Simple corporate tax reform is not about the legislation.
When passing law, simple is the gold standard. But simple doesn’t mean easily crafted legislation. Good lawmakers strive for simple and effective implementation. Basically, a law should be easy to follow, but accomplish the goal. Tax reform is no different. So legislators must boil down all the problems that have cropped up in corporate taxes into and craft a simple tax reform. Between inversions, tax avoidance, regulatory burdens and high statutory rate, simple is hard to come by
President Donald Trump made headlines before inauguration. He disavowed border-adjustment as part of his tax plan in the Wall Street Journal. President Trump specifically referred to the House GOP Border Adjustment Tax (BAT) plan as “too complicated.” He specifically pointed to problems of using origin-based costs for tax credits. He further argued against the strong dollar that would be necessary to make Border Adjustments work. It’s clear he is not sold. He wants it simple.
But Speaker Paul Ryan knows tax reform needs to address the core of Inversions and tax avoidance. If we simply end deferment and reduce the tax rate, foreign companies will have a significant advantage. So a foreign company would always pay only what they owe on sales in the U.S. while American companies pay on sales made everywhere. That means to stop inversions the administration would have to create new regulations or burdensome laws. Speaker Ryan and President Trump would rather avoid this. The problem is complex, but the solution can be simple. Our new President should look at Destination Based Sales Factor Apportionment instead.
Why is Destination-Based Sales Factor simple?
The idea for Destination Based Sales Factor is simple for the corporation paying their taxes. Figure out how much the corporation sold, figure out how much of it was sold in the U.S., apply tax to their profits associated with what they sold in the U.S. This is a simple concept. Now let’s break it down to details.
First, the corporation figures out how much money they made in world-wide sales that year. Then, they figure out their world-wide costs and subtract those. This gives them a world-wide income before taxes.
Now we want the U.S. to only tax the profits actually made in the U.S. To figure out this calculation, the company needs to know what they exported. Any company owner knows the details of where they sell using modern computers. The corporation can take their world-wide sales and deduct any sales they legitimately made overseas to figure out their U.S. Sales. Therefore, they fill out a form attesting to the best of their knowledge these are overseas sales, and they sign it on penalty of perjury.
Now the company takes the U.S. sales divides it by the world-wide sales. This gives them a fraction. That fraction represents the only part of the world-wide income the U.S. can tax. Therefore the fraction is multiplied by the world wide income before taxes. The company’s U.S. Profit is the company’s tax liability. This amount can now be taxed at whatever rate the U.S. decides in tax reform.
Why do corporations subtract overseas sales instead of just stating what they sold in the U.S.?
Major Corporations engage in tax avoidance because it is high yield, low reward. If a court finds tax avoidance occurred no jail time occurs. They just pay a fine. And usually it is pennies on the dollar in a settlement.
A subtraction-method Destination Based Sales Factor changes the dynamic. This method further prevents using an overseas seller to resell into the U.S. Without a subtraction method a corporation could simply deny knowledge of attempt to circumvent the tax code. Now this blatant tax avoidance crosses over into tax evasion. And tax evasion does have jail time potential. Meanwhile, the remaining tax avoidance tricks become low yield and high risk.
Destination Based Sales Factor should be part of the tax debate in Washingon, D.C.
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