International taxation is a complex puzzle for businesses operating globally. Countries use either worldwide or territorial tax systems, each with unique implications for corporate strategy and competitiveness. The choice between these systems affects how companies structure their operations, manage profits, and navigate cross-border transactions.

Understanding these tax systems is crucial for multinational corporations. It impacts decisions on where to invest, how to repatriate earnings, and how to optimize global tax burdens. As countries shift their approaches, businesses must adapt their strategies to stay competitive in the international marketplace.

Worldwide vs Territorial Tax Systems

Defining Characteristics of Tax Systems

• Worldwide tax systems require resident corporations to pay taxes on their global income, regardless of where it is earned
• Territorial tax systems only tax income earned within the country's borders, exempting foreign-source income
• United States historically used a worldwide tax system but transitioned to a modified territorial system with the Tax Cuts and Jobs Act of 2017
• Worldwide tax systems often provide foreign tax credits to avoid double taxation on income taxed by foreign jurisdictions
  • Example: A U.S. company earning profits in Germany would receive a credit for taxes paid to Germany, reducing its U.S. tax liability

Anti-Abuse Measures and Economic Considerations

• Territorial systems typically employ anti-abuse measures to prevent tax avoidance
  • Controlled Foreign Corporation (CFC) rules target passive income in low-tax jurisdictions
  • Example: UK's CFC rules apply to subsidiaries where the local tax rate is less than 75% of the UK rate
• Choice between worldwide and territorial systems reflects a country's economic goals, international competitiveness strategy, and approach to capital export neutrality
  • Capital export neutrality aims to make investment decisions independent of tax considerations
  • Example: A worldwide system with full foreign tax credits theoretically achieves capital export neutrality

Impact of Tax Systems on Businesses

Corporate Decision-Making and Strategy

• Tax system choice influences corporate decisions on foreign investment, repatriation of profits, and global expansion strategies
• Worldwide systems may encourage companies to defer repatriation of foreign earnings to avoid domestic taxation
  • Example: U.S. companies under the old worldwide system accumulated over $2.6 trillion in overseas cash holdings
• Territorial systems can promote the free flow of capital and simplify tax compliance for multinational corporations
  • Reduced barriers to repatriation can lead to increased domestic investment and dividends
• Tax system affects transfer pricing strategies and the location of intellectual property holdings within a corporate structure
  • Example: Companies may locate IP in low-tax jurisdictions under a territorial system to minimize global tax burden

Corporate Restructuring and Global Tax Planning

• Corporate restructuring and merger and acquisition activities may be influenced by the prevailing tax system in different jurisdictions
  • Example: Tax inversions where U.S. companies merged with foreign entities to relocate their tax residence
• Interaction between a company's home country tax system and those of its foreign subsidiaries impacts overall global tax planning
  • Firms must consider the interplay of multiple tax regimes when structuring international operations
  • Example: A U.S. multinational must navigate both U.S. GILTI provisions and local country tax rules for its foreign subsidiaries

Advantages and Disadvantages of Tax Systems

Revenue and Competitiveness Trade-offs

• Worldwide systems potentially offer greater revenue for governments but may reduce international competitiveness for domestic corporations
  • Higher tax burden on global income can disadvantage companies competing against firms from territorial systems
• Territorial systems can enhance competitiveness but may encourage profit shifting to low-tax jurisdictions
  • Example: A company might locate more profitable activities in countries with lower tax rates
• Worldwide systems provide neutrality in investment location decisions but may create complex foreign tax credit calculations
  • Neutrality means domestic and foreign investments face similar tax treatment
  • Complexity arises from tracking foreign taxes paid and applying limitations on credits

Compliance and Anti-Avoidance Considerations

• Territorial systems simplify tax compliance but may require more robust anti-avoidance measures to protect the tax base
  • Reduced need to track global income and foreign tax payments
  • Increased focus on transfer pricing rules and anti-deferral regimes
• Impact on a corporation's effective tax rate varies between the two systems, affecting profitability and shareholder returns
  • Territorial systems may lead to lower effective tax rates for companies with significant foreign operations
• Transition costs and complexities arise when countries shift between worldwide and territorial systems, as seen in recent U.S. tax reform
  • Example: U.S. transition tax on deemed repatriation of foreign earnings during the 2017 tax system change

Tax System Choice and Global Competitiveness

Investment Attraction and Corporate Retention

• Tax system design influences a country's ability to attract foreign direct investment and retain domestic corporate headquarters
  • Territorial systems may be more attractive for multinational corporations seeking to expand globally
• Interplay between tax rates and tax base definition in different systems affects cross-border competitiveness
  • Example: A country with a territorial system and a 25% tax rate may be more attractive than one with a worldwide system and a 20% rate
• Territorial systems may create a more level playing field for domestic companies competing in foreign markets
  • Domestic firms face similar tax burdens to local competitors on foreign-source income

Global Tax Dynamics and Trends

• Worldwide systems with high corporate tax rates can potentially disadvantage domestic companies in global markets
  • Example: Before 2017, U.S. companies faced higher global tax burdens compared to competitors from territorial system countries
• Choice of tax system impacts a country's negotiating position in international tax treaties and agreements
  • Territorial systems may reduce the need for extensive treaty networks to prevent double taxation
• Global trends in tax system adoption influence competitive dynamics, with many countries moving towards territorial systems to remain attractive to multinational corporations
  • OECD countries have increasingly adopted territorial or hybrid systems over the past two decades
  • Example: Japan and the UK switched from worldwide to territorial systems in 2009 and 2010, respectively, to enhance their global competitiveness