A Confused Explanation of the Effect on the Taxation of Foreign Income Under the Auerbach Tax

This Destination-Based Cash Flow Tax debate has generated a lot of discussion – some of it helpful and some of it quite confused. Tim Fernholz is making a noble attempt but he stumbles on something others seem to get confused about:

Some of that money appears to be a result of companies shifting earnings overseas by moving their intellectual property (IP) abroad. And some firms whose income is entirely predicated on easily movable IP, like drug makers, have simply moved their headquarters to tax havens in order to escape US tax obligations entirely.

Permit me to interrupt. Inversions only get rid of the repatriation tax. The real issue here is the tendency for companies like Amgen to migrate their U.S. created intangible assets offshore. But this is not where I fear Tim has gone astray:

The next feature of the plan to think about is the destination-based aspect of it. Republicans propose to end the longstanding, uniquely American idea of taxing worldwide income.

Sorry but I need to interrupt again. Other nations are on territorial systems (no repatriation tax) but tax corporate profits on a sourced-based system. Please continue Tim:

If you consider for a minute about what kind of incentives this might create, one of the obvious ideas for an American firm would be to move production and intellectual property overseas, to a low-tax or low-labor cost country, while continuing to sell products in the US. Just as companies today try to shift income overseas because it is effectively untaxed there, they would similarly do so if their foreign income was untaxed by law. To battle this incentive, we finally reach the border adjustment part of the proposal. The adjustment would, at its simplest, make it so that foreign purchases by companies would not be deductible, to balance the lack of taxes on exports—that is, the tax only targets domestic consumption.

Yes Amgen, Apple, and Google source a lot of income abroad under the current system which should receive a section 482 challenge from the IRS. This House proposal would not increase their U.S. taxes at all – it would simply mean that the IRS would no longer be able to challenge such aggressive transfer pricing. So why call this “to battle this incentive”? It is like throwing up the white flag of surrender. This is the point I was trying to make earlier.