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Evaluating the U.S. Corporate Tax Environment

The United States offers tax advantages to foreign investors in the form of a stable tax environment, federal and state-level tax incentives, and a fair dispute resolution system.

Location USA 2016
Globally expanding businesses face an increasingly long menu of destinations for foreign direct investment (FDI). There is a growing sense in boardrooms and management teams around the world that FDI choices are critical both to drive current business performance and also to position the business for the future. And, of course, because investment capital is limited, the decision to invest in a particular country must be weighed against other investment opportunities in the headquarters country or abroad.

Thus, businesses need to evaluate the positive and negative attributes of all potential investment locations. It is also important for governments and their economic development offices (EDOs) to understand the decision-drivers in order to attract and retain the business activities, jobs, and economic growth for which they compete.

When entering a territory for the first time, or expanding business activities in territories where they already have operations, investors must take many considerations into account. Input costs such as labor and energy, adequacy of infrastructure, regulatory burdens, and the overall economic environment are important to consider for investors as well as for governments and EDOs seeking to win investment.

Importance of the Tax Environment
This article focuses on another consideration — the tax environment, made up of tax policy, tax enforcement and administration, and conflict resolution. In particular, we’ll look at the high-level tax environment considerations within the United States.

Is tax important? In a survey of CFOs of U.S. subsidiaries of non-U.S. businesses, tax policy was named as the single biggest issue when considering the United States as an investment location. So, while there clearly are many inputs to analyze in the investment and management decision, tax is a very important consideration.

There are certainly challenging aspects of the U.S. tax rules for those considering investing into the United States. The challenges and the pitfalls to be considered by these investors have been written about elsewhere and discussed in a variety of forums. These considerations should be fully evaluated and understood by investors as they consider U.S. investment locations.

However, there are many positive aspects of U.S. tax policy and administration, and I’d like to focus on those areas where the United States fares favorably in a comparison among investment locations. In particular, I focus here on three key attributes in the current tax environment:
  • Is the environment certain and stable?
  • Are investment incentives clear and qualifications well understood?
  • Is there a fair dispute resolution system?
The United States actually performs quite well when measured against these attributes. This is encouraging for the future of investment into the United States.

There are incentives for investment at the federal and local levels of government. Certainty and Stability
As for tax legislation, the United States provides a great deal of certainty. While in some countries the tax laws can change quickly and without warning, this is not a material issue in the United States, where generally the legislative process is transparent and allows businesses time to anticipate and prepare for the legislative change.

For example, Congressional initiatives on U.S. tax reform — which may be enacted in 2017 or 2018 — began in 2014 with draft legislation and numerous hearings. In a global environment, this factor is a valuable attribute. To the extent certainty is provided by U.S. legislators at the federal, state, and local levels, it can and should be valued by investors.

While the states do not always follow as thorough a process as that undertaken at the federal level, the core foundation of the U.S. tax system is durable and reliable over time. Again, unlike local jurisdictions in many other countries, where the tax policy cannot be relied upon, U.S. tax policy provides reliability.

Tax Treaties
Tax treaties are also important in creating certainty for investors into the United States. The United States has in place bilateral income tax treaties with more than 60 countries. The U.S. government enters into such treaties for several reasons, including:
  • To stimulate international trade and investment
  • To promote cooperation among countries in enforcing and administering tax laws
  • To promote information exchange
  • To reduce or eliminate double taxation and excessive taxation
U.S. income tax treaties typically cover various categories of income, including:
  • Business profits
  • Passive income, such as dividends, interest, and royalties
  • Income earned by teachers, trainees, artists, athletes, etc.
  • Gains from the sale of personal property
  • Real property income
  • Employment income
  • Shipping and air transport income
  • Income not otherwise expressly mentioned
The U.S. tax treaty network includes treaties with most European countries and other major trading partners, including Mexico, Canada, Japan, China, Australia, and the former Soviet Union countries. This treaty network creates a stable foundation for many cross-border tax implications, although individual situations should be analyzed carefully.

There are two important caveats specific to treaties that investors should understand. First, there have been delays in the U.S. Senate ratification of negotiated federal tax treaties. Second, treaties only apply to federal taxation in the United States; the states are not bound by them. So although the federal government has agreed not to tax certain income, states are not subject to that agreement.

Clear Incentives with Well-Understood Qualification Criteria
Incentives are another positive attribute favoring investments in the United States. At all levels of government, there are incentives for investment and targeted economic activity. At the federal level, these are largely statutory incentives, including those for research and development, job creation, and investment in qualified types of property. For example, the research and development credit is a fixed credit defined in the tax rules. The research tax credit is available for companies that make qualified research expenditures to develop new or improved products, manufacturing processes, or software in the United States. It is available with respect to qualified research expenses (QREs) incurred.

As for tax legislation, the United States provides a great deal of certainty. At the state and local level, there are statutory incentives for many of the same activities incentivized at the federal level. But it also may be possible to negotiate certain incentives with state and local governments, ranging from relief from property and income taxes to additional credits against taxes for investment and job creation.

The types of incentives offered at the state level vary significantly, depending on jurisdiction and industry. The majority of incentives are based, at least partially, on increases in workforce and capital investment in property. A number of other factors — such as the location of the project, wages of employees, amount and types of benefits offered to employees, and type of investments — also may be considered.

These incentives, once negotiated, are reliable if the agreed criteria continue to be met. Businesses must take care to comply with the agreed activities to ensure that the promised tax benefits are captured and claimed.

Fair Dispute Resolution System
As we are learning, particularly as businesses expand into emerging economies, a clear, fair, and efficient process for resolving disputes between businesses and tax administrators can be a valuable attribute. The United States has such a system at the federal, state, and local level, although one criticism can be the length of time it can take to resolve matters.

Many large and mid-size businesses are under continuous audit by the IRS and state tax authorities. The audits may include the entire list of taxes for which the business is liable. However, smaller businesses and individuals with lower incomes generally are subject to audit on a random basis or if their returns are selected for audit based on certain criteria. An appeal process within the IRS can often be used to resolve matters without litigation.

Further, the United States has a strong court system that is fair and reliable. Again, the length of time to litigate tax matters can be frustrating at times, as can the cost of litigation in the U.S. court systems at all levels. However, in contrast to many countries, where the courts are less reliable and fair, such criticisms generally cannot be leveled at the U.S. judicial system.

In Sum
U.S. tax rules unquestionably are complex and can result in material tax compliance obligations and tax liabilities. However, while there are areas of caution that need to be watched carefully, when looking at the three principal areas discussed above, the United States lines up quite well and should continue to do so and perhaps even improve!
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