One of my favorite internet memes is the “99% vs. GE.” Depending on the author, GE is either an evil multinational corporation that enjoys massive US tax subsidies, or a concerned global citizen that welcomes year-round IRS examination with free office space and donuts.
In the latest salvo, Washington-based Citizens for Tax Justice (“CTJ”) has claimed that GE owed just 2.3 percent in federal taxes on $81.2 billion of pretax profits over the last ten years. According to CTJ Director Robert McIntyre, GE achieves this result by taking advantage of the “active financing” exception to the Tax Code’s subpart F rules, which would otherwise cause GE to owe US tax on its foreign income. McIntyre claims that GE uses this exception to treat offshore financial products as “nowhere income.”
What does all this mean?
Subpart F is an entire, well, subpart of the voluminous US Tax Code meant to impute the income of a foreign business to its US owners. Subpart F’s underlying purpose is to essentially prevent US taxpayers from sheltering income in nominee shell corporations formed in low-tax jurisdictions.
How does this “active financing” exception allow GE out of this regime?
Subpart F income does not include “qualified banking or financing income” of an “eligible” foreign subsidiary. Eligibility is triggered if the foreign sub is “predominantly” engaged in the active conduct of a banking, financing or “similar” business; and the sub is engaged in “substantial” activity with respect to those businesses. . Finally, “substantially” all of the subsidiary’s activities are carried out in its home country or the home country of one of its branches and taxed in one of those countries. GE has presumably established qualifying foreign subsidiaries that meet these elements.
Put simply: if GE owns a bank in Country X, that makes loans to actual Country X residents, and pays rent on its actual Country X storefront, that bank is subject only to Country X taxation. Even if Country X’s tax rate is 5% or 0%.
But let’s look at those requirements again: “substantially,” “predominantly,” “similar,” “substantial” (redux). To a tax lawyer, these words are ripe as a Georgia peach for creative structuring (and billables).
GE isn’t exactly creating “nowhere income,” but the combination of low-tax jurisdictions and the active financing exception’s subjectivity is enough to rankle CTJ.
I’m not suggesting GE is over-aggressive in its Subpart F compliance. In fact, even McIntyre doesn’t come out and point to any particularly questionable foreign finance vehicle. But with that much subjectivity built into the active finance exception, and with banking becoming more mobile and nimble every day, it’s not hard to imagine some serious envelope-pushing.
This possibility for abuse is probably why Congress has never made the active finance exception permanent. Originally, the exception was set to expire in 2002 but was extended to 2006, then to 2009. It was then extended again and again, and is currently, technically, finally . . . . expired. Despite presumed lobbying efforts to the contrary, conventional wisdom assumes that the exception will not be reinstated until after the November elections.