353. Memorandum from G. Griffith Johnson to U. Alexis Johnson, May 181

[Facsimile Page 1]

SUBJECT

  • General Objectives, Provisions, and Status of the Proposed Tax Legislation

The Administration objective in the proposed new legislation, as far as measures affecting U.S. investment and other interests abroad are concerned, is primarily to remove the existing tax advantages that encourage U.S. private investment in highly industrialized countries and in tax havens, in preference to investment in the United States and in the less developed countries. The sponsors of this tax reform expect that it will help control our unfavorable balance-of-payments position, contribute to the stimulation of the growth of our domestic economy, aid our policy of promoting investment in underdeveloped areas; increase the revenue; and help to equalize the tax burden.

The House of Representatives has already approved a bill (H.R. 10650) that includes a very large proportion (but not all) of the Administration recommendations. Among the principal innovations in this bill that would affect U.S. investments or other interests of American citizens abroad are: (1) abolition of the tax deferral privilege for the earnings of American controlled foreign corporations in industrialized countries, except earnings reinvested in the active conduct of the trade or business or reinvested in a less developed country; (2) imposition of a relatively low ceiling ($20,000 per year for the first three years of residence, $35,000 thereafter) on the exclusion from taxable income of the income of U.S. citizens who reside abroad; (3) subjection of real estate located abroad and owned by U.S. citizens to the U.S. estate tax; (4) provision for taxation of certain gains by U.S. citizens and corporations as ordinary income instead of capital gains, such as certain distributions by foreign trusts, gains from sales of stock in U.S. controlled foreign corporations and in foreign investment companies under certain conditions; (5) inclusion of the amount of the foreign tax paid in the basis upon which the U.S. tax is calculated (the “gross-up” technique) in allowing credit for foreign taxes paid by a foreign subsidiary of a U.S. corporation.

[Typeset Page 1531]

The House bill is now before the Senate Finance Committee. Hearings were completed May 11, and the Committee is scheduled to go into executive session on the bill on May 23. The Treasury Department is seeking a number of changes in the House bill, particularly adoption of the original Administration proposal for the general elimination of tax deferral for the operations of controlled foreign corporations in developed countries (the House bill would continue to permit rather extensive deferral in certain circumstances).

[Facsimile Page 2]

Business groups have registered strong protests against a number of the general proposals of the Administration and against specific provisions of the House bill. Among the principal objections are the following: (1) investments in developed countries stimulate U.S. exports, and elimination of tax deferral will destroy the stimulus; (2) elimination of deferral will place U.S. businesses abroad in a bad competitive position as compared with the businesses of other countries which will continue to enjoy tax favors; (3) recruitment of U.S. citizens for the staffs of foreign businesses will be made very difficult if they are denied the tax exemption to which they have been entitled in the past; (4) U.S. foreign investment produces a long-term favorable rather than unfavorable effect upon the U.S. balance-of-payments position, since a very large part of the investments are financed by foreign borrowing and reinvestment of earnings, and since a large part of the earnings are regularly repatriated; (5) the drastic provisions directed at tax-haven operations will do serious damage to the economies of certain under-developed areas, such as Panama, the West Indies, etc.

  1. Objectives, provisions, and status of proposed tax legislation. Official Use Only. 2 pp. Department of State, Central Files, 811.11/5–1862.