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The U.S. will sacrifice a great amount of tax revenue from foreign-source income but U.S. MNCs will have less incentive to move abroad and the ill effects of corporate inversions should stop.
In addition to the massive tax rate reduction, two of the most significant changes under the Tax Cuts and Jobs Act (P.L. 115-97, December 22, 2017) are the move from a "worldwide tax system" to a "modified territorial tax system" and the imposition of the new "base erosion and antiabuse tax" (BEAT) (Section 59A).1 Both have far-reaching consequences in terms of not only the magnitude but also their implications on international taxation principles.
Worldwide vs. Territorial Tax Systems
For a multinational corporation (MNC) engaged in operations abroad, how should its foreign-source income be taxed in its own home country and in the foreign host country? There are two choices: the "worldwide tax system" and the "territorial tax system."
Worldwide tax system. Under the worldwide tax system, a taxpayer's foreign-source income is taxable not only in the foreign host country but also in its home country. The taxpayer can claim a foreign tax credit for the tax paid to a foreign government against the tax owed to its home country2 to the extent of the homecountry tax attributable to the foreign-source income.3
Under this system, income tax is imposed on the entity that earns the income, not according to where the merchandise is sold or the service is rendered. It is based on the concept that whomever receives government services is liable for the tax, regardless of where the income is derived. Natural persons who live or corporations that are based in the U.S. require such government services. In the foreign country where a U.S. company earns income through sales or services, it will be taxed by the foreign government and can then offset what it paid against the total tax owed to the U.S. Before the Act, the U.S. and China were the two major industrialized countries in the world that had adopted the worldwide tax system.4
Example. IBM is a U.S.-registered corporation, but manufactures computers in Canada and sells to Canadian citizens. Can the U.S. government impose income tax on IBM for the income earned from Canada? Before the Act, in...