International Commerce through a Foreign Subsidiary: Navigating the Anti-Haven Tax Shoals of the Internal Revenue Code

Abstract

Traditionally, one of the advantages of doing business abroad through a foreign subsidiary has been the possibility of using tax havens to minimize foreign income taxes and, at the same time, defer the offshore profits for U.S. income tax purposes. As long as the foreign earnings that accumulated in the tax haven were not remitted to the United States, the U.S. tax bill was delayed. There are several Internal Revenue Code provisions, however, that curb or, in some cases, totally eliminate deferral benefits sought in this manner. Among these are the formidable Subpart F rules for controlled foreign corporations and the passive foreign investment company provisions. Nonetheless, with careful tax planning, foreign subsidiaries that engage in certain types of offshore business activities, notably manufacturing, can still navigate around these anti-haven tax shoals and enjoy substantial deferral benefits. Other foreign subsidiaries, in contrast to traditional wisdom, may set their course directly toward these anti-haven tax shoals in order to secure significant foreign tax credits. Due to the reduced corporate rates introduced by the Tax Reform Act of 1986, most U.S. multinational companies today find themselves in excess tax credit positions.' Accordingly, any foreign taxes they pay above the U.S. statutory rate of 34% are not allowed as a credit against their U.S. tax liability, a fact that directly reduces the company's bottom line, unless it can utilize these "excess" credits during the statutory carryover period. In many cases, companies can capture tax advantages by shifting some overseas operations from high-tax jurisdictions to low-tax jurisdictions. Shifting operations