By Lee A. Sheppard -- email@example.com
This is a hypothetical memorandum from the Treasury Department to U.S. multinationals, in response to their disbelief that the international tax system will have to change and that they will have to pay some taxes somewhere.
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Fortune 100 Companies
U.S. Treasury, Office of Deputy Assistant Secretary
(International Tax Affairs)
OECD Base Erosion and Profit-Shifting Report
Can the U.S. Treasury defend multinational tax planning practices and preserve the status quo?
No, the U.S. Treasury cannot defend tax planning not rooted in OECD model treaty provisions, nor can it preserve the status quo in its entirety.
1. The era of paying little or no corporate income taxes all over the world, including in the United States, is over.
Important trading partners are unhappy that some U.S. multinationals pay no corporate income tax anywhere. Often these companies are household names with a large consumer presence.
Elected officials in these countries are responding to popular pressure to make these companies pay some local tax, while citizens are being asked to pay more and to endure austerity. These officials have approached the OECD in good faith to resolve the base erosion and profit-shifting problem multilaterally.
Starbucks Corp. recently promised to pay a sum in the tens of millions of dollars to the British treasury as a goodwill gesture. The company was not legally required to make this payment, which would not be creditable as a tax. As a highly visible consumer products company, however, Starbucks understood that writing a decent-sized check was better than enduring a consumer boycott or getting a Molotov cocktail through the window of one of its stores.
Officials from these countries have informed Treasury that they would not be as unhappy with multinational tax planning if they thought that the same companies were paying significant taxes to the U.S. government. Apple's admission to the Senate Homeland Security and Governmental Affairs Permanent Subcommittee on Investigations that tax was paid nowhere on much of its foreign sales income does not sit well with the governments of countries with significant markets, even if its tax planning is permissible under U.S. law.
Many representatives of U.S. multinationals argue that the Europeans are being hypocritical, arguing for taxation of U.S. companies and not their own multinationals. The base erosion and profit-shifting problem, however, is perceived as primarily a U.S. problem. Fighting this perception could be counterproductive.
This project requires the cooperation of governments that are disgusted with the low levels of tax payments by U.S. multinationals. Germany, France, and the United Kingdom are prepared to act unilaterally if the OECD action plan is deemed insufficient. These governments believe that they are more constrained by European Union rules than by their OECD model treaties.
2. The United States no longer enjoys the ability to boss other countries, particularly European governments.
U.S. world leadership peaked at the end of the Cold War and entered an irreversible decline after the invasion of Iraq in 2003. Some European countries joined the coalition for the invasion. Some were paid to do so. Some vehemently opposed it.
The financial meltdown that began in 2008 had its origins in U.S. credit expansion and banking deregulation. The effects of this crisis will continue to have worldwide repercussions for many years to come. This crisis seriously dented the credibility of the U.S. economic model. It has put pressure on U.S. efforts to maintain open trade.
Taxation is not an exception to, or separate from, other geopolitical issues. As U.S. military and economic leadership declines, and as the U.S. economy suffers, U.S. world leadership suffers accordingly. The OECD base erosion report was not issued in a vacuum. Power relationships in the world are changing.
3. European adherence to the international consensus that favors residence country taxation is weakening.
If the OECD loses the loyalty of its core European members, the United States loses the OECD as a vehicle through which to convince those members to adopt its theories and practices for international taxation.
The OECD Centre for Tax Policy and Administration has put its credibility on the line with the base erosion report. It has to deliver a constructive action plan to the G-20, or face irrelevance. If the OECD becomes less relevant, the United States loses an important multinational vehicle.
The United States has to offer some concessions to other OECD members and important observers. The United States cannot simply argue that European countries should change local laws that permit arbitrage of tax systems. The OECD base erosion report states that it may be difficult for the complaining countries to stop base erosion by themselves.
The European countries that asked for the base erosion project do not want to be told that the issues that are exciting their populations will merely be studied. If the OECD delivers a weak report, these governments will act unilaterally and outside the bounds of the international consensus. Unilateral action may take the form of non-creditable taxes.
4. The concerns of the BRICS countries have to be addressed.
The United States and Europe, through the OECD, have long hoped that the BRICS bloc would eventually agree to the international consensus favoring residence country taxation of corporations. These countries have signed many treaties, but they have shown little sign of agreeing to the restrictive interpretation of tax jurisdiction favored by the United States and Europe.
It may be that it is time for core OECD members to understand that the BRICS' desire to preserve maximum source country tax jurisdiction will not change. Recognition of their alternative point of view would necessarily change the core OECD members' strategy for responding to their concerns, which is beyond the scope of this memo.
5. In the near future, U.S. multinationals will have to pay some tax somewhere.
Many U.S. multinationals object to residence-based worldwide taxation. Their attitude fails to recognize that the international consensus favoring residence-based taxation has accorded the residence country substantial latitude in determining the ultimate worldwide tax burden borne by its resident companies.
That is, residence country taxation has acted as a regulating mechanism on the total worldwide exposure of U.S. multinationals. This mechanism would be lost were the United States to adopt a territorial system.
A territorial system would remove the objections to worldwide taxation, but companies would be at the mercy of countries in which they do business. If Treasury were to get behind efforts to persuade Congress to adopt a territorial system, multinationals would have to accept that other countries would want a larger tax liability. And it would have to be explained to legislators that U.S. multinationals might be paying significant corporate income tax to other countries and nothing to the United States.
A territorial system would need credible controlled foreign corporation rules. Certainly a territorial system could be instituted with the current weak CFC rules, but that would enable multinationals to avoid U.S. tax on domestic sales and services. Congress might want to see some U.S. tax being paid on domestic sales.
In its framework for corporate tax reform, Treasury noted that the current system can effectively be a territorial system for many corporate taxpayers, giving them the benefit of shifting income to low-tax jurisdictions. The president has therefore proposed a minimum tax on foreign income to remove the benefit of shifting income to low-tax jurisdictions.
Treasury cannot defend U.S. multinational practices that are not rooted in OECD model treaties. The specific ramifications of this new reality are described below.
Permanent establishment. The United States is prepared to defend the PE concept of limited tax jurisdiction. The PE concept, however, has been put under severe stress by the modern ability of companies to do business without a physical presence. Some market countries are losing faith in the PE concept.
Source country taxation. The OECD has admitted that solutions to base erosion and profit shifting may result in increased source country taxation, even though treaty standards may not change. Treaties do not ascribe source to income.
Intangibles holding companies. Treasury has encouraged the OECD to finish its intangibles project, which will require analysis of economic ownership of intangibles, allowing auditors to disregard hollow holding companies with mere legal title. The project aims to correct the perceived overemphasis on legal constructs in analyzing risk allocation.
Commissionaires and stripped-risk distributors. Treasury will not defend commissionaire and stripped-risk distributor structures, which may already be questionable under OECD-approved article 7 interpretations and the dependent agent clause of article 5(5).
Intragroup interest payments. The OECD action plan may recommend that interest deductions be restricted. Germany has restrictive rules, which are being copied throughout Europe. More interest restrictions are likely to be adopted by market countries.
Check-the-box. It is likely that the OECD action plan will tell countries that they should change their domestic laws to reverse the effects of elections to disregard entities. The United Nations Economic and Social Council Committee of Experts on International Cooperation in Tax Matters recently suggested a non-U.S. entity that is a per se corporation or is treated as a resident be classified as a corporation in every case.
If countries were to adopt this response, the check-the-box privilege would be confined to U.S. entities. So even if check-the-box is sacrosanct under U.S. law, other countries and treaty partners are not required to permit hybrid arbitrage under their domestic laws.
Country-by-country reporting. Treasury will not be able to resist pressure from other countries to institute country-by-country reporting. The best that can be expected is that the information would be made available only to tax administrators and not the public. The Dodd-Frank Wall Street Reform and Consumer Protection Act instituted country-by-country reporting for public companies engaged in minerals extraction.
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