[Senate Hearing 114-389]
[From the U.S. Government Publishing Office]
S. Hrg. 114-389
INTERNATIONAL TAX:
OECD BEPS AND EU STATE AID
=======================================================================
HEARING
before the
COMMITTEE ON FINANCE
UNITED STATES SENATE
ONE HUNDRED FOURTEENTH CONGRESS
FIRST SESSION
__________
DECEMBER 1, 2015
__________
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Printed for the use of the Committee on Finance
______
U.S. GOVERNMENT PUBLISHING OFFICE
22-145-PDF WASHINGTON : 2016
-----------------------------------------------------------------------
For sale by the Superintendent of Documents, U.S. Government Publishing
Office Internet: bookstore.gpo.gov Phone: toll free (866) 512-1800;
DC area (202) 512-1800 Fax: (202) 512-2104 Mail: Stop IDCC,
Washington, DC 20402-0001
COMMITTEE ON FINANCE
ORRIN G. HATCH, Utah, Chairman
CHUCK GRASSLEY, Iowa RON WYDEN, Oregon
MIKE CRAPO, Idaho CHARLES E. SCHUMER, New York
PAT ROBERTS, Kansas DEBBIE STABENOW, Michigan
MICHAEL B. ENZI, Wyoming MARIA CANTWELL, Washington
JOHN CORNYN, Texas BILL NELSON, Florida
JOHN THUNE, South Dakota ROBERT MENENDEZ, New Jersey
RICHARD BURR, North Carolina THOMAS R. CARPER, Delaware
JOHNNY ISAKSON, Georgia BENJAMIN L. CARDIN, Maryland
ROB PORTMAN, Ohio SHERROD BROWN, Ohio
PATRICK J. TOOMEY, Pennsylvania MICHAEL F. BENNET, Colorado
DANIEL COATS, Indiana ROBERT P. CASEY, Jr., Pennsylvania
DEAN HELLER, Nevada MARK R. WARNER, Virginia
TIM SCOTT, South Carolina
Chris Campbell, Staff Director
Joshua Sheinkman, Democratic Staff Director
(ii)
C O N T E N T S
----------
OPENING STATEMENTS
Page
Hatch, Hon. Orrin G., a U.S. Senator from Utah, chairman,
Committee on Finance........................................... 1
Wyden, Hon. Ron, a U.S. Senator from Oregon...................... 3
.................................................................
WITNESSES
Stack, Robert B., Deputy Assistant Secretary for International
Tax Affairs, Department of the Treasury, Washington, DC........ 6
Coleman, Dorothy, vice president for tax and domestic economic
policy, National Association of Manufacturers, Washington, DC.. 8
Danilack, Michael, principal, PricewaterhouseCoopers LLP,
Washington, DC................................................. 10
ALPHABETICAL LISTING AND APPENDIX MATERIAL
Coleman, Dorothy:
Testimony.................................................... 8
Prepared statement........................................... 33
Responses to questions from committee members................ 36
Danilack, Michael:
Testimony.................................................... 10
Prepared statement........................................... 41
Responses to questions from committee members................ 43
Hatch, Hon. Orrin G.:
Opening statement............................................ 1
Prepared statement........................................... 46
Stack, Robert B.:
Testimony.................................................... 6
Prepared statement........................................... 48
Responses to questions from committee members................ 54
Wyden, Hon. Ron:
Opening statement............................................ 3
Communications
Business and Industry Advisory Committee to the OECD............. 63
Center for Freedom and Prosperity................................ 70
Motion Picture Association of America............................ 75
Tax Innovation Equality (TIE) Coalition.......................... 78
(iii)
INTERNATIONAL TAX:
OECD BEPS AND EU STATE AID
----------
TUESDAY, DECEMBER 1, 2015
U.S. Senate,
Committee on Finance,
Washington, DC.
The hearing was convened, pursuant to notice, at 2:49 p.m.,
in room SD-215, Dirksen Senate Office Building, Hon. Orrin G.
Hatch (chairman of the committee) presiding.
Present: Senators Grassley, Crapo, Thune, Portman, Scott,
Wyden, Stabenow, Carper, Cardin, Brown, Bennet, Casey, and
Warner.
Also present: Republican Staff: Chris Campbell, Staff
Director; Tony Coughlan, Tax Counsel; Eric Oman, Senior Policy
Advisor for Tax and Accounting; and Jeff Wrase, Chief
Economist. Democratic Staff: Todd Metcalf, Chief Tax Counsel;
and Tiffany Smith, Senior Tax Counsel.
OPENING STATEMENT OF HON. ORRIN G. HATCH, A U.S. SENATOR FROM
UTAH, CHAIRMAN, COMMITTEE ON FINANCE
The Chairman. The committee will come to order. I want to
welcome everyone here this afternoon and thank you all for
attending this important hearing on international taxation,
focusing particularly on the Organisation for Economic Co-
operation and Development's, or OECD's, project on Base Erosion
and Profit Shifting, or BEPS.
The overall discussion about international tax is very
timely. Just a couple of weeks ago, we were informed that a
major American pharmaceutical company had decided to invert,
meaning merging with another drug company with the headquarters
in a newly formed corporation to be located in a foreign
country.
Of course, this is nothing new. We have been seeing these
types of transactions take place for some time. Inversions like
these are some of the clearest examples of base erosion, and
are largely motivated by tax considerations as American
companies determine that they can reduce their overall
operating costs if they become foreign corporations.
Given the burdensome and anti-competitive nature of the
U.S. tax code, these companies are, unfortunately, not acting
irrationally. The administration's response to the wave of
inversions has, in my opinion, been very shortsighted, focusing
only on the symptoms rather than on the underlying illness.
While the latest guidance from Treasury might very well
stem the tide of inversions, it will leave other, potentially
more harmful avenues for tax avoidance--like foreign
takeovers--wide open, and perhaps even make them more
attractive than they are now. Long story short, any steps we
take to address inversions should focus on fixing the
shortcomings of the underlying system and make the U.S. a
better place for companies to do business.
The BEPS project is another effort aimed at addressing
international tax problems and base erosion. But on a more
global scale, the purpose of the project was to provide OECD
member countries with recommendations for both domestic tax
policy changes and amendments to existing tax treaties to
address business practices that do result in base erosion.
After several years of discussion, the OECD released its
final reports earlier this year, and last month, leaders from
the G20 countries endorsed the recommendations. Throughout this
process, we have heard concerns from large sectors of the
business community that the BEPS project could be used to
further undermine our Nation's competitiveness and unfairly
subject U.S. companies to greater tax liabilities abroad.
Companies have also been concerned about various reporting
requirements that could impose significant compliance costs on
American businesses and force them to share highly sensitive,
proprietary information with foreign governments. I expect that
we will hear about these concerns from the business community
and others during today's hearing.
In addition, throughout the BEPS negotiations, I urged the
Obama administration to both acknowledge the limits of their
authority under the law and to cooperate with Congress on any
and all efforts to implement the recommendations. And, while
the U.S. was a party to the BEPS negotiations, Congress had
neither a seat at the negotiating table nor a meaningful
opportunity to weigh in with the administration on the
substance of these proposals.
However, it is Congress, and Congress alone, that has the
ultimate authority to make changes to the U.S. tax code. And
while the Treasury Department does have broad regulatory
authority under the law, that power is not without limits.
Even in those areas where authority clearly exists for the
administration to promulgate regulations, it is virtually
always better if Congress is viewed as a partner in this
process, rather than an adversary. And in those instances where
the regulatory authority is less clear, congressional
involvement and approval is even more important to ensure that
policy changes are viewed by the public as legitimate.
Of course, most of this should go without saying. It is,
after all, a basic lesson in government, and I do not think
anyone here is in need of a civics refresher course from me.
However, I think it also goes without saying that the current
administration has not always viewed Congress as a necessary or
even important part of its efforts to develop and implement
policy changes.
So I think it is, at the very least, helpful to offer a
brief reminder to everyone that Congress has a role to play on
these issues that cannot be overlooked. That is another set of
concerns that I expect we will discuss during this hearing.
We have a representative from Treasury here today, so I am
looking forward to getting a better sense of what elements of
the BEPS recommendations the administration believes it can
implement unilaterally and where they believe congressional
action will be necessary.
I also want to note that I have asked the Government
Accountability Office to provide its own analysis on the BEPS
recommendations, taking into account all of the complex
elements, both domestic and global, that are implicated with
these types of policy changes. And I expect their work will
take some time, but gathering this type of information is, in
my view, an essential part of our overall evaluation of the
BEPS project.
There are other topics that I expect will come up today,
including a discussion of so-called ``state aid'' remedies and
recent activities in the eurozone that to me look like attempts
to impose retroactive taxation on multinational enterprises,
including a number of U.S.-based companies.
Speaking more broadly, I just want to say that when it
comes to international tax issues, I hope we can all have the
same goals in mind. I would hope that we all want to improve
conditions for American businesses, and I would hope that we
would all want to make our country more competitive on the
world stage.
And to that end, I would hope that we all want to improve
the overall health of the U.S. economy. That is why all of us
are here today--or at least it should be. Any regulations
promulgated by this administration to prevent businesses from
moving offshore should have these goals in mind.
At the same time, while international efforts to align tax
systems are worth exploring, we should not be negotiating
agreements that undermine our own interests for the sake of
some supposedly higher or nobler cause. The interests of the
United States, our own economy, our own workers, and our own
job creators, should be our sole focus.
So, throughout the day's discussion, whether we are talking
about BEPS, inversions, or any other international tax issues,
I am most interested in hearing views as to how various
policies and proposals will or will not serve our Nation's
interests and advance these important goals.
Long story short, we have quite a bit to talk about today,
and we have a distinguished panel of witnesses who should be
able to shed some light on these complicated issues. So I look
forward to their testimony.*
---------------------------------------------------------------------------
* For more information, see also, ``Background, Summary, and
Implications of the OECD/G20 Base Erosion and Profit Shifting
Project,'' Joint Committee on Taxaton staff report, November 30, 2015
(JCX-139-15), https://www.jct.gov/
publications.html?func=startdown&id=4853.
---------------------------------------------------------------------------
With that, I will turn to Senator Wyden for his opening
remarks.
[The prepared statement of Chairman Hatch appears in the
appendix.]
OPENING STATEMENT OF HON. RON WYDEN,
A U.S. SENATOR FROM OREGON
Senator Wyden. Thank you very much, Mr. Chairman, and, Mr.
Chairman, thank you for holding this hearing. I think you
describe it very appropriately in saying that it is especially
timely.
And the reality, colleagues, is that the inversion virus is
growing. The inversion virus is mutating, and nothing could
prove that more clearly than what we saw just a few days ago,
with Pfizer merging with Allergan and moving its headquarters
overseas in pursuit of a lower tax bill.
Now, we are doing some checking, but I believe this is the
biggest inversion to date. This is the biggest one on record--
and we will have the recorder note that Mr. Stack nodded his
head, quietly, yes. So I think that that gives me some added
validation.
But kidding aside, the point is, the Pfizer move is clear
proof of what everybody in this room knows, and that is that
the American tax code is a broken, dysfunctional mess, and it
is a drag on the American economy.
So we are now coming together for the third time in 18
months to examine the need for international tax reform. In
that time, the Treasury Department has taken multiple steps to
slow the spread of the inversion virus, but there is only so
much that the Treasury Department can do to quarantine the
problem. We are going to need comprehensive tax reform.
And while the broken tax code sits in place, something of
an antiquated monument to a different economic era, essentially
the sand shifts around it, and more and more of the country's
tax base erodes into this kind of international sea of harmful
tax practices and ruinous competition.
And my guess is, until the Congress has the political will
to do what has to be done, these inversions are going to
continue. And my guess is the Pfizer inversion will not be the
last, and it will not be the largest. And foreign governments
are going to continue to use our obsolete tax code against our
country by agreeing to give certain companies what amount to
sweetheart deals to locate within their borders.
Now, as matters have just continued to spin out of control,
the largest economies in the world, through the G20 and the
OECD, came together for a very significant tax policy project
known as the Base Erosion and Profit Shifting discussion. And
what they sought to do is come up with--and this is really
their singular goal: to make it harder to game the system.
Now, when it comes to these kinds of proposals, there are
some big questions that you have to get into right at the
outset. And certainly, they are going to take a lot of study by
the Congress.
I do want to commend our Treasury witness, Mr. Stack. He
has tried very hard to advocate our interests, the American
interests, in these discussions. And obviously, as Mr. Stack
will tell you, he has had a very steep hill to climb in these
discussions, and we appreciate his efforts.
Now, Chairman Hatch mentioned this question of unlawful
state aid. What we are really talking about is very aggressive
actions taken by the European Commission. And they call it
unlawful state aid, but what it really looks like to me is tax-
planning strategies that our broken tax code is driving our
companies to go out and pursue.
So, from the standpoint of a bottom line, here is mine: if
you shudder, colleagues, at these tax-avoidance schemes; if you
really get angry about matters like the double Irish with a
Dutch sandwich; if you want to crack down on it, you have to be
for comprehensive tax reform. If you want to give companies a
reason to invest and grow and headquarter in the United States,
the path to reach those goals is major tax reform.
And I do not see our colleague, Senator Coats, with us, but
he and I have worked together. I have worked with Senator
Gregg. I have worked with Senator Hatch. I want it clear that I
think Senators on both sides of the aisle want to move forward
on this, and the sooner we get to it, the better.
And, Mr. Chairman, also, an apology at this point. We are
beginning the reconciliation on the floor, and I am going to
have to be there for my portion of it here in a few minutes.
But I just want it clear that I am looking forward to working
with you in a bipartisan way and with our colleagues on both
sides of the aisle.
The Chairman. Well, thank you, Senator Wyden. We appreciate
it.
Now I would like to take a few minutes to introduce our
distinguished panel of witnesses.
First, we will hear from Assistant Secretary Robert Stack,
who covers international tax affairs issues in the Office of
Tax Policy at the Department of the Treasury. Mr. Stack serves
as the U.S. Delegate to the Committee on Fiscal Affairs in the
OECD. Mr. Stack has over 26 years of private-sector experience
in international tax matters, representing both corporations
and individuals. Mr. Stack is a graduate from Georgetown
University Law Center, where he was editor-in-chief of the
Georgetown Law Journal.
Second, we will hear from Dorothy Coleman, vice president
of tax and domestic economic policy at the National Association
of Manufacturers, or NAM. Ms. Coleman has served in her current
position for more than 15 years, bringing a wealth of knowledge
and experience. She has also worked for a major accounting firm
and in the tax press. Ms. Coleman received her law degree from
Georgetown University Law Center and her bachelor of arts in
economics from Manhattanville College in Purchase, NY.
Finally, we will hear from Michael Danilack, a principal at
PricewaterhouseCoopers, or PwC. Mr. Danilack currently works in
PwC's Washington national tax services practice and focuses
specifically on international tax issues. Before joining PwC in
2014, Mr. Danilack served as the Deputy Commissioner in the IRS
Large Business and International Division, where he was
responsible for all international tax matters for the IRS,
including serving as the U.S. competent authority. He also
served for 6 years as an assistant to the IRS Commissioner and
then as IRS Associate Chief Counsel for International Matters.
Mr. Danilack earned a B.A. from the University of Pennsylvania
and a J.D., as well as an LL.M., from New York University
School of Law.
I want to thank each of these distinguished witnesses for
being here today, but more especially for their hard work and
dedication, especially as they prepared for this hearing over
the Thanksgiving holiday.
Mr. Stack, we will start with you. If you will proceed with
your opening statement, we would appreciate it.
OPENING STATEMENT OF ROBERT B. STACK, DEPUTY ASSISTANT
SECRETARY FOR INTERNATIONAL TAX AFFAIRS, DEPARTMENT OF THE
TREASURY, WASHINGTON, DC
Mr. Stack. Thank you, Mr. Chairman. Chairman Hatch, Ranking
Member Wyden, and distinguished members of the committee, I
appreciate the opportunity to appear today to discuss some key
international tax issues, including the recently completed G20
OECD Base Erosion and Profit Shifting, or BEPS, program.
In June 2012 at the G20 Summit in Los Cabos, Mexico, the
leaders of the world's largest economies identified the ability
of multinational companies to reduce their tax bills by
shifting income into low- and no-tax jurisdictions as a
significant global concern. They instructed their governments
to develop an action plan to address these issues, which was
endorsed by the G20 leaders in St. Petersburg in 2013. The
project came to fruition this fall with the presentation of the
final reports to the G20.
The BEPS project covers 15 separate topics. Some reports,
such as those on the digital economy and controlled foreign
corporations, are more or less descriptive of the underlying
issues and discuss approaches or options that countries might
take without demonstrating any agreement among participants on
a particular path. Other reports, such as those on interest
deductibility and hybrid mixed securities, describe the
elements of a common approach that countries might take with
respect to those issues.
With respect to transfer pricing, the arm's-length standard
was further amplified in connection with issues around funding,
risk, and hard-to-value intangibles. Finally, in the areas of
preventing treaty shopping, requiring country-by-country
reporting, fighting harmful tax practices--including through
the exchange of cross-border tax rulings--and improving dispute
resolution, countries agreed to a minimum standard.
I believe that the transparency provided by country-by-
country reporting that tightens the transfer pricing rules and
the agreement to exchange cross-border tax rulings will go a
long way to curtail the phenomenon of stateless income that
pushed the BEPS program forward. Companies will very likely be
reluctant to show on their country-by-country reports
substantial amounts of income in low- or no-tax jurisdictions,
and the transfer pricing work will better align profits with
the functions, assets, and risks that create that profit.
The exchange of rulings on cross-border matters will drive
out bad practices and shine sunlight on the practices that
remain. The improvement of dispute resolution and the
inclusion, where possible, of arbitration will streamline
dispute resolution and should thereby reduce instances of
double taxation.
So where do we go from here? Well, certain technical work
remains for the OECD in 2016 and beyond, and the OECD will turn
its attention to implementation and monitoring of the various
BEPS deliverables on the action items. More importantly,
however, we believe that the best way to foster the G20 goal of
supporting global growth is to actively promote the connection
between foreign direct investment, growth, and efficient and
effective tax administration built on the rule of law. We are
working hard to ensure that issues around effective and fair
tax administration around the world are made part of the post-
BEPS agenda.
The BEPS project was one manifestation of global concern
about international tax issues, and the EU state aid
investigations are another. In 2014, the European Commission
opened four in-depth investigations to examine whether
decisions by tax authorities in Ireland, the Netherlands, and
Luxembourg with regard to corporate income tax paid by Apple,
Starbucks, Fiat Finance and Trade, and Amazon complied with EU
rules on state aid.
On October 21, 2015, the EU Commission announced its
conclusions that Luxembourg has granted selective tax
advantages to Fiat's financing company, and the Netherlands has
granted selective tax advantages to Starbucks Coffee Roasting
Company in the Netherlands. U.S. companies are reported to be
the subject of still more investigations.
Treasury has followed the state aid cases closely for a
number of reasons. First, we are concerned that the EU
Commission appears to be disproportionately targeting U.S.
companies.
Second, these actions potentially undermine our rights
under our tax treaties with European member states. The United
States has a network of income tax treaties with the member
states and has no income tax treaty with the EU, because income
tax is a matter of member-state competence, under EU law.
While these cases are being billed as cases of illegal
state subsidies under EU law, or state aid, we are concerned
that the EU Commission is, in effect, telling member states how
they should have applied their own tax laws over a 10-year
period. Plainly, the assertion of such broad power with respect
to an income tax matter calls into question the finality of
U.S. taxpayers' dealing with member states, as well as the U.S.
Government's treaties with member states in the area of income
taxation.
Third, the EU Commission is, by all accounts, taking a
novel approach to the state aid issue, yet they have chosen to
apply this new approach retroactively rather than only
prospectively.
While in the Starbucks case, the sums were relatively
modest--20 to 30 million euros--they may be substantially
larger, perhaps in the billions, in other cases. The
retroactive application of a novel interpretation of EU law
calls into question the basic fairness of the proceedings.
Fourth, while the IRS and Treasury have not yet analyzed
the equally novel foreign tax credit issues raised by the
payments that may be required under these cases, it is possible
that the settlement payments ultimately could be determined to
give rise to creditable foreign taxes. If so, U.S. taxpayers
would wind up footing the bill for these state aid settlements
when the affected U.S. taxpayers' companies either repatriate
amounts voluntarily, or Congress requires a deemed repatriation
as a part of tax reform, unless U.S. taxes are paid on the
repatriated amounts on account of the higher creditable taxes.
Finally--and this relates to the EU's apparent substantive
position in these cases--we are greatly concerned that the EU
Commission is reaching out to tax income that no member state
had the right to tax under internationally accepted standards.
Let me close with a quick reference to the topic of
inversions. As you are aware, the IRS and Treasury last week
issued Notice 2015-79 to deter and reduce further the economic
benefits of corporate inversions.
Treasury will continue to examine additional ways to reduce
the tax benefits of inversions, including through limiting the
ability of inverted companies to strip earnings with inter-
company debt. However, only legislation can effectively address
these issues. To this point, we look forward to working with
Congress in a bipartisan manner to protect the U.S. tax base,
to address the issue of corporate inversions, and to reform our
business tax system.
Let me repeat our appreciation for the committee's interest
in these important issues. I would be happy to answer any
questions that you may have.
Thank you.
The Chairman. Thank you, Mr. Stack.
[The prepared statement of Mr. Stack appears in the
appendix.]
The Chairman. We will turn to you now, Ms. Coleman.
OPENING STATEMENT OF DOROTHY COLEMAN, VICE PRESIDENT FOR TAX
AND DOMESTIC ECONOMIC POLICY, NATIONAL ASSOCIATION OF
MANUFACTURERS, WASHINGTON, DC
Ms. Coleman. Chairman Hatch, Ranking Member Wyden, and
members of the committee, thank you for the opportunity to
testify today about the BEPS project spearheaded by the G20 and
the OECD. I appreciate the chance to highlight the NAM's
concerns about some of the recommendations in the BEPS project
that would impose unnecessary compliance costs on companies,
and in some cases force disclosure of sensitive, confidential
taxpayer information.
The NAM is the Nation's largest industrial association and
voice for more than 12 million women and men who make things in
America. Manufacturers know how critically important it is for
U.S. companies to be able to invest and compete effectively in
a global economy where 95 percent of the world's customers are
outside the United States.
The BEPS project included 15 action items, and I would like
to focus my comments on Action 13, ``Re-examine Transfer
Pricing Documentation.''
Action 13 adopts a three-tiered approach: a master file to
provide a complete picture of a multinational company's global
operations, a local file of more detailed information relating
to specific intercompany transactions impacting a tax
jurisdiction, and a country-by-country report with aggregated
financial and tax data.
The country-by-country reports that companies would file
with their own country would impose an additional
administrative burden on companies. These reports, however,
would be submitted to foreign countries under bilateral
treaties and information exchange agreements with protections
to ensure confidentiality, consistency, and appropriate use of
the information by foreign countries. If a country fails to
abide by these conditions, the U.S. Treasury has stated its
intent to suspend the information exchange. This would not be
the case with the master file, which could be required directly
by any country where a company does business.
While both the country-by-country reports and the master
file include extremely sensitive information unrelated to
actual taxpayer activities in the country requesting the
information, the master file does not have the protections of
the information exchange process, and thus is not subject to
any confidentiality, consistency, or appropriate-use conditions
beyond those that may apply locally. Manufacturers also are
concerned that the master file requirement would force them to
disclose an unprecedented amount of proprietary information
about their global operations to foreign governments.
The master file would include organizational charts,
consolidated financial statements, and analyses of profit
drivers, supply chains, intangibles, and financing--in short, a
comprehensive plan that includes every aspect of a company's
worldwide business. For privately held companies, the
requirements to include a global organizational chart and
consolidated financial statements would constitute an
unprecedented level of disclosure to foreign governments.
The fact that taxpayers have some level of control over
what information is included in the master file does little to
address confidentiality concerns, since it is unclear how much
flexibility taxpayers actually have to exclude sensitive
information. The OECD recommends taxpayers use a prudent
business judgment standard to determine the appropriate level
of detail to be included in the master file. This standard
provides little comfort for taxpayers who want to omit
sensitive information and avoid penalties for failing to comply
with the filing requirements.
Even though the BEPS recommendations were finalized this
fall, confidentiality concerns can and should be addressed
during the BEPS implementation phase. Specifically, the NAM
believes that Treasury should link master file information to
its agreements to provide the country-by-country report to
other countries through information exchange.
Thus, we urge Congress to ensure that Treasury enters into
agreements with foreign countries specifying that Treasury
agrees to provide country-by-country reports for U.S.
multinationals only if U.S. multinationals or their
subsidiaries are not required to provide master file
information to the foreign country, that the foreign country
agrees that it will not collect country-by-country reports from
U.S. multinationals or their subsidiaries, and that Treasury
agrees to provide to the foreign country only the master file
information that a U.S. multinational chooses to file with its
country-by-country report in order to provide context for its
country-by-country data.
Manufacturers believe a fair and transparent tax climate in
the United States, including competitive business tax rates and
modern international tax rules, will boost standards of living
and economic growth worldwide. At the same time, an appropriate
balance needs to be struck between transparency and
confidentiality of the proprietary information that enables
companies to compete and prosper in a global economy.
Thank you for the opportunity to appear before the
committee to discuss the NAM's concerns with the master file
requirement. This concludes my testimony, and I would be happy
to answer any of your questions.
Thank you.
The Chairman. Well, thank you so much.
[The prepared statement of Ms. Coleman appears in the
appendix.]
The Chairman. Mr. Danilack, we will take your testimony
now.
OPENING STATEMENT OF MICHAEL DANILACK, PRINCIPAL,
PRICEWATERHOUSECOOPERS LLP, WASHINGTON, DC
Mr. Danilack. Chairman Hatch, Ranking Member Wyden, and
distinguished members of the committee, I appreciate the
opportunity to appear this afternoon as the committee considers
BEPS and state aid.
I would like to compliment the committee for holding
today's hearing. The subject is of considerable importance to
the U.S. tax base and to U.S. tax administration.
As Chairman Hatch mentioned at the outset, currently I am a
tax principal at PricewaterhouseCoopers in the Washington
national tax services practice, but previously I held a number
of
international-focused leadership positions at the IRS.
I appear here today, however, on my own behalf and not on
behalf of PwC or any client of the firm or certainly not on
behalf of the U.S. Government. And therefore, the views I
express today are entirely my own.
Before I begin, I would like to offer my compliments to Mr.
Stack personally and to his team at the Treasury Department.
The BEPS project seemed threatening to U.S. interests right
from the start, and Mr. Stack's diligent efforts to bring
balance and wisdom to the project are greatly appreciated.
The subject of today's hearing raises numerous legal and
policy considerations. In my view, however, the most important
effect of the BEPS project in the near term is likely to be on
international tax enforcement activities around the world, and
this I believe will create a serious challenge both for U.S.-
based multinational businesses and for the U.S. Government.
The scope of the BEPS project and the timetable set for
completing the work were extraordinarily ambitious. In
addition, the OECD invited participation by non-OECD-member
countries that brought new points of view to the table.
As a consequence, it is not surprising that the papers
issued on October 5th of this year do not reflect a clear
global consensus on many of the difficult issues that were
evaluated. In some respects, the papers merely provide
governments with options. In other respects, they draw
conclusions based on new concepts that are somewhat ambiguous.
In still other respects, the work is unfinished.
So, despite the OECD's accomplishments, so far the BEPS
project has created significant ambiguities and considerable
uncertainties. Notwithstanding the ambiguities, however, in my
estimation it is inevitable that countries will begin to assert
the new concepts through enforcement actions guided by their
own interpretations and with their own revenue collection goals
in mind.
Indeed, this is already happening around the world. I hear
stories about it from clients nearly every day.
Because the BEPS project provides concepts that can be used
to expand the revenue base of almost any country, the resulting
threat is widespread double taxation, or even multiple
taxation.
The U.S. network of tax treaties, of course, is designed to
eliminate double taxation, and all countries agree that double
taxation is wrong as a matter of policy. But when double
taxation is created by one country's enforcement action, it is
not automatically eliminated by a rule in the treaty. Rather,
the case is presented by the taxpayer to the designated
competent authorities of the two jurisdictions involved, and
those competent authorities seek to arrive at a principle-based
settlement to ensure that the profits of the business are taxed
only once.
But this so-called mutual agreement procedure is far from
easy to conduct. At the competent authority table, the country
that makes the adjustment has the greater leverage.
Essentially, that country is in a position to enforce its
determination at will.
The other country, the one where the profits were
originally reported, can only attempt to convince the adjusting
country to withdraw or reduce the adjustment by pointing to
well-established international principles. This can be
difficult under normal circumstances, but where the underlying
principles are unclear, the effort may well be a losing one.
A number of things might be done about the problem. One is
to ensure that the IRS competent authority is equipped to
handle the challenges that lie ahead. A second is to reform the
U.S. international tax system.
Lowering the U.S. corporate rate and reforming our
international rules are critical, but I note that even if such
changes are made, other taxing authorities will be looking to
tax a bigger share of a bigger pie.
I also note, in closing, that there seems to be a target
unfairly painted on the backs of U.S. companies. Nevertheless,
it is likely that taxing authorities will seek to tax a larger
share of global profits of all multinational businesses. There
is, however, an important difference between U.S. companies and
foreign companies in this respect.
As we all know, the United States has a worldwide system
with credits provided for foreign taxes paid, which may include
those imposed through foreign audits. So, if the U.S. competent
authority does not have the resources to handle the tsunami of
new double-tax cases predicted by many, or if the IRS cannot
successfully convince foreign governments that their
adjustments are wrong by pointing to established principles,
the U.S. companies generally will not bear the resulting double
taxation. Instead, they will be entitled to take a credit for
the adjusted foreign taxes in the United States, and the U.S.
tax base will be eroded as a result.
Chairman Hatch, Ranking Member Wyden, and other
distinguished members of the committee, I thank you again for
the opportunity to be heard today, and I would be happy to
answer any questions you may have.
The Chairman. Well, thank you so much.
[The prepared statement of Mr. Danilack appears in the
appendix.]
The Chairman. We will turn to Senator Grassley first.
Senator Grassley. Thank you very much for that courtesy,
Mr. Chairman.
I have three questions, if I have time, to ask Mr. Stack,
but if the other two of you would like to join in, that is all
right as well.
Mr. Stack, in a talk that you gave in June on the progress
of BEPS, you stated that you had, quote, ``been personally
shocked and appalled at the lack of attention that clarity and
the ability to administer get at the OECD.'' You further
stated, quote, ``This was motivated by the fact that tax
administrators like having whatever tools they can to go after
taxpayers.''
So, a question: do you continue to have concerns about the
lack of clarity and the ability to administer rules contained
in the final BEPS report? If so, should American companies be
worried that they will be unfairly targeted by foreign tax
administrators taking an I-know-it-when-I-see-it approach to
their implementation and enforcement of the recommendations?
Those two questions.
Mr. Stack. Yes, Senator, I stand by those remarks, and I
work very closely with the business community and lots of
stakeholders in the BEPS work.
I think that the areas that concerned us the most in these
negotiations were questions like a looser standard on permanent
establishments, and questions like how other countries were
going to determine treaty abuse by putting in place what we
consider a vague principal purpose test for treaty abuse. And I
stand by the remark that I did not find the questions of the
importance and clarity and administrability of rules to be a
central concern of the negotiators at the OECD.
I would say two things on those particular issues. Because
of our reservations on both the PE and the treaty abuse issues,
the United States has made it clear that we will not be
adopting the permanent establishment rules that were agreed to,
unless we get further guarantees on how profits will be
attributed once they are put in place. And second, the U.S. has
made clear that we will not be putting a principal purpose test
in our treaties.
Now, granted, U.S. multinationals operate all around the
world, so they are still going to run into these rules, but
that was a position that we were able to take on that.
Having said that, there were many areas where I think we
were able to push back and get better rules and more clarity
because we were insistent. The transfer pricing reports at the
end were a lot better than they were in the middle drafts, and
so we stayed focused on that.
And the last point I want to make is, we are trying to turn
the attention of the OECD next to this very issue, which is, we
have written a thousand pages of reports, but what are the
guarantees that your auditor in X country is going to
understand them and apply them fairly and that people will get
a fair shake?
So we think we can pivot now from having written some new
rules to try to turn the world's attention to what is fair and
efficient tax administration. And that is a heavy lift, but we
think it is a very important thing to do for global growth and
foreign direct investment.
Senator Grassley. All right. My next question to you is,
this project was sold as a means to stave off uncoordinated
unilateral action by some countries that would erode
international tax certainty and predictability, yet it is
unclear that this has been the case.
For instance, the U.K. and Australia have gone forward with
so-called diverted profits taxes, and now we have the EU state
aid cases, which could be seen as linked to BEPS concerns.
So, Mr. Stack, in your view, will the finalizing of the
BEPS project help put an end to unilateral action, or should we
be concerned that it has only emboldened countries to take even
more aggressive action towards American companies?
Mr. Stack. Thank you, Senator.
Look, I think the unilateral action point is, we will never
know, as we sit here, what more unilateral action there would
have been if we had not fully engaged in the BEPS project,
number one. And I think one of the things I have learned by
talking to other governments is that foreign, multinational tax
avoidance, often with a focus on U.S. companies, is headline
news around the world that very much creates a great deal of
political pressure.
So what might have happened if we had not engaged in BEPS
is a story we do not know the answer to. Has there been
unilateral action? Yes, there has. Are we upset about it in the
case of the U.K. tax and the Australian tax and the state aid?
Yes we are, and what can we do to manage it is an open
question.
We are hopeful that we can use the BEPS reports and monitor
the ongoing output to invite countries to pull back from places
where they have strayed from what is in the BEPS reports, to
come back to the rules that we have now all agreed to.
But I would say, that is very much a work in progress, as
working with these countries and their sovereignty in writing
their rules is not something we control all that easily.
Senator Grassley. Thank you.
Thank you, Mr. Chairman.
The Chairman. Well, thank you.
Senator Wyden?
Senator Wyden. Thank you, Mr. Chairman.
So we have obviously had, as the kind of cloud over all
this, the question of companies inverting because they say they
have to lower their tax bills. That is what Pfizer said. The
Wall Street Journal recently reported that Aon is using
earnings stripping to lower its tax bill, and certainly
evidence suggests it is not alone.
So, Mr. Stack, on this point, does the Treasury Department
have sufficient authority to, in effect, nullify efforts to
strip earnings out of the United States?
Mr. Stack. Senator, we continue to look at the earnings
stripping questions very closely. We are mindful of the point
the chairman made, that there are lines between what can be
done administratively and where the Congress needs to act. And
it is difficult for me to say point blank, because this work is
ongoing at the Treasury, where that line is between what we can
do regulatorily and what would require congressional action.
I can say that in the inversion space and the earnings
stripping space, Congress could tomorrow limit earnings
stripping below what it is currently in 163(j), but we are
still looking at the contours of our authority relative to your
authority. And we, as the Secretary said recently, continue to
examine these issues.
Senator Wyden. All right. Let us turn to the question of
state aid--and maybe for you, Mr. Stack, and I think probably
Mr. Danilack, but any of you who would like to participate.
The EU state aid cases look like, to me, another example of
foreign governments targeting American firms. And they are
targeting American firms because they would like to expand
their tax base.
So I think, based at least on comments I have read in the
press, that you all largely share my concerns that these cases
could lead to retroactive tax increases. Is that right, Mr.
Stack? That is just a ``yes'' or ``no.''
Mr. Stack. Yes, sir.
Senator Wyden. All right. And so we would be talking about
retroactive tax increases on American companies that could
result in American taxpayers footing the bill through foreign
tax credits, which is something we have had for quite some
time.
So my concern here is--and the point of the question is--
the effects could go far beyond what are just these initial
state aid cases.
So, let us see if we can get a reaction. One, are these
cases, in your view, Mr. Stack, paving the way for the EU to go
after the historical earnings of many more U.S. multinationals?
Mr. Stack. Senator, I only know that there have been
reported instances of more U.S. companies being examined. So
that would take you in the direction of saying yes, they might
go further than the cases we have been looking at. And yes, I
do believe that the target is the unrepatriated earnings of our
companies that have been deferred from U.S. taxes.
Senator Wyden. So these cases, then, could have a
substantial and direct impact on the U.S. fisc, and
consequently American taxpayers?
Mr. Stack. Yes, Senator.
Senator Wyden. All right. So on this point, what is the
Treasury Department's strategy on these issues, and what can
the Congress do in that effort?
Mr. Stack. Senator, we have taken measures to be sure that
the Commission understands the direct U.S. concerns around our
tax treaty network and the potential for these taxes to be
borne by American taxpayers. So the first thing we could do,
and we have done, is to let the Commission know that we have a
stake in these cases. We are not just bystanders.
I think a broader point is, we have also made it clear that
the retroactive element of these cases--because it seems clear
to me as an observer that the theories being put forth here
surprised countries, companies, advisers, auditors. And when
you have a new type of ruling that is not foreseen by the
community that effectively had no notice, for it to be
retroactive strikes me as particularly unfair.
Now, beyond the Treasury Department making clear our view
with respect to these issues, since this is a proceeding in
another jurisdiction, I do not have some magic bullet for the
next things that the Treasury can do, except I will say we did
not want to wait for these rulings to be in the books and the
money to be paid before we looked up and realized that these
issues had arisen.
So I believe we have been very aggressive and forward-
leaning in making sure that we are getting ahead of and not
being surprised about the direction this is heading.
Senator Wyden. Let me ask you about this in the context of
tax reform, and I think you and I have talked about it down
there in the office a few doors down. I really spent years,
particularly with Senator Gregg and Senator Coats, putting
together bipartisan bills and working with various colleagues
on the committee. And Chairman Hatch and I have discussed this
at some length.
And we never really had to deal with things like what we
are talking about now, the question of EU state aid cases and
what the implications are. Now, it looks to me that, given the
debate now, most international tax reform plans are going to
include revenue from some sort of deemed repatriation of
historical foreign earnings as a transition to a new system--
really, an exemption-based system.
How is the EU state aid situation going to impact something
like a deemed repatriation transition tax? The reason I am
asking is, I am telling you as somebody who has spent a lot of
time looking at this and working with the bipartisan groups
that Chairman Hatch set up as part of tax reform, I think this
is really new stuff and pretty ominous.
So what is your thought on that?
Mr. Stack. Thank you, Senator. First I want to lead by
being very clear that the Treasury Department, because we are
out in front of these cases, we have not done the analysis, the
technical analysis that, in fact, these payments constitute
taxes and that, in fact, they will be creditable.
Having said that, I think many people in the tax
practitioner community and many people who have thought about
these issues think that there is a substantial likelihood that
they may be creditable.
In that case, if they were to turn out to be creditable
taxes, when we do those deemed repatriations, those same
companies that are having deemed repatriations will claim a tax
credit for the amounts that the Commission has ordered the
local governments to impose on them, if one were to conclude
that they are taxes and that, in fact, they are creditable
taxes.
So that gives us a direct fiscal stake, and I did not think
we should wait until that horse is completely out of the barn
before letting our interests be known.
Senator Wyden. Let us do this. I am way over my time. I
would like to give you a couple more questions on this general
point. Can you get back to us, say, within a couple of weeks on
it?
Mr. Stack. Absolutely, Senator.
Senator Wyden. The question will be, I would like to know
what they mean, the EU state aid cases, for our tax treaties.
And also, what about the prospect that Europe tries to
retroactively impose some sort of back-door tax on what they
think are unfair earnings?
So you have a general sense of what I am interested in. We
will get that to you. If you can get back to me with your take
on that within a couple of weeks, that would be very helpful.
And again, I want to commend you because I know in a very,
very difficult forum you have been trying to represent American
interests, and I appreciate it.
Thank you, Mr. Chairman.
The Chairman. Well, thank you, Senator.
Senator Warner?
Senator Warner. Thank you, Mr. Chairman. And let me first
of all say I agree with you and the ranking member that we
desperately need to do international tax reform. We need to
have an international tax system that allows us to be
competitive, with lower rates.
I would point out, though, that one of the challenges we
have, and correct me if I am wrong, Mr. Stack, out of the 34
OECD nations, America, which has the most--I will take a
combination of both your comments--the most mixed-up, screwed-
up tax system of all with, technically on the business side,
some of the highest rates in the world, yet you look at what we
collect, state, local, and Federal combined, business and
personal combined, and we are 32nd out of 34 in terms of
percent of GDP. Is that correct, Mr. Stack? Yes. I will get you
the written validations.
So we have both the nemesis of the most complicated system
around, yet we collect, on a comparative basis, the least
revenue. One of the reasons--and again, I appreciate both of
you mentioning the challenges around inversions.
As somebody who has been a strong supporter of the benefits
of PhRMA for a long time, I am very disappointed by those
actions, and particularly disappointed by some of the comments
of the CEO there in terms of whatever obligation he feels he
has to this country, which has in many ways subsidized the R&D
for PhRMA for the whole world, since we pay higher drug prices
than the rest of the world, and things like NIH and others that
do not seem to go into his calculation.
I guess, Mr. Stack, what I am wondering is--and this kind
of goes with what the chairman and the ranking member have
said--this may be too early to have some data. But when we are
talking about inversions, when we are talking about the BEPS
process, which is now driving some of these state aid and other
potential actions, when we are seeing the growth in,
particularly, Europe, on patent boxes, has anyone calculated at
least a ballpark number in terms of amount of lost revenue to
our country, in the current year, future years?
How do we factor this in, if we need even more impetus to
try to get our tax codes fixed in terms of estimating what is
going to happen in terms of both erosion of our base, and even
companies that stay within our base, the tax actions that may
be taken against them in the OECD?
Mr. Stack. I am not aware, Senator, of the precise figures
on where we are headed. I would make a few observations.
In the inverted company cases, I think we know, once the
companies are gone, they are not coming back. So that is kind
of like a permanent loss.
And second, once----
Senator Warner. And yet there is--has there been any
estimate done by Treasury of over, say, the last 3 to 5 years,
of inverted companies, total amounts of revenue lost on a
projected basis?
Mr. Stack. Not that I am aware of, Senator, but I will
double-check, and if so, I will get back to you.
The second thing that happens is, once the company inverts,
it is able to strip revenue out of the United States through
interest in a far more generous way than it could have done
while it was still domestic.
And again, I will check to see if we have data on what that
has been, but I am not aware, off the top of my head. But those
are two very palpable issues with respect to inversions, and
where we lose our base.
I could speak to other issues in our tax reform, where we
want to shore up some of the rules about moving intangible
property offshore by U.S. companies, which is another way that
we have our base eroded.
In the President's tax reform proposal, we have a series of
ways to protect the U.S. base as we lower the tax rate and
broaden the base for corporate tax.
Senator Warner. Mr. Chairman, one thing I would hope, as we
look at whatever package that may come around on tax extenders,
is that some of the provisions that might be part of an
international tax reform package, that we do not make those
provisions permanent in the short term now, which frankly would
incent companies to keep more earnings offshore.
Some of the proposals being talked about I think will,
again, make it even harder for us to get to our ultimate goal,
which is an international tax reform system that makes America
competitive with lower rates, with less exemptions. I know
there is discussion about making some provisions permanent now
that I think would dramatically benefit American companies, but
would benefit them in the way of keeping those revenues and
profits offshore.
My last question--I guess this will be for the whole panel.
One of the areas I think the BEPS process resolved or came to
some conclusion on--and I love your general comments on this. I
have been very concerned about the movement towards the patent
boxes, what that regime may do in terms of dramatically
lowering corporate tax rates, particularly around high-value
intellectual property, with our competitive nations.
Now I understand BEPS has ended up saying there has to be a
linkage, a nexus in terms of R&D and patent boxes. How worried
should we be about the patent box regimes in the OECD nations?
Very briefly, because my time is out. If each of you would
take a crack.
Ms. Coleman. Manufacturers have looked at patent box
proposals in the United States. In reality, they do not provide
that much benefit to the industry across the board. We found
the benefits tend to be concentrated in different sectors of
the manufacturing industry. So I think patent boxes would
probably have a mixed impact on my industry.
Mr. Danilack. Senator, I would say generally speaking, we
should be worried about the nexus requirements, if we are
concerned about where the R&D jobs are, at the end of the day.
Because the nexus requirements call for those jobs to be in
those jurisdictions where the rates are beneficial. And
companies respond to incentives like this and will move jobs in
order to obtain the benefits of the tax regimes that are put in
place.
Mr. Stack. I will only say briefly, Senator, that I think
there has been some broad bipartisan notion that we should do a
revenue-neutral, broaden-the-base, and lower-the-rates tax
reform. And when you go in the direction of a patent box, you
have kind of broken away from that and are creating new special
treatment for a particular industry and a particular kind of
income that may make it harder to do international tax reform
rather than easier.
Senator Warner. Thank you, Mr. Chairman.
The Chairman. Senator Casey, you are next.
Senator Casey. Thank you, Mr. Chairman. And I appreciate
the testimony of the panel.
Mr. Stack, I want to start with you in terms of some
fundamentals that we try to keep an eye on here, such as wage
growth, which is, in my judgment, a several decades long
challenge for the country.
We really haven't turned wages in the right direction in
several decades--by one estimate this past January, 40 years of
wage growth amounting to just 9 percent. In the prior 25 years,
90 percent or 91 percent. So wage growth, economic growth, and
just job creation.
When we are looking at those issues and looking at tax
issues through that lens, one of the areas of concern would be,
in addition to what Congress can do and must do, in your work
at Treasury, what can you say that you are doing or the
Treasury Department overall is doing to protect those basic
U.S. interests when it comes to tax policy, to the tax
strategy, and how it ensures that we have the kind of wage and
job growth that we want?
Mr. Stack. Thank you, Senator. In the Office of Tax Policy,
I think the driver is, we want companies to be able to make
decisions for their economic benefits and not decisions
necessarily driven by tax incentives or tax regimes.
So to the extent one can remove the tax gimmicks out of
economic decision-making and investment, then you do wind up
with the jobs in the right places and the factories in the
right places.
One way the President has talked about doing that is by
lowering the rate so we are more competitive around the world,
and to do that, we need to broaden the base. And the minimum
tax proposal the President has put forward basically says to
companies, if you are operating abroad in a jurisdiction where
the tax rate is higher than the minimum, you are going to have
the same rate as your competitor. So you can make your
investment decisions in that jurisdiction based on that market
and the cost of operating and where to put the factory and who
to hire, and you are not so worried about having some
additional tax when that money comes back home, in which case
you wind up with skewed incentives.
So I think our goal is, take the tax out of the equation;
let companies make good investment decisions. That should put
the factories and the jobs in the places where they are
economically needed. And hopefully, at the end of the day, that
fuels the kind of growth that you are talking about.
Senator Casey. Mr. Danilack, or Ms. Coleman, do have any
opinions on this question?
Mr. Danilack. No, sir, I do not have a particular opinion
on the question you asked of the Treasury Department.
Senator Casey. I want to ask as well--I know that Senator
Wyden raised the question of the European Union state aid cases
and the overall impact because of potential targeting of U.S.
companies and what that impact is for American taxpayers.
Mr. Stack, could you kind of walk through that, just in
terms of, if a taxpayer were sitting in front of you asking how
does this affect me ultimately, or how could it potentially
affect that taxpayer?
Mr. Stack. Sure, Senator. When a U.S. company pays a tax in
a foreign jurisdiction and then they bring money home, they get
a credit for that tax paid in the foreign jurisdiction, up to a
certain limit. Now, in the normal case, that means you are
actually doing some business in Germany, let us say, and you
had some tax, and you brought it home and you got your credit.
In this fact pattern, the EU is coming along and they are
saying, oh, we think when you cut your deal with Ireland or
Luxembourg or the Netherlands that, in fact, you, company,
should have been paying more tax to those jurisdictions.
Now, if we were to determine that those payments are in
fact taxes, and were to determine that they are creditable
under our rules, now when that money comes home from those
countries, in addition to the credit the company got for the
tax they originally paid in those jurisdictions, they get an
extra credit.
And that credit, to this taxpayer you asked me about, means
in effect the U.S. Treasury got less money and in effect made a
direct transfer to the European jurisdiction that is getting
the ruling from the Commission. So if these turn out to be
creditable taxes, it is the U.S. taxpayer who is footing the
bill for these EU investigations.
Senator Casey. So now, you referred to it in your testimony
as well. Is there anything you want to add?
Mr. Danilack. Yes, and I would like to broaden out the
particular problem you are asking about, beyond state aid,
because the very same profits that the European Commission is
having a look at are also being looked at by other
jurisdictions around the world.
You will have another country that will see the low tax
profits in a jurisdiction like the ones Mr. Stack mentioned,
and they are currently already--this is what I am trying to get
across--in the enforcement mode, attempting to tax those
profits for themselves.
Now, if that happens, and it is happening, those taxes are
also going to be creditable taxes in the U.S. So that same pot
of profits is going to be subject to taxation, perhaps by
multiple countries, and those credits will all come back.
And you will not have the state aid tax credit question if
it is another jurisdiction. That is just applying their normal
income taxes, attempting to drag those profits into their
jurisdictions. And this is happening already with a number of
the clients of the firm.
Senator Casey. I appreciate that. And I know my time is up
and over. I do want to say for the record, Mr. Chairman, my
father-in-law, John Foppiano, spent a lot of his years as a tax
partner at Pricewaterhouse. So that is on the record now. Mr.
Danilack, you do not have to comment, but I wanted to make sure
that was part of the record.
Thank you, Mr. Chairman.
The Chairman. Well, I think every member of this committee
ought to be able to brag about his father-in-law once in a
while.
Senator Portman?
Senator Portman. Having a father-in-law who can do your
taxes is quite an advantage. [Laughter.]
Mr. Danilack. That is right. That is right.
Senator Portman. So I think Senator Casey asked a really
good question about jobs and wages, and how do we get past the
point in this country where we see not just flat but actually
declining wages, higher expenses, the middle-class squeeze. It
is very real.
And I think the testimony today has also been very helpful
and raised a lot of issues, and I think the answer to it all is
pretty obvious, which is tax reform.
I mean, we could do a number of things to get wages up. But
every economic study I have seen says the same thing, which is,
if you do in fact go with a pro-growth tax reform on the
business side, you are going to see the benefit go to the
workers. The CBO study that many of you have seen shows 70
percent of the benefit is going to go to higher wages and
better benefits. And it is because American firms will be more
competitive and they can pay more.
And I just think we are missing the boat. And I hope this
has been a wake-up call today for everybody to hear you all
talk about the fact that, even if we were not already convinced
that we are missing this opportunity to help the people we
represent--those workers should be able to have more
opportunity for themselves and their families--but now it is
getting even worse.
Because everything you have said--and I have looked at your
testimony. And also we have had a chance, some of us, to talk
about these issues, and if we do not move to do it--we should
do it anyway, reform our code to make it more competitive--in
effect what will happen is, this is not just in Europe, as you
know very well, Mr. Stack, because you have had to sit through
probably dozens of meetings on this, this is not just OECD;
this is the G20. As Mr. Danilack has said, this is other
countries as well. It is global now. They are going to go after
these profits.
So, in effect, we are having the worst of all worlds. We
have a non-competitive tax code that makes our workers have to
compete with one hand tied behind their back, that keeps their
wages depressed, and yet we are also seeing now that, because
we have not acted, other countries are moving in to try to grab
those earnings themselves.
And I just hope that we can figure out a way, on a
bipartisan basis, to fix this. And this committee has done a
good job, I think, on the hearings. And I think the working
group that Chairman Hatch asked us to convene was effective.
Senator Schumer and I do not agree on everything, to say
the least, but we did come up with an agreement on this issue,
which is a framework to deal with tax reform. And I know there
are some controversial parts of it, but I see a lot of
consensus as to what we ought to do.
And it does involve, as Mr. Stack has said, lowering the
rate, broadening the base, but also, on the international side,
moving to this territorial-type system before it is too late.
I just have a couple quick questions, if I might. This
nexus requirement that the BEPS project has now blessed, which
is to say, if you do have an innovation box or a patent box in
your country, you have to actually have the work connected with
it.
I assume you believe that is also going to draw additional
jobs overseas, because companies that are now taking advantage
of moving that intangible income overseas to lower-tax
jurisdictions are going to find, gosh, they have to actually
send the researchers, the scientists, the infrastructure over
there. Is that not true?
Mr. Stack. Not necessarily, Senator. I think--I want to
make two points about the work we did at BEPS on the patent
box.
First of all, I think we all have to appreciate where we
began. We began with countries like the U.K. that said, if you
just drop your paper patents into London, you can get a 10-
percent rate and you can strip out of all our neighbors at a
25- or 35-percent rate. And the OECD said, wait a second. That
is not having any domestic tax policy other than trying to
strip income out of your neighbors.
So the work at the OECD--and one premise we have at OECD
is, countries can have their own rates and countries can favor
some income over others. But what we said was, if you are going
to have a separate rate for patent box-type income, it has to
be promoting a domestic policy of encouraging research and
development. So do some research and development in country.
Now, once you go there, you have to--there are two things.
I do not think it is a given in the economic literature that
the tax rate of where the research is done is the determining
factor of where the research is done. People like to conduct
research in the United States because we have universities and
communities and synergies of all these great dynamic people we
have here, number one.
And number two, remember, if you are going to take your
winners at 6.5 percent in Ireland, your income, you are going
to have to take your deductions at 6.5 percent on your losers.
So it is not a no-brainer for a company to say, I am going
where there is a 6.5-percent rate, because they have to make a
judgment to give up the 28- or the 35-percent deduction in the
U.S. as they do it.
And finally, I do not also think it is a no-brainer that
U.S. tax policy should race to the lowest tax rates of any
neighbor we have, because that is a very expensive way to
proceed, given all of our competing fiscal demands.
So I think the work we did on patent boxes was good, from
where we started and got to a better place. And I do not think
it is necessarily going to drive U.S. researchers, and the
ownership of IP, out of the U.S. overnight.
And I have had an opportunity to discuss some of this with
my European counterparts, and a lot of them view their patent
boxes as probably more beneficial to some of their small and
medium enterprises that can benefit, because they are doing the
research there locally. Obviously, that is something we should
study and look at as we go forward, but I still think we did
good work in that space.
Senator Portman. I am not challenging your work, but I am
perplexed by your answer. I do not see how you can say this is
good for the United States to have a BEPS project that ends up
saying, for those American companies that do research overseas
because they can take advantage of a patent box or an
innovation box, now there is a nexus that they have to actually
not just move, as you say, the paper patents overseas, they
have to move the people overseas. How is that good for the
United States of America?
Mr. Stack. Well, Congressman, we do not get to tell
countries what rates they should have.
Senator Portman. No, I understand that. But I do not see
how you can say that is good. I mean, that should make you want
to look at our tax code and figure out a way to make our code
more competitive.
Mr. Stack. Absolutely.
Senator Portman. Which is the point that Senator Schumer
and I made in our report, having talked to a lot of experts,
including at least one member of your panel. This is the
reality. This is what is happening.
Now, we may not like it, and you are right, other countries
have the right to do it, I suppose. But that does not mean that
we should sit back and simply not react, because I do think you
are going to see an erosion, not just of inversions and foreign
takeovers--which, by the way, doubled last year in value as
compared to the year before, and this year is on track probably
to go up another 70, 80 percent. But I think you are going to
see not just the paper patents, but the researchers move
overseas. That just seems to me logical.
Mr. Stack. Well, Senator, that is why the President has
proposed lowering the rate, broadening the base, and doing a
whole host of other things to make us more competitive and pro-
growth in the world. And so I was answering, in isolation, the
patent box question.
But I fully agree with you: we need to do better at
international tax reform to make ourselves more competitive.
And on that, there is bipartisan agreement. So I fully agree
with you.
Senator Portman. On the--well, my time has expired. I
apologize. I see one of my colleagues has now arrived. But I
would like to talk to you more at some point about this notion
of these retroactive tax increases you talked about, and all
three of you talked about, being creditable, and what that
means for tax reform.
Because one of the very specific concerns we have obviously
is that in our proposal, there is a deemed repatriation. And
Treasury agrees with us on that, and obviously that deemed
repatriation will be a lot less to be able to pay for moving to
a territorial system if there are creditable tax credits
against it. And so that is my biggest concern: the impact of
this specifically on tax reform.
And just a quick--do you all agree with that as a concern,
and is that one reason for us to move quickly?
Mr. Stack. Yes, Senator.
Mr. Danilack. Yes, Senator, I believe it is something to
consider, yes.
Senator Portman. Thank you, Mr. Chairman.
The Chairman. All right, thank you.
I have deferred my questions, so I think I will ask a
couple right now.
Mr. Stack, I appreciate that you discuss the problem of
inversions in your testimony. It seems that the decision to
invert is driven, for the most part, by the fact that the tax
consequences for being a foreign company are much better than
being a U.S. company. I think that is coming out here today.
Some of the proposals from the administration, in an effort
to combat the problem of intangibles migrating from the U.S.,
call for a minimum tax on income of foreign subsidiaries of
U.S. companies. But I wonder if taxing U.S. companies more
heavily on the income of their foreign subsidiaries would
create yet more pressure to invert. So combating one type of
base erosion and profit shifting--that is, intangible property
migration--perhaps would create more pressure for another type
of base erosion and profit shifting, and that is inversion.
What are your thoughts on that? And, if Mr. Danilack would
like to weigh in as well, I would welcome his thoughts as well.
Mr. Stack. Thank you, Senator. I think that you mentioned
our minimum tax, and we think that the President's proposal
needs to be looked at in its entirety.
Ways to take pressure off inversions are, number one, to
lower our rate, broaden the base, and enact other elements of
our proposal like limiting the ability of inverted companies,
or all foreign multinationals, to strip interest out of the
United States once they invert.
The minimum tax proposal--it surprises me; we get so much
focus on the min tax piece. Because in my experience, companies
actually do business in jurisdictions with tax rates higher
than the minimum tax rate.
And what our proposal says is, if you are in a jurisdiction
with a tax rate higher than the minimum tax rate, you get to go
there and compete with all the competitors in that jurisdiction
and pay the same tax in, let us say Germany, as your
competitors in Germany get to pay. And when you repatriate that
money, you do not pay any additional tax.
What the minimum tax part of it does is to say, if you are
shifting income into very low-tax jurisdictions--and one can
always quibble on where the line is. We put it at 19 percent in
the budget, but my boss has said that is not divinely inspired.
We could pick other numbers. When that happens, it is probably
true that there is some shifting going on that is dangerous to
the U.S. base, because it is attracting people to put the
income offshore.
So one way to think about tax reform and inversions is,
lower the rates, broaden the base, put in an entire package of
sensible tax rules to take the pressure off inversions, and for
that, highlighting the need to get at interest-stripping, I
think is critical.
And then, if people are still putting high-value items in
low-tax jurisdictions and tax havens, we protect our base by
saying we will pick up the tax on that at the minimum rate.
The Chairman. Well, you also talk about earnings stripping
in your testimony. Apparently the ability to engage in earnings
stripping creates pressure to invert as well.
And if you agree that U.S. companies invert or become
foreign companies because the tax consequences to being foreign
are better than the tax consequences of being a U.S. company,
then perhaps limitations on earnings stripping reduce the
attractiveness to being foreign--that is, reduce the
attractiveness of inverting.
Earnings stripping is one factor in the decision to invert.
Do you agree with that?
Mr. Stack. Yes, Senator, I do very much.
The Chairman. And do you think that the OECD BEPS project
recommends a more aggressive posture against earnings
stripping?
Mr. Stack. Yes it does, Senator.
The Chairman. All right. Well, Mr. Danilack, I welcome your
comments on these two questions that I have asked, if you care
to make any.
Mr. Danilack. I think that each of these questions is
interrelated with each of the others. And what you are really
looking for is a formula to balance out your tax environment
for your U.S. companies with the environment for foreign
companies. And ultimately, you want to ensure that a U.S.
company is happy to be here and is not interested in being
somewhere else because the tax environment for a company abroad
is beneficial.
And this involves the U.S. rate. If the rate is lower,
there is less incentive to strip. If the rate is high, there is
clearly a lot of pressure to strip as much as possible.
So you are essentially asking, what is the right formula
for tax reform to ensure that businesses, as Mr. Stack said,
make decisions based on economics and not based on taxation? So
there is not a real magic answer; it takes a lot of hard work
to figure out exactly how to get it right.
The Chairman. All right.
Well, Senator Carper is next and then Senator Thune.
Senator Carper. When I walked for the second time into the
hearing, I think Senator Portman was asking a question relating
to BEPS, U.S. competitiveness, and the tax base, I think, of
Mr. Stack. And I do not know that we really heard from the
other witnesses on that question. I will just frame it briefly.
While we have been talking a lot about tax reform in this
country, other places have actually been doing it, and we have
been an observer in that process. But a lot of countries are
putting in place patent box regimes in order to offer some
lower rates on profits that are derived from intellectual
property.
In the context of these patent boxes, the BEPS project is
proposing what is called a nexus approach. And I think you were
having some discussion with Senator Portman about that.
I would just like to hear from our other two witnesses,
just your comments and thoughts in this regard, particularly
about the impact you believe a nexus requirement, if it is
adopted on a widespread basis, might have both on the U.S. tax
base and also the impact it might have on our ability to keep
intellectual property and R&D jobs here in the U.S.
Yes, ma'am?
Ms. Coleman. I think one way to keep R&D jobs in the United
States is to have a permanent R&D credit. And as I mentioned
before, the NAM took a look at the innovation box, and we had a
mixed reaction from our members.
In contrast, the NAM has been a strong proponent of a
permanent R&D credit. In fact, we are very optimistic about the
discussions going on right now. We feel that a permanent R&D
credit would keep R&D in the United States.
And when you look across our competitors in the OECD, all
of them have much stronger and, in most cases, permanent
incentives. As you know, we have an on-again-off-again
incentive, which currently is off. So the U.S. credit is not as
attractive as incentives in our competitor nations.
So I think a simple solution and something that we could do
right away is to make the credit permanent.
Senator Carper. All right. Thank you.
Mr. Danilack. I answered the question earlier, before you
came in, Senator.
Senator Carper. What did you say?
Mr. Danilack. I said generally speaking, I would be
concerned about patent box regimes cropping up around the
world, especially if they are widespread and especially if the
value of those regimes from a tax savings perspective is very
high.
I also agree with Mr. Stack's comments earlier that it is
not automatically going to be the case that jobs will migrate
to these jurisdictions, because it is a complex calculus that a
business needs to make.
There are businesses where there is a great deal of risk in
R&D, and there are losers. And the deductibility of the
expenses--you will have to also take into account the
respective tax rates.
So it is like anything else. This is not a one-issue
question. You necessarily have to bring in the other issues
that are on the table, like what the respective rates are in
the jurisdictions in question. If a baseline rate in the U.S.
is relatively low, you are obviously going to have less
incentives for jobs to migrate to a lower-tax jurisdiction than
if the baseline rate is very high.
So I do not have a strong sort of on-off type of view on
the threat posed by the nexus requirements. I think generally
it is something to really take into account, especially if
patent boxes become widespread and very beneficial and nothing
is done here in the U.S.
Senator Carper. All right. Thanks.
If we could talk a minute or so about the time frame for
BEPS implementation, and to Mr. Stack, could you give us some
reasonable estimate, if you will, as to when other countries
will ratify, might ratify, the BEPS multilateral instrument,
and will taxpayers be given a reasonable amount of time to
create systems to comply?
Mr. Stack. Thank you, Senator.
Because there are 15 different action items, each one
relates differently to the question of implementation. With
some, for example in digital economy and Controlled Foreign
Company rules, there is nothing to do or implement.
If you look at the interest deductibility in hybrids, since
they are effectively setting out common approaches for
countries, there is no particular expectation of when things
might be implemented. So it kind of runs the gamut.
The transfer pricing work in many countries, because it
amplifies the arm's-length standard, is kind of automatically
absorbed into law.
The two things on the multilateral instrument, that work
will be going on this year. They are hoping to have a draft out
by the end of the year. It is going to try to embody the
different treaty things we have agreed to.
Frankly, I think that is an ambitious schedule. Obviously,
we would have to work with the Senate Foreign Relations
Committee if we are going to move forward on elements of that.
So I think that is still a ways down the road, and we will have
plenty of time to work with Congress in terms of implementing
that, I would say.
Senator Carper. Good. Thanks. Thanks to all of you. Much
obliged.
Senator Thune [presiding]. Senator Cardin?
Senator Cardin. Chairman Thune, it is nice to be with you
here.
Let me sort of preface this question. Clearly we are
interested in collecting our taxes. To the extent that we do
not collect the taxes that are due from a particular entity,
everyone else pays a little bit more in taxes. So being able to
collect our fair share of taxes allows us to have lower tax
rates. That is one reason that we want to make sure that we
have a fair tax structure.
There is also the reason of fairness. Everybody should pay
their fair amount.
We are clearly concerned about these flagship tax
investigations that are taking place that we see targeting
American companies. And therefore we obviously want to support
the tax treaties that can help us deal with some of these
issues to make sure our companies are treated fairly and we do
collect our taxes.
And hopefully, we are going to move these tax treaties in a
more expedited way than we have over the last 4 or 5 years. All
that is very, very important, and we want to gauge our OECD
partners to make sure that we have more uniform rules in
determining allocations of costs and revenues.
But I want to get to the fundamental issue here and ask you
this question: if the business tax rates in the United States
were lower than the OECD countries, would we be having these
problems? If we, after all, were the low-tax jurisdiction
rather than the high-tax jurisdiction, it seems to me the
dynamics here would be dramatically different.
And I will give you a chance to answer that question.
Senator Thune and I worked on the business reform issues, and I
thought we made a lot of progress.
Senator Thune raised a very good issue about the corporate
entity, or the business entity you pick, and why that should be
neutral rather than what it is today. I agree that is certainly
an inequity in our tax code, depending on double taxation
issues.
And I raised the fact that the United States, among the
OECD countries, has by and large a lower reliance on the
governmental sector than they do, so therefore, since our
reliance on government revenues is less, we should have lower
marginal rates, not higher marginal rates.
Of course the reason is that the United States is stubborn.
We have always been. We do things right; the rest of the world
does not. And therefore, for Federal purposes we rely almost
solely on income taxes, where they use consumption taxes as
well as income taxes.
So my question to you is, if we could reform our tax code--
I know a lot of my colleagues have talked about that--to be
more in harmony regarding how we collect taxes, as the OECD
countries are, so that we would end up with the lowest marginal
tax rates among the OECD countries, would it not make some of
these discussions a little bit more different and dynamic? It
might be just the reverse of the arguments that we are having
today on targeting.
Whoever wants--Mr. Stack, you look anxious, and I think you
might agree with me, so----
Mr. Stack. Yes, certainly, Senator, if we had lower rates,
there is less pressure on stripping out of our jurisdiction.
Now, I would just add that in the case of multinationals,
you sometimes get these jurisdictions that sit in the middle
where you may not pay tax at all, and so you bring the money
home, and that is just something I think there is bipartisan
consensus we should be fixing as well.
Senator Cardin. I would point out that this is not
theoretical. I filed the Progressive Consumption Tax Act that
incorporates two major provisions that seem to be reasons why
we have not been able to advance this in the past.
One is, it is progressive. We do incorporate the current
benefits in the income tax code for the Earned Income Tax
Credit and the Child Tax Credit, and we do provide rebate
payments for recipients so that we are dealing with a more
progressive way to collect taxes.
And then second, we put a circuit breaker in the bill to
make sure that the revenue growth is not more than we say it is
going to be, so we do not grow government, which is another
complaint that has been made about consumption taxes, which I
think is a legitimate concern, because I expect that the Joint
Tax Committee will not score this for the true revenue
potential that it will unleash by having more competitive
rates.
So I do think this is doable, and I know we spend a lot of
time in this committee, and you all spend a lot of time talking
about ways that we can protect American companies from
discriminatory actions and how we can keep jobs in America and
how we can be competitive and how we deal with inversions or
deal with how we get the monies that are parked overseas back
to the United States. It seems to me that if we dealt with the
fundamental problem we have--and that is, America is out of
step with our competing countries in how we collect our
revenues and the sources of our revenues--that would go a long
way to resolving a lot of these issues, and we probably would
not have had to have this hearing.
So let us have a hearing on the progressive consumption
tax.
Thank you, Mr. Chairman.
Senator Thune. The Senator from Maryland has done a lot of
work and put a lot of effort into examining these issues and
coming up with solutions. And he is out there at least
advocating reforms to the tax code that would get us away from
many of the embedded problems that we have and that have led us
to where we are having hearings like this one today to talk
about issues that, unfortunately, I think could be solved if we
had a more competitive tax code in this country.
So I appreciate his efforts and enjoyed working with him on
our working group, and, as he said, we made a lot of good
progress. We will see how much of that can be incorporated. And
I know in the end he wants to see his concept, his idea, become
the law of the land. So we will see if that emerges as one of
the top ideas.
But I want to--first off, I think this is an important
hearing, because it does have important implications for how
American companies do business in Europe and around the globe.
And efforts to combat inappropriate tax base erosion, if done
incorrectly, could further damage the ability of American
companies to compete in the global economy.
And I think, to put it more simply, American businesses
deserve fair treatment and due process when it comes to their
tax obligations in foreign nations, including from European
nations as well as the European Commission.
And I hope today's hearing will send a signal that Congress
is paying attention to the actions taken at the OECD in
Brussels, and that Congress is not going to stand idly by if
these actions are conducted in a way that negatively impacts
innovative American companies from doing business abroad.
But I do want to just follow up on one point that the
Senator from Maryland was sort of getting at, and that is to
say that with the state aid cases, it would appear at least
that the EU is taking advantage of America's lack of a
competitive international tax system to pursue American
companies, to accumulate overseas earnings as a revenue source.
Those earnings are only overseas because Congress has failed to
reform the U.S. international tax system.
So the question is--this is just a general question--are
these cases, at least in large part, really just a symptom of
the larger problem of a non-competitive U.S. tax system?
Mr. Stack. Senator, I want to answer with kind of two notes
of humility. First, I am not an EU competition lawyer, and
second, these cases have not run the gamut over there so that
one can read and analyze final cases.
Having said that, we were faced with a choice as to whether
to speak up now, before multi-billion-dollar judgments are
rendered against our companies, or wait until the decisions
were handed down. So we have been raising this issue today.
From my personal observation and study of these cases, it
appears to me that the Commission here is attempting to tax
income that really, under international standards, does not
belong to any member.
My perception is that they are trying to tax the income
that they perceive is untaxed because it has been deferred for
U.S. tax, and they see it as something that is there for the
taking, because our system has let it sit offshore without
being taxed.
So that is my perception of the substantive state of those
cases. They have a ways to go. I could be wrong, but that is
the way I see them today.
Senator Thune. And, Mr. Stack, do you believe that the
Treasury Department--let me ask it this way. Does the Treasury
Department believe that the sovereign right of taxation resides
with the individual nations of Europe and their tax
departments, or does it reside in Brussels?
Mr. Stack. So my understanding under EU law is that income
tax is the right of the member states. Now, having said that,
there are a lot of complicated rules in the EU.
For example, you are not allowed to use your income tax to
benefit one company over another, or one industry over another,
and that is state aid in a very classic case. So there is some
complexity of when an income tax could turn into a state
subsidy that the EU Commission has every right to rule against.
In these particular cases where they are looking at
particular rulings and telling countries that their transfer
pricing rules should have been applied this way or that way,
from our perspective, that crosses the line from the
traditional state aid analysis, as I understand it.
That is novel, as I understand it, and that is why we have
been asking for this to be done prospectively and not
retroactively. And therefore these issues, the way I understand
it, should have been within the purview of the member states
and not the Commission. But again, I am not an EU lawyer and
certainly not a competition lawyer in the EU.
Senator Thune. So what recourse does the administration and
Congress have to ensure that these state aid investigations are
conducted fairly and not just simply another effort to tax or
target American high-tech companies?
Mr. Stack. Senator, beyond what we have been doing, which
is talking to the Commission, and what you are doing, which is
shining a light on them, I do not have a magic bullet for what
role we play in another sovereign's internal investigations.
But I do think it is a service to shine a light, talk about
these issues openly, and hope that the Commission will see that
being fair is better in the long run than perhaps what is about
to occur.
Senator Thune. I want to ask, just for a minute, a question
about base erosion and profit-shifting efforts at the OECD. You
were recently quoted in the Financial Times as saying--and this
is a quote: ``It is to the great credit of the U.K. that they
were able to step back from a patent box widely seen as
harmful.''
As you may know, there has been much discussion in Congress
about the possibility of a patent box, often called an
innovation box, as part of tax reform. In fact, it is something
that Senator Cardin and I examined in our tax reform working
group, as did Senators Portman and Schumer.
Could you elaborate on why you view the U.K. patent box as
harmful, and to whom do you view it as harmful? And perhaps
maybe follow up with, are there existing patent boxes or patent
box proposals that you would find to be beneficial?
Mr. Stack. Sure. Look, the U.K. started out and went around
the world and said to companies, come and take your patents and
just bring them on to our shores. You did not do any research
here. You did not do anything. And when those patents are
earning income, we are going to tax that at--I think 10 percent
was the rate. And that meant that companies were being invited
to strip out of the Germanies, the Frances, the U.S.es, at 25-
and 35-percent rates. Watch the income flow into the U.K.
The reason that was harmful is, it appeared to have no
other domestic policy purpose than attracting income from other
jurisdictions. And really, all of Europe got very, very upset
about it.
I gave them credit in that article--because they walked
back from it in an agreement with Germany--to realize it was
harmful and walk away from it, put that aside.
Now, the U.S. is unique with respect to intellectual
property, because I am told that 85 percent of our R&D is
already done in this country. We tend to agree that the R&D
credit is a superior way to incentivize research.
But in terms of the work we have done at the OECD, programs
built around the fact that we might want to reward research
done in this country are not something that will probably
violate what we have done at the OECD.
So I think the critical thing is, there are many shapes and
sizes of what one might think of as a patent box, and so it is
hard to speak about them generally. But none of the proposals I
have seen for the U.S. involves the same kind of naked tax
competition that the original U.K. proposal did, because we are
an engine of global research and development, and rewarding our
companies for the output of that in whatever way people think
best is a fair debate to have, even if the administration, for
example, would prefer the credit over an innovation box.
But nothing being proposed here is like what the U.K. had
been doing and that they walked back from.
Senator Thune. This question anybody may respond to. Europe
obviously is an important market for American companies, both
as a large consumer of American products and a location for
U.S. foreign direct investment.
From the perspective of American enterprises looking to do
business in Europe, what is likely to be the impact of these
state aid investigations if, as expected, they result in prior
tax rulings by certain EU member states being overruled by
Brussels? Again, there are assumptions we are making here.
And the broader question has to do with what does this do
to U.S. companies? Would it make them less likely to invest in
Europe if they know that the European Commission is exerting
this kind of authority, and are there likely to be more or
fewer jobs created in Europe by American businesses as a result
of these investigations?
I know these are kind of hypotheticals, but if you could
just perhaps elaborate on what the likely outcome is with
respect to jobs in that country and to investment by U.S.
companies.
Mr. Stack. I will take the first stab. First, I think
companies realize that there is this kind of instability, that
when all of a sudden there is a new game in town where somebody
can look back 10 years over rulings I got from members, I think
it creates issues with respect to that kind of investment.
I will point out--and this is one of the unfortunate
aspects of state aid, of these investigations--the landscape in
Europe is changing. I think it is going to be more difficult to
get Luxembourg rulings as we go forward, because of the BEPS
work.
I think that there is going to be more attention paid to
putting the actual profit where the activities occur. The Irish
have already taken steps to do away with some of the elements
that are under investigation with state aid.
So I think a prospective remedy, actually, would work for
the EU Commission, work for the companies, and also take the
moving landscape in a positive direction in Europe. And so I am
not sure that we would see that much more harm down the road in
practice from these things, because the landscape is changing
there.
Senator Thune. All right. If anybody else cares to comment,
feel free to.
Mr. Danilack. I would say generally what I would be worried
about if I were a company is not so much the specific results
and how they might change and what Ireland may do in response
and what Luxembourg may do in response, but more generally that
what the European Commission actions represent is an erosion of
a process by which to achieve tax certainty.
Not all companies are looking to achieve the lowest rate
possible. They are looking to achieve a certain degree of
certainty. The way companies generally think they should
achieve certainty is by working directly with the government
and entering into a ruling where that certainty is established.
And I think what the inquiries under state aid have done is
called into question whether rulings are good, whether you can
go into a country and get a ruling on transfer pricing
principles that is widely accepted by the OECD and not have it
subsequently challenged retroactively.
So there is a retroactive element. There is the fact that
it is a ruling. You are looking for prospective certainty, and
that is taken away. And the principles themselves that you
thought were the right principles, and governments agreed to,
suddenly now are being called into question.
And that type of a dynamic, where you cannot rely on a
ruling anymore, is very, very dangerous, not only in Europe,
but elsewhere. So, if other governments begin to think that you
can tear up a ruling and go back and start all over and come up
with a different tax answer, this is just very bad tax
administration.
Senator Thune. Good. All right. Does anybody have anything
else for the good of the order? Closing thoughts?
All right. Well, I want to thank our colleagues who have
been here, the distinguished panel of witnesses, and all the
staff who have worked so hard over the Thanksgiving holiday to
prepare for this hearing.
And I would say for the record that any member who wishes
to submit statements, they should be submitted by the close of
business on Monday, December the 7th.
And I certainly hope that this is something that we will
continue to discuss, going forward, on both sides of the aisle
as we work on topics related to tax policy in the future.
So thank you very much for being here, and with that, I
guess I will adjourn this hearing, even though I do not have a
gavel. This hearing is adjourned. Thank you.
[Whereupon, at 4:27 p.m., the hearing was adjourned.]
A P P E N D I X
Additional Material Submitted for the Record
----------
Prepared Statement of Dorothy Coleman, Vice President for Tax and
Domestic Economic Policy, National Association of Manufacturers
Chairman Hatch, Ranking Member Wyden, and members of the committee,
thank you for the opportunity to testify today about the Base Erosion
and Profit Shifting (BEPS) project spearheaded by the G20 and the
Organisation for Economic Co-operation and Development (OECD). I
appreciate the chance to highlight on behalf of the National
Association of Manufacturers (NAM) our concerns about some of the
recommendations in the BEPS project that would impose substantial and
unnecessary compliance costs on companies and, in some cases, force
disclosure of sensitive, confidential U.S. taxpayer information. These
recommendations would create a new set of challenges for manufacturers
and stand to harm our competitiveness in an already difficult global
economic environment.
The NAM is the nation's largest industrial association and voice
for more than 12 million women and men who make things in America.
Manufacturing in the United States supports more than 17 million jobs,
and in 2014, U.S. manufacturing output reached a record of nearly $2.1
trillion. It is the engine that drives the U.S. economy by creating
jobs, opportunity and prosperity. The NAM is committed to achieving a
policy agenda that helps manufacturers grow and create jobs.
Manufacturing has the biggest multiplier effect of any industry and
manufacturers in the United States perform more than three-quarters of
all private-sector R&D in the Nation--driving more innovation than any
other sector.
Manufacturers know full well how critically important it is for
U.S. companies to be able to invest and compete effectively in the
global marketplace. Indeed, 95 percent of the world's customers are
outside the United States. Investment by U.S. global companies has paid
off for the U.S. economy: U.S. global companies employ 35.2 million
workers and are responsible for 20 percent of total U.S. private
industry employment.\1\ Moreover, U.S. companies that invest abroad
export more, spend more on U.S. research and development performed by
U.S. workers and pay their workers more on average than other
companies.
---------------------------------------------------------------------------
\1\ Bureau of Economic Analysis, August 2014.
---------------------------------------------------------------------------
background
In 2012, representatives from the G20 asked the OECD to develop a
comprehensive approach to address aggressive global tax planning that
resulted in inappropriate corporate tax avoidance. The OECD released
its final recommendations in October 2015 and the recommendations were
approved by the G20 Finance Ministers on October 9, 2015, and by the
G20 Leaders on November 16, 2015.
In July 2013, the OECD released the G20/OECD Base Erosion and
Profit Shifting (``BEPS'') Action Plan, which provided for 15 actions
designed to reach consensus among members for recommended changes in
tax policy. The BEPS Action Plan included Action 13, ``Re-examine
Transfer Pricing Documentation,'' to develop rules to require
multinational companies (MNEs) ``to provide all relevant governments
with needed information on their global allocation of the income,
economic activity and taxes paid among countries according to a common
template.''
On October 5, 2015, the OECD released its final report on Action 13
(along with reports on all 15 BEPS Actions). The OECD identified Action
13 as one of the areas where all countries agreed to consistent
implementation. The Action 13 report was virtually identical to an
earlier draft (released in September 2015) and previously released
implementation guidance (released in February and June 2015). Action 13
adopts a three-tiered approach to achieve transfer pricing
documentation: a master file containing information to provide a
complete picture of the MNE's global operations, including an
organizational chart, consolidated financial statements, and analyses
of profit drivers, supply chains, intangibles, and financing; a local
file providing more detailed information relating to specific
intercompany transactions of the MNE group impacting the specific tax
jurisdiction; and a country-by-country report (CbCR) containing
aggregated financial and tax data by tax jurisdiction. According to the
OECD, the two documents that provide group-wide information--master
file and CbCR--are intended to provide governments with information
necessary to conduct high-level transfer pricing risk assessment.
The CbCR will only be required of multinational groups with annual
consolidated group revenue of at least 750 million Euro in the
immediately preceding year. The first CbCRs would be filed for tax
years beginning in 2016 with the tax residence country of the parent of
the MNE group (e.g., the United States for U.S. MNEs). Other countries
could obtain CbCRs through exchange of information processes under
bilateral treaties and tax information exchange agreements.
In order to obtain CbCRs, countries must agree to certain
conditions related to confidentiality, consistency and appropriate use
of the information. In this document, appropriate use is defined as
``assessing high level transfer pricing risk'' and ``other BEPS-related
risks.'' If the tax residence country of the parent company does not
collect CbCRs, or has not agreed to provide CbCRs via information
exchange, then other countries would be authorized to collect CbCRs
directly from subsidiaries in their jurisdictions.
Action 13 includes model legislative language for adopting CbCR
requirements and model competent authority agreements for use by
governments to implement CbCR exchange. It also provides a detailed
framework for confidentiality and data safeguards that need to be in
place for countries to receive the CbCR through information exchange.
Under Action 13, the master file and the local file would be
collected directly by each local jurisdiction in which the MNE conducts
business. Confidentiality, consistency, and appropriate use standards
that apply to the CbCR do not explicitly apply to the master file or
local file, although participating countries have agreed that the
confidentiality and consistent use standards associated with transfer
pricing documentation generally ``should be taken into account.''
potential impact of the cbcr and master file requirements
The CbCRs on a company's financial and tax data that companies file
with their own country could impose a significant, additional
administrative burden on companies. These reports however, would be
submitted to foreign countries under bilateral treaties and information
exchange agreements and thus have protections to ensure
confidentiality, consistency and appropriate use of the information by
foreign countries.
Unfortunately, this would not be the case with the master file,
which could be required directly by any country where a company does
business. The master file asks for extremely sensitive information
unrelated to actual taxpayer activities in the country requesting the
information. In this way, the master file is similar to the CbCR.
However, unlike the CbCR, the master file information does not have the
confidentiality protections of the information exchange process and is
not subject to any confidentiality, consistency, or appropriate use
conditions beyond those that may apply locally.
If a country fails to abide by these conditions with respect to the
CbCR, Treasury has stated its intent to suspend CbCR information
exchange. To the extent this threat is effective in ensuring that other
countries maintain confidentiality of CbCRs of U.S. MNEs, it is
irrelevant to the master file, which is arguably more intrusive. With
respect to maintaining confidentiality of the master file, U.S. MNEs
are at the mercy of foreign governments.
Manufacturers are concerned that the master file requirement would
force them to disclose an unprecedented amount of proprietary
information about their global operations to foreign governments. The
master file would include organizational charts, consolidated financial
statements and analyses of profit drivers, supply chains, intangibles,
and financing. In short, it would provide a comprehensive plan that
includes every aspect of a company's worldwide business.
While a small amount of the required information in the master file
may be contained in public filings with the Securities and Exchange
Commission (SEC), most of the required information is descriptive in
nature and even publicly traded companies will need substantial input
from across the business enterprise to recompose the data. Information
about global supply chains, for example, can be considered sensitive
commercial information that, if disclosed, would be of high value to
the MNE's market competitors. For privately held companies, the
requirements to include a global organizational chart and consolidated
financial statements would constitute an unprecedented level of
disclosure to foreign governments. Disclosure, misappropriation, or
inappropriate use of this information could be extremely detrimental to
the ability of U.S. manufacturers to create value in the United States
and global marketplaces.
The fact that taxpayers may have some level of control over what
information is included in the master file does little to address
confidentiality concerns since it is unclear how much flexibility
taxpayers have to exclude sensitive information.
In the Action 13 report, the OECD recommends taxpayers use a
``prudent business judgment'' standard to determine the ``appropriate
level of detail'' to be included in the master file. Information that
is ``important,'' however, cannot be omitted. The OECD considers
information to be important ``if its omission would affect the
reliability of the transfer pricing outcomes.''
Manufacturers believe that this standard provides little comfort
for taxpayers that want to omit sensitive information and avoid
penalties for failing to comply with the filing requirements. There is,
at best, a questionable nexus between the master file information and
transfer pricing outcomes within a particular country under the arm's
length standard, since that is the purpose of the local file. For
example, a taxpayer could reasonably take the position that omitting a
global organizational chart or consolidated financial statements would
not ``affect the reliability of the transfer pricing outcomes'' within
any particular jurisdiction, yet be concerned that such omissions would
constitute non-compliance.
addressing confidentiality concerns
Even though the BEPS recommendations were finalized this fall, the
NAM strongly believes that taxpayer confidentiality concerns can and
should be addressed during the BEPS implementation phase. Specifically,
we believe that Treasury should link master file information to its
agreements to provide the CbCR to other countries through information
exchange. Thus, we urge Congress to ensure that Treasury enters into
agreements with foreign countries specifying that:
Treasury agrees to provide CbCRs for U.S. MNEs only if U.S.
MNEs or their subsidiaries are not required to provide master file
information to the foreign country;
The foreign country agrees that it will not collect CbCRs from
U.S. MNEs or their subsidiaries; and
Treasury agrees to provide to the foreign country only the
master file information that a U.S. MNE chooses to file with its CbCR
in order to provide context for its CbCR data.
conclusion
NAM members recognize the crucial role tax policy plays in the
ability of businesses around the world to compete and grow, and we
support tax rules that are pro-growth, pro-competitiveness, fair,
clear, and predictable. In contrast, the proposed information sharing
and disclosure rules included in the BEPS recommendations described
above would impose new and unnecessary compliance costs on companies
and, in some cases, force disclosure of proprietary business
information, creating a new set of challenges for global companies.
In particular, the master file requirement would provide foreign
governments with a comprehensive roadmap detailing every aspect of a
company's worldwide business. Many manufacturers in the United States
with operations overseas would have to comply with this provision,
which represents an unacceptable and unprecedented expansion of
required proprietary data sharing and a very real competitive threat
for some of America's most innovative firms.
Manufacturers are particularly concerned about the lack of
safeguards to protect the confidentiality of this very sensitive
information in the master file. Unlike the CbCR, the master file is not
provided through information exchange and is not subject to any
confidentiality, consistency, or appropriate use conditions beyond
those that may apply in a local jurisdiction. If a country fails to
meet these conditions on CbCRs, Treasury can suspend the information
exchange. Unfortunately, this option does not apply to the master file
information, which is even more intrusive.
On a positive note, the United States has not announced plans to
collect the master file. We urge Treasury officials to go one step
further and only provide CbCRs to foreign countries that do not require
a master file. At a company's option, Treasury can provide any master
file information the company chooses to provide as context for its CbCR
data that is provided through information exchange.
When it comes to tax policy, manufacturers believe a fair and
transparent tax climate in the United States--including competitive
business tax rates and modern international tax rules--will boost
standards of living and economic growth worldwide. At the same time, an
appropriate balance needs to be struck between transparency and
confidentiality of the proprietary information that enables companies
to compete and prosper in a global economy.
______
Questions Submitted for the Record to Dorothy Coleman
Questions Submitted by Hon. Orrin G. Hatch
master file reporting and confidentiality
Question. There are concerns about taxpayer confidentiality in the
Master File reports. Treasury officials have suggested that those
concerns have been addressed because taxpayers have discretion over
what they put in the Master File.
But there must be some limits to that discretion, right? To what
extent will companies have discretion over what goes into the master
file? Foreign countries may very well ask for items that taxpayers will
wish to keep secret, right?
And what are other OECD countries thinking as to the amount of
discretion to be allowed here? What recourse does a company have if the
foreign tax authority disagrees with the company's judgment and demands
sensitive information on audit or imposes a fine for non-compliance?
Could a non-public company exclude from the master file
consolidated financial statements or a global organizational chart if
in its ``prudent business judgment'' that information goes beyond the
``appropriate level of detail'' and does not ``affect the reliability
of transfer pricing outcomes''?
The Treasury Department has indicated that other countries can
collect the Master File directly from multinational corporations,
rather than going through the more typical information exchange process
whereby foreign governments would ask the U.S. Government for such
Master Files on a given taxpayer.
What should the U.S. Government do if a foreign government fails to
keep a U.S. multinational corporation's master file confidential? Does
that heighten confidentiality concerns? Would there be greater
protection of U.S. taxpayer confidentiality if the U.S. Government were
the gatekeeper to this information?
Answer. Action 13 of the BEPS Final Report specifically requires
countries to adhere to certain confidentiality, consistency, and
appropriate use standards in order to obtain country-by-country reports
(CbCRs). In the case of the United States, the Treasury Department
plans to collect CbCRs from U.S. multinationals and transfer them to
other countries through treaty information exchange. Treasury officials
have stated that if a foreign tax authority does not comply with these
standards, they would suspend transmitting CbCRs to that tax authority.
Unfortunately, the master file, which individual countries will require
to be provided directly by companies, and would not be covered by the
confidentiality, consistency, and appropriate use standards that apply
to CbCRs. While countries have agreed that confidentiality ``should be
taken into account'' when it comes to the master file, there are
insufficient safeguards to protect against misuse of the information.
We believe that putting this information into the hands of foreign
tax authorities, without any clear safeguards to protect
confidentiality, could put critical commercial information at
substantial risk of public disclosure. At a time of widely reported
corporate espionage and high profile data hacks, there is no guarantee
that other countries would not inadvertently compromise companies'
information, a risk that U.S. businesses should not have to face.
Moreover, the EU has stated its ambitions to make CbCRs public. While
the information exchange process gives Treasury some leverage to
prevent that for U.S. multinationals, no such leverage exists under
current law with respect to master file information.
In addition, we disagree with any assertions that companies already
include the master file information in filings with the U.S. Securities
and Exchange Commission (SEC). Obviously, private companies do not file
with the SEC. Thus, requirements to provide foreign tax authorities
with a global organizational chart and consolidated financial
statements constitute an unprecedented level of disclosure to foreign
governments.
The master file also presents problems for publicly traded
companies. Since most of the required information is descriptive in
nature, it will have to be compiled with substantial input from across
the multinational enterprise (MNE) group and some of the information
could be considered confidential or proprietary. For example,
information about global supply chains could well be considered
sensitive commercial information that, if disclosed, would be of high
value to the MNE's market competitors, which could include state-owned
enterprises.
Moreover, even if there are individual pieces of information that,
taken alone, may not be sensitive, the master file requires companies
to pull it all together as a ``blueprint of the MNE group.'' Such a
``blueprint'' could reveal competitively important strategic
information that would be valuable to competitors. We also believe
that, like the CbCR, the global nature of information required in the
master file will lead to more aggressive foreign audits and tax
assessments that are inconsistent with international tax norms, and
U.S. MNEs are likely to be the primary targets.
Before the BEPS recommendations were approved, companies had the
ability to push back on specific information requested by a foreign tax
authority during an audit. This is particularly true with respect to
global information that has little or no connection with a MNE's
operations within a particular country. Before Action 13, this type of
global information was generally available only through treaty-based
information exchange, and the U.S. competent authority would require
the foreign tax authority to demonstrate a clear linkage to a tax
determination. Action 13, however makes local filing of master file
information part of the international standard, making it much more
difficult for U.S. companies to push back on specific information
requests.
On numerous occasions, Treasury officials have taken the position
that since taxpayers have control over what they include in the master
file, confidentiality concerns are manageable. In reality however, the
fact that taxpayers have some level of control over what information is
included in the master file does little to address confidentiality
concerns because, as noted above, it is not clear how much flexibility
taxpayers have to exclude sensitive information.
The ``prudent business judgment'' standard that the Action 13
report recommends taxpayers use to determine the level of information
to include in the master file is vague and subjective, and provides
little comfort for taxpayers that wish to omit sensitive information
and avoid penalties. For example, a taxpayer could reasonably take the
position that omitting a global organizational chart or consolidated
financial statements would not ``affect the reliability of the transfer
pricing outcomes'' within any particular jurisdiction, yet be concerned
that such omissions would constitute non-compliance.
Some Treasury officials and commentators also have suggested that
the master file requirement benefits taxpayers because it allows them
to put their CbCR data into a narrative context. If this is the case,
the master file itself, and the information included, should be
optional and part of the CbCR filing to allow companies that want to
provide more context for the financial information in the CbCR can do
so with the confidentiality protections that come with treaty-based
information exchange provided for the CbCR.
The NAM supports legislation--the Bad Exchange Prevention (BEPS)
Act (H.R. 4297)--introduced late last year by Rep. Charles Boustany (R-
LA) that addresses many of NAM's concerns outlined above. Specifically,
H.R. 4297 clearly describes potential abuses of the master file
requirements and requires the Federal Government to withhold CbCRs from
countries abusing master file documentation requirements or failing to
keep master file information confidential. Abuses of the master file
requirement include requesting trade secrets, group consolidated
financial statements not filed with the SEC, certain attorney-client
privileged information, and other information that Treasury determines
to be inappropriate. Thus, H.R. 4297 provides Treasury and taxpayers
with the same leverage for master file information that now exists for
CbCRs--suspension of CbCR exchange. This helps ensure that the Federal
Government will protect U.S. businesses from being forced to disclose
sensitive and confidential taxpayer information to foreign tax
authorities as part of their implementation of Action 13.
country-by-country reports
Question. Does the Treasury Department have the authority to issue
regulations as called for by the BEPS reports as to country-by-country
reporting? If so, how will the country-by-country reports assist the
U.S. Government in the collection of U.S. income taxes?
Answer. While manufacturers recognize that there is a compliance
burden associated with the CbCRs, we support efforts by the Internal
Revenue Service (IRS) and Treasury to issue CbCR guidance so U.S. MNEs
can file once with the IRS and have their information confidentially
exchanged via tax treaty or tax information exchange agreements with
countries that agree with these confidentiality protections. Other
countries already have announced that they will require CbCRs and our
members have some level of comfort in exchanging information under a
standard process that offers data protection. Moreover, if the United
States does not collect and remit CbCRs, other countries may require
local subsidiaries of U.S. MNEs to file a CbCR in a much less
controlled and confidential manner under the ``secondary mechanism''
laid out in the BEPS report. This approach would be more costly for
U.S. MNEs and provide less protection for confidential taxpayer
information than if the IRS requires CbC reporting.
______
Questions Submitted by Hon. Dean Heller
Question. I strongly believe that tax reform, done the right way,
can improve our fiscal picture. That said, without comprehensive tax
reform, we are left with a crumbling tax code that negatively impacts
our American and Nevadan businesses, while our other OECD partners are
lowering their corporate tax rates and expanding their tax base. I am
deeply concerned that U.S. multinational companies are being targeted
and that the administration is not taking steps to defend our U.S.
businesses.
Answer. The NAM strongly agrees with you on the need for
comprehensive tax reform. NAM members know firsthand that our current
tax system is fundamentally flawed and discourages economic growth and
U.S. competitiveness. Indeed, a key objective for the association is to
create a national tax climate that promotes manufacturing in America
and enhances the global competitiveness of manufacturers in the United
States. To achieve these goals, we need a comprehensive tax reform plan
that both reduces the corporate tax rate to 25 percent or lower and
includes lower rates for the nearly two-thirds of manufacturers
organized as flow-through entities. We also believe that comprehensive
tax reform must include a shift from the current worldwide system of
taxation to a modern and competitive international tax system, a
permanent and strengthened research and experimentation (R&E) incentive
and a strong capital cost-recovery system.
We also feel that while enactment of a pro-growth tax reform plan
will strengthen our economy and ensure vibrant economic growth in the
future, our economy is suffering because of inaction on tax reform. A
Missed Opportunity: the Economic Cost of Delaying Pro-Business Tax
Reform, a study released by the NAM in January 2015, takes a close look
at the economic impact of enacting a five-prong pro-business tax
package similar to NAM's priorities and concludes that lack of action
on pro-business tax reform is costing the U.S. economy in terms of
slower growth in Gross Domestic Product (GDP), investment and
employment. In contrast, the report finds that over a 10-year period, a
pro-business tax plan would increase GDP over $12 trillion relative to
CBO projections, increase investment by over $3.3 trillion and add over
6.5 million jobs to the U.S. economy.
Question. As you know, the OECD BEPS plan generally can't force
member governments to do anything they don't want to do. Does BEPS
strengthen the EU Commission's hand by providing political cover?
Answer. Yes. From our perspective, the European Commission (EC)
appears very committed to the BEPS recommendations. Based on recent
news reports, the EC later this month is expected to issue a proposal
that will require countries in the European Union (EU) to adopt the
BEPS proposals as legislation. According to a top EC official, the EU
could adopt the BEPS recommendations by June 2016. The NAM is extremely
concerned that adoption of these recommendations by the EU will force
U.S. companies to hand over a significant amount of detailed and, in
some cases, confidential business information to foreign tax
authorities without safeguards to protect confidentiality or misuse of
the information. We also believe that the type of amount of information
required under the BEPS recommendations will lead to more aggressive
foreign audits and tax assessments, particularly of U.S. multinational
companies.
Question. I am deeply concerned with recent reports, as I am sure
you are, that these EU state aid cases will lead to retroactive foreign
tax increases on U.S. companies. Does it make sense that if the
Commission finds that a country has violated its obligations to the EU
that the company should be held liable retroactively?
Answer. The NAM shares your concerns and those expressed by
Treasury at the hearing about the continuing EU ``state aid'' cases
involving the ex post facto and novel application of non-tax European
law to effectuate tax policy changes that lead to retroactive taxation.
It is a long-standing position of the NAM that the retroactive
imposition or increase of taxes is fundamentally unsound, unfair and
punitive.
Question. As you may know, this committee is dedicated to
overhauling the tax code. Earlier this year the committee held tax
reform hearings analyzing simplicity, fairness, growth and
international competitiveness. As this committee discusses overhauling
the tax code, including international tax reform, what is the single
biggest element that lawmakers can implement to promote pro-growth
international competiveness?
Answer. Manufacturers believe that the OECD's focus on global
profit shifting highlights the critical need for a comprehensive
overhaul of the U.S. tax system to reflect the global marketplace of
the 21st century. Indeed, policy makers in the United States should
focus on the underlying problems of the U.S. business tax system--the
high business tax rates and the double tax burden faced by U.S. global
manufacturers and other U.S. multinationals because of our outdated
worldwide tax system. Most of our competitor nations--including most of
the countries that participated in the BEPS project--have much lower
rates and territorial tax systems that only tax income earned within
their borders. Consequently, in order to spur economic growth--and
additional revenues for Treasury--the focus should be on reforming our
outdated tax code by lowering business tax rates and adopting
competitive international tax rules. In sum, we need a competitive tax
system that makes the U.S. the best place in the world to manufacture
and attract foreign direct investment.
Question. I am here to help. How can Congress protect U.S.
businesses from being targeted by foreign governments?
Answer. In addition to advancing pro-growth tax-reform as described
above, Senate action on pending tax treaties could be very helpful in
protecting U.S. businesses from being targeted by foreign governments.
Income tax treaties play a critical role in promoting U.S. bilateral
trade and investment. In particular, globally competitive tax treaties
protect U.S. businesses from double taxation of income earned overseas
and reduce U.S. withholding taxes thus encouraging foreign companies to
invest in the United States. The NAM supports inclusion in tax treaties
dispute resolution procedures for U.S. taxpayers, treaty-partner
taxpayers, and the U.S. and foreign taxing authorities to resolve
disagreements and to assist in the enforcement of individual countries'
tax laws. Unfortunately, no treaties or protocols have been approved
since 2010. Currently, treaties with Chile, Switzerland, Hungary,
Poland, Luxembourg, and Spain and a protocol to amend a multilateral
convention, all are pending in the Senate.
______
Questions Submitted by Hon. Michael B. Enzi
Question. The EU state aid cases are targeting multinationals--
predominantly U.S. multinationals. Based on its announcement of the
first two decisions last month, the Commission believes the
investigated countries are providing multinationals unfair competitive
advantages over smaller domestic competitors through tax rulings that
``do not reflect economic reality.'' We haven't seen the legal analysis
of these cases yet, but if these are the standards that are being
applied, do you agree that the decisions should not produce results
that actually disadvantage integrated multinationals and that do
reflect economic reality?
Answer. While the NAM has not been involved in any specific case,
we share Treasury's concerns expressed at the hearing about the
continuing EU ``state aid'' cases involving ex post facto and novel
application of non-tax European law to effectuate tax policy changes
that lead to retroactive taxation. It is a long-standing position of
the NAM that the retroactive imposition or increase of taxes is
fundamentally unsound, unfair and punitive.
Question. Isn't the arm's length principle the internationally
accepted mechanism that strikes that balance?
Answer. Manufacturers strongly believe that the current arm's
length standard--embodied in U.S. tax law and tax treaties--is the
appropriate standard for transfer pricing that is designed to, as you
put it in your question, ``reflect economic reality'' of intercompany
transactions. Basing intercompany pricing on what unrelated third
parties would do under the same or similar circumstances is a
fundamental principle of tax policy. The arm's length standard has
been, and remains, conceptually sound, relevant and reliable in
addressing related party transactions.
Transfer pricing transactions involve at least two jurisdictions
and the arm's length standard recognizes the natural ``tension'' when
each jurisdiction is interested in maximizing revenue and discouraging
``leakage'' from its tax base. In addition, a system of ``advance
pricing agreements,'' a mechanism whereby governments agree to pricing
arrangements in advance, provides certainty both to the governments and
taxpayers. The arm's length standard has been adopted by the
Organisation for Economic Co-operation and Development (OECD) and is
used by every major industrial nation. We would note that in announcing
its appeal of the European Commission's state aid decision in the
Netherlands/Starbucks case, the Dutch Minister of Finance said, ``the
Commission applies its own new criterion for profit calculation, which
is incompatible with domestic regulations and the OECD framework.''
Moreover, there is a well-developed body of law and regulatory
guidance on the standard in the United States. For example, over the
years, Treasury has issued numerous regulations and other guidance on
issues involving transfers of intangible assets, including inventions,
scientific discoveries, patents, designs, trademarks, brand names, and
copyrights. In addition, the Internal Revenue Service (IRS) has broad
authority to audit intercompany transactions and change the results
reported on tax returns, even absent intent to evade or avoid taxes.
Question. Regarding the EU state aid cases: What do these cases
mean for our ability to rely on bilateral tax treaties negotiated with
European countries if the European Commission can unilaterally change a
treaty partner's tax positions through enforcement of EU competition
policy?
Answer. The NAM shares Treasury's concerns expressed at the hearing
that the state aid cases potentially undermine U.S. rights under our
bilateral tax treaties with EU member states.
Question. Does the U.S. have any rights under the treaty to protect
U.S. tax interests while ensuring U.S. multinationals are not subject
to double taxation because of the EU state aid decisions?
Answer. See answer above.
Question. We've all heard how BEPS threatens the U.S. tax base
because its general policy objective is to align taxing rights with
value creating activities. While BEPS represents prospective tax policy
changes, and the U.S. at least had a seat at the table, the EU state
aid cases represent EU assertion of retroactive taxing rights over the
historical foreign earnings of U.S. multinationals, with the U.S.
Government unable to participate.
Do you view the EU state aid cases as an attempt by the EU to
unilaterally and retrospectively attack the ``stateless income'' issue
that the BEPS project was designed to address on a multilateral and
prospective basis?
Answer. The NAM shares Treasury's concerns expressed at the hearing
that, in substance, the state aid cases appear to reach results that
are inconsistent with the internationally accepted standards in place
at the time the income was earned.
Question. If the cases result in a single member state collecting
tax on virtually all of the income, without regard to the level of
economic activity within that state--wouldn't that actually contradict
the underlying premise of the BEPS project--to align taxing rights with
underlying value creating activity?
Answer.Yes, disregarding the level of economic activity within the
EU member state under investigation would seem to contradict the
underlying premise of BEPS to align taxing rights with underlying value
creating activity.
Question. With respect to income from intangible property, isn't it
true that a significant portion of this value-creating activity is
likely to have taken place in the U.S., giving the U.S. primary taxing
rights, on a deferred basis or otherwise?
Answer. We are not familiar enough with the cases to answer this
question.
______
Prepared Statement of Michael Danilack, Principal,
PricewaterhouseCoopers LLP
Chairman Hatch, Ranking Member Wyden, and distinguished members of
the committee, I appreciate the opportunity to appear this afternoon as
the committee considers the OECD's project on ``base erosion and profit
shifting'' and the European Commission's inquiries into ``State Aid.''
I'd like to compliment the Committee for holding today's hearing. The
subject is of considerable import to the U.S. tax base and tax
administration. In addition to having 20 years of experience with
various accounting and law firms advising businesses on tax matters,
from January 2010 until July of 2014, I had the honor of serving as the
Deputy Commissioner (International) in the Large Business and
International division at the Internal Revenue Service. In that
position, I was responsible for the IRS's international enforcement
programs and served as the U.S. competent authority under our bilateral
tax conventions. As competent authority, my team and I represented the
United States on all cross-border matters pertaining to dispute
resolution, treaty interpretation, and information exchange. From 1995
to 2000, I also had the honor of serving as the Associate Chief Counsel
(International) at the IRS, where my team and I were responsible for
all legal matters pertaining to U.S. international tax laws and tax
treaties. The effect of the BEPS project on tax administration will be
the focus of my testimony.
Currently, I am a tax Principal at PricewaterhouseCoopers LLP in
the firm's Washington National Tax Services practice. I appear here
today, however, on my own behalf and not on behalf of PwC or any client
of the firm. Therefore, the views that I express are entirely my own.
The subject of today's hearing--BEPS and State Aid--is both broad
and complex. The OECD BEPS project has called for numerous changes to
the laws and policies guiding the taxation of multinational businesses.
In my view, however, the most important effect of the BEPS project in
the near term is likely to be on international tax enforcement
activities around the world, and this, in turn, will create a serious
challenge for both U.S.-based multinational businesses and the U.S.
Government. Further, I believe this more practical impact on
international enforcement may well cause an erosion of the U.S. tax
base. I will focus my testimony on the reasons for this view.
Before I begin, I'd like to offer my compliments to Mr. Stack and
his team at the Treasury Department. The BEPS project seemed
threatening of U.S. interests from the start, and Mr. Stack's diligent
efforts to bring balance and wisdom to the project are greatly
appreciated.
I'll begin by observing that the scope of the BEPS project and the
timetable set for completing the work were extraordinarily ambitious.
In addition, the OECD invited participation by non-OECD member
countries that brought new points of view to the table. As a
consequence, it isn't surprising that the papers issued on October 5th
of this year do not reflect a true global consensus on many of the
difficult issues that were evaluated. The papers achieve consensus in
some respects by merely providing governments with options to address
the issues in question. In other respects, they draw conclusions based
on new concepts that are ambiguous and that could be read to mean any
number of things to countries seeking to enlarge their tax bases. In
still other respects, the work is unfinished. In addition, many of the
recommendations coming out of the project will need to be implemented
by each country through changes in law, regulations, or treaties, and
these haven't happened yet. So in important ways, we just don't know
what the new policies will be in each country. Despite its
accomplishments, the BEPS project has created significant ambiguities
and considerable uncertainty.
Creating uncertainty regarding how tax compliance will be measured
in a particular area is not necessarily a poor way for governments to
proceed if the effort is targeted at specific practices that clearly
should be ended. In other words, governments can and often do create
ambiguity about how a particular law will work going forward as a means
of addressing specific situations where the intent of current law is
clearly being circumvented. If BEPS were focused on ending a specific
kind of abusive tax planning, then perhaps the uncertainty the project
has created would be less objectionable, and companies would be advised
to react by moving out of the identified structures before the new
standards crystallize.
The problem, though, is that the October 5th papers are not aimed
at what might be fairly referred to as abusive. Rather, the papers will
have the effect of broadening the collective corporate tax base and
providing countries with new ways to claim a bigger share of that
corporate base. The papers also break down the previously accepted view
that each corporate entity in an affiliated multinational group should
be regarded as a separate taxpayer that is taxed based on the risks it
takes, the assets it owns, and the functions it performs. In this
regard, the papers edge toward the concept that a multinational group
should be viewed as an integrated whole. The risk is that the
multinational group's profits will be divided among the countries in
which it conducts business not based on the arm's-length principle that
has guided international taxation for decades, but based on what each
government perceives to be the value contributed by the part of the
enterprise operating within its borders.
I don't intend to explore these policy changes today. Rather, I
want to focus on the implications of setting forth broad and ambiguous
concepts without taking the time to work through the ambiguities, which
is essential to proper implementation and administration of the
concepts. In my estimation, it is inevitable that countries will begin
to assert these new concepts through enforcement actions, guided by
their own interpretations and with their own revenue collection
interests in mind. Indeed, this is already happening around the world.
I hear stories from clients about it nearly every day. Unlike IRS
agents, examining agents in other countries often are driven by
particular revenue collection metrics, and the BEPS project has for
them has established new goals. In the best of circumstances, it is a
challenge for taxing authorities to administer policy nuances and act
with caution when rules are unclear; and if examining agents are told
they're not collecting enough revenue, we should expect that they will
construe ambiguity in their own favor.
As a result, many are predicting that the BEPS project will lead to
far more aggressive tax enforcement efforts targeted at multinational
companies, many of which are headquartered in the United States.
Further, because the BEPS project provides concepts that can be used to
expand the revenue base of almost any country, the resulting threat is
widespread double taxation. Allow me to explain the double taxation
threat because it's critical. When an examining agent adjusts the
profits of a multinational business, the adjustment can, and often
does, mean the adjusted profits could be taxed twice--once by the
country making the adjustment and once by the country in which the
profits were originally reported. In my view, increased instances of
double, or even multiple, taxation is an unintended but very real
threat flowing from the BEPS reports.
The U.S. network of tax treaties is, of course, designed to
eliminate double taxation so as not to impede cross-border business,
and all countries agree that double taxation is wrong as matter of
policy. But when double taxation is created by one country's
enforcement action, it isn't automatically eliminated by a rule in a
treaty. Rather, the case is presented by the taxpayer to the designated
competent authorities of the two jurisdictions involved, and those
competent authorities seek to arrive at a principle-based settlement to
ensure that the profits of the business are taxed only once. But this
so-called mutual agreement procedure is far from easy to conduct. As I
mentioned at the outset, I had the honor to serve as the U.S. competent
authority for a number of years and feel the need to convey to this
body why I am so worried about the BEPS project from that perspective.
At the competent authority negotiating table, the country that
makes the adjustment has the greater leverage. That country is in a
position to enforce its determination at will, and in some cases the
tax has already been collected and the country can be quite reluctant
to negotiate in good faith. The other country--the one where the
profits were originally reported--can only attempt to convince the
adjusting country to withdraw or reduce the adjustment by pointing to
well-established international principles. This can be a difficult
under normal circumstances, but where the underlying principles are
unclear, the effort may well be a losing one.
If we were to roll back the clock to the 1990s, we would find that
the United States was the first, and for a while the only, country in
the world attempting to police income shifting through transfer pricing
audits. As a result, the cases in front of competent authorities at the
time were largely the result of IRS-proposed adjustments to increase
profits reported in the United States. Since then, the situation has
changed dramatically. When I left my position, in July of 2014, well
over 80 percent of the mutual agreement cases in inventory were the
result of foreign-initiated adjustments on U.S.-based companies; and
this, even though U.S. companies typically do not attempt to shift
profits to the United States from foreign countries where tax rates
generally are lower. Regardless, foreign tax authorities increasingly
have been seeking to tax profits reported and taxed in the United
States and it can be difficult for the U.S. competent authority to
convince the other government to accede to the taxpayer's reported
position--even by pointing to principles that are well-established. In
my estimation, in the post-BEPS world, this challenge will grow
exponentially. The risk is that, with ambiguous new principles,
governments will be even less willing to concede their adjustments
despite another government's objection.
In the near term, there is little that can be done to ameliorate
the enforcement problem I describe. Eliminating the ambiguities in the
BEPS papers will take a long period of time, and in the meantime, the
rhetoric that has driven the BEPS project will continue to affect how
taxing authorities administer the law. While there was a need to
examine the international rules to ensure consensus, I believe rhetoric
to the effect that governments must do something about BEPS quickly
negatively impacted the goal of achieving the consensus that is needed.
In the near term, experience suggests that what governments will do
quickly is seek to collect more revenue through enforcement actions
against foreign-based businesses. Without clear principles to guide
these enforcement actions, the result will be more disputes that will
be more difficult to resolve.
In the meantime, two things can be done. One is to ensure the IRS
competent authority is equipped to handle the increased challenges that
lie ahead. The second is to reform the U.S. international tax rules.
Making rapid changes in U.S. policy, however, will not, in my view,
reverse the enforcement problem. Lowering the U.S. corporate tax rate
and reforming our international system is critical. But even if such
changes are made, other taxing authorities will be looking to tax a
bigger share of a bigger pie, and that will not be stopped through U.S.
legislative change.
In summary, major multinational companies all around the world
likely will face the problems I am describing. While there seems to be
a target unfairly painted on the backs of U.S. companies, taxing
authorities will seek to tax a larger share of global profits by
pursuing what Senator Russell Long referred to as ``that fellow behind
the tree.'' That fellow will include foreign-based multinational
companies as well as those based here in the United States. There is,
however, an important difference between U.S. companies and foreign
companies in this respect. As we all know, the United States has a
worldwide system with credits provided for foreign taxes paid, not a
so-called ``exemption'' or ``territorial system.'' This means that we
allow a tax credit against U.S. taxes on income for foreign taxes
imposed on that same income, including those imposed through foreign
audits without a principled basis. So if the U.S. competent authority
does not have the resources to handle the tsunami of new double tax
cases predicted by many, or if the IRS cannot successfully convince
foreign governments that their adjustments are wrong by pointing to
well-established principles, U.S. companies generally won't bear the
resulting double taxation. Instead, companies will be entitled to take
a credit for the adjusted foreign taxes in the United States and the
U.S. tax base will be eroded as a result.
Chairman Hatch, Ranking Member Wyden, and other distinguished
members of the committee, I thank you again for the opportunity to be
here today, and I would be happy to answer any questions you may have.
______
Questions Submitted for the Record to Michael Danilack
Questions Submitted by Hon. Orrin G. Hatch
master file reporting and confidentiality
Question. There are concerns about taxpayer confidentiality in the
Master File reports. Treasury officials have suggested that those
concerns have been addressed because taxpayers have discretion over
what they put in the Master File.
But there must be some limits to that discretion, right? To what
extent will companies have discretion over what goes into the master
file? Foreign countries may very well ask for items that taxpayers will
wish to keep secret, right?
And what are other OECD countries thinking as to the amount of
discretion to be allowed here? What recourse does a company have if the
foreign tax authority disagrees with the company's judgment and demands
sensitive information on audit or imposes a fine for non-compliance?
Could a non-public company exclude from the master file consolidated
financial statements or a global organizational chart if in its
``prudent business judgment'' that information goes beyond the
``appropriate level of detail'' and does not ``affect the reliability
of transfer pricing outcomes''? The Treasury Department has indicated
that other countries can collect the Master File directly from
multinational corporations, rather than going through the more typical
information exchange process whereby foreign governments would ask the
U.S. Government for such Master Files on a given taxpayer.
Answer. What is to be included in a master file report and what
discretion a company will have in completing the report will be based
entirely on the laws and administrative practices adopted by each
country choosing to implement the requirement. In other words, the
requirements and how they are enforced will vary from country to
country, and possibly from situation to situation. Likely, some tax
authorities will be sensitive to the concerns of business and
circumspect about the information required, while others may make more
expansive requests.
Question. What should the U.S. Government do if a foreign
government fails to keep a U.S. multinational corporation's master file
confidential? Does that heighten confidentiality concerns? Would there
be greater protection of U.S. taxpayer confidentiality if the U.S.
Government were the gatekeeper to this information?
Answer. In general, if a foreign tax authority discloses a U.S.
company's tax information (whether master file information or other
information) in violation of its own confidentiality laws, the foreign
tax authority would not be accountable to the U.S. Government. If the
disclosure is by a U.S. treaty partner, however, the IRS would likely
take note of the violation, particularly if it reflects a systemic
problem, because its agreement to exchange tax information with any
foreign tax authority is premised on the country's laws and
administrative practices being adequate to safeguard all tax
information. Thus, any violation of a treaty partner's tax
confidentiality laws (whether with respect to master file reports or
otherwise) could cause the IRS to question the propriety of exchanging
tax information with the tax authority of that country.
If the disclosed information had been collected by the IRS and then
provided to the foreign tax authority under an exchange of information
provision (that is, if the IRS were a ``gatekeeper'' of the
information), the information would not be subject to any ``greater
protection'' legally speaking. The provisions of tax treaties and tax
information exchange agreements generally provide that information
exchanged is to be protected by the receiving tax administration in the
same manner as information collected directly by that tax
administration under its own laws. Thus, treaty exchange provisions do
not generally provide greater confidentiality protection to exchanged
information. Some heightened ``comfort'' may be achieved, however,
because a foreign tax authority may take more care with information it
receives from the IRS, either out of a general sense of duty or in
supposing the IRS will more likely call treaty exchange into question
if it provides the information that is inappropriately disclosed.
Further, the IRS may in fact be more watchful for, and sensitive about,
inappropriate disclosures of information it provides a foreign tax
authority than it may be about disclosures of confidential information
its treaty partner acquires elsewhere. In theory, however, the IRS
should be equally concerned about any violation of tax confidentiality
by its treaty partners.
country-by-country reporting
Question. Does the Treasury Department have the authority to issue
regulations as called for by the BEPS reports as to country-by-country
reporting? If so, how will the country-by-country reports assist the
U.S. Government in the collection of U.S. income taxes?
Answer. Statutory authority granted to the IRS to collect
information (whether under 6001, 6011, 6038, or 7602) is limited to
collections of information relevant to the determination of a U.S. tax
liability. Importantly, according to the preamble to the proposed
Treasury regulations requiring country-by-country reporting, the IRS
has concluded that the country-by-country reports it will collect from
U.S.-based multinational companies, as well as the country-by-country
reports it will receive from other governments in the exchange process,
``will assist in better enforcement of the Federal income tax laws by
providing the IRS with greater transparency regarding the operations
and tax positions taken by U.S. MNE groups.''
______
Questions Submitted by Hon. Dean Heller
Question. I strongly believe that tax reform, done the right way,
can improve our fiscal picture. That said, without comprehensive tax
reform, we are left with a crumbling tax code that negatively impacts
our American and Nevadan businesses, while our other OECD partners are
lowering their corporate tax rates and expanding their tax base. I am
deeply concerned that U.S. multinational companies are being targeted
and that the administration is not taking steps to defend our U.S.
businesses.
As you know, the OECD BEPS plan generally can't force member
governments to do anything they don't want to do. Does BEPS strengthen
the EU Commission's hand by providing political cover?
I am deeply concerned with recent reports, as I am sure you are,
that these EU state aid cases will lead to retroactive foreign tax
increases on U.S. companies. Does it make sense that if the Commission
finds that a country has violated its obligations to the EU that the
company should be held liable retroactively?
Answer. I have no views either on whether BEPS provides political
cover to the European Commission or on whether retroactive recoveries
following EU state aid determinations make sense. I will point out,
however, that if Congress is worried about retroactive taxation of U.S.
companies' offshore profits, EU state aid recoveries should not be the
only concern. The BEPS project outputs include vague new concepts that
provide tax administrations with discretion to ignore entities and
contracts in determining tax liabilities. Many U.S. companies are
experiencing audits by foreign tax authorities in which these vague
concepts are being applied for years past. The anti-BEPS rhetoric (that
tax planning is abusive and that multinational companies have not paid
a fair share) seemingly has encouraged tax authorities to apply these
vague new concepts retroactively. Thus, it is increasingly likely that
offshore profits will have already been taxed by foreign governments,
perhaps more than once, when repatriated to the United States.
Question. As you may know, this committee is dedicated to
overhauling the tax code. Earlier this year the committee held tax
reform hearings analyzing simplicity, fairness, growth and
international competitiveness. As this committee discusses overhauling
the tax code, including international tax reform, what is the single
biggest element that lawmakers can implement to promote pro-growth
international competiveness?
Answer. International tax reform will require that several complex
concepts be addressed carefully, but the ``single biggest element'' of
such reform, which is essential to promoting growth and international
competitiveness, is a substantially lower corporate tax rate.
Question. I am here to help. How can Congress protect U.S.
businesses from being targeted by foreign governments?
Answer. Establishing U.S. tax relevance of information to be
collected by the IRS is particularly important when the information is
located offshore. The courts have established that, under principles of
international law, the IRS has the authority to collect information
located offshore, but only if it clearly identifies its tax purpose and
the information is clearly relevant to that purpose. Presumably due to
this sensitivity about offshore information, Congress granted special
authority to the IRS, in section 6038 of the Internal Revenue Code, to
collect particular offshore information needed to determine a U.S.
person's liability under subpart F of the Code. Country-by-country
information is not expressly covered by section 6038 itself. Treasury,
however, was granted authority in section 6038(a)(1) to require other
information that is ``similar or related in nature'' to the information
listed in section 6038 or which the Secretary determines to be
appropriate to carry out the provisions of the Internal Revenue Code.
______
Questions Submitted by Hon. Michael B. Enzi
Question. The EU state aid cases are targeting multinationals--
predominantly U.S. multinationals. Based on its announcement of the
first two decisions last month, the Commission believes the
investigated countries as providing multinationals unfair competitive
advantages over smaller domestic competitors through tax rulings that
``do not reflect economic reality.'' We haven't seen the legal analysis
of these cases yet, but if these are the standards that are being
applied, do you agree that the decisions should not produce results
that actually disadvantage integrated multinationals and that do
reflect economic reality?
Isn't the arm's length principle the internationally accepted
mechanism that strikes thatbalance?
Question. Regarding the EU state aid cases: What do these cases
mean for our ability to rely on bilateral tax treaties negotiated with
European countries if the European Commission can unilaterally change a
treaty partner's tax positions through enforcement of EU competition
policy?
Does the U.S. have any rights under the treaty to protect U.S. tax
interests while ensuring U.S. multinationals are not subject to double
taxation because of the EU state aid decisions?
Question. We've all heard how BEPS threatens the U.S. tax base
because its general policy objective is to align taxing rights with
value-creating activities. While BEPS represents prospective tax policy
changes, and the U.S. at least had a seat at the table, the EU state
aid cases represent EU assertion of retroactive taxing rights over the
historical foreign earnings of U.S. multinationals, with the U.S.
government unable to participate.
Do you view the EU state aid cases as an attempt by the EU to
unilaterally and retrospectively attack the ``stateless income'' issue
that the BEPS project was designed to address on a multilateral and
prospective basis?
If the cases result in a single member state collecting tax on
virtually all of the income, without regard to the level of economic
activity within that state, wouldn't that actually contradict the
underlying premise of the BEPS project--to align taxing rights with
underlying value-creating activity?
With respect to income from intangible property, isn't it true that
a significant portion of this value-creating activity is likely to have
taken place in the U.S., giving the U.S. primary taxing rights, on a
deferred basis or otherwise?
Answer. I am neither expert in EU competition law nor knowledgeable
about the particular state aid cases pending at this time. Therefore, I
have no responses to offer to Senator Enzi's questions above.
______
Prepared Statement of Hon. Orrin G. Hatch,
a U.S. Senator From Utah
WASHINGTON--Senate Finance Committee Chairman Orrin Hatch (R-Utah)
today delivered the following opening statement at a committee hearing
examining the Organisation for Economic Co-operation and Development's
(OECD) Base Erosion and Profit Shifting (BEPS) reports, and the
European Union's (EU) State Aid investigations regarding member-
countries' tax rulings:
I want to welcome everyone here this morning and thank you all for
attending this important hearing on international taxation, focusing
particularly on the Organisation for Economic Co-operation and
Development, or OECD's, project on base erosion and profit shifting, or
BEPS.
The overall discussion about international tax is very timely.
Just a couple of weeks ago, we were informed that a major American
pharmaceutical company had decided to invert--merging with another drug
company, with the headquarters of the newly-formed corporation to be
located in a foreign country.
Of course, this is nothing new. We've been seeing these types of
transactions take place for some time.
Inversions like these are some of the clearest examples of base
erosion and are largely motivated by tax considerations, as American
companies determine that they can reduce their overall operating costs
if they become foreign corporations. Given the burdensome and anti-
competitive nature of the U.S. tax code, these companies are,
unfortunately, not acting irrationally.
The administration's response to the wave of inversions has, in my
opinion, been short-sighted, focusing only on the symptoms rather than
the underlying illness. While the latest proposed guidance from
Treasury might very well stem the tide of inversions, it will leave
other, potentially more harmful avenues for tax avoidance--like foreign
takeovers--wide open, and perhaps even make them more attractive.
Long story short, any steps we take to address inversions should
focus on fixing the shortcomings of the underlying system and make the
U.S. a better place for companies to do business.
The BEPS project is another effort aimed at addressing
international tax problems and base erosion, but on a more global
scale. The purpose of the project was to provide OECD member countries
with recommendations for both domestic tax policy changes and
amendments to existing tax treaties to address business practices that
result in base erosion. After several years of discussion, the OECD
released its final reports earlier this year and, last month, leaders
from the G20 countries endorsed the recommendations.
Throughout this process, we have heard concerns from large sectors
of the business community that the BEPS project could be used to
further undermine our nation's competitiveness and to unfairly subject
U.S. companies to greater tax liabilities abroad. Companies have also
been concerned about various reporting requirements that could impose
significant compliance costs on American businesses and force them to
share highly sensitive proprietary information with foreign
governments.
I expect that we'll hear about these concerns from the business
community and others during today's hearing.
In addition, throughout the BEPS negotiations, I urged the Obama
administration to both acknowledge the limits of their authority under
the law and to cooperate with Congress on any and all efforts to
implement the recommendations. While the U.S. was a party to the BEPS
negotiations, Congress had neither a seat at the negotiating table nor
a meaningful opportunity to weigh in with the administration on the
substance of the proposals.
However, it is Congress--and Congress alone--that has the ultimate
authority to make changes to the U.S. tax code. While the Treasury
Department does have broad regulatory authority under the law, that
power is not without limits. Even in those areas where authority
clearly exists for the administration to promulgate regulations, it is
virtually always better if Congress is viewed as a partner in this
process rather than an adversary. And, in those instances where the
regulatory authority is less clear, congressional involvement and
approval is even more important to ensure that policy changes are
viewed by the public as legitimate.
Of course, most of this should go without saying. It is, after all,
a basic lesson in government, and I don't think anyone here is in need
of a civics refresher from me.
However, I think it also goes without saying that the current
administration hasn't always viewed Congress as a necessary or even
important part of its efforts to develop and implement policy changes.
So, I think it is, at the very least, helpful to offer a brief reminder
to everyone that Congress has a role to play on these issues that
cannot be overlooked.
That's another set of concerns that I expect we'll discuss during
this hearing. We have a representative from Treasury here today--so,
I'm looking forward to getting a better sense of what elements of the
BEPS recommendations the administration believes it can implement
unilaterally and where they believe congressional action will be
necessary.
I also want to note that I have asked the Government Accountability
Office to provide its own analysis on the BEPS recommendations, taking
into account all of the complex elements--both domestic and global--
that are implicated with these types of policy changes. I expect their
work will take some time, but gathering this type of information is, in
my view, an essential part of our overall evaluation of the BEPS
project.
There are other topics that I expect will come up today, including
a discussion of so-called ``state aid'' remedies and recent activities
in the eurozone that, to me, look like attempts to impose retroactive
taxation on multinational enterprises, including a number of U.S.-based
companies.
Speaking more broadly, I just want to say that, when it comes to
international tax issues, I hope we all have the same goals in mind.
I would hope that we all want to improve conditions for American
businesses.
I would hope that we all want to make our country more competitive
on the world stage.
And, to that end, I would hope that we all want to improve the
overall health of the U.S. economy. That's why all of us are here
today, or at least it should be.
Any regulations promulgated by the administration to prevent
businesses from moving offshore should have these goals in mind.
At the same time, while international efforts to align tax systems
are worth exploring, we shouldn't be negotiating agreements that
undermine our own interests for the sake of some supposedly higher or
nobler cause. The interests of the United States--our own economy, our
own workers, and our own job creators--should be our sole focus.
So, throughout today's discussion--whether we're talking about
BEPS, inversions, or any other international tax issues--I am most
interested in hearing views as to how various policies and proposals
will or will not serve our Nation's interests and advance these
important goals.
Long story short, we have quite a bit to talk about today. And, we
have a distinguished panel of witnesses who should be able to shed some
light on these complicated issues. I look forward to their testimony.
______
Prepared Statement of Robert B. Stack, Deputy Assistant Secretary for
International Tax Affairs, Department of the Treasury
Chairman Hatch, Ranking Member Wyden, and distinguished members of
the committee, I appreciate the opportunity to appear today to discuss
some key international tax issues, including the recently completed
G20/Organisation for Economic Co-operation and Development (OECD) Base
Erosion and Profit Shifting (BEPS) project. We appreciate the
committee's interest in these important issues.
I would like to begin by describing the outcome of the G20/OECD
BEPS project, and then describe the expected BEPS follow-on work. I
will then link that discussion to a consideration of the need for
general corporate and international tax reform, as well as the related
need to address U.S.-base stripping and inversion transactions. I will
close with a discussion of the European Commission's current state aid
investigation of multinational firms, including U.S. multinationals.
g20/oecd base erosion and profit shifting (beps) project
In June 2012, at the G20 Summit in Los Cabos, Mexico, the leaders
of the world's largest economies identified the ability of
multinational companies to reduce their tax bills by shifting income
into low- and no-tax jurisdictions as a significant global concern.
They instructed their governments to develop an action plan to address
these issues, which was endorsed by G20 leaders in September 2013 in
St. Petersburg. The OECD has hosted this process, but all G20
governments, some of which are not members of the OECD, had a role. The
G20/OECD BEPS Action Plan outlined 15 specific areas for further
examination. The results were delivered to Finance Ministers this
October in Lima, Peru, and to President Obama and other world leaders
at last month's G20 summit in Antalya, Turkey.
The United States has a great deal at stake in the BEPS project and
a strong interest in its success. Our active participation is crucial
to protecting our own tax base from erosion by multinational companies,
much of which occurs as a result of exploiting tax regime differences.
A key goal of BEPS is to identify those differences and write rules
that close loopholes. In addition, as the home of some of the world's
most successful and vibrant multinational firms, we have a stake in
ensuring that companies and countries face tax rules that are clear and
administrable and that companies can avoid unrelieved double taxation,
as well as expensive tax disputes. Both the United States and our
companies have a strong interest in access to robust dispute resolution
mechanisms around the world. In contrast, failure in the BEPS project
could well result in countries taking unilateral, inconsistent actions,
thereby increasing double taxation, the cost to the U.S. Treasury of
granting foreign tax credits, and the number and scale of tax disputes.
Indeed, notwithstanding the BEPS project, some countries have taken
unilateral action, and it is our hope that they will reconsider those
actions in the post-BEPS environment.
The principal target of the BEPS project was so-called ``stateless
income,'' basically very low- or non-taxed income within a
multinational group. The existence of large amounts of stateless income
in a time of global austerity has called into question the efficacy of
longstanding international tax rules. This issue is prominent in a
global economic environment in which superior returns can accrue to
intangibles that are easily located anywhere in the world and that
often result from intensive research and development activities that a
single multinational may conduct in many countries, or that result from
marketing intangibles that can be exploited in one country but owned
and financed from another country. Some countries with large markets
believe that some of these premium profits should be taxed in the
market country, whereas current international norms attribute those
profits to the places where the functions, assets, and risks of the
multinational firm are located--which are often not the market
countries. Finally, I would be remiss to not note that the ability of
U.S. multinationals to defer tax on large amounts of income in low- and
no-tax jurisdictions has fed the perception of tax avoidance by these
multinationals. This perception exists even though the U.S. would tax
that income upon repatriation to the U.S. parent firm--whether
voluntarily by the taxpayer, or through a deemed repatriation that
might occur as a part of tax reform.
The G20/OECD project produced a broad array of reports outlining
measures addressing stateless income ranging from revision of existing
standards to new minimum standards, as well as describing common
approaches, all of which are expected to facilitate the convergence of
national practices. All OECD and G20 countries have committed to
minimum standards in the areas of preventing treaty shopping, requiring
country-by-country reporting, fighting harmful tax practices, and
improving dispute resolution. In transfer pricing, existing standards
have been updated. With respect to recommendations on hybrid mismatch
arrangements and best practices on interest deductibility, countries
have agreed on a general tax policy direction. In these areas, we
expect that practices will converge over time through the
implementation of the agreed common approaches. In the United States,
most of the rules restricting the use of hybrid entities and hybrid
securities and the rules limiting excessive interest deductibility
would require congressional action, and the administration proposed new
policies along these lines in the FY 2016 Budget. Guidance based on
best practices will also support countries in the areas of disclosure
initiatives and controlled foreign company (CFC) legislation. Finally,
participants agreed to draft a multilateral instrument that countries
may use to implement the BEPS work on tax treaty issues.
I would like to highlight some of the more important outputs from
the BEPS project. Interest expense deductions are a major contributor
to the BEPS problem. The ability to achieve excessive interest
deductions, including those that finance the production of exempt or
deferred income, is best addressed in a coordinated manner. The BEPS
project has agreed on a best practice approach, which recommends that
countries provide two alternative caps on interest deductions from
which companies can choose. The first cap is a fixed ratio, which is
similar to the rules under current U.S. law and looks at the ratio of
interest expense to earnings before interest, taxes, depreciation and
amortization, also known as EBITDA. The BEPS 2015 Final Report
recommends that countries adopt a fixed ratio for allowable interest
deductions within a range of 10 percent to 30 percent of EBITDA
(current U.S. law allows up to 50 percent). The report also recommends
that countries adopt as an alternative cap a group ratio based on
earnings. Under this cap, each entity in a multinational group could
deduct interest up to its allocable portion of the group's third party
interest expense, which would be determined based on the entity's
proportionate share of the group's worldwide earnings. This rule is
based on the premise that multinational groups should be able to deduct
interest up to their group-wide third party interest expense. The
combination of this rule with a low fixed ratio also would ensure that
groups would not be able to use related party loans to deduct interest
expenses well in excess of the group's third party interest expense. As
discussed below, the President's FY 2015 and FY 2016 Budget have
included a proposal that is in line with this recommendation.
The OECD has agreed on hybrid entity and hybrid security best
practices that target a ``deduction/no inclusion'' situation (i.e., a
tax deduction in one country without an income inclusion in the other
country) and a double deduction situation (i.e., tax deductions taken
in more than one jurisdiction for the same item). In the case of the
``deduction/no inclusion'' scenarios, these recommendations would
require Congressional action, and are broadly consistent with rules
proposed in the President's FY 2015 and FY 2016 Budget The
recommendations addressing double deductions are modeled after existing
U.S. rules. Importantly, the OECD approach to this action item is to
neutralize the mismatch in tax outcomes, but not otherwise interfere
with the use of such arrangements so as to not adversely affect cross-
border trade and investment.
An agreement on a minimum standard to secure progress on dispute
resolution was reached to help ensure that cross-border tax disputes
between countries over the application of tax treaties are resolved in
a more effective and timely manner. The Forum on Tax Administration
(FTA), including all OECD and G20 countries along with other interested
countries and jurisdictions, will continue its efforts to improve
mutual agreement procedures (MAP) through its recently established MAP
Forum. This will require an assessment methodology to ensure the new
standard for timely resolution of disputes is met. In parallel, a large
group of countries is committed to move quickly towards mandatory
binding arbitration. It is expected that rapid implementation of this
commitment will be achieved through the inclusion of arbitration as an
optional provision in the multilateral instrument that would implement
the BEPS treaty-related measures.
Standardized country-by-country reporting and other documentation
requirements will give tax administrations a global picture of where
profits, tax, and economic activities of multinational enterprises are
reported, and the ability to use this information to assess various tax
compliance risks, so they can focus audit resources where they will be
most effective. Multinational Enterprises (MNEs) will report their
revenues, pre-tax profits, income tax paid and accrued, number of
employees, stated capital, retained earnings, and tangible assets in
each jurisdiction where they operate. The implementation package
provides guidance to ensure that information is provided to the tax
administration in a timely manner, that confidentiality is preserved,
and that the information is used appropriately. The filing requirement
will be on multinationals with annual consolidated group revenue equal
to or exceeding EUR 750 million, meaning this regime applies only to
the largest and most sophisticated entities.
The existing standards in the area of transfer pricing have been
clarified and strengthened as part of the BEPS project. Because the
transfer pricing work is based on the arm's length principle, it is
consistent with U.S. transfer pricing regulations under section 482. A
key element of the work relates to the arm's length return to so-called
``cash boxes,'' which would be entitled to no more than a risk-free
return if they are mere funders of activities performed by other group
members. The work on cash boxes is one aspect of new approaches to
risk, which generally provide that contractual allocations of risk are
respected only when the party contractually allocated risk has the
capacity to control the risk and the financial capacity to bear it. The
transfer pricing work also addresses specific issues relating to
controlled transactions involving intangibles, including providing a
special rule for hard-to-value intangibles akin to the U.S.
``commensurate with income'' standard.
Where do we go from here? Certain technical work remains for the
OECD in 2016 and beyond. More importantly, however, we believe the best
way to foster the
G20 goal of supporting global growth is to actively promote the
connection between foreign direct investment, growth, and efficient and
effective tax administrations. Too often countries fail to recognize
that strong civil institutions promote growth and investment. The OECD
is expected to present to the G20 a framework for moving forward at the
Finance Minister's meeting to be held in China in February 2016. We are
working hard to ensure that issues around effective and fair tax
administration are made part of the post-BEPS agenda.
international tax reform
The G20/OECD BEPS project shined a spotlight on so-called stateless
income, a phenomenon that is a byproduct of outdated tax rules. I would
like to outline the steps the United States could take today to reform
our own tax system to improve competitiveness, secure our tax base, and
reduce incentives for profit shifting by U.S. firms.
As the President has proposed, we should reform our business tax
system by reducing the corporate income tax rate and broadening the
base. It is frequently noted that the United States has a high
statutory corporate rate, but much lower effective tax rates. High
statutory rates encourage multinational firms to find ways to shift
profits, especially on intangible income, to other jurisdictions. So
lowering our statutory rate while broadening the base could help reduce
erosion of the U.S. base.
But it would only be a start, because even with lower rates U.S.
multinationals would continue to aggressively seek ways to lower their
tax bills by shifting income out of the United States since there will
always be jurisdictions with lower tax rates. We can, however, take
other steps.
First, the President's framework for business tax reform proposes a
minimum tax on foreign earnings that represent excess returns, which
typically arise from intangible assets. This would reduce the benefit
of income shifting and impose a brake on the international ``race to
the bottom'' in corporate tax rates. Other recent tax reform plans have
included similar proposals, which would improve on the current complex
international tax rules by requiring that companies pay a minimum rate
of tax (either to the United States or to a foreign jurisdiction) on
all foreign excess returns.
Second, as part of tax reform, we should also take a close look at
interest deductibility, noting that our thin capitalization rules are
inadequate and that our system actually gives an advantage to foreign-
owned multinationals. These foreign-owned multinationals can lend funds
to their U.S. subsidiary to benefit from interest deductions against a
35 percent tax rate, while the related interest income is subject to
significantly lower tax rates, or no tax at all, in the lending
jurisdiction. It is especially disconcerting to observe that among the
foreign multinationals that most aggressively take advantage of this
strategy are so-called ``inverted'' companies--that is, foreign-
parented companies that were previously U.S.-parented. The
administration's FY 2016 Budget proposes to level the playing field by
limiting the ability of U.S. subsidiaries of a foreign multinational to
claim interest deductions in the United States that greatly exceed
their proportionate share of the group's global interest expense.
Specifically, this proposal would limit a U.S. subsidiary's interest
expense deductions to the greater of 10 percent of the subsidiary's
EBITDA or the subsidiary's proportionate share of worldwide third-party
interest expense, determined based on the subsidiaries' share of the
multinational's worldwide earnings.
A related administration FY 2016 Budget proposal would limit a U.S.
multinational's ability to claim a U.S. deduction for interest expense
that is related to foreign subsidiary income. U.S. multinationals
typically borrow in the United States to benefit from interest
deductions against a 35 percent tax rate, but they then use the
borrowed cash throughout the multinational group, financing operations
that may not be subject to current U.S. tax. Indeed, we have recently
seen examples of U.S. multinationals borrowing in the United States--
rather than bringing back cash from offshore operations--to pay
dividends to their shareholders. The proposal would align the treatment
of interest expense deductions with the treatment of the income
supported by the proceeds of the borrowing.
In addressing stripping of the U.S. base, it is also important to
consider so-called ``hybrid arrangements,'' which allow U.S.
subsidiaries of foreign multinationals to claim U.S. deductions with
respect to payments to related foreign entities that do not result in a
corresponding income item in the foreign jurisdiction. These
arrangements produce stateless income and should be remedied. To
neutralize these arrangements, the administration's FY 2016 Budget
proposes to deny deductions for interest and royalty payments made to
related parties under certain circumstances involving hybrid
arrangements. For example, the proposal would deny a U.S. deduction
where a taxpayer makes an interest or royalty payment to a related
person and there is no corresponding inclusion in the payee's
jurisdiction.
Additionally, shifting intangibles outside the United States is a
key avenue through which U.S. base erosion occurs. The principal means
of shifting intangible income is to undervalue intangible property
transferred offshore or to take advantage of the uncertainty in the
scope of our definition of intangibles. Once this intellectual property
is located offshore, the income that it produces can accrue in low- or
no-tax jurisdictions. The administration's FY 2016 Budget contains a
number of proposals that would discourage the corporate tax base
erosion that occurs via intangibles transfers. In addition to our
proposal to impose a minimum tax on excess returns, the FY 2016 Budget
would explicitly provide that the definition of intangible property
includes items such as goodwill and going concern value and would also
clarify the valuation rules to address taxpayer arguments that certain
value may be transferred offshore without any U.S. tax charge. Another
proposal would update subpart F to currently tax certain highly mobile
income from digital goods and services.
corporate inversions
By lowering rates and reducing the ability of multinationals to
severely reduce their U.S. taxable income through outsized interest
deductions, the United States could go a long way towards reducing the
incentives that U.S. multinationals have to invert. Doing nothing and
letting our corporate tax base erode through inversions will worsen our
fiscal challenges over the coming years. Once companies undertake an
inversion transaction, there is a permanent loss to the U.S. income tax
base because it is unlikely that these companies will return their tax
residence to the United States.
An anti-inversion provision has been part of the Internal Revenue
Code since 2004, but experience has shown that this provision
insufficiently deters inversions. According to a 2014 Congressional
Research Service report, 47 U.S. corporations reincorporated overseas
through corporate inversions in the 10-year period ending July 2014.
This marked an increase from only 29 inversions in the prior 20 years.
More inversions have occurred since the CRS report and proposed
inversions are being reported in the media on a fairly regular basis.
Only legislation can decisively stop inversions. The administration
has been working with Congress for several years in an effort to reform
our business tax system, make it simpler and more pro-growth, and
remove the incentives that encourage companies to engage in inversions.
To reinforce the existing anti-inversion statute, the administration
has proposed in recent Budgets to broaden the scope of the statute to
prevent more inversion transactions. As amended by the proposal, the
statute would provide that, unless the inverted company has substantial
business activities in the country where it purports to have moved its
tax residence, the inverted company would continue to be treated as a
domestic corporation for U.S. Federal income tax purposes if either (i)
shareholder continuity in the inverted company after the transaction is
more than 50 percent, or (ii) the transaction involved the combination
of a larger U.S. entity with a smaller foreign entity and the group
maintains its corporate headquarters in the United States. This
strengthened anti-inversion statute is necessary to prevent a permanent
reduction in Federal corporate income tax revenues.
In the interim, it is Treasury's obligation to protect the tax
base, and we have repeatedly stated that we will use all of our
existing administrative tools to address this problem. In Notice 2014-
52, which was issued in September 2014, Treasury and the IRS took
several steps to address inversions. First, the notice announced rules
that would prevent inverted companies from accessing a foreign
subsidiary's earnings while deferring U.S. tax through the use of so-
called hopscotch loans (which are loans from a foreign subsidiary of
the former U.S. parent either to the new foreign parent or one of its
foreign affiliates). Second, the notice closed a loophole pursuant to
which an inverted company could restructure the group's ownership in
the foreign subsidiaries of the former U.S. parent and thereby access
earnings in those entities without incurring the U.S. tax that would
otherwise have been due. Third, the notice made it more difficult for
U.S. companies to invert by strengthening the requirement that the
former owners of a U.S. company own less than 80 percent of the new
combined entity.
A few weeks ago, Treasury and the IRS issued Notice 2015-79 to
further limit the ability of U.S. companies to invert and to reduce the
tax benefits of inversions. This most recent notice makes it more
difficult for U.S. companies to undertake a corporate inversion by (1)
limiting the ability of U.S. companies to combine with foreign entities
using a new foreign parent located in a ``third country;'' (2) limiting
the ability of U.S. companies to inflate the new foreign parent
corporation's size and therefore avoid the rule requiring minimum
ownership of the combined firm by the shareholders of the foreign
target entity; and (3) requiring the new foreign parent to be a tax
resident of the country where the foreign parent is created or
organized in order to take advantage of the substantial activity
exception that permits an inversion into a country in which the
inverted group has at least 25 percent of its worldwide business
activities. Additionally, the notice reduces the tax benefits of
inversions by limiting the ability of an inverted company to transfer
its foreign operations to the new foreign parent after an inversion
transaction.
Treasury will continue to examine additional ways to reduce the tax
benefits of inversions, including through limiting the ability of
inverted companies to strip earnings with intercompany debt. However,
only legislation can effectively address these issues. To this point,
we look forward to working with Congress in a bipartisan manner to
protect the U.S. tax base, to address the issue of corporate
inversions, and to reform our business tax system.
state aid investigation
In June 2014, the European Commission opened three in-depth
investigations to examine whether decisions by tax authorities in
Ireland, the Netherlands, and Luxembourg with regard to the corporate
income tax paid by Apple, Starbucks, and Fiat Finance and Trade,
respectively, complied with the EU rules on state aid. In October 2014,
the EU announced that it had also opened an in-depth investigation into
whether the decision by Luxembourg's tax authorities with regard to the
corporate income tax to be paid by Amazon complied with EU rules on
state aid. On October 21, 2015, the EU Commission announced its
conclusions that Luxembourg has granted selective tax advantages to
Fiat's financing company and the Netherlands has granted selective tax
advantages to Starbucks's coffee roasting company. Finally, press
reports have explained that tax rulings given to several other U.S.
companies are also being examined by the EU Commission. In the area of
state aid, as I understand it, the remedy is for the Commission to
require the member state to collect the amount of income tax that, in
the Commission's view, should have been imposed in the first place.
State aid rulings can go back and reexamine up to 10 years of prior
conduct.
Treasury has followed the state aid cases closely for a number of
reasons. First, we are concerned that the EU Commission appears to be
disproportionately targeting U.S. companies. Second, these actions
potentially undermine our rights under our tax treaties. The United
States has a network of income tax treaties with the member states and
has no income tax treaty with the EU because income tax is a matter of
member state competence under EU law. While these cases are being
billed as cases of illegal state subsidies under EU law (state aid), we
are concerned that the EU Commission is in effect telling member states
how they should have applied their own tax laws over a 10-year period.
Plainly, the assertion of such broad power with respect to an income
tax matter calls into question the finality of U.S. taxpayers' dealings
with member states, as well as the U.S. Government's treaties with
member states in the area of income taxation. Third, the EU Commission
is taking a novel approach to the state aid issue; yet, they have
chosen to apply this new approach retroactively rather than only
prospectively. While in the Starbucks case, the sums were relatively
modest (20 to 30 million Euros), they may be substantially larger--
perhaps in the billions--in other cases. The retroactive application of
a novel interpretation of EU law calls into question the basic fairness
of the proceedings. Fourth, while the IRS and Treasury have not yet
analyzed the equally novel foreign tax credit issues raised by these
cases, it is possible that the settlement payments ultimately could be
determined to give rise to creditable foreign taxes. If so, U.S.
taxpayers would wind up footing the bill for these state aid
settlements when the affected U.S. taxpayers either repatriate amounts
voluntarily or Congress requires a deemed repatriation as part of tax
reform (and less U.S. taxes are paid on the repatriated amounts as a
result of the higher creditable foreign income taxes).
Finally, and this relates to the EU's apparent substantive position
in these cases, we are greatly concerned that the EU Commission is
reaching out to tax income that no member state had the right to tax
under internationally accepted standards. Rather, from all appearances
they are seeking to tax the income of U.S. multinational enterprises
that, under current U.S. tax rules, is deferred until such time as the
amounts are repatriated to the United States. The mere fact that the
U.S. system has left these amounts untaxed until repatriated does not
provide under international tax standards a right for another
jurisdiction to tax those amounts. We will continue to monitor these
cases closely.
conclusion
Chairman Hatch, Ranking Member Wyden, and distinguished members of
the committee, let me conclude by thanking you for the opportunity to
appear before the committee to discuss the administration's work on
various international tax matters. We appreciate the committee's
continuing interest in the BEPS Project, international tax reform,
inversions, State Aid, and other matters. On behalf of the
administration, that concludes my testimony, and I would be happy to
answer any questions.
______
Questions Submitted for the Record to Robert B. Stack
Questions Submitted by Hon. Orrin G. Hatch
master file reporting and confidentiality
Question. There are concerns about taxpayer confidentiality in the
Master File reports. Treasury officials have suggested that those
concerns have been addressed because taxpayers have discretion over
what they put in the Master File.
But there must be some limits to that discretion, right? To what
extent will companies have discretion over what goes into the master
file? Foreign countries may very well ask for items that taxpayers will
wish to keep secret, right?
And what are other OECD countries thinking as to the amount of
discretion to be allowed here? What recourse does a company have if the
foreign tax authority disagrees with the company's judgment and demands
sensitive information on audit or imposes a fine for non-compliance?
Could a non-public company exclude from the master file
consolidated financial statements or a global organizational chart if
in its ``prudent business judgment'' that information goes beyond the
``appropriate level of detail'' and does not ``affect the reliability
of transfer pricing outcomes''?
The Treasury Department has indicated that other countries can
collect the Master File directly from multinational corporations,
rather than going through the more typical information exchange process
whereby foreign governments would ask the U.S. government for such
Master Files on a given taxpayer.
Answer. The purpose of the so-called ``master file'' is to provide
context to the more detailed information on the taxpayer, including
financial information, provided in the country-by-country (CbC) report
and the local file. Apart from specific documents requested as part of
the master file, such as consolidated financial statements and a global
organizational chart, taxpayers have complete discretion to provide
this important contextual information in the way that they think best.
We think that taxpayers are in the best position to balance the desire
to protect sensitive information with the need to provide relevant
information to tax authorities, and this concept lies at the heart of
the work. The BEPS report on transfer pricing documentation
specifically explains that ``taxpayers should use prudent business
judgment in determining the appropriate level of detail for the
information supplied, keeping in mind the objective of the master file
to provide tax administrations a high-level overview of the MNE's
(multinational enterprise's) global operations and policies.'' The
reference to ``prudent business judgment'' is intended to highlight to
taxpayers and to revenue authorities that this is inherently a cost/
benefit exercise: maintaining the balance between taxpayer compliance
burden and confidentiality concerns and the provision of truly useful
information. During the course of the work, Treasury representatives
focused on maintaining such a balance.
It should be noted that foreign countries have always had and
continue to have under their own domestic laws the ability to ask for
information from entities doing business in their country in order to
enforce their tax laws. Those countries also have had and will continue
to have the ability to impose fines on taxpayers who do not supply
requested information (presumably after the exhaustion of local
administrative and judicial processes). The master file component of
the new guidelines on transfer pricing documentation does not alter
those domestic laws, nor could it be expected to do so. The transfer
pricing documentation work, taken as a whole, had the goal of bringing
increased harmonization to transfer pricing documentation requirements
in order to improve the information collected and to minimize the
burden on business that would result if each country set its own
documentation requirements.
Question. What should the U.S. Government do if a foreign
government fails to keep a U.S. multinational corporation's master file
confidential?
Please explain the reason for that. Does that heighten
confidentiality concerns? Would there be greater protection of U.S.
taxpayer confidentiality if the U.S. Government were the gatekeeper to
this information?
Does the U.S. Government anticipate requiring foreign-based
multinational corporations to file a master-file report with the IRS?
Answer. The United States cannot prevent foreign governments from
requesting the master file information directly from subsidiaries of
U.S. multinational groups, a capability these governments have always
had. The work at the OECD was aimed at helping minimize burden on
taxpayers by achieving international agreement on a single uniform
document that would be acceptable to all participating G20/OECD
jurisdictions. If the U.S. had insisted that this information be
presented by U.S.-based firms first to the IRS and then shared via
treaties and tax information exchange agreements, it is not clear that
we would have achieved the goal of standardization and burden reduction
desired by U.S. taxpayers.
If a foreign government fails to protect the confidentiality of a
U.S. multinational group's master file, the U.S. Government may raise
that issue directly with the foreign government and take the issue into
account in its assessment of the suitability of the foreign country's
data-protection safeguards for country-by-country reporting and other
exchange-of-information programs.
At this time, the Treasury Department does not have plans to modify
existing U.S. transfer pricing documentation regulations applicable to
foreign-based multinational corporations, which request much of the
same information as the master file requests, but will consider doing
so in the course of our continuing evaluation of our regulations and
reporting requirements.
country-by-country reporting
Question. Does the Treasury Department have the authority to issue
regulations as called for by the BEPS reports as to country-by-country
reporting? If so, how will the country-by-country reports assist the
U.S. Government in the collection of U.S. income taxes?
Answer. The Treasury Department has authority under sections 6001,
6011, 6012, 6031, 6038, and 7805 of the Tax Code to issue final
regulations consistent with the proposed regulations published on
December 23, 2015. The information that would be provided under the
proposed regulations will assist in better enforcement of the Federal
income tax laws by providing the IRS with greater insight into the
operations and tax positions taken by U.S. multinational groups. In
particular, it is expected that the information will improve
transparency and help the IRS perform high-level transfer pricing risk
identification and assessment.
Question. Could you please tell us more about how the IRS will use
the information from the country-by-country reports? Specifically, does
Treasury plan on following the BEPS Action 13 report in terms of who
must file (i.e., those multinationals with group revenue in excess of
750 million euros) and the information that is to be included in the
report (i.e., income, taxes paid, etc.)? If not, what additions or
changes should taxpayers expect in terms of the reporting requirements?
Is Treasury considering making the reporting requirement effective
for taxable years beginning in 2016? If so, when would the reporting be
provided to the IRS and Treasury? By the extended due for the tax
return for the applicable tax year?
When would the first CbC reports be shared with foreign
governments?
Do Treasury and the IRS currently plan on requesting CbC reports
from foreign governments? What is the criteria that Treasury and the
IRS plan on utilizing in making the determination of what CbC reports
they want to obtain? Do Treasury and the IRS currently have a plan of
action for analyzing and utilizing the data they may obtain from CbC
reports?
It appears that Treasury agreed to provide foreign governments with
a significant amount of information on U.S. multinationals via the CbC
report, as well as agreeing to allow foreign governments to directly
obtain master file and local file information from local subsidiaries
of U.S. multinationals. What is Treasury getting in return,
particularly if it may not obtain master file or local file information
from local subsidiaries of foreign multinationals and if CbC reports
provided by foreign governments are not effectively utilized?
Answer. The Treasury Department issued proposed regulations to
implement country-by-country (CbC) reporting on December 23, 2015.
Those regulations do, in general, follow the BEPS Action 13 report in
terms of filing threshold and information included in the report.
Specifically, a U.S. MNE group does not have to file a CbC report if
the group has revenues of less than $850 million. The information to be
reported includes: (i) revenues generated from transactions with other
constituent entities of the U.S. MNE group; (ii) revenues not generated
from transactions with other constituent entities of the U.S. MNE
group; (iii) profit or loss before income tax; (iv) income tax paid on
a cash basis to all tax jurisdictions, including any taxes withheld on
payment received; (v) accrued tax expense recorded on taxable profits
or losses, reflecting only the operations in the relevant annual
accounting period and excluding deferred taxes or provisions for
uncertain tax positions; (vi) stated capital; (vii) accumulated
earnings; (viii) number of employees on a full-time equivalent basis;
and (ix) net book value of tangible assets other than cash or cash
equivalents.
The regulations incorporating the CbC reporting requirement are
proposed to be applicable to taxable years of ultimate parent entities
of U.S. MNE groups that begin on or after the date of publication of
the final regulations. As a practical matter, this will mean that for
most U.S. taxpayers the CbC reporting requirement will be effective for
taxable years beginning in 2017. The regulations require the CbC report
to be filed with the U.S. MNE group's tax return, on or before the
extended due date of that return.
CbC reports generally will be provided to foreign countries with
which the United States has a treaty or tax information exchange
agreement within 15 months of the end of the fiscal year to which the
CbC report relates. For example, a CbC report for the year ending on
December 31, 2017, will be filed with the U.S. corporate parent's tax
return on or before September 15, 2018 (the due date for returns with
extensions to file), and will be provided to foreign countries before
March 31, 2019. Likewise, foreign countries generally will provide
foreign CbC reports to the IRS within 15 months of the end of the
fiscal year to which the CbC report relates. Importantly, CbC reports
will only be provided to foreign countries in which one or more members
of the U.S. MNE group carry on a business that is subject to tax and
only if the foreign country has agreed to provide the United States
with CbC reports filed in that foreign country by foreign MNE groups
that have operations in the United States. Treasury plans to enter into
Competent Authority Arrangements that will require foreign countries
with which the United States has an exchange of information agreement
to automatically provide the IRS with CbC reports that are filed by all
foreign MNE groups that carry on a business in the United States.
The IRS plans to use the data provided by CbC reports in high-level
transfer pricing risk assessment. The CbC reports will provide the IRS
with information related to the MNE group's income and taxes paid,
together with indicators of the location of economic activity within
the MNE group on a country-by-country basis. This information, along
with other transfer pricing documentation provided by the MNE group,
will aid in the identification of transfer pricing practices that may
warrant further inquiry, resulting in more efficient use of IRS
examination resources.
By agreeing to provide CbC reports to foreign countries pursuant to
exchange of information agreements, Treasury secured several benefits
for U.S. MNE groups and tax administration in the United States. It is
important to note that foreign countries already have the right to ask
U.S. MNE groups to provide, at a minimum, the CbC information, master
file information, and local file information. In agreeing to the Action
13 standards, particularly with respect to CbC reporting, these
countries have effectively agreed not to exercise their right to
require additional information, such as transactional data on
intercompany royalties and intercompany service fees, as part of the
standard reporting package. The model CbC reporting template reflects
an agreed international standard for reporting that will promote
consistency of reporting obligations across tax jurisdictions and
reduce the risk that countries will depart from the agreed standard by
imposing inconsistent and overlapping reporting obligations. This will
reduce compliance costs of U.S. MNE groups. In addition, the IRS will
receive CbC reports that will be useful in evaluating the compliance
risk associated with transfer pricing practices of both U.S. MNE groups
and foreign MNE groups conducting business in the United States,
thereby enhancing the efficient use of IRS examination resources. In
sum, Treasury limited the reporting burdens of U.S. MNE groups and
provided the IRS with a useful tool for the efficient risk assessment
of transfer pricing practices of U.S. and foreign MNE groups.
senate advice and consent to multilateral instrument
Question. BEPS Action 15 envisions a multilateral process to come
up with a multilateral instrument to allow for numerous tax treaties to
be amended in one fell swoop, rather than having the world's network of
tax treaties be renegotiated in thousands of bilateral tax treaty
negotiations. I understand the U.S. Treasury is participating in this
process.
Please tell us what you envision the U.S. Treasury's negotiating
posture to be as to this multilateral instrument? Please confirm that
any multilateral instrument that the U.S. signs on to would need the
Senate's Advice and Consent in order to become ratified and effective.
Answer. The multilateral instrument discussions will generally be
limited to negotiations on the different treaty provisions recommended
as a part of the BEPS project. Given that most U.S. tax treaties
already contain most of the treaty provisions that are part of the BEPS
minimum standard, theTreasury Department will have to determine if
signing the multilateral instrument, or agreeing to particular
provisions in it, will on balance be beneficial to the United States.
The multilateral instrument is a treaty instrument and as such, if
the United States becomes a signatory, the instrument would require the
advice and consent of the Senate.
______
Questions Submitted by Hon. Dean Heller
Question. I strongly believe that tax reform, done the right way,
can improve our fiscal picture. That said, without comprehensive tax
reform, we are left with a crumbling tax code that negatively impacts
our American and Nevadan businesses, while our other OECD partners are
lowering their corporate tax rates and expanding their tax base. I am
deeply concerned that U.S. multinational companies are being targeted
and that the administration is not taking steps to defend our U.S.
businesses. Will you fight to protect U.S. businesses from targeting?
``Yes'' or ``No.''
Answer. Yes.
Question. Does the U.S. have any legal authority to fight these
rulings on behalf of U.S. multinationals?
Answer. The U.S. Government may have a sufficient stake in the
outcome of these cases such that it can intervene in any or all of
these cases when and if they are appealed, either to the European
General Court, or subsequently to the European Court of Justice.
Question. As you know, the OECD BEPS plan generally can't force
member governments to do anything they don't want to do. Does BEPS
strengthen the EU Commission's hand by providing political cover?
Answer. The G20/OECD BEPS project has heightened awareness of
techniques used by multinationals to minimize their tax bills. It is my
view that this general awareness has influenced efforts in Europe and
elsewhere to constrain the use of these practices.
Question. Can you explain the process for how the EU Commission
determines if a case is deemed state aid?
Answer. The Commission's antitrust (competition) authorities are
investigating tax arrangements between EU member states and
multinational firms. These investigations are meant to examine whether
the tax authorities of specific countries have entered into special
arrangements with individualfirms to provide tax benefits that are
unavailable to competitor firms and thus constitute impermissible state
aid under EU competition rules.
It is my understanding that the EU's state aid rules are aimed at
member state policies that favor one business or sector over another,
and typically come into play when states give subsidies to businesses
or sectors to the detriment of other businesses or sectors.
Demonstrating ``selectivity'' is the key to a showing of improper state
aid. In tax cases, the Commission typically establishes, first, the
general rules and practices that apply to similarly situated taxpayers
in a country and, second, that the practice or law in question deviates
from that framework in a material way (commonly referred to as
``selectivity'' or ``selective benefit''). This might occur, for
example, if one company obtained a ruling that a similarly situated
company was unable to obtain, or, more broadly, where a specific
industry obtained rulings that other industries could not obtain.
Question. I am deeply concerned with recent reports, as I am sure
you are, that these EU state aid cases will lead to retroactive foreign
tax increases on U.S. companies. Does it make sense that if the
Commission finds that a country has violated its obligations to the EU
that the company should be held liable retroactively?
Answer. As I understand it there are well-grounded ways in which
state aid law could be, and has been, applied to tax rules. However, to
our knowledge, the Commission has never before examined determinations
by member state tax authorities regarding the application of their tax
laws (as opposed to examining the laws/rules themselves) in particular
cases without finding that a specific benefit was given to specific
taxpayers that was not available to similarly situated taxpayers. In
the current cases, our understanding is that there is no allegation
that the countries involved gave special deals to these companies that
were not available to similarly situated companies that engaged in
cross border transactions. Rather, the theory of selectivity appears to
be that the rulings would be available only to companies with affiliate
dealings (for which transfer pricing is set by tax rules), but would
not be available to firms without affiliates (for which the market sets
prices). It is this latter theory of selectivity that is novel. Given
that the theory is novel and could not have been anticipated by the
firms and Member states involved in the ruling process, it seems unfair
to apply it on a retroactive basis.
Question. These back-door tax increases on American companies could
also result in American taxpayers footing the bill through foreign tax
credits. Does the Treasury have any plans to address this?
Answer. We have not yet analyzed whether the resulting payments to
be made by companies as a result of the state aid investigations are
creditable foreign taxes and whether they would generate foreign tax
credits that could be used by the affected firms.
Question. As you may know, this committee is dedicated to
overhauling the tax code. Earlier this year the committee held tax
reform hearings analyzing simplicity, fairness, growth and
international competitiveness. As this committee discusses overhauling
the tax code, including international tax reform, what is the single
biggest element that lawmakers can implement to promote pro-growth
international competiveness?
Answer. Reducing the Federal corporate income tax rate by
broadening the tax base, as outlined in the President's Framework for
Business Tax Reform (an updated version of which the administration
released in April) and implementing the international tax reform
proposals outlined in the administration's FY 2017 budget, would
promote growth and the competitiveness of U.S. businesses, including
U.S.-based multinational corporations as well as domestic and small
businesses.
Question. I am here to help. How can Congress protect U.S.
businesses from being targeted by foreign governments?
Answer. Enacting comprehensive business tax reform that includes
measures such as a minimum tax on low-taxed excess returns earned
abroad would help by eliminating the income that other countries regard
as ``stateless income'' and try to tax. The President's Framework for
Business Tax Reform and the FY 2017 Budget submission provide more
detail on desirable tax policies in this area.
Question. I am deeply concerned with the EU Commission's
determination of whether a measure constitutes state aid. Specifically,
that state aid is determined based on its effects, not its objectives.
Would that mean that all tax rulings that include an element of
negotiation be deemed state aid in the future?
Answer. The Commission's position as to when interactions between a
company and a member state concerning tax issues might or might not
constitute state aid is unclear, so it is difficult to draw a
conclusion as to their view of the scope of their authority.
Question. In what ways did the Treasury consult Congress as the
BEPS plan was taking shape?
Answer. I briefed interested staff members at various times,
answered questions, and welcomed comments.
Question. If nothing is legally binding in the BEPS process, why
has the Treasury decided to implement country-by-country reporting?
Answer. The Treasury Department has determined that the information
that would be required under the proposed regulations published on
December 23, 2015, will assist in better enforcement of the Federal
income tax laws by providing the IRS with greater insight into the
operations and tax positions taken by U.S. multinational groups.
Country-by-country reporting also assists U.S. businesses by
harmonizing transfer pricing documentation across jurisdictions around
the world, thereby reducing compliance costs.
______
Question Submitted by Hon. Pat Roberts
Question. Mr. Stack, Interest-Charge Domestic International Sales
Corporations (``IC-DISCs'') are important vehicles that enable small
businesses to reach foreign markets. I understand that farmers and
farmer cooperatives are eligible to use IC-DISCs to facilitate the
export sale of agricultural product grown by farmers and cooperative
members. However, guidance is needed to clarify how the accounting
rules applicable to farmer cooperatives under subchapter T of the
Internal Revenue Code interact with the IC-DISC rules. Without such
clarity, cooperatives may not go forward with IC-DISCs, hindering the
ability for farmers to efficiently reach export markets. I understand
that the IRS may not have the resources to issue private letter rulings
to all cooperatives seeking to form IC-DISCs. I believe that Treasury
could and should issue formal guidance clarifying these issues.
Properly drafted guidance would remove uncertainty in this area,
provide uniform treatment among similarly situated taxpayers, and
ensure that farmers can avail themselves of the benefits Congress
intended in enacting the IC-DISC rules.
Thank you for your attention to this matter. I respectfully request
that Treasury and the IRS add a guidance project on the next quarterly
revision of your Priority Guidance Plan to address these issues, and
would appreciate a response to this request beforehand.
Answer. Thank you for highlighting this issue encountered by
farmers and farmer cooperatives. We have in fact met with
representatives of these taxpayers to discuss the questions that you
describe regarding how the accounting rules applicable to farmer
cooperatives under subchapter T of the Internal Revenue Code interact
with the IC-DISC rules, and we can appreciate the need for guidance in
this area. As you noted, the IRS has limited resources. In this regard,
Treasury and IRS have to make difficult decisions regarding which
formal guidance is needed most within the next plan year. We will take
your views into account when making these determinations.
______
Questions Submitted by Hon. Michael B. Enzi
Question. The EU state aid cases are targeting multinationals--
predominantly U.S. multinationals. Based on its announcement of the
first two decisions last month, the Commission believes the
investigated countries as providing multinationals unfair competitive
advantages over smaller domestic competitors through tax rulings that
``do not reflect economic reality.'' We haven't seen the legal analysis
of these cases yet, but if these are the standards that are being
applied, do you agree that the decisions should not produce results
that actually disadvantage integrated multinationals and that do
reflect economic reality?
Isn't the arm's length principle the internationally accepted
mechanism that strikes that balance?
Answer. Yes. The arm's length principle is the internationally
accepted mechanism for cross-border transactions that strikes the
balance. The concern is whether the EU Commission will reach the same
interpretation of the arm's length standard that the member state did
when it initially granted the multinational the ruling in question, and
whether taxpayers were on notice that the Commission might be reviewing
member country transfer pricing rulings well after they were issued. If
taxpayers were not aware that the Commission would be reviewing
transfer pricing rulings for their adherence to the arm's length
standard then it seems unfair to impose substantial retroactive
payments on them.
Question. Regarding the EU state aid cases, what do these cases
mean for our ability to rely on bilateral tax treaties negotiated with
European countries if the European Commission can unilaterally change a
treaty partner's tax positions through enforcement of EU competition
policy?
Answer. We are concerned that the European Commission's broad new
assertion of authority in tax matters if applied to cases directly
between a U.S. entity and an EU entity would undermine our ability to
rely on our treaties with member states, in particular our ability to
utilize the mutual agreement procedures.
Question. Does the U.S. have any rights under the treaty to protect
U.S. tax interests while ensuring U.S. multinationals are not subject
to double taxation because of the EU state aid decisions?
Answer. None of the current cases we are aware of have yet to
implicate a treaty issue between the U.S. and a member state.
Question. We've all heard how BEPS threatens the U.S. tax base
because its general policy objective is to align taxing rights with
value creating activities. While BEPS represents prospective tax policy
changes, and the U.S. at least had a seat at the table, the EU state
aid cases represent EU assertion of retroactive taxing rights over the
historical foreign earnings of U.S. multinationals, with the U.S.
Government unable to participate.
Do you view the EU state aid cases as an attempt by the EU to
unilaterally and retrospectively attack the ``stateless income'' issue
that the BEPS project was designed to address on a multilateral and
prospective basis?
Answer. Yes, and done on a retroactive basis.
Question. If the cases result in a single member state collecting
tax on virtually all of the income, without regard to the level of
economic activity within that state, wouldn't that actually contradict
the underlying premise of the BEPS project--to align taxing rights with
underlying value-creating activity?
With respect to income from intangible property, isn't it true that
a significant portion of this value-creating activity is likely to have
taken place in the U.S., giving the U.S. primary taxing rights, on a
deferred basis or otherwise?
Answer. To us, ``aligning taxing rights with underlying value-
creating activity'' is another term for ``appropriately remunerating
functions, assets, and risks under the arm's length principle.'' Under
our domestic law and the OECD transfer pricing guidelines (which all EU
countries embrace), all contributions of value must be appropriately
remunerated. Accordingly, if a single member state collects tax on
virtually all of the firm's income regardless of the amount of economic
activity that occurs in the state that may imply that important
contributions to value are not being considered, which would reflect a
contradiction of the underlying premise of the BEPS project.
While it is difficult to comment in the absence of specific facts,
we agree that quite often a critically important value-creating
activity with respect to intangible assets or intellectual property is
R&D activities, and that these activities often take place in the U.S.
______
Questions Submitted by Hon. Ron Wyden
Question. Regarding the EU state aid cases, I am concerned about
the implications for our tax treaty policy when it comes to members of
the EU.
What do these cases mean for our ability to rely on bilateral tax
treaties negotiated with European countries if the European Commission
can unilaterally change a treaty partner's tax positions through
enforcement of EU competition policy?
Answer. We are concerned that the European Commission's broad new
assertion of authority in tax matters if applied to cases directly
between a U.S. entity and an EU entity would undermine our ability to
rely on our treaties with member states, in particular our ability to
utilize the mutual agreement procedures.
Question. Does the U.S. have any rights under the treaty to protect
U.S. tax interests while ensuring U.S. multinationals are not subject
to double taxation because of the EU state aid decisions?
Answer. None of the current cases we are aware of have yet to
implicate a treaty issue between the U.S. and a member state.
Question. How can Congress protect U.S. taxpayers and help ensure
that Europe does not retroactively impose a back-door tax on these
earnings?
Answer. If Congress were to deny a foreign tax credit for amounts
recovered under the State Aid rules, U.S. taxpayers as a whole would
not be at risk of footing the bill for amounts imposed by the EU
Commission in these cases. However, the U.S. MNE would be required to
make the payment, disadvantaging this U.S.-based firm.
______
Questions Submitted by Hon. Thomas R. Carper
Question. Following up on a question during the hearing, I'd like
to ask about the timeline for ratification of the BEPS Action on
permanent establishment (PE). It's admirable how quickly the BEPS
process has moved forward; it's rare for a multilateral negotiation to
successfully develop and come to (general) agreement around a
comprehensive set of recommendations--or at the very least, options--
within just a couple years.
However, I have concerns that the speed of the BEPS process may not
leave sufficient time for even the most diligent and prescient
taxpayers to adjust and build the accounting systems needed to comply
with new PE proposal.
Mr. Stack, can you give us a reasonable estimate as to when other
countries will ratify the BEPS multilateral instrument regarding
permanent establishment? What do you think is a reasonable effective
date?
Answer. The work on the multilateral instrument is supposed to be
complete at the end of 2016, and assuming that the timeline is met, we
may expect that some countries would be in a position to sign and
ratify the instrument in 2017. It is common practice among countries to
make the text of a tax treaty available when the agreement is signed.
This public release of a signed tax treaty before it enters into force
can serve as a helpful advance notice to taxpayers of the terms of the
treaty before it enters into force. Further, it is common for treaty
provisions to take effect for the taxable periods beginning on or after
the first day of the year following the date on which the convention
enters into force.
Question. Will taxpayers given a reasonable amount of time to
create the necessary accounting systems (and possibly inventory
systems) to comply?
Answer. At this time the Treasury Department has not decided
whether to include most of the new permanent establishment provisions
into U.S. tax treaties, or to agree to the multilateral convention
provisions relating to permanent establishment. Unfortunately, we
cannot speak to how or if other countries that seek to adopt the new
permanent establishment rules will permit transition periods to allow
taxpayer to create any necessary accounting or inventory systems.
Question. The BEPS changes regarding permanent establishments will
trigger a permanent establishment based on a person ``habitually
playing the principal role leading to conclusion of contracts that are
routinely concluded without material modification by the enterprise.''
The commentary further indicates that this principal role will
``typically be associated with the actions of the person who convinced
the party to enter into a contract.''
Mr. Stack, does this trigger a permanent establishment even if the
sales person has no authority to modify a contract and does not even
participate in conclusion of a contract that is done online?
Answer. Permanent establishment determinations are fact intensive.
We would need to determine what type of activities are performed by the
sales person in your example and whether such sales solicitation
activities play the principal role leading to the conclusion of
contracts that are routinely concluded without material modification by
the enterprise. If, for example, the sales activities are merely
providing marketing and promotional services, such activities would not
directly result in the conclusion of contracts on behalf of the
enterprise. See also bottom of paragraph 32.5 of the Commentary to
Article 5(5) of the OECD Model Tax Convention.
Question. I have concerns about how clear a standard we are talking
about when discussing who may or may not have ``convinced the party to
enter into a contract.'' What about a case in which a seller of a good
or service is already well known prior to any customer contact? Or
alternatively, what about a situation in which the principal
contributing factor was a positive recommendation by an unrelated third
party? Can you outline for us your concerns you have that this standard
might leave taxpayers unclear on whether they have any genuine taxable
presence or permanent establishment? If so, what actions should be
taken, going forward, to provide more clarity and certainty?
Answer. Throughout the development of the new tax treaty
provisions, in particular the development of the so-called ``principal
purpose test'' to combat treaty shopping and the new permanent
establishment provisions, the Treasury Department has stressed our
concern that any new treaty provisions be as clear as possible, because
ambiguous or unclear rules are likely to lead to disputes between
taxpayers and the revenue authorities. The lack of certainty in the
application of the principal purpose test is a primary reason why the
Treasury Department (in concurrence with the views of the Senate)
rejects the inclusion of such a rule in U.S. tax treaties. The Treasury
Department is interested in developing ways to mitigate the compliance
burdens that the new permanent establishment rules could create, and to
facilitate the resolution of any disputes of interpretation, perhaps by
coupling such rules with mandatory binding arbitration.
______
Communications
----------
Business and Industry Advisory Committee to the OECD
13-15 Chaussee De La Muette, 75016, Paris, France
Tel: + 33 (0) 1 42 30 09 85
Fax: + 33 (0) 1 42 88 78 38
Position Paper on the Organisation for Economic Co-Operation and
Development's Project on Base Erosion and Profit Shifting
Submitted to The United States Senate Committee on Finance
In relation to Full Committee Hearing: International Tax: OECD BEPS
and EU State Aid
Date 3 December 2015
_______________________________________________________________________
BIAC has been supportive of the OECD's Base Erosion and Profit Shifting
(``BEPS'') project since its inception and has provided constructive
and detailed input from the international business community in
response to all discussion drafts. Although we value the openness of
the consultation processes and acknowledge the efforts of OECD and G20
member governments and the OECD Secretariat, we are anxious that some
serious business concerns have not been sufficiently considered or
addressed.
At the March 2015 meeting of the BIAC Tax Committee, a substantial
number of member organizations expressed concerns over the direction of
certain aspects of the BEPS project, and the potential significant
negative economic consequences of several Action Items, and it was
agreed to set those out in a short document. This document has been
updated following the release of the OECD's final reports in October
2015. We would reiterate, despite the concerns noted below, that we
want the BEPS project to succeed. We will continue to approach this
project--both before and after the adoption of the recommendations by
the G20--in a constructive, flexible and incremental way as we believe
this is the best way of achieving that success. We call on the OECD to
continue to include us in the completion of outstanding work, and the
development and implementation of the G20 proposed framework for
implementation.
General Comments
Many of the concerns identified in this Position Paper are common
across the range of Action Items. We feel they are worth repeating up
front as their importance continues to grow as the follow-up and
implementation work commences.
Economic Impact: There is great concern that the economic consequences
of the recommendations have not yet been fully considered. Countries
should be undertaking realistic assessments of the tax revenues they
may be due under the consensus reached, rather than assuming that
implementation will bring additional tax revenues. The possibility
should be understood that overly strict regulation could force economic
activity out of countries. Countries should not rush to implement
proposals with such aims in mind when the actual impact on their tax
revenues has not been determined--this could undermine the BEPS process
and bring about unintended economic implications. Although uncertainty,
double taxation, disputes and compliance burdens are a focus of
business, we are also concerned about the broader economic impact,
which may include, for example, the impact on the efficiency of
markets, or the sustainability of certain legitimate non-tax driven
commercial transactions and structures (for example, cross-border
infrastructure projects or regionalisation of certain functions to
improve quality and efficiency). We believe that the justified
targeting of BEPS activities must be integrated with larger economic
concerns related to creating jobs and growth through cross-border trade
and investment.
Complexity and Compliance: In a number of areas, the BEPS Action Plan
proposes substantially new and complex rules to tackle avoidance. Given
the pressures of the ambitious timeframe, there have been very few
opportunities to explore how these complex proposals can be adopted and
implemented on an international basis. Both tax authorities and
businesses will need detailed implementing guidance to ensure that the
intention of each recommendation is clear. This will be critically
important in ensuring that the recommendations are uniformly adopted,
whilst avoiding overlaps. The challenges that will be brought about
through the interaction of different timelines and domestic
implementations should not be underestimated. They could lead to double
taxation and a significant compliance burden on both businesses and tax
authorities and create uncertainty that will delay necessary
investments. We look forward to the OECD's development of an inclusive
framework to support and monitor the implementation (as proposed by the
G20 Finance Ministers) to assist in maintaining international co-
operation and as much consistency in timing and application as is
possible. We would encourage the OECD to seek agreement from involved
countries on effective dates after which new rules and guidelines will
apply; even with the OECD's work on Action 14, it will be very
difficult to eliminate double taxation and would be inequitable if some
tax authorities seek to revisit past years with new concepts and
methodologies.
Scoping: As part of the implementation framework, we believe it would
be helpful to target the scope of each recommendation more narrowly to
increase the chance of developing the necessary inter-governmental co-
operation. At present, many proposals appear to go beyond the scope
required to effectively target BEPS related activities. We strongly
believe that ``success'' in the BEPS project would be achieved with a
set of detailed, well-defined proposals that can be (and are)
implemented consistently. Countries should be encouraged to avoid
overly-broad implementation that could lead to a less uniform
international tax regime.
Timing: As well as the timing concerns raised above in relation to the
potential economic impact and the potentially disjointed international
adoption of the recommendations, we also have a more general timing
concern that impatient countries and tax authorities may seek to
commence full implementation of recommendations where it has been
agreed that further work is required. For example, critically important
work remains in relation to profit attribution to permanent
establishments and specific rules in relation to financial services and
insurance businesses.
Reaching Consensus
BIAC has strongly supported the OECD as the best organisation to
deliver a successful consensus outcome under the BEPS mandate and
recognises the phenomenal work that the OECD has done in brokering
compromises and consensus wherever it has been possible. However,
despite the OECD's claims, we are concerned that in many instances it
has proved difficult (and occasionally impossible) for member
governments to reach consensus. This has resulted in a lack of clarity
and a degree of ambiguity. For example, whilst the OECD has not
recommended solutions regarding the ``digital economy,'' the door has
been left open for countries to implement solutions unilaterally which,
if implemented, could lead to double taxation.
Understanding the Economic Impact
It remains a matter of some regret that, owing to the political nature
of the timetable, the BEPS project could not begin with a detailed
economic analysis of the abuses identified in the Action Plan,
including the scale and importance of ``double non-taxation'' and ``tax
competition.'' We are concerned that the public announcements and
discourse have been optimistic in terms of the amounts of additional
tax that will be collected as a result of the BEPS recommendations, due
in part to the conclusions reached in Action 11, and strengthened by
the impression that the expectation of additional tax receipts was in
some way a pre-requisite of reaching a broad consensus. Whilst we
understand the public and political pressure surrounding the project
elevated a need for consensus in agreeing that businesses should be
taxed on all profits, most countries who have offered a public opinion
on the matter seem to have assumed that the implementation of the
proposals will increase their tax revenues substantially.
In reality, depending on which of the proposals are introduced by
themselves and/or other countries, there could be many countries that
do not receive additional tax revenues. There may be cases where overly
strict regulation pushes economic activity out of some countries. If
not dealt with by rigorous impact assessments both at international and
domestic levels, we are concerned that this expectations gap could lead
to countries budgeting for higher tax revenues than they will receive.
The resulting pressure could end in countries opting not to implement
all of the proposals uniformly, an outcome that would result in double
taxation and more pressure on individual tax authorities to
aggressively audit taxpayers in an attempt to collect more tax rather
than the right amount of tax based on the consensus agreed. A failure
of the BEPS project in such a manner is not in the interests of
business, governments or the public and will significantly increase the
costs of tax administration and tax compliance.
Complexity and Compliance Burden
The BEPS recommendations are likely to create significant
implementation difficulties and greater compliance burdens, not only
for Multinational Enterprises (MNEs), but also governments--this is in
part due to the substantial number of recommendations, but also their
complexity and the different timelines that will need to be followed to
implement them (for example, the adoption of revised OECD Guidelines
into domestic law, or different processes for implementing domestic
recommendations). Public and considered consultation and strong
commitment by countries to work together (supported by the OECD's
implementation framework to be developed in 2016) are essential to
avoid fragmentation.
We would encourage the OECD to seek agreement from involved countries
on effective dates after which new rules and guidelines will apply;
even if the OECD's work on Action 14 is successful in improving dispute
resolution, it will be very difficult to eliminate double taxation and
would be inequitable if some tax authorities seek to revisit past years
with new concepts and methodologies.
We support the OECD's statement that VAT registrations should not
create PEs, and we would encourage tax administrations to heed this and
not assume that PEs exist where a company is registered for VAT (or
vice versa), which would result in significant compliance burden. Other
Action Items (for example, Actions 2, 3, 4, 7 and 12) are also likely
to require significant additional resource to ensure compliance with
new, complex and sometimes contradictory rules.
Discouragement of Related Party Trade
Many of the BEPS Action Items apply only in an intra-group context and
could significantly increase the cost of performing various functions
or undertaking certain transactions inside a group of related
companies. For example, the recommendations to lower the PE threshold
and the complex new transfer pricing analyses that only apply to
transactions between affiliates could greatly increase the compliance
cost and tax liabilities associated with various intra-group
activities. In some cases, taxpayers may, effectively, be forced to
conduct business with third parties to mitigate excessive tax cost or
uncertainty. This would reduce commercial and economic efficiencies and
hamper international trade (as well as, quite possibly, lowering the
wages and benefits in outsourced functions--especially in developing
countries). We believe that these effects should be considered in
greater detail and encourage additional guidance to be developed to
provide greater certainty.
Appropriate Resources for Tax Administrations
Tax administrations already receive significant amounts of information
that they often struggle to process. We are concerned that without
additional resources, tax administrations will face difficulties in
effectively using additional information and in dealing with the
expected increase in requests for exchange of tax information between
countries. It may actually become more difficult to identify risks, or
to target abuse, to the advantage only of the most aggressive
taxpayers.
We believe a greater focus on tax administration would be beneficial--
for example, through fully integrating the work of the Forum on Tax
Administration--and the use of targeted risk-based measures. This could
include materiality thresholds and other risk-identification tools to
target higher risk taxpayers/issues that represent the most substantial
sums of lost tax revenues. Such approaches reduce the burden on the
vast majority of compliant taxpayers, freeing up resources for more
productive, value-creating activities. Cooperative compliance also has
an important role to play in this area.
Multilateral Implementation
The ultimate success of the BEPS project will be the multilateral
implementation of specific, measurable, achievable and realistic
recommendations on a timely basis. Whilst much work on implementation
mechanisms is still to come throughout 2016; we encourage early
discussions on approaches to enhance credibility and likely success of
the project. We make the following recommendations in this regard:
The G20 proposed engagement framework should be prepared and
managed by the OECD Secretariat;
As a first step, all countries should agree to key principles to
be followed in any domestic legislation used to enact BEPS proposals.
Such principles could include that:
the policy objective should be clearly stated;
the policy objective should be consistent with the BEPS
recommendation, and in particular, should be limited to addressing
specific abuses;
draft legislation should be prospective in application
and be published with a minimum period for detailed stakeholder
consultation; and
an impact assessment should be prepared to evaluate any
compliance burdens created.
We encourage the OECD to coordinate the implementation so that
national measures have a reasonable degree of consistency.
BEPS Action Item-Specific Comments
Address the Tax Challenges of the Digital Economy (Action 1)
We greatly welcomed the original 2014 report (Addressing the Tax
Challenges of the Digital Economy), but we consider that the final 2015
report does not go far enough by recommending only that such countries
are mindful of their treaty obligations until further review in 2020.
There is concern amongst BIAC members that some countries are
considering withholding taxes on digital transactions, and whilst the
final report recognises that this is not recommended, it neither
discourages such action nor identifies the treaty obligations and
implications that such taxes could breach. Such unilateral action will
certainly result in double or even multiple-
taxation unless there is a very clear and strong consensus as to how
the profits of digital business transactions should be taxed. BIAC
looks forward to participating in ongoing monitoring and evaluation
characteristics of digital trade that may cause BEPS concerns.
Neutralizing the Effects of Hybrid Mismatch Arrangements (Action 2)
While we do not defend hybrid mismatches as a general policy matter, we
do want to make three important points on the final report:
It is not clear which countries intend to implement any or all
of the recommendations, when they plan to do so, or how the interaction
with the local legislative processes will result in differences between
countries in terms of application or timing. Implementation through a
combination of complex changes to domestic laws, bilateral treaty
provisions and potentially a multilateral instrument increases the
uncertainty on timing further. We welcome the development of an
inclusive monitoring framework in early 2016 to assist international
cooperation but retain concerns in particular regarding the risk of
double taxation, increased compliance burden, and uncertainty that will
arise from countries implementing at different times.
Even if implemented in a coordinated manner, the complexity of
the proposed rules will create substantial compliance difficulties, and
will complicate the allocation of taxing rights between jurisdictions,
increasing the risk of double taxation (e.g., the rules on ``imported
mismatches''). The accompanying expanded examples may provide clarity
on some issues, but at the price of still further complexity.
The financial services industry continues to be concerned that
insufficient attention has been given to how the proposals will impact
instruments deemed important by banking regulatory authorities for
systemic liquidity. By relying on countries to opt not to tax such
transactions at their discretion increases uncertainty and the risk of
double taxation.
Strengthen CFC Rules (Action 3)
The broad nature of the OECD's final CFC proposals illustrate the
difficulty in reaching a consensus position on even the basic purpose
of rules, with clear disagreements between governments over whether
such rules should tackle profit shifting from the parent entity or
foreign-to-foreign abuse. Without clear agreement over the underlying
principles, the chances of delivering clear, proportionate and
practical solutions were almost impossible. This was an opportunity
missed to refine a useful tool, based on well-understood concepts of
``active'' and ``passive'' income in ways that could reduce dependence
on subjective, fact-intensive enquiries while at the same time limiting
the compliance burden and risk of double taxation. We urge the OECD to
consider CFC rules further when addressing any future BEPS concerns
that the monitoring and analysis highlight.
Limiting Base Erosion Via Interest Deductions and Other Financial
Payments (Action 4)
The final report on Action Item 4 will have serious implications for
groups' economic activity and their ability to obtain tax deductions
for funding costs. The proposals have been made without a clear
articulation of how they specifically target BEPS activities. The
OECD's proposals are likely to restrict interest deductions for a
significant number of non-aggressive taxpayers, particularly those
investing in infrastructure or long term projects where it remains
unclear whether they would qualify for the proposed exemptions. The
lack of support for the arm's length principle in Action Item 4 also
undermines legitimate commercial reasons for having intercompany debt.
A group's cash position and decisions on how to deploy cash should not
be limited by rules that are not based on the arm's length principle.
However, given the options previously put forward in discussion drafts,
we do welcome the broadening of the corridor approach to a range
between 10 percent and 30 percent of EBITDA and the relative simplicity
it brings. However, this approach could have serious consequences if
detailed work is not undertaken to determine appropriate ratios, taking
into account the funding requirements of different industries. Where
ratios are set too low, this could substantially raise the cost of
capital for low-risk taxpayers undertaking commercial transactions. We
are disappointed that the proposals do not recommend more strongly the
elements of the proposals that would seek to limit double taxation,
such as the ability to carry forward unutilised interest capacity
(especially for start-ups and companies in loss-making positions) or
give credit for all withholding taxes suffered.
Additionally, we note that interest is the ``raw material'' for
financial services businesses. Although a ``net interest'' approach is
endorsed, it is important that the outstanding questions facing the
financial services industry be resolved, particularly so that proposals
do not contradict the regulatory agenda.
Whilst we welcome the attention that the OECD plans to give to the
group wide ratio rules, financial services and insurance industries
2016, we have serious concerns that so much work remains outstanding in
this area at a time when countries are otherwise being encouraged to
start implementing the rules.
Prevent Treaty Abuse (Action 6)
We are concerned that significant uncertainty remains as to whether
treaty relief is available in ordinary commercial circumstances. This
uncertainty risks undermining the usefulness of treaty networks in
facilitating trade and promoting economic growth. Whilst we recognise
that tax administrations require assurance that treaty benefits are
only being granted in appropriate circumstances, anti-abuse rules
should be applied in a proportionate and targeted manner. The existing
provisions and Guidance could provide more clarity (e.g., low taxed
branches with substance, calculation of head office tax rate). Broad
disapplication of treaty benefits could create substantial withholding
tax burdens and negatively impact cross-border trade.
The final proposed minimum treaty standards are at the very least
expected to create a significant compliance burden for taxpayers
(especially where both a simplified LOB and a PPT rule are adopted in
certain treaties), and will potentially bring into scope legitimate
structures that ought to be entitled to treaty benefits. We remain
concerned that:
Structures not involving treaty shopping may be unintentionally
caught by broad rules.
There will be increased cross-border investor uncertainty,
especially for pension fund investors and sovereign wealth funds, where
the potential for tax treaty abuse is low.
Uncertainty for Collective Investment Vehicles (CIVs) will be
unavoidable, and the time taken to receive repayments of tax deducted
at source will impact the Net Asset Values of funds.
Source country tax authorities may experience additional demands
to process an increased volume of reclaims, placing further pressure on
already resource constrained administrations.
Whilst we recognise that the OECD has further work to do regarding the
commentary on LOB rules and the impact on non-CIVs and pension funds
and welcome the OECD's commitment to consult on such matters, we remain
concerned that in order for this to be taken into account as a
meaningful component of the multilateral instrument negotiations, this
work must be completed swiftly.
Preventing the Artificial Avoidance of PE Status (Action 7)
Whilst many of our members welcome the move away from the ambiguous
language of the discussion draft that sought to establish a PE where
persons ``negotiated the material elements of contracts,'' we are
concerned that the final deliverables introduce new concepts that were
not open to consultation and so retain ambiguity. Whilst we welcome the
move to recommendations that a dependent agent PE is only established
where a person ``plays the principal role'' in negotiating contracts,
we urge the OECD to undertake additional consultation and provide tax
authorities with additional guidance to clarify the meaning further.
Similarly, the meanings of ``complementary functions that are part of a
cohesive business operation'' in relation to fragmentation and ``at the
disposal of'' regarding fixed places of business should be more tightly
defined to ensure consistency in implementation.
It is disappointing that recommendations regarding PE thresholds have
been released before the guidance that will follow on profit
attribution. We are concerned that tax authorities will seek to
establish the existence of PEs based on new concepts before providing
business with any certainty regarding the attribution of profits to
these newly defined PEs. For instance, the example of a PE being
triggered by an agent who convinces customers to accept standard
contracts without any authority to make deviations is very different to
the previous definitions. Additionally, we would welcome the
confirmation that PEs can be loss making.
It is more disappointing still that the changes required to the OECD
Model Treaty, OECD Guidance and domestic/multilateral implementation
thereof will undoubtedly be disjointed, and we fear that some tax
authorities may seek to apply the new concepts to open periods, which
will cause considerable uncertainty and double taxation to arise. We
urge the OECD to consider the impact of this as part of the
implementation framework being developed and wait until there is a
consistent understanding of the concepts before updating the Model
Treaty and Guidance.
Transfer Pricing (Actions 8-10)
We have consistently acknowledged the need to update international tax
rules on Transfer Pricing (TP), especially in relation to intangibles.
However, aspects of BEPS project illustrate fundamental differences in
opinions between countries over the Arm's Length Principle (ALP) in TP
and its continued viability. We are hesitant in agreeing with the OECD
that the final report's recommendations have been finalised without a
departure from the ALP.
We welcome the confirmation that where clear contractual arrangements
exist that are supported by economic reality, then recharacterisation
is not generally required. However, we are concerned about the
complexity of the process, the level of detail required, and the
consequences it will entail in the practical application. For example,
the modifications do not clearly address the relevance of or extent to
which (control and) performance of DEMPE functions and risk should
contribute to calculating price under the ALP. These are not generally
factors that are taken into account by unrelated parties. We welcome
the reiteration that the most appropriate TP methodology should be
used, and the OECD's commitment to developing guidance on profit split
methodologies. However, we note that with this work expected to remain
incomplete until 2017, a significant period of uncertainty remains,
which will cause considerable uncertainty and double taxation to arise.
We urge the OECD to consider the impact of this as part of the
implementation framework being developed and prioritise these areas
accordingly.
We welcome the confirmation that tax authorities should only be
permitted to consider ex post outcomes as presumptive evidence about
the appropriateness of the ex ante pricing arrangements where taxpayers
cannot demonstrate that the uncertainty was appropriately measured in
the pricing methodology adopted. However, the distinction between
foreseen and unforeseen is subjective and very difficult to make.
Additionally, there are many areas of the report that appear ambiguous
which will allow countries to take divergent positions. We believe that
there remains a significant risk of divergence in interpretation and
extent of these approaches, and ultimately of tax authorities using
hindsight to recharacterise non-abusive transactions.
Whilst we would welcome the simplicity that the elective regime for
Cost Contribution Arrangements (CCAs) could provide, without a
commitment from a significant number of countries to implement such a
regime it remains the case that businesses will still face a
significant compliance burden in satisfying the countries that do not
implement it. If a significant number of countries could be encouraged
to implement the elective regime at least in part (e.g., service CCAs)
this would address these concerns in some cases.
Financial services institutions face regulatory pressures that
differentiate them from groups operating in other sectors. The OECD's
2010 report on the attribution of profits to PEs remains relevant for
the taxation of this sector. BIAC cautions against special measures or
general principles that move away from this well-
established approach.
BEPS Data (Action 11)
Whilst the business community generally agrees that insufficient data
is available and that such data would be useful (and are thus
supportive of the initiative), there has not been significant
engagement with business in this area. We would welcome the opportunity
to assist the OECD in its further work on identifying and analysing
data on BEPS.
Re-examine Transfer Pricing Documentation (Action 13)
BIAC fully supports the recognition under Action 13 of the importance
of protecting the confidentiality of commercially sensitive
information. This protection should apply across all three pillars of
TP documentation. We consider it would be a useful addition (perhaps
under the framework to be developed in 2016) if peer review mechanisms
could be developed to monitor jurisdictions' adherence to appropriate
confidentiality standards, and to ensure that the OECD's proposals are
uniformly adopted.
The Action 13 recommendations will create substantial burdens for
business, and effective compliance will require much preparation. For
example, there remains ambiguity around areas such as the
practicalities of reporting Master Files on a business line basis
whilst maintaining a global overview, and many countries are already
seeking to implement the country-by-country reporting elements
recommendations before the guidance and XML schema are even released.
Without further guidance, much of the necessary preparation is
impossible. Such implementing guidance should, where possible, leverage
data reported under similar regimes (for example the EU's CRD IV for
banking organisations) to streamline the compliance burden for as many
taxpayers as possible. Only uniform TP documentation rules across
countries will limit the resulting increase in compliance costs for
companies, and we urge the OECD to encourage consistency in this area.
Make Dispute Resolution Mechanisms More Effective (Action 14)
We congratulate the OECD on the significant steps forward that have
been taken in its work on Mutual Agreement Procedure (MAP). The
recommended minimum standards on MAP and peer reviews is a welcomed
development in the final report. We welcome the OECD FTA's MAP Forum as
the best place for peer reviews to be undertaken, and encourage the
OECD and governments to commit appropriate resource to ensure that the
minimum standards can be upheld. The full picture of the success of the
minimum standards on MAP (and the success of the BEPS Project as a
whole) cannot be judged with reference only to tax authorities' data;
we would welcome the opportunity to also be consulted as part of the
OECD's monitoring framework.
We also congratulate the OECD on securing the commitment of 20
countries to binding arbitration and we urge the OECD to allocate
necessary resource to ensuring this area is successful. We hope that
this will demonstrate to non-participating countries the benefits of
such a process to its participants and hope that this will become an
international standard that other countries are compelled to join.
Multilateral Instrument (Action 15)
We congratulate the OECD on securing the commitment of c.90 countries
to participate in the development of this ambitious project in 2016. We
recognise the benefits that could arise from a significant number of
countries signing up to the instrument in order to swiftly and
uniformly implement the OECD's proposals.
Whilst the detailed timeline and consultation requirements have not
been made public; we hope that the OECD will seek to consult widely and
take up BIAC's offer of support in its work on development of the
Multilateral Instrument.
______
Center for Freedom and Prosperity
Statement of
Andrew F. Quinlan
President
Senate Committee on Finance
Hearing on International Tax: OECD BEPS and EU State Aid
December 1, 2015
Chairman Hatch, Ranking Member Wyden, and Members of the Committee on
Finance, thank you for the opportunity to submit written testimony on
the OECD's project on Base Erosion and Profit Shifting (BEPS).
My name is Andrew Quinlan. I am the president of the Center for Freedom
and Prosperity (CF&P). The primary mission of the Center for Freedom
and Prosperity is to defend tax competition as an important principle
that helps ensure a prosperous global economy.
The BEPS project poses a direct threat to tax competition and American
business.
First and foremost, it is necessary to understand that the OECD does
not have American interests at heart, nor even the welfare of the
global economy. Rather, it is an unaccountable bureaucracy that serves
the narrow interests of finance ministers and tax collectors from its
rich-nation members.
The OECD has a long documented history of advocating policies against
the interests of American taxpayers and businesses, and of abusing its
reputation to strong-arm jurisdictions into adopting self-destructive
tax policies.
The United States must not buckle under pressure to do so in the case
of BEPS.
The project on Base Erosion and Profit Shifting has been pushed under a
dishonest premise. Despite a relatively small and temporary dip in
recent years thanks to the recession, corporate tax revenues as a share
of global GDP have trended steadily and decisively upward over the last
few decades. The contrary but popular idea of a corporate tax dodging
problem is a myth designed to draw attention away from irresponsible
budgets and profligate government spending.
In order to avoid scrutiny of the project, BEPS preceded rapidly from
conception to completion. The OECD is now hoping that the world
similarly implement its dictates without the careful consideration the
subject demands.
It is paramount that Congress prevent the U.S. Treasury from
unilaterally fulfilling the OECD's wish to rewrite global tax rules
without democratic oversight. In particular, rules designed to enable
global fishing expeditions on American businesses through demands for
inordinate and unnecessary amounts of private and proprietary data
should be rejected.
Far from acquiescing to the OECD's scheme, the U.S. should take a
leading role in defending the principles of free and open markets, and
call on other nations to similarly reject their demands.
For further substantiation of the OECD's motives and more in-depth
explanation of the true costs of allowing BEPS to proceed, please
consider the additional materials appended to this statement.
______
Coalition for Tax Competition
July 14, 2015
Dear Senators and Representatives:
The Organisation for Economic Co-operation and Development (OECD) is
rapidly working to rewrite global tax rules in the name of combating
base erosion and profit shifting (BEPS). We the undersigned
organizations are deeply concerned that this process lacks oversight
and will result in onerous new reporting requirements and higher taxes
on American businesses, and are urging Congress to speak up for U.S.
interests by adding its voice to the process.
The OECD has a history of supporting higher tax burdens and larger
government, and the BEPS project represents just the latest salvo in a
long-running campaign by global bureaucrats to undermine tax
competition and its restraining force on political greed.
Because the OECD is populated by tax collectors and finance ministers,
new rules being drafted through the BEPS initiative are necessarily
going to be skewed in their favor. Businesses are given only a token
voice, while other interests are not considered at all. Consumers,
employees, and everyone that benefits from global economic growth are
not able to make their preferences known.
The inevitable prioritizing of tax collection over every other
political or economic interest ensures that the result of the BEPS
project will be economic pain. And based on the OECD's own
acknowledgement that corporate tax revenues have not declined in recent
years, that pain will provide little to no real gain to national
treasuries.
BEPS recommendations already released further show a troubling trend
toward excessive and unnecessary demands on taxpayers to supply data
not typically relevant to the collection of taxes. This includes
proprietary information that is not the business of any government, and
for which adequate privacy safeguards are not and likely cannot be
provided.
The Treasury Department should not be the only voice representing U.S.
interests during this critical process. We urge members of Congress to
get involved before it is too late, and to protect American interests
by ensuring that the voices of tax collectors are not allowed to speak
for everyone.
Sincerely,
Andrew F. Quinlan, President Grover Norquist, President
Center for Freedom and Prosperity Americans for Tax Reform
Pete Sepp, President Michael A. Needham, CEO
National Taxpayers Union Heritage Action for America
Tom Schatz, President Seton Motley, President
Council for Citizens Against
Government Waste Less Government
Wayne Brough, Chief Economist and J. Bradley Jansen, Director
Vice President of Research Center for Financial Privacy and
Human
Freedom Works Rights
Phil Kerpen, President David Williams, President
American Commitment Taxpayers Protection Alliance
Bob Bauman, Chairman Karen Kerrigan, President
Sovereign Society Freedom Alliance Small Business and Entrepreneurship
Council
Sabrina Schaeffer, Executive
Director James L. Martin, Chairman
Independent Women's Forum 60 Plus Association
Heather Higgins, President George Landrith, President
Independent Women's Voice Frontiers of Freedom
Lew Uhler, President Terrence Scanlon, President
National Tax Limitation Committee Capital Research Center
Tom Giovanetti, President Andrew Langer, President
Institute for Policy Innovation Institute for Liberty
Eli Lehrer, President Chuck Muth, President
R Street Institute Citizen Outreach
______
BEPS Has Tax Competition in the Crosshairs
Brian Garst, Center for Freedom and Prosperity
Originally published October 2015 by Offshore Investment
The OECD's work on Base Erosion and Profit shifting is completing after
what can only be described as an extremely rushed process by global
policy standards. In an effort to understand the broader implications
of the project and what it means for the future of international
taxation, I authored a study published June 2015 by the Center for
Freedom and Prosperity titled, ``Making Sense of BEPS: The Latest OECD
Assault on Tax Competition.'' \1\ The following is an abridged version
of the paper.
---------------------------------------------------------------------------
\1\ The full version is available at www.freedomandprosperity.org/
2015/publications/making-sense-of-beps.
---------------------------------------------------------------------------
Introduction
Under direction of the G20, the Organisation for Economic Co-operation
and Development (OECD) began 2 years ago a major initiative on ``base
erosion and profit shifting'' (BEPS). The project has garnered little
interest from U.S. policymakers to date, yet its ever expanding scope
and profound implications for the global economy should demand their
attention.
In February 2013 the OECD released a report titled, ``Addressing Base
Erosion and Profit Shifting'' (BEPS Report), declaring that, ``Base
erosion constitutes a serious risk to tax revenues, tax sovereignty,
and tax fairness for OECD member countries and non-members alike.'' The
OECD followed up with a plan in July 2013, ``Action Plan on Base
Erosion and Profit Shifting'' (Action Plan), that identified 15
specific areas to address.
Through the BEPS project, the OECD is continuing its war against tax
competition. Its proposals would enable endless global fishing
expeditions and provide cover for governments to choke the economy with
new taxes.
The Threat to the Economy
The OECD and other supporters of the BEPS initiative argue that there
are economic benefits to preventing legal tax avoidance techniques.
Namely, they contend that activity undertaken in response to tax policy
represents a market distortion. In the narrow sense this is accurate,
but as a justification for the OECD's current activities, it falls
short.
Typically ignored in the BEPS discussion are the broader implications
of proposed reforms on the political economy. If all differences in tax
policy were successfully minimized, to some extent it would indeed
reduce profit-shifting aimed at suppressing tax burdens. So too would
reducing taxes to zero, but policymakers have a variety of objectives
to weigh and ought not elevate ending profit-shifting above all other
national interests.
BEPS would lead to an overall higher tax environment as politicians
freed from the pressures of global tax competition inevitably raise
rates to levels last seen in the early 1980s, when reforms by Reagan
and Thatcher sparked a global reduction in corporate tax rates that has
continued to this day. Through tax competition, the average corporate
tax rate of OECD nations declined from almost 50 percent in 1981 to 25
percent in 2015.
Taxes themselves distort the market by shifting resources away from
market driven activities and toward politically driven activities, and
higher rates, all else being equal, increase the effect of the
distortion. Poorly designed tax systems--the global norm--introduce yet
more distortions through the common practice of double taxing capital,
which is of particular importance when discussing BEPS given that
corporate taxes are often identified as the most destructive form of
capital taxation, as even OECD affiliated economists have acknowledged.
Governments necessarily need taxes to fund essential functions, but
ideally should seek to minimize the economic footprint of taxation as
much as possible. Political incentives, however, often work in
opposition of this goal. Politicians face pressure to demonstrate to
constituents that they are performing and to please the interests that
support their campaigns, and that in turn encourages taxes to rise
above and beyond the level of optimum growth, or where new spending no
longer provides net economic benefits.
Tax competition thus provides one of the main sources of push-back
against the drive to spend and tax.
Tax collectors and finance ministers have inordinate say in the
activities of the OECD, so it's expected that the BEPS initiative would
represent their views above all else. The Action Plan thus considers
the benefits of tax competition to be the real problem, explaining that
``there is a reduction of the overall tax paid by all parties involved
as a whole.'' The prospect of there being less money to be spent by
politicians is perceived as a problem to be solved, rather than as a
positive for the global economy.
The Threat to Privacy
Several BEPS action items raise serious privacy concerns. Proposed
recommendations for transfer-pricing documentation and country-by-
country reporting, for instance, feature broad reporting requirements
that go far beyond what is required for purposes of immediate tax
assessment.
Guidance for Action 13 recommends a three-tiered approach to transfer-
pricing documents consisting of a master file, a local file, and a
country-by-country (CbC) reports. Information contained in the local
and master files are particularly vulnerable, since it would take a
breach in only a single jurisdiction for it to be exposed. The OECD
makes assurances for the confidentiality of these reports, but they are
empty promises. Such government assurances of privacy protection are
contradicted by experience and the long history of leaks of taxpayer
information. In the United States alone tax data has frequently been
exposed thanks to inadequate safeguards, or even released by officials
to attack political opponents.
Even without malicious intent, governments are ill equipped to protect
sensitive information from outside access. According to the U.S.
Treasury Inspector General for Tax Administration, 1.6 million American
taxpayers were victimized by identity theft in the first half of 2014,
up from just 271,000 in 2010. Chinese hackers were blamed for a breach
that exposed the data of 4 million current and former federal
employees, and the massive new collection effort and reporting system
being established to enforce the Foreign Account Tax Compliance Act has
also been faulted for its insufficient privacy safeguards.
As poor as the United States has proven at protecting privacy, there
are likely to be nations even more vulnerable. Through the master file
and other reporting mechanisms, BEPS will demand of corporations
propriety information and other sensitive data that they have every
right to keep private and out of the hands of competitors. When it
takes a breach of only a single national government to expose this
information, there will no longer be such expectation of privacy.
Is BEPS a Serious Problem?
The OECD's website describes BEPS as ``tax planning strategies that
exploit gaps and mismatches in tax rules to artificially shift profits
to low or no-tax locations where there is little or no economic
activity, resulting in little or no overall corporate tax being paid.''
The BEPS Report further claims that, ``it may be difficult for any
single country, acting alone, to fully address the issue.'' Or as the
website more succinctly describes, BEPS ``is a global problem which
requires global solutions.''
No significant evidence for these assertions is provided, however. The
OECD's BEPS Report itself undercuts the argument that there is a
pressing need for a global response when it acknowledges that
``revenues from corporate income taxes as a share of GDP have increased
over time.''
Academic research on the impact of BEPS is far less certain than the
rhetoric of the G20 and the OECD. The strongest analysis yet to date
comes from Dhammika Dharmapala, whose survey of the literature reports
that recent studies tend to find lower levels of shifting than earlier
works. It also challenged arguments that ``point to the fraction of the
income of MNCs that is reported in tax havens or to various similar
measures as self-evidently demonstrating ipso facto the existence and
large magnitude of BEPS.'' Simply identifying money in other
jurisdictions, even those with low tax rates, is not evidence of a BEPS
problem. It should be expected to see more money being earned where tax
policy is less hostile.
Part of the reason there exists little evidence of a significant global
BEPS problem is that domestic policy solutions are already available to
address legitimate areas of concern when they arise. More importantly,
the best solution available for preventing base erosion is the adoption
of a competitive tax code. Pro-growth tax policy that eschews double
and worldwide taxation not only won't cause capital flight, but will
attract investment instead.
Broader Aims of the OECD
To fully understand the significance of the BEPS effort, it's necessary
to place the current agenda within the broader context of the OECD's
work in recent decades. In 1998 the OECD declared war on tax
competition with a report entitled, ``Harmful Tax Competition: An
Emerging Global Issue.'' Its authors worried that, among other things,
tax competition ``may hamper the application of progressive tax rates
and the achievement of redistributive goals.''
The organization was eventually forced by political opposition to back
away from explicit condemnations of all tax competition, but has not
abandoned its views. Rather, it has adopted new tactics toward the same
end. To make this point clear, the Action Plan favorably references
Harmful Tax Competition as justification for its recommendations. It
also repeats a popular but baseless theory among left-wing academics
and politicians about tax competition--that it promotes a ``race to the
bottom.''
The ``race to the bottom'' theory has claimed for decades that tax
competition would force zero rates on mobile capital. It hasn't
happened. One review of common such claims finds: ``there can be little
doubt that history has proven wrong the prediction of a complete
erosion of capital tax revenue. Comparative data on corporate and
capital tax rates demonstrate that governments in all economies
continue to tax mobile sources of capital, effective capital tax rates
have not changed much compared with the mid-1980s, when tax competition
was triggered by the 1986 U.S. tax act, and tax systems are as varied
as countries and political systems themselves, with no visible sign of
converging.''
Nevertheless, the BEPS report notes: ``In 1998, the OECD issued a
report on harmful tax practices in part based on the recognition that a
`race to the bottom' would ultimately drive applicable tax rates on
certain mobile sources of income to zero for all countries, whether or
not this was the tax policy a country wished to pursue.'' Reality,
essentially, is an unwarranted intrusion on the desire of policymakers
to act without consequence. The BEPS report goes on: ``It was felt that
collectively agreeing on a set of common rules may in fact help
countries to make their sovereign tax policy choices.'' Unless, that
is, their sovereign choice involves something other than raising taxes.
Nations that opt for little to no taxes on capital are a problem for
this quixotic theory of sovereignty--where the rest of the world must
be brought to heel in order to ensure that politicians ought not have
to consider the economic consequences of their policies--hence why the
primary indicator for determining whether a nation is to be identified
as ``potentially harmful'' is that it has ``no or low effective tax
rates.''
Other factors are said to be considered, but without clear indication
of how they are to be weighted any calculation will be arbitrary and
open to excessive emphasis on the ``gateway criterion'' that is a low
tax rate. When a low-tax scourge is identified, the OECD benevolently
provides that, ``the relevant country will be given the opportunity to
abolish the regime or remove the features that create the harmful
effect.'' To make perfectly clear that this is the sort of offer a
nation cannot refuse, they warn: ``Where this is not done, other
countries may then decide to implement defensive measures to counter
the effects of the harmful regime, while at the same time continuing to
encourage the country applying the regime to modify or remove it.''
The OECD's previous aggressions against low-tax jurisdictions in
pursuit of its quest to abolish tax competition make clear just what
``defensive measures'' it has in mind, and how its members will go
about trying to ``encourage'' compliance. In the years that followed
release of Harmful Tax Competition, the OECD used threats of
blacklists, peer pressure, and intimidation to cajole low-tax
jurisdictions into adopting various policies presented under the
auspices of increasing tax transparency and combating evasion. In
practice the changes were intended to undermine the attractiveness of
low-tax jurisdictions and protect high-tax nations from base erosion
due to capital flight.
Of particular relevance for understanding the BEPS initiative is the
pattern demonstrated by the OECD during the course of this campaign.
After each recommendation was widely adopted--typically under duress in
the case of low-tax jurisdictions--the OECD immediately pushed a new
requirement that was more radical and invasive than the last.
The fact that the OECD is always ready with a new policy after one is
implemented suggests either that the organization's goal is not merely
what is stated, or that it is horribly ineffective. In either case it
should serve as a blow to its credibility and a reason to question its
work on BEPS.
Conclusion
Were the OECD merely a research institution, its work could be
dismissed simply as a bad idea that no nation need adopt.
Unfortunately, Europe's dominant welfare states use the OECD's work as
a benchmark when coercing other nations through use of political and
economic leverage. For the low-tax jurisdictions, and now multinational
businesses, caught in the OECD's crosshairs, the ride truly never ends.
The BEPS project is a continuation of the OECD's well-documented effort
to eliminate tax competition, and will likely follow the same pattern
of consistently moving goalposts.
The BEPS project began at the behest of a tiny few, without open and
public debate regarding the assumptions motivating the effort, its
goals, or the most appropriate methods to achieve them. There is a lack
of accountability, reflected in the activities of the BEPS initiative,
that can only be rectified through real public debate and more direct
political oversight.
______
Motion Picture Association of America
December 15, 2015
The Honorable Orrin Hatch The Honorable Ron Wyden
Chairman Ranking Member
Senate Finance Committee Senate Finance Committee
Re: December 1st Hearing: ``International Tax: OECD BEPS and EU
State Aid''
Dear Chairman Hatch and Ranking Member Wyden:
The MPAA and its member companies are grateful to you and your
staffs for your efforts to reform the U.S. tax system. We very much
appreciate the Committee's recent hearing entitled ``International Tax:
OECD BEPS and EU State Aid'' and the examination of the potential
effects of BEPS Actions on U.S. companies. We also are grateful for the
efforts of the various working groups, which helped to advance the tax
reform process.
In particular, we are hopeful that the bipartisan findings of the
International Tax Bipartisan Tax Working Group will provide an impetus
and structure for international tax reform. We believe one of the most
important elements of tax reform will be to modernize our international
tax system in order to put American companies on a level playing field
when competing in the global market place. The current U.S. worldwide
system is an outlier among major developed countries with its high
statutory rates and the imposition of a residual U.S. tax on foreign
earnings. This has a number of adverse economic consequences, causing
our companies to be less competitive overseas, encouraging foreign
ownership of IP, and locking out cash that could be used for domestic
investment. We also agree with the co-chairs' conclusion ``that we must
take legislative action soon to combat the efforts of other countries
to attract highly mobile U.S. corporate income through the
implementation of our own innovation box regime that encourages the
development and ownership of IP in the United States, along with
associated domestic manufacturing.'' \1\
---------------------------------------------------------------------------
\1\ Senate Committee on Finance, Report of the International Tax
Bipartisan Tax Working Group (July 2015), p. 76.
In that regard, we would like to submit the following comments for
the record focused on BEPS Action 5 and the need for the U.S. to adopt
an innovation box to respond to actions being taken overseas. This is
essential to encourage domestic innovation and development, to preserve
and create well-paying U.S. jobs, and to generate economic growth in an
increasingly competitive global marketplace.
Introduction
The MPAA's six members--Walt Disney Studios Motion Pictures,
Paramount Pictures Corporation, Sony Pictures Entertainment, Inc.,
Twentieth Century Fox Film Corporation, Universal City Studios LLC, and
Warner Bros. Entertainment Inc.--produce, distribute and export
theatrical motion pictures, television programming, and home video
entertainment. The studios typically license their IP directly, or
indirectly through subsidiaries, to unrelated parties for distribution
in U.S. and foreign markets. In exchange, they receive royalties that
historically have been subject to tax in the United States.
The motion picture and television industry is an important
productive component of the U.S. economy. The industry employed
directly or indirectly nearly 2 million people in the United States in
2013 and generated $113 billion in wages. Core production, marketing,
manufacturing, and distribution jobs paid an average of $84,000, which
is nearly 70 percent higher than the national average. The industry is
comprised of a nationwide network of tens of thousands small businesses
across all 50 states, with 85 percent of these businesses employing
fewer than 10 people. The industry also supports good jobs and wages in
thousands of companies with which it does business, such as caterers,
hotels, equipment rental facilities, lumber and hardware suppliers,
transportation vendors, and many others. Finally, the industry creates
one of our country's most successful products, garnering a positive
balance of trade with virtually every country to which we export and
generating an overall $13.4 billion trade surplus in 2013.
Background--BEPS Action 5
Several countries have introduced favorable tax regimes for income
that is derived from ownership of intellectual property. These ``IP
Box'' regimes were enacted with the aim of attracting foreign
investment and ownership of IP in the applicable country. Prior to BEPS
and Action 5, such regimes generally have not required work related to
the IP be carried out within the country in order to be eligible for IP
box benefits. Thus, the tax benefit is currently not dependent on
economic activity and innovation taking place in the jurisdiction.
Several OECD countries had raised concerns that these types of
regimes are ``harmful'' and artificially shift IP ownership and taxable
profits away from the country or countries where the value of the IP is
created. In part to address whether these regimes are harmful, the OECD
released its final report on Action 5 ``Countering Harmful Tax
Practices More Effectively, Taking into Account Transparency and
Substance'' in early October. Under the final report, to avoid being
labeled as harmful, a preferential regime generally must require
substantial economic activity occur within the country for a taxpayer
to be eligible for benefits. Specifically, Action 5 proposes that there
must be a nexus between the income receiving the benefits and the
expenses contributing to that income. Put another way, IP income will
only qualify under this ``nexus approach'' for the preferential rates
under an innovation box regime to the extent that the IP development
expenses are incurred in the relevant country. Consequently, companies
wishing to take advantage of the preferential regimes will need to
shift at least a portion of their IP development jobs overseas.
International Tax Reform: The Need for a U.S. Innovation Box
In addition to adopting lower statutory rates and a dividend
exemption system, the U.S. needs to take specific steps to respond to
BEPS and other developments overseas that, if left unanswered, will
result in significant U.S. job and revenue loss. We agree with the co-
chairs of the International Tax Bipartisan Tax Working Group that ``the
anticipated impact of the new nexus requirements on innovation box
regimes will have a significant detrimental impact on the creation and
maintenance of intellectual property in the United States, as well as
on the associated domestic manufacturing sector, jobs, and revenue
base.'' \2\
---------------------------------------------------------------------------
\2\ See id, p. 73.
As noted above, other countries are aggressively seeking to attract
IP creation and commercialization through the introduction of broad IP
regimes and other incentives.\3\ The nexus requirement under BEPS
Action 5 will likely require companies to shift IP development and jobs
overseas in order to take advantage of innovation box incentives.
Because companies like ours are facing increased pressure from
stakeholders to take advantage of these incentives, many will decide to
locate IP ownership and a higher proportion of IP development functions
overseas to establish the requisite ``nexus'' to claim such benefits or
to justify a higher allocation of income attributable to that IP. This
will cause U.S. tax revenues to shrink as the U.S. tax base
attributable to IP decreases and credits for foreign taxes paid on IP
developed and owned overseas increase.
---------------------------------------------------------------------------
\3\ Specifically, with respect to films, many of our major trading
partners (e.g., Australia, Canada, France and the United Kingdom) offer
significant wage credits and other above-the-line incentives to attract
film productions and jobs abroad, in addition to their lower statutory
rates. In fact, recognizing the benefits of film production to its
economy, the United Kingdom this year sweetened its film and television
production incentives by increasing its refundable tax credit from 20
percent to 25 percent for all qualifying UK film expenditure.
To prevent greater migration of IP ownership and quality jobs to
other developed countries, and loss of the associated tax revenue, we
believe the U.S. needs to respond quickly by adopting an IP box that
encourages the development, ownership and commercialization of film and
other IP in the United States. This is essential to counteract BEPS and
other actions overseas, and help ensure that IP development and the
---------------------------------------------------------------------------
associated well-paying jobs remain in the United States.
To date, there are two principal alternative approaches to
designing an innovation box regime. First Congressmen Boustany and Neal
released an innovation box proposal in late July that proposes a 10.15-
percent effective rate of corporate tax on certain ``innovation box
profits'' derived from qualifying IP, including films.\4\ We believe
the inclusion of films in the types of ``qualified property'' eligible
for the innovation box deduction properly reflects the fact that
production of films, like other forms of IP, is highly mobile and
susceptible to other developed countries' incentives. The determination
of innovation box profits would be dependent on a nexus ratio based on
the taxpayer's research and development expenditures in the United
States.
---------------------------------------------------------------------------
\4\ The effective tax rate would be achieved through a 71-percent
corporate tax deduction on ``innovation box profits.''
To ensure the purposes of adopting an IP box are fully met with
respect to films, we believe that certain modifications should be made
to the Boustany-Neal bill that properly account for differences between
the development of films and other forms of IP. Most notably, the ratio
in the discussion draft is based on incurring R&D expenses, rather than
IP production expenditures generally. The production of films, in
contrast to most other forms of IP, requires only limited R&D expenses.
The numerator and denominator of the nexus ratio should be modified
appropriately to reflect all IP development costs (incurred
domestically compared to worldwide), not just R&D expenses. Also, the
inclusion in the numerator and denominator of costs of an expanded
affiliated group will often lead to anomalous results. For example, a
corporation with significant business activities unrelated to
development of IP, such as cruise ships, will be disadvantaged for no
apparent reason relative to competitors without such activities.
Conversely, a corporation that has an affiliate with significant
unrelated IP development activities could be advantaged relative to its
---------------------------------------------------------------------------
competitors.
Also, similar to section 199, income derived from film-related
copyrights and trademarks should be eligible for the deduction under
the discussion draft, because such income is a significant portion of
the film's revenue stream and is essential to the decision whether to
produce a film or not.
In addition, on-line viewing is a rapidly evolving portion of the
film and television market that should be encouraged. Congress
recognized this when it specifically provided that the methods and
means of distributing a film should not affect eligibility under
section 199. Failure to extend eligibility for innovation box benefits
to income derived from digital broadcasts could mean that, as the
demand for digital programming grows, the intended tax incentive for
domestic film production could shrink substantially over time.
Finally, we believe it is important that the benefits of an
innovation box be available to partnerships, as well as corporations. A
substantial number of film projects every year are produced through
partnerships, co-productions and joint ventures. Film production by
partnerships is also susceptible to foreign incentives and the effects
of nexus requirements under BEPS. Thus, to counteract those incentives
and preserve the U.S. revenue base and jobs, partnerships should also
be eligible for innovation box benefits.
The other alternative approach to implementing an innovation box in
the U.S. would be to adopt an approach similar to the one taken by
former Ways and Means Committee Chairman Camp in his tax reform bill
(H.R. 1) to address base erosion.\5\ By establishing a competitive tax
rate on IP income and a balance between the treatment of exported IP
and IP owned overseas, the ``carrot and stick'' approach of H.R. 1 will
promote the creation, ownership and commercialization of IP in the
United States.
---------------------------------------------------------------------------
\5\ See H.R. 1 , ``The Tax Reform Act of 2014,'' sec. 4211.
The incentive effect of the ``carrot'' in H.R. 1 could be enhanced
in several sensible ways. For example, the carrot will be heavily
dependent on how intangible property development expenses are allocated
for purposes of determining foreign intangible income. Specific rules
are provided in the regulations under section 861 to allocate and
apportion R&D expenses (Treas. Reg. sec. 1.861-17). These rules were
adopted in part to encourage domestic research and development.
Applying similar allocation and apportionment rules to film industry
content and other intangible property for purposes of determining net
foreign intangible income would provide similar incentives and help to
ensure the carrot properly encourages domestic production of intangible
---------------------------------------------------------------------------
property.
It would also enhance the ``carrot'' to specify that indirect
expenses are not taken into account in computing net foreign intangible
income. This would exclude expenses not directly allocable to IP
development, including SG&A, stewardship and interest costs. A similar
approach is used in Chairman Camp's discussion draft to define foreign
source taxable income for purposes of the foreign tax credit
limitation. This would provide a consistent approach for both purposes.
Finally, similar to the computation of the ``stick'' (which is done
on a CFC-by-CFC basis), net losses from one transaction should not
offset net intangible income from other transactions in determining the
carrot under the bill.
Conclusion
We are very appreciative of the work by the Finance Committee to
improve our tax system in order to promote domestic job growth and
enhance the global competitiveness of U.S. businesses.
As we have written to the Committee before, our industry is highly
sensitive and responsive to global competition. Recent technological
developments have created an environment where jobs related to the
production of underlying works, and the creation and commercialization
of valuable intellectual property, are more highly mobile than ever
before. At the same time, other countries are becoming more aggressive
in using lower statutory tax rates, targeted tax incentives, broad
innovation box regimes, and other subsidies to attract IP production
and ownership overseas. The nexus requirements under the BEPS project
will create pressures for companies like ours to move film and other IP
development (and the associated jobs) overseas to take advantage of
these incentives. We believe the U.S. must act quickly to respond to
these challenges to avoid migration of IP development to foreign
countries.
We are grateful for your efforts to address these challenges so
U.S. companies remain highly competitive, and IP development (and the
resultant revenue base) remains at home. We believe that a significant
reduction in the U.S. corporate tax rate and adoption of a dividend
exemption system with an appropriate IP box will successfully achieve
these goals.
Please contact Patrick Kilcur (202) 378-9175 if you have any
questions or need anything else from us. We look forward to working
with the Committee members and the staff on these important issues.
Sincerely,
Joanna McIntosh
Executive Vice President, Global Policy and External
Affairs
cc:
Members of the Senate Finance Committee
______
Tax Innovation Equality (TIE) Coalition
Working Together for Tax Innovation Equality
Washington, DC 20005
[email protected]
202-525-4872 ext. 110
Senate Finance Committee
Hearing on OECD BEPS Reports
December 1, 2015
The Tax Innovation Equality (TIE) Coalition is pleased to provide this
statement for the record of the Finance Committee's hearing on the OECD
BEPS Reports.\1\ As the testimony at the hearing made clear, many of
the concerns of the U.S. government and U.S. businesses with the BEPS
Reports would be alleviated by reforming the U.S. tax code. Therefore,
as the Committee considers what actions to take in view of the OECD
BEPS Reports, we urge you to move forward with tax reform that will
modernize the U.S. tax system and help American businesses compete in a
global market. The TIE Coalition believes that the U.S. must: (i)
implement a competitive territorial tax system; (ii) lower the U.S.
corporate tax rate to a globally competitive level; and (iii) not pick
winners and losers in the tax code by discriminating against any
particular industry or type of income--including income from intangible
property (IP).
---------------------------------------------------------------------------
\1\ The TIE Coalition is comprised of leading American companies
and trade associations that drive economic growth here at home and
globally through innovative technology and biopharmaceutical products.
For more information, please visit www.tiecoalition.com.
Recognizing the importance of IP to the U.S. economy, many of the
members and witnesses at the hearing expressed concern about the
adoption of so-called ``innovation boxes'' by OECD countries, raising
questions about whether these measures will result in the movement of
IP jobs from the U.S. to other countries and asking whether the U.S.
should adopt similar measures. The TIE Coalition does not have a
position on the adoption of a U.S. ``innovation box'' but we are very
concerned that in prior international tax reform proposals income from
intangible property (IP) would be singled out for harsher tax treatment
than income from other assets. By discriminating against IP income as
compared to income from other types of assets, these prior proposals
would create an unfair advantage for companies who don't derive their
income from IP and significantly disadvantage the most innovative U.S.
---------------------------------------------------------------------------
companies, especially compared to their foreign competition.
For example, the ``Tax Reform Act of 2014'' (H.R. 1), as introduced by
former House Ways and Means Chairman Camp, would seriously disadvantage
innovative American companies. Under that proposal, Chairman Camp chose
to use what is now widely known as ``Option C.'' \2\
---------------------------------------------------------------------------
\2\ Please note that the TIE Coalition is opposed to both versions
of ``Option C'' (version one of ``Option C'' in the Camp Draft and
version two of ``Option C'' in H.R. 1 as introduced).
The problem with ``Option C,'' is if it became the law of the land, its
adverse tax treatment of IP income would significantly hinder U.S.
companies who compete globally, and it would result in more inversions
of U.S. companies. The TIE Coalition is opposed to ``Option C'' because
it would have a devastating impact on both innovative technology and
---------------------------------------------------------------------------
biopharmaceutical companies.
In an effort to really understand the full scope of ``Option C,'' the
TIE Coalition earlier this year commissioned a study by Matthew
Slaughter, the Dean of the Tuck School of Business at Dartmouth
University. We have attached a copy of the January 2015 study,
entitled, ``Why Tax Reform Should Support Intangible Property in the
U.S. Economy,'' and urge the Finance Committee to consider its findings
when examining options for international tax reform. A copy of the
study can also be found at: http://www.tiecoalition.com/why-tax-reform-
should-support-intangible-property-in-the-u-s-economy.
As Dean Slaughter emphasizes, ``Policymakers should understand the
long-standing and increasingly important contributions that IP makes to
American jobs and American standards of living--and should understand
the value of a tax system that encourages the development of IP by
American companies.'' The study finds that ``Option C'' in the Camp
legislation would fundamentally change the measurement and tax
treatment of IP income earned by American companies abroad. The study
finds that ``Option C'' of the proposal would disadvantage IP income
earned abroad by U.S. companies in three ways. First, it would tax IP
income at a higher rate than under current law. Second, it would tax IP
income more than other types of business income. Third, it would impose
a higher tax burden on the IP income of U.S. companies compared to
their foreign competitors. The likely outcome of using ``Option C'' as
proposed in the Camp legislation would be to increase corporate
inversions and incentives for foreign acquisitions of U.S. based IP
intensive companies.
The Slaughter study finds that the ``United States, not abroad, is
where U.S. multinationals perform the large majority of their
operations. Indeed, this U.S. concentration is especially pronounced
for R&D, which reflects America's underlying strengths of skilled
workers and legal protections such as IP rights that together are the
foundation of America's IP strengths, as discussed earlier.'' The
Slaughter study concludes that the overseas operations of these
companies complement their U.S. activities and support, not reduce, the
inventive efforts and related jobs of their U.S. parents. So it is
increasingly important to America's IP success that these companies
continue to operate profitably overseas and any tax reform proposals do
not impose discriminatory taxes on income from intangible assets
located there.
IP jobs are very important to the U.S. economy and make up a large
portion of the workforce. That is why it is important to have a tax
code that supports the IP economy here in the U.S. To that point, the
U.S. Chamber's Global Intellectual Property Center commissioned a study
on the benefits of IP jobs to economic growth in the U.S. The study
found that in 2008-09 that there were 16 percent or 19.1 million direct
IP jobs and 30 percent or 36.6 million indirect IP jobs in the U.S. IP
or IP related jobs account for 46 percent of the U.S. economy or 55.7
million jobs. With our modernizing economy it is likely that this
number has grown.\3\
---------------------------------------------------------------------------
\3\ See, http://image.uschamber.com/lib/fee913797d6303/m/1/
IP+Creates+Jobs+-+Executive+
Summary+Web+-+2013.pdf.
To be constructive and help the Committee find solutions that will
allow American companies to succeed in a very competitive global
market, the TIE Coalition has developed anti-base erosion solutions
that do not target IP income. We would like to work with the Committee
to develop alternative options that would apply to situations in which
companies are simply trying to shift income to low tax jurisdictions
with no substance or real business presence, but would not discriminate
against income from intangible assets. Such options would apply to
income from all goods and services, not just income from intangible
---------------------------------------------------------------------------
assets.
In conclusion, the TIE Coalition supports tax reform that modernizes
the U.S. tax system, allowing American businesses to compete in global
markets in a manner that does not discriminate against any particular
industry or type of income, including income from intangible property.
As the witnesses at this hearing indicated, many other countries are
lowering their corporate tax rates and adopting tax rules to attract IP
companies to their shores. So, it would be especially harmful to the
U.S. economy to adopt a tax policy that will hurt, not help, American
companies who compete globally. Now is not the time to drive high
paying American jobs overseas.\4\
---------------------------------------------------------------------------
\4\ The U.S. Chamber study found that ``IP-intensive companies
added more than $2.8 trillion direct output, accounting for more than
23 percent of total output in the private sector in 2008-09'' and that
the ``Output per worker in IP-intensive companies averages $136,556 per
worker, nearly 72.5 percent higher than the $79,163 national average.
Id.
______
Why Tax Reform Should Support Intangible Property
in the U.S. Economy
Matthew J. Slaughter
January 2015
About the Author
Matthew J. Slaughter is Associate Dean for Faculty and Signal
Companies' Professor of Management at the Tuck School of Business at
Dartmouth. He is also a Research Associate at the National Bureau of
Economic Research, an adjunct Senior Fellow at the Council on Foreign
Relations, and an academic advisor to the McKinsey Global Institute.
From 2005 to 2007, he served as a Member of the President's Council of
Economic Advisers.
This report was sponsored by the Tax Innovation Equality Coalition. The
views expressed in this report are those of the author.
2015 Matthew J. Slaughter
Executive Summary
America today continues to confront a competitiveness challenge of too
little economic growth and too few good jobs. In the future America has
the potential to create millions of good, knowledge-intensive jobs
connected to the world via international trade and investment. Doing so
will require sound U.S. policies that are based on a comprehensive
understanding of how innovative American companies succeed in today's
dynamic global economy.
In particular, policymakers should understand the long-standing and
increasingly important contributions that intangible property (IP)
makes to American jobs and American standards of living--and should
understand the value of a tax system that encourages the development of
IP by American companies. Unfortunately, the tax-reform proposals in
former House Committee on Ways and Means Chairman Camp's Discussion
Draft, the Tax Reform Act of 2014, would undermine these contributions.
This white paper develops three central messages.
1. The Discussion Draft proposes sweeping changes to the U.S. tax
treatment of IP. It would fundamentally alter the measurement and tax
treatment of IP income earned by the foreign affiliates of U.S.-based
multinational companies--and in so doing would discriminate against
these affiliates' IP income relative to their non-IP income. Moreover,
it would imperfectly measure this IP income--in many cases far too
broadly. The bottom line is that the Discussion Draft would raise the
current U.S. tax liability on IP income earned by the foreign
affiliates of U.S.-based multinational companies--and thus would
discourage these companies' investment in IP.
2. In three important ways, the Discussion Draft would
disadvantage IP income earned abroad by U.S.-based multinationals.
First, the U.S. tax burden on IP income would be higher than the tax
burden on IP income under current law. Second, the U.S. tax burden on
IP income would be higher than the tax treatment of many other forms of
business income under the Discussion Draft. Third, the U.S. tax burden
on IP income of U.S.-headquartered multinational companies would be
higher relative to the tax burden on IP income of their foreign
competitors as compared to current law. This would aggravate the
nettlesome issue of corporate inversions and would create additional
incentives for foreign acquisitions of U.S.-based IP-intensive
companies.
3. Globally engaged U.S.-headquartered multinational companies,
which create the large majority of America's IP, rely on their
worldwide operations to maximize the creativity and benefits of their
U.S. inventions. These globally engaged U.S. companies have long
performed the large majority of America's IP discovery and development.
Increasingly central to America's IP success is the ability of U.S.
companies to operate profitably around the world. The latest research
continues to show that the foreign-affiliate operations of U.S.-based
multinationals complement their U.S. activities. Foreign affiliates
support, not reduce, the inventive efforts and related jobs of their
U.S. parents.
America's economic recovery remains too tentative and productivity
growth has slowed dramatically in recent years. America stands to gain
much from broad and fundamental policy reform that creates an
internationally competitive tax system. But that reform should not
discriminate against IP and its increasingly important contributions to
the American economy.
Section One:
Overview of the Discussion Draft's Proposals
for Reform of U.S. Tax Treatment of IP Income
------------------------------------------------------------------------
-------------------------------------------------------------------------
The Discussion Draft would enact sweeping changes to U.S. tax treatment
of IP. It would fundamentally alter the measurement and tax treatment
of IP income earned by the foreign affiliates of U.S.-based
multinational companies--and is so doing would discriminate against
these affiliates' IP income relative to their non-IP income. Moreover,
it would imperfectly measure this IP income--in many cases far too
broadly. The bottom line is that the Draft would raise the current U.S.
tax liability on IP income earned by the foreign affiliates of U.S.-
based multinational Companies--and thus would discourage these
companies' investment in IP.
------------------------------------------------------------------------
The Treatment of Intangible Income Under the Discussion Draft:
Description of FBCII
In February 2014, Chairman of the House Committee on Ways and Means,
Dave Camp (R-MI), introduced a Discussion Draft on comprehensive tax
reform, the Tax Reform Act of 2014. This Discussion Draft proposed
sweeping changes to America's taxation of both individuals and
corporations overall--including current taxation of intangible income
of U.S.-headquartered multinational companies.\1\
---------------------------------------------------------------------------
\1\ At the end of the 113th Congress, the Discussion Draft of
Chairman Camp was formally introduced as H.R. 1, The Tax Reform Act of
2014. At the time of writing in early 2015, the 114th Congress showed
no indications of reviving this bill.
Under current law, when a foreign subsidiary of a U.S.-headquartered
multinational earns income in a foreign jurisdiction, that income--
regardless of whether related to tangible property or to intangible
property (IP)--generally can be deferred and does not bear U.S. tax
until the income is distributed to the U.S. parent. Thus, like other
income, a foreign subsidiary's intangible income generally is not
taxable in the United States so long as it is not repatriated back to
the U.S. parent. Stated differently, a foreign subsidiary's intangible
income is not currently subject to immediate taxation under Subpart
F.\2\
---------------------------------------------------------------------------
\2\ The Internal Revenue Service defines intangible property to
include the following six broad sets of ideas and related economic
manifestation thereof: ``computer software; patents, inventions,
formulae, processes, designs, patterns, trade secrets, or know-how;
copyrights and literary, musical, or artistic compositions; trademarks,
trade names, or brand names; franchises, licenses, or contracts;
methods, programs, systems, procedures, campaigns, surveys, studies,
forecasts, estimates, customer lists, or technical data.'' See this
definition and related discussion at http://www.irs.gov/irm/part4/
irm_04-048-005.html. This paper follows this definition of intangible
property.
When fully phased in over 5 years in 2019, the Discussion Draft would
implement a statutory corporate tax rate of 25 percent, 10 percentage
points below today's rate of 35 percent. In addition, it would
effectively replace today's worldwide taxation of U.S.-based
multinationals with a hybrid territorial system. The non-IP related
foreign earnings of U.S.-based multinationals would enjoy a dividends-
received deduction of 95 percent. This would result in an effective
U.S. tax rate of just 1.25 percent on the non-IP related foreign-
affiliate earnings repatriated back to U.S. parents through
dividends.\3\ Thus, the Discussion Draft would establish a baseline of
largely exempting from U.S. taxation the non-IP related income of the
foreign subsidiaries of U.S. multinationals.
---------------------------------------------------------------------------
\3\ The tax rate of 25 percent applied to the non-deductible 5
percent of foreign-affiliate non-IP related earnings results in an
effective tax rate on those earnings of just 1.25 percent (5 percent
multiplied by 25 percent).
The IP-related income of these foreign subsidiaries would be treated
quite differently, however. Section 4211 of the Discussion Draft would
create a new category of immediately taxable income, ``foreign base
company intangible income'' (FBCII), and thus would replace today's
deferral-based worldwide system with a pure worldwide system for IP-
related income. Here is the definition: \4\
---------------------------------------------------------------------------
\4\ Tax Reform Act of 2014 Discussion Draft, Committee on Ways and
Means Majority Tax Staff, pp. 149-150. House Ways and Means Committee
Majority Counsel and Special Advisor for Tax Reform Ray Beeman later
clarified that FBCII would likely include royalties, after initial
uncertainty arose on this. ``I don't believe we meant to exclude
royalties because that is where we started in the process. . . . That's
definitely something we will want to go back and evaluate.''
FBCII would equal the excess of the foreign subsidiary's gross
income over 10 percent of the foreign subsidiary's adjusted
basis in depreciable tangible property (excluding income and
---------------------------------------------------------------------------
property that are related to commodities).
In addition, the calculation of FBCII would also subtract from gross
income an ``applicable percentage'' of the foreign affiliate's other
``foreign base company income,'' or FBCI. Depreciable tangible property
consists of physical assets used by the affiliate in the course of its
production, such as office buildings and equipment. The adjusted basis
on this tangible property would be determined each tax year in
accordance with rules specified elsewhere in the tax code. The 10
percent applied to the adjusted basis in depreciable tangible property
receives little explanation in the Discussion Draft or its technical
explanation, beyond being described as ``in effect exempting normal
returns on investments in tangible property.''
Consistent with current U.S. tax treatment of Subpart F income, this
newly created FBCII would cause an immediate tax liability for a U.S.
multinational. The effective tax rate applied to FBCII would vary
depending on whether the goods and services linked to that FBCII were
for use inside or outside of the United States.
For goods and services for use in the United States--e.g., for FBCII
realized by a foreign affiliate exporting products back to customers in
the United States--the effective tax rate on FBCII would ultimately be
the Discussion Draft's statutory rate of 25 percent. This 25 percent
tax rate on U.S.-connected foreign-affiliate IP earnings would be 20
times the effective tax rate of 1.25 percent that the Discussion Draft
would levy on non-IP related earnings of foreign affiliates.
For ``foreign derived'' FBCII related to goods and services intended
for use outside the United States, the Discussion Draft would allow a
deduction that, if enacted, would result in a lower effective tax rate.
``The U.S. parent could claim a deduction equal to a percentage of the
foreign subsidiary's FBCII that relates to property that is sold for
use, consumption, or disposition outside the United States or to
services that are provided outside the United States.'' \5\ During the
phase-in years, the amount of this deduction from FBCII would phase
down in conjunction with the phase-in of the new lower statutory
corporate tax rate, ultimately reaching 40 percent starting in 2019.
This 40 percent deduction, if enacted, would imply a 15 percent
effective tax rate on FBCII linked to foreign sales. A 15 percent tax
rate on foreign-derived foreign-affiliate IP earnings would be 12 times
the effective tax rate of 1.25 percent that the Discussion Draft would
levy on non-IP related earnings of foreign affiliates.\6\
---------------------------------------------------------------------------
\5\ Tax Reform Act of 2014 Discussion Draft, Committee on Ways and
Means Majority Tax Staff, p. 150.
\6\ Suppose a foreign affiliate earns FBCII of 100 through sales to
host-country customers. Then against its FBCII it can claim a deduction
of 40 (i.e., of 40 percent of 100) and thus face a
deduction-included FBCII of just 60. A statutory 25-percent tax on this
60 yields 15; thus would the effective tax rate on FBCII linked to
foreign sales be just 15 percent.
This deduction would also be available to any U.S. corporation that
earns foreign intangible income directly--e.g., through exports from
the United States to a foreign customer--rather than through a foreign
affiliate. Thus, a U.S. company--a purely domestic company or a U.S.
parent of a U.S. multinational--would also face an effective tax rate
of 15 percent (assuming the 40 percent deduction applies), rather than
the baseline statutory rate of 25 percent, on intangible income linked
---------------------------------------------------------------------------
to sales or services abroad.
This particular deduction, if enacted, results in an effective rate of
15 percent on intangible income from serving foreign markets regardless
of the location of intangible property or whether it is earned by the
foreign affiliate or by the U.S. parent. Chairman Camp therefore
claimed that the Discussion Draft ``removes incentives companies
currently have to move their innovation offshore, by providing a
neutral 15-percent tax rate on profits from innovations regardless of
whether the manufacturing takes place in the United States or
overseas.'' \7\
---------------------------------------------------------------------------
\7\ The Tax Reform Act of 2014: Fixing Our Broken Tax Code So That
It Works for American Families and Job Creators, House Ways and Means
Committee, p. 20. These revenue estimates should most accurately be
thought of as 9-year estimates (rather than the more-common 10-year
estimates) because its effective date is generally the tax years
beginning after 12/31/14.
To avoid foreign affiliates facing double taxation of FBCII, their
effective U.S. tax would be reduced for any affiliate whose FBCII first
faced a tax liability to the host-country tax authorities: all foreign
taxes on FBCII would be eligible for credit against the U.S. tax. FBCII
would be taxable immediately in the U.S. only when that foreign
---------------------------------------------------------------------------
effective tax rate was lower than the effective U.S. tax rate.
Relative to current law, which leaves untaxed by the U.S. any un-
repatriated foreign-affiliate intangible income, the Discussion Draft
would raise substantial amounts of U.S. tax revenues. This is mainly
because it would treat all such FBCII as immediately taxable (subject
to any foreign tax credits). The Joint Committee on Taxation estimated
that this new FBCII, along with some related changes, would raise net
U.S. tax revenues by $115.6 billion over the years of 2014 through
2023.\8\
---------------------------------------------------------------------------
\8\ Technical Explanation of the Tax Reform Act of 2014: Title
III--Business Tax Reform, Joint Committee on Taxation, JCX-14-14,
February 26, 2014.
---------------------------------------------------------------------------
The Discussion Draft Would Disadvantage the IP Income of Foreign
Affiliates of Multinationals
Under Discussion Draft the IP income of foreign affiliates of U.S.
multinationals (as calculated under the FBCII formula) would become
immediately taxable income. This would mean foreign affiliates would
face a higher rate of U.S. taxation on their IP income than they do
today under current law. These affiliates may face some foreign tax
liability on this IP income (a foreign tax liability that would tend to
offset any U.S. tax liability). But today there is no U.S. tax
liability until and unless that IP income is repatriated. Under the
Discussion Draft, that IP income would face an immediate additional
U.S. tax liability of up to 25 percent.
As described above, the effective tax rate on this FBCII is intended to
be the statutory 25 percent for income linked to serving U.S. customers
and 15 percent for income linked to serving foreign customers--the
lower effective rate attainable only if the intended 40 percent deemed
deduction of the calculated FBCII ends up enacted into law. So, under
the Discussion Draft, a foreign affiliate of a U.S.-headquartered
multinational would face a U.S. tax rate on IP income somewhere between
12 and 20 times the effective tax rate of 1.25 percent that the Draft
would levy on non-IP related earnings of that foreign affiliate.
A fundamental problem with the overall structure of Discussion Draft is
it would disadvantage IP income earned abroad by U.S.-based
multinationals. The U.S. tax burden on IP income under the Draft would
be higher compared with the tax burden on IP income under current law.
And the U.S. tax burden on IP income under the Draft would be higher
compared with the U.S. tax burden on many other forms of business
income under the Draft. As Section Two of this paper will discuss,
there is no economic rationale for discriminating against IP income.
Indeed, as Section Three of this paper will discuss, IP has long driven
the large majority of the productivity growth and job creation at the
foundation of generations of American economic success--investment in
which is complemented by the foreign affiliates of U.S. multinationals.
The Discussion Draft's policy preference for foreign affiliates
intensive in the ownership and use of tangible property is underscored
by the FBCII formula itself. The larger the adjusted basis in
depreciable tangible property that a foreign affiliate owns, the
smaller the affiliate's FBCII would be and thus its current U.S. tax
liability (thanks to being able to subtract off 10 percent of the
adjusted basis). As Section 2 discusses, this preference would tend to
dampen investment in tangible property in the United States by U.S.-
based multinational companies.
Beyond this fundamental economic problem with the Discussion Draft's
increased and uneven taxation of foreign-affiliate IP income, two other
concerns with the design of FBCII merit mentioning: its formulary
approach and its possible violation of World Trade Organization (WTO)
obligations. Consider each of these in turn.
Using the formula of FBCII to measure IP-related income of foreign
affiliates would constitute a radical departure from the current
practice of defining and taxing income based on legal and market-based
definitions that distinguish different sources and kinds of income
based on the assets and/or the operations generating the income. This
deviation has little precedent, either within the history of U.S. tax
code or in terms of other countries' treatment of IP income.
This formulary approach to measuring IP income does promote
administrative simplicity because it would not require companies to
identify specific intangible assets or income flowing from those
intangible assets. On this point, here are the words of House Ways and
Means Committee Majority Counsel and Special Advisor for Tax Reform Ray
Beeman.\9\
---------------------------------------------------------------------------
\9\ Comments delivered on a March 7, 2014 webcast sponsored by
KPMG, LLP.
We developed a formula that would apply to everybody. We could
have gone in a direction where you created exact ways to
measure embedded intangible income. . . . The formula should be
a lot simpler to apply. . . . We are aware of and appreciate
the fact that in service industries, there may be more of an
effect. . . . Now I think we have something that is probably
not always going to perfectly measure intangible income, but
it's far easier to use. It's a formula that basically measures
the return on invested capital . . . an example where you see
---------------------------------------------------------------------------
precision in measuring income at war with simplicity.
Simple though the administration of FBCII might be, as will be
discussed below, conceptually it is only vaguely linked to IP and thus
cannot capture and adjust for the complex variety of business models
both within and across industries. This vague link is especially
worrisome given today's reality of U.S.-based companies increasingly
producing their goods and services in elaborate global supply networks
dictated by their evolving business needs. And, it is essential to
stress again, these measurement problems of FBCII sit in the broader
context of the more-fundamental problem with FBCII discussed above;
namely, that it discriminates against the IP that has long driven the
large majority of the productivity growth and job creation at the
foundation of generations of American economic success.
On measurement, it is also important to note there is no obvious
economic rationale for setting this percentage at 10 percent, rather
than at some other share. This chosen percentage is intended to be a
``normal'' return to tangible investments. But there is nothing
inexorable about this 10 percent. In particular, there is no
established research literature supporting its chosen constancy.
Rather, it is well documented that different countries often have
persistently different real interest rates because of different
underlying fundamentals. Simple though a fixed rate of return of 10
percent might be, no standard economic theory or evidence supports its
blanket application in FBCII.
The other design feature of the Discussion Draft's treatment of IP
income that raises concerns is the possibility that it may not comply
with the rules of the World Trade Organization (WTO). Recall the tax
rate of 15 percent that the Draft aims to impose on IP income linked to
foreign customers regardless of whether that foreign customer is served
by a U.S. multinational's U.S. parent or foreign affiliate (again,
assuming that the 40 percent deduction is applied to foreign-linked IP
income). This means a U.S. company earning IP income from exports would
pay a 15-percent tax rate. But IP income stemming from the imports by a
U.S. customer from a foreign affiliate of a U.S. multinational would be
subject to a 25 percent tax rate. Many WTO rules prohibit countries
from subsidizing exports relative to imports. Thus have a number of
analysts voiced concern about taxing income from imports at a higher
rate than income from exports.
For example, scholar Reuven S. Avi-Yonah has commented that Section
4211 ``translates into a 15 percent tax rate applied to rents from
exports but a 25 percent rate on rents from imports, which raises
serious WTO compatibility issues.'' \10\ Similarly, ``former Ways and
Means staffer John Buckley previously argued that [a similar provision,
Option C in the 2011 Camp international tax reform draft, which largely
resembles the Discussion Draft's treatment of FBCII,] violated WTO
agreements as a prohibited export-contingent subsidy.'' \11\
---------------------------------------------------------------------------
\10\ ``The Devil Is in the Details: Reflections on the Camp
Draft,'' by Reuven S. Avi-Yonah, in Tax Notes International, March 24,
2014, p. 1056.
\11\ ``Royalties Included in Reduced Intangibles Rate in Camp
Draft, Ways and Means Says,'' by Andrew Velarde, Tax Notes, March 11,
2014.
For over a decade the WTO has been struggling to close a successful
Doha Development Round and to make progress on other important
initiatives such as updating the original Information Technology
Agreement. In this fragile trade-policy environment, a new U.S.
violation of WTO rules would not help. And history clearly demonstrates
that U.S. tax-related WTO violations can carry serious consequences--
for example, when U.S. law regarding Foreign Sales Corporations was
---------------------------------------------------------------------------
forced to be altered because of such violations.
Regardless of whether the higher tax rate on affiliates' exports to
America would be WTO compliant, it clearly would impair the global
competitiveness of these affiliates relative to foreign-headquartered
companies exporting to America because under the Discussion Draft,
foreign companies would face no FBCII tax. This anti-competitive
implication of the Draft Section Two explores. For now, it also
underscores a substantial concern about the Draft's practical
implementation, to which this paper now turns: the challenges of
measuring FBCII in today's complex reality of global supply networks.
Measuring FBCII Would Not Be Simple in Today's Complex Reality of
Global Supply Networks
In today's era of rapidly expanding global supply networks, measuring
FBCII by a simple formula would be only vaguely linked to IP
conceptually and would not be adjustable for a complex variety of
business models within and across industries. For example, in these
networks global companies often choose not to own the physical assets
involved in the production of their goods and services. It is critical
to stress that favoring owned tangible assets in today's era of
globalized production is a major conceptual mismatch of FBCII.
A distinguishing feature of the world economy over the past generation
has been the fragmentation of production. Companies increasingly
produce within elaborate global supply networks in which parts of final
products are made by companies of all sizes, in many stages, spanning
many countries, and linked together by knowledge, trade, and
investment. How companies produce their goods and services today
differs dramatically from earlier generations, when companies made in-
house most of the components and value of their products.
This proliferation of global supply networks is a striking and (barring
catastrophe) irreversible feature of the world economy in which
companies must operate to succeed. Three main forces account for their
rise.
One has been widespread reductions in political barriers to trade,
investment, and immigration. At the multilateral level, the Uruguay
Round, in many ways the most comprehensive trade agreement ever, was
implemented in the years after its 1994 closing. At the national level,
a number of far-reaching unilateral, bilateral, and regional
liberalizations have been implemented in the past generation, including
the North American Free Trade Agreement in 1994 and China's accession
to the World Trade Organization (WTO) in December 2001. At the industry
level, the WTO Information Technology Agreement was signed in 1996,
whereby 70 countries representing about 97 percent of world trade in IT
products agreed to eliminate duties on hundreds of intermediates,
capital goods and final products in the IT industry. Government
restrictions on inward and outward foreign direct investment (FDI) have
also fallen.
A second important force driving global supply networks has been the
choice of many mainly labor-abundant countries to allow their billions
of citizens to integrate into the global economy by lowering trade and
investment barriers--rather than choosing to prevent globally engaged
companies from competing in their markets, as so many countries did
over much of the 20th century. Prominent here are the BRIC countries of
Brazil, Russia, India, and China.
The third and perhaps most dramatic force driving global supply
networks has been IT innovations that have driven to near zero the cost
of global communication and information transmission. In the past
generation, connectivity and communication facilitated by IT and the
Internet have dramatically reduced the costs of trading many goods and,
for services as discussed above, vastly expanding the scope of what
activities are tradable.
This IT revolution has interacted with the first two forces. The
conscious choice of so many countries to connect to the global economy,
plus falling policy barriers to the international flow of ideas,
people, capital and products, have opened to global companies
dramatically more options for how to configure what they produce where.
But in many ways it has been IT that has made these options both low-
enough cost to do and also manageable despite this complexity.
The net result of these three forces has been a proliferation of global
supply networks: elaborate and fluid structures in which companies
locate different production tasks in different countries, some
performed in-house and others with external partners. The productivity
gains have been enormous: more innovation, lower costs, faster customer
responsiveness and lower risks. The result for America (and others) is
deeply globally engaged companies, each determining and building its
strengths connected to the world to ensure continued success in keenly
competitive world markets.
Publicly available data on U.S.-headquartered multinational companies
shed clear light on how important global production networks are to
them. Figure 1A provides one indicator of this. For each of three years
1989, 1999 and 2009, it reports the share of total sales of U.S.
parents and foreign affiliates of U.S.-headquartered multinational
companies.\12\
---------------------------------------------------------------------------
\12\ Every year since 1977, the U.S. Bureau of Economic Analysis
has multinational companies in America through legally mandated surveys
(with penalties for noncompliance) that collect and publicly
disseminate operational and financial data. By design, BEA statistics
track all multinational companies in the United States: both the U.S.
parents of U.S.-headquartered multinationals (as well as their foreign
affiliates) and the U.S. affiliates of foreign-headquartered
multinationals (but not their foreign parents). In accord with the
practice of many countries, the BEA defines a U.S.-headquartered
multinational company as any U.S. enterprise (the ``parent'') that
holds at least a 10 percent direct ownership stake in at least one
foreign business enterprise (the ``affiliate''). The BEA analogously
defines a U.S. affiliate of a foreign-headquartered multinational
company as any U.S. enterprise in which at least a 10 percent direct
ownership stake is held by at least one foreign business enterprise. In
Figure 1A, shares data were obtained from the BEA data online at
www.bea.gov.
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
The key message of Figure 1A is that the share of intermediate inputs
(i.e., of goods and services that companies purchase from other
companies to help produce their own goods and services) in total sales
has been high and rising for both the U.S. and foreign operations of
U.S.-based multinationals: from 66.6 percent in 1989 to 68.0 percent in
1999 and 73.3 percent in 2009 for U.S. parents and from 71.7 percent in
1989 to 74.5 percent in 1999 and 76.5 percent in 2009 for foreign
affiliates. These high and rising shares reflect the deepening
---------------------------------------------------------------------------
engagement of these companies in global supply networks.
Looking at different industries offers additional insight into the
dynamic evolution of how these companies produce. Companies changing
their positions in global supply networks sometimes switch primary
industry--and this trend has increased over time as companies switch
focus from goods to services. In the words of the U.S. Department of
Commerce:
The tendency for U.S. sellers of goods to shift their
activities from manufacturing toward wholesale trade predates
1999, but it has been growing in importance. For example, the
number of parent companies whose primary industry
classification changed from manufacturing to wholesale trade in
1999-2009 more than doubled from the preceding 10-year period.
The acceleration in this trend may be partly related to the
rise of global value chains in firms' business strategies.\13\
---------------------------------------------------------------------------
\13\ Barefoot, Kevin B., and Raymond J. Mataloni, Jr. 2011.
``Operations of U.S. Multinational Companies in the United States and
Abroad: Preliminary Results from the 2009 Benchmark Survey.'' Survey of
Current Business, November, pp. 29-55.
This blurring of traditional distinctions between goods and services,
not just across but even within companies, is a hallmark of global
supply networks. These networks allow the production of goods to be
unbundled into a collection of inputs that are not just goods but
services as well--and conversely the production of services such as
wholesale trade, may require supply chains of goods. Successful
globally engaged companies must continually shift the blend of goods
and services they produce and sell. Indeed, many of America's leading
manufacturing companies make and sell services as an essential part of
their overall operations. One recent study found that companies whose
main business was manufacturing are among America's largest exporters
and importers of services spanning R&D, business processing, and
management consulting.\14\
---------------------------------------------------------------------------
\14\ Barefoot, Kevin B., and Jennifer Koncz-Bruner. 2012. ``A
Profile of U.S. Exporters and Importers of Services.'' Survey of
Current Business, June, pp. 66-87.
The clear implication of the rise of complex global supply networks is
that FBCII would be only vaguely linked to IP conceptually and would
not be adjustable for the complex variety of business models within and
across industries. This combination of features means FBCII likely
would carry two unattractive features: (1) it would capture an
unreasonably large fraction of current affiliate income, sharply
reducing the Discussion Draft's stated goal of largely exempting from
U.S. taxation foreign-affiliate income; and (2) it would measure cross-
industry variation that is only somewhat linked to common measures of
industry IP intensity because of variation driven by different global-
---------------------------------------------------------------------------
supply-network strategies of different companies.
Consider, for example, a labor-intensive foreign affiliate whose many
employees work with capital goods that are leased from its main
customer in making its products. Under the FBCII formula, because this
affiliate owns little tangible capital it would have very little to
subtract from its gross income--and thus would be measured as having
high IP-related income regardless of the actual IP intensity (or lack
thereof) of the underlying production activities.
More generally, companies that are more adept in situating themselves
into the high-value-added positions of global supply networks will be
companies that earn high profits whether or not those positions are in
any way linked to IP assets. In some cases IP would be involved in a
successful global production strategy, but surely not in all cases as
there are a number of non-IP-related strategies that can yield
profitability. High-quality customer service, for example--perhaps
linked to products wisely tailored to local tastes--can generate high
foreign-affiliate income regardless of any particular role for IP.
This problematic tendency of FBCII to measure income as IP-related when
it actually is not has been identified by a number of analysts. Here,
for example, is an excerpt from a Tax Notes International article that
includes the thoughts of Peter Merrill of PWC.\15\
---------------------------------------------------------------------------
\15\ ``The Camp Proposal: Patent Boxes in the Age of BEPS,'' by
Marie Sapirie, Tax Notes International, March 24, 2014, p. 1065.
Taxpayers in the services industry may not like the proposal
much, particularly if they do not have significant amounts of
depreciable property. Merrill pointed out that under the draft
[Camp bill], a services firm could face a situation in which
nearly all of its foreign income becomes FBCII. That result is
contrary to the residual profit-split method used in transfer
pricing, which gives a routine return for things like payroll
and other factors of production before allocating residual
profits. Merrill said the focus on depreciable property has
implications for other types of industries, too. Banks, for
example, have mostly non-depreciable assets would get no return
on those assets under the formula, he said. Taxpayers who rent
buildings and equipment abroad would have a huge incentive to
buy them. . . . Another complication would arise when a company
has acquired another company that has already depreciated its
assets and would therefore have no tangible returns to reduce
---------------------------------------------------------------------------
the amount . . . attributed to intangible income.
In general, foreign affiliates with low profits--for whatever long-
terms structural or short-term cyclical reasons--will have little or no
FBCII. In contrast, foreign affiliates with large profits and/or little
tangible property will have FBCII calculated to be very close to their
total profits. In a world of constantly evolving global supply
networks, only some of this variation in calculated FBCII will be
driven by variation in IP-intensity. This less-than-tight correlation
between calculated FBCII and
IP-intensity is far from ideal.
These measurement concerns can be demonstrated using publicly available
Bureau of Economic Analysis (BEA) data on the operations of majority-
owned foreign affiliates of U.S.-headquartered multinational companies
(see note 12). Figure 1B below uses these BEA data for the most recent
year available, 2012, to approximate the formulaic calculation of FBCII
of these foreign affiliates, both for all industries together and for a
number of particular industries.
To estimate FBCII, the formula's ``gross income'' is approximated using
the BEA's measure of net income.\16\ The formula's ``depreciable
tangible property'' is approximated using the BEA's measure of net
property, plant, and equipment (PPE) assets--i.e., the book value of
these PPE assets net of accumulated depreciation charges. The
Discussion Draft may intend to include other types of tangible
property, but PPE are clearly an important part of this concept.
Finally, the publicly available BEA data do not contain sufficient
detail to adjust FBCII for the other ``foreign base company income;''
this may result in a slight over-estimate of FBCII. The six industries
in Figure 1B highlighted with an asterisk are, as Section 3 will
discuss, on many measures among America's most IP-intensive. One is
software; the other five are part of manufacturing: pharmaceuticals,
machinery, computers, electrical equipment, and transportation.
---------------------------------------------------------------------------
\16\ Note that these BEA calculations assume that implementation of
FBCII would not measure gross income as something like total revenues--
i.e., would not encompass basic costs of goods sold such as materials
purchased and payroll. If FBCII approximated gross income with
something broader like total revenues, then the mismeasurement of FBCII
discussed in the text would be all the more egregious because it would
capture business expenses wholly unrelated to IP such as purchases of
electricity, heating fuel, water, and sewer connectivity.
Figure 1B: Estimated FBCII for U.S.-Multinational Affiliates, 2012
----------------------------------------------------------------------------------------------------------------
Industry Group Net Income ($M) Net PPE Assets ($M) Calculated FBCII FBCII Share of NI
----------------------------------------------------------------------------------------------------------------
All Industries 1,062,817 1,283,875 934,430 87.9%
----------------------------------------------------------------------------------------------------------------
Manufacturing 176,714 399,922 136,722 77.4%
----------------------------------------------------------------------------------------------------------------
Pharmaceuticals * 42,376 28,089 39,567 93.4%
----------------------------------------------------------------------------------------------------------------
Machinery * 13,252 22,417 11,010 83.1%
----------------------------------------------------------------------------------------------------------------
Computers * 36,428 46,456 31,782 87.2%
----------------------------------------------------------------------------------------------------------------
Electrical Equipment * 5,366 8,043 4,562 85.0%
----------------------------------------------------------------------------------------------------------------
Transportation Equipment * 1,915 50,028 -3,088 -161.2%
----------------------------------------------------------------------------------------------------------------
Software* 14,633 3,128 14,320 97.9%
----------------------------------------------------------------------------------------------------------------
Retail Trade 8,991 63,392 2,652 29.5%
----------------------------------------------------------------------------------------------------------------
Wholesale Trade 69,593 45,727 65,020 93.4%
----------------------------------------------------------------------------------------------------------------
Finance and Insurance 93,665 37,127 89,952 96.0%
----------------------------------------------------------------------------------------------------------------
There are two important points from the analysis in Figure 1B. First,
FBCII would seem to encompass the very large share of total foreign-
affiliate net income of not just IP-intensive industries but of many
other industries as well. For all industries this share is estimated to
be 87.9 percent. For five of the six IP-intensive industries in Figure
1B this share exceeds 80 percent--and for two, pharmaceuticals and
software, it exceeds 90 percent. The only other such estimate of FBCII
to date, by Martin Sullivan, uses IRS data but reaches a very similar
conclusion: his estimates from 2008 IRS data conclude that for all
industries 79 percent of total earnings and profits of foreign
subsidiaries would be considered FBCII.\17\
---------------------------------------------------------------------------
\17\ ``Camp's Approach Treats Most CFC Income as Intangible,'' by
Martin A. Sullivan, in Tax Notes International, March 24, 2014.
Whether such breadth of scope was intended when creating FBCII, in
light of the above discussion of global supply networks this share
seems implausibly high. To attribute to IP assets about or over 80
percent of all foreign-affiliate earnings misses the many other reasons
for success such as high-quality products, responsive customer service,
and efficient links to input suppliers. It seems to border on
tautological to consider advantages of IP as encompassing all the many
competitive advantages firms develop and deploy. Indeed, these FBCII
calculations might more broadly call into question the notion that the
Discussion Draft creates a near-
territorial tax system for the United States. If upwards of 87.9
percent of all foreign-affiliate income is immediately taxable as
Subpart F FBCII at rates of at least 15 percent, then only 12.1 percent
of foreign-affiliate income would be left eligible for territorial
treatment. It is doubtful such a regime would be more territorial than
---------------------------------------------------------------------------
today's worldwide-plus-deferral regime.
The second important message of Figure 1B is the insensitivity of FBCII
calculations to legitimate variation in business strategies and
environments unrelated to IP--even among those industries that
scholarship shows are IP-intensive.
To see this, compare transportation equipment to pharmaceuticals and
software. Transportation equipment has nearly twice the PPE assets of
pharmaceuticals and over 10 times that of software, which at least
partly reflects the obvious difference in production technologies among
the sectors. Building planes, trains, and automobiles requires massive
amounts of sophisticated equipment and buildings. And the underlying
demand dynamics often differ among these sectors. Much of the personal
and business demand for transportation equipment is very sensitive to
business-cycle conditions such as overall GDP growth, employment, and
consumer confidence--conditions that in 2012 remained sluggish and
fragile in regions such as the Europe. Demand for pharmaceuticals and
software, in contrast, is often much less cyclically sensitive.
For these economic reasons, it is not surprising that 2012 net income
in transportation equipment was so much lower than in pharmaceuticals
and software. But the FBCII formula does not account for these economic
differences in any way--and thus implies a vastly different tax
liability for the two sectors. Pharmaceuticals and software face an
FBCII estimated to be 93.4 percent and 97.9 percent of each's overall
net income, respectively. But transportation equipment, because it
earned so little net income and owned so many tangible assets, has
negative FBCII.
Other IP-intensive businesses in Figure 1B resemble pharmaceuticals and
software. Electrical equipment, for example, has been widely studied as
having some of the world's most elaborate global supply networks in
which participating companies tend to occupy relatively narrow spaces
within the networks and contract heavily with partners for key
intermediate inputs and even for renting shared production capacity.
Thus it is not surprising how it, too, looks asset-light and has FBCII
at a high 85 percent share of net income.
Surely some of the estimated FBCII for affiliates in pharmaceuticals,
software, and electrical equipment is surely connected to their IP. But
some of it is not, and the FBCII methodology would allow no way to
distinguish these underlying causes. Regardless, of all this calculated
FBCII would face an immediate U.S. tax liability of between 15 percent
and 25 percent--i.e., between 12 and 20 times the effective tax rate of
1.25 percent that the Discussion Draft would levy on non-IP related
earnings of foreign affiliates.
It is important to stress that, with the continued expansion of global
supply networks, foreign affiliates increasingly operate for global
distribution, which includes exporting goods and services to the United
States--either to U.S. parents or to purely domestic unrelated U.S.
companies. This increasingly important dimension of global supply
networks means that over time, a rising fraction of the FBCII
calculated in Figure 1B would, under the Discussion Draft, face an
immediate tax liability of 25 percent rather than just 15 percent (as
discussed earlier in this section).
Figure 1C demonstrates this point. For the four most recent years of
BEA data, the figure reports for majority-owned foreign affiliates
their exports to the United States of goods (exports of services are
tracked by BEA only infrequently); their total manufacturing sales, as
a proxy for goods sales; and the share of these U.S. exports in
affiliates' total manufacturing sales.
Figure 1C: Rising U.S.-Export Intensity of Foreign Affiliates
----------------------------------------------------------------------------------------------------------------
Goods Exports to U.S. ($ Manufacturing Sales ($
Year Billion) Billion) Export Share
----------------------------------------------------------------------------------------------------------------
2009 258.1 2,029.4 12.7%
----------------------------------------------------------------------------------------------------------------
2010 292.6 2,228.6 13.1%
----------------------------------------------------------------------------------------------------------------
2011 345.3 2,570.2 13.4%
----------------------------------------------------------------------------------------------------------------
2012 346.4 2,525.2 13.7%
----------------------------------------------------------------------------------------------------------------
The key message of Figure 1C is the steadily rising share of foreign
affiliates' goods production that is exported to the United States:
from 12.7 percent in 2009 to 13.7 percent in 2012. This rising share
accords with the substantial body of research that has documented the
spread of global supply networks.\18\ Indeed, much of what affiliates
are exporting to America are today intermediate inputs essential in the
production of goods and services made in America. In recent years, over
60 percent of America's goods imports were intermediate inputs that
were used in America with American workers, capital and know-how.\19\
To succeed in global supply networks increasingly requires U.S.
companies to import as well as export. ``Made in America'' increasingly
hinges on creative new ways to make goods and services in conjunction
with the world--including in conjunction with the foreign affiliates of
U.S.-based multinationals. Yet under the Discussion Draft, the FBCII of
these foreign affiliates connected to exports back to America and other
ways of serving U.S. customers will face an immediate tax liability of
25 percent--versus just the effective tax rate of 1.25 percent that the
Draft would levy on non-IP related earnings of foreign affiliates.
---------------------------------------------------------------------------
\18\ For an overview and many references to research studies on
global supply networks, see American Companies and Global Supply
Networks: Driving U.S. Economic Growth and Jobs by Connecting with the
World, white paper for Business Roundtable and United States Council
for International Business, Matthew J. Slaughter, 2013.
\19\ The trade data cited in this sentence come from the U.S.
Census Bureau and the BEA.
Whether taxed at a rate of 15 percent or 25 percent, Figures 1B and 1C
together make clear that the tax base of foreign-affiliate FBCII income
would be very large: hundreds of billions of dollars in 2012 alone.
Again, the U.S. parents of these foreign affiliates would pay a U.S.
tax only above and beyond whatever foreign taxes these affiliates would
first pay. But the result would be a minimum effective tax on all
foreign-affiliate income treated as FBCII, with any foreign tax rate
below 15 percent (or 25 percent) on FBCII topped up to at least 15
---------------------------------------------------------------------------
percent (or 25 percent) for the U.S. owners.
For these reasons the Joint Tax Committee forecasts that the Draft
``increases the U.S. taxation of income derived from intangibles owned
or licensed by a CFC.'' \20\ This tax increase would be large. JCT has
estimated that this new Subpart F FBCII, along with some related
changes to Subpart F income, would raise U.S. tax revenues by $115.6
billion over the years of 2014 through 2023.
---------------------------------------------------------------------------
\20\ Technical Explanation of the Tax Reform Act of 2014: Title
IV--Participation Exemption System for the Taxation of Foreign Income,
Joint Committee on Taxation, JCX-15-14, February 26, 2014, p. 40.
------------------------------------------------------------------------
-------------------------------------------------------------------------
The Discussion Draft's tax treatment of IP-intensive activities of
multinational companies would be very discriminatory relative to all
other activities. The IP-Prelated income of foreign-affiliates would
lose current-law deferral without any offsetting territoriality and
thus would be subject to a minimum tax rate of between 15 percent and
25 percent--between 12 and 20 times the effective tax rate of 1.25
percent that the Discussion Draft would levy on non-IP related income
of foreign subsidiaries.
------------------------------------------------------------------------
Section Two:
Three Ways In Which the Discussion Draft Would
Disadvantage the Foreign-Affiliate IP Income of American Companies
------------------------------------------------------------------------
-------------------------------------------------------------------------
In three important ways, the Discussion Draft would disadvantage IP
income earned abroad by U.S.-based multinationals. First, the U.S. tax
burden on IP income under the Draft would be higher compared with the
tax burden on IP income under current law. Second, the U.S. tax burden
on IP income under the Draft would be higher compared with the U.S. tax
burden on many other forms of business income under the Draft. Third,
the U.S. tax burden on IP income of U.S.-headquartered multinational
companies would be higher relative to the IP income of their foreign
competitors under the Draft compared with under current law. This third
aspect, in particular, would aggravate the already nettlesome issue of
corporate inversions dominating much recent U.S. tax discussion and
would further encourage the foreign acquisition of U.S.-headquartered
IP-intensive firms.
------------------------------------------------------------------------
Section 1 focused on the mechanics of Foreign Base Company Intangible
Income (FBCII) under the Discussion Draft. The analysis highlighted
important problems, taking as a given the current structure of
operations of U.S.-headquartered multinational companies. Section 2
broadens the focus to analyze the strategic choices that multinational
companies intensive in intangible property (IP) would face under the
Discussion Draft. For these IP-intensive multinational companies, three
different strategic trade-offs are important to consider:
1. The U.S. tax burden on foreign-affiliate IP income under the
Draft compared with the tax burden on foreign-affiliate IP income under
current law.
2. The U.S. tax burden on foreign-affiliate IP income under the
Draft compared with the U.S. tax burden on other forms of foreign-
affiliate business income under the Draft.
3. The U.S. tax burden on foreign-affiliate IP income of U.S.-
headquartered multinational companies relative to the IP income of
their foreign competitors under the Draft compared with under current
law.
The central message of this section is that the U.S. tax burden on
foreign-affiliate IP income under the Discussion Draft is higher in all
three comparisons: relative to current law, relative to other business
activities under the Draft, and relative to foreign competitors under
the Draft. From all three of these perspectives, U.S.-headquartered
multinational companies will be disadvantaged by the treatment of
foreign-affiliate IP income under the Discussion Draft.
Comparing Foreign-Affiliate IP Income Under the Discussion Draft Versus
Under Current Law
Under current law, income related to IP that is earned by a foreign
subsidiary of a U.S.-headquartered multinational can be deferred and is
not a taxable event until distributed to the U.S. parent. Thus, a
foreign subsidiary's intangible income is not taxable in the United
States so long as it is not repatriated back to the U.S. parent. Stated
differently, that foreign subsidiary's IP income is not considered part
of immediately taxable income.
The Discussion Draft would exempt from U.S. taxation most of the non-IP
income of the foreign subsidiaries of U.S. multinationals, by
establishing a dividends-
received deduction of 95 percent on the foreign earnings of U.S.-based
multinationals. This would result in an effective U.S. tax rate of just
1.25 percent on the non-IP related foreign-affiliate earnings
repatriated back to U.S. parents through dividends. The intangible
income of these foreign subsidiaries would be treated quite
differently, however. Section 4211 of the Discussion Draft would create
a new category of immediately taxable income, FBCII, creating a
worldwide tax base (without deferral) for IP-related income at an
effective rate of either 15 percent or 25 percent--12 to 20 times more
than the 1.25 percent effective tax rate on non-IP income of these
subsidiaries.
In a Discussion Draft world, U.S.-based multinational companies would
thus realize a smaller after-tax rate of return on IP investments
relative to today's world because the incremental U.S. tax liability on
that income would be realized much earlier in time. This higher
taxation on IP income would, all else being equal, reduce the
incentives of U.S.-based multinationals to invest in IP assets because
of this lower after-tax rate of return. Indeed, JCT analysis of the
economic impacts of the Discussion Draft finds that lower investment
rates in IP--presumably through channels such as lower R&D spending--
would, along with the loss of accelerated depreciation, contribute to a
slightly smaller U.S. capital stock under the Draft than under current
law. ``Overall, the proposal is expected to increase the cost of
capital for domestic firms, thus reducing the incentive for investment
in domestic capital stock.'' \21\
---------------------------------------------------------------------------
\21\ Macroeconomic Analysis of the ``Tax Reform Act of 2014,''
Joint Committee on Taxation, JCX-22-14, February 26, 2014, pp. 15-16.
The bottom line here is that the higher U.S. tax liability on foreign-
affiliate IP income under the Discussion Draft would induce U.S.-
headquartered multinational companies to undertake less IP investment
than they would under current law--e.g., less R&D spending and less
other forms of knowledge discovery. As Section Three of this paper will
discuss, IP has long driven the large majority of the productivity
growth at the foundation of generations of American economic success--
investment in which is complemented by the foreign affiliates of U.S.
multinationals.
Comparing Foreign-Affiliate IP Income Under the Discussion Draft Versus
Other Business Activities Under the Discussion Draft
A second important perspective to consider is the U.S. tax burden on
foreign-
affiliate IP income compared with the U.S. tax burden on all other
forms of business income, both under the Discussion Draft. Here, three
important points merit stressing.
First, economic theory clearly implies that pre-tax rates of return on
IP investments should be higher than rates of return on investments in
most tangible properties. This is because of the inherent riskiness of
new-knowledge discovery: the uncertain prospects of cutting-edge
innovations means the returns to successful discoveries should be and
are high to compensate for their increased riskiness. Yet, because the
intent of FBCII is to implement an immediate U.S. tax liability on
foreign-affiliate IP income but not on income from other less-risky
assets and activities, in practice the Discussion Draft would dull the
economic incentive that induces companies to undertake risky
investments in knowledge discovery.
Second, some companies in IP-intensive industries may be less intensive
in physical capital--e.g., property and equipment--than will other,
more-traditional industries. Of course the optimal blend of knowledge
and human capital in operations varies widely across companies--as was
discussed in Section 1 in the context of measuring FBCII in an era of
global supply networks--but some highly innovative firms do not use
much tangible capital.
Third, evolving global supply networks mean that many globally engaged
companies connect with foreign partners to help them produce and
distribute their knowledge-intensive products in ways that do not
require ownership abroad of a great deal of depreciable tangible
assets. Section 1 discussed this important consideration in greater
detail.
The net implication of these three business-strategy and economic
considerations is that the calculation of FBCII will likely mean a
greater share of foreign-affiliate income will be subject to immediate
incremental U.S. tax for IP-intensive multinationals than will be the
case for multinationals concentrated on other, more-
traditional business activities. And, this calculated IP income of
foreign affiliates will be taxed at much higher rates than the non-IP
income of these foreign affiliates: at rates of 15 percent up to 25
percent, in contrast to just 1.25 percent. Incentives matter, and all
of these considerations will tend to reduce the after-tax rate of
return on U.S. multinationals' investments in IP assets--and thus will
induce these multinationals to invest less in IP assets and more in
non-IP assets.
For foreign affiliates, this skewing of business decisions away from IP
might take a number of forms. The tax-induced value of owning tangible
assets by foreign affiliates might compel multinationals to buy rather
than lease tangible assets--e.g., to purchase an office building where
employees work rather than simply leasing space in that building--
purely for tax reasons rather than for more-fundamental business-
competitiveness reasons.
This skewing of business decisions away from IP might also compel U.S.-
based multinationals to invest in tangible assets in their foreign
affiliates rather than in their U.S. parent operations. Creating
incentives to invest in physical capital abroad, not in America, would
never make wise economic policy. But it would be especially unwelcome
today given Figure 2A. For each year since 1980, Figure 2A reports
America's total investment in non-residential structures and equipment
as a share of U.S. GDP (gross domestic product, the value of all newly
produced goods and services).\22\
---------------------------------------------------------------------------
\22\ The underlying data in Figure 2A come from Table 1.1.5 of the
National Income and Product Accounts of the Bureau of Economic
Analysis, accessed on-line at www.bea.gov. The underlying dollar
figures in Figure 2A are annual nominal totals. These two components of
total U.S. capital investment together are the closest NIPA measure of
the tangible assets specified in the Discussion Draft.
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
The key message of Figure 2A is that investment in the United States in
business equipment and structures as a share of GDP has been falling
for decades. Except for the increase in this share over much of the
1990s driven by the IT revolution and the resulting accelerated
investment in IT capital goods, the share has fallen from a bit above
12 percent around 1980 to only about 8 percent in recent years. Indeed,
slow growth in capital investment is one reason for the sluggish U.S.
economic recovery from the Great Recession. Tax policies that
incentivize U.S.-headquartered multinationals to invest in physical
capital outside America without any underlying economic or strategic
rationale to do so--multinationals that, as Section 3 will document, in
2012 accounted for 43.3 percent of all the U.S. investment in Figure
2A--would be especially unwelcome today, for reasons including the fact
---------------------------------------------------------------------------
that such investment tends to spur job creation.
Tax distortions that disfavor one line of business relative to others
are precisely what tax reform should avoid. The U.S. tax code should
not induce U.S.-headquartered companies to migrate away from IP
investments because, as Section 3 will discuss, IP has long been
central to U.S. economic strength. Tax reform should not discriminate
against any particular business activity--especially not IP creation
and development. Yet the Discussion Draft would do just that: by
raising the U.S. tax burden on foreign-affiliate IP income compared
with the U.S. tax burden on many other forms of foreign-affiliate
business income.
The Discussion Draft Would Undermine the International Competitiveness
of IP-
Intensive U.S. Multinationals
A third important perspective to consider is the U.S. tax burden on IP
income of U.S.-headquartered multinational companies relative to the IP
income of their foreign competitors. Suppose an IP-intensive U.S.-
headquartered multinational competes in world markets against another
IP-intensive multinational headquartered in a territorial country.
Suppose further that in some third market these two companies earn the
same pre-tax income and thus face the same (if any) third-market tax
liability. Under current law, the U.S. company faces an incremental
U.S. tax liability that its foreign competitor does not--but this U.S.
tax liability can be deferred by not repatriating these foreign
earnings. So, under current U.S. law of worldwide taxation plus the
possibility of deferral, the U.S. company can structure its operations
to compete evenly in terms of not facing any immediate U.S. tax
liability.
Under the Discussion Draft, the situation would be markedly different.
The U.S. multinational would face an immediate tax liability--at least
15 percent and as high as 25 percent--on the FBCII calculated for its
foreign affiliate. As shown in Section 1, for most affiliates their
taxable FBCII will likely constitute the large majority of their net
income. Because FBCII would apply only to U.S.-based companies, the
territorial-based foreign competitor would face no such new tax
liability. Thus the Discussion Draft would disadvantage U.S. IP-
intensive companies against the rest of the world's IP-intensive
companies. The short-term and long-term distortions of this tax
disadvantage created by FBCII are many.
Start with the simple math of cash flows. All else being equal, U.S.-
headquartered multinationals would have smaller after-tax cash flows
from which to fund their R&D efforts to discover and develop new IP.
This plus the reduced after-tax return on any IP investments would, as
discussed earlier in this section, reduce the total amount of U.S. IP
investment. Seen relative to other countries, this would also tend to
mean more IP innovation being done abroad in foreign-headquartered
global companies that would not face this FBCII tax burden--all at a
time where, as Section 3 discusses, it is well documented that
America's predominance in the world's IP production has long ago
passed.
The differential after-tax cash flows would also mean that foreign-
based companies would tend to outbid U.S.-based companies for other IP
assets around the world, such as inventive new companies. This foreign-
company bidding advantage may be especially salient in many IP-
intensive industries in America in which start-ups play a central
creative role. Under the Discussion Draft, these American start-up
companies and/or their IP assets would be more likely to be purchased
by foreign companies.
Over time, the FBCII disadvantage facing U.S.-based IP-intensive
companies would make them more vulnerable to acquisition by their
foreign-based competitors: at least to acquisition of their foreign
affiliates, and in many cases to acquisition of their U.S. operations
as well. Indeed, the already nettlesome issue of corporate inversions--
in which the merger of a U.S. and foreign company results in a company
domiciled outside America--would be aggravated for U.S.-headquartered
IP-
intensive firms. Under current law, today many of these U.S. companies
already can realize tax savings on future foreign-affiliate earnings if
incorporated outside of America. For many IP-intensive companies that
would face certain U.S. taxation on their FBCII under the Discussion
Draft, the tax advantages would be even stronger either of being
acquired by a larger foreign company or of acquiring a smaller foreign
company and inverting.
There is one other important dimension on which the Discussion Draft
would disadvantage U.S.-based IP-intensive companies: it would
undermine the likelihood of new IP-intensive companies being founded in
America. The same logic by which the Discussion Draft would
disadvantage existing U.S.-based IP-intensive multinationals against
their foreign counterparts would be a force compelling new IP-
intensive companies to be established abroad rather than in the U.S.
This new tax burden on U.S. start-ups would come at a time when U.S.
start-up rates have already been falling.
Research has long documented that young startup companies are a key
source of U.S. innovation dynamism. Younger, smaller firms tend to
produce more innovations per dollar of innovation effort than do many
older, larger companies. This innovation edge stems from a number of
impediments facing many older and larger companies: worries about
innovation disrupting existing lines of business; more-rigid
bureaucracies that inhibit new ideas; and weaker individual incentives
connected to innovation success.\23\ (Of course, U.S.-based
multinational companies tend to contradict this overall pattern; as
documented in Section 3, they are among America's most dynamic and
innovative companies--thus their ability to succeed globally, an
ability that would be impaired by tax reform as envisioned by the
Discussion Draft.)
---------------------------------------------------------------------------
\23\ See surveys in, e.g., Cohen, Wesley, and Steven Klepper, 1996,
``A Reprise of Size and R&D.'' Economic Journal, 106(437). Another
useful survey is Acemoglu, Daron, Ufuk Akcigit, Nicholas Bloom, and
William Kerr, 2012, ``Innovation, Reallocation, and Growth,''
manuscript.
Tax policy that disadvantages the returns to IP income will be tax
policy that inhibits the start-up of new IP-intensive companies in
America. Lest one think from the above discussion that all globally
competitive U.S. companies are monolithically large and old, that is
not the case. By virtue of having operations outside America, in scope
and in aspiration all U.S.-based multinationals are expansive. Yet,
there are striking differences in their size in terms of common metrics
such as employment and sales. Figure 2B documents this wide range: For
the most recent year of data available, 2009, it splits the 2,347 U.S.-
based multinational companies into four groups categorized by the
number of U.S.-parent employees.\24\
---------------------------------------------------------------------------
\24\ In Figure 2B, data were obtained from the BEA multinationals
data online at www.bea.gov.
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
At one end of the spectrum, 415 companies each employ more than 10,000
people in America--indeed, an average of 43,630 workers each. At the
other end of the spectrum, nearly 50 percent more multinationals, 613,
each employ fewer than 500 people in America--and thus, as this report
later discusses, fit the U.S. government definition of being a small or
medium-sized enterprise (SME). Many of these SME multinationals are
likely dynamic, fast-growth companies that were recently ``born'' into
the group of U.S.-based multinationals by establishing their first
foreign affiliate. Many of America's largest and most successful
companies today once started small, with the quintessential person
---------------------------------------------------------------------------
pursuing a dream from a garage or dorm room.
The fact that today 26.1 percent of U.S. multinationals are SMEs speaks
to how diverse these important companies truly are. Many small
multinationals dream of growing much bigger tomorrow. For those that
are IP-intensive, tax disadvantaging IP income through the Discussion
Draft would make achieving these dreams harder.
There is clear international evidence that tax burdens inhibit
entrepreneurship. A recent study spanning 85 countries over decades
estimated the drag of corporate taxes on entrepreneurship (measured
either as new business establishments and also the rate of new-business
registration). It found that a 10-percentage point increase in
corporate tax rates reduces the rate of new-business startups by an
average of 1.4 percentage points, which is 17.5 percent below the
average startup rate of about 8 percent. This study also found that a
similar increase in corporate taxes reduces a country's ratio of
capital investment to GDP by a sizable 2-2.5 percentage points.
And it is important to recognize that America today is already facing
an ongoing, worrisome decline in the rate of new-business start-ups. In
the early-to-mid 1980s, each year about 12 percent to 13 percent of all
U.S. firms were newly started that year. Starting in the late 1980s,
however, this startup rate began to decline. This decline long pre-
dates the World Financial Crisis, but its pace has quickened recently
such that today only about 7 percent to 8 percent of all U.S. companies
are startups.
A consequence of this drop in the rate of new-business startups is that
the share of the overall U.S. economy--in terms of the number of
companies or where people work--accounted for by young firms has been
steadily declining. Figure 2C, reproduced from a recent publication on
waning U.S. economic dynamism, shows this.\25\
---------------------------------------------------------------------------
\25\ This figure is reproduced from ``The Role of Entrepreneurship
in U.S. Job Creation and Economic Dynamism,'' Journal of Economic
Perspectives, Summer 2014, pp. 3-14, by Ryan Decker, John Haltiwanger,
Ron Jarmin, and Javier Miranda.
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
Defining young firms as those aged five or less, in the early 1980s
nearly 50 percent of all U.S. companies were young. Today that share is
down to only about 39 percent--the lowest on record-- with falls across
all states. Similarly, the share of U.S. employment at these young
firms has fallen from about 19 percent in the early 1980s to barely 10
percent today. And the share of job creation each year accounted for by
these young firms has also been sliding: from over 40 percent in the
early 1980s to only about 30 percent today.\26\
---------------------------------------------------------------------------
\26\ Startup statistics in this and the previous paragraph come
from the study in note 24 and also from Haltiwanger, John, Ron Jarmin,
and Javier Miranda. 2012. Where Have All the Young Firms Gone? Kansas
City: Kauffman Foundation.
Taken together, ebbing startup trends indicate the United States is
becoming less entrepreneurial. It has a much lower rate of new-business
startups and thus a much smaller share of new firms in the overall
private sector. The underlying causes at play are not fully known. That
said, this development should worry policymakers. Given the historical
importance of startups in many IP-intensive industries, tax
disadvantaging IP income through tax reform as envisioned by the
Discussion Draft would dampen innovation in IP-startups and reduce the
number of such start-ups arising in the United States. And compounding
this dampening, high-talent individuals might accordingly be more
inclined to seek employment with foreign-based rather than U.S.-based
---------------------------------------------------------------------------
companies.
------------------------------------------------------------------------
-------------------------------------------------------------------------
The U.S. tax burden on foreign-affiliate IP income under the Discussion
Draft would be higher in three important comparisons: relative to
current law, relative to other business activities under the Draft, and
relative to foreign competitors under the Draft. From all three of
these perspectives, U.S.-headquartered multinational companies would be
disadvantaged by the treatment of foreign-affiliate IP income under the
Discussion Draft. This legislation would thus induce U.S.-headquartered
multinationals to invest less in new ideas and innovation, to invest
more in non-IP assets, to make those non-IP investments outside America
rather than inside, and to be acquired by a larger foreign company or
to acquire a smaller foreign company and invert. It would advantage
foreign-headquartered multinationals not subject to its worldwide
taxation in bidding for IP assets around the world, and it would
discourage the start-up of new IP-intensive companies in America.
------------------------------------------------------------------------
Section Three:
How IP Innovation Strengthens the U.S. Economy
------------------------------------------------------------------------
-------------------------------------------------------------------------
Globally engaged U.S. companies, which create the large majority of
America's IP, increasingly rely on their worldwide operations to
maximize the creativity and benefits of their U.S. inventions. Globally
engaged U.S. companies have long performed the large majority of
America's IP discovery and development. Increasingly central to
America's IP success is the ability of U.S. companies to deploy their
IP abroad-especially in light of the worrisome recent slowdown in U.S.
productivity growth.
------------------------------------------------------------------------
Intangible property (IP) has long played a central role in driving
growth in U.S. output, jobs, and income--and this role will be even
more important in the years ahead.
The Past: The Massive Contribution of Innovation and IP to America's
Economy
Since the founding of the American republic, IP has played a central
role in driving growth in U.S. output, jobs, and income. This central
economic fact of knowledge discovery and development via innovation has
been widely established by academic and policy research in recent
decades, and it is widely recognized by leaders in business, in
government, and beyond. For example, here is an opening of a recent
White House report on innovation in America.
The history of the American economy is one of enormous progress
associated with remarkable innovation. . . . Innovation--the
process by which individuals and organizations generate new
ideas and put them into practice--is the foundation of American
economic growth and national competitiveness. Economic growth
in advanced countries like the United States is driven by the
creation of new and better ways of producing goods and
services, a process that triggers new and productive
investments.\27\
---------------------------------------------------------------------------
\27\ See page 7 of The White House. 2011. A Strategy for American
Innovation: Securing Our Economic Growth and Prosperity. February:
National Economic Council, Council of Economic Advisers, and Office of
Science and Technology Policy.
Here is a similar statement on the centrality of IP to America's
economic growth and overall success from a recent landmark study by the
U.S. government of IP and the U.S. economy that focused on a subset of
---------------------------------------------------------------------------
IP: patents, copyrights, and trademarks, or ``intellectual property.''
Innovation, the process through which new ideas are generated
and put into commercial practice, is a key force behind U.S.
economic growth and national competitiveness. . . . Innovation
protected by intellectual property rights is key to creating
new jobs and new exports. Innovation has a positive pervasive
effect on the entire economy, and its benefits flow both
upstream and downstream to every sector of the U.S. economy.
Intellectual property is not just the final product of workers
and companies--every job in some way, produces, supplies,
consumes, or relies on innovation, creativity, and commercial
distinctiveness.\28\
---------------------------------------------------------------------------
\28\ See page 1 of United States Department of Commerce. 2012.
Intellectual Property and the U.S. Economy: Industries in Focus.
Washington, DC: Economics and Statistics Administration and the United
States Patent and Trademark Office.
IP created through innovation has been the foundation of America's
economic strength. Over the arc of American economic history, many
innovations have been incremental--slight refinements of products and
processes that better served companies' customers. Other innovations
have been truly disruptive and transformational, creating entire new
industries and jobs--often while simultaneously displacing existing
---------------------------------------------------------------------------
companies, jobs, and technologies.
The cumulative economic benefit of IP developed via innovation--indeed,
the cumulative impact on the average standard of living of a country's
citizens is best expressed in terms of productivity: the average value
of output of goods and services a country produces per worker. The
following quotation from Nobel laureate Paul Krugman concisely makes
this point that is widely acknowledged by leading economists of all
political persuasions.
Productivity isn't everything, but in the long run it is almost
everything. A country's ability to improve its standard of
living over time depends almost entirely on its ability to
raise its output per worker . . . the essential arithmetic says
that long-term growth in living standards . . . depends almost
entirely on productivity growth.\29\
---------------------------------------------------------------------------
\29\ Pages 9 and 13 of Krugman, Paul R. 1990. The Age of Diminished
Expectations. Cambridge: MIT Press.
The economics of this ``essential arithmetic'' for why productivity
matters is very simple. The more and better quality goods and services
people produce--that is, the more productive they are--the more income
they receive and the more they can consume. Higher productivity means a
---------------------------------------------------------------------------
higher standard of living.
How can a country raise its productivity? There are two basic means.
One is to save and invest to accumulate the other inputs people work
with to produce things. The most important other input needed is the
tangible capital discussed earlier in this report, broadly defined as
goods and services that help people make other goods and services--
e.g., buildings, machinery, and software.
The second way to raise productivity is to improve the technological
know-how for transforming inputs into outputs thanks to innovation. New
products and processes allow workers to make new and/or more goods and
services. What makes innovation so potentially powerful for
productivity is that many ideas don't depreciate with extensive use
(unlike, e.g., capital goods). Thus, the more ideas a country has
today, the easier it is to produce additional ideas tomorrow.
So, what do the data say has driven America's rising productivity--and
thus average standards of living--over the generations? A large body of
academic and policy research has found that the overwhelming majority
of America's growth in productivity and living standards over the 20th
century was driven by new IP and the resulting technological advances
of new products and processes, not by tangible capital.
Robert Solow, in seminal work that ended up being a major reason for
being awarded the Nobel Prize in economics, calculated that the very
large majority of U.S. growth during the first half of the 20th century
was driven by innovation and technological progress. Of the rise in
real GDP per person-hour in the United States from 1909 to 1949, he
concluded that ``It is possible to argue that about one-eighth of the
total increase is traceable to increased capital per man hour, and the
remaining seven-eighths to technical change.'' \30\ Looking at the
second half of the 20th century, an authoritative study found that for
growth in U.S. per capita GDP from 1950 to 1993, 80 percent was
accounted for by greater discovery and development of innovative ideas
fostered by the combination of rising educational attainment and rising
R&D effort.\31\
---------------------------------------------------------------------------
\30\ Page 316 of Solow, Robert M. 1957. ``Technical Change and the
Aggregate Production Function,'' The Review of Economics and
Statistics, 39(3). See also his closely related work: ``A Contribution
to the Theory of Economic Growth,'' Quarterly Journal of Economics,
70(1), 1956.
\31\ Jones, Charles I. 2002. ``Sources of U.S. Economic Growth in a
World of Ideas.'' American Economic Review, 92(1).
And looking at the most recent period of strong U.S. productivity
growth that ran for a decade several years starting around 1995, the
majority of that growth was driven by faster technological innovation
in information-technology (IT)--one of the most IP-intensive
industries. Post-1995, technical change has accounted for well over
half of U.S. per capita GDP growth.\32\
---------------------------------------------------------------------------
\32\ For example: Feenstra, Robert C., Benjamin R. Mandel, Marshall
B. Reinsdorf, and Matthew J. Slaughter, 2013, ``Effects of Terms of
Trade Gains and Tariff Changes on the Measurement of U.S. Productivity
Growth,'' American Economic Journal: Economic Policy, 5(1).
Substantial research has found that IP and innovation matter because
the social benefits of knowledge often exceed its private benefits--in
the jargon of economics, discovery of ideas generates ``positive
externalities'' through several channels (such as worker mobility, and
the more-general property that ideas, different from nearly all goods
and services, are easily shared). Studies have found that the social
return to R&D tends to be at least double the private return.\33\
---------------------------------------------------------------------------
\33\ Jones and Williams (1998), p. 1121, estimate ``the social
return [to R&D] of 30 percent and a private rate of return of 7 to 14
percent: optimal R&D spending as a share of GDP is more than two to
four times larger than actual spending.'' Bloom, et al (2012), p. 3,
report, ``We find that technology spillovers dominate, so that the
gross social returns to R&D are at least twice as high as the private
returns. . . . We estimate that the (gross) social return to R&D
exceeds the private return, which in our baseline specification are
calculated at 55 percent and 21 percent, respectively. At the aggregate
level, this implies under-investment in R&D, with the socially optimal
level being over twice as high as the level of observed R&D.'' Jones,
Charles I., and John C. Williams, 1998, ``Measuring the Social Returns
to R&D,'' Quarterly Journal of Economics, 113(4). Bloom, Nicholas,
Marck Schankerman, and John Van Reenen, 2012, ``Identifying Technology
Spillovers and Product-Market Rivalry,'' Manuscript.
Public policies that help foster and protect IP and innovation have
long been an essential ingredient to America's overall economic
success. ``Strong protection of intellectual property rights, business-
friendly bankruptcy laws, a flexible labor force, and an
entrepreneurial culture and legal system that favor risk taking and
tolerate failure are among the framework conditions that have kept the
U.S. at the forefront of innovation. Another crucial American advantage
has been its openness to foreigners''--especially because of
immigration's contribution to the talent, such as engineers and
scientists, that discover, develop, and implement IP.\34\
---------------------------------------------------------------------------
\34\ Both quotations in this paragraph come from p. 65 and p. 43,
respectively, of National Research Council of the National Academies,
2012, Rising to the Challenge: U.S. Innovation Policy for the Global
Economy, Washington, DC, The National Academies Press.
Substantial academic and policy research has demonstrated how
appropriate public policies have fostered America's innovation
strength--especially when compared to other countries that are far less
innovative. ``Differences in levels of economic success across
countries are driven primarily by the institutions and government
policies (or infrastructure) that frame the economic environment in
which people produce and transact. Societies with secure physical and
intellectual property rights that encourage production [capital
accumulation, skill acquisition, invention, and technology transfer]
are successful.'' \35\ And one important policy that shapes America's
overall innovation environment is its tax treatment of IP.
---------------------------------------------------------------------------
\35\ Page 173 of: Hall, Robert E., and Charles I. Jones, 1997,
``Levels of Economic Activity Across Countries,'' American Economic
Review, 87(2).
---------------------------------------------------------------------------
The Present: The Strength of IP-Intensive Industries in America's
Economy Today
IP's central role in driving growth in output, jobs, and income for the
overall U.S. economy can perhaps best be seen at the level of
individual companies and industries. Examples of innovative companies
achieving great success thanks to their IP abound in the public lore:
e.g., companies born in the garages of Silicon Valley (sometimes
literally, other times proverbially) that grow into global leaders in
technology and many other IP-intensive industries. These examples are
clearly borne out in more-systematic research. Companies that produce
more IP tend to be more successful on several dimensions including
profitability, revenues, and employment.\36\ Looking more broadly,
entire new industries such as biotechnology and software have been
created by new IP--new industries that, as explained above, have
boosted national output, created jobs, and raised standards of living.
---------------------------------------------------------------------------
\36\ See, for example, Bloom and Van Reenen (2002) cited in note
33.
The U.S. Department of Commerce recently undertook a landmark study
aiming both to identify IP-intensive industries and to document their
productivity-leading characteristics and the overall economy. Drawing
on records and resources such as the USPTO, this study identified 75
industries (out of 313 total) that produce large amounts of IP measured
by the three forms of IP-protection that entail government-granted or
government-recognized legal rights: patents,\37\ copyrights,\38\ and
trademarks.\39\ These industries were collectively defined to be ``IP-
intensive.'' Figure 3A reports their share of several key dimensions of
U.S. economic activity in 2010.
---------------------------------------------------------------------------
\37\ This U.S. Department of Commerce study (cited in note 28)
focused on utility patents, which it defines (p. 5) as ``patents which
assist owners in protecting the rights of inventions and innovative
processes.'' Utility patents can be applied to processes, machines,
articles of manufacture, and compositions of matter. The other two
categories of U.S. patents are design patents, which cover the design
of items (rather than the items themselves), and plant patents, which
cover innovations of living plants. Patents enable the owner to pursue
legal action to exclude, for a finite amount of time, others from
making, using, or selling that invention in America. Patents are issued
to individual inventors, who as they like can assign ownership rights
to other individuals, corporations, universities, other organizations.
\38\ As described by U.S. Department of Commerce (2012), p. 29,
copyrights protect ``original works of authorship. These works must be
fixed in a tangible form of expression, meaning that concepts that
never leave the confines of our minds cannot be copyrighted. Protection
under copyright, which lasts for the life of the author plus an
additional 70 years, is secured automatically when a work is created.
Neither publication nor registration with the U.S. Copyright Office is
required to secure copyright protection. But registering a copyright
does establish a public record of the copyright, and it can be
beneficial because of incentives provided to encourage registration.''
Works eligible for copyright protection include literary works,
computer programs, musical works, dramatic works, pictorial and graphic
works, motion pictures, and sound recordings. More than 33.7 million
copyrights have been registered in America since Congress enacted the
first copyright law in 1790. In 2009, more than 382,000 new basic
copyrights were registered.
\39\ Trademarks protect the brands of goods and services. As
defined by the U.S. Department of Commerce (2012), p. 11, a trademark
is ``a word, phrase, symbol, design, or combination thereof that
identifies and distinguishes the source of the goods of one party from
those of others. . . . Unlike a patent, which protects an invention, or
a copyright, which protects a work of original authorship, a trademark
does not protect a new product or service per se. A trademark instead
confers protection upon the brand or identity of a good, thus
preventing competitors from leveraging another firm's reputation and
confusing consumers as to the source of the goods. Service marks are
similar in nature to trademarks, but distinguish the source of a
service rather than a good.'' With payment of a nominal fee, any
company or individual, American or foreign, can apply to register a
trademark with the United States Patent and Trademark Office. Once
granted, trademark registrations can remain in force indefinitely as
long as the trademark remains in active use and maintenance payments
are made.
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
The key message of Figure 3A is that America's IP-intensive industries
perform large shares of America's economic activities that together
---------------------------------------------------------------------------
support high and rising standards of living.
Employment: IP-intensive industries directly employed 27.1
million jobs, 18.8 percent of total U.S. jobs (counting payroll jobs
plus the self-employed and also unpaid family workers). IP-intensive
industries supported an additional 12.9 million jobs indirectly through
their supply-chain intermediate-input purchases of goods and services
needed to make IP-intensive products. So, IP-intensive industries
supported a total of 40.0 million U.S. jobs, 27.7 percent of the
national total. If anything, this jobs tally is conservative because it
does not examine indirect jobs downstream, e.g., in distribution and
trade of IP-intensive products.
Output: IP-intensive industries produced 34.8 percent of all
U.S. output (measured in terms of GDP)--nearly $5.1 trillion.
Exports: IP-intensive industries exported $775 billion of
merchandise to the rest of the world. This constituted 60.7 percent of
total U.S. goods exports. From 2000 to 2010, IP-intensive exports
expanded by 52.6 percent.
For workers in IP-intensive industries, the bottom line of all these
productivity-
enhancing activities has been high and rising earnings. In 2010,
average weekly wages in IP-intensive industries were 42 percent above
that of other industries ($1,156 versus $815). This IP compensation
premium has been growing over time: from 22 percent in 1990 and 38
percent in 2000 to 42 percent in 2010.\40\
---------------------------------------------------------------------------
\40\ What is tracked here is average weekly earnings of private
wage and salary workers. Included in wages are pay for vacation and
other paid leave, bonuses, stock options, tips, cash value of meals and
lodging, contributions to deferred compensation plans such as 401(k)
plans. All data in this paragraph, in the following paragraph, and in
the related figure and related discussion come from U.S. Department of
Commerce (2012).
Part of this compensation premium is explained by the higher average
talent of workers in IP-intensive industries. 42.4 percent of workers
aged 25 and older in IP-intensive industries had a bachelor's degree or
higher--versus just 33.2 percent in the private sector. IP-intensive
demand is commensurately lower for those with some college or an
associate degree (27.4 percent vs. 27.7 percent), for high-school
graduates (25.2 percent vs. 28.9 percent), and for high-school dropouts
---------------------------------------------------------------------------
(5.0 percent vs. 9.2 percent).
The contributions to the U.S. economy of IP-intensive industries looks
strong not only in and of itself, as indicated above, but also in
relation to other countries as well. In recent years the United States
remains the world's largest producer of many IP-intensive goods and
services: in 2010, $3.6 trillion of knowledge-intensive services and
$386 billion in high-technology manufactures, according to estimates by
the U.S. National Science Foundation.\41\
---------------------------------------------------------------------------
\41\ Figures O-27 and O-28 of: National Science Board, 2012,
Science and Engineering Indicators 2012, Arlington, VA: National
Science Foundation (NSB 12-01).
---------------------------------------------------------------------------
The Future: Signs that America's IP Strength Is Waning
Despite America's historic strength in creating IP and transforming IP
innovations into new products, companies, industries, and jobs, concern
is rising among leaders in both the private and public sectors that
America's IP strength is waning.
Perhaps the most alarming case for America's waning innovation strength
has been made by the 2007 initial and 2010 follow-up Gathering Storm
reports--alarming, not alarmist, because of the breadth of data brought
to bear in this pair of studies for the National Academies of Sciences
and Engineering by a distinguished committee comprised of leading
academics, university presidents, CEOs of global firms, and Nobel
laureates.
It is widely agreed that addressing America's competitiveness
challenge is an undertaking that will require many years if not
decades . . . a primary driver of the future economy and
concomitant job creation will be innovation. . . . So where
does America stand relative to its position of 5 years ago when
the Gathering Storm report was prepared? The unanimous view of
the committee members participating in the preparation of this
report is that our nation's outlook has worsened. . . . The
only promising avenue, in the view of the Gathering Storm
committee and many others, is through innovation. Fortunately,
this nation has in the past demonstrated considerable prowess
in this regard. Unfortunately, it has increasingly placed
shackles on that prowess such that, if not relieved, the
nation's ability to provide financially and personally
rewarding jobs for its own citizens can be expected to decline
at an accelerating pace. . . . The Gathering Storm Committee's
overall conclusion is that . . . the outlook for America to
compete for quality jobs has further deteriorated over the past
5 years. The Gathering Storm increasingly appears to be a
Category 5.\42\
---------------------------------------------------------------------------
\42\ Pages 1-5 of: National Academy of Sciences, National Academy
of Engineering, and Institute of Medicine, 2010, Rising Above the
Gathering Storm, Revisited: Rapidly Approaching Category 5, Washington,
DC: The National Academies Press.
The sobering message of this gathering-storm metaphor has been widely
repeated: ``America cannot rest on its laurels. Unfortunately, there
are disturbing signs that America's innovative performance slipped
substantially during the past decade. Across a range of innovation
metrics . . . our nation has fallen in global innovation-ranked
competitiveness.'' \43\ Several studies using many indicators and
methodologies continue to reach the same startling conclusion:
America's overall innovativeness, though still high, is falling--in
many ways at a rapid rate.\44\
---------------------------------------------------------------------------
\43\ The White House (2011), p. 8 as cited in note 27.
\44\ For the three studies listed, see World Economic Forum (2014),
World Intellectual Property Organization and INSEAD (2012), and
Atkinson and Ezell (2012). World Economic Forum, Center for Global
Competitiveness and Performance, 2014, The Global Competitiveness
Report: 2014-2015. World Intellectual Property Organization and INSEAD,
2012, The Global Innovation Index 2012: Stronger Innovation Linkages
for Global Growth, Fontainebleau: INSEAD Press. Atkinson, Robert D. and
Stephen J. Ezell, 2012, Innovation Economics: The Race for Global
Advantage, Yale University Press: New Haven and London.
The World Economic Forum's 2014-2015 rankings have U.S. ``Total
Competitiveness'' at #3, down from #1 two cycles ago, and down to #5 in
the ``Innovation'' category.
For 2012, the World Intellectual Property Organization (in
conjunction with the business school INSEAD) ranks the United States at
#10 in its Global Innovation Index--down from #1 in 2009.
In 2009, the Information Technology and Innovation Foundation
ranked 44 countries and regions on 16 core indicators of innovation
capacity. The United States ranked #4. This was down from America's #1
ranking based on 1999 data. But when assessing the rates of change in
innovation capacity during 2000-2009 (that is, the rate of improvement
on these 16 indicators), the United States ranked #43--ahead of only
Italy. On this rate-of-improvement metric, China ranked #1.
Consistent with these studies of weakening U.S. innovativeness are the
data on America's slowing productivity growth. Figure 3B documents this
productivity slowdown. For each of four post-World War II periods,
Figure 1.1 reports two items: the average annual rates of growth in
productivity (output per worker hour) in the U.S. non-farm business
sector, and the average U.S. unemployment rate during that period.\45\
---------------------------------------------------------------------------
\45\ These productivity-growth averages were calculated from annual
data reported online by U.S. Bureau of Labor Statistics on 10/20/14 at
www.bls.gov for data series #PRS85006092. The non-farm business sector
is the most-commonly used measure of overall productivity growth for
the U.S. economy, in part because of greater measurement challenges for
both the public and agricultural sectors. Non-farm business accounted
for about 74 percent of total U.S. gross domestic product in 2013. The
unemployment rates are calculated for each period as the simple average
of the constituent monthly unemployment rates, as reported online by
U.S. Bureau of Labor Statistics on 10/20/14 at www.bls.gov.
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
The first period in Figure 3B, 1947 to 1973, was marked by a strong
average annual rate of productivity growth of 2.81 percent. During this
period American companies across many industries were dynamic world
leaders, thanks in part to their emerging connections to the world
economy rebuilding in the wake of World War II devastation. The 1973-
1995 period, however, saw average productivity growth plummet to just
1.45 percent per year. The initial causes of this slowdown included two
major oil-price shocks and high and volatile inflation. Its persistence
came to concern scholars, policymakers, and business leaders alike.
With productivity growth averaging 1.45 percent per year average
standards of living need 48 years to double--far slower than the 25
years needed when productivity growth was averaging 2.81 percent each
year. Unemployment was painfully high in many years of this generation,
---------------------------------------------------------------------------
averaging nearly 7 percent throughout.
Then came a productivity renaissance. For the decade starting with
1995, U.S. productivity growth unexpectedly accelerated--to an average
annual rate of 3.00 percent. This surge was widely visible in
accelerated growth in U.S. GDP, jobs, and worker earnings. At one point
in 2000, U.S. unemployment dipped to just 3.9 percent, and for several
years during this period real earnings rose briskly for all U.S.
workers--even less-skilled workers including high-school dropouts.
These large economic gains spread even to the U.S. government, for
which unexpected surges in personal and business tax receipts led to
federal-budget surpluses in the 4 years 1998 through 2001. A large body
of scholarship has analyzed this U.S. productivity acceleration and has
found that much of it was related to one particular IP-
intensive industry: IT.
But since 2005, U.S. productivity growth has slowed dramatically. It
has averaged just 1.53 percent in the past several years, a rate back
to nearly the levels of the ``lost generation'' of 1973-1995. And even
within this period productivity growth has been slowing even more: at
annual rates of just 0.5 percent in 2011, 1.5 percent in 2012, and 0.5
percent in 2013. Several leading scholars are now forecasting that U.S.
innovativeness and productivity growth may be permanently lower.
Indeed, one such scholar has recently forecast that, in contrast to the
average growth in U.S. GDP per capita of the past 150 years of about
1.9 percent, ``future growth in consumption per capita for the bottom
99 percent of the income distribution could fall below 0.5 percent per
year for an extended period of decades.'' \46\
---------------------------------------------------------------------------
\46\ Page 1 of Robert J. Gordon, 2012, ``Is U.S. Economic Growth
Over? Faltering Innovation Confronts the Six Headwinds,'' National
Bureau of Economic Research Working Paper No. 18315. See also, for
example, the following three careful recent studies and references
therein. John Fernald, 2014, ``Productivity and Potential Output
Before, During, and After the Great Recession,'' National Bureau of
Economic Research Working Paper No. 20248. Robert J. Gordon, 2014, ``A
New Method of Estimating Potential Real GDP Growth,'' National Bureau
of Economic Research Working Paper No. 20423. Robert E. Hall, 2014,
``Quantifying the Lasting Harm to the U.S. Economy from the Financial
Crisis,'' National Bureau of Economic Research Working Paper No. 20183.
The Economist 2012 special report from its October 13 issue, ``For
Richer, For Poorer,'' also summarizes much of this recent and ongoing
academic work.
This productivity slump is feared to continue not just by leading
scholars but, increasingly, by many important policy-making agencies as
well. In its most recent update to its 2014-2024 economic outlook in
August 2014, the U.S. Congressional Budget Office foresees average
annual growth in potential U.S. labor productivity of just 1.5 percent.
Because of a similarly guarded outlook on U.S. productivity, the most
recent September 2014 forecasts of the members of the Federal Open
Market Committee foresee beyond 2018 annual U.S. GDP growth of
somewhere between 1.8 percent and 2.5 percent.\47\
---------------------------------------------------------------------------
\47\ Table 2-2 and related discussion of An Update to the Budget
and Economic Outlook: 2014 to 2024, U.S. Congressional Budget Office,
August 2014. Economic Projections of Federal Reserve Board Members and
Federal Reserve Bank Presidents, September 2014, released September 17,
2014.
What explains America's darkening IP and productivity outlook? Part of
the cause is America's waning investment in its innovation inputs--the
people and resources dedicated to knowledge discovery and development.
The pair of Gathering Storm reports cited above gather a wave of
sobering evidence on America's declining IP investments--both relative
to America of the past and relative to more and more other countries of
---------------------------------------------------------------------------
today.
At one level, the growth in innovation investments around the world
presents a tremendous opportunity for America--to, if supported by the
right public policies, connect its innovation efforts with those of the
world. Indeed, the surge in global innovation investments has
transformed how new ideas are discovered and developed--now much more
across borders rather than just within. ``The innovation process can no
longer be confined within geographic boundaries. Globalization has
ushered in a swiftly evolving new paradigm of borderless collaboration
among researchers, developers, institutions, and companies spanning the
world.'' This new global norm for discovering and developing IP is
clearly evident in at the micro-level of patents, article writing, and
other individual building blocks of IP. One prominent study examined
nearly 20 million academic papers and over 2 million patents over 50
years and across all major disciplines ``to demonstrate that teams
increasingly dominate solo authors in the production of knowledge.''
\48\
---------------------------------------------------------------------------
\48\ In this paragraph, the first quote comes from p. xvi of
National Research Council of the National Academies, 2012, Rising to
the Challenge: U.S. Innovation Policy for the Global Economy,
Washington, DC: The National Academies Press. The second quote comes
from Wuchty, Jones, and Uzzil (2007), p. 1036, who report (p. 1036)
that, ``Research is increasingly done in teams across nearly all
fields. Teams typically produce more frequently cited research than
individuals do, and this advantage has been increasing over time. Teams
now also produce the exceptionally high-impact research, even where
that distinction was once the domain of solo authors. These results are
detailed for sciences and engineering, social sciences, arts and
humanities, and patents, suggesting that the process of knowledge
creation has fundamentally changed.'' Wuchty, Stefan, Benjamin F.
Jones, and Brian Uzzil, 2007, ``The Increasing Dominance of Teams in
Production of Knowledge,'' Science, May 18.
At another level, however, whether America can benefit from the rising
IP strength around the world will depend on whether America can
continue to design and implement public policies that maintain
America's IP strengths in this rapidly changing innovation world. It is
possible that America will succeed in this way, but success is by no
means guaranteed. The assessment of many private and public leaders is
that America's position is precarious--in large part because U.S.
policies across a wide range of areas, including tax policy, do not
adequately reflect today's globally-competitive reality. A recent
report by a distinguished panel of government, business, and academic
---------------------------------------------------------------------------
leaders framed the innovation challenge thus.
At the same time that the rest of the world is investing
aggressively to advance its innovation capacity, the pillars of
America's innovation system are in peril. . . . It is not just
policies directly addressing the development and deployment of
new technologies but also policies concerning tax, trade,
intellectual property, education and training, and immigration,
among others that play a role in innovation. . . . In this
dramatically more competitive world, the United States cannot
return to a path of sustainably strong growth, much less
maintain global leadership, by living off past investments and
its capacity for innovation. . . . Nor can the U.S. compete on
the basis of a policy approach that is the legacy of an era
when American advantages were overwhelming and innovative
activity tended to remain within our borders. . . . The U.S.
has every opportunity to secure its economic leadership and
national security well into the future. But it will require a
fresh policy approach, one that ensures that the United States
can compete, cooperate, and prosper in this new world of
competitive innovation.\49\
---------------------------------------------------------------------------
\49\ National Research Council of the National Academies (2012), p.
12, as cited in note 48.
Whether America can restore its innovation strength will depend largely
on whether America can craft IP-supporting public policies that reflect
the competitive global economy of today--not the world economy of much
of the 20th century when America was largely unrivaled in IP. That time
of American predominance has passed. Today calls for policies--
including tax policies--that reflect the reality of how America's IP-
intensive companies and industries actually operate in the 21st century
global economy. To this reality we now turn.
America's Most Innovative, IP-Intensive Companies Tend To Be
Multinational
Companies
What do we know about the relationship between the IP, innovation, and
productivity performance of companies and their global engagement?
Start with the following first important fact: there is now a large
body of evidence for many countries that plants and/or firms exhibit
large and persistent differences in innovativeness and
productivity.\50\ A second important fact that researchers have
documented in recent years is a robust correlation between productivity
and global engagement: plants and/or firms that export or, even more
so, are part of a multinational enterprise tend to have higher
productivity--and a bundle of other good-performance characteristics,
such as innovative intensity and wages--than their purely domestic
counterparts.\51\
---------------------------------------------------------------------------
\50\ In their survey of micro-level studies of productivity,
Bartelsman and Doms (2002, p. 578) state that, ``Of the basic findings
related to productivity and productivity growth uncovered by recent
research using micro data, perhaps most significant is the degree of
heterogeneity across establishments and firms in productivity in nearly
all industries examined.'' This heterogeneity in productivity and other
characteristics (e.g., size) appears in both developed countries (e.g.,
Olley and Pakes, 1996, and Syverson, 2004 for the United States) and
developing countries (e.g., Cabral and Mata, 2003). Bartelsman, Eric
J., and Mark Doms, 2002, ``Understanding Productivity: Lessons from
Longitudinal Microdata,'' Journal of Economic Literature, 38. Olley, G.
Steve, and Ariel Pakes, 1996, ``The Dynamics of Productivity in the
Telecommunications Equipment Industry,'' Econometrica, 64(6). Syverson,
Chad, 2004, ``Market Structure and Productivity: A Concrete Example,''
Journal of Political Economy, 112(6). Cabral, Luis M. B., and Jose
Mata, 2003, ``On the Evolution of the Firm Size Distribution: Facts and
Theory,'' American Economic Review, 93(4).
\51\ Superior productivity of U.S. exporters is usefully summarized
in studies including Lewis and Richardson (2001) and Bernard, et al
(2007), which states the following (pp. 110-111): ``Firms that export
look very different from non-exporters along a number of dimensions . .
. even in the same detailed industry. Exporters [in 2002 were]
significantly larger than non-exporters, by approximately 97 percent
for employment and 108 percent for shipments; they are more productive
by roughly 11 percent for value-added per worker and 3 percent for TFP;
they also pay higher wages by around 6 percent. Finally, exporters are
relatively more capital- and skill-intensive than non-exporters by
approximately 12 and 11 percent, respectively.'' Lewis, Howard III and
J. David Richardson, 2001, Why Global Commitment Really Matters!
Washington, DC. Institute for International Economics. Bernard, Andrew
B.; Jensen, J. Bradford; Redding, Stephen J.; and Peter K. Schott,
2007, ``Firms in International Trade,'' Journal of Economic
Perspectives, 21(3).
Multinational companies are an important segment of globally engaged
companies. Multinational companies tend to exhibit even higher
productivity than just exporters or importers do, and thus tend to
appear at the very top of the productivity distribution of firms. They
also tend to be very trade-intensive, capital-intensive, innovation-
intensive, and high-wage not just relative to purely domestic companies
but also just exporters and importers.\52\
---------------------------------------------------------------------------
\52\ Representative evidence of this performance advantage for U.S.
multinationals appears in Doms and Jensen (1998), who documented how
plants that are part of multinational companies--both U.S. parent
companies of U.S.-based multinationals and U.S. affiliates of foreign-
based multinationals--tend to exhibit higher TFP, labor productivity,
and other performance characteristics such as capital intensity, skill
intensity, and wages. This superior performance of multinationals has
also been documented in many other countries: e.g., Criscuolo, Haskel,
and Slaughter (2010) for the United Kingdom. Doms, Mark E., and J.
Bradford Jensen. 1998. ``Comparing Wages, Skills, and Productivity
Between Domestically and Foreign-Owned Manufacturing Establishments in
the United States.'' In R. Baldwin, R. Lipsey, and J. D. Richardson
(eds.), Geography and Ownership as Bases for Economic Accounting.
Chicago: University of Chicago Press. Criscuolo, Chiara, Jonathan E.
Haskel, and Matthew J. Slaughter. 2010. ``Global Engagement and the
Innovation Activities of Firms,'' International Journal of Industrial
Organization, 28(2).
The superior performance of U.S. parents of U.S.-headquartered
multinational companies is shown in Figure 3C, which reports the share
of important activities in the overall U.S. private sector accounted
for by the U.S. parent operations of U.S.-headquartered multinationals
in 2012, the most recent year of available data.\53\
---------------------------------------------------------------------------
\53\ In Figure 3C and the supporting text, BEA data on U.S.
multinational companies have been matched as needed with private-sector
economy-wide data from appropriate government sources. The BEA data are
available online at www.bea.gov. Details on the source and definition
of these non-multinationals data are as follows, where all data--in
Figure 3C and all subsequent figures--were obtained online or from
Barefoot (2012). Employment: Bureau of Labor Statistics, U.S.
Department of Labor--U.S. private-sector nonfarm payroll employment.
Output: BEA--
Private-sector value-added output adjusted to exclude value added in
depository institutions and private households, imputed rental income
from owner-occupied housing, and business transfer payments.
Investment: BEA National Income and Product Accounts--Table 5.2.5
(Gross and Net Domestic Investment by Major Type) Line 10
(Nonresidential gross private fixed investment). Research and
Development: National Science Foundation--Total R&D performed by the
industrial sector, current dollars. Exports and Imports of Goods--BEA
National Income and Product Accounts, as reported in Barefoot and
Mataloni (2011). Compensation Premium for U.S. Multinational Companies:
The national measure of private-sector labor compensation comes from
the BEA National Income and Product Accounts Table 6.2 (Compensation of
Employees by Industry) Line 3 (Private Industries). Employee
compensation as measured in the BEA data includes wages, salaries and
benefits--mandated, contracted and voluntary. Finally, note that at the
time of writing NSF R&D data for 2012 were not yet available, so in
Figure 3C shares of U.S. private-sector R&D for 2011 are reported.
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
The parent operations of U.S.-headquartered global companies perform
large shares of America's productivity-enhancing activities--capital
investment, international trade, and R&D--that create tens of millions
---------------------------------------------------------------------------
of well-paying jobs for their American workers.
Output: Parent companies produced 26.8 percent of all private-
sector output (measured in terms of GDP)--over $3.2 trillion.
Capital Investment: Parent companies purchased $584.4 billion in
new property, plant and equipment--43.3 percent of all private-sector
capital investment.
Exports: Parent companies exported $728.1 billion of goods to
the rest of the world. This constituted 47.7 percent of the U.S. total.
R&D: To discover and develop new products and processes, parent
companies performed $220.3 billion of R&D. This was a remarkable 74.9
percent of the total R&D performed by all U.S. companies.
All these innovative activities contribute to millions of well-paying
jobs in America. In 2012, U.S. parent companies employed more than 23.1
million U.S. workers, 20.0 percent of total private-sector payroll
employment. Total compensation at U.S. parents was $1.77 trillion--a
per-worker average of $76,538, over a quarter above the average in the
rest of the private sector.
Moreover, the important contribution of U.S. parent operations to the
overall U.S. economy has been quite stable for decades. In 1988, for
example, U.S. parents' R&D spending was 72.5 percent of the economy-
wide private-sector totals--not much above the 2010 share of 68.8
percent. This stability over time demonstrates their ongoing
contributions to the overall U.S. economy.
The important fact that globally engaged companies--exporters,
importers, and especially multinationals--exhibit higher innovativeness
and productivity than do purely domestic companies begs the question
about causation. Do high-productivity companies tend to become globally
engaged? Or does global engagement trigger productivity gains? The
answer is, ``some of both.''
First, there is clear evidence that high-innovation, high-productivity
companies tend to select into being globally engaged--and, if
particularly productive, being a multinational company.\54\ This
resonates with much of the discussion above. More-innovative companies
tend to be able to crack into foreign markets--and they also want to do
so to boost returns on their IP investments.
---------------------------------------------------------------------------
\54\ ``Results from virtually every study across industries and
countries confirm that high productivity precedes entry into export
markets. These findings are suggestive of the presence of sunk entry
costs into export markets that only the most productive firms find it
profitable to incur'' (Bernard, et al, 2007, p. 111). This fact of
high-productivity companies selecting into global engagement has
spurred a large and ongoing literature in international economics with
a variety of new general-equilibrium models built on the foundation of
this fact. For example, a now standard research framework of
multinational firms assumes these firms obtain high-
productivity knowledge assets that are transferred from home-country
parents to host-country affiliates.
Second, there is also clear evidence that global engagement spurs the
productivity performance of companies. Some of the most comprehensive
research on this issue has been conducted by the McKinsey Global
Institute, which over the past generation has examined thousands of
firms and industries. A repeated finding is that exposure to ``global
best-practice firms'' via trade and FDI stimulates firm productivity. A
clear statement of this globalization-to-productivity link appears in
---------------------------------------------------------------------------
the work of Nobel laureate Robert Solow.
A main conclusion of the studies . . . has been that when an
industry is exposed to the world's best practice, it is forced
to increase its own productivity. . . . The more a given
industry is exposed to the world's best practice high
productivity industry, the higher is its relative productivity
(the closer it is to the leader). Competition with the
productivity leader encourages higher productivity.\55\
---------------------------------------------------------------------------
\55\ Pages 166-167 of: Baily, Martin Neil, and Robert M. Solow,
2001, ``International Productivity Comparisons Built from the Firm
Level,'' Journal of Economic Perspectives, 15(3).
This integration into the world economy boosts productivity in
companies through many channels. One is the competitive pressure to
reduce costs via innovating processes, creating or shifting firm scope
towards new products, and becoming more capital intensive. Another is
the spread of knowledge by learning from customers, suppliers, and
---------------------------------------------------------------------------
competitors.
It is also important to stress that global engagement boosts industry-
level productivity by spurring the reallocation of workers, capital,
and other resources from struggling companies to more-productive
innovators--often exporters and multinationals. As discussed in Section
II, countries boost average productivity by reallocating resources
across industries. Recent research has documented a very important
second dimension of resource-reallocation gains: within all
industries--regardless of the pattern of exports and imports--across
companies towards the higher-productivity, globally engaged firms. An
important part of this industry-level resource allocation is the
contraction of low-productivity firms, along with the faster expansion
of firms already engaged in international trade and investment. This
reallocation from low- to high-productivity firms as a result of trade
liberalization raises average industry productivity, a process that has
been documented for the United States and for many other countries as
well.
In addition to having very high productivity levels, for decades
globally engaged U.S. companies have played an outsized role in driving
aggregate U.S. productivity growth. This is the key finding of an
important recent study that focused on productivity growth ``because,
even though studies of [multinational] performance based on
microeconomic data have tended to identify effects on the level of
productivity, if these underlying productivity-enhancing effects are
spreading and/or filtering in over time, productivity aggregates will
be affected in terms of growth rates (as well as levels).'' Their
results they rightly describe as ``quite striking.''
Although the MNC [multinational corporation] sector accounts
for only 40 percent of the output of nonfinancial corporations
(NFCs) between 1977 and 2000, MNCs appear to have accounted for
more than three-fourths of the increase in NFC labor
productivity over this period. Moreover, MNCs account for all
of the NFC sector's pickup in labor productivity in the late
1990s; accordingly, they account for more than half of the
much-studied acceleration in aggregate productivity. And, while
MNCs involved in the production of IT contributed significantly
toward this acceleration, MNCs in other manufacturing and
nonmanufacturing industries contributed significantly as
well.\56\
---------------------------------------------------------------------------
\56\ Page 333 of: Corrado, Carol, Paul Lengermann, and Larry
Slifman, 2009, ``The Contributions of Multinational Corporations to
U.S. Productivity Growth, 1977-2000,'' In Marshall B. Reinsdorf and
Matthew J. Slaughter (eds.) International Flows of Invisibles: Trade in
Services and Intangibles in the Era of Globalization, NBER and
University of Chicago Press.
---------------------------------------------------------------------------
Foreign Activity by IP-Intensive Companies Complements, not Substitutes
for, U.S. IP Investment
How exactly are American IP-investment and employment affected by the
global reach discussed above? It is important to understand that U.S.
IP jobs and investments are created not only by exporting to foreign
markets but also by producing and selling in them through FDI in
foreign affiliates. Contrary to what is often presumed, expansion
abroad by globally engaged U.S. companies tends to complement, not
substitute for, their domestic activity.
The link between exports and American jobs is clear. When companies in
America gain new customers abroad for their goods and services, meeting
this demand creates new American jobs in these companies. Because of
the rich variety of goods and services America exports and the rich
variety of production methods used by companies in America, the link
from exports to jobs varies across companies, industries, and time.
That said, research has documented the many ways in which exporting
companies tend to be stronger than nonexporters.
Less well understood is the link between jobs and IP investment in
America and business growth abroad. Much of the public policy
discussion surrounding U.S. multinationals assumes that engagement
abroad necessarily substitutes for U.S. activity--in particular, for
employment and R&D investment. This substitution concern misses the
several channels through which the global engagement of U.S.
multinationals tends to support, not reduce, their operations in
America. As studies presented below have found, foreign-affiliate
activity tends to complement, not substitute for, key parent activities
in the United States. Three crucial features of how multinationals work
that belie the substitution idea are complementarity, scale and scope.
For some given level of firm-wide output, when firms employ many
kinds of workers and many non-labor factors of production, affiliate
and parent labor can often be complements in which more hiring abroad
also means more hiring in the United States. Complementarity is quite
common in global production networks, in which U.S. workers operate not
in isolation but rather in close collaboration with colleagues around
the world.
When affiliates are expanding abroad to boost their revenues,
the resulting reduction in costs and boost in profits (thanks to
greater scale and richer returns on IP) often spurs higher output in
the company around the world, which can mean more U.S. hiring.
Affiliate expansion often not only boosts firm scale but also,
as discussed previously, refines the mix of activities performed across
parents and affiliates. U.S. parents' employment can rise as they shift
their scope into higher value-added tasks--especially R&D and other IP
investments.
The concern that global expansion tends to hollow out U.S. operations
is not supported by the facts of existing research--now presented
below. Rather, the scale and scope of U.S. parent activities
increasingly depends on their successful presence abroad.
To see this, start with the often-heard claim that globally engaged
U.S. companies have somehow hollowed out their U.S. operations, leaving
only activity abroad. Is that true? What about the magnitude of U.S.
parent activities relative to the scale of their foreign affiliates?
Figure 3D reports the share of U.S. multinationals' 2012 worldwide
employment, output, capital investment, and R&D that was accounted for
by their U.S. parent operations.\57\
---------------------------------------------------------------------------
\57\ In Figure 3D, data for the shares were obtained from the BEA
multinationals data online at www.bea.gov.
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
The key message of Figure 3D is that the worldwide operations of U.S.
multinational companies are highly concentrated in America in their
---------------------------------------------------------------------------
U.S. parents, not abroad in their foreign affiliates.
Employment: U.S. parents account for 65.6 percent of worldwide
employment of U.S. multinationals--23.1 million parent workers versus
12.1 million at affiliates. This translates into a ratio of nearly two
U.S. employees for every one affiliate employee.
Output: U.S. parents account for 69.6 percent of worldwide
output (in terms of value added) of U.S. multinationals--over $3.2
trillion versus about $1.4 trillion.
Capital Investment: U.S. parents undertake 72.7 percent of
worldwide capital investment by U.S. multinationals--$584.4 billion
versus $219.8 billion. For every $1 in affiliate capital expenditures,
parents invested $2.66 worth in the United States.
R&D: U.S. parents perform 83.2 percent of worldwide R&D by U.S.
multinationals--$220.3 billion versus $44.6 billion, or $4.94 in parent
innovation and knowledge discovery and development for every $1 by
affiliates.
The United States, not abroad, is where U.S. multinationals perform the
large majority of their operations. Indeed, this U.S. concentration is
especially pronounced for R&D, which reflects America's underlying
strengths of skilled workers and legal protections such as IP rights
that together are the foundation of America's IP strengths, as
discussed earlier.
This much larger scale of U.S. parents than foreign affiliates has been
present for decades. A generation ago, the share of U.S. parents in the
worldwide activity of U.S. multinationals was slightly higher. In 1988,
U.S. parents accounted for 78.8 percent of U.S. multinationals'
worldwide employment and 79.2 percent of their worldwide capital
investment. So over the past generation, the foreign-affiliate shares
of employment and investment have risen by about 0.5 percentage points
per year. As this report documented above, however, this rise has been
driven mainly by ongoing expansion of parents that was outpaced by even
faster expansion of affiliates, not by parent contraction. Faster
affiliate expansion, in turn, has been driven mainly by faster economic
growth abroad and thus faster growth in customers there.
The bottom line is that the United States firmly remains where globally
engaged U.S. companies locate the majority of their operations--
especially their innovation activities--even as they have been growing
more quickly abroad.
What does the evidence show about the key question of complementarity:
has that foreign expansion complemented or substituted for their U.S.
activities? Aggregate, industry and company-level research to date
shows that foreign-affiliate expansion tends to complement U.S. parent
employment, investment, sales--and innovation efforts via R&D.
One such recent study examined industry-level data for 58 U.S.
manufacturing industries from 2000 through 2007. It found that the
productivity gains and cost savings from expanding global production
networks tended to boost overall U.S. employment in these industries--
albeit with changes in the scope of U.S. activities being performed.
Similar studies to this one have repeatedly found that when American
manufacturing industries invest more abroad, this outward investment
stimulates U.S. exports.\58\
---------------------------------------------------------------------------
\58\ Ottaviano, Gianmarco I.P., Giovanni Peri, and Greg C. Wright,
2010, ``Immigration, Offshoring, and American Jobs,'' National Bureau
of Economic Research Working Paper No. 16439. Studies that find a link
from outward investment and U.S. exports are well summarized in: Moran,
Theodore, 2009, American Multinationals and American Economic
Interests: New Dimensions to an Old Debate, Washington, DC: Peterson
Institute for International Economics.
Another study examined industry-level data for dozens of U.S.-based
multinational companies in services over recent decades. It found that
greater foreign-affiliate employment and sales correlated with greater
U.S.-parent employment as well, consistent with the idea that affiliate
and parent activity tend to, on net, complement each other.\59\
---------------------------------------------------------------------------
\59\ United States International Trade Commission. 2011. U.S.
Multinational Services Companies: Effects of Foreign Affiliate Activity
on U.S. Employment. Washington, DC: Office of Industries.
A third important study, conducted at the level of individual
companies, carefully analyzed all U.S. multinationals in manufacturing
from 1982 to 2004. It found that a 10 percent increase in foreign-
affiliate capital investment causes a 2.6 percent increase, on average,
in that affiliate's U.S. parent capital investment. It similarly found
that a 10 percent increase in foreign-affiliate employee compensation
causes a 3.7 percent increase, on average, in that affiliate's U.S.
parent employee compensation. These links were clearest when analyzing
the changes in affiliate jobs and investment driven by changes in
---------------------------------------------------------------------------
affiliate sales.
Their findings of complementarity were especially compelling for how
U.S.-parent R&D is supported by foreign-affiliate sales. They found
that 10 percent faster sales growth in foreign affiliates raises U.S.-
parent R&D spending by somewhere between 3.2 percent and 5.0 percent.
The authors concluded, ``Since foreign operations stand to benefit from
intangible assets developed by R&D spending, it is not surprising that
greater foreign investment might stimulate additional spending on R&D
in the United States. . . . These results do not support the popular
notion that expansions abroad reduce a [multinational] firm's domestic
activity, instead suggesting the opposite.'' \60\
---------------------------------------------------------------------------
\60\ Page 195 and page 181 of: Desai, Mihir A.; Foley, C. Fritz;
and James R. Hines, Jr. 2009. ``Domestic Effects of the Foreign
Affiliates of U.S. Multinationals.'' American Economic Journal:
Economic Policy, 1(1).
A fourth important study also examined individual companies, but this
time European-based multinationals. It linked within these
multinationals the employment and patenting activity of these
companies' inventors across both parent and affiliate countries, to
enable them to ascertain the effect of companies' expanding use of
researchers abroad on their use of researchers at home. Contrary to the
common presumption that foreign researchers will substitute for parent
researchers, this study found the opposite: ``Our main result suggests
that a 10 percent increase in the number of inventors abroad results in
a 1.9 percent increase in the number of inventors at home.'' \61\
---------------------------------------------------------------------------
\61\ Page 1 of: Abramovsky, Laura, Rachel Griffith, and Helen
Miller, 2012, ``Offshoring High- Skilled Jobs: EU Multinationals and
Domestic Employment of Inventors,'' Center for Economic Policy Research
Discussion Paper No. 8837.
One final important study also examined individual U.S. multinational
companies--not just in manufacturing but also in services, and for the
generation 1990 through 2009. As with the above earlier study of U.S.
multinationals, this very recent analysis also found consistent and
strong evidence that expansion abroad by foreign affiliates tends to
expand, not contract the activities of these affiliates' U.S. parents.
Figure 3E, taken from this study, summarizes its key findings.\62\
---------------------------------------------------------------------------
\62\ The U.S. Manufacturing Base: Four Signs of Strength, by
Theodore H. Moran and Lindsay Oldenski, Peterson Institute of Economics
Policy Brief No. 14-18, June 2014.
[GRAPHIC(S) NOT AVAILABLE IN TIFF FORMAT]
For U.S. parent companies in manufacturing as well as U.S. parent
companies in services, expanded foreign-affiliate employment is
associated with economically and statistically significant increases in
parent employment, capital investment, output, exports, and--most of
all--R&D expenditures. This latter correlation is especially notable
here: expanding foreign affiliates trigger more, not less, parent
---------------------------------------------------------------------------
efforts to discover IP and other such innovations.
All of the strengths of the U.S.-headquartered multinational companies
at the heart of America's IP-intensive industries would be curtailed,
not supported, by tax policy that discriminates against the IP income
of the foreign affiliates of these companies.
------------------------------------------------------------------------
-------------------------------------------------------------------------
The clear conclusion from research to date is that, on average, foreign
affiliates and U.S. parents expand together--driven by the dynamism of
complementarity, scale and scope. In particular, foreign-affiliate
growth tends to stimulate, not reduce, U.S.-parent IP investments. In
the current environment of sharply slower productivity growth, America
now more than ever needs policies that support, not constrain, the
dynamic energies of its most innovative companies. Tax reform that
penalizes IP income and activity is precisely the wrong policy
direction for helping America reaccelerate economic growth through
innovation and the resulting growth in U.S. jobs and incomes.
------------------------------------------------------------------------
Conclusions
Intangible property has long played a central role in driving growth in
U.S. output, jobs, and incomes. Discovering and developing ideas with
value boosts output in existing companies and industries and creates
entire new industries. This innovation has long created new jobs and
higher standards of living for all American workers and their families.
Maintaining IP's many contributions to the U.S. economy will require
smarter public policy now and in the future, however, given the breadth
of indicators that America's innovation strength is waning. In
particular, policymakers must understand the value of a tax system that
does not discriminate against the IP performed by American companies.
Such a tax system needs to recognize the global nature of America's IP
innovators. U.S.-headquartered multinational companies, which create
the large majority of America's IP, increasingly rely on their global
operations to maximize the creativity and benefits of their U.S.
inventions. These globally engaged U.S. companies have long performed
the large majority of America's IP discovery and development.
Increasingly central to America's IP success is the ability of its
multinational companies to deploy that IP abroad. Connecting foreign
customers with U.S. ideas tends to complement, not substitute for,
American IP investments--both in terms of the quantity and the quality
of U.S. innovation.
The potential is great for American IP activity to connect with global
markets. Tax policy should support, not inhibit, this potential.
Unfortunately, the tax-reform proposals in the Discussion Draft would
undermine this potential. The Discussion Draft would fundamentally
shift the measurement and tax treatment of IP income earned by the
foreign affiliates of U.S.-based multinational companies--and in so
doing would discriminate against these affiliates' IP income relative
to their non-IP income.
The U.S. tax burden on foreign-affiliate IP income under the Discussion
Draft would be higher in three important comparisons: relative to
current law, relative to other business activities under the Draft, and
relative to foreign competitors under Draft. From all three of these
perspectives, U.S.-headquartered multinational companies would be
disadvantaged by the treatment of foreign-affiliate IP income--and thus
would be discouraged from investing in IP.
This legislation would incentivize U.S.-headquartered multinationals to
invest less in new ideas and innovation, to invest more in non-IP
assets, to make those non-IP investments outside America rather than
inside, and to be acquired by a larger foreign company or to acquire a
smaller foreign company and invert. It would advantage foreign-
headquartered multinationals not subject to its worldwide taxation in
bidding for IP assets around the world, and it would discourage the
start-up of new IP-intensive companies in America.
America stands much to gain from broad and fundamental policy reform to
create an internationally competitive tax system. But that reform
should not discriminate against IP and its increasingly important
contributions to the U.S. economy of growth, good jobs, and
opportunity.
[all]