Memorandum by the Special Assistant in the Office of Financial and Development Policy (Robinson) to the Director of That Office (Corbett)

  • Subject:
  • Treasury Foreign Tax Proposals

We had a lengthy and, I think, very fruitful discussion last Friday in Mr. Walter Sauer’s office at the Treasury on the proposals being developed for tax changes affecting foreign earned income.* Present from the Department were Messrs. Fred Livesey (OFD), Isaiah Frank (EDT), Charles Thompson (ED), Harlan Bramble (OMP), James Corliss (AR), and myself. Mr. Sauer was joined by Messrs. Nathanial Gordon and Julius Greisman.

I pointed out that in discussing the Treasury’s proposals among ourselves certain questions had come up which we wanted to explore further with the Treasury people. Mr. Sauer said they were particularly glad to do so as they were just in the process of preparing a memorandum setting forth the proposals more specifically and analyzing some of their implications and effects. He admitted that events were moving quickly, and while he could not be certain how fluid the thinking was in upper levels at the Treasury he was confident that any views we might have would be given consideration. He seemed uncertain as to whether the specific foreign tax proposals would be included in the budget message stated by the President to be forthcoming on January 21.

We talked first about the proposal that the Western Hemisphere provisions be left in their present form, and that a similar 14 point preferential rate of taxation be given to the income from subsidiaries actively engaged in a trade or business anywhere abroad, and from branches which elect to be treated as subsidiaries for tax purposes (which would thereby lose their rights to any depletion allowances and to consolidating their income with that of the parent for tax purposes.) We pointed out that this appeared to discriminate in favor of investment in the Western Hemisphere, since a domestic corporation qualifying thereunder could get both the preferential rate and depletion allowances. Mr. Sauer admitted that this was the effect, and that the Treasury had no answer for it. He did point out that the requirements would be much less rigid for firms to [Page 353] qualify under the new procedure, which would be available to firms operating in the Western Hemisphere as well as elsewhere (no special domestic subsidiary necessary in order to qualify, for example).

It is apparent that the Treasury feels that any proposal which does away with the Western Hemisphere device, or so alters it as to exclude exporting firms, would be politically unfeasible because of the opposition it would encounter from the exporting interests. Therefore, it will propose preferential treatment for this new category of enterprises. Such treatment would be available only to subsidiaries or branches actively engaged in the conduct of a trade or business within a foreign country. The qualifications would presumably be so drawn as to include firms such as Sears Roebuck which undertake their own retail distribution and develop local sources of supply, and exclude firms which export goods on consignment or who operate only through sales offices or agencies abroad.

It became clear in the discussion that the Treasury’s test will be the nature and extent of the service or production performed abroad by the American firm. The mere holding of shares in a foreign firm would not be sufficient to qualify for the preferential tax rate, unless the holding corporation actively participates in the management or operation of the foreign firm. There seemed to be some difference of opinion in the Treasury as to whether a firm would have to draw a line between income derived from the active conduct of a trade or business and investment income, for example, or whether all income would receive preferential treatment if a substantial part thereof was derived from the active conduct of trade or business. Since we are endeavoring to encourage investment as such, we suggested strongly that the Treasury consider extending the preferential rate to income arising from such investment (i.e. net, new corporate investment) regardless of whether the investment is accompanied by the active participation of the American investor. The provision of capital per se is often as vital to economic development as technical and/or managerial skills. Although investments by individuals would not qualify, the individual would merely have to incorporate in order to qualify. Mr. Sauer recognized the validity of our point and agreed to flag it for the attention of Mr. Smith.

We made it clear that we were in agreement with the Treasury’s desire to encourage active business operations abroad, i.e. investment, rather than American exports as such. We did point out that additional channels of distribution are sometimes very important in terms of a country’s economic development, but agreed that a line had to be drawn somewhere if the principal emphasis was to be on the encouragement of active business operations abroad. I’m [Page 354] sure the Treasury people understood that we were in agreement with their general approach to the problem, except for the suggested inclusion of investment income and some uneasiness about the difference in treatment between investment in Latin America and in the rest of the world.

We then turned to the question of extending the definition of foreign taxes that would qualify as a tax credit. The Treasury is still proposing to permit a credit for foreign income taxes or any other single tax that constitutes the principal tax on business income. We did not take exception to the Treasury’s thinking on this point, except for suggesting further flexibility through tax treaties (see below). It was noted that if the principal tax was, for example, an excise tax or a turnover tax the total collected might be unrelated to the firm’s taxable income and if credited against the U.S. tax would in many cases result in complete exemption from the U.S. tax.

We then raised the question of still further tax incentives through tax treaties. Mr. Sauer agreed personally that there are two additional areas which should be explored in extending the tax treaty program: (1) additional flexibility in defining the particular foreign taxes that might qualify as a tax credit, and (2) accommodation to situations in which the foreign government offers local tax concessions to new investment, so as to enable American firms to receive the advantage of such concessions. There was little discussion of this notion, but Mr. Sauer indicated that a nudge from the Department in this direction would be quite appropriate. In urging the Treasury to consider doing something along this line we pointed out that, even though legislation might not be required, it would be well for something to be said about it in the forthcoming tax message as such a statement of intent, for example, would be highly useful at the Caracas conference or in some other international forum where we might be pressed on this matter.

We expressed our appreciation for the opportunity of exploring these matters with Mr. Sauer and his associates, and they seemed to feel quite genuinely that they too had benefitted from the discussion. Mr. Sauer undertook to pass our questions and suggestions along to Mr. Smith, and to keep us informed of any further developments.

  1. See memo of conversation in Mr. Waugh’s office dated December 7, 1953. [Footnote in the source text; the memorandum is printed supra.]
  2. This has since been confirmed. [Footnote in the source text.]
  3. Mr. Thompson later suggested that the Treasury may well want Congress to deal with this situation, without itself taking the initiative of altering the Western Hemisphere benefits so as to exclude export firms. [Footnote in the source text.]