Forbes

14 May 2003
Janet Novack

WASHINGTON - Former Senate Finance Committee Chairman Russell B. Long (D-La.), who died last week, will be remembered for, among other things, his pithy and pointed description of tax reform: "Don't tax you, don't tax me, tax that fellow behind the tree."

These days, however, some in Congress are looking even farther afield, to tax that foreign fellow behind the tree.

One example is in the House-passed $550 billion tax cut, which would reduce the top individual tax rate on dividends received from domestic corporations, but not foreign ones, to 15%. Foreign dividends would continue to be taxed as ordinary income. (The top ordinary rate is now 38.6%, but would fall to 35% under the bill.)

This provision isn't likely to become law, but it is an indication of the growing challenges foreign companies face in Washington. "The last time I saw this kind of legislative activity was in the early 1990s," sighs Nancy McLernon, deputy director of the Organization for International Investment, a lobbying group that includes100 foreign corporations with U.S. operations, including DaimlerChrysler, Shell, Nokia, Siemens, Unilever, BP, Novartis, Sony, GlaxoSmithKline, Bayer, Hitachi, Toyota Motor and Honda Motor.

The foreign companies were shocked when they discovered that House Ways and Means Chairman Bill Thomas (R-Cal.) had inserted the discriminatory provision in the bill. "They weren't stopping foreign companies from getting a tax break, they were stopping the American stockholders who had followed the advice of their financial advisers (to diversify internationally) from getting a tax break," McLernon says. According to the Federal Reserve, Americans' foreign stock holdings rose to $1.8 trillion in 2000 from $198 billion in 1990, in part due to the rapid growth in foreign companies traded in the U.S. through American Depositary Receipts.

Luckily for the foreign companies, members of the House Republican Study Committee, an 85-member conservative caucus, were also not happy. They secured a promise from Thomas that dividends of foreign and domestic companies would receive equal treatment in any final bill.

But the foreign companies' problems are far from over. Political threats to foreign companies tend to rise when the U.S. economy is weak, McLernon notes. On top of that are current U.S. security concerns and resentment in Washington over the lack of support from some traditional allies for the Iraqi war. Adding to all that in the tax area is the much publicized problem of corporate inversions. That's the phenomenon in which certain U.S.-born-and-bred companies, including Tyco International (nyse: TYC) and Cooper Industries (nyse: CBE), reincorporated in tax-haven countries to cut their U.S. tax bill.

Some in Congress want to punish the inverters; the Senate tax bill, for example, includes new limits on inverted companies' use of earnings stripping--the process by which loans from a foreign parent to a U.S. subsidiary are used to drain the U.S. operations of taxable profit.

But both the Bush Administration and Rep. Thomas have concluded that the problem is a bigger one, namely that the U.S. tax code places U.S. companies at a disadvantage versus their foreign-based competitors. Part of their proposed solution involves tougher rules on earnings-stripping for all U.S. subsidiaries, not just those of inverted companies. In other words, the U.S. subsidiaries of traditionally foreign companies would have to live with these new rules too. An OFII analysis of a Bush Administration proposal on earnings stripping concludes it would violate international treaties, impose "prohibitive administrative and compliance costs" and possibly lead to foreign retaliation and less investment in the U.S.

Now, the foreign corporations are awaiting Thomas' proposal. "Flaws in the Tax Code force U.S. companies to move their headquarters overseas in order to compete,'' Thomas said last week. "The Committee on Ways and Means will be addressing this larger issue in this Congress." And the foreign companies will be playing defense. But they won't be playing it alone. "What's true now, that wasn't true in the 1990s,'' says McLernon, "is we've got our defenders on the Hill. They know over 6 million Americans work for these companies."

Copyright 2003 Forbes, Inc.