July 2006

Stripping Away U.S. Taxes

By: Becky Wiese

Many academics and policymakers have raised ethical questions about corporate inversion transactions in which a subsidiary located in a tax haven such as Bermuda becomes the organization’s parent company. But the related but less-talked-about practice of earnings stripping is also draining a significant proportion of U.S. tax revenue.

Earnings stripping involves multinational corporations using intercompany debt as a way to shift taxable income from U.S. operations to the lower-taxed foreign parent.

In a study published in the National Tax Journal, Accountancy Professor James Seida and a colleague discovered extensive earnings stripping practices in a subset of foreign-controlled domestic companies.

For four inverted firms with necessary financial statement information, they found that more than $2 billion of U.S.-based income was shifted to foreign jurisdictions through the use of intercompany debt and fees. This apparent earnings stripping by the four firms resulted in an estimated $713 million revenue loss to the U.S. Treasury. To the extent that other foreign-based companies use similar earnings stripping mechanisms, Seida’s research shows that billions of dollars of corporate tax revenues may be at risk.

“While the 2004 Tax Act made changes to eliminate corporate inversion transactions,” says Seida, “no changes were made to rules that prevent the stripping of U.S. earnings. Policymakers should consider legislation to limit earnings stripping and to protect the U.S. corporate tax base.”

Contact James Seida at James.A.Seida.1@nd.edu

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