|The Congressional Budget Office (CBO) updated its report comparing the corporate income tax rates of the U.S. and other G20 countries.|
The report examines not only the statutory top rates, of which the U.S. has the highest, but also provides information on the average and effective corporate tax rates, including insight as to how certain corporate decision-making is influenced by each.
Current U.S. Corporate Rates
The U.S. federal income tax rate on an ordinary corporation is:
These graduated rates are phased out as follows:
With state taxes added in, the average top statutory rate for 2012 (the most recent year for which complete data was available) was 39.1%. This rate was 10 percentage points higher than the average of the top rates in the other G20 countries, the CBO estimates.
While Japan, Germany and the U.S. had the highest statutory corporate tax rates among G20 countries in 2003, by 2012 Japan and Germany had reduced their top rates, leaving the U.S. at the top of the list. Tax rates varied more widely among non-G20 countries in 2012, ranging from 55% (United Arab Emirates) to “tax haven” jurisdictions that, in some cases, collect no corporate income taxes at all.
Measures of Corporate Tax Rates
As explained by the CBO, the statutory corporate tax rate influences corporate behavior as well as tax preferences, surtaxes and noncorporate taxes. There are several alternative measures of tax rates that account for the effect of some of those factors, such as average and effective marginal corporate tax rates.
The average corporate tax rate is a measure of the total amount of corporate taxes that a company pays as a share of its income. It reflects a country’s corporate tax rate schedule, the system’s tax preferences for business investments, any surtaxes, and possibilities for tax avoidance or evasion. The report states that companies consider the average corporate tax rate when deciding whether to undertake a large or long-term investment in a particular country.
The effective marginal corporate tax rate is a measure of a corporation’s tax burden on returns from a marginal investment (that is, one that is expected to earn just enough, after taxes, to attract investors). According to the CBO, the effective corporate tax rate is more informative for business decisions about whether to expand ongoing projects in countries where a company already operates.
The CBO says that statutory corporate tax rates, on the other hand, are more often the focus when a business is developing legal and accounting strategies to shift income earned in high-tax countries to low-tax jurisdictions — especially low-tax jurisdictions where those businesses do not plan to invest and from which they don’t expect any benefits from tax preferences for business investments.
For 2012, the five G20 countries with the highest corporate tax rates were:
Changes in Recent Years
Since 2012, four G20 countries have modified their corporate income tax systems:
As of 2015, Japan’s top statutory corporate tax rate was 32.1% — 5 percentage points lower than its top rate in 2012. As a result, the CBO estimates that Japan’s effective corporate tax rate fell from 21.7% in 2012 to 18% in 2015.
South Africa’s top statutory corporate tax rate fell from 34.6% in 2012 to 28% in 2015, and its estimated effective corporate tax rate fell from 9% in 2012 to 6.2% in 2015.
The UK reduced its top statutory corporate tax rate from 24% in 2012 to 20% in 2015 but also slightly tightened the tax treatment of depreciation for equipment. On net, those changes led to a reduction in the estimates of effective corporate tax rates from 18.7% in 2012 to 15.7% in 2015.
India’s top statutory corporate tax rate rose from 32.5% in 2012 to 34.6% in 2015 due to a surcharge increase. That change led to an increase in the estimates of the effective corporate tax rates from 13.6% in 2012 to 15% in 2015.
The Trump Effect?
Note: President Trump has vowed to reduce corporate taxes, specifying a target rate of 15%. Republicans in the House of Representatives have similarly called for reducing the rate, but to a 20% rate.
EU Proposes Major Changes to Anti-Money Laundering Rules
In a significant development, the European Union (EU) plans stricter rules that would enable EU citizens to access registers of beneficial owners of companies and trusts without having to demonstrate a “legitimate interest” in the information. Currently, access is restricted to authorities and professionals such as journalists and lobbyists.
The new rules are amendments to the EU Anti–Money Laundering Directive agreed to by the EU Economic and Monetary Affairs and Civil Liberties committees and approved by the EU Parliament. The directive is aimed at curbing money laundering, tax evasion and terrorism financing activities.
The committees said public access would allow greater scrutiny of information by civil society, and contribute to preserving trust in the integrity of business transactions and of the financial system.
The scope of the Directive has also been expanded to cover trusts and other legal arrangements with a structure or functions similar to trusts. These were previously excluded from the Directive on privacy grounds. Trusts will now have to meet the full transparency requirements of firms, including the need to identify beneficial owners.
The establishment of company beneficial ownership registers has been gathering pace around the globe since the Panama Papers and Bahamas leaks showed the financial details of hundreds of thousands of accounts.
In Australia, for example, the government recently released a Consultation Paper on the issue that seeks views on increasing the transparency of the beneficial ownership of companies for relevant authorities, to better assist these authorities to combat illicit activities.
Public access to such registers wasn’t suggested — the paper merely talks of “access for domestic and international ‘relevant authorities’ to beneficial ownership information.” The government is seeking feedback on what information needs to be collected in order to achieve this objective and how it should be collected, stored and kept up to date. It is also seeking feedback on the expected compliance costs for affected parties.
In the UK, Her Majesty’s Revenue & Customs has signed arrangements with 10 Overseas Territories and Crown Dependencies for sharing beneficial ownership information.
IRS Explains How Foreign and Domestic Losses Affect Foreign Tax Credit
In a further indication of the IRS’s continued focus on international tax issues, the tax agency updated an International Practice Unit (IPU) summarizing the calculation and recapture of foreign and domestic losses and their impact on the foreign tax credit.
Avoiding Double Taxation
The United States taxes U.S. persons on their worldwide income, including their foreign taxable income. The foreign tax credit generally prevents U.S. taxpayers from being taxed twice on that income — once by the foreign country where the income is earned, and again by the United States — by allowing U.S. taxpayers to reduce (on a dollar-for-dollar basis) the U.S. tax on that income by the foreign taxes they pay.
A limitation is imposed on the amount of foreign tax credits that can be claimed in a year in order to prevent taxpayers from claiming more in credits than the amount of U.S. tax that would have otherwise been imposed. The limit is generally calculated as: (foreign taxable income divided by worldwide taxable income) times pre-credit U.S. tax. It is calculated separately for various categories of foreign income.
In order to determine the U.S. and foreign taxable income in each separate category, business expenses, losses, and other deductions are allocated and apportioned to U.S.-source income and the separate categories of foreign source income. To the extent the allocations and apportionments create either a domestic or foreign loss in one or more separate categories, those losses are allocated against other net income, if any. When a net loss offsets net income of a different source or a different category of foreign taxable income, loss recapture rules are triggered.
A net loss in a separate category of foreign income is known as a separate limitation loss (SLL). This must offset net income in other foreign income categories (separate limitation income) on a pro rata basis before offsetting U.S. taxable income. When an SLL in one category offsets separate limitation income in another, an SLL account is created or increased.
An SLL account is recaptured when future foreign taxable income is produced in the same separate category as the SLL. Recapture occurs when this income gets recharacterized as foreign taxable income in the other separate category/categories in which the separate limitation income was previously offset by the SLL. The rules help to regulate the use of foreign tax credits among and within separate categories and generally ensure that credits aren’t used disproportionately.
Overall Foreign Loss
To the extent aggregate SLLs exceed aggregate separate limitation income, the excess (or overall foreign loss) may reduce the taxpayer’s taxable income in the United States. When an overall foreign loss offsets U.S. taxable income, a foreign loss account is created or increased.
A taxpayer with one of those accounts recaptures it by recharacterizing a portion of the future foreign taxable income, produced in the same separate category/categories that originally generated the overall foreign loss, as U.S. taxable income. As a result of that recapture, the foreign income of a taxpayer electing to credit foreign taxes is decreased by the recaptured amount for purposes of calculating the tax credit limit for that category, thus trimming the allowable foreign tax credit for the year. Recapture continues until the total foreign taxable income recharacterized as U.S. taxable income equals the amount in the overall foreign loss account.
The overall foreign loss recapture amount equals the lesser of the aggregate amount of maximum potential recapture in all such accounts or 50% of the taxpayer’s total foreign taxable income. The maximum potential recapture of a separate overall foreign loss account is equal to the lesser of the balance in the account or the foreign taxable income for the year in the same separate category.
If the aggregate amount of maximum potential recapture in all overall foreign loss accounts exceeds 50% of the total foreign taxable income, the income in each separate category with such a loss account is proportionately recharacterized as taxable U.S. income.
Overall Domestic Loss
A net U.S. source loss is known as an overall domestic loss. When this loss is allocated to reduce foreign taxable income, an account is created or increased.
These accounts are recaptured by recharacterizing future U.S. taxable income as foreign taxable income in the same category as the foreign income that was originally offset by the domestic loss. The domestic loss rules eliminate the double taxation of foreign taxable income over time. When U.S. taxable income is recharacterized as foreign taxable income in a later year, the recharacterization may generate a federal tax credit limitation that can absorb excess credits that may have resulted from the reduction of credit limitation in the earlier tax year, when the domestic loss offset foreign taxable income.
A taxpayer with an overall domestic loss account recaptures that account by recharacterizing a portion of the taxpayer’s U.S. taxable income for each following year as an amount that is the lesser of the aggregate balance of the taxpayer’s overall domestic loss accounts (to the extent not recaptured in prior years) or 50% of the taxpayer’s U.S. taxable income for such future year.
As a result of the domestic loss recapture, if the taxpayer elects to credit its foreign taxes, the taxpayer’s foreign income is increased by the recaptured amount for purposes of the computation of the federal tax credit limitation, thereby increasing the allowable amount of the credit for the year.
A Guide to Potential Audits
This International Practice Unit may help you prepare for a potential call from an IRS auditor asking to review your firm’s use of the foreign tax credit. Consult with your tax advisor with any questions or concerns you have.