[IMGCAP(1)]The perpetual drumbeat for tax reform continues to echo around Capitol Hill.
On August 5, Senators Richard Durbin, D-Ill., Elizabeth Warren, D-Mass., and Jack Reed, D-R.I. urged President Obama to take independent action to stop the tax-avoidance practice commonly known as corporate inversions. Their plea was made to the deserted corridors of the Capitol, as Congress has left Washington, D.C., for its August recess. The Administration has suggested that executive authority might be exercised to prevent inversions, albeit only as an alternative to Congress not moving forward with tax reform.
To stem the latest strategy of U.S. corporations employing mergers with foreign businesses to escape the high U.S. tax rates, the most effective counter-measures would require a comprehensive reform of the U.S. tax system, an overwhelming and unrealistic prospect before or after the mid-term elections, and possible only slightly after the 2016 Presidential election. More attainable stop-gap solutions, such as cutting U.S. corporate tax rates to 28 percent, will not stop companies from moving to lower tax “havens” such as Ireland, where the tax rate is 12.5 percent.
During a press briefing on August 5, White House spokesman Josh Earnest told reporters that the administration is not prepared to make an announcement about any unilateral actions from the president on inversions. In the absence of tax reform, the onus is on Congress to pass specific legislation that would retroactively close current inversion (merger) strategies.
Rep. Sander M. Levin, D-Mich., ranking member on the House Ways and Means Committee, noted, "Corporate inversions, as well as other tax-avoidance strategies, threaten to cause long-term damage to the U.S. tax base and increase the tax burden on ordinary Americans—and swift collective action is required." Shakespeare’s Macbeth offered his précis on life and death, which, unfortunately, applies equally well to Congress’ many attempts to refashion U.S. tax law: “[A] tale told by an idiot, full of sound and fury, signifying nothing.”
Since the original 1916 tax code, reformists have fought behind the familiar banners of fairness and simplification, as well as the prevention, recovery and salvation of the American and global economy, while maintaining a measured focus on collecting tax revenues sufficient to fund the massive federal budget. However, the Internal Revenue Code has become burdened with countless layers of provisions included to satisfy politically correct, “of-the-moment” social objectives and entitlements or to provide some urgently required stimulus.
Rather than separating out these distinctly purposed laws, the path of least resistance has pointed to targets that have no (or lower) apparent impact on the general public. In an economic and financial environment of increasing globalization, the U.S. has sought to brand all things “international” as presumptively evil (read: “tax avoidance”) and even unpatriotic. The current “sound and fury” of Congressional and Administration calls for action are but the latest example of playing to the public’s fears without actually stepping forward with actual, substantive tax proposals.
From the Kennedy-era Subpart F rules seeking to retain U.S. tax coverage over U.S taxpayers investing wealth offshore, to the myriad efforts to limit the movement of manufacturing, services and the companies to lower-taxed foreign countries, the clear message proclaimed by the current Administration in its two campaigns is that your life and well-being is diminished by U.S. companies looking outside, and not within, the U.S.
The Senate’s hearings on “profit-shifting” attacked structures used by multinational giants Microsoft, Apple and others, illustrating how those companies managed their very significant U.S. tax costs with planning available under the current tax code, resulting in large cash reserves held offshore. The sheer size of the tax dollars actually paid, and the comparative numbers of what these companies could have paid under less sophisticated structures, created a media event, and generated calls for tax reform. Again, the message was that the tax savings of these U.S. companies hurt the so-called average taxpayer. No data was presented on how the companies’ higher tax costs might have impacted the consumer prices those average taxpayers paid.
With significant statutory change approaching, IRS has sought data to support whatever changes might be implemented, as well as to enforce any laws currently available to them. Enforcement of filing requirements for information returns detailing U.S.-owned foreign financial accounts and foreign entities, as well as increased scrutiny of required tax withholding from payments to foreign recipients, has increased the risks of inadequate or missing reporting. Moreover, the accumulated data will effectively roadmap future enforcement of new anti-deferral provisions.
This discussion is not intended to suggest that the U.S. is alone in its international crusade for tax revenues. Rather, the Organization for Economic Co-operation and Development (OECD) has commissioned multiple studies under an action plan to combat the erosion of separate country taxable income and the shifting of profits between related parties (under the acronym BEPS, for Base Erosion and Profit Shifting). BEPS study areas include many of the exposures focused on by Congress and the Administration.
The conclusion is inescapable that U.S. tax reform, or at least tax change, will occur at some point. Changes will impact existing transfer pricing and profit shifting provisions, as well as permanent establishment standards extending countries’ tax bases beyond their borders. Consequently, multinational businesses will be well-advised to prepare to react to these changes.
Douglas W. Nakajima, J.D., LL.M., managing director of tax services at Smart Devine, has over 30 years of experience in federal and international tax and strategic business planning, serving a U.S. and foreign client base of multinational manufacturing, service and technology businesses. He has advised clients on the tax treatment of domestic and cross-border transactions, inbound and outbound business expansion strategies, domestic and cross-border acquisitions, dispositions and reorganizations, intercompany transfer pricing analysis, documentation and audit defense, treaty interpretation, and repatriation planning. Doug has worked extensively with tax advisors in foreign countries to develop global structures that minimize U.S. and foreign tax exposures, and in this role, has forged effective working relationships with key professionals throughout North America, Europe, Asia and the Pacific Rim. For more information, he can be reached at (267) 670-7307 or firstname.lastname@example.org.