[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

                               __________


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                          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

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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.
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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\
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    \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\
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    \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.
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    \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\
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    \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 
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        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\
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    \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 
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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\
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    \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 
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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\
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    \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.
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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\
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    \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 
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        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\
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    \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 
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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\
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    \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 
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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\
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    \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\
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    \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-
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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\
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    \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.
                                   
                                   
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