Treasury's long-awaited Subpart F study breaks no new ground, touts ending deferral.

Introduction

On December 29, 2000, the U.S. Treasury Department released its long-awaited study on Subpart F. Treasury's stated impetus for undertaking the study was to "reexamine whether Subpart F is the most appropriate -- or effective -- way to tax foreign income."(1) Underlying its interest to revisit the anti-deferral rules is Treasury's perception that recent developments have undermined the ability of Subpart F to serve its intended purpose. In December 1998, Treasury's then Assistant Secretary for Tax Policy, Donald Lubick, announced that Treasury would be undertaking such a study. His announcement came at the close of a year in which Treasury had issued -- and then retreated from -- Notices 98-11 and 98-35, addressing the treatment of so-called hybrid branches in the Subpart F context, and taken other steps aimed at curtailing what it believed to be abuses of Subpart F.

The lengthy study -- which is set forth in seven chapters running more than 100 pages, plus an additional 100 pages of appendices -- begins by tracing the historical development of the Subpart F rules and examines from an economic perspective the various policies available to any jurisdiction with respect to taxing foreign income. The study focuses on the extent to which particular policies would promote economic welfare and also addresses the effect of Subpart F on the competitiveness of U.S. businesses. The study then examines whether Subpart F has achieved its policy goals and whether certain developments may challenge Subpart F in the future. Following this progression, Treasury presents options for replacing or reforming Subpart F.

The following international tax policy principles served as a guide to Treasury in developing these options:

* Meeting the revenue needs determined by Congress in an adequate and fair manner;

* Minimizing compliance and administrative burdens;

* Minimizing distortion of investment decisions through tax considerations;

* Conforming with international norms, to the extent possible; and

* Avoiding placing an undue burden on the competitive position of our nationals.

This article summarizes the Treasury Study and comments on several of its conclusions. We note that Treasury has acknowledged that the conclusions of this study are neither recommendations nor legislative proposals.

Chapter 1: Why Subpart F Was Enacted: Developments In the Law Before 1962

The Treasury Study examines the events that led to the enactment of Subpart F -- information that is then used to attempt to determine the intent of Subpart F when originally enacted.

Anti-deferral rules are necessary, the study says, because of two fundamental features of the U.S. income tax system that operate to allow the avoidance of tax: the treatment of a corporation as a separate person and the imposition of tax on a U.S. person's worldwide income. These two features are inconsistent and have produced an inherent tension in the U.S. income tax system, the study notes, because the treatment of a corporation as a separate person provides taxpayers an avenue to avoid worldwide taxation through the use of a foreign corporation (i.e., the foreign corporation is untaxed on its foreign-source, non-effectively connected income). In a tax system that employs these two fundamental features, the ability to avoid tax is made available unless anti-deferral techniques are implemented.

The Treasury Study concludes that both of these fundamental features of the U.S. tax system are important. It states that worldwide taxation ensures equity in the tax system by treating all income the same, by ensuring that investments are not made for tax-motivated reasons, and by avoiding the perception of unfairness that would occur if tax reduction were more readily available to those with the ability to invest abroad. On the other hand, Treasury recognizes that the treatment of a corporation as a separate person is integral to maintaining the "`classical' system of taxation"(2) where a corporation's earnings are subject to two levels of taxation and there is an ability to defer the second level of taxation until distribution. It is this opportunity to avoid taxation that anti-deferral provisions should attempt to remedy.

The study reviews several different anti-deferral provisions that preceded the Subpart F rules beginning in 1913 and continuing through the 1962 enactment of Subpart F.(3) The study concludes that the "main thrust of the tax avoidance techniques which led to the enactment of Subpart F was the `deflection' of income to low-tax jurisdictions, not only from the United States, but also from foreign high-tax developed countries where the principal value adding activity took place."(4)

By presenting the chronology of the distinct anti-deferral regimes that preceded the enactment of Subpart F, Treasury seeks to illustrate that between 1913 and 1962, Congress acted to thwart attempts by taxpayers to avail themselves of the tax avoidance opportunities presented by the tension between the treatment of corporations as separate persons and the taxation of worldwide income. The study emphasizes that in 1962 Congress acted decisively to enact legislation that would enforce the principle of worldwide taxation by restricting deferral.

Chapter 2: The Intent of Subpart F

Treasury next focused on identifying the specific intent behind the enactment of Subpart F. The study points out that the Kennedy Administration originally "proposed to end `tax deferral privileges in developed countries' and to eliminate `tax haven deferral privileges' in all countries." In 1962, after consideration of President Kennedy's proposal, Congress enacted legislation to end "tax haven deferral," but stopped short of following the Kennedy Administration's proposal to end tax deferral for all income earned in developed countries. The Administration and Congress defined the types of transactions that gave rise to "tax haven deferral" as those "`artificial arrangements' between related corporations that `exploit the multiplicity of foreign tax systems and international agreements in order to reduce sharply or eliminate completely [their] tax liabilities at home and abroad.'"(5) The Treasury Study acknowledges that tax haven abuses greatly contributed to the enactment of Subpart F. Furthermore, the study emphasizes that Congress sought to end deferral for income obtained through such "artificial arrangements" that shifted income from high-tax jurisdictions (either the U.S. or high-tax foreign jurisdictions) to low-tax jurisdictions.(6)

In addition to tax haven abuses, the Treasury Study says that Subpart F was also enacted to tax passive income currently, promote equity among taxpayers, and promote economic efficiency based on the concept of tax neutrality. In this connection, Congress reasoned that taxing passive income currently would not jeopardize the competitiveness of multinationals. When explaining why it had not followed the Kennedy Administration's proposal to end deferral on all income, Congress made clear that it was concerned that an end to all deferral would place U.S. companies at a competitive disadvantage with respect to their foreign investments.

Treasury's report on the intent of Subpart F then concludes that "Congress [in 1962] may have believed that by ending deferral only in the tax haven context (as opposed to ending all deferral) and with respect to passive income, it addressed the goals of equity and efficiency without unduly harming competitiveness."(7)

Chapter 3: Economic Welfare and the Taxation of Foreign Income

Having concluded that in 1962 Congress intended to enact Subpart F in order to prevent income shifting from the U.S. or other foreign non-tax haven jurisdictions to foreign tax havens, the Treasury Study attempts to determine whether this intention is a valid economic goal and whether it is achieved currently with Subpart F (i.e., whether Subpart F improves global and economic welfare). Treasury begins by presenting outside economic research studies discussing the best way to tax foreign income to maximize global and U.S. economic welfare. Then Treasury focuses on how the Subpart F foreign-to-foreign related party rules (i.e., the foreign personal holding company income rules (other than the "same country" and rents and royalties exceptions) of section 954(c), the foreign base company sales income rules of section 954(d), and the foreign base company services income rules of section 954(e)) affect global and U.S. economic welfare.

In its analysis, Treasury employs two basic economic models developed independently(8) to measure how foreign investment should be taxed in order to maximize economic welfare. To reach its conclusions, Treasury also changes several of the assumptions of these models in an attempt to further add to the credibility to its findings. (It also seems more critical of studies not supporting the po]icy of capital export neutrality that of those that do.) In sum, Treasury concludes that a basic economic analysis using the models presented supports the conclusion that capital export neutrality is probably the best policy available to promote economic welfare. Pursuant to this conclusion, Treasury asserts that imposing equal taxes on domestic and foreign investment income will provide for the greatest global economic output. Furthermore, Treasury asserts that it finds no evidence that setting the U.S. tax rate on foreign income at least equal to the U.S. tax rate on domestic income would harm U.S. economic welfare.

It is, of course, interesting to note that even prior to undertaking this analysis for purposes of the study, Treasury had already embraced and advocated the policy of capital export neutrality and cited its role in the creation of the Subpart F rules to support its position in Notice 98-11, among other things.

Having -- to no one's surprise -- established that it believes the policy of capital export neutrality should guide its analysis, Treasury then focuses on the narrower issue of whether the Subpart F foreign-to-foreign related party rules promote global and U.S. economic welfare. Treasury concludes that it remains unclear whether these rules serve to promote capital export neutrality. In addition, the study also concludes that the effect of the Subpart F foreign-to-foreign related party rules on U.S. economic welfare is uncertain. Treasury does state its belief, however, that limiting the deferral sanctioned by the Subpart F foreign-to-foreign related party rules would increase U.S. tax revenues by reducing the incentive for capital to leave the United States. In other words, without the Subpart F foreign-to-foreign related party rules, taxpayers would have the ability to effectively reduce tax on foreign income. Such reductions would violate the principles of capital export neutrality.

Chapter 4: Competitiveness and the Taxation of Foreign Income

Recognizing that in 1962 Congress was concerned about Subpart F's effect on the ability of U.S. multinationals to compete abroad with foreign multinationals, Treasury also addresses whether Subpart F has, in fact, affected the competitiveness of U.S. multinationals in relation to that of their foreign-owned competitors. Treasury notes that the ability of U.S.-owned multinationals to compete with foreign-owned multinationals involves many elements and that the available data are insufficient to accurately determine whether Subpart F alone has had a significant effect on U.S. multinationals' ability to compete. Treasury also notes that the promotion of competitiveness may conflict with the aim of promoting economic welfare. The study makes it clear that most of the U.S. trading partners have implemented what Treasury considers to be similar anti-deferral regimes, seemingly to assert that this trend levels the playing field and balances competitiveness worldwide by subjecting foreign-owned competitors of U.S. multinationals to similar anti-deferral regimes.(9)

Once again, although most major U.S. trading partners do have some form of anti-deferral regime, not everyone would agree with Treasury's assessment that these are comparable to Subpart F. Over the past few years, Treasury has generally rejected the competitiveness argument, although it has resonated among the business community and many on Capitol Hill.

Treasury's study concludes that Congress in 1962 intended to prevent tax haven abuses, tax passive income currently, promote economic equity between taxpayers, and promote economic efficiency while avoiding undue harm to competitiveness.

Chapter 5: Avoiding the Rules of Subpart F

It is with this foundation that Treasury proceeds to identify transactions commonplace in the present day business environment that, it says, undermine the aims of Subpart F.(10) Specifically, the study cites transactions using hybrid entities and those that take advantage of the manufacturing exception of the foreign base company sales income rules of section 954(d).

The study explains that tax avoidance techniques making use of hybrid entities undermine Subpart F by exploiting the "corporate focus" of Subpart F and the failure of Subpart F to "address directly inter-branch passive income payments."(11) By citing several examples of such techniques, the study concludes that hybrid entities are used by taxpayers to avoid the Subpart F rules and effectively deflect income from high-tax jurisdictions to low-tax jurisdictions. The study specifically says that Subpart F could be compromised by techniques that exploit: "(1) the difference in the tax treatment of corporations and partnerships, (2) differences in entity classification among jurisdictions, and (3) the same country exception to the foreign personal holding company income rules of [section] 954(c)(3)(A)."(12)

The study also delves into several techniques that, it says, defeat the intention of Subpart F by abusing the manufacturing exception to the foreign base company sales income rules. Specifically cited are the use of contract manufacturing and the use of commissionaire arrangements to divert income into low-tax jurisdictions.(13) Yet another technique discussed by the study is the ability to use dual resident corporations to avoid the application of the foreign base company income rules.(14)

By presenting a compilation of various techniques that defeat what it believes was, and continues to be, the intention of Subpart F, Treasury determines that such techniques provide clear evidence that Subpart F may no longer be effective in preventing the shifting of income to low-tax jurisdictions that it was intended to stop. Again, regarding Treasury's view of changing business paradigms, such as the use of contract manufacturers, many would take issue with Treasury's conclusion that this is not intended and is inappropriate.

Chapter 6: Challenges to Subpart F: Entity Classification, Services, and Electronic Commerce

In addition to the specific transactions and tax planning techniques discussed above, the study revisits the interaction of the check-the-box entity classification rules and Subpart F. It includes statistics showing the proliferation of hybrid entities -- especially disregarded entities -- since the January 1, 1997, effective date of the check-the-box rules.(15) While asserting that the disregarded ehtity has been used extensively as a planning tool and that it, along with hybrid entities in general, has undermined the intentions of Subpart F, Treasury acknowledges that it was the introduction of the check-the-box regulations that exacerbated the perceived problem.

The Treasury Study also discusses the effect of two other recent developments on the effectiveness of Subpart F. The first is the transition of the world economy away from manufacturing-based industries to service-based industries. This trend, the study asserts, compromises the effectiveness of Subpart F because Subpart F was originally designed to combat the deflection of income from high-tax jurisdictions to low-tax jurisdictions in an economy that was based primarily on manufacturing. According to the study, "despite their level of detail, the financial services rules do not sufficiently address the mobility of business enterprises or of income, nor do they adequately distinguish active from passive business.(16)

The study questions the effectiveness of the "activity" rules that are designed to ensure that a financial services business is active, describing those rules as "imperfect" and illustrating the concern by pointing out that "many of the major functions of certain insurance companies can be performed by third parties." This discussion concludes with the observation that, "as more of these activities are performed by outside contractors, the insurance company begins to look more like a passive entity." "In the case of finance companies," the study suggests, "it may be difficult to distinguish an active company from a passive one."(17) The study then asserts that it may be possible for "a large multinational with a significant amount of retained foreign earnings to capitalize a finance company and then have it engage in a few significant transactions with unrelated persons."(18) This discussion concludes that "while this may be little different from purchasing corporate debt or other passive assets which generate Subpart F income, in this case the income earned will be `active' and thus, not subject to Subpart F."(19)

Regarding "mobility of enterprise," the stated concern is that "the types of entities covered by [the financial services exception] may be highly mobile in that they can be relatively easily located in a tax-favorable jurisdiction completely unrelated to where the recipients of the income are based."(20) The study suggests that a "financial services business may be able to choose its location based on tax considerations rather than non-tax business considerations," because "in the case of certain active financial services businesses ... the non-tax factors that affect the location of a manufacturing business may not apply."(21) While conceding that, "at least for finance companies and insurance companies, the statute may limit the ability of businesses to exploit their potential mobility,"(22) the study goes on to raise the specter of tax avoidance by noting that "this provision may become less effective in the future as it becomes more difficult to tell where activities are performed and to which QBU (or QBUs) activities should be attributed. For example, some of these rules might potentially be circumvented if a taxpayer were to provide financial services over the internet and were to argue that it had a QBU in each country in which there is a customer."(23)

The third and last stated concern presented by the active financing exception, according to the study, relates to the characterization of the affected income as "highly mobile in that it may be easily shifted from jurisdiction to jurisdiction, often without imposition of tax."(24) In this connection, the study takes another swipe at hybrid branches by including the statement that the statutory rules designed to ensure that income is "earned" in a home country do not "prevent subsequent deflection of this income for foreign purposes by [the use of hybrid transactions]."(25) The final criticism noted is that "the statute prevents all active financing services income from constituting foreign base company services income. As a result, to the extent income can be earned in a low-tax jurisdiction, such income (unlike other types of services income) is insulated from treatment as foreign base company services income."(26)

In the end, the study recognizes that an effort to alter the Subpart F rules to better deal with a service-based industry may only unduly complicate these rules and create an overwhelming administrative burden on both taxpayers and the government.(27)

The final challenge to the Subpart F regime that Treasury contemplates is that posed by electronic commerce. Treasury states that electronic commerce will further undermine the ability to determine where income-producing activities are performed and the ability to classify income derived from such activities -- both integral to the application of the Subpart F rules. The study also cites several examples of how electronic commerce and other new technologies affect the ability to circumvent the rules of Subpart F.(28)

Having delved into the history of Subpart F and the challenges that Subpart F faces in today's economy, Treasury considers what it believes may be viable options for reforming or replacing Subpart F to maintain the integrity of what Treasury believes was intended.

Chapter 7: Criteria and Options for Change

As a preface to introducing its options for reforming the current Subpart F regime, Treasury explains what it considers to be the appropriate criteria to evaluate these alternatives. Treasury identifies the following four factors as the "fundamental goals of international tax policy":(29)

* Meeting revenue needs in an equitable manner,

* Promoting economic welfare,

* Minimizing compliance and administrative burdens, and

* Conforming with international norms to the extent possible.

Treasury also recognizes that these goals should be achieved without compromising the competitiveness of U.S.-owned companies.

In the discussion concerning the need to raise revenue in an equitable manner, the study states that a tax system that is perceived as unfair by taxpayers will contribute to non-compliance. Furthermore, it asserts that equity can be achieved by subjecting foreign income to a similar tax burden as domestic income and that an anti-deferral regime is necessary to achieve this result. Treasury also emphasizes the need to "eliminate inappropriate distinctions between business conducted in corporate form and business conducted in other forms, such as through partnerships and disregarded entities."(30)

In evaluating the need to promote economic welfare, the study states that economic efficiency is achieved when investment decisions are driven by business and non-tax considerations. Again, an anti-deferral regime is said to promote economic welfare by taxing foreign income at the same rate as domestic income.

As to the next criterion, simplicity would promote voluntary compliance while administrability would reduce costs to taxpayers and the government. Treasury admits that any anti-deferral rules may have an inherent degree of complexity in order to deal with the complex situations existing in today's business and legal environment.

Lastly, Treasury believes that "countries should adopt, to the extent possible, tax policies that harmonize with the tax policies generally in use internationally."(31) Broadly speaking, such an effort will minimize both double taxation and double non-taxation.

An anti-deferral policy that meets the above criteria is preferred, although the policy should not unduly harm the ability of U.S. companies to compete in the world's markets. Although the study admits this position, it also includes the contrary assertion that the goals of equity and economic efficiency (i.e., the prerequisite to achieving economic welfare) may be in conflict with the maintenance of a U.S. company's ability to compete with foreign-owned companies. It therefore recommends that alternative anti-deferral regimes consider their effect on competitiveness while weighing such effect on the positive consequences of such options (i.e., the effect of promoting equity and economic efficiency).

Three primary options to the current Subpart F rules are presented by the study. The study acknowledges that these options do not attempt to analyze the competitiveness issue.

      Option 1 is the complete repeal of deferral. The study notes that the
   complete repeal of deferral could be achieved in three different ways.(32)
   Treasury emphasizes that equity among taxpayers would be achieved and
   economic welfare would be promoted. Furthermore, this option would greatly
   simplify the current anti-deferral regime. Treasury also claims that this
   option would operate harmoniously with the tax laws of other countries.

      Option 2 entails subjecting foreign income to current inclusion but at a
   rate lower than the rate imposed on domestic income. Therefore, all net
   income of a CFC would be currently includible in the gross income of its
   U.S. shareholders, but such inclusion would be taxed at a lower rate of
   U.S. tax. Treasury also claims that this option achieves equity (defined by
   reference to the disparity between the tax burden borne by domestic income
   and that borne by income earned through a foreign corporation), economic
   efficiency, and simplification.

      Option 3 would modify the current Subpart F rules by repealing the
   foreign-to-foreign related party rules but adding an effective tax rate
   test. Deferral would be available under an effective rate test that would
   require a CFC's active income to be currently included in the gross income
   of the CFC's U.S. shareholders if the foreign effective tax rate on such
   income were less than a certain percentage. Treasury states that both
   equity and economic efficiency would be enhanced if the effective-tax-rate
   test used a rate close to the rate of tax imposed on domestic income.
   Treasury also asserts that this option would conform to international norms
   and would achieve simplification.

Income from passive investments would be taxed at the full U.S. tax rate under any of the three options. In addition to the presented options, Treasury also notes that reforms to Subpart F could take many other avenues. The study very briefly mentions a few of the other suggestions that Treasury offers.(33) These include special rules to treat both corporate and non-corporate entities the same for Subpart F purposes, changing to a "list" approach in determining whether or not to allow deferral, and clarifying the definition of the types of active income that would be eligible for deferral.

Chapter 8: Restatement of Conclusions

In its concluding remarks Treasury simply reiterates its belief that capital export neutrality is probably the best policy to ensure the maximization of economic welfare. Treasury insists that capital export neutrality is most easily achieved by subjecting foreign income to a tax rate similar to that which domestic income is subject. Therefore, it believes that an anti-deferral regime continues to be necessary to prevent significant tax disparity.

These conclusions stem from Treasury's determination that Subpart F was intended to alleviate the problems that arose from a structural tension in the tax system in 1962. Furthermore, Treasury asserts that these tensions still exist and have only been exacerbated by recent developments in today's business and legal environments.(34)

Contents of the Appendices

In addition to the body of its report, the Treasury Study includes four appendices. Appendix A is an historical review of U.S. laws relevant to the current anti-deferral regime (i.e., Subpart F) and entity classification. Appendix B is a survey of the quantitative economic studies that examine the international mobility of capital. Appendix C provides the detail on how different tax rates used as support in the study were measured. Appendix D is a survey of the quantitative economic studies that examine income shifting by multinational companies.

Summary

Although Treasury took about two years from the date of its announcement to issue its Subpart F study -- during which it promised to, in essence, begin with a clean slate -- the study presents itself more as a re-statement of the position that Treasury has espoused for the past several years on policy issues relating to Subpart F.

Congress's intent -- to prevent taxpayers from using artificial income-shifting arrangements -- should be respected. But U.S. multinational corporations that must constantly drive out non-value adding costs and centralize their supply chain management should not be caught up in an overly broad Subpart F net. The business pages have been filled with announcements of global corporations partnering with competitors, suppliers, and customers to contract manufacture products, acquire raw materials and components through e-commerce ventures, and co-promote products in the world markets -- all for the purpose of remaining competitive. If similar transactions among related parties carry the same weight of economic substance and business purpose and meet the arm's-length standard, they should remain outside the reach of Subpart F.

Interestingly, the study gives very short shrift to the role of intercompany transfer pricing rules in dealing with inappropriate diversions of income to low-tax jurisdictions. Perhaps this is because in 1962 the U.S. rules, as set forth under Code section 482, were broadly sketched and the Internal Revenue Service was not terribly experienced or sophisticated in their administration. This is, of course, not true today and may be one reason for viewing any changes to Subpart F in a different light from which the need for such rules was viewed in 1962. Much has changed in the last 38 years. There are now dozens of detailed, technically drawn pages of regulations spanning 12 sections. The IRS has a large body of international agents, economists, lawyers, APA experts, business consultants (internal and external), and trial experience. And, perhaps most important, there is a healthy, consistent dialogue among Treasury, the IRS, and the business community on the design, administration, and enforcement of these rules.

In any event, while the study mainly echoes Treasury oft-stated views, what is different is that proponents of Treasury's views now have a "comprehensive study" to point to in support of those views. Opponents of those views can be grateful that Treasury's stated options for reforming Subpart F -- ending deferral or most deferral -- are so extreme as to make them unlikely candidates for legislative actions.

In this latter regard, given the lack of a significant majority in the House and a virtual tie in the Senate, it seems equally unlikely that any major or controversial tax law changes -- outside of those applicable to individual taxpayers -- will occur in the near term. There may well be opportunities, however, for modest revisions to the Subpart F rules, changes that could be focused on updating the rules to reflect the business realities of the 21st century, rather than dwelling on the supposed intent of the rules laid out in a bygone era.

TEI's 51st Midyear Conference

International Tax Sessions

Building upon the recent creation of a TEI Subcommittee on Customs, the International Tax Committee will sponsor a series of presentations that can colloquially be called "Customs for Dummies," which are designed to bring tax executives up-to-date on what they need to know. Extremely useful sessions will also be held on planning with the recent regulations under section 367; dealing with the single European trading structure; amd emerging issues related to cross-border services and foreign acquisition management. What's more, the conference will feature a program on the Clinton Administration's belated but nevertheless still important Subpart F Study -- a session we thought would be held a year ago -- and whether it lays down a marker for the future. For more information on the Midyear Conference, direct your browser to www.tei.org/MY01Info.html.

(1) The Deferral of Income Earned Through U.S. Controlled Foreign Corporations: A Policy Study vii (2000) (hereinafter referred to as the "Treasury Study"), vii(2000). All page references are to this study.

(2) Treasury Study, 2.

(3) These laws include, among others, a 1913 predecessor to the accumulated earnings tax, the personal holding company rules, and the foreign personal holding company rules.

(4) Treasury Study, 9.

(5) Treasury Study, 13.

(6) The study notes that the U.S. balance of payments deficit, which placed the then-fixed exchange rate of the dollar under pressure, was also a motive for the adoption of Subpart F, but states that, "As exchange rates now float ..., this factor is not a concern today and will not be considered further." While no longer an issue, it may be argued that the study places too much weight on capital export neutrality concerns at the expense of other factors that underlay Subpart F. See Treasury Study, 12 n2.

(7) Treasury Study, 22.

(8) The base studies conducted by Peggie Musgrave (Taxation of Foreign Investment Income, An Economic Analysis (1963) and United States Taxation of Foreign Investment Income, Ch. 7 (1969)) and Gary Hufbauer (American Enterprise Institute, Hoover Institute Policy Study No. 16, A Guide to Law and Policy, US Taxation of American Business Abroad) were used by Treasury.

(9) Treasury seems to suggest that if everyone is doing it, it must be right, or at least that all multinational companies are similarly disadvantaged: "Although competitiveness concerns were considered relevant when Subpart F was enacted and continue to be cited in more recent discussions on deferral, the available data provide no reliable basis for evaluating whether Subpart F has had a significant effect on multinational competitiveness. However, the fact that many countries have recently introduced or strengthened their CFC regimes suggests that the U.S. policy limiting the deferral of income earned by U.S.-owned foreign corporations is fully consistent with the policies of our major trading partners and that foreign multinational corporations are subject to rules that are similar in effect to our Subpart F rules." Treasury Study, 61.

(10) "The purpose of this chapter is to examine generally the effectiveness of the specific rules of Subpart F in meeting [the goals of preventing tax haven abuse, taxing passive income currently, promoting equity and economic efficiency and avoiding undue harm to competitiveness]. Subpart F attempts to achieve its goals through specific rules that are intended to tax passive income on a current basis and to prevent the deflection of income to low-tax jurisdictions and other special tax regimes. This chapter considers two illustrative categories of transactions that avoid the application of those specific rules." Treasury Study, 62.

(11) In this regard the study notes, "The rules of Subpart F are largely premised on the assumption that for non-tax reasons business will be carried on in corporate form (e.g., to limit liability)." Treasury Study, 62.

(12) Treasury Study, 64.

(13) Treasury Study, 65.

(14) Treasury Study, 66.

(15) Treasury notes that, as of March 2000, 640 foreign entities have elected to be treated as corporations, 3,920 have elected to be treated as partnerships, and 7,875 have elected to be disregarded entities. Treasury Study, 70.

(16) Treasury Study, 71.

(17) Treasury Study, 72.

(18) Treasury Study, 73

(19) Id.

(20) Treasury Study, 71

(21) Treasury Study, 73.

(22) Treasury Study, 74.

(23) Id.

(24) Treasury Study, 71.

(25) Treasury Study, 74.

(26) Id.

(27) Treasury Study, 75.

(28) Treasury Study, 77.

(29) Treasury Study, 82.

(30) Treasury Study, 83.

(31) Treasury Study, 85.

(32) First is the full-inclusion method. This method would operate by including all of a CFC's net income in the gross income of the CFC's U.S. shareholders as a deemed dividend. This method would treat the CFC as a separate entity and therefore determine the amount of the inclusion at the CFC level. Under this method, losses could not be used to reduce the income of U.S. shareholders. Alternatively, the branch method would treat a CFC as if it were a branch or a transparent entity. U.S. shareholders of the CFC would consequently take into account both the income and losses of the CFC. Lastly, the domestic corporation method would treat a CFC as if it were a domestic corporation for all purposes of the Internal Revenue Code. Each of these methods would effectively end deferral.

(33) Treasury Study, 94.

(34) Treasury Study, 94.

ERNEST F. AUD, JR. is an international tax partner in the Chicago office of Ernst & Young LLP, and a frequent speaker at TEI's educational programs.

DAVID M. BENSON is a partner in the firm's Washington, D.C. international tax services group.

LaBRENDA GARRETT-NELSON is a partner in the firm's Washington Council Ernst & Young division. THe authors wish to thank Mark Hazelton for his assistance in the preparation of this article.