In a pure worldwide tax system, resident individuals and entities are taxable on their worldwide income regardless of where the income is derived. By contrast, in a pure territorial tax system, the country taxes only income derived within its borders, irrespective of the residence of the taxpayer.

There have been proposals that the United States move from a worldwide tax system (its current tax system) to a territorial tax system. As alluded to earlier, under the territorial system most income earned overseas would not be taxed in the United States. Therefore, if the United States moves toward the territorial system the taxpayer will need to model and think about what a territorial system might mean. Specifically, the system would not offer the same strategies to reduce U.S. taxes, such as by foreign tax credits. However, a territorial system should eliminate the need for complicated rules such as the controlled foreign corporation (CFC or Subpart F) rules and the passive foreign investment company (PFIC) rules that subject foreign earnings to current U.S. taxation in certain situations.

Congress and the President are also considering a combined version of a territorial system and a "border-adjustable" system which would involve taxing imports and exempting exports, referred to as the "import tax". This may be done with direct duties or by denying the United States income tax deduction to U.S. companies for the cost of the goods imported into the United States. 

Deemed Repatriation

The Republican’s proposed legislation and President Trump’s proposal also calls for the repatriation of assets held outside of the United States. Specifically, President Trump has promised to allow United States’ companies to repatriate to the United States corporate profits not previously taxed in the United States and held offshore at a one-time tax rate of 10 percent. However, given that a territorial system would allow for the “parking” of corporate profits from foreign jurisdictions offshore, it is unclear whether this repatriation allowance would be incorporated into the new territorial system or be a one-time revenue raiser to offset the revenue lost from the move to a territorial system.

Although these changes are intended to make U.S. companies more competitive on a worldwide basis, the effect to each U.S. business may be greatly varied. A careful review of these proposals is crucial to understanding a company’s U.S. tax position going forward.