foreign tax investment incentives subject to the rule and to determine whether specific practices or benefits constitute such an investment incentive in broad terms. It would include any income tax related benefit, however effected, which is intended to encourage or has the effect of encouraging investment in the foreign country which provides the benefit, and whether or not granted to nationals as well as foreigners. Such a benefit may be provided by law, regulation, or individually negotiated agreements. However, the fact that there is a generally low rate of tax in a country will not be considered by itself a tax incentive. It is intended that only major tax concessions would be affected. Examples of benefits or practices of the type which constitute investment incentives include tax holidays-which are partial or complete exemptions from tax for a period of time-deductions for reinvestment reserves; certain grants; and certain depreciation rules which bear no relationship to useful life. Our second proposal relates to so-called runaway plants. We believe that the United States has a legitimate interest in taxing currently the income of a corporation that has moved abroad to take advantage of lower tax rates to manufacture goods destined for the United States. To accomplish that purpose we propose, in addition to the tax holiday rule, that where a U.S.-owned foreign corporation has more than 25 percent of its receipts from the manufacture of goods destined for the United States and is subject to a significantly lower tax rate abroad, the income of such corporation will be taxed currently to the U.S. shareholders. A foreign tax will be deemed significantly lower where the foreign effective tax rate is less than 80 percent of the U.S. statutory corporate tax rate. The tests as to the percentage of exports to the United States and the effective foreign tax rates would be applied annually. Our proposal for tax holidays and runaway plants will add a new section to the Internal Revenue Code providing that a U.S. shareholder that is, a shareholder who is a U.S. person owning 10 percent or more of the stock-of a controlled foreign corporation will be treated as having received his pro rata share of the corporation's earnings and profits for a taxable year if the corporation is one that receives a tax holiday or a similar tax investment incentive or is a runaway plant, under the definition I have just described. A controlled foreign corporation is one having more than 50 percent of its combined voting power owned by U.S. shareholders, a concept already in the code. The tax holiday and runaway plant rules would be in addition to those added by the Congress in 1962 and in its tax haven legislation, and the mechanism for taxing the shareholders would be comparable, but without certain escape clauses that were provided in the 1962 legislation. A corporation will be regarded as engaged in manufacturing or processing operations if the unadjusted basis of the tangible property and real property used in its manufacturing or processing operations exceeds 10 percent of the unadjusted basis of all tangible property and real property of the corporation. Corporations engaged in other businesses, such as mining, would be unaffected. The provisions will apply to any new investment or additional investment in existing manufacturing or processing operations after April 9, 1973. In the case of additional investment or replacement of existing investment, a transitional rule is proposed so that these provisions will not be applicable until the increased investment exceeds 20 percent of the investment on April 9, 1973. Our third and last proposal relates to the subject of foreign losses. We have proposed that where U.S. taxpayers have used foreign losses to offset other income taxable by the United States and those foreign losses are not taken into account by the foreign jurisdictions in later years, then the United States will, in effect, recapture those losses by a reduction of the foreign tax credit or an inclusion in the gross income of the taxpayer in later years. This proposal modifies the present system under which the United States bears the cost during the loss years, but receives none of the revenue during the profitable years. In these circumstances, we wish to be sure of our fair share of the tax revenues. The reduction in the tax credit would apply where the taxpayer itself continues to operate abroad in profitable years. However, since initial losses are frequently anticipated, one tax planning technique has been to operate in a branch form to deduce losses against U.S. income during the start-up period followed by incorporation of the foreign branch as a foreign subsidiary at or near the time the operation becomes profitable. In order to prevent this maneuver, the legislation proposes the recapture of losses by taking the previous losses into income upon the incorporation of a branch or comparable change in its tax status. Mr. Chairman, this completes my statement. The CHAIRMAN. Without objection, the tables appended to your statement will appear in the record at this point, Mr. Hickman. No objection is heard. [The tables referred to follow:] TABLE 1.-U.S. DIRECT FOREIGN INVESTMENT: BALANCE OF PAYMENTS FLOWS, 1970 AND 1971 1 Includes after-tax branch profits plus dividends, interest, royalties, fees, and film rentals net of foreign withholding taxes. 2 Includes unallocated international direct investment. Source: U.S. Department of Commerce, "Survey of Current Business," November 1972. 1 Where a reduced rate of withholding is applied for parent-subsidiary dividends, that rate is shown. 221 percent of first $35,000, and 50 percent of the excess. 3 Progressive rate structure of 5 to 42 percent. 4 Corporations are taxed according to a progressive rate structure with bracket progression. The highest percent on the excess is 50 percent. $ 30 percent of taxable income and 5 percent on distributed profits of other than service corporations. • Progressive rate structure with a maximum rate of 50 percent of income over 28,000,000 bolivares. Corporations engaged in oil and mining activity are subject to a rate of 60 percent on gross increments. 730 percent for distributed income with a floating rate on undistributed income; maximum is 35 percent on excess over B.Fr. 5,000,000. 10 percent surcharge on basic rate. Tax on undistributed profits/distributed profits. Distributed profits also bear substantial local taxes. Companies in Italy are subject to both the income tax, at rates varying from 18 to 25 percent, and the company tax of 18 percent. 10 Federal tax is a maximum of 7.2 percent; however, the cantons assess a progressive corporation tax. The maximum rate is 29.78 percent including Federal and communal rates. 11 A corporate tax of 40 percent is levied on all corporate profits and a 38.75 percent tax is applied on distributed profits. 12 The normal tax on companies is 43 percent. There is a 25-percent tax on undistributed profits. Mining income is taxed at 40 percent except for diamond mining (45 percent) and gold mining (special formula). 13 Undistributed profits are taxed at a maximum rate of 36.75 percent. Distributed profits are taxed at a maximum rate of 26 percent. 14 Corporate tax is 25 percent of first 100,000 pesos and 35 percent of the excess. TABLE 3.-PAYOUT RATIOS OF EARNINGS OF U.S. SUBSIDIARIES ABROAD 1 Preliminary. Data exclude interest earnings as well as royalties and fees. Source: Department of Commerce, "Survey of Current Business." Mr. HICKMAN. Mr. Chairman, if I may, on table 3, it has been pointed out to me that line "f" under Roman I and II should say, "(as percent of e)" not "(a as percent of d)". The CHAIRMAN. All right. Without objection, that correction is made in the table. Mr. Ullman. Mr. ULLMAN. First, Mr. Chairman, I would like to say to Mr. Eberle that I do agree with the general scope of your approach to the problem. I have said for some time now that the old GATT rules are not adequate to cope with the trade problem; it has been quite evident that that is true, that all kinds of new trade barriers and obstructions have arisen in the world that can only be negotiated out, and I think you have analyzed the problem quite carefully. You have indicated and repeated the fact that this is a partnership and that the Congress should be involved. I think that this certainly has to be the case. I have some doubts, however, that your proposal involves the Congress to the extent that it should if we have a true partnership. Now, recognizing the difficulties of any legislative body getting involved in actual negotiations and the fact that we haven't had a good mechanism to directly participate, I can't offer a criticism in the form of a more specific proposal as to how we should be involved. All I would say is that, as one member of the committee, that as we are writing the legislation I am certainly going to try to find better mechanisms of getting the Congress involved in the procedure and also a better stating of our U.S. trade policy as to what our objectives are in approaching this overall problem of trade reform. Let me turn now, Mr. Hickman, very briefly, to your analysis of foreign investments. It is a very difficult area to work in and to thoroughly understand. Your proposals on both holidays and percentage of products sold back into the country would have their effect primarily in less developed countries, would they not? Mr. HICKMAN. I think that that is primarily true, although you understand that we are working in the latter case with an effective tax rate so that you have to look at it on a company-by-company basis, and you will remember from the executive sessions earlier this week that even in the United States, where we have a 48-percent statutory rate, the effective rate may be very much less than that, depending upon how income is defined and rated in the particular situation. Mr. ULLMAN. Why is it that the deferred income concept has little application in countries that have the same tax rate as the United States? Mr. HICKMAN. Why is it that our proposals have little application? Mr. ULLMAN. Why is it that the concept of deferred income is not particularly significant in countries that have the same tax rate that we do? Mr. HICKMAN. The reason why that is so is that if one pays $48 in country X, and then brings the dividend back either as an actual dividend under existing law, or if we were to accelerate the taxation of shareholders and it were deemed to be distributed, he would be taxed at 48 percent in the United States, but he would have a tax credit for 48 percent on the tax that he paid abroad, so that where the foreign rates are nearly the same as the U.S. rates, there is no particular effect on the corporation from a different rule. Mr. ULLMAN. Well, except what troubles me is this. Is there a wide discrepancy in the amount of dividends actually paid between the dif ferent corporations? In other words, we tax the profits of all corporations abroad in with the U.S. income. Is that a true statement? In other words, foreign corporations in their foreign operations are taxed under U.S. rates the same as if they were operating domestically. Mr. HICKMAN. No. A foreign subsidiary is not taxed under our tax laws, but the earnings of the subsidiary are taxed when they are returned as a dividend to the domestic corporation. Mr. ULLMAN. Then how does the tax credit apply ? Mr. HICKMAN. The tax credit applies by determining the amount of the tax previously paid abroad with respect to the dividend. In other words, if you had paid an effective tax of 40 percent abroad, then 40 percent of the dividend that you get (grossed up by the foreign tax) would be deemed subject to the credit. Mr. ULLMAN. Have you made any recommendation with respect to the problem of the application of the tax credit as to whether we shall continue to allow corporations to choose between an overall basis or a per-country basis? Mr. HICKMAN. We have not felt that it was advisable to take away the existing option. There are arguments both ways. We do not feel that there are significant distortions in either case. It is simpler in many cases for companies to use the overall limitations. Surely that would be simpled from an administrative point of view. Some people feel that a per-country limitation is more logical insofar as it deals with the tax actually paid to a particular country. Mr. ULLMAN. The main criticism of the per-country income has been the companies with a heavy loss in a given country can deduct that loss directly against their American taxes. Mr. HICKMAN. That is a criticism of the per-country limitation, yes. Mr. ULLMAN. That is right. Have you tackled that problem ? Mr. HICKMAN. We have dealt with that problem in our proposal with respect to losses. We are not denying the deduction of the loss against U.S. income, but we are saying that when the foreign operation turns the corner and begins to show a profit, we want our share of the tax on that profit. So we have solved that problem, we think, by approaching it in a slightly different way. Mr. ULLMAN. Have you kept it on a prospective basis, however? Mr. HICKMAN. Yes. It would be effective with respect to losses starting next year. Mr. ULLMAN. My time is up, Mr. Chairman. Thank you. Mr. SCHNEEBELI. Thank you, Mr. Chairman. Ambassador Eberle, on page 3 you say that “* * * the longer-term implications of the institutional defects of the GATT are serious." Up to this point, we have heard very little about GATT. I hope this is not indicative that we may be ignoring the GATT or that we are going to get into a lot of bilateral agreements outside of the GATT. What is the position of the U.S. negotiating group with regard to the GATT? Are we interested in strengthening the GATT where we recognize there are weaknesses? Do we plan on using it extensively in the future? Is this going to be the arena where we conduct our negotiations? Ambassador EBERLE. Congressman, we feel that the GATT should be made full use of. It is at the present time the only international set |