Grant Thornton Weighs In on Foreign Entities in U.S.

Accountancy says the heated growth rate for overseas control would have been hotter still had U.S. taxes not been so high.

Recent reports of the groundswell of foreign-controlled domestic corporations (FCDCs) in the U.S. have suggested that high corporate taxes don’t discourage such activity here. But a study by Grant Thornton LLP cites evidence that overseas companies may actually have been holding back — and could increase their activity in the U.S. even more were taxes to be cut.

The latest report suggesting that foreign companies operating here aren’t deterred by U.S. taxes came from the Internal Revenue Service itself. The IRS released data from the 2005 tax year (the most recent available) showing that there were 61,820 FCDCs then, accounting for just 1.1 percent of the total of all U.S. corporations, but generating $3.5 trillion of total receipts, with $9.2 trillion of total assets. That accounted for 13.7 percent of all U.S. corporate income-tax receipts and 13.9 percent of reported assets.

In addition, profits reported by FCDCs for tax purposes were $165.2 billion, an 81.9 percent increase from $90.8 billion reported in the prior year. (The IRS uses net income less deficit to indicate the profit line.) And the U.S. tax liability for FCDCs (total income tax after credits) was $42.4 billion for 2005, a 41.7 percent increase over 2004.

But that explosion in foreign investment might have been much greater had taxes not been as high as they are, the Grant Thornton report suggests.

“Despite the high corporate tax rates, many foreign multinationals recognize the importance of the U.S. market from a global standpoint,” says Joseph Calianno, a partner in Grant Thornton LLP’s National Tax Office. “They understand that the business and profit opportunities in the United States often outweigh the tax costs of doing business in the United States.”

And Grant Thornton sees in the IRS data a suggestion that foreign companies may indeed have been reluctant to enter the market,and that FCDC assets and earnings might have grown even more robustly if the U.S. had more competitive rates.

As proof of its thesis, Grant points out that the number of such foreign entities operating and filing returns in the U.S. has remained largely stagnant for over 10 years, even as total assets and receipts have gone up. So, with total corporate filings continuing to increase every year, FCDCs now represent a smaller percentage of total domestic corporations than they did in 1996, the accounting firm adds.

According to Grant, the U.S. corporate tax rate has changed little since the late 1980s while countries all over the world have been cutting rates to compete for investment and spur economic growth. The U.S. now has an average combined state and federal corporate rate of almost 40 percent, the second highest to Japan among OECD countries.

“There is a growing consensus across the ideological spectrum that the U.S. needs to cut its corporate rate to remain competitive in a global economy,” Grant states. “The idea has been long championed by conservatives, but many Democrats have recently supported lowering rates.”

Calianno insists a real, meaningful reduction in the U.S. corporate tax rate would likely stimulate even greater investment by foreign based multinationals into U.S. corporations. “Several other countries in recent years have reduced corporate tax rates in an attempt to attract such investment and, for the most part, such measures have been successful,” he adds.

A rate reduction would also help U.S.-based multinational groups as long as there is not a corresponding tax cost that essentially wipes out the benefit, Grant stresses.

“U.S.-based multinational groups often feel they are at a disadvantage compared to certain foreign-based multinational groups because of high U.S. corporate tax rates, a U.S. tax system that taxes U.S. corporations on their worldwide income, and the application of certain anti-deferral regimes, such as the subpart F regime,” according to Calianno.

Grant addes that antideferral rules such as subpart F often require U.S. companies to include certain types of income earned by their foreign subsidiaries into income even though such income has not been repatriated.

In any case, Grant notes that most FCDC receipts come from corporations with owners in just a few countries.

FCDCs with foreign owners from the United Kingdom, Japan, Germany, Netherlands, Canada, and France were responsible for over three-quarters of all FCDC receipts in 2005. Most of the FCDC receipts are also earned in just a few industries. Over 80 percent of FCDC receipts came from the manufacturing, wholesale trade, and the finance and insurance industries.

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