April 11, RE: NAM Comments on International Tax Reform Discussion Draft. Dear Chairman Camp:

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1 Dorothy Coleman Vice President Tax and Domestic Economic Policy April 11, 2012 The Honorable Dave Camp Chairman, House Ways and Means Committee U.S. House of Representatives 1102 Longworth House Office Building Washington, DC RE: NAM Comments on International Tax Reform Discussion Draft Dear Chairman Camp: The National Association of Manufacturers (NAM) the largest industrial trade association in the United States, representing over 11,000 small, medium and large manufacturers in all 50 states is pleased to submit the attached comments on the discussion draft of the Tax Reform Act of 2011 you released on October 26, The NAM has long believed that our current tax system is fundamentally flawed and discourages economic growth and U.S. competitiveness. In order to make U.S. manufacturers more competitive, the NAM supports comprehensive tax reform that includes a corporate tax rate of 25 percent or lower and a move to a territorial tax system. To this end, your discussion draft is an important step in the right direction. As outlined in our comments, NAM members believe that some issues in the discussion draft need to be addressed in order to implement a territorial system of taxation that will operate in the manner intended. Moreover, given the critical importance of the tax system to the U.S. economy, any changes to the international tax rules or the tax rules applicable to domestic operations should be addressed in the broader context of tax reform. NAM members very much appreciate the thoughtful and deliberative approach to tax reform taken by you and your staff. Your discussion draft represents a significant step forward in the tax reform debate and we appreciate the opportunity to share our thoughts and concerns with you. We look forward to further discussing these issues and working with you and your staff to achieve a pro-growth, pro-competitiveness and pro-manufacturing tax system. Sincerely, Leading Innovation. Creating Opportunity. Pursuing Progress Pennsylvania Ave, NW, Suite 600, Washington, DC P F

2 Comments of The National Association of Manufacturers on House Ways and Means Committee Chairman Dave Camp s International Tax Reform Discussion Draft April 12, 2012 I. Introduction The National Association of Manufacturers (NAM) welcomes the opportunity to comment on the discussion draft of the Tax Reform Act of 2011 that would reduce the top corporate tax rate to 25 percent and rewrite the rules for taxing the foreign income of U.S. multinationals ( discussion draft ), released by House Ways and Means Committee Chairman Dave Camp (R-MI) on October 26, The NAM is the largest industrial trade association in the United States, representing over 11,000 small, medium and large manufacturers in all 50 states. We are the leading voice in Washington, D.C., for the manufacturing economy, which provides millions of high wage jobs in the U.S. and generates more than $1.6 trillion in GDP. In addition, two-thirds of our members are small businesses, which serve as the engine for job growth. NAM members commend Chairman Camp and the Committee for significantly advancing the discourse surrounding a lower corporate tax rate and the adoption of a territorial tax system. The NAM has long believed that our current tax system is fundamentally flawed and discourages economic growth and U.S. competitiveness. Current U.S. tax laws make it difficult for U.S. companies with worldwide operations to thrive and compete in the global marketplace. If U.S. companies cannot compete abroad, where 95 percent of the world s consumers are located, the U.S. economy suffers from the loss of both foreign markets and domestic jobs that support foreign operations. In order to make U.S. manufacturers more competitive, the NAM supports lower tax rates on business income (including dividends and capital gains), a permanent and strengthened R&D incentive, a robust capital cost recovery system, the adoption of a territorial tax system and a simpler, fairer and balanced tax code. We support efforts to make the tax code more pro-growth, pro-competitive, fairer, simpler and predictable. Because of the critical importance of manufacturing to our nation s economy, any effort to rewrite the tax laws should result in a fiscally responsible plan that allows manufacturers in the United States to prosper, grow and create jobs. While recognizing that the discussion draft is an important step in the right direction, NAM members also feel strongly that some issues in the discussion draft need to be addressed in order to implement a territorial system of taxation that will operate in the manner intended. Moreover, given the critical importance of the tax system to the U.S. economy, any changes to the international tax rules or the tax 1

3 rules applicable to domestic operations should be addressed in the broader context of tax reform. Given that all the components of a comprehensive tax reform package have yet to be determined, the comments below focus on technical issues and policy decisions in the discussion draft. In addition, NAM comments on any individual part of the discussion draft are based on the premise that the provisions would be part of an overall territorial tax plan and comprehensive tax reform. II. Corporate Rate Reduction The discussion draft takes the important step of proposing a reduction in the corporate income tax rate from 35 percent to 25 percent. As outlined in NAM s A Manufacturing Renaissance: Four Goals for Economic Growth, 1 a key objective for the association is to create a national tax climate that enhances the global competitiveness of U.S. manufacturers. An important step in achieving this goal is to adopt a corporate tax rate of 25 percent or lower to make the United States more competitive with our major trading partners. In recent years, the United Kingdom, France and Germany three of the top six countries in the Organization for Economic Cooperation and Development (OECD) measured by GDP for 2010 have reduced their corporate income tax rates below the U.S. tax rate. 2 Lowering the U.S. federal corporate tax to 25 percent would bring the U.S. rate more in line with other OECD member countries, which in 2010 had an average top corporate rate (including subnational corporate income taxes) of 25.4 percent. 3 III. Dividends Received Deduction Moving From a Worldwide System The discussion draft also would fundamentally change the way the United States taxes foreign income by moving toward a territorial system. Under the proposal, U.S. corporate taxpayers would receive a 95 percent dividends-received deduction ( DRD ) for foreign source dividends from controlled foreign corporations ( CFC s) and deemed CFCs. The discussion draft treats certain foreign branches and non-cfcs as CFCs for all purposes of the Internal Revenue Code (the Code ). In parallel with the DRD, the discussion draft excludes from gross income 95 percent of a domestic corporation s gain from the sale or exchange of CFC stock, if at least 70 percent of the CFC s assets are active assets, and repeals section 956 (which taxes CFC investments in U.S. property similarly to dividends). 1 Available at 2 Organization for Economic Development and Cooperation, Challenges in Designing Competitive Tax Systems: Tax Reform Trends in OECD Countries (June 30, 2011). 3 Id. In 2000, the average corporate income tax rate for OECD member countries was 32.6%. Id. 2

4 NAM believes that this approach is a very important step in creating a pro-manufacturing tax climate to enhance U.S. competitiveness, not raise revenue. Adopting a territorial system like those used by other industrialized countries will allow U.S.-based companies to compete on a more level playing field. In particular, a territorial system would allow for the free flow of capital back to the United States from foreign operations for reinvestment in the domestic economy. The current high corporate tax rate of 35 percent, even though it is partially offset by foreign tax credits at lower tax rates imposed outside the United States, often results in a high U.S. tax charge on the repatriation of earnings from foreign subsidiaries. This additional charge causes what is often referred to as a lockout of earnings, preventing them from being repatriated to the United States. The 95 percent DRD would reduce the disincentive to repatriate foreign earnings, freeing up resources for investment in the United States. Territorial systems are now the international norm. The vast majority of our trading partners have a territorial system of taxing foreign income. Japan and the United Kingdom two of the largest economies recently abandoned worldwide taxation systems in favor of a territorial approach. Adopting a tax system that is not more burdensome than the tax systems applying to foreign manufacturing companies is critical to the ability of U.S. manufacturers to compete in the global marketplace. A competitive tax system will impact jobs at U.S. headquarters, increase exports from U.S. manufacturers and improve the efficiency of their supply chains. Finally, the enactment of a territorial system would simplify U.S. tax law by allowing for the elimination of several complex tax rules. For example, the discussion draft would significantly reduce the importance of the foreign tax credit. Eliminating the use of the foreign tax credit system as the primary means of preventing international double taxation will reduce the possibility of double taxation currently experienced by U.S. multinationals. For example, the rules for allocating and apportioning interest expense have long been criticized for over allocating interest expense to foreign source income, resulting in double taxation of foreign source income. See, e.g., H.R. Rep. No , at (2004), setting forth the Committee s reasons for adopting what became Code section 864(f). By limiting the importance of the foreign tax credit rules, this and other inequities in the rules are minimized. Under the discussion draft, the foreign tax credit primarily would be relevant to subpart F income and withholding taxes on interest and royalties earned from foreign loans and licenses. Taxpayers only would be required to compute one foreign tax credit limitation, rather than separate limitations for separate baskets. In addition, only directly allocable expenses would reduce the limitation. The NAM believes these proposed changes are important steps toward eliminating the complexity of the U.S. tax system and addressing the policy issues of double taxation. Partial DRD NAM generally supports the partial exemption approach in the discussion draft that would continue to tax five percent of the dividends from CFCs (and deemed CFCs). While the NAM would prefer the approach taken by many of our trading partners including the United Kingdom, Spain, Denmark, Finland, Austria, and Netherlands that provide a 100 percent participation exemption, we realize that the taxation of five percent of CFC dividends presumably obviates the allocation of costs such as 3

5 administrative expenses and research and development that support U.S. multinationals global operations. These expenses cover activities that generate high-paying U.S. headquarters jobs that might not otherwise be located in the United States. Treatment of Previously Taxed Income NAM members also have concerns about a proposal in the discussion draft that would repeal section 959, which allows for the tax-free distribution of a foreign subsidiary s earnings and profits previously taxed under subpart F. As a result of the repeal of section 959, an additional 1.25 percent tax or penalty would be imposed on the remittance of previously taxed subpart F income. This incremental tax appears to be inconsistent with the policy objective of encouraging the remittance of offshore earnings to the United States to fund U.S.-based operations. In addition, as discussed in more detail below, given the repeal of section 959, greater clarity is needed regarding the ability of taxpayers to repatriate pre-effective date E&P without any tax over and above the one-time transition tax (i.e., the additional 1.25 percent tax on previously taxed income). IV. Treatment of Branches Another area of concern for the NAM is the proposal in the discussion draft to treat certain foreign branches of domestic corporations like CFCs for all purposes of the Code. This approach generally would result in a 95 percent exemption of active business income earned by the foreign branch when it is paid as a dividend to its domestic parent. The treatment of foreign branches in territorial tax systems varies among other industrialized countries. For example, France, the United Kingdom, Germany, and the Netherlands exempt active business income from foreign branches. Some other countries, such as Japan, do not provide an exemption system with respect to branches. Only one of our major trading partners France provides for branch exemption by treating the branch as a CFC for all tax purposes. The proposed treatment of branches as CFCs for all purposes of the Code raises some technical issues. For example, it is unclear how the conversion from branch status to deemed CFC status will be treated under the Code. More specifically, it is unclear whether the deemed conversion will trigger U.S. tax consequences such as dual consolidated loss recapture, branch loss recapture, overall foreign loss recapture or income recognition under section 367. In addition, it is unclear whether otherwise disregarded transactions between branches would result in potential subpart F income. 4 Moreover, if the branches are treated as CFCs, it is unclear whether five percent of a foreign branch s earnings would be subject to U.S. taxation in the year earned or whether the U.S. tax on five percent of a branch s earnings would be deferred until the earnings are remitted to the U.S. owner. If the tax is deferred until the earnings are repatriated, it is unclear how such a remittance would be determined in the context of true foreign branches. 4 We understand that for French tax purposes the incorporation of the branch is simply used to determine whether a branch has income subject to immediate French tax under their CFC rules. The treatment of a branch as a CFC, however, does not result in additional income recognition from otherwise disregarded transactions between branches or between a branch and the French home office. 4

6 The NAM encourages the Committee to consider branch exemption mechanisms similar to the approach adopted in the United Kingdom that allows a taxpayer to make a one-time election to adopt the branch exemption rules with respect to all of its branch operations. V. Transition Tax The discussion draft generally provides for a 5.25 percent tax on all accumulated deferred foreign earnings in the last tax year before the DRD is effective ( transition tax ). This provision is a major concern for a number of NAM members and other capital-intensive companies that have reinvested a significant portion of those earnings in the bricks and mortar of their foreign business. These companies, which have invested in hard assets outside the United States to address the needs of a global marketplace, could face a significant tax liability without sufficient cash to pay the tax. While the draft allows companies to pay this tax liability over eight years with an interest charge, the mandatory transition tax would impose an additional cost burden on U.S companies at a time when they are otherwise facing significant challenges in the global marketplace. Their competitors would not have a comparable burden during the same period. Further, the financial statement impact of this tax cost may be significant and could negatively affect share prices. The transition tax also would pose a sizable compliance burden on taxpayers and a challenging administrative burden on the IRS because the tax would apply to all accumulated deferred earnings and profits, regardless of how long ago they were earned. In particular, it will be difficult to determine with precision the accumulated earnings and profits for companies with long standing foreign subsidiaries. In light of the liquidity and competitiveness problems of the transition tax as drafted, the NAM encourages the Committee to allow taxpayers to repatriate pre-effective date earnings tax-free regardless of when they are remitted. Both Japan and the United Kingdom, which recently adopted dividend exemption systems, do not impose a tax on the remittance of pre-effective date earnings in the post-effective date period. Alternatively, the Committee should allow companies to elect to transition their pre-effective date earnings into the new regime and pay a transition tax. If a transition tax is adopted, the NAM encourages the Committee to allow taxpayers to net CFCs with deficits in earnings and profits and those with positive earnings and profits. It makes no sense for a U.S.- based multinational with no net foreign earnings to pay a toll charge for the benefits of a territorial system. The ability to use deficits to offset positive earnings and minimize the transition tax should not be limited by the structural limitations of a company s organization chart given the magnitude of this tax and the importance of providing some relief. Further, the ability to use foreign tax credit carryovers against the transition tax, and loss carryovers against the income on which it is imposed, should be confirmed. In addition, if a transition tax is adopted, greater clarity is needed on the remittance of pre-effective date earnings. As currently drafted, the proposal does not clearly provide that all earnings deferred in the pre-effective date period and subject to the transition tax can be remitted to the United States taxfree. If these earnings cannot be remitted before the repeal of section 959, these previously taxed 5

7 earnings would appear to be subject to an additional 1.25 percent tax. The draft should clarify that taxpayers with pre-effective date earnings can repatriate these earnings without incurring another level of tax. VI. Subpart F Income The NAM also has concerns about the discussion draft s approach to subpart F income, especially the alternatives for changing the subpart F income definition to address concerns about the erosion of the U.S. tax base under a territorial tax system. The discussion draft would retain the permanent subpart F income rules now in the Code, and is silent on extension of the expiring subpart F income exceptions that have been effective since their enactment in 1998 and In a departure from prior rules however, the discussion draft would expand the definition of subpart F income through one of three alternative prevention of base erosion provisions (the options ). While NAM members do not think that moving to a territorial system poses an increased threat of eroding the U.S. tax base, the NAM agrees that the subpart F income rules need to be reconsidered because they were developed in an era when business models and the role of the United States in the global economy were quite different. Each of the options in the discussion draft however, represents what we believe to be a backward shift. One is even similar to an approach offered, and rejected, in Any such expansion of those rules needs to be studied carefully. In particular, policymakers need to focus on the impact of the subpart F income rules on U.S. multinationals operating abroad and their ability to compete with their foreign counterparts that often have a lighter tax burden on their foreign operations. This is especially important since some of our major competitors, such as the United Kingdom, are currently reforming their CFC rules to make them less stringent. The NAM strongly believes that the options are a step in the wrong direction to the extent that income from active foreign business operations would be treated as subpart F income. A well-designed territorial regime exempts active foreign business income. Indeed, the technical explanation of the discussion draft indicates that the DRD would apply to distributions of foreign active business income. However, the discussion draft also proposes to continue to currently tax active foreign business income within the scope of the existing subpart F income rules and subject even more active business income to immediate U.S. tax by expanding the scope of subpart F. The options for expanding subpart F income would impose an additional tax charge for many U.S.-based companies selling goods and providing services in foreign markets, creating an additional and significant hurdle to competing with non-u.s.-based companies in these same markets. From a competitiveness perspective, it is critical that policy makers avoid broadening the scope of foreign income subject to immediate U.S. tax in a way that essentially makes it a full inclusion system with respect to a significant portion of a U.S. multinational s active foreign earnings. While each of the options provides some 5 See footnote 14. 6

8 exception for income earned by a CFC from sales into its own home-country market or the performance of services therein, in all options this exception for home country active income is far too narrow. Specifically, this approach would require a taxpayer to set up a separate CFC to provide goods and services for each local market. In contrast, the demands of a highly competitive global marketplace require companies to centralize operations to provide goods and services across borders with the greatest operational efficiency. France originally provided for a very limited home country exception, but later abandoned this approach. France, like other countries, now provides an exception from current taxation where the CFC engages in active business operations in the jurisdiction in which the CFC is located. While the discussion draft labels the three options prevention of base erosion, each option lacks a meaningful active business exception and would impact a wide range of legitimate transactions. U.S. manufacturers operate in foreign countries to be near their customers, and foreign operations help American companies market products effectively to foreign consumers, cut transportation costs, avoid tariff barriers, meet local content requirements and provide services locally. These foreign operations do not shrink the U.S. tax base or U.S. operations. Rather they generate additional jobs both at U.S. headquarters, in the U.S. supply chain and at U.S. facilities that manufacture for the export market. 6 Option A The NAM believes that the excess intangible income option (Option A) has several serious flaws and should be rejected. Under Option A, which is the Obama Administration s excess intangible income proposal, 7 gross income derived by a CFC from the performance of services outside its country of incorporation, or the disposition of property for use, consumption, or disposition outside such country, would be currently subject to tax in the United States if: the transaction involves the use of U.S.- transferred or co-developed intangible property; the gross income exceeds 150 percent of costs directly allocable to the income other than taxes; and the income is taxed by a foreign country at an effective tax rate of 10 percent or less. All of the excess intangible income would be subpart F income if the effective tax rate on the intangible income was less than 10 percent and none of the income would be treated as subpart F income if the effective tax rate exceeded 15 percent, with a sliding scale applicable to income subject to rates between 10 and 15 percent. Insofar as it relies on a foreign tax rate test that will foster counterproductive behavior, the excess intangible income option is similar to the two other alternative options. This shared defect in the options is discussed in connection with Option B below. 6 U.S.-based multinational companies were responsible for nearly half of all U.S. exports $558.6 billion in Department of the Treasury, General Explanations of the Administration s Fiscal Year 2013 Revenue Proposals 88 (February 2012); Office of Management and Budget, Living Within Our Means and Investment in the Future: The President s Plan for Economic Growth and Deficit Reduction 50 (September 2011); The President s Plan for Economic Growth and Deficit Reduction: Legislative Language and Analysis 269, as published by Tax Analysts under the headline Draft Legislative Language of Obama Deficit Plan is Available, 2011 Tax Notes Today (September 28, 2011); Department of the Treasury, General Explanations of the Administration s Fiscal Year 2012 Revenue Proposals 43 (February 2011). 7

9 Under present law, a domestic corporation that develops intangible property and transfers that property to a foreign affiliate must be compensated for the property on an arm s length basis. This standard is the cornerstone of international taxation for the United States as well as other members of the OECD. In addition, the IRS recently adopted more stringent cost sharing regulations to address concerns regarding the arm s length compensation for intangible property. In contrast, treating income from active business operations as subpart F income solely on the basis that a CFC used intangible property that was acquired in an arm s length transaction is inconsistent with the arm s length standard and would threaten the U.S. treaty and competent authority negotiations with other countries. Moreover, it would be difficult for the United States to argue that other countries should abide by the U.S. view of the arm s length standard when the United States enacts a law whose rationale is that the arm s length standard is ineffective for protecting its tax base. In addition, the excess intangible income provision would increase the cost of maintaining research and development activities in the United States. Because the provision only applies to income from the use of U.S.-transferred or co-developed intangible property, it would incentivize the migration of high paying research and development jobs outside the United States. Many U.S. trading partners already are offering companies permanent and more generous R&D incentives than the United States. This provision would add a significant new incentive to perform R&D entirely outside the United States. NAM members know first hand the important role R&D plays in promoting innovation and job growth in the United States. It is critical therefore, that any tax reform plan recognize the important role of research and technology investment in the U.S. economy. The goal of tax reform should be to attract a greater portion of the global research and development investment to the United States, not to discourage it. The excess intangible income provision also appears to bring within its scope situations where most of the R&D occurs outside the United States, but there is some amount (no matter how small) of U.S.- transferred or co-developed intangible property. An approach like this would lead to needless and expensive disputes between the IRS and taxpayers regarding whether intangibles were or were not wholly developed outside the United States, creating a further incentive to move all R&D outside of the United States. NAM members also are concerned that the excess intangible income provision would cover transfers of intangibles and co-development arrangements that occurred before the provision went into effect. The unlimited retroactivity of the provision means that prior licensing or joint development of intellectual property which was explicitly sanctioned by Treasury regulations in the pre-effective date period would fall within the scope of the provision. This result would discriminate against companies that placed their reliance on these rules in establishing their global businesses. Companies have already engaged in transactions in which they established an arm s length price for the right to use intangibles outside the United States in the context of their businesses and in co-development activities with affiliated companies. Moreover, many of these transactions have been audited and agreed to by the IRS. It is quite common for companies to seek Advance Pricing Agreements (APAs) from the governments with taxing jurisdiction over the business operations. These agreements are often bilateral, and they provide a transparent and timely resolution of the issues. The NAM strongly recommends that, in the 8

10 interest of fairness, if the Committee adopts the excess intangible income provision, it should not apply to pre-effective date transfers of intangibles or joint development agreements. Finally, the NAM has serious concerns with the provision in Option A that would trigger current taxation when the gross income of the CFC exceeds 150 percent of direct expenses. This focus on the CFC s rate of return would provide an incentive to push deductible marketing and other costs into the CFC and lead to the migration of high paying U.S. jobs. In addition, since only current year costs are taken into account, other significant costs like R&D, which are incurred in prior years, would not be captured. The 50 percent limitation on the mark-up of directly allocable expenses in arriving at the non-subpart F income portion of the gross income also would pose particular issues for manufacturers if the limitation ignores (as it appears to do) costs that are capitalized into cost of goods sold since the cost of goods sold is deducted from sales proceeds to determine gross income from sales. The discussion draft s statutory language does not appear to treat cost of goods sold as part of the cost base on which the non-subpart F income portion of the CFC s gross income can be based. Option B The NAM also has significant concerns about Option B, which would create a category of subpart F income called low-taxed cross border income. Under Option B, all the income of a CFC would be taxed currently in the United States if the CFC is subject to an effective foreign income tax rate of 10 percent or less, and does not meet a narrow same-country exception. This approach arguably represents the broadest expansion of subpart F among the three options in the discussion draft. NAM members believe that a foreign tax rate test for determining subpart F income status is could encourage non-u.s. countries to increase taxes on earnings by U.S. companies, resulting in the payment of increased foreign tax, not U.S. tax, by U.S. companies. In addition, based on experience with the several foreign tax rate tests presently governing subpart F, 8 a tax rate test is difficult to implement. The breadth of income within the scope of Option B, the narrowness of the proposed home country exception (discussed below) and the country-by-country tax rate determination required would make the tax rate test in Option B far more complicated than any comparable test under present law and expose nearly every item of CFC income to the difficulties of applying such a test. Another concern for the NAM is that the exception for home-country business income in Option B is far more restrictive than the exceptions found in the CFC regimes of other countries that subject income of CFCs to current home-country taxation by reference to a foreign tax rate. The CFC regimes of both France and Japan for example, generally provide an exception from the CFC rules where a CFC has an active business in the CFC s home country. The active business exception in Japan generally requires a CFC to conduct a local business with sufficient substance and local management and control. In France, the CFC rules provide an exception when a CFC carries on industrial and commercial activities in the 8 For example, under the high tax exception of section 954(b)(4), it can be difficult to determine the income and taxes that may be taken into account in applying the test because of complex rules for grouping income. Treas. Reg (c)(1)(iii) and (d)(1). 9

11 jurisdiction in which the CFC is located, unless a certain percentage of the CFC s income is passive in nature. As noted above, France abandoned a home-country exception that required local country sales or services in 2005 because it was deemed too restrictive. Moreover, the requirement of sales for use, consumption or disposition in the CFC s country of incorporation (Option B s proposed Code section 952(e)(2)(C)) 9 makes little sense when applied in the small countries in Europe, where manufacturing plants typically supply the whole or a significant part of the European region, not just a single country s small market. The NAM recommends that, if the Committee were to adopt Option B, then at the very least it should do so without including proposed subsection 952(e)(2)(C). Without subparagraph (C), Option B would provide an exception for income derived in the conduct of a trade or business in the country where the CFC has an office and is incorporated. Option B goes far beyond the Japanese model and is unlike any CFC rules in other developed countries territorial systems, and therefore would not be an element of a competitive territorial system. In sum, the NAM believes that Option B is out of step with international norms. If the Committee were to adopt Option B, the NAM strongly encourages the Committee to consider a broad exception for active business operations in the CFC s country of organization. Option C NAM members recognize the need to locate high-value jobs and investment associated with the development of intellectual property in the United States. The NAM however, has serious concerns about the two-part approach in Option C, which appears to be based on the premise that the derivation of so-called intangible income in the conduct of an active business outside the United States is an abusive, base eroding activity. First, this option would provide that a CFC generally would have a new type of subpart F income ( foreign base company intangible income, herein abbreviated FBCII ) if it has any income that is properly attributable to intangible property. 10 However, a special version of the normal high tax exception would exclude FBCII from subpart F income if the income is subject to a greater-than-13.5 percent foreign effective tax rate. Part two of Option C would provide a deduction equal to the sum of 40 percent of the foreign intangible income of the U.S. shareholder, and 40 percent of the lesser of (1) its subpart F inclusion from its CFCs FBCII, or (2) the U.S. shareholder s hypothetical subpart F inclusion due to its CFCs FBCII, computed under the assumption that FBCII is limited to foreign intangible income. Foreign intangible income is intangible income that is derived in connection with sales of property that is used, consumed or disposed of outside the United States, or derived in connection with services provided with respect to persons or property outside the United States. 9 Page 51, lines of the discussion draft. 10 Income properly attributable to intangible property is called intangible income. 10

12 Contrary to the underlying premise of the provision, the use of intangible property in the conduct of a global business, and the derivation of income necessarily attributable, in part, to such property, represents one of the key exports of the U.S. economy. Rather than taxing currently income from intellectual property used outside the United States for the conduct of active business operations, U.S. tax policy should promote the U.S. based development of intellectual property and the use of that property outside the United States. As discussed above under Option A, under U.S. tax law, intangible property developed in the United States cannot be transferred to an affiliate operating in another country without paying an arm s length charge for the use of the intangible property. In addition, the value of any intangible property that is transferred from the United States for use in an offshore business is subject to tax. There is no base erosion when a CFC is required to pay an arm s length charge for the right to use intellectual property that is developed by a U.S. corporation. Indeed, the interaction of section 367(d) and this provision could have the effect of double taxation. Moreover, Option C is significantly broader than rules adopted by our competitors because it imposes U.S. tax on the use of the intangible property by a foreign subsidiary based on an arbitrary tax rate, regardless of the active business context in which that asset is used. Similar to Option A, Option C is inconsistent with the goal of retaining and growing the United States leadership in technology development. Another problem with Option C is the requirement that taxpayers determine the amount of a CFC s income that is attributable to intangible property. This measurement of intangible income requires taxpayers to unscramble the economic egg by identifying the amount of revenue and expenses attributable to intangible property as compared to income of the CFC derived from a return on capital, services, manufacturing or marketing activities. Requiring segregation of the return from intellectual property would result in significant controversy during the examination process as taxpayers and the IRS attempt to subdivide the returns on transactions. The unproductive and unnecessary controversy associated with this provision seems unmerited given the difficulty of reconciling the operation of this rule with the policy objectives of subpart F. 11 CFC Look-Through Rules Although the current draft is silent on the continuation of the CFC look-through rule that exclude from subpart F income certain payments of dividends, interest, rents and royalties between related CFCs, the NAM strongly encourages the Committee to retain these rules. The CFC look-through rule properly treats the redeployment of earnings between and among CFCs as active income. 11 Something similar to Option C was proposed and passed by the House in its version of the Revenue Act of 1962, only to be stripped from the bill by the Senate. See S. Rep. No. 1881, 87 th Cong, 2d Sess. 110 (1962) ( A considerable body of testimony before your committee indicated that it was impractical to attempt to determine this constructive income. ). 11

13 These payments represent an important source of funding for CFC operations. The rules, which have bipartisan support in Congress, put U.S. based companies on a level playing field with foreign-based companies when redeploying foreign earnings in foreign businesses. Applied in the context of the draft s participation exemption, there would be no net incremental amount of earnings being exempted because the payment of these items would be allocated to active business income in order to be exempted. These payments should be viewed as allowing for the efficient use of capital among CFCs. VII. Treatment of Interest Expense While the NAM understands some limitation on interest expense is required under a territorial system, it encourages the Committee to carefully study any such limitation on the deductibility of interest payments. The discussion draft would expand the present-law limitation on the current deductibility of interest expense in a manner similar to rules applied to foreign companies investing in the United States through U.S. subsidiaries. Specifically, current deductions for net interest expense would be subject to the greater of two limits: (1) net interest expense attributed to non-excess domestic indebtedness (computed by comparing the U.S. debt-to-asset ratio to the worldwide debt-to-asset ratio); or (2) a specified percentage of adjusted taxable income as that term is defined in section 163(j). The proposed restrictions on interest deductions could have a negative impact on borrowing and capital investment. In addition, the effect of the provision would depend on the borrowing needs of a particular industry and would have a more damaging impact on some industries than others. Given these concerns and the arbitrary nature of the percentage of adjusted taxable income chosen, the NAM encourages the Committee to consider using a higher percentage of adjusted taxable income to minimize unintended consequences. VIII. Conclusion The NAM thanks Chairman Camp and the members of the House Ways and Means Committee for their diligent work in developing a corporate income tax structure that attempts to put U.S. business on a level playing field with its competitors organized in other countries, as well as making the United States a more competitive environment in which to do business. As outlined above, the NAM believes that the discussion draft represents a significant step forward in the tax reform debate and appreciates the opportunity to share our thoughts and concerns with you. We look forward to further discussing these issues and working with you and your staff to achieve a pro-growth, pro-competitiveness and promanufacturing tax system. 12