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In the early 1990s, Bolivia tried to adopt a popular U.S. tax reform proposal: replacing its corporate income tax with a cash-flow -type consumption tax, broadly similar in structure to taxes proposed by a long line of theorists from Prof. William Andrews in 1974 to the President's Advisory Panel on Federal Tax Reform in 2006. Unfortunately, the Bolivian experiment ran into an insuperable obstacle: the U.S. foreign tax credit (FTC) rules. The U.S. Treasury decided that the Bolivian tax would not be creditable for U.S. corporations investing in Bolivia. Given the importance of U.S. foreign direct investment (FDI) for Bolivia, that was the end of the experiment. Why was the Bolivian tax ruled not creditable? The code does not put explicit limits on which taxes should be creditable, although it does refer to "income taxes." Under the interpretive regulations, a creditable tax must contain three elements: It must be imposed on gross income (the gross income requirement), it must allow for deductions similar to those permitted under the U.S. income tax (the net income requirement), and it must incorporate a realization requirement. There are two basic ways of designing a cash flow tax, identified by the Meade Commission in the United Kingdom as the R (real) and R+F (real and financial) methods. Under the R method, all receipts are included in income and all expenditures are currently deductible, but financial transactions (borrowing and debt repayment) are ignored. Under the R+F method, loans are included in income and both interest and principal


Reprinted with the permission of Tax Analysts.