811.112/12–753
Memorandum of Conversation, by the Special Assistant in the Office of Financial and Development Policy (Robinson)
- Subject:
- Treasury’s views concerning the taxation of foreign-earned income.
- Participants: Mr. Samuel Waugh, Assistant Secretary of State
- Mr. Dan T. Smith, Assistant to the Secretary of the Treasury
- Mr. Kenneth W. Gemmill, Assistant to the Secretary of the Treasury
- Mr. Walter Sauer, Treasury Department
- Mr. Jack C. Corbett, OFD; Mr. Hamlin Robinson, OFD
- Mr. Charles O. Thompson, ED
This meeting was arranged at Mr. Smith’s request to enable him to apprise the Department informally of the Treasury Department’s tentative conclusions concerning additional tax measures affecting foreign earned income. He asked that these conclusions be [Page 349] kept strictly confidential for the time being as the Treasury has not yet taken them up with the House Ways and Means Committee. Mr. Smith indicated that he was under instructions to seek the views of the Departments most directly concerned (Commerce, State, and FOA), and the Randall Commission.
1. Mr. Smith said the Treasury was prepared to recommend that the present benefits available for so-called Western Hemisphere Trade Corporations1 be applicable to income received from any foreign source, and that the requirements for taxpayers qualifying for such benefits be liberalized. At the present time a special tax rate of 38% (in contrast to the 52% regular rate) is available to domestic corporations receiving 95% of their income from sources within the Western Hemisphere (but outside the U.S.) and 90% of their income from the active conduct of a trade or business. The Treasury’s thought is to maintain this 14 point spread (52–38) for all foreign earned income. In addition, changes would be recommended in the source percentages for qualification, and in the requirement for establishing a separate domestic corporation in order to take advantage of the lower rate. In discussing this proposal, Mr Smith pointed out that it would pretty much amount to a full waiver of taxes on foreign income since the local tax rate in most countries (allowable as a credit against U.S. taxes) is at least as high as 38%.
2. The Treasury also proposes to eliminate the so-called “overall” limitation in computing the credit for foreign taxes paid. Under this limitation all foreign income is treated as a single unit and the tax credit is limited to the amount of the U.S. income tax on the net income from operations in all foreign countries. Thus, losses in one country must first be set off against income from others in calculating the limitation on the amount of the credit.
3. The Treasury proposes to retain the so-called “per-country” limitation, whereby foreign income received from each country must be treated as a separate unit and the credit is limited to the U.S. tax attributable to income from each country. This limitation prevents the taxpayer from crediting the full amount of taxes paid in a country having higher tax rates than the U.S. through an offset with respect to operations in a country with a lower tax rate than the U.S.
[Page 350]4. The Treasury has had some second thoughts concerning the proposal for postponing the tax on foreign branch income until it is transferred to the U.S. parent—a provision now applicable to income from foreign subsidiary operations. The Treasury feels that branch operations already receive substantial benefits under the tax laws, such as the consolidation of losses with the U.S. parent and the depletion allowances presently available to petroleum and mining enterprises. Since it is precisely this type of enterprise that usually uses the branch form of organization the Treasury now feels that further tax benefits are unwarranted. In short, it questions the desirability and necessity of giving to both branches and subsidiaries the benefits applicable to each. (The next step might be to permit subsidiaries to “bring home” losses as branches can now do through consolidated returns with the parent.)
Mr. Sauer suggested a possible alternative to the unrestricted postponement of the tax on foreign branch income until received by the U.S. parent: namely, the possibility of permitting such postponement only if the foreign branch agreed not to consolidate its losses with the U.S. parent and not to take advantage of any depletion allowances otherwise available. Thus, branch income could not claim the cumulative effect of all benefits but could select those most favorable to its particular circumstances. Mr. Smith agreed that this approach had some merit, but required further study and refinement.
There was some discussion of the relative merits of branch and subsidiary forms of organization from the policy point of view. It was suggested that less capitalization is generally required to establish a foreign branch, which has been an important factor in conducting branch banking abroad, for example. Moreover, a foreign branch may have readier access to the U.S. capital market through the established standing of its parent in the U.S. On the other hand, a foreign subsidiary may be more effective in mobilizing local share participation and in developing local securities markets. It was also suggested that perhaps we ought not weight the scales unduly in favor of the branch type of organization and thereby discourage American companies from establishing domestic corporations under local laws abroad and thus becoming identified as domestic organizations within the foreign country. In reply to Mr. Smith’s question Mr. Waugh indicated that he thought American companies would be well advised to associate themselves with local interests and to organize with some local participation.
5. Mr. Smith said that the Treasury was thinking of liberalizing the definition of foreign taxes that qualify as a credit against the U.S. tax. Foreign income taxes, and foreign taxes in lieu of an income tax, may now be credited. (All foreign taxes may generally [Page 351] be deducted from gross income in computing taxable income.) The Treasury would propose allowing a credit for foreign income taxes or for any other one tax which constituted the principal tax on business operations. If there were both an income tax and, for example, a turnover tax, the company could elect which to take as a tax credit and which to deduct as an expense from gross income.
6. We asked Mr. Smith how the Treasury felt about the charge frequently made that the existing tax credit procedure limited the flexibility of foreign countries in offering effective tax concessions to new industries contributing to their economic development. He said the Treasury had given considerable thought to this, but that in view of the special treatment of foreign subsidiary income (postponement of tax until dividends repatriated), local tax concessions could be very meaningful, and thus the Treasury thought nothing additional was necessary on this point—particularly in view of proposals in paragraphs 1, 2 and 5 above.
7. Mr. Smith then brought up the general subject of the definition of foreign-earned income, in which the Treasury’s views seemed to be much more uncertain. He pointed out that under present practices the Western Hemisphere Trade Corporation provisions have been very beneficial to American export organizations. Since income is considered as accruing where title passes, such organizations need only arrange for the title on exports to pass in the foreign country for the income thereon to be considered as foreign. Mr. Smith felt that the requirements could be so drafted as to eliminate this if desirable, and asked what the Department’s views were on this point. We stated that we would, of course, want to explore this with other interested offices in the Department but admitted that our starting point in considering this problem was to encourage local productive operating enterprises abroad rather than U.S. exports as such. We agreed to give this problem some thought and to give Mr. Smith any views we might develop.
8. The meeting concluded with Mr. Waugh’s expressing our appreciation to Mr. Smith for giving us the Treasury’s tentative conclusions in this important field, and for consulting us concerning them. He noted that the Treasury’s views went a long way toward meeting the problem, and stressed again his feeling that the major emphasis in the matter of encouraging foreign investment ought to be on what other countries should do to attract investment rather than on what we should do to push it out—a proposition to which Mr. Smith expressed thorough agreement. Mr. Smith said the Treasury is anxious to consult the House Ways and Means Committee in the very near future, and thus would appreciate receiving our views as soon as possible.
- Reference is to the provisions incorporated into the Internal Revenue Code in 1942 extending tax advantages to foreign investment by U.S. firms in the Western Hemisphere. To qualify as a Western Hemisphere Trade Corporation, a domestic firm had to do all of its business, aside from incidentals, in the Western Hemisphere, derive more than 95 percent of its gross income from sources outside the United States, and obtain more than 90 percent of its gross income from the actual conduct of trade or business.↩