Two years before then-Ambassador of Ireland Michael Collins would write members of a U.S. Senate subcommittee to dispute claims that Ireland is a tax haven and that his government negotiated a special tax deal with Apple Inc., he was dealing with a variation on the same theme at the state level.
Montana, a worldwide unitary apportionment state that offers a water's-edge election, in 2003 began maintaining a list of foreign tax havens in its combined reporting law. Multinational corporations making the water's-edge election in Montana must include in the unitary combined tax base the income and apportionment factors of affiliates incorporated in listed tax havens. And Montana had Ireland on its radar.
Brenda Gilmer, senior tax counsel at the Montana Department of Revenue, in 2010 wrote a memorandum describing the department's rationale for recommending that the list of havens be expanded to include Ireland and the Netherlands. She wrote that Ireland had enacted numerous tax law provisions that alone or in combination with multinational entity structuring reduced or eliminated the country's nominal 12.5 percent tax on profits earned by companies formed in Ireland. As support for adding Ireland to Montana's list, she noted that the return on assets for U.S. subsidiaries in Ireland is almost 300 percent more than for U.S. subsidiaries worldwide.
Collins responded, sending a letter to every Montana state lawmaker. The ambassador conveyed his government's surprise at SB 94, which Collins said "groundlessly labels Ireland and the Netherlands 'tax havens.'"
Ireland is neither a tax haven nor a tax secrecy jurisdiction, nor is it a nominal or no-tax jurisdiction, Collins said. Ireland is fully compliant with all applicable international standards and frameworks, including those of the OECD and European Union, and has a successful double taxation agreement in place with the United States, he said.
The Montana State Legislature adjourned its 2011 session without enacting changes to the state's list of tax havens. But in preparation for the 2013 legislative session, the DOR again recommended that Ireland and the Netherlands be added to the list -- this time along with new candidates Hong Kong, Singapore, and Switzerland. Sen. Dick Barrett (D) introduced legislation (SB 309) that would have implemented those changes.
Here's what followed:
- Jean-Paul Senninger, Luxembourg's ambassador to the United States at the time, traveled to Montana in 2012 in an attempt to convince lawmakers to take his country off the list, where it has been since 2003. Senninger then wrote to Dan Bucks, the then-revenue director for Montana, taking issue with the department's rationale for continuing to classify Luxembourg as a tax haven, as well as with some of Bucks's public comments on the matter.
- In March 2013 Swiss Ambassador Manuel Sager sent a letter to the chair of Montana's Senate Taxation Committee protesting the identification of Switzerland as a jurisdiction that could be considered a tax haven. Reiterating the position his country took in 2012, Sager wrote, "Switzerland has a transparent, comprehensive, and balanced tax system imposing an overall tax burden at a comparable international level." He said the bilateral double taxation treaties to which the United States is a party are predicated largely on separate company accounting and the arm's-length transfer pricing method, noting that all the countries Montana proposed adding to its list of tax havens have similar agreements with the United States. Sager called Switzerland a "pioneer" in negotiating an agreement with the United States to implement the Foreign Account Tax Compliance Act.
- Diplomats from the Washington embassy of the Kingdom of the Netherlands in July 2013 e-mailed a Montana legislative staff member offering to explain the tax system of the kingdom and its constituent countries. Annette Deckers, financial counselor for the Netherlands, and Jocelyne Croes, the kingdom's minister plenipotentiary for Aruba, wrote that the Netherlands is in "no way considered a tax haven by the OECD or other international bodies." They forwarded a three-page fact sheet titled "Aruba: A Transparent Tax and Banking Jurisdiction" and offered to provide state lawmakers with more details about transparency measures and U.S.-Dutch information exchange agreements.
Almost all the ambassadors wrote that the term "tax haven" should be used to identify countries or territories that levy no or very low taxes on income, wealth, capital, and profits and that their nations don't belong in that category.
The Irish ambassador said his country's 12.5 percent corporate tax rate is not even the lowest corporate tax rate within the European Union. The diplomats from the Netherlands said that under Aruba's revised tax system, the profit tax rate became an overall flat 28 percent, while the investment allowances and accelerated depreciation were abolished. And the Swiss ambassador pointed out that Switzerland's total tax revenue as a percentage of GDP exceeds that of the United States.
The ambassadors also warned that adding their nations to Montana's list of tax havens would make the state less competitive for direct foreign investment and jobs. The Swiss ambassador said the proposed changes would burden cross-border investments and "could discourage Swiss affiliates from continuing to do business in Montana or from choosing Montana as a place of incorporation." The Irish ambassador noted that companies in Ireland employ more than 80,000 Americans and that the nation is the 13th largest source of international investment in the United States.
Matthew Gardner of the Institute on Taxation and Economic Policy said the reaction from nations that were targeted isn't surprising. After all, one of an ambassador's jobs is damage control. He pointed out that Collins is the same ambassador who last year denied to members of Congress that Ireland is a tax haven, even as the U.S. Senate was being shown flowcharts describing how the country's tax laws facilitate Apple's use of the "double Irish Dutch sandwich" tax maneuver.
"If the common-sense definition of a tax haven is a country that goes out of its way to allow companies to avoid paying taxes, then it's hard to see how an ambassador from a country like Ireland can protest being called a tax haven and do it with a straight face," Gardner said.
But the Montana Legislature in 2013 again adjourned its session without enacting changes to the state's list of tax havens, making 2009 the last time Montana modified its list, when lawmakers approved legislation adding Cyprus, Malta, Mauritius, and San Marino and removing Tonga.
Barrett told Tax Analysts that Montana's process for adding nations to its statutory list of tax havens is "messy to go through" and invites controversy. "We fight, and people come out from Washington and tell us why we shouldn't be doing this," Barrett said. "It's kind of a state legislator's nightmare."
Tax Haven Language
Montana and Oregon are the only states whose tax codes list foreign jurisdictions to be treated as tax havens for corporate tax purposes. Last year Oregon adopted its new law, which took effect January 1. As required under that law, Oregon's DOR on January 28 forwarded to the Legislative Assembly a report on international and domestic shelters.
Alaska, West Virginia, and the District of Columbia have adopted combined reporting statutes that require the income of controlled foreign affiliates incorporated in tax havens to be included in the combined report, but none of them maintains its own list of tax havens directly in its code.
Lawmakers in Minnesota and California also have considered adding tax haven provisions to their combined reporting statutes. When California considered a proposal in 2010 that would not have listed nations but would have provided a general description of a tax haven, the United Kingdom and Singapore were among the nations that got involved.
"This bill reminds us of similar attempts to widen the tax base which the State of California tried to put in place in the 1980s," then-Consul General of Britain Julian Evans wrote to the governor and lawmakers. Evans said the United Kingdom believes that those kinds of approaches are essentially a "tax grab."
Gilmer noted in her DOR recommendations that states are not required to offer multinational corporations a water's-edge election. The U.S. Supreme Court confirmed that states can tax multinationals with a U.S. parent on a worldwide combined basis in Container Corp. of America v. Franchise Tax Board, 463 U.S. 159 (1983), and to similarly tax multinational corporations with a foreign parent in Barclays Bank PLC v. FTB, 512 U.S. 298 (1994).
Montana began offering a water's-edge election in 1987, after unitary combination states acceded to pressure from the U.S. Treasury, congressional leaders, and foreign governments to provide a water's-edge election despite the Container decision and the Barclays Bank litigation then underway. But in 2003, Montana lawmakers enacted the tax havens provisions to correct the most egregious multinational income shifting and restore some equity lost when the state adopted the water's-edge election, according to the DOR.
The Montana approach predates the Multistate Tax Commission's development of its model combined reporting statute, which has its own definition of tax haven for purposes of the water's-edge election. The MTC model originally had two tests for determining whether a jurisdiction is a tax haven, the first of which was whether the OECD listed the jurisdiction as having a "harmful preferential tax regime" in the current year. However, the MTC deleted references to the OECD in 2011 when it stopped maintaining its classification system and shifted its focus.
The Montana DOR continues to use the more general OECD framework, which recognizes that tax havens have three principal purposes: The jurisdiction provides a location for holding passive investments (money boxes); provides a location where paper profits can be booked; and enables the affairs of the taxpayers, particularly regarding their bank accounts, to be effectively shielded from authorities of other countries.
The DOR and the MTC model both expand on key factors that the OECD developed for identifying a tax haven jurisdiction. For example, the MTC model specifies that the factors to consider include whether the jurisdiction imposes no tax or a nominal rate of tax on the relevant income in addition to exhibiting any of the following characteristics:
- laws and practices that prevent effective exchange of information;
- a tax regime that lacks transparency;
- a legal system that facilitates the establishment of foreign-owned entities without a substantial local presence;
- a tax regime that excludes the jurisdiction's resident taxpayers from some benefits available to foreign investors; or
- a tax regime favorable for tax avoidance, based on an overall assessment of relevant factors, including whether the jurisdiction has a significant untaxed financial sector.
Barrett said ambassadors frequently take offense at the tax haven label. He proposed eliminating it and calling the jurisdictions nonexempt countries instead, which Sager said is simply semantics.
Bucks, former executive director of the MTC, told Tax Analysts that the fact that nations have information exchange agreements with the U.S. federal government and meet OECD transparency standards does nothing to correct the excessive assignment of income to tax havens. Citing cooperation with laws aimed at curbing tax haven abuses "seems to be more an admission of one's tax haven status than a defense," he said.
The arguments raised by ambassadors in their letters are irrelevant in the context of full and fair apportionment, Bucks said, adding that the letters generally confuse the difference between the federal arm's-length system and state apportionment laws, which seek to assign income where it was earned in proportion to the taxpayer's real business activities.
Dan Smith of the U.S. Public Interest Research Group (PIRG) agreed that none of the issues the ambassadors raised in their letters are reasons for a state not to classify a nation as a tax haven. Those nations have laws that allow corporations to assign income disproportionately to locations where it will not be taxed, Smith said, noting that Montana lists countries that are widely recognized around the world as tax havens.
Smith pointed out that adding tax havens to the list is a challenge when there's so much lobbying, adding, "But it's important to have the list, because otherwise companies will just tie up the state in litigation that it can't afford until eventually the state drops it."
Regarding the Swiss ambassador's reference to FATCA, which requires foreign financial institutions to report to the IRS information about U.S. account holders and their accounts, Smith said the federal law deals more with the issue of wealthy individuals engaging in clearly illegal individual income tax evasion.
"The tax-dodging gimmicks used by these corporations are, for the most part, perfectly legal, and that's the problem," Smith said. "There should be a way for states to say, 'We know what's really going on here, and we're going to tax those profits accordingly.'"
Gilmer elaborated on FATCA in her reports, writing that it addresses individual income tax evasion and the secrecy prong of the definition of tax havens, but not the use of entities to artificially lower taxable income. Individual income tax evasion generally isn't relevant to the issue of whether to include a jurisdiction on a list of tax havens for water's-edge reporting purposes, she said.
U.S. PIRG last year estimated that states lost $26 billion in corporate tax revenue in 2011 because of offshore havens. On January 30 the organization released a new report examining the mechanics of Montana's tax haven law and Oregon's new statute, estimating that combined reporting states could collect an additional $1 billion in corporate taxes if they followed Montana's and Oregon's examples and maintained a statutory list of tax haven jurisdictions. (Prior coverage: State Tax Notes, Feb. 3, 2014, p. 264.)
Barrett said that from both a political and tax policy perspective, a better approach than listing tax havens would be for Montana to eliminate the water's-edge election and mandate worldwide combination instead, adding that the state is basically headed in that direction anyway. He called the successive, incremental additions to the state's list of tax havens a de facto, if gradual, approach to getting rid of the water's-edge election.
Last year Barrett introduced legislation (SB 208) to eliminate the election, but it died in committee. He said lawmakers who voted against the bill indicated they might support an alternative to mandating worldwide combination or adding nations to Montana's list of tax havens.
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