Former US Secretary of Defense Donald Rumsfeld was much mocked in 2002 when he responded to a question about Iraqi WMDs with an answer about ‘known knowns’, ‘known unknowns’ and ‘unknown unknowns’.
The long-awaited nine-page Unified framework for fixing our broken tax code, published by the US President Donald J Trump in late September 2017, contains a few ‘known knowns’, more ‘known unknowns’ and omits an even greater number of ‘unknown unknowns’.
One hope from many policymakers outside the US is that the consequences of a successful tax reform in America will disincentivise US multinationals from entering into international tax avoidance arrangements. The theory goes that a territorial system necessitates anti-base erosion and profit shifting measures (I’m sure someone could think of an acronym) that will, intentionally or unintentionally, put pressure on their ability to use ‘double Irish’ and ‘Dutch Sandwich’-type structures.
Much depends on what is meant by this statement in the plan: ‘To prevent companies from shifting profits to tax havens, the framework includes rules to protect the US tax base by taxing at a reduced rate and on a global basis the foreign profits of US multinational corporations’.
The key point to note is that the policy aim underlying this statement is protecting the US tax base, not preventing the avoidance of tax outside America. In other words, as long as profits that arise in a ‘tax haven’ would not otherwise have arisen and fallen to be taxed in the US, then the US system should, in theory, be indifferent as to how much overseas tax is paid on them. However, one reading of this sentence suggests that the US will only be indifferent as long as some overseas tax is paid (I’ve heard that rate might be around 5%), seemingly regardless of whether those profits have been diverted from the US or not. But the US won’t be happy for profits that have clearly been diverted from the US to be taxed at the 5% global rate rather than the 20% US rate. That would be a #policyfail.
A lower global tax rate would still provide an incentive to existing tax-planning US multinationals to pay a tax rate on their non-diverted overseas profits of around 5% which, admittedly, may be a higher rate than a number are currently paying on said profits. It may even provide an incentive to those US multinationals that are currently remitting overseas profits to the US to start planning because, under a territorial system, any overseas tax paid is effectively lost as it is no longer creditable.
The risk to the US government is that multinationals might find a way under a new system to pay 5% tax overseas, rather than 20% tax in the US. It may be conceptually challenging for the US to draft CFC rules that do not create loopholes under which US multinationals can argue that there was no diversion away from the US.
I don’t understand America well enough to know how seriously the president and the ‘big six’ believe that reforming the tax system will stop American companies from establishing overseas operations. I’ve never come across a situation where a non-American company hasn’t established operations and created jobs in the US because of the US tax system. The little detail we have on the framework doesn’t immediately persuade us that it will, on its own terms, have a meaningful effect on American jobs. On the other hand, the UK moved to territorial taxation in 2009 and employment has been rising ever since, and maybe that was the reason...
Donald Rumsfeld ended his answer with this observation: ‘If one looks throughout the history of our country and other free countries, it is the latter category [‘unknown unknowns’] that tend to be the difficult ones’.
By definition, we cannot know how many unknown unknowns there are, or what they are. I would wager that there are vast numbers of unknown unknowns inherent in US tax reform, and the outcome and interaction of these, will determine the impact on non-US tax systems.
One ‘known known’ is that US policymakers will not particularly care what that impact is to the extent that it does not, or is not perceived not to, affect America.
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The potential impact of US tax reform
Former US Secretary of Defense Donald Rumsfeld was much mocked in 2002 when he responded to a question about Iraqi WMDs with an answer about ‘known knowns’, ‘known unknowns’ and ‘unknown unknowns’.
The long-awaited nine-page Unified framework for fixing our broken tax code, published by the US President Donald J Trump in late September 2017, contains a few ‘known knowns’, more ‘known unknowns’ and omits an even greater number of ‘unknown unknowns’.
One hope from many policymakers outside the US is that the consequences of a successful tax reform in America will disincentivise US multinationals from entering into international tax avoidance arrangements. The theory goes that a territorial system necessitates anti-base erosion and profit shifting measures (I’m sure someone could think of an acronym) that will, intentionally or unintentionally, put pressure on their ability to use ‘double Irish’ and ‘Dutch Sandwich’-type structures.
Much depends on what is meant by this statement in the plan: ‘To prevent companies from shifting profits to tax havens, the framework includes rules to protect the US tax base by taxing at a reduced rate and on a global basis the foreign profits of US multinational corporations’.
The key point to note is that the policy aim underlying this statement is protecting the US tax base, not preventing the avoidance of tax outside America. In other words, as long as profits that arise in a ‘tax haven’ would not otherwise have arisen and fallen to be taxed in the US, then the US system should, in theory, be indifferent as to how much overseas tax is paid on them. However, one reading of this sentence suggests that the US will only be indifferent as long as some overseas tax is paid (I’ve heard that rate might be around 5%), seemingly regardless of whether those profits have been diverted from the US or not. But the US won’t be happy for profits that have clearly been diverted from the US to be taxed at the 5% global rate rather than the 20% US rate. That would be a #policyfail.
A lower global tax rate would still provide an incentive to existing tax-planning US multinationals to pay a tax rate on their non-diverted overseas profits of around 5% which, admittedly, may be a higher rate than a number are currently paying on said profits. It may even provide an incentive to those US multinationals that are currently remitting overseas profits to the US to start planning because, under a territorial system, any overseas tax paid is effectively lost as it is no longer creditable.
The risk to the US government is that multinationals might find a way under a new system to pay 5% tax overseas, rather than 20% tax in the US. It may be conceptually challenging for the US to draft CFC rules that do not create loopholes under which US multinationals can argue that there was no diversion away from the US.
I don’t understand America well enough to know how seriously the president and the ‘big six’ believe that reforming the tax system will stop American companies from establishing overseas operations. I’ve never come across a situation where a non-American company hasn’t established operations and created jobs in the US because of the US tax system. The little detail we have on the framework doesn’t immediately persuade us that it will, on its own terms, have a meaningful effect on American jobs. On the other hand, the UK moved to territorial taxation in 2009 and employment has been rising ever since, and maybe that was the reason...
Donald Rumsfeld ended his answer with this observation: ‘If one looks throughout the history of our country and other free countries, it is the latter category [‘unknown unknowns’] that tend to be the difficult ones’.
By definition, we cannot know how many unknown unknowns there are, or what they are. I would wager that there are vast numbers of unknown unknowns inherent in US tax reform, and the outcome and interaction of these, will determine the impact on non-US tax systems.
One ‘known known’ is that US policymakers will not particularly care what that impact is to the extent that it does not, or is not perceived not to, affect America.
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