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February 11, 2014
Beyond BEPS: The Problem of Double Taxation
by Mindy Herzfeld

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GAFA, for those of us not up on high-tech acronyms, stands for Google-Apple-Facebook-Amazon, and represents a host of large Internet-based companies that have big pools of accumulated foreign earnings with low effective tax rates. The OECD base erosion and profit-shifting program and similar U.S. legislative international tax reform proposals are attempts to capture some of that GAFA revenue. GAFA (and their less visible cohorts in the high-tech world) feel that such legislative and supra-governmental proposals to tax stateless income restrict their right to conduct their global business in any (legal) way they see fit. However, these companies may ultimately face a greater threat from failed public efforts to coordinate multilateral dispute resolution than from any anti-base-erosion initiative.

At the recent Pacific Rim Tax Institute (PRTI) in Palo Alto, Calif., representatives from the U.S. and Pacific Rim countries (including India, which the PRTI has unilaterally decided fronts on the Pacific Rim) focused on two main topics:

    • double nontaxation (also known as stateless or nowhere income) and what countries and global organizations (such as the OECD) are doing to prevent it; and
    • double taxation and how countries are struggling to prevent it.

Many of the speakers, including the government representatives on the panels, were more concerned with double taxation than double nontaxation. The U.S., various other countries, and the OECD have legislative proposals in the works or are developing initiatives to eliminate stateless income. But while double nontaxation can be fixed with agreement on policy and the enactment of new laws, concerns about double taxation are not easily addressed. Double taxation cannot be prevented solely by legislation or bilateral treaties because the rules rely on auditors in the field to implement them equitably and consistently with the letter of the law.

The clear message for (the primarily U.S.) multinationals at the conference was this: The threat to your global effective tax rates comes less from initiatives to prevent double nontaxation than from inactivity and lack of coordination on efforts to prevent double taxation.


Double Nontaxation: The Proposals

The OECD's much-publicized BEPS initiative has made the subject of double nontaxation a top priority for international tax practitioners, and many governments have also begun to unilaterally address base erosion. However, as panelists at the PRTI noted, any serious proposal to eliminate base erosion must first establish whose base is being eroded. There is no consensus on whether base erosion is the erosion of the resident country's base, the source country's base, or the global base.

Pamela Olson of PricewaterhouseCoopers and Michael Mundaca of EY, both former Treasury officials, outlined the various proposals for international tax reform in the U.S. They agreed that there is limited likelihood of tax reform soon.1 Nevertheless, they said the proposals are worthy of discussion because they represent a base case for any future reform proposals. As Olson put it, even if the proposals aren't enacted tomorrow, they will be the starting point for the next round of tax reform proposals.

Sen. Max Baucus, D-Mont., introduced the most recent comprehensive U.S. legislative proposal addressing the same concern as the OECD BEPS initiative -- base erosion by multinational companies -- as is evident from its discussion draft:

The Chairman's staff is considering additional ways to address U.S. base erosion by foreign multinational companies beyond the proposals in the staff discussion draft. Under current law, foreign multinational corporations have substantial opportunities to avoid taxation through financing and licensing arrangements involving their U.S. subsidiaries. For example, foreign multinationals can take advantage of differences between U.S. and foreign tax laws to qualify for income tax treaty benefits 
while paying little or no U.S. or foreign tax on income earned in the United States. Comments are requested regarding appropriate rules to limit such opportunities beyond the limitations imposed by current law or proposed in the staff discussion draft. For example, the Chairman's staff is considering whether deductions for payments to related foreign companies should be disallowed if the payment is taxed at a low rate in the foreign jurisdiction or whether to provide rules subjecting to U.S. tax income generated by customer-based intangibles related to sales in the United States by foreign multinationals.2 [Emphasis added.]

Two of the objectives in Baucus's proposal also focus on base erosion, namely:

    • to reduce incentives for U.S. and foreign multinationals to invest in or shift profits to low-tax foreign countries rather than the United States; and
    • to end the lockout effect by taxing the foreign income of U.S. businesses either immediately when earned or not at all.

The Baucus proposal focuses primarily on preserving the U.S. tax base by making sure that U.S. multinationals are subject to immediate U.S. tax on foreign earnings. However, that would make U.S. multinationals less likely to engage in foreign tax planning. By reducing immediate U.S. tax to the extent that such income has been subject to high rates elsewhere, the Baucus proposal and other legislative proposals demonstrate a concern about global base erosion consistent with the OECD.

In his keynote address, Michael Danilack, deputy commissioner (international), IRS Large Business and International Division, asked why U.S. taxpayers pursue aggressive foreign tax planning strategies when the U.S. tax rate is so much higher than most other countries and foreign taxes are creditable against U.S. tax. Under SEC financial reporting rules, if a company plans to reinvest its foreign earnings, it doesn't need to account for immediate U.S. tax on such earnings. Thus, the combination of U.S. tax laws that allow for deferral and accounting rules that allow for noninclusion mean that for U.S. multinationals, any foreign tax savings is a dollar-for-dollar reduction of its overall effective tax rate. If the U.S. international tax reform legislation results in the elimination of deferral for U.S. multinationals, corporations' appetite for foreign tax planning will likely decrease accordingly. That is, if the Baucus proposal becomes law, the drivers behind the OECD BEPS project may disappear.

As Gary Sprague of Baker & McKenzie pointed out in his insightful introduction to a panel on BEPS, the OECD project and U.S. legislative efforts are both targeting the same pool of income -- untaxed or low-taxed earnings parked overseas by U.S. multinationals. They can't both win.

If the BEPS project represents the efforts of the G-20 and OECD member countries to get their fair share of the global profits of U.S. multinationals, and the U.S. legislative proposals are attempts to ensure immediate U.S. taxation of the same income, regardless of the technical merit and the coherence of the OECD proposals, there is likely to be conflict. The U.S. is not signing on to some of the BEPS action plan's more comprehensive proposals, which could involve wholesale changes to traditional international law concepts, such as permanent establishment.3It is unlikely to cede primary taxing jurisdiction over the worldwide income of its multinational companies to other countries. Politically or economically, the U.S. has little to gain by encouraging foreign countries to raise taxes on its multinationals, which potentially could weaken their profitability. Initiatives to reduce the U.S. corporate tax rate rely on taxing more of companies' worldwide income in the U.S. on a current basis. If the BEPS project is successful and this income is taxed elsewhere, the U.S. legislative backing for international tax reform necessarily must collapse; because foreign earnings have already been taxed elsewhere, U.S. corporate rate reduction becomes an impossibility.

At another panel on BEPS, David Forst of Fenwick & West LLP said that the BEPS Action 2 on hybrid mismatches may be viewed as nothing more than an attack on U.S. check-the-box rules. The check-the-box rules make it easy for U.S. multinationals to engage in foreign base erosion at no cost to the U.S. fisc. Given the history of check-the-box legislative proposals, there is little political will to enact tax reform initiatives developed by the OECD that would hurt U.S. multinationals without increasing U.S. tax revenues. The appetite to address base erosion once again comes down to whose base is on the table.

If the U.S. won't change its domestic laws to restrict the foreign tax planning of U.S. multinationals, the multilateral nature of the BEPS initiative may be doomed. However, other countries have begun trying to capture the revenue associated with U.S. multinationals' foreign earnings themselves. (Related coverage: p. 490 of this issue.) Israel, France, and Germany have introduced legislative proposals to tax highly profitable U.S. companies that extract revenue and intellectual property from their jurisdictions without contributing to their respective revenue bases.


Double Taxation

While the BEPS project casts multinationals engaged in cross-border tax planning in a sinister light, multinationals have not been vocal in their opposition to the project.
4 This is because they realize that without concerted action, they are likely to become subject to multiple sets of inconsistent rules and inevitably double taxation. Danilack, in his keynote address, pointed out that the issue with double taxation is not how the laws are written but how they are enforced by various governments. Laws and bilateral treaties alone cannot prevent double taxation. Multilateral agreement on enforcement of principles negating double taxation is the only means by which this can be prevented.

While stateless income gets most of the attention today, double taxation has a greater potential to adversely affect the global economy. Treaties are designed to prevent double taxation, and many have an article mandating mutual agreement procedures (MAPs) for resolving issues around double taxation. But law and treaties only pronounce principles. As Danilack and other panelists pointed out, the practical prevention of double taxation is in the hands of individual auditors and revenue administrations that decide the extent to which they wish to enforce the policies and arbitration clauses in the treaties.

Even the best designed laws and regulations can't prevent double taxation without effective means of dispute resolution. And the lack of effective means of dispute resolution is where multilateral efforts appear to be breaking down.

The mutual agreement caseload is rising exponentially.5 In response, the Mutual Agreement Procedures Forum, a meeting of competent authorities from 25 countries, has developed its own strategic plan. The MAP Forum's focus areas include empowering competent authority agents, making sure the competent authority agencies have adequate resources, and determining whether a competent authority has oversight over the individuals negotiating the settlements under the MAP articles.

Danilack and other panelists focused in particular on empowerment. Empowerment means that the people who are negotiating a competent authority adjustment actually have the ability to conclude such negotiations without the risk of being reversed by another department. A reversal brings all kinds of pressures to bear on the system. Auditors operate in a world of their own, and they often rely on their perceptions of what the law should be to enforce policies that aren't written in law. The difficulty of this was demonstrated anecdotally, as panelists spoke of auditors who were citing BEPS to renege on previously accepted transfer pricing positions.

As Danilack put it, U.S. competent authority negotiators aren't "seeing eye-to-eye" with some of their counterparts in other countries. Much of the focus here was on India, which is denying under domestic law what is available under treaty. Although Indian legislation is becoming more aligned with international norms, these changes may not always be implemented by revenue officers. Whether as a result of deliberate policy or through administrative ineptitude, U.S. companies are not faring very well in tax negotiations between India and the U.S.

As the panelists pointed out, the key aspect of the BEPS project for most multinationals may be the last action item, which is not getting much attention. Action 14, "Make dispute resolution mechanisms more effective," aims to improve treaty-related dispute resolution under MAPs, including the absence of arbitration provisions in most treaties and the denial of access to MAPs and arbitration in some cases. The message from the PRTI to U.S. multinationals was clear: If the business community does not publicly support Action 14, the resulting double taxation problems arising from a lack of multilateral coordination on enforcement of cross-border disputes could make current concerns over stateless income appear insignificant.


FOOTNOTES

1
 See Martin A. Sullivan, "Top 10 Reasons There Is No Corporate Tax Reform," Tax Analysts Blog, available athttp://www.taxanalysts.com/taxcom/taxblog.nsf/Permalink/MSUN-9FXM57?OpenDocument.

2 Chairman Max Baucus, U.S. Senate Committee on Finance, "Summary of Staff Discussion Draft: International Business Tax Reform" (Nov. 19, 2013). 

3 Kristen A. Parillo, "BEPS Solutions Should Be Narrowly Focused, U.S. Says," Tax Notes Int'l, Apr. 1, 2013, p. 7. 

4 The Digital Economy Group, which issued a letter arguing against taxing digital companies in a unique way, is a notable exception.

5 See OECD MAP statistics for 2012, available at http://www.oecd.org/ctp/dispute/mapstatistics2012.htm.


END OF FOOTNOTES


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