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in about a $4.5 to $6 billion increase in taxes, mainly on multinational corporations.

On the other hand, representatives of our major corporations and their trade associations have pretty much attempted to defend every provision and to basically come as close to maintaining the status quo as possible.

My own feeling is that a moderate reform package is possible in this area which will achieve many of the goals that ought to be achieved here, goals which I would label neutrality, that foreign income should be treated equally but no better than domestic income. I think there is a tilt in our tax laws now leading to foreign investment and being overly generous with foreign source income.

Now, this moderate package which I would propose would probably have around $2 billion of tax consequences annually. The elements of it are briefly as follows:

First, I think it is correct to keep the foreign tax credit basically as it is. I think there has not been a case made for turning the foreign tax credit into a deduction. The foreign tax credit is the bulwark of our way of accommodating to other countries' taxing systems. It needs some minor modifications such as providing for grossup and correcting the limitations, but essentially a full foreign tax credit is where I start.

The key change that is needed is the elimination of deferral. The committee has attempted for almost 15 years to find some way to do something less than eliminate deferral while coming as close to achieving the goals of eliminating deferral as possible.

The conference committee on the 1975 Tax Adjusment Act took some further steps in this direction which I would call eliminating deferral for tax haven abuses or cases where they felt deferral on a case-by-case basis produced some sort of abuse.

I think this alternative of eliminating abuses of deferral is doomed to failure because it is a highly complex area. There is no practical way to sort out the kind of problems that we are attempting to sort out. I think a clean elimination of deferral will not be onerous to multinational corporations. I think it can be done on a practical basis.

I have suggested in my prepared statement for the benefit of your staff some of the techniques which I think could be used to make it relatively simple, reasonable, and practical. These would involve basically using the overall limitation, a consolidation technique for earnings, and providing other provisions that would allow companies to accommodate to it without serious difficulty.

I think that if the committee can once bring itself to eliminating deferral, then a number of the other difficult problems in the foreign area can begin to be resolved. I think the attempts to keep slicing in the middle, between where we are and eliminating deferral, are only apt to make the law in this area more difficult.

I hate to be a harbinger of bad things but I think that if the clean act of eliminating deferral is not taken and we get only piecemeal reforms, we are eventually going to wind up with a minimum tax mechanism in the foreign area which, as a technician, I would hope we never come to.

I think minimum tax mechanisms reflect nothing more than the inability of people to come to some firm decision about how to handle.

basic problems of income taxation. I so regard it in the domestic area and I think the same thing would be true in the foreign area.

Now moving on to other major elements of my moderate reform package, I would call for the repeal of DISC. DISC costs more than $1 billion a year. It mostly subsidizes exports which would take place whether or not the provisions were in the law. It is totally unjustified, in my mind, in this day of high unemployment, high taxes, to be paying money to subsidize the export of goods that would be exported whether or not there was a DISC.

I think there have to be better, more selective ways to encourage exports. I think the basic encouragement of exports comes from a sound economy and sound international economic and financial policies. I think great progress has been made on these fronts in the past 4 or 5 years since DISC was enacted and I think there would be no harm to exports in repealing DISC.

With DISC a variety of other, small or preferences also ought to go the Western Hemisphere Trade Corp. provisions, over 30 years in the code and no demonstration of benefits; the section 911 exclusion is another one that ought to go. I think it is difficult to tell American taxpayers that they ought to subsidize people who choose to live over. seas. I just think that neutrality has to be the watchword in this day of high taxes.

I also include in my package, although it is unrelated, eliminating the 30-percent withholding tax on dividends and interest paid to foreign persons. I agree with Mr. Roosa; I think it is important that we attract capital from abroad. We often exempt or reduce the rate on such income by tax treaties and I think that doing it in the Code would be far preferable.

With these remarks, I stand ready to answer any questions which I can usefully answer. Thank you, sir.

[The prepared statement follows:]

STATEMENT OF STANFORD G. Ross

SUMMARY

1. Favors a moderate reform package to achieve neutrality in the treatment of foreign income.

2. Urges that foreign tax credit be maintained, with only limited changes, such as gross-up.

3. Favors elimination of deferral of United States taxation for foreign corporations owned and controlled by Americans.

4. Suggests that framework for elimination of deferral include overall limitation on the foreign tax credit, consolidation of foreign earnings, and other mechanisms to avoid hardship and to insure a fair implementation of the reform. preference items over proposals for a

5. Favors basic reform of foreign

minimum tax on foreign income.

6. Urges repeal of other corporate preferences: DISC; WHTC; and China Trade Act provisions.

7. Urges repeal of exclusion for income earned abroad by individuals.

8. Urges elimination of the 30% withholding tax on dividend and interest income from portfolio investments in the United States by foreign persons.

9. Outlines views on the other items listed in Committee announcement.

STATEMENT

Mr. Chairman and members of the Committee, my name is Stanford G. Ross. I am a member of the Washington law firm of Caplin & Drysdale. I appear today

at the request of the Committee to present my individual views on reform of the taxation of foreign income and, in particular, the list of items you specified in your announcement of these hearings.

I am honored by the Committee's kind invitation. I was not surprised to see foreign income included in the topics for the first phase of tax reform. This subject has been the subject of active consideration for more than two years and is ready for legislative action. I had the privilege of testifying before this Committee in February 1973 on this same subject and have appended a copy of my remarks on that occasion. I will not repeat material included there, but will go on to address myself to more current aspects of the subject.

My own view is that significant reform of the tax rules governing foreign income is clearly justified, and I specify below the particular package of changes which I favor. I will, in the course of my remarks, refer to the positions of others to make it clear how my own views fit in with the spectrum of opinion which the Committee will have to consider in deciding on what actions to take. I tend to be one who favors moderate reforms as contrasted with those who call for more farreaching types of changes or those who are essentially in favor of maintaining the status quo.

In general, I regard the present treatment of foreign income as overly generous and providing in essence a tax subsidy for foreign business activity. The specific reforms I propose are designed to seek neutrality in the tax treatment of foreign income. They would in no way penalize or discriminate against foreign business activity for, as a general matter, I am strongly in favor of as free a flow of international commerce as can reasonably be attained. I believe that the continued growth and efficiency of the multinational corporation is vital to the prosperity of the United States and the international economy.

In essence, I believe a moderate reform package in this area can increase equity greatly, can contribute significantly to simplicity in a highly complex area, and can raise a substantial amount of revenue, $2 billion or more annually. I believe that a moderate reform package can accomplish all of these and other desirable public goals without unduly burdening the competitive posture of United States multinational corporations or imposing upon them more burdensome taxes than are imposed on domestic business activities. In short, I stand for fairness and practicality in the taxation of foreign income while at the same time advocating long-overdue reforms in the law.

MAINTAIN FOREIGN TAX CREDIT

A fundamental problem with designing national rules for taxing foreign income is that the taxing jurisdictions of two or more different countries may be involved. If various countries with a claim for taxing an international business transaction were to impose their tax laws without regard to the others, the result would be double taxation with burdens that would deter international commerce. Accommodations of conflicting national claims for tax jurisdiction are absolutely necessary and the foreign tax credit is the basic mechanism by which the United States adapts its tax system to that of foreign countries.

There are those who have proposed eliminating the foreign tax credit and instead making foreign taxes deductible. This proposal, in my opinion, would have very deleterious effects. If there were no foreign tax credit, American companies would be heavily burdened, would find it difficult to compete abroad, and in many instances would have no practical alternative to divesting themselves of their foreign operations. Allowing only a deduction for foreign taxes would not realistically accommodate to the conflicting claims of other taxing jurisdictions.

In short, I strongly support the allowance of a full foreign tax credit, basically along the lines of present law. There are, however, aspects of the present allowance which are in need of reform, which I describe more specifically below, and these changes should be made part of the reform package in this area.

ELIMINATE DEFERRAL

Under present law, the United States generally does not tax the foreign income of foreign corporations controlled by Americans. The starting place for reform in this area-and the key to all other reforms-is to eliminate deferral of United States tax for foreign corporations controlled by Americans. The failure of American taxpayers to pay current United States taxes on income earned

abroad by directing it into foreign corporations is the critical problem that the Congress must confront and correct.

The Revenue Act of 1962 enacted Subpart F designed to end deferral for certain tax haven operations. Subpart F was a compromise that emerged after two years of intensive legislative activity and for the first time provided some limits on the deferral privilege. The problem with Subpart F, however, is that it is highly selective in its coverage, and while it curbs some tax haven practices, it allows others to flourish. More importantly, it allows deferral to remain as a tax subsidy for the foreign income of those United States persons that can successfully exploit it.

The Tax Adjustment Act of 1975 recently added to the tax haven coverage of Subpart F, but even with these changes the essential problem remains that Americans can continue to utilize deferral to avoid United States taxes on foreign income. Some kinds of tax haven operations will continue to be attractive, and, more generally, deferral will continue to provide a tax subsidy for overseas activity. The only way that evenhanded tax treatment of all kinds of foreign income can be achieved is to take the clear step of ending deferral.

I believe that considerable benefits will flow from ending deferral. A fairer treatment of all types of foreign income will be established, complexity and administrative burdens will be lessened, and other difficult problems of the taxation of foreign income can begin to be resolved.

One problem with advocating elimination of deferral is, frankly, that the proposal is often misunderstood. To some extent this is understandable since the concept implies different things to different people. As I view it, ending deferral is not a proposal, like changing the foreign tax credit into a deduction, which would penalize foreign income or deter overseas investment. It would undoubtedly increase the United States taxes paid by those multinational corporations whose foreign effective rate is well below the United States rate; but in most cases, any adverse effects would not be significant in the total picture. Further, many collateral effects would stem from its enactment that would benefit multinational corporations. In an attempt to encourage reasoned response to my proposal, I provide below some detail as to what I mean by elimination of deferral. Provide For Overall Limitation On The Foreign Tax Credit

It is important in eliminating deferral that it be done under a framework that fairly implements this reform. Critical to designing this framework is the decision as to the appropriate foreign tax credit limitation. While there are many factors to balance, I believe that there should be a single limitation and that it should be computed on the overall basis.

Many of the pending bills callings for elimination of deferral combine it with the per country limitation. There are many things to be said for the per country limitation which attempts to relate the foreign tax credit to other countries' taxing systems one at a time. However, the bills using it in connection with elimination of deferral are generally defective, in my opinion, in that they do not provide adequate source rules for the application of the per country principle. Detailed statutory source rules involving a tracing of income and deductions to underlying business activities would be necessary to adequately implement the per country limitation in the elimination of deferral context. In particular, the dividend source rule, which generally looks to the country of incorporation of the payor, and the sales source rule, which generally depends on passage of title, allow for manipulation and would have to be changed. Considerable complexity would be inevitable since concepts would be necessary that are like those presently found in the section 482 regulations, proposed regulations § 1.861-8, and the destination rules under the Subpart F sales provisions. Even with adequate statutory rules, there would be difficulty in application and considerable expense to compliance and administration.

In short, I believe that the per country approach is impractical in the context of elimination of deferral. The better approach would be to provide for the overall limitation which requires only a separation of foreign from domestic source income. Even this single separation is far from a simple and existing source rules would have to be reviewed to judge their effects in this new context, but, in general, this limitation should work reasonably and not be burdensome. In general, treatment of foreign income on a multinational basis is simpler and more practical. From the standpoint of fairness, the overall limitation, to my mind, realisti

cally recognizes that modern business enterprises spill across national boundaries and that allowing an averaging of high and low foreign tax rates is appropriate United States tax policy.

Consolidation of Foreign Earnings

Deferral would preliminarily be eliminated on a company-by-company basis. Present Subpart F operates in this fashion under present law. However, consistently with the considerations underlying the overall limitation, all foreign income and deductions of all foreign corporations and branches owned by a United States person should be allowed to be consolidated. Thus, a typical United States multinational corporation would, in effect, prepare two consolidated returns: one for its domestic activities and one for its foreign activities. Any net foreign income with associated foreign tax credits on the foreign return would be brought into the domestic return.

I would not favor at this time a single consolidation of domestic and foreign income, as has been proposed by some, because it would tend to obscure the special characteristics of foreign income and tend to make cumbersome the proper treatment of such income. Certain statutory provisions apply solely to domestic activities, like the investment credit. Certain provisions apply solely to foreign income, like the foreign tax credit. A two return system would permit the computations and reconciliations that are necessary to reaching proper results in both returns. Perhaps at some later date when more experience with elimination of deferral is secured a single consolidation of all income from all sources will be feasible and appropriate.

Other Aspects Of The Framework For The Elimination Of Deferral

A number of technical provisions are necessary for elimination of deferral. For example, provision must be made for exclusion of income that has already been taxed on a constructive basis. Provision must be made for not unduly burdening individual shareholders who are subject to progressive rates. Many of these problems are already adequately provided for in Subpart F and would only need to be reviewed and reoriented to the new context.

Some new provisions might also be needed. For example, consideration might be given to allowing a reserve in the computation of foreign taxable earnings for foreign withholding taxes that would be incurred when such earnings were actually distributed. When amounts are actually distributed and the withhholding taxes actually paid, the reserve would be eliminated and the withholding taxes would become creditable taxes.

Treatment Of Earnings Of Controlled Foreign Corporations Where There Is A Disposition Of Stock Representing These Earnings

Under present law section 1248 provides that upon disposition of the stock of a controlled foreign corporation gain will be treated as a dividend to the extent of the accumulated earnings reflected in the stock. With the elimination of deferral, so that earnings of controlled foreign corporations are generally taxed currently, the function served by section 1248 will for the future largely be removed. However, assuming deferral is eliminated prospectively only and that some exceptions to elimination of deferral, such as for blocked income, will be justified, section 1248 in some version will properly need to be retained in the Code.

Sufficient experience has been had with section 1248 to make a current review desirable. For example, any revised version of section 1248 should eliminate many of the exceptions presently found in section 1248, such as those afforded less developed country corporation earnings. The goal here should be the same as with the elimination of deferral provisions, to make coverage as neutral in its application to different situations as is possible.

Alternatives To Elimination Of Deferral

Finally, it is helpful to an understanding of the elimination of deferral proposal to consider the alternatives. The apparent alternative is an increasingly encompassing, and complex. Subpart F that eliminates deferral on a piecemeal basis by providing for more and more areas of coverage. Thus, the Tax Adjustment Act of 1975 added to the coverage of Subpart F in several material respects, the proposals of the Treasury in April 1973, if enacted, would extend coverage in

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