on dividend distributions from U.K. subsidiaries to their U.S. parent corporations operating in worldwide unitary states. If implemented, this legislation would clearly violate the U.S.-U.K. bilateral income tax treaty, This legislation, by virtue of a provision which makes possible the retroactive imposition of avy penalties, was having an adverse effect on the willingness 0.8. companies to repatriate earnings of their U.K. subsidi aries to the United States. (The U.K. has now agreed to defer implementation of this legislation for the time being.) The adoption of this legislation by the U.K. illustrates that state worldwide unitary taxation is clearly adversely affecting the United States' foreign economic relations. Foreign governments and businesses that are subject to worldwide unitary taxation argue that this method of computing state tax gives rise to double taxation of foreign income. They also contend that worldwide unitary taxation is administratively burdensome, particularly for foreign owned companies. These results are inevitable as long as a few states rely on a method of measuring income that is different from the approach used by the rest of the world. Theoretically, if all jurisdictions, domestic and foreign, were use of the worldwide unitary method by some states may also inhibit and distort the international flow of investment capital. In the words of one foreign government, "[t]he [unitary tax] sethod can chill international investment and decrease efficient allocation of resources and employment opportunities. In particular, the unitary method can impede foreign entry into the United States market." Consequently, according to a group of foreign governments, worldwide unitary tax constitutes serious obstacle to the further development of our trade and investment relationships." (Note signed by the Ambassadors of fourteen of our major trading partners). The United States is strongly committed to encouraging the free movement of international direct investment capital across national boundaries. State use of the worldwide unitary method is unacceptable because it can adversely affect this clearly articulated federal policy. The United States, as the country hosting the largest amount of foreign direct investment, has gained enormously from the inflow of foreign investment. If the use by some of our states of the worldwide unitary method inhibits the flow of capital, the economic well-being of the country as a whole would suffer. states may be in a position in which their use of the unitary method causes foreign investors to turn away from the United States altogether (rather than shift investments to other 0.8. states). Боле In September 1983, in response to complaints raised by both the U.S. and foreign business community and foreign governments over the Supreme Court decision in Container Corp. v. Franchise Tax Board, President Reagan asked then Treasury Secretary Donald Regan to establish and chair a Worldwide Unitary Taxation Working Group. This group was composed of representatives of the federal government, state governments, and the business community and was asked to provide recommendations suitable for resalving the issues raised by worldwide unitary taxation. At its final meeting on May 1, 1984, the Worldwide Unitary Taxation Working Group agreed on three principles that should guide state taxation of the income of multinational corporations: Principle 1s Principle 2: Principle 3: 'Water's edge" unitary combination for both Increased federal administrative assistance and Competitive balance for 0.8. multinationals, foreign multinationals, and purely domestic businesses. While the first and third principles were to be adopted voluntarily on a state-by-state basis, Principle 1, in particular, represented a clear recognition by the Working Group that the 1 separate accounting method was superior to the worldwide unitary Since the adoption of the Working Group Report some states have In transmitting the report of the Working Group to the President, III. State Taxation of Foreign-Source Dividends The taxation of foreign-source dividends is directly related to Unrestricted state taxation of foreign dividends would subject domestic businesses to serious double taxation of foreign Income. Federal tax policy has long been characterized by its commitment to avoid international double taxation. Indeed, the United States has been a leader in a worldwide effort to establish taxing rules under treaties and commonly accepted principles that minimize international double taxation. If a clear federal policy is not to be undercut by state action, states must comply with this policy of eliminating double taxation and therefore be limited to taxing some equitable portion of foreign source dividends. The legislation does not mandate that any specific method of dividend taxation be imposed on the states. In our view, arguments of state fiscal sovereignty strongly indicate that states should have leeway to tailor their own systems of taxation to the extent that they do not cause serious foreign commerce difficulties by resulting in systematic overtaxation and double taxation of U.3. business in contravention of established federal and international policy. The legislation therefore provides in broad terms for the equitable taxation of dividends and suggests certain guidelines that states could follow in. satisfying that standard. As an illustration of the flexibility of the approach, the legislation would accept as appropriate the treatment of dividends in such states as Colorado, Oregon, Florida and Illinois, states which have been intimately involved in the worldwide unitary tax controversy. IV. Information Reporting and Other Federal Assistance The States have legitimately contended in the Working Group and elsewhere that they lack the resources and ability to monitor adequately transactions between members of a water's edge unitary group and related foreign companies outside that group. Treasury Department agreed with recommendations of the Working Group to provide appropriate federal assistance to the states in order to assure proper working of the separate accounting method. The Working Group suggested that an annual information return be filed with the Internal Revenue Service by multinational companies. This retura would in turn be shared with the states and with multistate audit agencies and would provide states with some assurance that corporations had allocated and apportioned the appropriate share of the corporation's income to each state. The report would also identify those related companies with which serious income shifting would be most likely to arise. In the summer of 1985, the Treasury Department published for comment a draft of legislation implementing this reporting system. Section 3 of the bill is based upon that draft after taking into account the many comments received from affected businesses and the various states. We believe that the information reporting system provided for in the bill is an integral part of the solution to the worldwide unitary problem. In order to provide states with greater assistance the Treasury Department also indicated in the Working Group an intention to increase the resources devoted to the IRS's administration of tax lavs applicable to foreign operations of multinational companies. **Imurge your assistance in approving the increased budget appropriations that are being requested for this purpose. Conclusion I strongly urge the prompt and favorable consideration of this legislation by the Finance Committee. The serious foreign commerce difficulties caused by the use of the worldwide unitary tax method by a few states must now be resolved. OMB has advised that there is no objection from the standpoint of the Administration's program to the presentation of this legis lation to the Congress and that its enactment would be in accord with the program of the President. Sincerely, да mes A. Baker, III The Honorable Bob Packwood Royal |