A pair of influential Senate Democrats have introduced a bill aimed at stopping multinational corporations from taking advantage of tax havens abroad.

Carl Levin

Senators Carl Levin, D-Mich., and Sheldon Whitehouse, D-R.I., introduced the Cut Unjustified Tax Loopholes Act, also known as the CUT Loopholes Act, or S. 268, on Monday. The bill was introduced in the midst of a congressional and White House showdown over the impending budget sequestration and growing calls for corporate tax reform, but builds on earlier legislation introduced by Levin in previous congressional terms (see Senators Introduce Bill to Cut Tax Loopholes). This bill, which closes loopholes and strengthens enforcement measures against offshore tax haven abuse, could raise nearly $200 billion over 10 years, according to estimates.

Key provisions in the bill would ensure that companies, which are managed and controlled in the United States, are unable to claim foreign status in order to avoid taxes. The bill would also close loopholes that allow high-tech, pharmaceutical and other companies to license the patents for their products to sham shell companies in tax havens so they can book their profits there and avoid taxes. In addition, the CUT Loopholes Act would require full reporting from companies to determine if they’re booking profits to places where they are doing legitimate business, versus a P.O. Box tax haven subsidiary with no employees.

This loophole has come under particular scrutiny in recent days because Treasury Secretary nominee Jack Lew used to invest in a Citigroup hedge fund with a mailing address in a notorious office building known as Ugland House in the Cayman Islands that supposedly houses thousands of shell companies. Lew reportedly invested $56,000 in the Citigroup Venture Capital International Growth Partnership (Employee) II, L.P. hedge fund, but sold it at a loss for $54,418 in 2010 after he was confirmed as director of the Office of Management and Budget, according to NBC News.

The senators contend that large multinational corporations are making record profits while taking advantage of tax loopholes that helps them reduce their tax bills significantly. A study from the advocacy group, Citizens for Tax Justice, found that  30 Fortune 500 companies paid no federal income taxes in 2008-2010 while collectively earning almost $160 billion in profits.  Offshore tax abuses cost the U.S. Treasury an estimated $150 billion per year in lost revenues.

The bill would penalize offshore financial institutions and jurisdictions that impede U.S. tax enforcement; and defer tax deductions for U.S. corporations moving jobs and operations offshore until the corporation repatriates the offshore profits from those operations and pays taxes on them. It would also end transfer pricing abuses by taxing immediately excess income to foreign affiliates receiving U.S. intellectual property, limiting income shifting through U.S. property transfers offshore, and tightening the rules related to the valuation of “goodwill” and other intangibles.

The bill also aims to prevent corporations that renounce their U.S. residency despite their U.S. origins and operations from “earnings stripping” to avoid U.S. taxes. It would require foreign tax credits to be calculated on a pooled basis to stop the manipulation of those tax credits to dodge U.S. taxes. In addition, the bill would shift the burden of proof on establishing who controls an offshore entity; and stop corporations managed and controlled in the United States from claiming foreign status.

The bill would treat derivative payments made from the U.S. to offshore recipients as U.S. income; and end vanishing companies by stopping “check-the-box” for foreign entities and “CFC look-through” for controlled foreign corporations.

In addition, the bill would end a loophole that allows corporations to avoid paying taxes on repatriated income by treating it as a loan; and require multinationals to disclose their employees, revenues, and tax payments on a country-by-country basis.

“These loopholes are bad policy even in the best of circumstances, but it would be unconscionable to allow them to continue if we can use revenue from closing them to avoid the devastating effect sequestration would have on national security, homeland defense, law enforcement, public safety, education and other important priorities,” Levin said in a statement.

Other provisions would strengthen tax enforcement by tightening rules related to tax shelter promoters, stiffening penalties on aiders and abettors of tax evasion, and modernizing federal tax lien registration.

Another provision would end the carried interest tax break, ensuring that investment managers, such as hedge fund managers and venture capital firm partners, would pay ordinary income rates on all of their income from providing management services.

“It’s time to put an end to offshore tax abuses that allow powerful corporations to play ‘hide-the-pea’ tax games at the expense of honest taxpayers, and I’m proud to join Senator Levin in this effort,” said Whitehouse.

The bill also aims to ending excessive corporate tax deductions for stock options. Stock options are currently the only type of compensation where the federal tax code allows corporations to claim a bigger deduction on their tax returns than the corresponding expense on their corporate books. That approach enables profitable corporations to report higher earnings to shareholders, while using the stock option deduction to reduce or eliminate those earnings on their tax returns and pay little or no taxes. For example, Facebook booked stock options given to its founder at 6 cents per share, but was able to later claim a tax deduction at about $40 per share.

Corporations are also generally precluded from deducting compensation above $1 million paid to any employee. However, stock option compensation is exempt from that limit. Provisions in the bill would require corporations to take stock option tax deductions at the time, and in an amount not greater than, the stock option expenses shown on their books; and require that stock options compensation is subject to the same tax deductibility cap as other forms of compensation (at $1 million per executive).

Another provision would close a derivatives blended rate tax break. Since 1981, profits from certain derivatives—including commodity futures— have benefited from a more favorable “blended tax rate.” Specifically, a short-term capital gain from these derivatives is taxed, not at the short term capital gains rate, but at a rate which is 60 percent long term capital gains and 40 percent short term capital gains, even if the derivatives are held for seconds.

Normally, investments have to be held for at least 1 year to get preferential long term capital gains tax treatment. This blended rate loophole lowers the taxes on these derivatives by about 10 percent, which encourages commodity speculation (and high frequency trading) compared to investments in stocks, bonds, and other financial instruments subject to normal capital gains rules.

This provision has been supported by President Obama and is in line with a recent House Republican Ways and Means Committee draft, according to Levin’s office. This provision would end the blended rate for derivatives.

Another provision would end a tax break for tar sands oil spills. An IRS interpretation citing guidance from 1980 excludes oil produced from “tar sands” from having to contribute to the Oil Spill Liability Trust Fund. The bill would update the law to reflect the commercial use of tar sands and other unconventional oils and ensure they help pay for oil spills.  The provision would require the tar sands oil industry to contribute to the Oil Spill Liability Trust Fund.

The Financial Accountability and Corporate Transparency, or FACT, coalition, which actively works on the issues of offshore tax haven abuse and anonymous corporations, supports S.268. “Offshore tax loopholes hurt domestic businesses, large and small, as well as individual taxpayers who must shoulder the extra tax burden through higher taxes and  and endure massive cuts to public services,” said Nicole Tichon, executive director of Tax Justice Network USA and a co-founder of the FACT Coalition.

Jubilee USA Network executive director Eric LeCompte said, “Every year, some of the most profitable corporations use a long list of loopholes to avoid paying taxes. With the sequester right around the corner, the CUT Loopholes Act will cut the loopholes and generate billions of dollars to avoid the next cliff.  Further, this legislation sends a global message that corporate tax dodging should not be tolerated in any corner of the world.”

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