Wednesday, March 14, 2012
President Obama initially announced his international tax reform proposals on May 4, 2009 [BNA Daily Tax Report, May 5, 2009]. His language sounded as if it were a stump speech rather than anything even approaching a matter of policy. The essence of his explanation of the current situation was that many American taxpayers are “shirking” their responsibilities, and that the U.S. tax Code is “a broken system, written by well-connected lobbyists on behalf of well-heeled interests and individuals”:
Now, understand, one of the strengths of our economy is the global reach of our businesses. And I want to see our companies remain the most competitive in the world. But the way to make sure that happens is not to reward our companies for moving jobs off our shores or transferring profits to overseas tax havens....And that's why today, I'm announcing a set of proposals to crack down on illegal overseas tax evasion, close loopholes, and make it more profitable for companies to create jobs here in the United States....Now, it will take time to undo the damage of distorted provisions that were slipped into our tax code by lobbyists and special interests....
The Internal Revenue Code is the result of generations of congressional review and action, both by Democrats and Republicans. For example, the Subpart F provisions that the President characterized as “loopholes” were proposed by President Kennedy and debated in Congress almost 50 years ago, and have been reviewed, revised, and debated consistently over the years. To characterize these as provisions “slipped into our tax code by lobbyists and special interests” is, obviously, a political pitch by the President. This is the same type of language used to pillory the bankers of Wall Street.
The President obviously failed to acknowledge what has been apparent to Treasury for a long time—that U.S.-based MNEs are burdened with a tax regime that penalizes them to the tune of 8%-10% compared with MNEs based in almost any other country. The President at least acknowledges the need for U.S. companies to “remain the most competitive in the world.” The word “remain” contradicts the express conclusions of Treasury.
Perhaps the President's bombastic language is required in the political arena to show his devotion to addressing equity in the Code. Nonetheless, it unnecessarily waves a red flag in the face of U.S.-based companies. As Treasury itself has noted for many years, U.S.-based MNEs are burdened by the Code. Of course, these companies seek every legitimate means of reducing their effective tax cost worldwide to compete against foreign-based companies that are given a competitive advantage. It is business after all. Some major MNEs face competitors that have an effective tax rate of around 20% vs. the 35% rate of their own.
Regardless of rhetoric, and actual substantive content, the Obama proposals reflect a reasonable agenda for a dialogue on international tax reform, provided there is a balance between the competitiveness of U.S.-based MNEs and the need to raise revenue to finance an economic recovery, as Chair of the Senate Finance Committee Max Baucus (D-MT) has indicated [see This Week with Cym Lowell ¶ 2 5/18/2009]. Absent this balance, the White House would leave many U.S.-based MNEs little choice but to consider the possibility of moving their headquarters offshore, as has been a trend in recent years in all developed countries.
At least three items are conspicuously absent from the Obama list: (1) a careful exposition of the exact competitive position of U.S.-based MNEs by industry; (2) whether the United States should adopt two of the consistent elements of the taxation systems of most of its trading partners, i.e., a territorial income tax system and a national consumption tax; and (3) an express election for U.S.-based MNEs to become foreign based if they prefer to be subject to taxation in the United States on the same terms as their foreign competitors (which would preclude a race to the exit while market capitalization rates are low).
There is no such analysis in the Obama Administration budget proposals, including those made for the 2013 budget, which simply restate prior proposals with little substantive or economic change [BNA Daily Tax Report, February 23, 2012, page GG-1].
The Obama Administration transfer pricing proposals are rather generic. However, they provide enough detail to see where the Administration is headed. The proposals essentially would tighten the outbound intangible transfer provisions in Code Sec. 367(d) [Lowell, Briger & Martin: U.S. International Transfer Pricing ¶ 2.02[e][ii] ] to address the perceived out-migration of intangibles from the U.S. tax base at less than arm's-length pricing, which the Obama Administration makes a centerpiece of its perceived “tax gap” relating to international taxation of MNEs in the United States.
The Administration proposals explain the need for change in the extant rules as follows:
Controversy often arises concerning the value of intangible property transferred between related persons. Further, the scope of the intangible property subject to Code Sec. 482 and Code Sec. 367(d) is not entirely clear or consistent. This lack of clarity and consistency may result in the inappropriate avoidance of U.S. tax and misuse of the rules applicable to transfers of intangible property to foreign persons....To prevent inappropriate shifting of income outside the United States, the proposal would clarify the definition of intangible property for purposes of Code Sec. 367(d) and Code Sec. 482 to include workforce in place, goodwill and going concern value
The original Obama Administration proposals would also clarify that (1) in a transfer of multiple intangible properties, the Service may value the properties in the aggregate where that achieves a more reliable result; and (2) intangible property must be valued at its highest and best use, as it would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having reasonable knowledge of relevant facts.
The Administration's 2011 budget proposed expanding the scope of Subpart F to currently tax “excessive” returns from transfers of intangible property to “low-tax” jurisdictions. Treasury officials stated that this proposal does not conflict with U.S. transfer pricing or treaty obligations, since it is a Subpart F proposal, not a transfer pricing proposal, and provides a “backstop” to the existing transfer pricing rules [Lowell, Briger & Martin: U.S. International Transfer Pricing ¶ 2.02[e][ii] ]]. This would be a difficult position to sustain in Competent Authority proceedings [Lowell & Martin: U.S. International Taxation: Practice and Procedure ¶ 9.04 ].
For all the President's rhetoric about offshore tax abuse, these proposals seem innocuous as a practical matter. Absent effective enforcement, word changes will make no real difference. The Administration should take a realistic approach to these transfer pricing matters with budgetary proposals that will hold the Service's feet to the fire.