352. Memorandum from Trezise to Acting Secretary, March 201

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  • Ways and Means Committee Bill on Tax Treatment of Foreign Income

The bill that emerged from the Ways and Means Committee is extremely complicated. In a meeting at Treasury on March 16 attended by Isaiah Frank, Stanley Surrey outlined its main features.

1. Income of a controlled foreign corporation is to be currently taxed without deferral if derived from the licensing or use of patents, copyrights and exclusive processes developed in the United States. Income of a controlled foreign corporation derived from sales of products manufactured in the United States is to be currently taxed to the extent that the profits are allocable to the parent company.

2. Tax-haven income other than that defined in 1 above—i.e., base company income from interest, dividends, rents, royalties and “trading profits”—is to be taxed as earned whether or not distributed to U.S. shareholders, except if it is reinvested in underdeveloped countries.

3. Income of operating companies engaged in manufacturing or mining is also taxable without deferral unless the profits are either left in the same business or reinvested in underdeveloped countries.

The definition of investment in less-developed countries which would qualify for deferral under 2 and 3 is rather narrow. It would apply to branch or equity investment, and, in the latter case, the subsidiary in the less-developed country must be controlled to the extent of more than 50 per cent by U.S. interests (unless the laws of the country prevent majority ownership). Surrey is giving consideration to proposing widening the qualifying investment to include loan capital, which is often more acceptable to the less-developed country, and also to making less stringent the rule relating to percentage of ownership.

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Although Treasury has not fully worked through the complexities of the bill, it would appear to us to go a long way toward a sensible compromise among divergent views on this subject. It would eliminate most of the tax-haven abuses while permitting deferral for bona fide reinvestment in existing enterprises in advanced countries. At the same time it is consistent with our policy of promoting private investment in the less-developed countries by allowing deferral for reinvestment [Typeset Page 1529] in less-developed countries either of tax-haven income or of income from operating subsidiaries. We are, of course, not in a position to assess the administrative feasibility of the new provisions and expect that they will be subject to continued attack on this score.

There are many other changes incorporated in the bill which would tighten the taxation of foreign-earned income—e.g., the gross-up provision, and the establishment for the first time of a limitation on the exclusion from tax of income of U.S. citizens establishing residence abroad. A fuller listing of the changes in tax treatment included in the Ways and Means bill is contained in the attached Treasury summary.

  1. “Ways and Means Committee Bill on Tax Treatment of Foreign Income.” Official Use Only. 2 pp. Department of State, Central Files, 811.112/3–2062.