Featured Articles

Border Adjustment Treaty Damage Could Hinder Tax Enforcement

Posted on March 28, 2017 by Nathan J. Richman

by Nathan J. Richman -- nathan.richman@taxanalysts.org

While the destination-based cash flow tax proposal has triggered a vigorous debate about currency valuation, revenue, and wealth effects, the potential effect on offshore tax enforcement has received less attention.

Perhaps one reason for the lack of attention is that the potential enforcement effect of the border adjustment would be indirect -- the result of damage to the country's network of tax treaties and, more specifically, the information exchange provisions in those treaties. There have already been suggestions that the proposal could violate tax treaties or at least require them to be renegotiated. 

Kathryn Keneally, former assistant attorney general in the Justice Department Tax Division and now with DLA Piper, said the Tax Division relies on tools from the tax treaties as part of its investigations. While it is not yet clear how the proposed destination-based cash flow tax may affect the treaties, "the information exchange provisions in our tax treaties play a very important role in tax enforcement," she said.

Because the gap between the amount of revenue that should be collected under the tax code and the amount actually collected is always a challenge for the United States, it would not be a good idea to hinder enforcement efforts, Keneally said, adding, "Our treaties are there for a reason."

During Keneally's tenure as the head of the Tax Division, the United States and Switzerland entered into an agreement to enable Swiss banks to resolve any exposure they may have had to U.S. criminal tax charges. 

The Swiss bank program arose from a mutual effort between the Justice Department and the Swiss government "to make sure that we were exchanging information consistent with the U.S.-Swiss tax treaty, which has some unique language in it," Keneally said, adding that most other tax treaty information exchange provisions do not have that language and thus would not require a special program. Under the tax treaties with other countries, the information needed to develop investigations of U.S. tax crimes is available from competent authorities, she said. 

Scott Michel of Caplin & Drysdale Chtd. said any disruption to treaty information exchange would be a big deal. He said the Swiss bank program is an example of the frustration that can come from information exchange issues. The "fraud and the like" standard for information exchange in the Switzerland-U.S. tax treaty is much narrower than the standard in most other tax treaties to which the United States is a party, he said.

In 2009, during the litigation of the John Doe summons issued to UBS AG, the United States and Switzerland negotiated a new protocol that would have brought information exchange provisions of the Switzerland-U.S. tax treaty in line with most other U.S. tax treaties. However, even though the Swiss parliament has approved the protocol, Sen. Rand Paul, R-Ky., has placed a hold on it and at least nine other treaties and information exchange agreements, preventing consideration in the Senate. 

Paul declined to comment because the House blueprint's destination-based cash flow tax has not yet been implemented. On March 1 the American Institute of CPAs sent a letter to the Senate urging approval of the treaty backlog to facilitate cooperation "in the fair and efficient enforcement of tax laws," among other things.

Michel said there were thousands of accounts at issue in the Swiss bank program that would have been difficult for the Justice Department to obtain information on using treaty requests under the "fraud and the like" standard. The Swiss bank program "would have been a completely different animal had the [2009] protocol been ratified," he said. Further, under the standard information exchange provision in that protocol, the amount of information and investigative leads the Justice Department would have received would have been an order of magnitude larger than the substantial amount of information it did receive under the Swiss bank program, he said.

There is a strong case to be made that the weaker information exchange provision has hampered U.S. law enforcement "in a circumstance where there actually is a treaty in place," Michel said. "One can only imagine if the U.S. starts to take a different view of tax treaties, and information exchange under those treaties, how that might multiply itself around the world."

Michel said a retreat from the international tax community spurred by anti-globalist sentiment could leave the United States without a seat at the table for the discussion of what should happen next.