the appropriate 
link on the hearing page of the Committee website and complete the 
informational forms. From the Committee homepage, http://
waysandmeans.house.gov, select ``Hearings.'' Select the hearing for 
which you would like to submit, and click on the link entitled, ``Click 
here to provide a submission for the record.'' Once you have followed 
the online instructions, submit all requested information. ATTACH your 
submission as a Word document, in compliance with the formatting 
requirements listed below, by the close of business on Thursday, 
December 1, 2011. Finally, please note that due to the change in House 
mail policy, the U.S. Capitol Police will refuse sealed-package 
deliveries to all House Office Buildings. For questions, or if you 
encounter technical problems, please call (202) 225-3625 or (202) 225-
2610.
      

FORMATTING REQUIREMENTS:

      
    The Committee relies on electronic submissions for printing the 
official hearing record. As always, submissions will be included in the 
record according to the discretion of the Committee. The Committee will 
not alter the content of your submission, but we reserve the right to 
format it according to our guidelines. Any submission provided to the 
Committee by a witness, any supplementary materials submitted for the 
printed record, and any written comments in response to a request for 
written comments must conform to the guidelines listed below. Any 
submission or supplementary item 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 submissions and supplementary materials must be provided in 
Word format and MUST NOT exceed a total of 10 pages, including 
attachments. Witnesses and submitters are advised that the Committee 
relies 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. All submissions must include a list of all clients, persons and/
or organizations on whose behalf the witness appears. A supplemental 
sheet must accompany each submission listing the name, company, 
address, telephone, and fax numbers of each witness.
      
    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.
      
    Note: All Committee advisories and news releases are available on 
the World Wide Web at http://www.waysandmeans.house.gov/.

                                 

    Chairman TIBERI. The hearing will come to order. Good 
morning, and thank you for joining us for another in a series 
of hearings on comprehensive tax reform.
    At the Ways and Means Committee's first hearing this year, 
Chairman Dave Camp said that comprehensive tax reform would be 
a ``long discussion.'' Last month, Chairman Camp initiated a 
new phase of this long discussion when he released his 
international tax reform discussion draft. I applaud Chairman 
Camp and his staff for their wonderful work in putting together 
a discussion draft, and they should be also commended for the 
transparency in the process of doing it.
    The purpose of the discussion draft is to gather feedback 
on how the Ways and Means Committee can best transition from a 
worldwide system to a territorial system of taxation. I look 
forward to gathering some of that feedback today with our 
witnesses. We are lucky to have before us a panel of some of 
the most well-respected international tax practitioners in our 
country.
    In addition, I very much encourage practitioners, 
businesses, academics, and other interested parties, to share 
their feedback with us, as well. They can do so by visiting the 
comprehensive tax reform section of the Ways and Means 
Committee website.
    And finally, I want to emphasize that comprehensive tax 
reform remains our goal. By the time we are finished, we will 
have reformed the Tax Code for all employers and all 
individuals.
    I look forward to hearing from our witnesses today, and I 
now yield to my friend, Ranking Member Neal, for his opening 
statement.
    Mr. NEAL. Thank you, Mr. Chairman. And I want to thank you 
for calling this hearing today to examine Chairman Camp's 
international tax reform discussion draft.
    If there is one thing I think that we can all agree on, it 
is that our corporate and international tax rules need to be 
reformed. The United States has one of the highest statutory 
corporate tax rates in the world, which many economists say 
acts as a barrier to domestic investment.
    We have also heard a lot about the so-called lock-out 
effect of high corporate tax rate, where U.S. multinational 
companies don't bring their earnings home to the United States 
because of the repatriations tax. At the same time, our current 
system includes loopholes which allow companies to shift income 
from the United States to low-tax or no-tax jurisdictions.
    Therefore, I certainly commend Chairman Camp for releasing 
his international tax reform proposal. The Chinese philosopher 
noted that the journey of 1,000 steps begins with the first 
step. And I think Chairman Camp's proposal is a good first 
step, as I did with Mr. Rangel's proposal some years ago, as 
well. When that proposal was offered, I was always amazed at 
the hysteria that once again prevented us from having a 
conversation about what an international tax system ought to 
look like for the United States.
    I think Chairman Camp should also be applauded for 
providing us what he envisions our new international tax regime 
to look like. I am also pleased that the proposal included 
approaches for preventing erosion of U.S. corporate tax base, 
the U.S. tax base, which is a critical concern as we move 
toward perhaps international tax reform.
    That being said, I have an awful lot of questions about the 
chairman's proposal. For example, what impact would the 
proposal have on purely domestic companies and small 
businesses? Would the proposal encourage investment and job 
creation here, in the United States? Although I think lowering 
our corporate tax rate on a revenue-neutral basis is a worthy 
goal, can we lower the corporate rate to 25 percent without 
eliminating important tax incentives that benefit job creation 
and investment in the United States like the R&D tax credit?
    When it comes to lowering the top corporate rate to 25 
percent on a revenue-neutral basis, Chairman Camp has given us 
a map without any street signs. So I am glad we are having this 
hearing today to examine the chairman's proposal, and I thank 
you and thank the witnesses for bringing the hearing forward. 
Thanks, Mr. Chairman.
    Chairman TIBERI. Thank you, Mr. Neal. Before I introduce 
the witnesses, I ask unanimous consent that all Members' 
written statements be included in the record.
    [No response.]
    Chairman TIBERI. Without objection, we now turn to our 
witnesses and our panel, and welcome all of you today. I will 
introduce you all, and then we will start from left to right.
    Mr. John Harrington is a partner with SNR Denton. Mr. Tim 
Tuerff is a partner with Deloitte Tax LLP. Mr. David Noren is a 
partner with McDermott, Will & Emery. Mr. Paul Oosterhuis is a 
partner with Skadden, Arps, Slate, Meagher & Flom LLP, and Dr. 
Martin Sullivan is a contributing editor with Tax Analysts.
    Thank you, gentlemen. Mr. Harrington, you are recognized 
for five minutes.

     STATEMENT OF JOHN L. HARRINGTON, PARTNER, SNR DENTON, 
                        WASHINGTON, D.C.

    Mr. HARRINGTON. Thank you, Chairman Tiberi. My name is John 
Harrington, and I am a partner at the law firm of SNR Denton. I 
appreciate the opportunity to appear before the Subcommittee on 
Select Revenue Measures to discuss the Ways and Means 
discussion draft released on October 26, 2011. The views 
expressed in this testimony are solely my own.
    Before diving into the specifics of the discussion draft, I 
want to commend Chairman Camp and you all regarding the 
discussion draft. The materials released with the discussion 
draft included both statutory language and explanations of what 
is and is not in the discussion draft, facilitating 
understanding and scrutiny of the proposed participation 
exemption system.
    This is not the standard way tax legislation is unveiled, 
but I believe that this is the right way to approach 
fundamental tax reform. We are often quick to complain about 
the legislative process, and so we should let you know when you 
get it right.
    My written testimony goes into detail regarding various 
aspects of the discussion draft. In my oral testimony, I will 
highlight some of the major items.
    Corporate rate reduction.  The discussion draft would 
reduce the top corporate tax rate to 25 percent. I believe that 
a reduction in the corporate tax rate is a good idea for 
multiple reasons. I note, however, that reducing the corporate 
rate to 25 percent in a revenue-neutral manner would require a 
significant increase in the corporate tax base. Whether the 
prize is worth the cost can only be determined as the base-
broadening proposals are identified and debated.
    Regarding the basics of the participation exemption system, 
I believe that the discussion draft's participation exemption 
system is a fundamentally sound starting point. I think there 
are significant advantages to using as a base the participation 
exemption system adopted by many other countries, rather than 
creating a new territorial system out of whole cloth. By using 
a frequently adopted system as a framework, it allows you to 
avoid the practical problems that would arise with an idealized 
but untested system.
    The discussion draft includes certain rough justice rules.  
Although I may have suggestions to modify specific ones, I 
believe that, generally, rough justice rules are necessary. And 
much of the simplification advantages of the discussion draft 
are derived from such rough justice rules. For example, I 
believe that the discussion draft's choice to allow a partial 
95 percent exemption and narrow expense allocation and 
disallowance rules is a better approach than a full exemption 
and more expansive expense allocation rules.
    Treatment of branches of CFCs.  Under the participation 
exemption system, foreign branches of U.S. corporations would 
be treated as controlled foreign corporations, or CFCs. I 
believe that this deemed CFC rule raises several practical 
concerns. In particular, I believe that the proposed threshold 
for deemed CFC status, the U.S. effectively connected income, 
or ECI, rule is both too transitory and too vague to serve as 
the necessary threshold. Not only would the deemed CFC rules 
require a domestic corporation to determine whether the ECI 
threshold has been crossed, it would require a domestic 
corporation to determine exactly when the threshold has been 
crossed.
    Under the discussion draft, crossing the ECI threshold 
would result in the formation of a CFC, and the cessation of 
foreign activities would result in the demise of the CFC. In 
light of the technical problems of the deemed CFC rules, I 
strongly encourage you to consider allowing branches to be 
exempt without treating them as CFCs.
    Treatment of 10/50 companies.  The discussion draft 
provides an all-or-nothing election to treat 10/50 companies as 
CFCs. Domestic corporations will have to make the election if 
they want to keep the indirect foreign tax credit. Because 
electing 10/50 companies would become subject to subpart F, 
however, this election can raise serious questions about the 
shareholder's ability to get the information needed to comply 
with the myriad U.S. reporting rules. If you retain this rule, 
you will either have to simplify the information needed for 
subpart F, or have to deal with significant unintentional non-
compliance.
    Deemed repatriation.  Any switch to a participation 
exemption system necessarily requires some rule to address old 
untaxed earnings of CFCs. The breadth and mandatory nature of 
the deemed repatriation rule raises several fairness issues, 
particularly with respect to individuals who would be subject 
to the deemed repatriation, even though they are not eligible 
for the participation exemption. If there are concerns about 
individuals, I suggest a more targeted rule.
    Subpart F.  A participation exemption system, where the 
question is whether to tax now or never, is fundamentally 
different than our foreign tax credit and deferral system, 
where the question is whether to tax now or later. Rules that 
were designed with deferral in mind have to be modified to 
reflect a different paradigm. This is true not only for subpart 
F, but cross-border reorganization rules, transfer pricing, and 
other such rules.
    In closing, I urge you, when you take up individual tax 
reform, to simplify and reform the international tax rules for 
individuals, as well. Many of the rules were designed with 
large businesses in mind, and they can be quite onerous on 
individuals and small businesses.
    Thank you for the opportunity to present these views on the 
discussion draft. I would be happy to answer any questions that 
you may have.
    [The prepared statement of Mr. Harrington follows:]

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    Chairman TIBERI. Thank you, Mr. Harrington. You got a lot 
of information in that 5 minutes with about 10 seconds to 
spare. Thank you so much.
    Your work is cut out for you, Mr. Tuerff. You are 
recognized for five minutes.

STATEMENT OF TIM TUERFF, PARTNER, DELOITTE TAX LLP, WASHINGTON, 
                              D.C.

    Mr. TUERFF. Mr. Chairman, Ranking Member Neal, and Members 
of the Subcommittee, thank you for the opportunity to share my 
views on the discussion draft for establishing a territorial 
system for taxing foreign income. I am a tax partner with 
Deloitte Tax LLP, with over 27 years of experience as a tax 
attorney and CPA. I appear today on my own behalf, not on 
behalf of Deloitte Tax or a client of Deloitte. I am honored to 
be present and to participate in this hearing.
    U.S. corporations are taxed on their worldwide income, and 
are allowed a credit for foreign income taxes. This system is 
different from the territorial tax system used by almost all 
other OECD countries, which exempt foreign income from domestic 
corporate tax.
    Most recently, Japan and the United Kingdom adopted 
territorial systems of taxation. The use of territoriality by 
our competitors, along with the higher U.S. corporate tax rate 
has given serious concern about U.S. competitiveness. In my 
oral testimony today, I would like to discuss a proposed deemed 
dividend deduction, and the expansion of subpart F.
    An exemption system is a more competitive alternative to 
the current U.S. tax regime. The high U.S. corporate tax rate 
results in an increased tax charge on repatriation of earnings 
from foreign subsidiaries. This additional charge causes what 
is often referred to as a lockout of foreign earnings, 
preventing them from being returned to the United States. The 
proposed 95 percent dividends received deduction would reduce 
the U.S. tax charge on remitted earnings to 1.25 percent, 
thereby allowing for the movement of capital back to the United 
States for reinvestment in domestic operations.
    Furthermore, an exemption system would simplify U.S. tax 
law by significantly reducing the importance of the foreign tax 
credit. Under the discussion draft, the foreign tax credit 
would be primarily relevant to subpart F income and withholding 
taxes on interest and royalties. Only one foreign tax credit 
limitation would be needed, and only directly allocable 
expenses would reduce that limitation.
    The proposal raises the question of whether deductions 
should be allowed for expenses attributable to exempt foreign 
income. The discussion draft follows the position adopted in a 
number of countries which reduce the amount of the exemption, 
typically to 95 percent, as a reasonable proxy for disallowing 
expenses incurred in the domestic country attributable to 
exempt foreign income.
    The deductibility of expenses is a factor in retaining and 
expanding corporate headquarters functions in the United 
States. By comparison, United Kingdom adopted a 100 percent 
exemption for active foreign income, and did not place any 
restrictions on deductions. This change was adopted to 
encourage performance of corporate activities in the United 
Kingdom.
    Moving on to subpart F income, the discussion draft 
includes three options for significantly expanding the existing 
subpart F rules. The proposed options A and C require CFCs to 
bifurcate their sales and services income between intangible 
related returns and non-intangible related returns. I know of 
no other country that does this. The bifurcation of intangible 
income requires taxpayers to unscramble the economic egg by 
identifying the amount of revenue and expenses attributable to 
intangible property, compared with other functions of the CFC.
    Requiring segregation of return from intellectual property 
will result in significant controversy during the examination 
process, as taxpayers and the IRS attempt to subdivide returns 
on transactions. Such a theoretical subdivision of a single 
transaction is considerably more complex than adjusting a 
transfer price for an actual transaction.
    Historically, our subpart F rules have focused on whether 
income was derived from an active conduct of a trade or 
business. If any of these options were enacted, it would 
represent the first time that subpart F rules would look to 
foreign tax rates for purposes of defining when a CFC's 
earnings should be currently taxed in the United States.
    Option A, in addition, has the novel feature of focusing on 
the CFC's rate of return on expenses. By triggering current 
taxation when the return exceeds 150 percent, option A 
encourages taxpayers to push deductible development and 
marketing costs into the CFC, which is inconsistent with the 
policy objective of the subpart F provisions.
    Under current law, the CFC must pay for the right to use 
its U.S. parent's intellectual property outside the United 
States. These proposals would treat income from active business 
operations as subpart F income, solely on the basis of 
intangible property that was acquired in arms-length 
transactions. This treatment is inconsistent with the arms-
length standard, the cornerstone of international taxation for 
members of the OECD.
    In conclusion, I hope my comments on these proposals are 
constructive, and I look forward to addressing your questions. 
Thank you.
    [The prepared statement of Mr. Tuerff follows:]

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    Chairman TIBERI. Thank you, sir.
    Mr. Noren, you are recognized for five minutes.

STATEMENT OF DAVID G. NOREN, PARTNER, McDERMOTT, WILL & EMERY, 
                        WASHINGTON, D.C.

    Mr. NOREN. Chairman Tiberi, Ranking Member Neal, and 
distinguished Members of the Subcommittee, thank you for the 
opportunity to testify today regarding the Ways and Means 
Committee discussion draft on international tax reform. My name 
is David Noren, and I am a partner at McDermott, Will & Emery 
LLP, where I focus on international tax planning. The views I 
am expressing here today are my own, and do not necessarily 
represent the views of McDermott or any of its clients.
    I would like to start by commending the committee 
leadership and staff for producing such a detailed and 
thoughtful proposal in an important area of the tax law. My 
testimony today focuses on the discussion draft's three 
alternative subpart F proposals addressing concerns about the 
potential erosion of the U.S. tax base through the shifting of 
income to low-tax jurisdictions.
    My view is that adopting a territorial system is unlikely 
to place significant additional pressure on the transfer 
pricing and subpart F regimes, and that questions relating to 
the proper scope of the transfer pricing and subpart F rules 
are largely independent of whether a deferral or a dividend 
exemption approach is pursued. Thus, the adoption of 
territoriality, in and of itself, does not create any new 
imperative to tighten these rules.
    The discussion draft's proposed reduction of the top 
corporate income tax rate to 25 percent actually may have more 
bearing on the proper approach to transfer pricing and subpart 
F than does dividend exemption itself. A case could be made for 
taking a more restrictive approach to transfer pricing and 
subpart F as the corporate rate is reduced to a level more in 
line with the rates applicable in other OECD countries, 
although the strength of such a case would, of course, depend 
on the nature and scope of the restrictions in question.
    The discussion draft's three alternative subpart F 
proposals reflect three quite different ways of further 
limiting the ability of taxpayers to shift income to low-tax 
jurisdictions and, ultimately, three different theories of what 
behavior is thought to be objectionable.
    Is it the earning of profits from IP by a foreign 
subsidiary? If so, does it matter whether the IP was developed 
entirely within the U.S., entirely outside the U.S., or partly 
within and partly outside the U.S.?
    Are low foreign tax rates a concern in and of themselves, 
or only when paired with other factors, such as IP return, or a 
lack of certain kinds of business activities in the relevant 
jurisdictions?
    To what extent does it matter whether a foreign subsidiary 
is earning income from selling into its home country market, 
foreign markets in general, or the U.S. market?
    How are concerns about potential income-shifting to be 
balanced against other economic policy concerns such as U.S. 
employment and innovation leadership?
    Each of the three alternative proposals provides different 
answers to these questions. Option A, which is substantially 
similar to the Obama Administration's excess returns proposal, 
reflects a concern about U.S.-developed IP being transferred to 
a foreign subsidiary. Option A would tax currently a foreign 
subsidiary's excess income that is subject to a low foreign tax 
rate if the income has any connection at all to IP transferred 
from a related U.S. person. A narrow exception is provided for 
cases in which the CFC sells into its home country market.
    The most fundamental concern about the excess returns 
proposal is that, by gearing taxation to where IP originates, 
it might encourage the migration of R&D activity from the U.S. 
This option thus entails significant tension between the goal 
of restricting income shifting and other economic policy goals.
    Option B provides that a foreign subsidiary's income that 
is subject to a low foreign effective tax rate is subpart F 
income, subject to a narrow home country exception. Under 
option B, unless a foreign subsidiary is essentially selling 
into its own home country market, an effective tax rate of 10 
percent or less will lead to the treatment of the subsidiary's 
income as subpart F income, regardless of the other facts and 
circumstances surrounding the subsidiary's earning of the 
income.
    Thus, even if the subsidiary makes very significant 
contributions to the earning of the income, and no U.S. 
affiliate provides IP or makes any other contribution, subpart 
F would apply.
    Both option A and option B might be improved, in my view, 
by providing a somewhat broader home country exception that 
would accommodate structures with a significant business 
presence in the country of organization, even if the foreign 
subsidiary is selling into other markets. Low foreign tax rates 
alone, or low foreign tax rates in the presence of some 
relevant IP originating in the United States, should not 
suffice to trigger subpart F.
    Option C is a very inventive proposal that essentially 
boils down to current basis taxation of income attributable to 
IP, with a preferential rate being applied for IP income 
relating to serving foreign markets, and a normal rate being 
applied for IP income relating to serving the U.S. market. A 
key issue under option C will be how to attribute income to IP, 
which could create a need for valuation and transfer pricing 
type analyses of a kind not required under present law.
    In sum, I think all three options have some merit, and 
might usefully be developed further, but all three raise 
significant issues. Under any approach to tightening the 
subpart F rules, I would urge that efforts be made to 
accommodate structures with substantial functionality in the 
relevant locations in order to avoid interfering with common 
business models.
    I thank you again for the opportunity to present my views 
on this important subject, and I again commend committee 
leadership and staff for advancing the debate in this area. I 
would be pleased to answer any questions you may have at this 
time or in the future.
    [The statement of Mr. Noren follows:]

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    Chairman TIBERI. Thank you.
    Mr. Oosterhuis, you are recognized for five minutes.

STATEMENT OF PAUL W. OOSTERHUIS, PARTNER, SKADDEN, ARPS, SLATE, 
       MEAGHER & FLOM LLP & AFFILIATES, WASHINGTON, D.C.

    Mr. OOSTERHUIS. I too appreciate the opportunity to speak 
to you today here on this important bill. I think when 
international tax reform is finally enacted--and hopefully that 
is sooner, rather than later--we will see the introduction of 
this bill as one of the key milestones to move in that 
direction. It is a very important event.
    By eliminating our current system of taxing foreign income 
but with deferral, and replacing it with a mixture of exempting 
a large portion of foreign business income, and beginning the 
discussion of how much of that income should be currently 
taxed, it seems to me the bill provides a framework for 
resolving the important issues in international tax reform that 
members of both parties can engage in, and that, indeed, those 
of us who have thought about a territorial system for a long 
time can embrace.
    Ending the lock-out effect, as Mr. Neal mentioned in his 
remarks, and limiting the role of the foreign tax credit, which 
is a terribly complicated and flawed mechanism as it has 
evolved in our law over the last 30 years, as some of the 
witnesses have mentioned, achieves very important goals in 
international tax reform.
    Mr. Noren spoke at some length in his five minutes on the 
various subpart F options that are expanding the potential 
business income that is subject to current taxation. I would 
like to focus in my five minutes on the expense disallowance 
issues that are raised by the bill, and comment on their 
treatment in the bill.
    Today, as other witnesses have mentioned, because we have a 
system that, when it taxes foreign earnings, it taxes them 
worldwide with a foreign tax credit, there is a lot of pressure 
on the issue of what is foreign income against which you can 
take the credit, and what expenses are allocated to that 
income. We have a very broad definition of foreign-source 
income that is eligible for the credit and of expenses 
allocable to that income.
    When you move to a territorial system, as this bill does, 
the definition of income that is eligible for exemption is much 
more narrow, as it should be. Income like royalties that U.S. 
companies are earning from abroad, interest that U.S. companies 
are earning from abroad, are not eligible for the exemption. 
That is appropriate, because they are deducted in a foreign 
jurisdiction, so if they were eligible for an exemption they 
wouldn't be taxed anywhere in the world.
    But they are foreign-source income under today's rules. So, 
once you dramatically change, as this bill does, the amount of 
income that is treated as foreign and therefore eligible for 
the exemption, from what we have today, you do need to rethink 
what expenses are treated as being attributable to that income, 
and therefore, under today's rules, they are allocated to 
foreign-source income in determining how much credits you get.
    In an exemption system any allocated expenses would be 
disallowed. And disallowing major expenses for U.S. 
multinationals is obviously a very important issue, because it 
can affect them competitively, compared to foreign companies, 
as well as can result in tax policy that just doesn't make 
sense, in terms of the matching of income and expense.
    There are three expenses that are normally put in this 
category, and are allocated under present law: R&D expenses, 
G&A expenses, and interest expense. Those are the three kinds 
of indirect expenses that are at issue.
    The bill rightly does not disallow any deduction for R&D 
expenses. And that is because, as I said before, we are now 
taxing royalty income, and not allowing a foreign tax credit, 
by and large, against it. And in that system, it is entirely 
appropriate to allow a full deduction for R&D expense, because 
it is the royalties that are the income offset for the expense, 
and that is being fully taxed. So, just as a tax accounting 
matter, that makes sense.
    The second area of expense, which is G&A, the bill does not 
disallow a deduction for that expense, either. And I think that 
is entirely appropriate because, to the extent U.S. 
multinationals can charge out that expense to their foreign 
affiliates, it should be deductible. And to the extent it can't 
be charged out to foreign countries, then it is appropriately, 
in my mind, attributed to the U.S. income that is taxed, and 
not attributed to foreign income. Otherwise, the expense would 
not be deductible anywhere in the world.
    Finally, with respect to interest expense, the bill does 
propose a thin capitalization mechanism that, in some 
circumstances, could disallow interest expense. In my own view, 
that is an appropriate approach because it says if a U.S. 
company has a very large amount of interest expense it should 
think about whether some of that expense shouldn't be pushed 
down to its foreign affiliates, and not just deducted in the 
United States.
    I think the bill needs some refinement in that respect, but 
it is an important movement in the right direction, and I 
applaud the chairman for introducing it.
    [The prepared statement of Mr. Oosterhuis follows:]

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    Chairman TIBERI. Thank you.
    Mr. Sullivan is recognized for five minutes.

   STATEMENT OF MARTIN A. SULLIVAN, CONTRIBUTING EDITOR, TAX 
                 ANALYSTS, ALEXANDRIA, VIRGINIA

    Mr. SULLIVAN. Thank you, Mr. Chairman, Ranking Member Neal, 
and Members of the Committee. Mr. Chairman, there is no doubt 
about it. U.S. multinationals play an invaluable role in the 
American economy. They are export-intensive, they provide 
millions of high-paying jobs, they do most of the nation's 
research and development. It is certainly not in America's 
interest to let its multinationals be at a competitive 
disadvantage.
    But we must not forget that multinational corporations are 
only part of the American economy. And multinational 
competitiveness is not an end, in and of itself. A far more 
important objective is to promote the overall competitiveness 
of the economy. Too often in Washington, the term 
``competitiveness'' is equated with competitiveness of 
multinationals, and this is a serious mistake.
    Our goal is job creation through tax reform. We cannot 
neglect small businesses, we cannot neglect large and mid-sized 
businesses that do not have foreign operations, but 
nevertheless do compete internationally with their exports on 
foreign markets and with imports into the United States. And 
finally, we also want to encourage job-creating foreign 
companies to locate in the U.S.
    Tax policies that only promote the interests of 
multinationals are a double whammy to the rest of the economy 
for two reasons. First, they create a tax-induced tilt to the 
playing field that shifts resources away from domestic 
business. This reduces the productivity of the overall economy. 
And second, now that we have extremely tight budgets that 
require tax reform to be revenue-neutral, or perhaps even 
revenue raising, any tax cuts for domestic operations of a 
multinational--any tax cuts for foreign operations of 
multinationals are likely to result in tax increases for 
domestic business.
    U.S. tax rules give multinationals a large incentive to 
shift production offshore. This incentive is growing, and it is 
much larger than most folks realize. That is because we are not 
just talking about the difference between 35 percent in the 
U.S. and 12.5 percent in Ireland. The ease with which a 
multinational can shift profits turbo-charges the incentive of 
that rate differential. A toehold of real investment allows a 
truckload of profit to follow. The net effect is that the 
marginal effective rate on foreign investment is driven below 
zero. This is corporate welfare, plain and simple. It is no 
different than the Department of Commerce sending subsidy 
checks to companies. And the worst part of it is that the 
checks only go to companies that invest abroad.
    For obvious reasons, it has been customary throughout our 
history to limit business tax incentives like the investment 
credit and the research credit to domestic business activities. 
From this perspective, it is mind-boggling that one part of our 
Tax Code does the exact opposite. Our international tax rules 
provide a tax incentive exclusively for foreign investment and 
exclusively for foreign job creation.
    If we do want to promote the competitiveness of our 
multinationals, there are better ways than expanding foreign 
tax breaks. Our multinationals have a domestic side and a 
foreign side. We should focus tax benefits on the domestic 
side. In addition, we must not forget that providing tax 
benefits to domestic suppliers also improves the 
competitiveness of our multinationals.
    The U.S. has a worldwide system. Most other countries have 
territorial systems. To those who are unschooled in the 
realities of international tax, these circumstances imply that 
U.S. multinationals are at a huge disadvantage compared to 
other multinationals. But this just is not the case.
    One recent study compared the top 100 U.S. multinationals 
to the top 100 multinationals in the EU. Well, who had the 
higher tax rate? The EU multinationals had 31 percent; the U.S. 
had 24 percent. No competitive disadvantage there. This result 
is not surprising for those of us who work with the data. We 
can readily observe that multinationals pay low tax--low rates 
of foreign tax, and we can also readily see that multinationals 
with foreign operations have low overall effective tax rates.
    We also know that territorial systems employed in other 
countries are not pure territorial systems that exempt all 
foreign profits. Many countries do not allow exemptions if 
profits are from low-tax jurisdictions, which brings us to the 
chairman's proposal.
    The chairman has been emphatic that the proposal should be 
revenue-neutral. Territorial systems that do not bleed revenue 
losses cannot simply exempt foreign profits from the U.S. tax 
base. In order to protect the domestic tax base, they need 
backstops and anti-abuse rules, which the rest of the panel has 
discussed.
    The chairman has wisely included several features in the 
draft to prevent base erosion and maintain revenue neutrality. 
These provisions would prevent an exacerbation of the economic 
problems that we now experience under current law. In 
particular, the so-called base erosion features of the plan are 
essential. The draft offers three options.
    I urge the committee to pursue the simplest option, option 
B. It would not spark endless disputes about the definitions of 
intangible income, and it would, for once--once and for all, 
eliminate the spectacle of mailbox holding companies and tax 
havens booking billions of profits.
    The chairman has stressed--in conclusion, the chairman has 
stressed that the rate reduction is an integral part of his 
plan. As someone who has crunched a lot of numbers in and out 
of government, it is hard to be optimistic about getting to 25 
percent. In the 1980s, Congress started the tax reform process 
with President Reagan's blessing to repeal the investment tax 
credit. Translated into today's terms, that gave tax reformers 
about $100 billion of annual revenue for rate reduction.
    We don't have anything like that now. On the contrary, 
repeal of the current top three corporate tax expenditures--
accelerated depreciation, Section 199, and the research 
credit--would only get us to about 30 percent. Furthermore, 
because the primary beneficiaries of these expenditures are 
manufacturers, this type of revenue-neutral reform would be a 
tax increase on America's manufacturers.
    So, where is the money going to come from to pay for the 25 
percent rate? Value-added tax? Limiting deductions on corporate 
debt? Increasing the tax rate on capital gains? Well, of 
course, I understand these are non-starters in today's 
political environment. But if we are talking about a 25 percent 
rate, that is where the numbers lead you.
    Thank you, Mr. Chairman.
    [The prepared statement of Mr. Sullivan follows:]

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    Chairman TIBERI. Thank you, Mr. Sullivan, and thanks for 
reminding us that not everybody is for corporate tax reform. 
But I do want to point out my opening statement, just so you 
remember, that the chairman is for comprehensive tax reform for 
all employers and individuals, including pass-through entities 
and small businesses and medium-sized businesses and domestic-
only businesses as well. So this is a phase in a long 
discussion.
    With that, let me begin by asking you, Mr. Harrington, a 
question. In your written testimony that you provided today, 
you say, ``Proposed corporate tax rate reduction would be good, 
from international tax policy standpoint.'' Can you elaborate 
more on that, and how that would be good for the U.S., U.S. 
economy?
    Mr. HARRINGTON. Sure, Chairman Tiberi. I think part of it 
goes back to David's comment about the lower rate--by having a 
lower rate, you have less of a distortion, less of an impact of 
potential incentives. So, to the extent that someone is 
concerned about, for example, activities being moved to another 
place, I think having a tax rate that is more in keeping with 
the international norm will necessarily result in less income-
shifting, just from a purely tax standpoint.
    And to the extent that the tax rules are trying to reflect 
the economic activity, I think that result makes sense. There 
are consequences to being an outlier, in terms of tax rates.
    Chairman TIBERI. Thank you. And if you could, all answer 
this question, starting with Mr. Tuerff. And we will just go 
down the line, ending with Mr. Harrington.
    Most of the countries in the OECD have converted to a 
territorial system with either 100 percent or 95 percent 
exemption and no expense allocation. So, do you believe that 
the discussion draft that Chairman Camp has presented moves the 
U.S. international tax system within international norms? And, 
if so, how again is that--how is that going to benefit the U.S. 
economy? Mr. Tuerff.
    Mr. TUERFF. Chairman Tiberi, I believe certain component 
pieces of the discussion draft are within international norms. 
Most of the other countries have a--somewhere in the range of 
95 percent to 100 percent exemption system for foreign 
earnings. The 95 percent represents a haircut attributable to 
expenses that might be in the home country related to the 
foreign earnings. So, I think in that regard, the fundamental 
aspect of the dividends received deduction that has been 
proposed is consistent.
    The subpart F rules, however, are an extension beyond the 
normal international norms, because they target more active 
income conducted outside a home country that typically is 
within the exemption, the territoriality exemption that is 
allowed. So in that respect, I would say it is beyond the 
typical norms of what we see in other countries.
    Chairman TIBERI. Mr. Noren.
    Mr. NOREN. I would agree with Mr. Tuerff. I think the 
proposal would bring our system into greater conformity with 
international norms. I think it would do a real service by 
substantially eliminating the lock-out effect. It would produce 
maybe some simplification benefits, subject to how these income 
shifting or anti-base erosion approaches are worked out. And I 
would agree that the one thing that could push us outside of 
international norms in an unhelpful way would be if we got too 
aggressive in pursuing base erosion, and started interfering 
with common business models, where you actually do have some 
significant business presence and functionality in the 
jurisdiction that we are talking about.
    Chairman TIBERI. Thank you.
    Mr. OOSTERHUIS. Yes. I agree with the other witnesses. I 
think, in terms of how it helps the economy, just looking at it 
from my own little viewpoint of the world here as an 
international tax practitioner with a firm that does a lot of 
transactional work, first of all, the lock-out effect has the 
impact of incentivizing companies to use that money that is 
outside of the United States to spend that money outside the 
United States, whether it is buying other companies or building 
plants.
    And that hurts the U.S. economy. It doesn't necessarily 
hurt a huge amount today, because companies can borrow cheaply 
in the United States today, and most of these companies are not 
highly levered. But over time it will increasingly be, as some 
have called it, an investment credit for foreign investments. 
And that has to hurt the U.S. economy.
    The second thing that I see is the very inefficient system 
that we have today leads to very high compliance costs, both in 
terms of planning with a deferral system, and particularly 
planning with a foreign tax credit. The ratio of the amounts 
that multinationals spend on people like those of us to my 
right at the table, at least, and others compared to the amount 
of revenue we raise is very high. That is good for a few of us, 
but it is not good for the economy.
    Chairman TIBERI. Thank you. Mr. Sullivan.
    Mr. SULLIVAN. I think you have to look at the totality of--
when you are making these international comparisons. It is true 
that the 95 percent is within the international norms. But what 
other countries are doing to pay for these territorial systems 
is increasing taxes elsewhere. They are increasing their 
capital gains rates, they are increasing their value-added tax 
rates. These are things we are not even willing to consider.
    So, as long as we are within the framework of revenue 
neutrality, I just don't understand how we can just focus on 
the benefits and not look at the costs.
    Chairman TIBERI. Mr. Harrington.
    Mr. HARRINGTON. Thank you. Not surprisingly, I agree with 
the other three obvious suspects. As a general matter, I 
believe the participation exemption system approach in the 
discussion draft is within international norms. I think the 95 
to 100 percent is pretty standard.
    And again, I think for most OECD countries, certainly 
countries with economies like ours, they tend to follow a 
participation exemption, rather than the broader territorial 
approach that you might see in Latin America and some other 
countries.
    I also agree that the subpart F rules are more stringent 
than you would typically see. Again, I think part goes back to 
the perspective issue. I think most countries think of these 
rules as CFC rules. You know, these are anti-deferral rules, 
from our perspective.
    The one thing I would like to point out about base erosion 
is that I think you are right to be worried about base erosion 
in the sense that you don't want to lose what you have. But at 
the same time, you also have to be mindful of base erosion in 
the sense that you want to have a broader base because of 
growth and attraction of it bringing business. You can't be so 
focused on losing what you have that you also lose sight of 
creating a system that potentially makes the U.S. a better 
place to do business. Because then you are not just protecting 
your base, you are growing your base. So you want to protect it 
and grow it at the same time.
    Chairman TIBERI. Thank you all. I will now recognize the 
pride of Massachusetts, Mr. Neal.
    Mr. NEAL. Thank you, Chairman Tiberi. Chairman Camp's 
proposal would lower the top corporate rate to 25 percent in a 
revenue-neutral manner. However, the proposal doesn't include 
details on how we would achieve the goal. As I noted in my 
opening statement, Chairman Camp has given us a road map 
without any street signs.
    Dr. Sullivan, how can we achieve this 25 percent top rate 
goal in a revenue-neutral manner? Or, more importantly, can we 
lower the rate to 25 percent in a revenue-neutral manner 
without eliminating many of the tax incentives that benefit job 
creation and investment here in the United States, like the R&D 
tax credit? What tax expenditures would we have to consider 
eliminating?
    And I would be happy to hear from the other witnesses after 
Mr. Sullivan on this question, as well.
    Mr. SULLIVAN. Thank you, Mr. Neal. I take my information 
from the 2007 Treasury study, the Bush Administration study, 
which clearly shows and--that in order to get the corporate 
rate down to in the neighborhood of 30 percent, we would have 
to eliminate accelerated depreciation and expensing, eliminate 
the research credit, and eliminate the Section 199 deduction.
    Given that those tax expenditures have strong political 
constituencies and do serve an important purpose, it just seems 
out of the question that a revenue-neutral reform could ever 
get anywhere near the neighborhood of 25 percent, unless--and 
then we have to look at international experience--we look to 
revenue sources outside of the corporate sector, we start 
thinking outside of the box.
    And again, I just would mention that what we see going on 
in other countries is increases in value-added taxes to pay for 
reduced corporate taxes. We see increases in personal taxes, 
particularly at the high end on capital gains to pay for 
reductions in corporate taxes.
    Mr. NEAL. Thank you. The other panelists----
    Mr. OOSTERHUIS. I will add one thing. I think it is a real 
dilemma. And as Marty says, thinking about a new revenue source 
may be the best way.
    You have this imperative that our tax rate is higher than 
other countries, and lowering it becomes important, 
competitively, for corporations. On the other hand, in this 
country we don't want the corporate tax rate to get way out of 
line with the highest individual tax rate, because we do not 
want to go back to what I remember in my father's day, when 
individual rates were 30 percent higher than corporate rates, 
and everybody did business through their own corporations to 
get the lower rate.
    And so, there is a huge tension there that, to my mind, 
means we need to think about an alternative revenue source, and 
not allow the inefficiencies in the income tax system to 
continue because of our unwillingness to do that. But that is 
just my personal view.
    Mr. NEAL. Let me follow up on that, because you raised an 
interesting point, Mr. Oosterhuis. The committee has heard from 
a number of multinational companies during the course of this 
year in the hearings that we have undertaken to complain that 
the current U.S. worldwide tax system and high corporate rate 
effectively prevents them from reinvesting foreign earnings in 
order to create jobs, domestically.
    Given your commentary on interest rates, do you think that 
today's low current rates on borrowing offer a credible 
argument?
    Mr. OOSTERHUIS. It depends on the company. But I do think 
the problem is not as big in a low-interest rate environment as 
it is in other environments.
    For example, take the period of time in the fall of 2008 
and the spring of 2009, when companies couldn't borrow because 
short-term debt markets dried up. Had that continued for a 
substantial period of time, it could have been a real problem. 
And I think if interest rates go back up to more historical 
levels, it will be a problem.
    I think as we move through time, foreign earnings build up; 
I mean they have built up from maybe 500 billion 7 years ago to 
1.2 or 1.3 trillion now. As they build up, it gets to be worse 
of a problem over time.
    Mr. NEAL. One of my priorities here at the committee for a 
long, long period of time has been to tackle the issue of low 
tax or no tax jurisdictions that compete with us. And it is 
particularly pronounced in the reinsurance industry. So I am 
pleased that the chairman's discussion draft included 
approaches for preventing erosion of the U.S. corporate tax 
base, which is often times critical, as we move in the 
direction of international tax reform.
    But it is unfair, patently, for American corporations, 
particularly those, as you might note, are located in my 
constituency, or in the state of Massachusetts, to have to 
compete with similar companies who claim a residential address 
in an offshore tax haven. Now we can have an argument here 
about what constitutes a corporate tax system, and we can even 
argue about countries that compete with us that have low 
corporate rates. But at least they have corporate rates. It is 
very different than the structure that some have set up, which 
is for the purpose of avoiding American corporate taxes.
    And I know my time has run out, but if you would--if 
anybody would like to give a quick answer--Mr. Chairman.
    Chairman TIBERI. Anyone want to give a quick answer?
    Mr. OOSTERHUIS. In a world economy, it is very difficult to 
design a system that doesn't have some optionality for foreign 
companies on whether they have income in the United States or 
outside the United States, whether it is through reinsurance or 
through interest or royalties, or whatever it is. It is just 
very hard to have a system that doesn't allow foreign companies 
to have some optionality. And that just means we need to keep 
our rates reasonably low.
    Mr. NEAL. But the argument there is not over the idea of 
the corporation being a foreign corporation. The idea is that 
it really is an American company with a foreign address.
    Mr. OOSTERHUIS. Fair enough. And that may lead to 
consideration of some of the rules determining residency.
    Chairman TIBERI. All right----
    Mr. NEAL. Thank you.
    Chairman TIBERI [continuing]. The gentleman's time has 
expired. Thank you, Mr. Neal. Mr. Paulsen is recognized for 
five minutes.
    Mr. PAULSEN. Thank you, Mr. Chairman. I don't think many of 
you touched on the component of the treatment of deferred 
foreign income upon the transition of the participation in this 
exemption system of taxation, so let me ask this.
    The discussion draft talks about deeming all deferred 
income that is earned prior to the effective date to be 
repatriated, but with an 85 percent exemption. And that is 
payable over eight years. Do you think that this treatment is 
appropriate? And what issues do you see, as a part of that 
deeming? I mean, is this the right approach?
    And you can just start off, Mr. Harrington, if you want to 
comment, and all the panelists.
    Mr. HARRINGTON. Sure. Thank you, Mr. Paulsen. I do touch on 
this a little bit in my testimony on page eight. But I think 
the answer on this is really one of process of elimination. 
There really is no right answer here.
    You could effectively say the participation exemption is 
going to apply going forward, so all the old earnings can come 
back exempt. I mean that has revenue issues, that has sort of, 
you know, effects in terms of how people would respond.
    You could just simply say well, we are going to make you 
keep separate accounts. And I think Paul touches on this to a 
certain extent, the details on this, as well.
    But you could just say let's have a two-track system for a 
long period of time. That is not really a good answer, either.
    Then again, sort of by process of elimination, I think you 
wind up where the discussion draft is, and that is you have to 
have some sort of forced repatriation--it is either voluntary 
or it is forced. Obviously, I think people would prefer a 
voluntary repatriation, because there will be sympathetic 
instances in which someone doesn't have the cash to bring 
things back. And I do worry about that, particularly with 
respect to individuals. I think individuals are another sort of 
issue.
    But, I mean, there are fairness issues about telling people 
to, you know--that you have to bring this back, particularly 
people that don't have the cash to do that. So I worry about it 
in that sort of sense. But again, I think at the end of the day 
it is choosing your options.
    In terms of the time period, what percentage comes back, I 
think none of those are tax policy issues. Those are all 
somewhat arbitrary. Those are dealing with kind of what do you 
think is the fairness or unfairness of the issue. I think if it 
is more voluntary, you might make it less favorable. If it is 
compulsory, you have to make it more favorable. I think that is 
the tension.
    Mr. PAULSEN. Mr. Tuerff.
    Mr. TUERFF. I would agree with Mr. Harrington's comments in 
that if you have a system where you have old earnings and to 
try and run a two-track system with respect to the old earnings 
and retain the old system and have a new exemption system on a 
go-forward basis is far too complex, and I would not recommend 
that.
    The difficulty then determines as to whether or not you 
wish to exempt old earnings. In the territorial systems adopted 
by Japan and the UK they exempted old earnings. Or, do you wish 
to go to a system whereby either elective or mandatory 
recognition of income of those earnings--but it needs to be 
done in a way that will promote and remove the lock-out with 
respect to those earnings, because we want the cash to be able 
to come back to the United States at a low cost, where it can 
be reinvested in the U.S. economy.
    Mr. PAULSEN. Mr. Noren.
    Mr. NOREN. Yes, I would agree with what my fellow witnesses 
have said. And in particular, I think Mr. Harrington put it 
just right, that it is sort of a process of elimination. You 
don't want the complexity of maintaining separate pre-effective 
date earnings accounts. While at the same time some would say 
it might be a windfall to just start applying exemption to pre-
effective date earnings, wholesale. And so, I think what the 
discussion draft has done on the transition side is just a 
really great compromise of the various revenue and complexity 
considerations.
    I would add one point. On the eight-year period, I think 
that is a particularly important feature, because I think what 
gets lost often in tax policy discussions is the distinction 
between earnings and cash. So we are talking about repatriation 
of earnings, and yet to pay tax you are going to need cash.
    And so, some companies might say, ``How do I repatriate a 
building?'' To the extent that my foreign earnings were 
reinvested in a building, that is a little tricky to 
repatriate. And so I think eight years gives you some time to 
kind of earn out of that and deal with the liquidity issues 
that might be raised by this big deemed repatriation.
    Mr. PAULSEN. Mr. Oosterhuis, I know time is running down, 
but----
    Mr. OOSTERHUIS. Yes. I think we do need to deal with 
revenues in all of this, and from a revenue perspective, you 
need to do something significant. Taxing the prior earnings, or 
at least a portion of the prior earnings, is a good way to go.
    As others have talked about, you might come up with a 
somewhat narrower definition of prior earnings, including 
earnings that are reflected in relatively liquid assets, 
because that is, in a sense, more fair among companies, 
depending on what their earnings have been used to fund.
    Mr. PAULSEN. Just real quick, I know time is out.
    Mr. SULLIVAN. Briefly, it is the 85 percent in the 8 years. 
They are arbitrary numbers, they are just about revenue.
    I just would mention that if this is being used to preserve 
revenue neutrality in the 10-year window, it will not preserve 
revenue neutrality in the later years.
    Chairman TIBERI. Thank you, Mr. Paulsen. Mr. Larson is 
recognized for five minutes.
    Mr. LARSON. I thank Chairman Tiberi and Ranking Member Neal 
for holding today's hearing on Chairman Camp's international 
tax reform proposal, and I would like to thank all of our 
witnesses for their testimony. Tax reform provides us with a 
number of exiting opportunities, not the least of which is the 
potential to create jobs and strengthen America's international 
competitiveness. That is why I think we all share the happiness 
to see Chairman Camp come forward with a thoughtful proposal 
that serves as a starting point on tax reform.
    Now, not all of us will agree on every part of anyone's 
proposal when it comes to comprehensive reform. I still believe 
that we will need to examine innovative methods of taxation to 
ensure our Tax Code is fair and efficient for all.
    I do have a couple of questions that I would like to ask, 
and I would like to start with Mr. Sullivan. And they are broad 
in their context. But Mr. Sullivan, I would be interested in 
getting your thoughts on how the corporate rate reduction 
assumed by Chairman Camps [sic] might impact research and 
development efforts in the United States. I have long supported 
simplifying and permanently extending R&D credit, and I am 
concerned that if we are forced to eliminate R&D credit to get 
to the 25 percent rate, we may reduce the amount of research 
and development that occurs in the U.S. Your thoughts on that?
    Mr. SULLIVAN. Thank you. If we did eliminate the research 
and development credit, that would certainly be to the 
detriment of research in the United States. It would raise--
that accounts for about one percentage point of the rate 
reduction. So, if we don't repeal the research credit, that 
allows--that means we have to have a corporate statutory rate, 
which is one percentage point higher than it otherwise would 
be. So, it certainly would be detrimental to U.S. research.
    Mr. LARSON. The other panelists agree?
    Mr. TUERFF. I think it will have a--some effect. But I 
would say it is only incremental effect, because research and 
development activities, in many cases, are centered throughout 
the world. The issue is what is the impact on incremental 
research.
    I think the proposal would authorize the ability to remit 
funds back to further develop and increase research activities 
in the United States, where today a significant amount of 
research is currently conducted. By reducing the cost of 
remitting funds back to the United States, it encourages the 
expansion of those existing activities of research and 
development.
    Obviously, that needs to be balanced against the fact that 
if a research credit is lost, that there would--may be a net 
impact. But I think the proposal promotes the return of funds 
to the United States for additional research here.
    Mr. LARSON. In striving for revenue neutrality, as Mr. 
Camp's proposal seeks to do--and we commend him for that--it 
does seem to create gaps. And a number of you have alluded in 
your testimony about what is happening globally.
    With respect to global transactions, what do you make of 
Europe's move towards a transaction tax? Would a transaction 
tax be conceivable in this country? Should a nation that 
consumes more than anyone else in the world look at this as 
striving towards getting to revenue neutrality and filling up 
some of the gaps that would otherwise be created?
    Mr. OOSTERHUIS. Were you referring to a financial 
transaction tax, or a broader, value-added tax?
    Mr. LARSON. A broad tax, in general, but we could start----
    Mr. OOSTERHUIS. Right.
    Mr. LARSON [continuing]. If you want, with a--just in a 
financial tax area----
    Mr. OOSTERHUIS. Yes.
    Mr. LARSON [continuing]. On taxes on over-the-counter 
drugs. There are transaction taxes that are placed already on 
both the commodities and on the SEC.
    Mr. OOSTERHUIS. Right.
    Mr. LARSON. But not on the over-the-counter, or the ``dark 
market,'' as it is referred to.
    Mr. OOSTERHUIS. Yes. I really don't have any expertise on 
the questions raised by a direct tax like that on a specific 
transactions, what does it do to the market, how mobile are the 
transactions to go to other markets, and how does it build 
inefficiencies in these markets. Marty may be better able to 
comment on that than I would be.
    Mr. SULLIVAN. There is a lot of interest in financial 
transactions tax. At first blush it looks very attractive, 
because it is a very low rate and a very broad base. But I 
think it is really--operationally, would be impossible to 
prevent administrative problems and competitiveness problems. 
There are a lot of better ways of taxing financial institutions 
and the markets and regulating the markets than imposing that 
type of tax.
    On a broader commodity--broad value-added tax, we 
economists all think it is a great idea, and we should look at 
it. I don't think you will find 1 economist out of 100 that 
would disagree with that.
    Mr. LARSON. How would you define the difference between 
transaction taxes in general--not just financial transactions--
and a value-added tax?
    Chairman TIBERI. The gentleman's time has expired, but you 
can answer the question.
    Mr. SULLIVAN. They have different administrative 
mechanisms. But economically, their effects are the same.
    Chairman TIBERI. Thank you. Dr. Boustany is recognized for 
five minutes.
    Dr. BOUSTANY. Thank you, Chairman Tiberi, for holding this 
really important hearing. And I want to publicly thank Chairman 
Camp for putting out this discussion draft in a very public way 
to start a real earnest discussion on what we need to do with 
our Tax Code to promote American competitiveness.
    And gentlemen, I want to thank you. Your testimony has been 
very helpful. I read through most of it real carefully. And I 
want to focus some questions on the base erosion options that 
we have, and specifically option C, or the third option, which 
is the reduced rate of taxation for foreign intangible income. 
And granted, we--and this came up in some of the previous 
discussion and your oral comments--we have some key questions 
about how to attribute income to intangibles, and we have to 
work through that.
    But if we can do that successfully, would this third option 
be effective in preventing our base erosion? If we can answer 
those key questions on the attribution of income----
    Mr. NOREN. Yes, I think it would be effective. I do think 
that the attribution of income would be awfully tricky. And 
then the question is, does it become too effective, such that 
it produces an excessive tax burden on U.S. companies?
    It is sort of a step in the direction of current basis 
taxation. And certainly at a sufficiently low rate that is 
workable. But the concern that has been historically expressed 
about ideas like this is that the rate could end up increasing 
at some later point in time, and yet you would be stuck with 
this current basis taxation model. And so what might start out 
as being a perfectly workable system could kind of slip into 
something more harmful to companies. And that would be the main 
concern.
    Dr. BOUSTANY. Other comments?
    Mr. OOSTERHUIS. The one thing about it that I think is 
definitely worth a lot of consideration is that it 
differentiates between intangible income that relates to 
foreign sales and intangible income that relates to sales back 
to the United States.
    And in terms of the base erosion concerns that many have 
articulated going forward, I think focusing on that distinction 
and focusing on ways to implement a differential regime is 
important. Because if there is base erosion, it has got to 
likely mostly be with respect to activities back in the United 
States, and not purely foreign transactions.
    Dr. BOUSTANY. And to follow up on that, Mr. Oosterhuis, so 
this approach would address current incentives for R&D to 
migrate offshore?
    Mr. OOSTERHUIS. Yes, it certainly would, particularly to 
the extent that the functions that are moved offshore are 
ultimately leading to transactions back in the United States, 
as opposed to just further exploiting foreign markets.
    Mr. NOREN. Yes, and I might add on that that one difference 
between option C and option A is that option C does not 
distinguish between the origins of the IP, whereas option A, 
the excess returns proposal, does. And so that might be an 
additional benefit that C would have over A, in that it would 
provide less of an incentive to do R&D, for example, in one 
location as opposed to another.
    Dr. BOUSTANY. Okay. And, Mr. Noren, in your testimony about 
option C, you state that a key issue will involve attributing 
income to IP, which would give rise to valuation and transfer 
pricing type analysis that is not required under present law. 
How would this be different? Elaborate further on that for me.
    Mr. NOREN. Sure. And so present law certainly requires 
plenty valuation and transfer pricing analysis. But I think Mr. 
Tuerff perhaps put it better than I did when he said that this 
option can cause you to have to tease apart or sort of 
unscramble----
    Dr. BOUSTANY. The egg----
    Mr. NOREN [continuing]. The economic omelette, yes, in a 
way that present law doesn't require. And so that is what I had 
in mind.
    Dr. BOUSTANY. Okay. And Mr. Tuerff, that does add a layer 
of complexity. And from a compliance/enforcement standpoint, 
could you----
    Mr. TUERFF. Yes, it raises----
    Dr. BOUSTANY [continuing]. Elaborate?
    Mr. TUERFF. It raises a significant concern, because our 
current transfer pricing rules look to a given transaction, and 
compare that transaction with third-party transactions, 
requiring documentation up front at the time of filing a return 
to justify the transfer price. This takes it to another level 
by saying you have a transaction, now we are going to start 
carving off the returns within that transaction to identify 
intangible versus non-intangible income. So it is much more 
complex.
    Dr. BOUSTANY. Thank you. My time has expired. Thank you, 
Mr. Chairman.
    Chairman TIBERI. Thank you, Dr. Boustany. The subcommittee 
is fortunate to have with us today the former chairman of the 
full committee, and the author of the mother of all tax reform 
proposals, Chairman Rangel, you are recognized.
    Mr. RANGEL. Thank you so much, Mr. Chairman, and thank you 
so much for calling this hearing. For purposes of my questions, 
I have been asked an hypothetical to advise a New Yorker as to 
where to place his firm. He is a big manufacturer of widgets. 
So I would want you to stop me if I am giving the wrong advice 
as to the positive things that--if he decided to go to this 
foreign country.
    One, they have a much lower corporate rate. Two, the 
country is prepared either to subsidize or give you the 
property if you want to reinvest there, because you don't--you 
can't send your money back home. Three, their market for 
widgets is actually growing, so you don't have the big problem 
there. The workforce is more highly trained. I mean all this 
stuff about Americans and high productivity, I didn't hear 
anyone argue against the training. I'm sorry I didn't. Climate, 
language, all of those things, depending on what.
    Then I get a call from the President of the United States, 
and he says, ``Whatever it is to take your client to build in 
the United States, that is going to be done,'' so I immediately 
rush to you guys and say, ``Please give me a list of things 
that I can tell my client that he has to stay in New York, we 
need the jobs, we--that has to be.''
    So immediately, I would say we got to find some way to 
lower the corporate rates, and that is going to be difficult in 
terms of winners and losers with the exemption. I can't tell 
him to train the workers. But we can provide tax incentives. 
What can we do to turn around all of the positive things that I 
have already given to fulfill the mandate that we have got to 
have stamp, ``Made in the USA''? Mr. Sullivan?
    Mr. SULLIVAN. Thank you, Mr. Rangel. I think you are 
hitting the nail on the head here by asking this question. We 
all want jobs in the United States. How can we do that most 
effectively?
    Certainly lowering the corporate tax rate, that helps us in 
the United States. That helps foreign companies come in to New 
York, it helps New York companies stay in New York.
    We can have tax credits for research and development and 
for jobs. What I----
    Mr. RANGEL. You mean--I'm sorry.
    Mr. SULLIVAN. Go ahead.
    Mr. RANGEL. You mean retain the credit was have for----
    Mr. SULLIVAN. Retain the credit and strengthen it.
    Mr. RANGEL. Well, I didn't tell you how I was going to 
reach a lower tax. That would be a problem I have to face if 
you tell me, you tell the President----
    Mr. SULLIVAN. Right.
    Mr. RANGEL [continuing]. If he wants a lower rate he has to 
give up R&D, I got another problem. But assuming everything is 
going to work the way the President wants, which is really 
hypothetical, but okay. Make certain that we do have an 
incentive for research and development, one way or the other. 
Okay----
    Mr. SULLIVAN. And I would suggest strengthening it. But 
what I would not suggest is hoping for--expanding offshore tax 
incentives in the hope that somehow increasing employment 
offshore will reverberate back to increased employment back in 
the United States.
    Mr. RANGEL. I agree.
    Mr. SULLIVAN. I think it is much better to focus all of our 
efforts on the domestic side, which will help the foreign side, 
rather than the other way around.
    Mr. RANGEL. I couldn't agree with you more. But how do you 
just always pass over education? I mean we have a part of our 
workforce locked up in jails, producing nothing at a tremendous 
cost to the taxpayer with the understanding that they will be 
trained to cause more expenditures. And it would seem to me, 
forgetting the morality of it, that business would say, ``You 
have got to do a hell of a lot better if you got to compete 
against these people who start off educating their kids.'' And 
I am not talking about me. I am 81.
    But it seems like the future of the country, if I have got 
a billion people, just educating a fraction of theirs, and I 
have a large segment of mine living longer, doing less, 
fighting technology, going to jail, being absolutely 
unemployable, why is business so quiet about that? Albeit that 
it is not a national responsibility, but to me, it is national 
security and economic security. How do you handle that, Mr. 
Sullivan? I am hiring you guys now.
    Chairman TIBERI. Well, the gentleman's time has expired, 
but the witnesses may answer.
    Mr. SULLIVAN. Thank you. What I would just strongly 
emphasize is that competitiveness is about everybody, not just 
large U.S. corporations. Of course we want them to prosper and 
succeed in the world. But we need--as we in the joint committee 
wrote in the early 1990s, competitiveness is about education, 
training, deregulation. All of these factors contribute. And to 
just focus on multinationals and use the word 
``competitiveness'' in that context I think is misplaced.
    Mr. RANGEL. Thank all of you.
    Chairman TIBERI. Anybody else have a comment before we go 
on to our next questioner?
    [No response.]
    Chairman TIBERI. Mr. Marchant from Texas is recognized for 
five minutes.
    Mr. MARCHANT. Thank you, Mr. Chairman. Before we go any 
further, I would kind of like to clear up an earlier 
discussion, and make it clear. I don't see anywhere in this 
draft that it contemplates a financial transactions tax. Do any 
of the panelists see any suggestion of that in this draft?
    Mr. HARRINGTON. No.
    Mr. MARCHANT. Because I can tell you back in my district 
this is a--I get lots of cards and letters on the financial 
transactions tax, and I want to make sure that it is clear that 
this draft does not involve that.
    My first question is many commentators and stakeholders 
urge the committee to adopt a territorial system with no 
expense disallowance. The discussion draft does not disallow 
expenses. Rather, it exempts 95 percent of foreign dividends 
using the 5 percent as a proxy for expenses incurred in the 
U.S. to create foreign source income. Do you agree that this is 
the best method to address the U.S. expenses in a territorial 
system? And we will just go down the line in the panel, please.
    Mr. HARRINGTON. Thank you, Mr. Marchant. the short answer 
is yes, I agree. I think that the amount of expenses that 
should be--well, I mean as a theoretical matter, you should 
disallow expenses that are related to exempt income. But I 
think from a practical standpoint, you are talking about a very 
small amount of expenses, if any, that would fall in that 
category.
    So, the approach taken by the discussion draft, I think, is 
appropriate in terms of its narrowness, in terms of expense 
disallowance. In terms of whether it is 95 or 96 or some other 
number, I think to a certain extent that is in part a revenue 
issue and in part is sort of a compromise between resolving 
disputes between people who think there should be more or less.
    What I do think, though, is that you should not have some 
very broad set of expense allocation rules like we have 
currently that you would apply to this type of income. I think, 
one, it is too broad and I think it is complicated.
    Mr. MARCHANT. Thank you. Mr. Tuerff.
    Mr. TUERFF. Yes, Mr. Marchant. I would agree with Mr. 
Harrington, that I think the approach of taking a small 
percentage of the income and making it taxable is a reasonable 
approach, as opposed to a very detailed method of allocating 
specific expenses. And it is consistent with international 
norms. Whether it is 95 percent is the right percentage can be 
debated, but I think that approach is much better than the 
specific allocation approach.
    Mr. MARCHANT. Thank you.
    Mr. NOREN. I would agree that the approach makes a lot of 
sense. It avoids a lot of the complexity that would go with 
expense allocation and disallowance. I would also note that, in 
addition to the five percent so-called haircut on the 
distribution, there also is a set of thin capitalization rules 
applied, and I would say both the haircut, taken together with 
the thin cap rules, really direct two different responses to 
the concerns that might lead people to say that you need to 
allocate expenses and disallow them.
    So I think the discussion draft really represents a serious 
effort at dealing with that issue.
    Mr. OOSTERHUIS. I take a little bit different approach, 
although I disagree with--I do agree with the bill.
    I don't see the five percent haircut--as we have been 
calling it, the 95 percent deduction rather than 100--as being 
a substitute for what otherwise would have been the proper 
disallowance of expenses, because I don't think, with respect 
to R&D and G&A, as I mentioned in my oral statement, there 
should be any disallowance, no matter what the exemption is. 
And with respect to interest, the thin capitalization rule 
provides a framework for dealing with the disallowance of 
interest expense. And so, therefore, you don't need the haircut 
with respect to that expense, either.
    So it is fine to have the 95 percent rather than 100, if 
from a revenue point of view that is what you need. But I 
wouldn't say you need it because we otherwise would have 
expenses that we would be disallowing.
    Mr. SULLIVAN. I generally agree with the panel, but I think 
we need to be very careful. Remember, we are exempting foreign 
income. If we do not properly allocate expense, or have a proxy 
for that allocation, that means we are not only exempting 
foreign income entirely from tax, we are subsidizing foreign 
income. So we are driving the effective rate of tax below zero. 
So, we want to be careful about that.
    Having said that, it is extremely complicated to get these 
rules to work. And they need to be judged in conjunction with 
the thin capitalization rules. It is how--it is--the whole 
entire package has to be judged, and not just one--this one 
feature alone.
    Mr. LARSON. Will the gentleman from Texas yield?
    Chairman TIBERI. He has about two seconds.
    Mr. LARSON. It will be less than 10 seconds. Because you 
mentioned about the no transaction tax anywhere in the draft. 
Can you tell me where in the chairman's proposal the table is 
showing his proposal to be revenue-neutral?
    I brought it up because I think we have to demonstrate how 
we can get to that 25 percent.
    Mr. MARCHANT. I yield my time back, Mr. Chairman.
    Chairman TIBERI. Thank you, Mr. Marchant. The gentleman 
from Pennsylvania, Mr. Gerlach, is recognized for five minutes.
    Mr. GERLACH. Thank you, Mr. Chairman. Mr. Sullivan, I am 
looking at your October 17th op ed or article to ``Tax Notes.'' 
And you make a very clear point. In fact, I will quote. ``On 
rare occasions when Congress gets serious about reform, it 
gives priority to the individual income and corporate taxes. 
Taxation of small business and pass-through income is neither 
here nor there.''
    And you go on to then talk about some strategies and 
efforts we ought to undertake, as Congress, to deal with small 
business pass-throughs relative to overall tax reform.
    Recognizing that the chairman's draft focuses on the issue 
of territorial versus a worldwide system of taxation, I would 
like to have your thought on the issue of comprehensive tax 
reform, whether it should be done comprehensively at one time, 
so as to avoid or help minimize any adverse impacts that would 
occur within the economy domestically, or whether a phasing of 
that reform--i.e. doing a territorial piece of legislation 
first, then coming back, doing a--say a small business pass-
through piece of legislation--and this is also for the other 
panelists--does it really matter, one way or the other, how we 
phase? Or, from a flip side, a more comprehensive approach to 
doing tax reform, relative to what the impacts would be, 
positive or negative, on our economy?
    Mr. SULLIVAN. Thank you very much for the question, Mr. 
Gerlach. The--because I live such an exciting lifestyle, I 
think about these things a lot. And I have tried to 
compartmentalize just a simple topic of corporate tax reform by 
itself, which--of course it is a very complicated topic, but it 
can't be compartmentalized. It has got to be closely--the 
revenues have to balance out, and then there are the 
interactions on the rates.
    And then, on the specific issues of small business, you 
know, it is just amazing to me that we have these incredibly 
complex rules for small businesses. They have to choose between 
sub-S partnerships, sole proprietorships, or even--some of 
them, many of them, millions of them, because sub-chapter C 
corporations. This is a crazy mish-mash.
    We could do a great deal for the competitiveness of small 
businesses without spending any revenue by just taking this 
ridiculously complex system and simplifying it. And the reason 
why I said it is not--it is just not getting any attention. 
Nobody is thinking about this. And I think, you know, part of 
it is that multinationals have more people and more resources 
and get more attention on Capitol Hill.
    But the problems that--the complexity issues that small 
businesses face are, per dollar of sales, are much greater and 
they deserve more attention.
    Mr. GERLACH. We are having a lot of those discussions 
within our committee. I know Chairman Camp is very much aware 
of that issue, as well. So it is not an issue that we are not 
thinking about and talking about. But I am just curious as to 
whether, when you step out with tax reform on the business 
side, either corporate or pass-through, does it matter if you 
do it all at one time, or whether you do it in a sequencing 
process, starting with a territorial approach first, and then 
moving on to other aspects----
    Mr. SULLIVAN. I will briefly say I think it has to be done 
all together, absolutely.
    Mr. OOSTERHUIS. Yes, I would agree with that because how 
the territorial system is designed depends on what the 
corporate rate is. And then, what the corporate rate is, 
really, you have to start thinking about the impact of that 
reduction, if it is a reduction in the corporate rate, on 
incorporated businesses. And so, once you start broadening your 
framework to think about unincorporated businesses, you are 
really talking about the whole system.
    Mr. NOREN. I would agree that the whole tax reform package 
ought to be pursued at one time, because the different areas do 
interact with each other technically. And as well, the Congress 
should want to keep track of what it is doing to the overall 
tax mix of the country, and how much are we raising from 
different areas.
    That being said, I would say that it makes a whole lot of 
sense to have released this discussion draft on this 
particularly complex part of tax reform to get the community 
started looking at it now, even if it needs to be ultimately 
pursued together with a broader package.
    Mr. TUERFF. I would also agree if the objective is to 
reduce the cost of repatriation of earnings back to the United 
States for reinvestment in the U.S. Then the tax rate is going 
to be critical in that determination. So I think doing a 
territoriality system in conjunction with addressing a 
corporate tax rate is an important element that needs to be 
considered together.
    Mr. GERLACH. Thank you.
    Mr. HARRINGTON. Just briefly, I agree that ideally you do 
want to try to do all the reforms together. I mean it is a lot 
like the pushing down on the tube of toothpaste, it is going to 
pop up somewhere else.
    But at the same time, I think one has to be mindful that 
each of these component parts are very difficult by themselves. 
And putting them together makes it also hard, as well. So, if 
it turns out that you are unable to do the broader reform, but 
you have pieces, then I think you might have to go that way, 
just because they shouldn't be held hostage.
    But I think it is difficult to get consensus on particular 
items without knowing how they fit in the bigger picture.
    Mr. GERLACH. Thank you. Thank you, Chairman.
    Chairman TIBERI. Chairman Camp will be pleased with your 
response on that last question. With that, I will recognize the 
gentleman from Wisconsin, Mr. Kind.
    Mr. KIND. Thank you, Mr. Chairman. Mr. Chairman, I am 
pleased with that response, because I think it is the right 
approach to comprehensive tax reform. I don't think we should 
just be limited to the C side, but also the pass-through, given 
the fact that the majority of businesses operating in this 
country are pass-through entities to begin with. So, if we are 
going to do this, I think we got to do it together, do it in a 
way that doesn't discriminate or set up this disparity between 
C corporation versus S and limited and everyone else.
    But let me--Mr. Sullivan, let me start with you. And I have 
been trying to figure out--and I have been the one kind of 
thinking aloud here on the committee for quite some time--that 
if the overall goal is to simplify lower rates, try to make us 
more competitive, and the goal is 25 percent, we would have to 
eliminate all of the expenditures on the corporation side in 
order to achieve that. And how you pay for that is going to 
make a big difference.
    But by eliminating 199, accelerated depreciation R&D, the 
impact on the manufacturers of this country would be impacted. 
Do you see it that way, too? If you are eliminating that while 
still lowering rates to a goal of 25 percent?
    Mr. SULLIVAN. That is just the way the numbers come out. 
Manufacturers are research intensive. Manufacturers are capital 
intensive. And obviously, manufacturers benefit from the 
manufacturing deduction. So we have put into place tax rules 
with good intentions--and they are good intentions--to help 
manufacturing. And if we lower the rate and get rid of those, 
we are going to hurt the manufacturing sector.
    Mr. KIND. Well, let me ask you this on that same line. 
There is a lot of feedback, 199, very complicated, the 
compliance and the justification thing, and all that. It is too 
cumbersome.
    So, what is wrong with the simple proposition that if your 
business operating in the United States, and if you are making 
something, you are inventing something, creating something, 
building something, growing something, you are going to get a 
major tax advantage for doing that right here in the United 
States of America, and get rid of 199 and structure a different 
provision that rewards that type of activity here in this 
country, creating those type of jobs right here?
    Mr. SULLIVAN. I absolutely--Section 199 is needlessly 
ridiculously complex for the simple thing that it is trying to 
achieve. It would be much better to get rid of it and lower the 
rate.
    Mr. KIND. Yes.
    Mr. SULLIVAN. And----
    Mr. KIND. Let me ask everyone on the panel here, and--
because, obviously, we are going to be wrestling with the how 
do we pay for this in a deficit-neutral fashion. That is--
unless we are willing to dip in to the individual side to get 
down to 25, which will not be popular at all, I think we are 
going to have to be a little more creative in thinking out of 
the box.
    And for the life of me, I don't understand. With all the 
zeal to go to a territorial system, the fact that virtually 
every country that has it has other supplemental forms of 
revenue--and shall I dare say it, the VAT--and yet all the 
multinationals are already living in the world of VAT, so they 
are already complying with that, and it is not going to be a 
new burden or a new added complexity in their life.
    So if we want to try to lower rates, why aren't we 
seriously considering, you know, moving towards a VAT system in 
order to supplement that lost revenue that we would otherwise 
see going to 25?
    Mr. SULLIVAN. May I?
    Mr. KIND. Yes, go ahead.
    Mr. SULLIVAN. I think any economist would say we are glad 
to get rid of the corporate tax and replace it with a value-
added tax.
    I also think it is important to point out that in the 1980s 
there were lots of Republicans advocating replacing the 
corporate tax with a value-added tax. And for some reason that 
has gone off the radar now. And I think it is--may not be 
politically attractive, but economically it makes a heck of a 
lot of sense.
    Mr. OOSTERHUIS. You know, when you stand back and look at 
the difficult issues we are talking about, it really does take 
you in that direction. Because inherently in an income tax, an 
income tax taxes where you perform an activity. And given how 
mobile activities are in a global economy, that means countries 
have to compete for those activities, and tax rates is an 
element of that competition.
    A value-added tax doesn't work that way. A value-added tax 
taxes where the person who buys the good is located. And that 
doesn't move. People aren't going to move from Wisconsin to 
Dublin to pay a lower value-added tax. And so whether you 
manufacture the good in Japan or in Singapore or in the United 
States, the tax is the same.
    And so, that tax, from an international location of 
activities perspective, is much more rational than an income 
tax. And that means you have to be careful how much pressure 
you are putting on the income tax, in terms of how much of the 
revenue that you have to raise--you are raising revenue through 
a tax where that inevitable mobility of activities is an 
important factor.
    Mr. KIND. Mr. Oosterhuis, let me stay with you just for a 
second. I mean you are familiar with the substance of what this 
committee works on. Anything that jumps out at you that gives 
you pause or concern about the proposed draft that the chairman 
has released so far? Any----
    Mr. OOSTERHUIS. No. I think, as a framework for the 
discussions of what is the right type of territorial system to 
have--and we really do need to move to a territorial system----
    Mr. KIND. Well, I would love to follow up with you on 
sections 904, 909 in particular----
    Mr. OOSTERHUIS. Sure.
    Mr. KIND [continuing]. Some of the concerns being raised 
with that.
    Mr. OOSTERHUIS. Happy to do that.
    Chairman TIBERI. The gentleman's time has expired. With 
that, the gentleman from North Dakota is recognized for five 
minutes. Mr. Berg.
    Mr. BERG. Thank you, Mr. Chairman. I want to thank the 
panel for being here. I apologize, we had some severe flooding 
issues in North Dakota, and I was in a meeting with FEMA, still 
trying to correct some of that.
    The number-one issue we are faced with here is how do we 
get our economy going, how do we create jobs. And so, clearly, 
one of the things that this committee has done has spent a lot 
of time on our international tax law, and is there a way that 
we can, again, create a more fair, simpler, more streamlined 
system that would encourage more capital being reinvested, 
preferably here in America, which, you know, brings us to 
territorial system.
    So, at the same time, I am learning that things don't move 
very quickly here. And, you know, I understand the merits and 
rationale for an overall reform package. I mean, obviously, if 
we deal with corporate, that impacts all the small businesses 
that aren't incorporated but operate as a partnership, those 
that are both in the country and out of the country.
    I guess my question for you--and I hope the chairman 
doesn't hear this--but if we could only--if our focus was 
simply to try and streamline this one component quickly to try 
and bring more capital back into the United States, is that 
possible? Mr. Harrington, you kind of touched on that in your 
last answer.
    Or, I mean, would that be an option? How--any advice on----
    Mr. HARRINGTON. Well, if the chairman isn't going to hear 
your question, is he going to hear our answers?
    Mr. BERG. No, no.
    Mr. HARRINGTON. Okay.
    Mr. BERG. We will expunge all that.
    Mr. HARRINGTON. Okay. The short answer, I think, is yes. 
You could do this as a discreet piece. I mean I think you could 
do, you know, a participation exemption replacing these sets of 
rules. You could do that. I think you couldn't do it as well as 
you could if you did it as part of a broader issue, because I 
think, again, some of these issues, how, from a practical 
standpoint, the rate is going to matter.
    Mr. BERG. Yes.
    Mr. HARRINGTON. Like I said, I would look at some of these 
differently, if it is a 25 percent rate--wanting to know how do 
you treat individuals, what is going on with pass-through 
entities, I think those would be significant enough. I think 
they would--I can't call them barriers, but they would be 
significant obstacles to doing this alone, but it is possible 
to do it on its own, I believe.
    Mr. BERG. Well, and certainly the challenge would be if we 
made this change, and then businesses made decisions based on 
the tax policy before we could get the rest of the components 
changed and in place. Therein might lie the bigger challenge.
    Mr. HARRINGTON. And effectively, you are doing part one, 
and then you would have to have a part two that followed up. So 
you would have to know there would be issues.
    Mr. BERG. And we don't need to go through that, unless 
anyone had any specific things that you would like to address 
on that.
    I had another question I would like to talk in relation to 
the base erosion and, you know, just really, if we move the 
territorial system, how do we prevent that from happening. And 
in the draft there are a couple things that deal with the thin 
capitalization rule, as well as other options to prevent this 
base erosion.
    And I am just wondering. Are there other base erosion rules 
that you believe the committee should consider, in addition to 
those that are in place? I would like to address that to the 
whole panel.
    Mr. OOSTERHUIS. I will start out. I think there are. I 
think people are just beginning to think about it. We, as a tax 
community, haven't done a lot of thinking about reforming 
subpart F more broadly, including dealing with base erosion, 
and we need to start thinking about it. And that is one of the 
important things that the bill does; it sets the table for 
everybody to give it concentrated thought.
    I do think one thing would be helpful for us. The revenue 
estimators in scoring a territorial system have perceived that 
there is going to be a substantial erosion that occurs under a 
territorial system that is not occurring today. We need to 
understand that better, because if we are going to talk about 
base erosion reforms to subpart F, that is the income that 
ought to be targeted first.
    And I don't quite, on my own, understand where they see 
that much base erosion coming from, to be honest. But if it is 
there, then we need to understand what it is so we can think 
about redesigning subpart F to minimize the chances of that 
income, which today is being taxed in the United Stats, being 
eligible for exemption.
    Mr. NOREN. Yes. In terms of other options, I think, as I 
laid out in some of my written testimony, I think there are 
modifications that you could make to all of the different 
options, and particularly to accommodate structures where you 
have significant functionality in the CFC's location.
    Another point I would make is that this could be an 
opportunity to really accomplish a comprehensive reform of 
subpart F. And so, rather than just focusing on adding further 
restrictions, and thus, further complexity, you know, if we 
decide that there is a better way to balance concerns over 
income shifting and other concerns about competitiveness and so 
forth, maybe we could eliminate some of the existing categories 
of subpart F income, and then replace them with the better new 
idea that we come up with.
    The final thought that I had is that you could also reduce 
the incentive for income shifting somewhat by administering the 
proposal's five percent haircut on a current basis, rather than 
allowing that piece to be deferred. And so that might be 
another small step to take to reduce some of the income-
shifting incentives without creating a lot of additional 
complexity.
    Chairman TIBERI. Well, the gentleman's time has expired, 
but anybody else want to answer the question?
    Mr. TUERFF. I would just agree with the comment that in 
looking at base erosion I think the focal point should be on 
the active business operations that are conducted offshore, and 
that those should be allowed to be conducted, consistent with 
other norms that are applied in other countries.
    Chairman TIBERI. Anyone else? Well, thank you. Thank you, 
Mr. Berg.
    That concludes today's hearing. Please be advised that 
Members may submit written questions to the witnesses. The 
questions and the witnesses' answers will be made part of the 
record for today's hearing.
    I want to thank the five of you for your participation 
today. It was very, very helpful, very educational. I believe 
it helps us move forward on this debate of comprehensive tax 
reform, specifically with respect to the international tax 
piece, and will help us as we continue to try to move a bill on 
comprehensive tax reform.
    Thanks so much. The hearing is adjourned.
    [Whereupon, at 11:35 a.m., the subcommittee was adjourned.]

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