Will a Territorial Taxing System for US Firms Improve Investment?
Worldwide taxation system
Currently, the US has a system of worldwide taxation as compared to a territorial tax system like other developed nations have. In the US, business income is taxed at US rates, no matter where it is earned. However, the income can be taxed only if it is brought to the US. US companies can defer tax on their investments abroad until they are brought back to the US. However, the US isn’t alone in taxing worldwide income. Let’s look at the distribution of taxation systems across nations in the below chart.
Interested in VOO? Don't miss the next report.
Receive e-mail alerts for new research on VOO
Territorial tax system
Many US trading partners follow the territorial tax system, as seen in the above chart, which is considered to be a huge disadvantage for US firms. The territorial system taxes businesses only on income earned within a country’s borders. It’s applied to all firms that operate within a country’s borders, whether their business is headquartered in that country or another. Since the income earned abroad is not taxed under territorial tax system in other developed nations, US firms stand at a huge disadvantage due to the tax levied on their foreign income.
By adopting a territorial tax system, investments are likely to increase in the US, as companies like Apple (AAPL) won’t be taxed on income earned abroad. This adoption would result in these companies being more open in repatriating funds back home. The increased investment is likely to stimulate productivity and economic growth in the US. Capital markets (VOO) (SPY) are also likely to benefit from the improved economic growth.
The territorial system would allow all future foreign profits of US corporations to be repatriated without any extra tax. The Trump government is expected to provide a special corporate tax repatriation holiday rate of 10% for companies to bring back their cash to the US.
According to Forbes, the repatriation of profit is going to increase investments in the US, no matter where the repatriated profits are utilized including buybacks and dividends. The repatriated cash could be a significant benefit for large US multinational companies, as they can channel those profits towards growth and development. Some of the multinationals to take advantage of the repatriation include Microsoft (MSFT), General Electric (GE), Apple (APPL), and Pfizer (PFE).
In the next article, we’ll look at the border adjustment tax as part of the overall proposed tax reforms.