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US Tax and Trade Policy Supports the Growth of International Financial Services


By Professor Denis Kleinfeld, Kleinfeld Legal Advisors, PA (01/02/2019)

 

The United States’ tax and trade policies primarily aim to boost foreign capital investment, encourage domestic capital creation, and provide the money that facilitates politically driven, vote enhancing social engineering.

 

As international trade and global development grew, the need to service ever-intricate transnational business requirements was met by small and large countries alike, offering a diverse menu of financial services, including privacy, efficiency and tax benefits.

 

The United States, as the most capital-hungry country on the global stage, took full advantage of all the onshore and offshore financial centre and tax haven offerings. It became the world’s largest financial centre and tax haven.  Quite simply, without capital, there is no capitalism.

 

How that capital is allocated within the economy has been a long-time, ongoing battle of competing interests between those who believe in the individuality of the free market and those who believe in the collective state. The same points of contention apply to the United States today and every other country.

 

The remarkable election of President Trump brought Washington, D.C., a new administration which, more than any administration in modern US history, was imbued with an understanding of the need for private sector entrepreneurs to have both access to money to expand their business productivity as well as freedom from costly governmental regulation.

 

The Trump administration, quite dramatically and against fierce opposition, took it upon itself to both radically cut governmental regulation and reverse the anti-business policies of the last administration. The combination gave the domestic and international private sector economy an immediate economic jumpstart. But the question of how to generate the additional hard cash necessary to spur the growth of sustainable economic productivity remained.

 

There were two potential sources of cash available: the first being more foreign capital investment, and the second, a reduction of taxes.

 

The United States is at the top of the short list of countries considered safe and secure for capital investment. Its legal system which protects private property and personal rights enabled the country to become the world’s dominant economy. With passage of the Tax Cuts and Jobs Act 2017 (the TCJA), the United States further advanced its tax competitiveness, thereby boosting its reputation as the largest capital and tax haven of the world. In effect, the United States is a huge capital magnet pulling in money from all over the globe.

 

This is occurring against the backdrop of a political climate in the United States that is (and this is perhaps understated) volatile and fractious. Blips of violence occur from small but apparently well financed groups of physically confrontational protestors. The entire Democratic Party, which labels itself ‘The Resistance’, and the anti-Trump Republicans are reflexively opposed to any policy initiative by the Administration.

 

Despite this opposition, the reticent political establishment in Congress was pushed by the Trump Administration, bludgeoned some have said, to pass the TCJA in only six weeks. It is the most consequential and significant tax legislation in over three decades.

 

The TCJA strategically altered the foreign tax regime to encourage untaxed foreign money to be repatriated to the United States. The TCJA also aims to entice foreign direct investment and assist future business expansion in the United States. Domestic business operations and workers received significant tax breaks.

 

 “…there is now an emerging consensus that the law may pull so much investment into the United States that it could impoverish governments across the globe,” writes James Freeman for the Wall Street Journal[1]. For the offshore jurisdictions dependent on providing international financial services this enhanced capital flow represents an exciting opportunity.

 

What the TCJA shows is that a reasonable combination of trade-offs and compromises can produce a result which is good enough. Fortunately for the US, Trump, unlike previous presidents, had the political will and freedom to overcome the opposition from deeply entrenched political interests. Unfortunately, political leaders in the European Union, Britain and other countries lack the fortitude or cannot afford to buck the political establishment. For the so-called ‘major industrial powers’ it is politics as usual. 

 

The small countries making up the offshore tax haven and financial services industry were hamstrung by the major industrial countries of the OECD. Imposed upon them are the anti-offshore regimes of the OECD with its blacklists, the Common Reporting Standards, FATCA, and new financial statement disclosure standards, among other changes to the international financial environment. All are serious impediments to the mobility of capital, a huge drag on the global economy, and severe incursion on personal freedom.  

 

One could reasonably wonder whether any of this is doing any good. And if it is, then at what cost? And if it is not good, then why is it being done?

 

Quite dramatically, the TCJA impacted on the OECD anti-tax competition initiative to promote tax harmony globally. The United States, in effect, stole the OECD’s lead in addressing the contentious issues of multi-national profit shifting and tax base erosion. The issue that the OECD was particularly distressed by was digital companies, such as Apple, Google, Facebook, Amazon, paying little or no income tax. Somehow these unaccountable OECD bureaucrats, living tax free in Paris, thought that making a profit and building shareholder value was wrong; and that the money would be better redistributed to more deserving countries to achieve social justice goals. The United States, however, believes that the money should come to the United States and took steps accordingly. So much for global tax harmony.    

 

The changes in the tax code under the TCJA mean that US tax persons who have non-US businesses and asset holding legal structures (outbound configurations), as well as international persons with investments into the US (inbound arrangements) will need to review and revise all their existing tax planning structures. There are a lot of tax minimisation benefits on offer in addition to capital safety representing new planning avenues for international financial services.

 

Although the TCJA is massively complex, there are a couple of outbound developments that can be highlighted.

 

Dealing with the controlled foreign corporation rules and the other anti-tax deferral provisions has always been challenging. Adding to that is a new category called ‘global intangible low-taxes income’ (GILTI). This new type of income designation will be subject to rules like Subpart F income, but with other limitations and new deemed ownership rules.

 

The effect of the new legislation is to move the United States to a modified territorial tax system. There is a one-time mandatory inclusion of income on so-called ‘deferred foreign income corporations’ (DFICs). The clear purpose of this provision is to encourage the foreign operations of US multinationals to return to the United States at a low tax rate (essentially a toll charge), rather than be held in a foreign financial account by some competing tax haven. So far, it’s working.

 

The United States created its own version of the participation exemption, which operates differently than that used in the EU. Under this new US participation exemption scheme, at least 10 per cent of DFIC corporate shareholders could be exempt from corporate tax on dividends received if those dividends are paid out of foreign-sourced earnings. Capital gains may also qualify.

 

Inbound structures also benefit from the ground-breaking reconfigurations of the tax code.  These include, for example:

 

·         the US corporate rate, lowered to 21 per cent, along with accelerated expensing.

 

·         the new interest deduction limitations, which are more severe, making it necessary to re-evaluate whether to invest into the US by way of debt or equity.

 

·         interest expense deductions which arise from hybrid instruments and entities are denied.

 

The US has also introduced its new base erosion and anti-abuse tax rules (BEAT), effectively beating the OECD at its own game.

 

This dramatic change in tax policy is happening along with the US demand to renegotiate existing trade treaties reinforced by the imposition of sanctions. Consequently, there is the threat of a trade war with the European Union, Canada, Mexico, Russia, China and Iran if new treaty terms cannot be reached.

 

Who Will Win This?  Let’s Look at the Facts

 

The United States is the largest agricultural producer in the world, the largest manufacturer, the largest energy producer; it has the largest retail market, and more annual immigration than the rest of the countries in the world combined. The US dollar is the sole reserve currency for the global financial system. The dollar’s dominant position is backed by the sole super-power of military might.

 

Exports represent a small part of the US GDP, while its trading partners are in the opposite position. Consequently the United States has negotiating leverage since it can afford to walk away from any negotiation and come back later. The other countries are not so blessed.

 

Make no mistake, the US needs its trading partners and must cooperate as well as compete. But it would be best if everyone in the future did business fairly on a level playing field for trade.  

 

The offshore financial service jurisdictions have the opportunity to grow their customer base. More developing countries will need offshore financial services as they adopt the methodologies of economic success. Financial and tax compliance services will replace tax avoidance. Like the existing market of the industrial countries, new customers will also want transnational service providers who can help capital flow in safety and efficiency in an environment reliably compliant with international tax disclosure norms.

 

Those offshore service providers that adapt and innovate will be successful in garnering their share of new business. Video conferencing services, for example, are not only incredibly inexpensive, but can be employed with just one click on the computer. In the virtual world of technology, there is little difference between onshore and offshore financial services. Everyone can compete for their share of customers and clients.

 

What will be of most importance are the skills, knowledge, experience, and efficiency of the service provider. And motivated by personal will (not unlike President Trump’s) to make it all happen in the face of opposition.

 



[1] J. Freeman, ‘Trump’s Tax Wisdom’,www.wsj.com, Wall Street Journal, 2018, https://www.wsj.com/articles/trumps-tax-wisdom-1533850010, (accessed 28 August 2018) 

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