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[A] tax provision that allows multinational corporations to defer U.S. taxes by moving profits into offshore financial subsidiaries. This provision -- known as the "active financing exception" -- is the main tool GE uses to avoid nearly all U.S. corporate income tax.

Source

Is it true that there is a single law that allows for the off shoring of profits(and thus the avoidance of US Taxes) and that it would have expired with the Fiscal cliff but for the compromise?

  • International agreements limit the ability of any government to tax earnings made on foreign soil. Of course, depending on specific local laws there may still be far too much freedom to declare a large proportion of all profit in low tax countries. Usually this results from a complicated mix of laws. Maybe the US is different, but I suspect someone is oversimplifying. – matt_black Jan 4 '13 at 2:32
  • @matt_black - This money would be made in the US and transferred offshore prior to paying taxes. – Chad Jan 4 '13 at 14:12
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    I think the source of the confusion is that many big american firms are actually multinationals who make a lot of money outside the USA. This is different to taking US money and moving it abroad. Tax is only paid if the foreign profit is returned to the US. Apple, for example, has a huge provision in its accounts in case its vast foreign earnings are ever returned to the US for investment or distribution as dividends. – matt_black Jan 4 '13 at 14:21
  • @matt_black - That is not the claim of the article though. The article is specific that this is income made in the US and moved to a foreign country. – Chad Jan 4 '13 at 14:22
  • @Chad I didn't realize that the claim involved moving profits earned in the US offshore. I've updated my answer (the answer is "No" for that definition of "off shoring"). – Larry OBrien Jan 4 '13 at 20:02
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It depends on what you mean by "off shoring profits". If you mean "shelter profits earned offshore," then the answer is "Yes." If you mean "move profits earned in the US offshore and then shelter them," the answer is "No."

The "Active Financing Exception" rule was originally enacted in 1997 and has been extended on a "temporary" basis regularly since then. It was extended again for 2 years in Sec. 322 (page 50) of The American Taxpayer Relief Act of 2012.

SPECIAL RULE FOR INCOME DERIVED IN THE ACTIVE CONDUCT OF BANKING, FINANCING, OR SIMILAR BUSINESSES.—Paragraph (9) of section 954(h) is amended by striking ‘‘January 1, 2012’’ and inserting ‘‘January 1, 2014’’.

This article written in 2007 by Matthew Stevens ("a Partner in the International Tax Group for the law firm of Alston & Bird. He has also served as special counsel to the Chief Counsel for the IRS.") makes the structure of the rule fairly clear and that it is used to shift the status of some types of corporate income (specifically, "qualified banking or financing income"):

As a general rule, if a controlled foreign corporation (CFC) receives income from interest or dividends, or recognizes gain from the sale of property that produces interest or dividends, such income or gain constitutes foreign personal holding company income, which in turn is a type of Subpart F income. Accordingly, the U.S. shareholder of the CFC—I assume throughout this article that there is only one—must generally include such amount in income, after it has been reduced by all properly allocated deductions. However, at least until December 31, 2008, for calendar year taxpayers, Code Sec. 954(h) provides that foreign personal holding company income does not include “qualified banking or financing income” of an “eligible controlled foreign corporation.”

(Note that the article refers to a sunset of 2008, but as noted above, the rule has been continuously extended.)

In the case of GE, the rule benefits GE Capital which had a net income of $6.5B in 2011.

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    It is probably worth mentioning that as a practical matter the distinction between "shelter profits earned offshore" and "move profits earned in the US offshore and then shelter them" is often not very meaningful, as corporations have considerable flexibility in where they choose to make their profits show up. – Evan Harper Jan 26 '13 at 20:39

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