Taxes

The Principle of Territorial Taxation of Income

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The Principle of Territorial Taxation of Income. Historically, the United States of America has always been the first country to support the principle of worldwide taxation of income. Basically, a company resident in the US is required to pay the related income taxes, wherever it has received such income. With the tax reform implemented by President Trump, the US has essentially departed from this principle.

There are two elements, in particular, that move taxation in the United States towards a principle of territorial taxation of income. These elements are as follows:

Absolute exclusion from taxation of dividends from investee companies resident outside the USA;

Absolute exclusion from taxation of capital gains deriving from the sale of equity investments in non-resident subsidiaries. This is for the part of the capital gain generated by retained earnings.

These two elements are certainly not negligible in a taxation system, and could lead, over time, to incentivize foreign companies to move their registered office to the USA.

I refer, for example, to companies that act as holding companies or that hold the paternity of the so-called “intangibles”. For these companies, in fact, the tax exemption of dividends and capital gains linked to investments in non-resident subsidiaries can bring a considerable tax advantage.

Exclusion of the lock out effect

The transition from a worldwide taxation principle to a territorial principle has led the US to exclude what is commonly called the “lock out” effect.

We can say, in fact, that before the tax reform in the USA it was possible to notice a dysfunction of the same, known with the term lock out. In practice, this is the incentive to keep profits in foreign companies, perhaps located in countries with privileged taxation.

This dysfunction certainly disappeared after the tax reform. The same, in fact, has led to a significant incentive to have the registered office in the USA, to obtain tax exemptions for dividends and capital gains.

Alongside these elements, however, there are other very important ones, which I will deal with below, which go in the same direction. That is to make it easier for companies around the world to establish their headquarters in the USA.

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