Comparing International Tax Systems in the Introductory Tax Class

Editor: Annette Nellen, J.D., CPA

Given the increasingly global nature of the economy, the AICPA has included an international/global perspective among the broad business perspective competencies it considers essential for accounting professionals to develop (AICPA, Core Competency Framework (2005)). The AICPA explains that “individuals entering the accounting profession should be able to identify and communicate the variety of threats and opportunities of doing business in a borderless world. The accounting professional of the future must provide services to support and facilitate commerce in the global marketplace” (“Broad Business Perspective Competencies,” Core Competency Framework).

Further, the AICPA Model Tax Curriculum suggests that instructors could incorporate the international/global perspective from the core competencies into the learning objectives of typical introductory tax courses. However, given the limited time devoted to tax courses in most university curricula and the multitude of topics that can be covered in introductory tax courses, instructors may have difficulty devoting an entire module to international tax issues or incorporating in-depth cases dealing with international tax issues into their introductory courses.

In response to this difficulty, this column presents an assignment that requires a more modest time commitment to bring international tax issues into the introductory tax course and to raise student awareness of differences in tax systems. The assignment requires students to research parts of another country’s tax system to provide tax planning advice to a client who is considering taking a job overseas.

Educational Objectives

In most introductory tax classes, instructors will spend a portion of the beginning of the course discussing different tax rate structures (i.e., progressive, proportional, regressive) and different types of taxes (e.g., income, sales, wealth transfer, payroll). The assignment described below provides a basic set of facts that instructors can use early in the course as a means to reinforce these concepts by comparing the rate structure and types of taxes used in the United States with those of another country. By examining some features of another country’s tax system, students can gain an appreciation for the fact that the specific rates and income levels chosen for the income tax by a particular country (including the United States) can take a variety of different forms. Likewise, this comparison between countries can also help students realize that a government can choose among many different types of taxes.

This understanding of the possible variations of the portfolio of taxes available to a government can offer an opportunity for instructors to incorporate a discussion about the tax policy implications of these decisions. This objective fits nicely with the learning outcome articulated in the Model Tax Curriculum that students entering the profession should have the ability to “[c]omprehend the rationale for tax laws by differentiating the types of tax bases and weighing the multiple objectives tax policymakers consider when developing tax law” (Model Tax Curriculum, Preamble, p. 2).

The second educational objective of the assignment is to give students a better understanding of the role that taxes play in the decision-making process. As noted in the Model Tax Curriculum, students should have the ability to apply “analytical reasoning tools to assess how taxes affect economic decisions for all taxpaying entities (including individuals, partnerships, Subchapters C and S corporations)” (Model Tax Curriculum, Preamble, p. 2). The assignment achieves this objective by requiring students to consider both the tax and nontax factors that individual taxpayers might consider as they decide whether to take an overseas position.

The assignment also serves to fulfill some secondary objectives. Because students must write a letter to the client that summarizes their findings, the assignment can help students further develop their written communication skills and their ability to communicate the relative attractiveness of different alternatives. Finally, the assignment can also expose students to and/or reinforce the topic of foreign currency conversion.

Implementation Guidance

To achieve the educational objectives described in the preceding section, the assignment describes a recent graduate who is considering two career paths. For the first career path, the graduate can choose to continue as an employee of a large U.S. company. For the second career opportunity, she can choose to take an overseas job with her current employer. The assignment requires students to (1) perform an analysis of the two options for the current year as well as two additional years and (2) write a letter to the client to advise her on this analysis. Students are instructed that the letter should include a comparison of after-tax income (calculated as salary minus the tax liability) for each option as well as a discussion of other tax and nontax factors that the graduate should consider.

Exhibit 1 contains one version of the assignment sheet. The sheet indicates the country to which the student was assigned and provides the current conversion rate for the country’s currency as compared with U.S. dollars. The salary and raises in the United States and the comparison country can be varied among the different versions.

The assignment was distributed during the second week of class as an individual project due during the fourth week of class. At the point in the semester when it was distributed, the students had learned limited tax material. More specifically, during the first several classes, the instructor covered the concepts of different types of taxes used in the United States, marginal and effective tax rates, and progressive, regressive, and proportional tax rate systems. With this limited knowledge, the assignment was simplified to limit the aspects of the tax systems that the students were expected to examine. More specifically, students ignored any potential deductions or exclusions to which the taxpayer might be entitled. Instead, they considered salary to be the taxpayer’s taxable income.

Students were randomly assigned to three different countries: Australia, Ireland, and the Philippines. These three particular countries were chosen because of differences in the number of tax brackets and top marginal tax rates. For example, Ireland has only two tax brackets, while the Philippines has seven. However, instructors can vary the assignment with each offering of the class by choosing different countries. A table summarizing characteristics of the individual income tax for a number of countries for which tax system information is currently readily available can be found here. Additional sources with helpful summaries of various tax systems include the European Union and the Federation of International Trade Associations.

Instructors may want to choose countries that have differing philosophies about tax rate structure (e.g., larger versus smaller number of tax brackets or smaller versus larger difference between the bottom and top marginal tax rates) to encourage more discussion and debate among students. Because websites sometimes contain different versions of the tax rate system for a particular country, instructors may want to require students to print and attach a copy of the rate system and the web address where they found the information.

Students were evaluated on the accuracy of their calculations of the taxpayer’s after-tax earnings as well as the quality of their discussion of the income tax implications and other tax and nontax factors that the taxpayer should consider in making a final decision. In addition to the written assignment, instructors may wish to devote class time to discussing the project. Effective questions for sparking discussion include asking students what they liked most or least about the foreign tax system that they researched or what they found to be surprising about the tax system. Often student responses to these questions will center on the rate structure of the system, so instructors may wish to hand out copies of the three different rate structures as the discussion begins so students can compare them during the class.

Alternative Uses

While the assignment provided in Exhibit 1 is a simplified scenario that students can complete individually, it is versatile, and instructors can incorporate it into the classroom in a variety of ways. The following discussion offers two types of variations of this simplified version of the assignment: alternative ways to implement the project and an expansion of the scope of the problem to incorporate differing degrees of technical requirements.

Instead of treating the assignment as an individual project, instructors could use it as a group exercise in which they assign small groups of students (3–4 per group) to a particular country and require them to research that country’s tax system. The groups can then present their findings to the class. At some universities, there are a substantial number of international students in accounting programs, which may offer additional opportunities to vary the assignment. Instructors could pair an international student with one or more U.S. students and have the students prepare the exercise for each other’s tax system (i.e., the U.S. students research the tax system that is native to the international student, and the international student researches the basics of the U.S. system). The students can work together to prepare the international and U.S. comparison of tax implications.

The assignment also offers an opportunity for instructors to invite tax professionals to help with the assignment. Professionals from the tax department of a large corporation or an international accounting firm who frequently travel to other countries and must deal with other tax systems can serve as guest speakers when the assignment is discussed in class. Alternatively, tax professionals from other countries who may be visiting local offices of international firms can serve as guest speakers.

The assignment is also versatile in the level of technical tax rules that the instructor can choose to incorporate. In addition to using the assignment early in the semester without incorporating any deductions or exclusions in the analysis, instructors could reintroduce the assignment at later points in the semester and expand the issues required for completion. For example, instructors could require students to include other types of income beyond the basic salary or various items of expense.

For those courses that want to focus on the specific tax rules associated with income earned by a U.S. citizen in other countries, instructors can expand the assignment to incorporate a requirement to calculate and compare the tax exclusion or credit for foreign earned income. Exhibit 2 illustrates one way that an instructor can tailor the assignment to incorporate these issues. In this scenario, the taxpayer is a middle manager who is considering an overseas assignment. Increased salary levels ensure that the taxpayer’s foreign earned income will exceed the amount of the exclusion provided in Sec. 911 (for 2010, the maximum amount of foreign earned income that can be excluded is $91,500). The overseas work assignment will begin on February 1, so dealing with a partial year will increase the complexity of the problem because students will have to determine if the taxpayer meets the physical presence test required to claim the exclusion and will have to apportion the exclusion based on the days the taxpayer resides in the foreign country. Including other sources of income besides the foreign earned income shows that the exclusion does not decrease the marginal tax rate on the taxpayer’s total income. Instead, the U.S. government is able to tax this income at the higher tax brackets that would apply had there been no exclusion.

Instructors can further increase the complexity of this version of the assignment by having the students prepare a second-year analysis assuming that the taxpayer continues to stay in the foreign country. Instructors could also ask students to incorporate a foreign housing exclusion that the employer might offer employees if they accept the overseas assignment.

As another option, instructors could add a scenario looking at the issue from the employer’s point of view. Exhibit 3 presents a scenario in which the company has decided to establish a physical presence in another country to implement its sales and marketing operations. Based on this information, students must decide whether a subsidiary or a branch would be the best option for establishing this presence. This scenario requires students to consider the various taxes that the company would pay in the other country and the tax rates they would pay. Students also need to consider which foreign tax systems would allow the company to maximize its foreign tax credit in the United States.

This scenario can also be used to enable students to gain an understanding of the withholding rates that the respective treaties of the various countries require, assuming that the corporation wants to repatriate earnings back to the United States at some point. This comparison could lead to a discussion of the role that treaties play in promoting cross-border transactions. Instructors can also use the corporate scenario to have students investigate the types of incentives offered by each country to promote foreign investment. Finally, instructors could introduce the concept of transfer pricing and its effects on the tax costs and opportunities of operating overseas.

Conclusion

As the global nature of business continues to increase, many tax instructors teaching introductory courses have limited time to cover the required material and as a result may forgo discussions about international tax issues. This column offers suggestions for using a comparison of the U.S. and international tax systems in a tax assignment. While requiring only a modest investment of class time, the assignment provides instructors with an opportunity to highlight similarities and differences in tax rate structures and the policy issues that underlie them.

EditorNotes

Annette Nellen is a professor in the Department of Accounting and Finance at San Jose State University in San Jose, CA. She is a former member of the AICPA Tax Division’s Tax Executive Committee and a current member of the AICPA Tax Division’s Individual Income Tax Technical Resource Panel. Timothy Rupert is a professor and the James Carey Faculty Fellow, Timothy Gagnon is an assistant academic specialist, and Paul Oliveira is a lecturer, all in the Accounting Group at Northeastern University in Boston, MA. For more information about this column, contact Prof. Rupert at t.rupert@neu.edu.