To prevent negative effective tax rates in a territorial system, a multinational corporation’s deductions for interest expense attributable to foreign profits must be disallowed. To determine what portion of worldwide interest is foreign, it is commonly suggested that interest be allocated in proportion to assets. Because it would ease administrative problems and because it would reduce the incentives to shift profits through aggressive transfer pricing, allocation of interest in proportion to gross profits would be a superior approach. Also, contrary to the usual argument, the United States should not be reluctant to unilaterally adopt interest disallowance rules because it would create incentives for other countries to adopt similar rules and during the interim it would reduce taxes of U.S. multinationals at the expense of foreign governments.
Martin A. Sullivan
A Proposal for the Tax Treatment of Interest in a Territorial System,
40 Pepp. L. Rev.
Available at: http://digitalcommons.pepperdine.edu/plr/vol40/iss5/10