The combination of expanding international trade and climbing corporate income tax rates in the early part of this century required nations to evolve methods for reducing the level of international double taxation. While most countries came to rely upon a variety of techniques, two general approaches emerged to the taxation of the income of residents derived from foreign economic activity. Some countries adopted a territorial based system in which foreign source income is normally exempted from domestic tax. That system generally leaves the taxation of foreign income to the government within whose territory the activity occurs and thus avoids double taxation entirely. Other countries, including the United States, chose to impose their tax on the world-wide income of their individual citizens and residents and domestic corporations. That approach necessitated the development of specific mechanisms to reduce double taxation when the country within whose borders the income had been derived also imposed a tax on that income.The prevailing solution to this source of double taxation is for the residence country to allow its taxpayers to credit taxes paid to foreign jurisdictions against their domestic income tax liability. The extent to which such a foreign tax credit effectively relieves double taxation, however, depends in part upon the adequacy of the description of the foreign taxes that may be credited against the domestic tax liability. If the description is overinclusive, allowing too broad a range of foreign taxes to be credited, the foreign income will be taxed too lightly. Conversely, if the description is under-inclusive, double taxation will not be fully relieved and the foreign source income will be taxed more heavily than domestic income.

Coven argues that the rules extending nonrecognition treatment to the incorporation of property never have been properly integrated with the double taxation of corporations. As a result, the duplicate burden or benefit is applied retroactively. That defect, Coven believes, has been long overlooked, but now that it has been exploited by one popular version of the loss replicating corporate tax shelter, it must be addressed. The remedy applied by Congress to the tax shelter in section 358(h) is insufficient, does not operate correctly and undermines the integrity of the code, he says. This article proposes a more comprehensive solution that would improve the code by eliminating both the benefits and the burdens of the retroactive double tax through dual basis adjustments similar to those used in partnership taxation. The article was prepared before the adoption of section 362(e)(2). That provision, however, merely underscores the need for the solution suggested here, Coven concludes.

The past seven years have witnessed the culmination of a series of dramatic changes in our income tax policies towards corporations and their shareholders. Relationships among the principal provisions of the individual and corporate income taxes that had prevailed for the preceding one-half century, and the expectations that those relationships created, were quitea bruptly turned on their heads. One might expect that such a mini-revolution in income tax policy would be succeeded by a prolonged period of relative calm during which vaguely conceived modifications were rationalized and structural gains consolidated.(1) That, however, seems most unlikely to occur. The major elements of the current statutory approach to corporate taxation have not gained general acceptance and the political equilibrium that produced and briefly sustained that statutory pattern has been destabilized by the change in political administrations. The prescription is for further change, and even now serious proposals are piling up before Congress. That continuing change is not to be regretted; the statutory pattern that emerged primarily in the 1986 legislation was far too economically irrational to deserve greater longevity.While further modification to our corporate tax policy seems both inevitable and imminent, the direction in which that policy now will move is far from clear. It is therefore an appropriate time to reflect upon corporate tax policy for the twenty-first century. As in other human endeavors, the look forward is illuminated by the light of the past.A. THE ABOLITION OF AD Hoc TAX INTEGRATIONAt least since 1936, the United States nominally has imposed a separate and cumulative tax on the incomes and profits of both individuals and corporations. While that general statutory pattern is deeply entrenched in our taxing system, the resulting potential for the taxation of profits derived by incorporated business has discomforted virtually all students of income taxation. Over the history of the dual system of taxation, that discomfort produced a variety of statutory provisions designed to ameliorate the nominal income tax burden in greater or lesser degree.(2) Perhaps more importantly, other less calculated but equally effective policies and practices which further mitigated double taxation were widely tolerated throughout this period.As corporate taxation entered 1986, a wide range of features of the taxing system served to reduce the effective rate of tax at either the corporate or the shareholder level, in many cases eliminating one or the other level of tax all together. The more significant of those elements of the taxing system might include the following.At the corporate level:1. Corporate Tax Rate. In general, the maximum rate of income tax applicable to corporations was substantially lower than the maximum rate of tax that might be applicable to individuals. For example, during much of the period following World War II, the corporate tax rate was less than seventy-five percent of the maximum individual rate.(3) In addition, relatively small, closely held corporations benefited from further rate reductions at the corporate level through the progressive rate structure which, in its various manifestations, had the general effect of halving the tax rate on very low corporate incomes.(4)2. Exemption from Tax on Certain Distributed Income. The income tax on income or gain inherent in property distributed to shareholders was entirely forgiven under the so-called Genera) Utilitie's doctrine.(5) That peculiar feature of prior law opened numerous avenues for elimination of double taxation. Thus, in its most abusive application, the double taxation of closely held corporations could be essentially eliminated by confining dividends to distributions of appreciated property, including inventory.(6) Any corporation, large or small, might eliminate tax on the appreciation in corporate properties, again including inventory, by purporting to sell all of its assets to a second corporation, even one partly owned by the shareholders of the transferor. …