There are some aspects of this problem, however, that are worth
noting:
1. The past Administration’s commitment to tax-sparing came about, as I
understand it, as a result of a visit by Secretary Anderson to an Inter-American
conference and because of the pressure of a number of Latin American
countries for negotiation of tax treaties containing such
provisions.
2. It is not at all clear that the Congress approves of tax-sparing or,
for that matter, that the Treasury Department will continue its
adherence to the policy.
3. The Senate Foreign Relations Committee delayed in giving its approval
to the first tax treaty containing a tax-sparing provision (that with
Pakistan) and only did so after the Pakistani tax legislation had
expired and the tax-sparing provision therefore was no longer operative.
Stan Surrey, recently appointed Assistant Secretary of the Treasury for
Tax Policy, led the side against the Pakistan treaty. Moreover Wilbur
Mills has made plain his opposition to tax-sparing, both on policy
grounds as well as on jurisdictional grounds, i.e., he does not like the
[Typeset Page 1503] idea of
the Senate enacting what is in effect legislation reducing the incidents
of domestic tax on domestic corporations.
4. In view of the above facts it is not at all certain that the Treasury
Department’s position on tax-sparing will remain fixed. Indeed the
Treasury may face opposition from within as well as from Congress in
connection with the three treaties now before the Foreign Relations
Committee. It is difficult to imagine how Surrey can defend the three
treaties before this Committee having waged such a vigorous and
successful campaign before the same Committee on the Pakistan
treaty.
5. Therefore, although at the present time the Department’s position
should be reaffirmed by you as a matter of general policy, it would be
well to anticipate the difficulties that are likely to arise in
obtaining Senate approval for the treaties and in particular the
prospect of Treasury Department defection. I would therefore recommend
that you talk to Secretary Dillon about his disposition on the matter and determine
whether he proposes to hold the line in support of the three pending
treaties.
Attachment
January 27,
1961
SUBJECT
- Background Information on “tax-sparing”
Among the legislative inducements passed by less developed countries
to attract new industry, there is typically included reduction or
suspension of income tax. If the investors affected by these
incentives also pay income tax in the United States, the tax credit
provisions of the U.S. Internal Revenue Code will often reduce or
cancel the incentive effect of the tax holiday, since the credit
allowed against U.S. tax is generally reduced in the same amount
that the foreign tax is decreased, leaving the taxpayer’s total tax
liability unchanged. We seek to remove this frustrating effect of
the U.S. tax credit by providing by treaty, in appropriate
instances, a credit for the taxes spared, as if the spared taxes had
in fact been paid.
There are at present before the Senate Foreign Relations Committee
three treaties including such a provision—with India, Israel, and
the [Typeset Page 1504]
United Arab Republic. A brief discussion of the subject of tax
treaties, with special attention to the tax sparing feature, taken
from the testimony of Dan Throop Smith, Deputy to the Secretary of
the Treasury, before the House Subcommittee on Foreign Trade Policy,
is attached (Tab A). Passages dealing with tax sparing are marked in
red. President Kennedy, in a
letter to Business International, published
in the October 28, 1960 issue (Tab B) declared, “. . . Specific
resumes that should be considered include . . . a much more vigorous
utilization of tax-sparing agreements abroad.”
There has been some opposition, spearheaded by Professor Stanley
Surrey of the Harvard Law School, to the principle of granting
credit for taxes spared. An extract of Professor Surrey’s testimony
before the Foreign Relations Committee on August 9, 1957 [Facsimile Page 5]
concerning the tax-sparing clause of the Pakistan treaty is attached
(Tab C). Neither the Senate nor the Foreign Relations Committee has
expressed a position on the principle of tax sparing. The only
treaty ever submitted to the Senate providing credit for taxes
spared, with the exception of the three now before the Committee,
was that with Pakistan (1957). In that case, the Pakistan
tax-sparing law expired before the Committee voted on the treaty.
The Committee’s report on the treaty called for deletion of the
tax-sparing provision on the grounds that it was most, without
prejudice to future consideration of the principle in case the
Pakistan law should be reenacted. The Senate gave its advice and
consent to ratification on the basis of the Committee’s report.
The Treasury Department, in answer to an inquiry from Senator John J.
Williams, agreed in October 1960 not to undertake further
negotiations of treaties containing tax-sparing provisions until the
Senate’s position on the principle was known, except in cases where
negotiations were already at an advanced stage. The State
Department’s reply to a similar letter (Tab D) avoided making any
commitment of this nature.
It has been proposed, as for instance, in H.R. 5 of the 86th Congress (the Boggs Bill) that
credit for taxes spared be granted unilaterally by U.S. legislation.
The Department of State and Treasury feel that the provision should
remain in the field of treaties (or possibly of executive
agreements, if statutory authorization were given). If such a credit
were authorized unilaterally by tax legislation, the U.S. would
relinquish a large degree of the relativity it now exercises over
the foreign tax concessions eligible for credit. Moreover, the
prospect of tax sparing is the principal inducement we can offer to
lose developed countries to enter into tax treaties with us. If this
benefit were granted unilaterally, its incentive effect would be
lost.
[Typeset Page 1505]
Tab A
[Facsimile Page 6]
Extract from Statement of Hon. Dan Throop Smith, Deputy to the
Secretary of the Treasury (in charge of Tax Policy), before the
Subcommittee on Foreign Trade Policy of the Committee on Ways and
Means, House of Representatives, in its hearings on Private Foreign
Investment, December 1, 1958.
The basic provisions of the tax law applicable to income from foreign
sources are supplemented by a network of 21 income-tax treaties
which help eliminate tax barriers to the international movement of
trade and investment. Their principal purpose is to set forth agreed
rules of source, either explicitly or implicitly, through reciprocal
tax-rate reductions and exemptions, which reduce the cases in which
two countries impose tax on the same income without either one
giving recognition to the tax imposed by the other.
Let me illustrate the problem.
While we allow a credit for the tax imposed by country X on income
derived in that country, our concepts of source may differ from
those accepted in the foreign country. As a result, there may be a
flow of income to an American firm which is considered under United
States law to be income from sources within the United States, but
which under the laws of the foreign country may be considered income
from sources within its borders. Both countries would impose a tax
on that income, but we would not allow a credit for the foreign tax,
since the income does not have its origin in that country so far as
the United States law is concerned.
With tax rates as they are, the combined tax burden in such a case
might well exceed the total income involved. This problem arises, in
greater or lesser degree, in connection with various types of
international transactions, including trading activities, the
rendition of personal services, licensing arrangements, and the
like.
Mr. Chairman, if I may, I would like to emphasize the importance of
this point I have just mentioned. It is often, I think, overlooked
in discussions on the subject and thought of as simply something of
a technical nature to be worked out. But it is a thing that does
call for bilateral agreements for each country to accede to some
degree in its basic concepts. We regard it as a key element in our
treaty program, and that is one reason why we are anxious to extend
the treaties.
Of late we have undertaken another step in connection with the
tax-treaty program which holds considerable promise of facilitating
the international movement of investment. I refer to the credit for
tax incentives or tax sparing which some less-developed countries
have chosen to use as part of their programs to attract capital and
know-how from abroad and to encourage reinvestment of profits.
[Typeset Page 1506]
The tax-credit mechanism designed to achieve equality of tax burdens
operates so as to offset, to some extent, tax incentives granted by
a foreign country. For, as the tax imposed in a foreign country is
reduced, whatever the reason may be, the amount of the tax credit
allowed against United States tax is also reduced. When the tax
credit declines, the amount of United States tax payable tends [Facsimile Page 7] to
increase, and thus to negate the tax reduction offered by the
foreign country.
This has been a source of irritation among some foreign countries.
Though it may not be desirable from the point of view of an ideal
tax system, uniformly administered, to give a credit for an amount
of tax which has not been collected by a foreign government, it is
our view that, in the interest of foreign economic policy, we should
recognize, rather than nullify, the revenue sacrifices made by a
foreign government under certain conditions. This question is
developed more fully at a later point. . . . (pp. 46–47)
One objective of the tax proposals under review is to make it
possible for American firms investing abroad to benefit from the tax
inducements offered by foreign governments to attract new capital.
As previously noted, such inducements can now be taken advantage of
by a foreign subsidiary engaged in business abroad and seeking to
plow back its earnings.
However, if a business is conducted abroad through a branch, or if
the opportunity and desire to reinvest are lacking, then the tax
incentive offered by a foreign country is offset by operation of our
tax system. This problem has already been mentioned, but the
declaration of policy which the administration has made in
connection with the tax-treaty program may be repeated at this
point.
It has announced that we are prepared to consider the inclusion in
tax treaties with less developed countries of a provision by which
recognition would be given to tax-incentive schemes under so-called
pioneer industries legislation or laws for the development of new
and necessary industries.
Briefly, what we are proposing is this:
If a country believes that by giving up tax revenues in certain
cases, it will be serving the cause of economic development, we will
forego the opportunity to increase our tax revenues by nullifying
their concessions. However, we would be prepared to forego this only
under certain conditions.
First, there should be a firm commitment to eliminate unnecessary and
inequitable tax barriers to the flow of private investment in
accordance with sound rules of taxation such as are generally
embodied in our income-tax treaties. This includes agreement not to
discriminate against American business enterprises.
[Typeset Page 1507]
Second, its tax incentive laws should be of general application, thus
assuring maximum benefit to the economy from such legislation.
Third, the conditions and terms under which the tax incentives are
available should be those provided in an existing law with full
disclosure of the conditions under which they are granted, and with
procedures for granting or withholding tax incentives which involve
a minimum of administrative discretion.
Fourth, the tax incentive should be for a limited duration of time,
and preferably limited in amount.
Finally, the tax from which exemption is granted must be a genuine
part of the country’s tax structure and not a spurious levy created
for the occasion.
[Facsimile Page 8]
Whatever one may think about a credit for taxes spared as an element
in an ideal tax system, and there are some who have misgivings, it
is our view that this is a sensible way to approach an issue that is
of considerable importance to foreign countries and that has the
seeds of substantial growth in promoting private investment abroad
at a minimum cost.
It may be said of the tax treaty programs that a credit for taxes
spared permits foreign governments to determine the tax burden
imposed on American firms and to vary that tax burden among American
firms in different ways. In a broad sense, this is quite correct.
However, it is a charge that is equally true of any method of taxing
foreign income which in any way removes income from the scope of the
United States tax. It is true in large measure today of income
derived abroad through foreign subsidiaries. (pp. 51–52)
