Fleming Peroni & Shay on Corporate Tax, Credits, and even Customary International Law

Fleming Peroni & Shay recently posted a new article, of interest as it renews the authors' case, in the wake of BEPS, for both worldwide corporate taxation without deferral (a controversial proposal to say the least) and the foreign tax credit as an appropriate mechanism to allocate tax among home and host countries. As the abstract below indicates, the argument in favour of tax creditability is contra Dan Shaviro, who has argued for foreign taxes to be deductible rather than creditable. The FP&S argument in favour of full current taxation without deferral is contra almost everyone, so it's fun to see FP&S make it, especially in the face of what appears to be a rapidly rising tide of sentiment going in the opposite direction. 

My own view is that a switch to deductibility would increases pressure on capital importing countries to reduce their source-based taxes (a deduction does not fully offset the foreign tax, so it would make such taxes more costly to US firms as compared to fully creditable foreign taxes), and therefore transfer revenues from poor to rich countries. Deferral already places tremendous tax competition pressure on host countries, while ending it might enable some countries (to which US capital is a major source of inbound investment) to increase their source-based taxation (as explained in this paper). Therefore I was happy to see this FP&S paper give additional support to the beleaguered tax credit while still recognizing that there is such a thing as giving too much credit.

I was also intrigued to see FP&S begin their paper by picking up Reuven Avi-Yonah's premise that taxation on the basis of residence and source is customary international law. That is not only a relatively unusual argument to find in a US-authorized tax paper, but it is a potentially controversial perspective, which I am exploring in a paper of my own (making the international law case against citizenship based taxation). So, thank you Fleming, Peroni and Shay, for the additional citation support for my arguments.

It is also worth noting that FP&S include in this paper a defense of the corporate income tax in the form of footnote 200, which spans more than a page in tiny but useful print. It summarizes the main points regarding why corporate tax is necessary as a backstop to individual income taxation, citing to the main arguments for and against, thus serving as a valuable micro treatise on the subject.  

Finally, I note that FP&S only give the FTC two cheers instead of three because they feel that it conflicts with the principle of ability to pay, an argument I have not seen before and that gives me pause. Their argument is that foreign taxes are a cost to individuals attendant to investing abroad, and that crediting these taxes is too generous from the perspective of fairness, that a deduction would sufficiently account for the cost in terms of measuring ability to pay. I can understand that argument where the FTC is itself too generous, allowing cross-crediting and not restricting its application to double taxation. But I do not understand that argument applied to an FTC that restricts itself to a dollar for dollar credit of actual taxes paid, which I believe is the argument being advanced here. That's something to think about a little more.

In any event, abstract below and paper at the link above. Well worth a read.

 Reform of the U.S. international income  taxation system has been a hotly debated topic for many  years. The  principal competing alternatives are a territorial or  exemption system and a worldwide  system.   For reasons  summarized  in  this  Article, we favor worldwide taxation if it is real worldwide  taxation; that  is, a nondeferred U.S. tax is imposed  on all foreign income  of U.S.  residents at  the  time the  income is earned.  However,  this approach  is not  acceptable unless  the resulting double  taxation  is alleviated.    The longstanding U.S. approach for  handling the international  double taxation  problem is a foreign tax credit limited to the U.S. levy  on the taxpayer’s  foreign  income.   Indeed,  the foreign tax credit  is an essential element of the case  for worldwide taxation.  Moreover, territorial systems often apply worldwide taxation with a foreign tax credit to all income of resident individuals as well as the passive income and tax haven income of resident corporations.  Thus, the foreign tax credit also is an important feature of many territorial systems. The foreign tax credit has been subjected to sharp criticisms though, and Professor Daniel Shaviro has recently proposed replacing the credit with a combination of a deduction for foreign taxes and a reduced U.S. tax rate on foreign income.  

In this Article, we respond to the criticisms and argue that the foreign tax credit is a robust and effective device.  Furthermore, we respectfully explain why Professor Shaviro’s proposal is not an adequate substitute.  We also explore an overlooked aspect of the foreign tax credit—its role as an allocator of the international tax base between residence and source countries—and we explain the credit’s effectiveness in carrying out this role.  Nevertheless, we point out that the credit merits only two cheers because it goes beyond the requirements of the ability-to-pay principle that underlies use of an income base for imposing tax (instead of a consumption base). Ultimately, the credit is the preferred approach for mitigating international double taxation of income.