Most analyses of the taxation of international income earned by U.S. corporations or individuals have addressed income from direct investments abroad. With the exception of routine bows to the "international tax compromise" and sporadic discussions of the practical difficulties residence countries face in collecting taxes on international portfolio income, the taxation of international portfolio income generally has been ignored in the tax literature.1
Analysis and reassessment of U.S. tax policy regarding international portfolio income is long overdue. The amount of international portfolio investment and its role in the world economy has grown exponentially in recent years. In most years since 1990, the total market value of U.S. persons' foreign portfolio investments has exceeded the value of U.S. corporations' foreign direct investments, and the total amount of U.S. taxpayers' foreign portfolio income has exceeded their income from foreign direct investments.2 Cross-border portfolio investments are no longer a tiny tail on a large direct-investment dog. International portfolio investments now play a major role in the world economy, a role quite different from that played by foreign direct investments. We can no longer afford simply to assume, as we have in the past, that the way the United States taxes the latter is obviously appropriate to the former. Instead we must ask explicitly what tax policy for income from portfolio investments best serves our nation's interest. That is the task we undertake here.
Corporations raise money to do business in three ways: They retain what they have earned, they borrow, and they issue equity to shareholders. At the corporation's inception, borrowing and raising equity capital are the only options. When U.S. equity capital is invested abroad, sometimes a U.S. corporation will open a foreign branch, but typically it invests equity capital in the shares of a foreign corporation.Often the voting stock of the foreign corporation is wholly or majority- owned by a U.S. corporation or corporations or by U.S. persons. Even without control, important shareholders-whether individuals or other corporations-may exercise substantial influence over the company's business decisions. To have control or even significant influence over corporate decisionmaking, one must own a substantial percentage of shares in the company. In the commonly used vernacular, one must be a "direct investor." Those who do not own sufficient shares to influence business decisions are labeled passive, or portfolio, investors. If portfolio shareholders are unhappy with the company's business decisions, they may sell their shares.
Michael J. Graetz & Itai Grinberg,
Taxing International Portfolio Income,
Tax L. Rev.
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