Corporations couldn’t wait to "check-the-box" on huge tax break

But within days of its announcement in 1996, tax lawyers were on the phone saying the Treasury Department had overlooked the international ramifications. Inadvertently, the government had provided a way for companies to move profits from subsidiaries in high-tax countries like Germany to Luxembourg, the Caymans or other jurisdictions with lower or no taxes on certain kinds of income. Often, this is done by making royalty or interest payments between operations in different countries.

For decades, the IRS has had anti-abuse rules to make sure such payments could be subject to taxes. However, these rules generally don’t apply to payments made within a corporation. Check-the-box made it simple for a company to designate a subsidiary as a branch, with no U.S. tax consequences for the income unless it is repatriated.

Joseph Guttentag, international tax counsel at Treasury when check-the-box was introduced, said the government may not have understood, but tax lawyers quickly “saw all the avoidance goodies they could do.”

Countries like the U.K. and Germany quickly raised concerns that the rule was stripping earnings from their tax bases. By early 1998, the U.S. said check-the-box was being used to “circumvent” anti-abuse rules.

Treasury proposed new regulations — and corporate America erupted.

General Electric, PepsiCo, Morgan Stanley, Merrill Lynch, Monsanto and other major companies urged Congress to resist the change. The U.S., they said, was trying to be “the tax policeman for the world.” Allies in Congress dug in, and Treasury quickly rescinded the proposal.

What followed was a check-the-box boom as multinationals and tax advisers around the globe embraced its benefits.

By March 2000, Treasury reported the existence of nearly 8,000 “disregarded entities.” A paper by Heather M. Field, an associate professor at the University of California’s Hastings College of the Law in San Francisco, found that tens of thousands more were created between 2001 and 2006.

Check-the-box became an essential tool in tax planning, driving down the average effective corporate tax rate on the foreign income of U.S. businesses by 1 percent to 2 percent between 1996 and 2004, according to a private, unpublished paper by Treasury economist Harry Grubert.

The Netherlands became the preferred place for U.S. companies using check-the-box, according to tax lawyers and government data, although Luxembourg also attracts considerable activity.

The Dutch tax system offers a favorable legal and regulatory environment, including special tax treatment for financial services and for licensing and royalty payments. As a result, multinationals channel trillions of dollars a year through the Netherlands.

A report by the Dutch Central Bank found that the U.S. corporate share of funds flowing in and out of the country via special Dutch entities increased sixfold in recent years. U.S. Commerce data show that U.S. businesses kept $118 billion of income in Dutch holding companies from 2006 to 2009.

In 2004, with overseas earnings piling up, Congress approved a temporary tax holiday that allowed American companies to bring home profits at a rate of 5.25 percent. The largest source of repatriated funds, about $90 billion, came from the Netherlands, according to a 2008 IRS study.

Obama shifts stance

Check-the-box continued unchallenged until 2009, when Obama took office. In his first budget proposal, the president made closing tax loopholes a top revenue-raising goal. And in the international area, check-the-box was his top target, the biggest revenue raiser in a list of 11 reforms.

Again, corporate opposition was swift. Philip D. Morrison, a tax lawyer at Deloitte Tax, wrote in a prominent tax journal that the Obama proposal on check-the-box was “ridiculous,” and faulted the administration for overheated rhetoric and a “deep cynicism.” Morrison said the business community had already fought — and won — this battle in 1998.

Some of the nation’s most influential business groups, including the Business Roundtable, National Association of Manufacturers, National Foreign Trade Council and Chamber of Commerce, quickly criticized the Obama proposals in May 2009 as part of a pro-jobs campaign.