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Glossary Active income: Although not a statutory or regulatory term it is generally under- stood as income generated from the active conduct of a trade or business (e.g., making widgets). Technically, it is the residual left after passive and other types of income defined by statute or regulation have been identified. [Cf. Passive income.] Alternative incremental research and experimentation credit: An alternative method a taxpayer may elect to use in calculating the research and experi- mentation tax credit, based on comparing certain percentages of qualified research expense to certain percentages of average annual gross receipts. [Cf. Research and experimentation credit.] Alternative minimum tax (corporate): An alternative tax typically imposed on firms with low taxable income as calculated under the regular corporate in- come tax. The tax rate is generally 20 percent rather than 35 percent but applied to a broader income base than the regular corporate income tax be- cause certain deductions, credits, and allowances permitted under the regular tax are added back to income for AMT purposes. Capital export neutrality: The principle that the tax system should not provide incentives for U.S. firms and residents to operate outside the United States by taxing domestic income more heavily than foreign income. Capital import neutrality: The principle that the income from all investments within a country should face the same tax burden, regardless of the national- ity of the investor. Comprehensive Business Income Tax (CBIT): A proposal advanced by the U.S. Treasury Department in 1992 that would integrate the corporate and personal income taxes so that corporate-source income would be taxed only 147
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48 GLOSSARY once, rather than twice, as under the current system. CHIT would effectively make the corporation tax a withholding tax on corporate source income. Deferral: The general rule that the foreign earnings of foreign corporations are not taxable in the United States currently even though the foreign corpo- ration is controlled by a U.S. shareholder or shareholders, usually a U.S. multinational parent corporation. Such earnings are taxable in the United States when paid to the U.S. shareholder, usually as dividends, interest, or royalties. Destination principle taxation: A hypothetical system in which a country taxes imports of goods and services but not exports. [Cf. Origin principle taxation.] Excess limitation: The position of a U.S. corporation when the average foreign tax rate on its foreign-source income is less than the average U.S. tax on the same foreign-source income. This phrase derives from the fact that foreign tax credits generally are limited to an amount equal to the U.S. tax rate mul- tiplied by a taxpayer's foreign source income. When a taxpayer is not af- fected by this limitation, it has limitation remaining or "excess limitation." [Cf. Foreign tax credit.] Export source rule: A tax code provision (section 863(b)) that permits firms to claim that half of the profits on any sale which "passes title" in a foreign country were generated abroad. Flat tax: A broad class of proposals to broaden the tax base and lower marginal tax rates, generally to a single marginal tax rate. In the Hall-Rabushka flat tax proposal, individuals and firms would be taxed at the same rate, and individuals would be taxed only on their wages, benefits, and pension payouts. Capital income would not be part of the tax base, so the flat tax would be a consumption tax. Foreign sales corporation rules: A set of tax provisions, introduced in 1984 as a replacement for DISC (Domestic International Sales Corporations), that allows some tax deferral on U.S. export profits, when the taxpayer employs a "foreign sales corporation" as defined by the Internal Revenue Code. Foreign tax credit: To avoid double taxation of the same income, U.S-based multinational companies may claim a credit against U.S. tax liabilities for taxes paid to foreign jurisdictions on income earned within those foreign jurisdictions. [Cf. Foreign tax credit limitations and excess limitation.] Foreign tax credit limitation: To avoid the claiming of foreign tax credits against domestic U.S. income, the United States limits foreign tax credits generally to either lower taxes paid to foreign jurisdictions or an amount equal to the U.S. tax rate multiplied by the taxpayer's foreign source income. When a taxpayer has paid taxes abroad at a rate higher than the U.S. rate, such that it may not claim credit for all of its foreign taxes because of the foreign tax credit limitation, the taxpayer is said to be in an "excess credit" position. [Cf. Foreign tax credit, excess limitation, and section 904(d).] General Agreement on Tariffs and Trade (GATT): The umbrella multilateral
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GLOSSARY 149 trade agreement addressing tariffs and non-tariff barriers and providing means of resolving disputes. [Cf. World Trade Organization.] Interest allocation rules: Rules issued under Section 1.861-8 that specify the portion of interest expenses incurred in the United States that multinational firms must charge against foreign-source income for purposes of calculating their foreign tax credit limitation. [Cf. Foreign tax credit limitation.] National Retail Sales Tax: A form of national consumption tax, sometimes proposed as an alternative to the current U.S. income tax, which would use a point-of-sale retail sales tax to raise revenue. Origin principle taxation: A hypothetical system in which a country taxes ex- ports of goods and services but not imports of goods and services. [Cf. Des- tination principle taxation.] Passive foreign investment company (PFIC): Any foreign corporation with excessive passive income (75 percent or more) or excessive passive assets (50 percent or more) is a PFIC. A U.S. shareholder of a PFIC generally must either forego deferral on the PFIC' s income and subject that income to cur- rent U.S. taxation, even if not distributed to that shareholder, or defer taxa- tion until the income is distributed but pay interest based on the deferral period. [Cf. Deferral and subpart F.] Passive income: Investment income such as interest or dividends not generated from the active conduct of a trade or business. Passive income is generally not bound by geography. For example, a U.S. taxpayer can earn interest in the United States by depositing excess cash in a U.S. bank or abroad by depositing cash in a foreign bank. [Cf. Active income.] Research and experimentation credit: Currently, a 20 percent credit for the amount by which a corporate taxpayer's qualified research expenditures (pri- marily for wages and supplies) for a tax year exceed a base amount. First instituted in 1981, the credit has been modified and extended several times, most recently in the 1997 tax bill. [Cf. Alternative research and experimen- tation credit.] Residence basis: A national tax system, such as that of the United States, in which resident individuals and corporations are taxed on income earned abroad as well as domestically. In such countries, double taxation is avoided typically by granting a credit for taxes paid to the foreign jurisdiction in which the income is earned, which is considered to be the "primary" taxing jurisdiction. [Cf. Foreign tax credit and territorial basis.] Section 1.861-8 allocation rules: U.S. Treasury regulations governing U.S. multinational corporations' allocation of U.S. expenses, such as interest and R&D, between domestic and foreign-source income for purposes of calculat- ing the foreign tax credit limitation. The 861-8 rules as they apply to R&D were first issued in 1977 and have been modified by statute and regulation several times since. Section 174: The general rule that companies may deduct 100 percent of qualify
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50 GLOSSARY ing research and development expenses in the year incurred rather than capi talizing such expenses and depreciating them over a number of years. Section 904(d): The section of the Internal Revenue Code that creates separate foreign tax credit limitations for separate categories or "baskets" of income, such as active income, passive income, financial services income, and sev- eral other categories of income. Section 904(g): The section of the Internal Revenue Code that treats certain in- come earned by foreign subsidiaries as domestic rather than foreign source, to curtail the parent company's ability to absorb foreign tax credits. Section 956A: A section of the Internal Revenue Code (enacted in 1993 and repealed in 1996) that was designed to prevent the build-up of excessive cash and other passive assets in controlled foreign subsidiaries by imposing cur- rent U.S. taxation (i.e., eliminating deferral) once a certain threshold of pas- sive assets was reached. . Subpart F anti-deferral provisions: Rules enacted in 1962 and subsequently modified to impose current U.S. taxation (i.e., eliminate deferral) on foreign- source income by treating certain income, generally income between related parties or passive income, as if it had been distributed currently to the U.S. parent company, thereby subjecting it to current tax. These rules generally apply to foreign corporations at least 50 percent owned by U.S. persons hold- ing stakes of at least 10 percent each. 10-50 Ventures: Joint ventures between U.S. and foreign firms in which the U.S. firm owns between a 10 and 50 percent stake. Foreign tax credits from such ventures are calculated separately from the credits associated with other for- eign earnings of the U.S. firm, so that the credits cannot be "averaged" to- gether. [Cf. Section 904(d).] Territorial basis: A national tax system in which resident individuals and cor- porations are taxed only on income earned within the country's borders. In such a system, foreign tax credits are not necessary to avoid double taxation on income earned in a foreign jurisdiction. [Cf. Residence basis.] USA (Unlimited Savings Allowance) Tax: A form of national consumption tax proposed by Senators Sam Nunn and Pete Domenici to replace the current U.S. income tax system. The USA tax would expand current IRA-type ar- rangements to permit individuals to deduct their net savings from their tax- able income. In conjunction with corporate income tax changes this would effectively exclude corporate and other capital income from the tax base. World Trade Organization (WTO): The international institution established by the parties to the GATT in 1995 for negotiating trade agreements and resolving trade disputes. [Cf. General Agreement on Tariffs and Trade.]