Special rules may exist that tax certain shareholders, such as  a parent corporation, currently on the income of certain subsidiaries in  order to protect the domestic tax base. Study Countries Vary in the Types of Foreign-Source Income Exempted from Domestic Tax and in the Rules Governing Those Exemptions

Our study countries—Australia, Canada, France, Germany, and the  Netherlands—have hybrid tax systems that exempt some types of foreign- source income and tax others. In general, these rules are intended to protect the  domestic tax base by preventing taxpayers from avoiding domestic tax on  passive or other specific types of income by moving to or holding these  types of income in a foreign country. Study Countries Face Areas of Compliance Risk and Burden Known to Exist in the United States

Differences in tax rates across countries and differences in the taxation of  different types of income may create incentives to avoid tax by shifting  income from a high tax jurisdiction to a lower taxed jurisdiction or by  converting income from a taxable type to tax-exempt type. Tax experts identified four areas as sources of compliance risk or  taxpayer compliance burden in our study countries. Similarly, many business representatives said complying with  transfer pricing rules was often the most burdensome aspect of  international taxation. The changing nature of international trade, particularly the growing trade  in intangibles, is making international transactions more susceptible to  transfer pricing abuse. All Study Countries Use Advanced Pricing Agreements to Address Compliance Risks

All of the study countries have developed advanced pricing agreement  (APA) programs that allow taxpayers and tax agencies to resolve transfer  pricing issues before tax returns are filed and without the need for time  consuming and expensive audits. While the Netherlands does not have specific CFC rules, taxpayers and tax  officials stated that the compliance burden associated with other anti- avoidance rules can be significant. Exemption of Foreign- Source Income Reduces the Need for Foreign Tax Credits, but They Can Still Serve as a Compliance Risk

The study countries all have FTC systems; however, according to both tax  agency officials and tax practitioners FTCs play less of a role in these  countries than in the United States because of the extent to which foreign- source income is exempt. For exempt income, taxpayers do not have to  track and report foreign taxes paid. Some tax experts that we spoke to generally agreed that tracing would be  ineffective. Study Countries and the United States Do Not Regularly Report Basic Information about the Revenues Generated by Taxing Foreign-Source Corporate Income

In addition to lacking data about compliance and compliance burden for  their foreign tax rules, our study countries lack data on the amount of tax  revenues generated from the foreign activities of domestic corporations. This is also the case for the United States. Appendix I: Objectives, Scope, and Methodology

The objectives of this report were to (1) describe, for select case study  countries that take a territorial approach, what types of foreign-source  income the countries exempt and the rules governing those exemptions;  and (2) describe, to the extent information is available, the compliance  risks and taxpayer compliance burdens that the taxation of foreign-source  corporate income presents for each of these countries. We collected and analyzed data on the  countries and their systems for taxing foreign-source corporate income,  including tax policies, administrative mechanisms, compliance activities,  and taxpayer reporting and documentation requirements. Contemporaneous documentation required for cross border,  related party transactions.
Why GAO Did This Study

A debate is underway about how the United States should tax foreign-source, corporate income. Currently, the United States allows domestic corporations to defer tax on the earnings of their foreign subsidiaries and also gives credits for foreign taxes paid, while most other developed countries exempt the active earnings of their multinational corporations' foreign subsidiaries from domestic tax. The debate has focused on economic issues with little attention to tax administration. GAO was asked to describe for a group of study countries with exemption systems: (1) the rules for exempting foreign-source income, and (2) the compliance risk and taxpayer compliance burden, such as recordkeeping, of the rules. The study countries, selected to provide a range of exemption systems, are Australia, Canada, France, Germany, and the Netherlands. For these countries GAO reviewed documents; interviewed government officials, academic experts, and business representatives; and compared tax policies, compliance activities and taxpayer reporting requirements.

What GAO Found

The study countries exempt some corporate income, such as dividends received from foreign subsidiaries, from domestic tax. However, the study countries tax other types of foreign-source income such as royalties. Multinational corporations present a compliance risk because they can use subsidiaries to convert taxable income into tax-exempt or lower taxed income, eroding the domestic tax base. Although quantitative estimates of noncompliance do not exist, tax experts interviewed by GAO identified sources of compliance risk and taxpayer burden in each of the study countries. These issues, particularly the ones below, have also been identified as sources of compliance risk and burden in the United States. Transfer prices--the prices for transactions between related parties--can be manipulated to shift profits. Tax experts in the study countries said the growing importance of intangible property such as trademarks and patents is making international transactions more susceptible to transfer pricing abuse. In response, the study countries have all increased their scrutiny of transfer prices, including increased demands for documentation and more audits, resulting in increased compliance burden for taxpayers. Cooperative efforts between taxpayers and tax agencies to reduce audits, such as Advanced Pricing Agreements, received mixed reviews in the study countries. Anti-avoidance rules prevent taxpayers from moving passive income (interest and royalties are often passive income) to a foreign subsidiary in order to avoid domestic tax. Generally, the rules make such passive income, even if moved, taxable. Tax agencies and taxpayers reported difficulties in obtaining information from other countries to make complex determinations about whether the anti-avoidance rules apply or not. The United States does not report taxes paid on foreign-source income. Treasury officials said it would be feasible to do so. Such reporting would make more explicit the role international tax rules play in raising revenues and protecting the domestic tax base. All experts we spoke with on this topic agreed.