The continuing globalizationof economies means that most businesses, including middle-market and private companies, are engaged in cross-border transactions. And because virtually all transactions that cross international borders have tax implications, international tax issues are becoming increasingly important to practitioners of every size.
Issues such as transparency and information reporting (including FATCA and FBAR), transfer pricing and advance pricing agreements, tax rates and tax reform, are all being talked about at the legislative and regulatory level. Meanwhile, as a result of the tax rates they face at home, more U.S.-based multinationals are leaving huge amounts of the earnings of their foreign subsidiaries abroad, shielding them from being subject to taxation here.
"It's critical that we deal with what's become a confiscatory corporate tax rate in the U.S. that encourages U.S. corporations to spend their profit overseas in order to avoid being taxed in the U.S.," said Mark Friedlich, director of publishing for international taxation, accounting and audit for CCH. "That is a critical issue facing us right now, since the U.S. will be losing billions in dollars in tax revenue because of cash floating out of the country. Of course, the other side is our various high corporate tax rates acting as a disincentive for foreign corporations to do business in the U.S., which negatively impacts competition and which ultimately results in higher prices for goods and services for U.S. consumers."
"The trend around the world, with two exceptions -- the U.S. and Japan -- is to reduce corporate income tax rates and increase indirect cash rates such as the value-added tax," added Friedlich. "Countries are more and more using the VAT as a way to increase revenues while they're reducing corporate tax rates in order to attract investment in their country, and that makes it even that much more important that the U.S. deal with extremely high corporate income tax rates."
"Another trend," Friedlich noted, "is the move by the OECD, the European Union, and taxing authorities around the world for greater transparency with respect to tax returns and information, and a much greater willingness of these taxing authorities to share information regarding taxpayers and tax returns in order to reduce tax avoidance and fraud. FATCA and FBAR are examples of this."
"The increased sharing of information applies both to the relationship of taxpayers to the taxing authorities, and actual sharing of information between tax authorities of different countries," he observed. "A related trend is that authorities are increasing their level of scrutiny of these transactions around the world, and there is a significant increase in the number of audits that are being conducted in these areas."
The terms of the debate
Proposals for tax reform in the international area typically begin by addressing the differences between the U.S. system, which taxes corporations on their worldwide income, and the territorial systems of most other countries, which tax companies on the revenue earned within their own jurisdiction.
Under a worldwide approach, the home country considers all of the income of its multinational corporations to be taxable, regardless of where the income is earned, but allows a foreign tax credit against taxes paid to a foreign jurisdiction. Under a territorial approach, the home country taxes only the income earned within its borders.
The recent brush between the Congressional Budget Office and the chairman of the Ways and Means Committee, Rep. Dave Camp, highlights the issues inherent in the choice of a system of taxation. The CBO report, titled "Options for Taxing U.S. Multinational Corporations," purports to provide "an even-handed review of different policy issues related to the taxation of foreign source income," Camp wrote. "However, a closer analysis of the report reveals that it is heavily slanted and biased in favor of one specific approach to the taxation of foreign source income - and relies heavily on sources that tend to support that conclusion while ignoring sources that support a different conclusion."
The report presumes that capital export neutrality is the appropriate stance for the U.S. system, over capital import neutrality, according to Camp. This is evidenced by the report's extensive analysis of tax policy options proposed by the administration, and the complete lack of consideration of alternative policy options proposed by Congress, he indicated. Furthermore, he charged the CBO essentially with "shopping" the report "in order to find a senator or member of Congress who would request CBO to conduct this analysis."
In its response, the CBO mentioned the work of two authorities cited in the report, describing them as "specialists who keep up with emerging research." As for the charge of shopping the report, the response stated that the request for the report "came from the then-chairman of the Senate Budget Committee after discussions between CBO analysts and the Budget Committee staff."
"It's not so much cutting-edge news," said Bill Armstrong, international tax partner at Moss Adams. "[The debate] has been going on for the last 50 to 60 years. The CBO has three options - zero tax, which is beyond anyone's radar, and a territorial system and a global system."
From the administration side, the territorial system is something that will drive business and revenues, he observed. "Given the way both sides have chalked up what they think the tax rates should be, the two sides are not necessarily all that far apart. Many companies will be willing to pay 5 or 10 percent more for political stability or resource availability, but a 20 percent differential is a lot -- it can buy a lot of infrastructure. Tax reform can't simply be territorial and leave the rates high, it has to be territorial and reduce the rates. And most of the countries with lower corporate tax rates have substantially higher individual rates."
Internal, but international
Transfer pricing, which is the amount that related affiliates pay each other for goods, services and other intercompany transactions, is subject to growing scrutiny from tax authorities, according to Guy Sanschagrin, managing director with WTP Advisors in Minneapolis.
Some companies enter into advance price agreements with the Internal Revenue Service and other taxing authorities, where they agree ahead of time on a transfer pricing methodology and thus gain some certainty as to how covered transactions will be taxed -- but there can be problems with this.
"Part of the issue is that an APA is undefined," said Sanschagrin. "It seems to be a never-ending process, going back and forth. It can take three to five years before it's concluded. By the end of the APA process it might not be the same company there that started the process."
Would he recommend that a company engage in the process? "Only if there were a huge amount of risk and a huge appetite for certainty," he said. "Many companies have found that the benefits of going through the APA process don't make up for the costs and resources that the process requires."
As an alternative, Sanschagrin suggested a company use a more robust approach to documenting its transfer pricing. "Instead of using one transfer pricing method, use multiple methods," he said. "Prepare more support around transfer pricing for higher risk areas than for lower risk areas."
FATCA and FBAR
Information exchange has traditionally been about one country sharing information with another country, noted Bruce Reynolds, managing editor of international tax at Bloomberg BNA. "Generally a taxpayer is being audited in one country, and there's a request to another country asking 'What do you have on this person?' But [the Foreign Account Tax Compliance Act] imposes on every foreign financial institution an obligation to advise the IRS on U.S. citizens who have an account with them."
FATCA, not to be confused with FBAR, was enacted as part of the HIRE Act in 2010. FBAR, on the other hand, was enacted as part of the Bank Secrecy Act of 1970. They both ask individuals to supply similar information, but TF 90-22.1, the FBAR form, isn't filed with the tax return, but is filed by June 30 of the year following the account activity it reports; Form 8938, the FATCA form, is filed with returns by the due date of the return.
But FATCA not only requires information from individuals, but asks overseas financial institutions to supply information about accounts held by U.S. taxpayers. Reporting for individuals under FATCA started in 2011, but registration for banks and other foreign financial institutions began Jan. 1, 2013.
"Right now, FATCA has sucked the air out of any other international issue for the IRS," said Reynolds. "It's absorbing a huge amount of their time. And the burden on financial institutions has been tremendous."
Reynolds believes that any progress toward corporate tax reform will have to be part of a broader reform initiative. "There's been a lot of talk about corporate tax reform, and the signs are that there are large areas of agreement between the Democrats and Republicans over reform in the international area," he said. "But the Democrats insist that anything that results in additional revenue should be capped and used to finance programs, but the Republicans insist on keeping it revenue-neutral. It's a subset of the broader tax reform discussion -- it's hard to imagine it happening on its own."
"If it's cheaper to do business abroad than at home, how will you keep business from leaving? There are several possible answers, but you need people to get together and agree," he said.
"In the interest of being competitive, the U.S. should look at ways to put together a tax structure that is competitive to the rest of the world," agreed Sanschagrin. "If they could put together a more competitive tax structure, they would probably collect more tax revenue. Jobs follow income, and companies are considering moving jobs and profits offshore. I would prefer not to have discussions with a client on these issues, but those are the discussions we are having because the U.S. has such high tax rates."
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