Statement of the U.S. Council for International Business to the Senate Finance Committee Regarding Hearings on International Tax Reform

March 11, 1999

Chairman Roth and Members of The Senate Finance Committee:

The United States Council for International Business commends Chairman Roth and this Committee for calling these hearings in an effort to simplify and improve the rules governing the taxation of U.S. based companies doing business abroad. We agree that the complexities and inequities inherent in the current system of taxation unnecessarily limit the ability of U.S. companies to compete internationally. At the same time, we recognize that, in an increasingly global economy, there will be increased pressure on both the U.S. and foreign governments to tax income derived from sources within their respective countries. Among the many items in the Administration's budget proposals affecting foreign income, the item impacting the so-called "export source rule" creates particularly new and unwarranted tax obstacles to U.S. multinationals. We would like to concentrate our remarks on this one provision.

The United States Council advances the global interests of American business both at home and abroad. It is the American affiliate of the International Chamber of Commerce (ICC), the Business and Industry Advisory Committee (BIAC) to the OECD, and the International Organization of Employers (IOE). As such, we officially represent U.S. business positions in the main intergovernmental bodies, and vis-a-vis foreign business and their governments. Its objective is to promote an open system of world trade, finance, and investment.

Repeal Of The Export Source Rule

Since 1922, regulations under Code § 863(b) and its predecessors have contained a rule which allows the income from goods that are manufactured in the U.S. and sold abroad (with title passing outside the U.S.) to be treated as 50% U.S. source income and 50% foreign source income. This export source rule has been beneficial to companies who manufacture in the U.S. and export abroad because it increases their foreign source income and thereby increases their ability to utilize foreign tax credits more effectively. Because the U.S. tax law restricts the ability of companies to get credit for the foreign taxes which they pay (e.g., through the interest and R&D allocations), many multinational companies face double taxation on their overseas operations, i.e., taxation by both the U.S. and the foreign jurisdiction. The export source rule helps alleviate this double taxation burden and thereby encourages U.S.-based manufacturing by multinational exporters.

The President proposes to eliminate the 50/50 rule and replace it with an "activities based" test, which would require exporters to allocate income from exports to foreign or domestic sources based upon how much of the activity producing the income takes place in the U.S. and how much takes place abroad. The justification given for eliminating the 50/50 rule is that it provides U.S. multinational exporters operating in high tax foreign countries a competitive advantage over U.S. exporters that conduct all their business activities in the U.S. The Administration also notes that the U.S. tax treaty network protects export sales from foreign taxation in countries where we have treaties, thereby reducing the need for the export source rule. Both of these arguments are seriously flawed.

The export source rule does not provide a competitive advantage to multinational exporters vis-a-vis exporters with "domestic-only" operations. Exporters with only domestic operations never incur foreign taxes and, thus, are not even subjected to the onerous penalty of double taxation. Also, domestic-only exporters are able to claim the full benefit of deductions for U.S. tax purposes for all their U.S. expenses, e.g., interest on borrowings and R&D costs, because they do not have to allocate any of those expenses against foreign source income. Thus, the export source rule does not create a competitive advantage; rather, it helps to "level the playing field" for U.S.-based multinational exporters.

Our tax treaty network is certainly no substitute for the export source rule since it is not income from export sales, but rather foreign earnings, that are the main cause of the double taxation described above. To the extent the treaty system lowers foreign taxation, it can help to alleviate the double tax problem, but only with countries with which we have treaties, which tend to be the most highly industrialized nations of the world. We have few treaties with most of the developing nations, which are the primary targets for our export growth in the future.

Exports are fundamental to our economic growth and our future standard of living. Over the past three years, exports have accounted for about one-third of total U.S. economic growth. The export source rule also operates to encourage companies to produce their goods in their U.S. plants rather than in their foreign facilities. Repeal on cutbacks in the export source rule will reduce exports and jeopardize high paying jobs in the United States. Given the danger that the current Asian crisis poses to our exports, repeal of the rule would be especially unwise and counterproductive.

The U.S. Council expresses its appreciation for the opportunity to express its views on this important subject. We look forward to working with Congress to address the complexities and inequities inherent in the current system of taxation while providing for the fair and adequate taxation of both U.S. and foreign persons.