Double Taxation
New Overseas?
Why Is It Wrong?
Trade and Treaties
Export Tax
Wrong Answer
A Level Field
The Contract
History of Failure
26 Talking Points
No Jurisdiction
No Representation
The Good
The Bad
The Undecided
What To Do
Form Letter
Why Is It Wrong?

What is wrong with Citizinship Based Taxation and Section 911?

The AMCHAM-KOREA Journal          June 1992

Seoul Korea                       Vol 26, No 6

Section 911: A Taxing Burden

By Brian Boru Quinn

As the cold war exits stage left and the US Government begins to emphasize international trade as the driving force behind its foreign policy, "competitiveness" is becoming an increasingly common rallying cry in the halls of Congress.

   This veritable paradigm shift, as some analysts are calling it, is welcomed by American businessmen overseas, many of whom feel that the US Govornment should do more to support US business efforts abroad. While much ofthe US Government's trade-related activities focus on bilateral negotiations aimed at improving market conditions for US goods and services, many

American businessmen believe that there are some things the US Government should do at home, on its own, to support American business. Taxation is one particular concern to American businessmen. The United States is the ONLY major industrialized country that taxes its nationals on income earned overseas, even though the individual may be living outside the United States. This taxation policy represents an additional cost to American business, and has a directly negative impact on an American company's ability to compete in overseas markets, especially in light of the fact that NONE of America's competitors, NONE of the major industrialized nations -including the Germans, Japanese, French or the British--are strapped with the same burden. IN EFFECT, THE US GOVERNMENT IS STACKING THE DECK AGAINST US COMPANIES BY AUTOMATICALLY INCREASING THEIR BASIC OPERATING COSTS IN OVERSEAS MARKETS.

   Because of tax credits allowed by the US Govornment, the tax on US companies operating overseas differs from country to country, and is based on the amount paid in foreign local taxes. US tax policy allows American companies tax credits of up to 90 percent of the local tax paid in a foreign country. The higher the local tax, the lower the amount paid to the US Govornment.

   If a company operating in Hong Kong pays a local tax rate of 15 percent, for example, the amount of US tax it would pay would naturally be higher than that of a firm operating in Korea, where the rate is closer to 50 percent. In addition to tax credits, US tax policy also permits US citizens an exclusion of $70.000 (plus a housing allowance) on foreign earned income. It is the income in excess of the exclusion and tax credits that is subject to US tax, and it is this burden-the so called "minimum tax on tax credits" that negatively impacts American business overseas.


   Keeping an employee abroad can be an expensive proposition for a company. Keeping one in Korea can be especially hard on the budget. A typical expatriate package to keep an upper-level manager and his family in Korea will cost an American company about $250,000. This includes base salary, housing, cost-of-living allowance and other expenses such as transportation and moving and storage. After the automatic $70,000 exclusion, and credits for local taxes paid, an American firm might shell out about $7000 to the US Govornment in individual expatriate taxes, and again, more if the local tax rate is lower than Korea's.

US Taxes on Foreign Earned Income: Hong Kong

Citizen of Expat Pack Exclusion  Tax.Income Tax.Liab Tax.Credit Tax.Burden

USA        $250.000   $70.000    $170.000   $51.000  $37.000    $12.000

Japan      $250,000   NA         NA         NA       NA         $0

Germany    $250,000   NA         NA         NA       NA         $0

   Some might argue that American firms should be able to endure this kind of cost and still remain competitive, but the fact is, every dollar is important. Dollars are especially important in tight overseas environments, where many companies find themselves in loss situations.

   "It plays hell with your P&L" says an American manager at an American technology firm in Korea. "It really hurts when you are not making money in your foreign operation and the government comes in and starts taking money from you. Our company is having to send people back from Asia, now, especially Hong Kong, because things are so tight."


   But the burden of Section 911 goes beyond the actual tax liability. A number of secondary effects associated with Section 911 amplify the negative impact on American business--and the American economy.


   First, there are the administrative costs associated with managing the individual expatriate tax portfolios. One international accountant estimates that American companies couls cut their ex-patriate administrative accounting expenses- currently about $5,000 per expatriate-- in half, if Section 911 were eliminated.


   Then there are the hidden R&D costs, with all their implications. "Say you've got 100 expats around the world. You're paying the taxes and the administrative costs and that's about $1 million a year--right out of profit. Another way to look at that is to say that's 10 engineers, or fuel for another product development package. Suppose one of those engineers developed a hot new product that gave you an edge in the market? Sure Section 911 is very significant. Every dollar counts."


   Of course there are marketing implications, too, as the director of an American firm marketing consumer products in Korea points out. "We could use this money to develop the market. $1 million is about 20 local sales reps. Our sales guys each usually get about $1.6 million per year, so that's over $30 million in sales that we never see-- that the United States never sees." [+ well paid US export mfg jobs]


   Morover, Section 911 can make hiring an American expatriate prohibitively expensive, forcing American firms to hire expatriates from third nations or the local market, where such taxes are not required.


   The negative impact of hiring non Americans is further exacerbated when third country nationals instinctively set up their offices with product brands that are probably not American.   "Suppose the company looks at the tax code and sees that it is cheaper to hire an Australian," says an Amercian businessman in Korea. "Well, the Aussie goes in and sets up an office or a new marketing operation. He's Australian, so he sets it up with Australian computers, Australian appliances,Australian accounting companies, Australian banks. Everything in the office is Australian--the stuff he's familiar with and comfortable with-where, all things being equal, an American would probably have used American goods and services. And all because of the tax code.The effect on the American economy is compounded. What Congress doesn't realize is that every dollar spent by American firms overseas can mean 10 dollars for the American economy.


   In addition, while hiring someone familiar with the customs and ways of doing business on the local market can have its benefits, woe to the American firm that fails to consider the dangers inherent in hiring local help for executive positions--especially in the fiercely nationalistic, Japanese-modeled, importblocking economies of Asia, where official and unofficial pressure to limit foreign market share is immense.  "A short time ago a major American appliance maker installed a Korean national as the president of its marketing operations on the peninsula," offers an American businessman all to familiar with the problem. "The next thing we knew, this guy was telling the local press and US Government officials that he didn't think American companies should be allowed to sell their appliances in Korea--that the Korean people did not need the spacious and efficient American models, which he termed 'luxurious'." This notwithstanding his responsibility to promote the sale of these very same products produced by his company.


   Then, too, many foreign companies use international experience as an important part of their training program for managers. On tight budgets, many companies are choosing to keep their people at home, and the tax issue is a factor in that decision to do so. As a result, says the manager of a large American firm in Korea, "Our employees don't get the important crosscultural, cross-functional experience so important when dealing with world markets.It's an educational process, and it is absolutely key that our people know what its like to do business overseas, know the ins and outs of business in Asia and Europe. The only way to learn is to go over there and do it; and if we can't afford to send them over there, we lose, they lose, America loses."


   While Section 911 is a burden for American companies overseas, it represents a tremendous loss for the American economy as well. "Given the state of the economy and America's position in the world markets," says a Hong Kong-based consultant, "the US Government should be doing everything that it can to encourage the development of overseas trade. Taxing income earned overseas by expats is not the kind of thing they should be doing. Section 911 should be eliminated."  AmCham-Korea agrees. AmCham-K strongly believes that in order to enhance the competitiveness of American business overseas, and to promote the export of American products and services, the American Government should discontinue taxing foreign earned income.   Barring this, at the very least, the US Government should raise the exclusion from $70,000 to $100,000 of foreign earned income to keep up with inflation.In 1986, the current exclusion amount was actually reduced from $80,000 to the current $70,000, under the Tax Reform Act. Also as a result of the Tax Reform Act, scheduled annual increases from 1988, which would have brought the exclusion amount up to $95,000 by 1990, were never implemented. If the tax is not entirely eliminated and the current policy continues, AmCham-Korea believes the exclusion should be adjusted for inflation on an annual basis.


Note - the exemption was increased to 80.000 $ again during the Clinton administration.

                                       What to do


[Double Taxation] [New Overseas?] [Why Is It Wrong?] [Trade and Treaties] [Export Tax] [Studies] [Wrong Answer] [A Level Field] [The Contract] [History of Failure] [26 Talking Points] [No Jurisdiction] [No Representation] [Legislation] [The Good] [The Bad] [The Undecided] [What To Do] [Form Letter]