Tax Provision Lets Companies Defer Taxes on Overseas Income

By WaPo, WaPo - December 23, 2010

A breakdown of what Democrats and Republicans won (and lost) in the tax cuts deal, and how it will impact the economy.

President Obama and congressional Republicans reached a tentative deal to preserve George W. Bush administration tax cuts for families at all income levels for two years.

Amid all the goodies for ethanol producers, NASCAR racetracks and the like, the tax-cut compromise legislation approved by Congress this month also includes a little-noticed sop for Wall Street banks and major multinationals.

And it only costs U.S. taxpayers $9 billion.

Under the provision, financial services firms and manufacturers can defer U.S. taxes on overseas income from a type of financial transaction known as "active financing." Boosters say the two-year exemption helps level the playing field with foreign competitors by ensuring that U.S. corporations aren't taxed twice.

Major business groups and financial companies consider the exemption a key lobbying priority in Congress, which has regularly extended it on a temporary basis for more than a decade. Those lobbying in favor of the policy include dozens of the largest U.S. companies, from General Electric to J.P. Morgan Chase to Caterpillar, records show.

The Active Financing Working Group, a coalition of companies and trade associations focused on the issue, has paid $540,000 in lobbying fees to Elmendorf Strategies since last year, according to Senate disclosure forms.

The exemption ensures "that U.S.-based financial services [businesses] are able to continue to operate competitively and provide the funds needed for investment and economic growth," the working group wrote in a letter to the Treasury Department.

But the provision has long been opposed by watchdog groups and labor unions as a needless tax break that encourages companies to create jobs overseas instead of within the United States.

"This loophole creates an enormous tax shelter for the companies who have lobbied it into law," said Steve Wamhoff, legislative director at Citizens for Tax Justice, a liberal advocacy group. "It ought to be allowed to expire."

Companies have long been allowed to defer U.S. taxes on most money earned by their overseas subsidiaries, but financial activities have traditionally been left out of this exemption because such transactions are too easy to shift offshore, according to Wamhoff and other experts.

But the business lobby gained an exception in 1997 for "active financing," which includes some kinds of insurance and banking income as well as income from financing the sale of products overseas. A heavy-equipment manufacturer, for example, can use a foreign subsidiary to finance the sale of its machines to an overseas customer, and does not have to pay any U.S. corporate income tax on that transaction.

Backers say the measure amounts to simple common sense in the global marketplace, especially since many other countries have lower corporate tax rates and do not attempt to tax foreign income.

The Joint Committee on Taxation, which calculates the costs of congressional legislation, estimates the provision will cost $9.16 billion through 2011. The entire package - which also includes unemployment benefits and a two-year extension of the Bush administration tax cuts - will cost $858 billion.

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