This document originally appeared in the June 14, 2013 edition of Tax Notes Today.
by Jaime Arora and Matthew R. Madara
Questioning a panel of experts on the merits of a territorial regime, offshore cash stockpiles, and the promotion of American manufacturing, the House Ways and Means Committee considered how best to combat base erosion and profit shifting (BEPS) at a hearing on June 13. Also up for deliberation was an anti-base-erosion proposal that committee Chair Dave Camp, R-Mich., included in his 2011 discussion draft on corporate taxation.
In his opening statement, Camp said the practice of multinational companies reducing their tax liability by separating where income is taxed from where the economic activity occurs is the consequence of bad laws.
"We're proud of American corporations," added committee ranking minority member Sander M. Levin, D-Mich. "But we very much want to have a tax system that makes sense for all of us."
Panelists said America's corporate taxation woes related to BEPS aren't unique and that reform may need to be considered in light of the global response to those problems.
Pascal Saint-Amans, director of the OECD Centre for Tax Policy and Administration, told the committee that BEPS is a growing concern for OECD member states and nonmembers alike. It has received attention as nations struggle with the weak economy, he said, adding that the OECD has begun a project to address double nontaxation by bringing countries together to identify and discuss different options. A single country cannot confront the issue on its own, nor should countries ignore the consequences of their actions, he said.
Edward D. Kleinbard, a professor at the University of Southern California Gould School of Law, said the prospect of stateless income distorts investment decisions and seems to offer U.S. firms the possibility of "supersize" returns on the foreign investments. Noting that countries must be aware of what other jurisdictions are doing, he said that multinational corporations are the only winners in the current system, while every taxing country is a loser.
Camp's Option C
Perhaps the most widely discussed option in Camp's first discussion draft on international corporate taxation is option C, under which intangible profits from U.S. manufactured goods sold into foreign markets would receive a reduced tax rate. Option C would lower the corporate tax rate for all foreign intangible income to 15 percent but would treat a controlled foreign corporation's foreign intangible income as subpart F income if it were taxed in the foreign jurisdiction at a rate less than 13.5 percent.
In his prepared testimony , Paul W. Oosterhuis of Skadden, Arps, Slate, Meagher & Flom LLP said that option C offers a "well-designed starting point for crafting an appropriate base erosion proposal because it is fundamentally based on the distinction between U.S. sales and foreign sales that is critical to preserving the essential character of a territorial system." He told the committee that adopting option C would be a move in the right direction.
Kleinbard disagreed, saying option C would both work poorly and be inadministrable, regardless of its theoretical merit. If it were enacted, the IRS and corporations would fight endlessly about what fraction of a company's total income was attributable to which intangible asset, he said, adding that that would be an unfair burden to put on the system.
Oosterhuis argued that if intangible property were defined in relation to excess profits, the option would be relatively administrable.
Oosterhuis also said that option C would level the playing field between U.S. and foreign manufacturers. By providing a lower tax rate on the intellectual property element of value in exported products, it would tax products exported from the U.S. at an aggregate rate similar to that of foreign manufactured products, he said.
Pointing out that there are already incentives for U.S. manufacturers, such as the section 199 deduction, Kleinbard said the country's tax system shouldn't be designed to subsidize a particular sector. "Let's design an efficient tax," he said.
Territorial vs. Worldwide
Kleinbard said a territorial or hybrid system warrants consideration as a way to increase U.S. companies' competitiveness, but he also suggested a simpler but more radical alternative: worldwide tax consolidation. He argued that that could follow a process similar to what is being used for financial reporting standards convergence. If it were combined with a lower tax rate of about 25 percent, the effects would be much the same as those of a territorial system, he said, adding, "The idea is less wacky than you might think."
There are no pure systems, Saint-Amans told the committee, adding that countries that purport to follow a territorial approach still tax some profits earned offshore. "It's a territorial system with teeth," he said. Likewise, he said, when a country uses a worldwide taxation scheme, there are still exceptions that allow companies not to pay tax on all of their earnings. There is hybridism almost everywhere, he said, adding that what matters most isn't the characterization of the system but its design.
Corporate Tax Too High
Camp argued that a lower corporate tax rate is the most effective anti-base-erosion rule but emphasized that additional measures are necessary to protect the U.S. tax base. Saint-Amans pointed out that the U.S.'s 35 percent corporate tax rate is the highest in the OECD.
Kleinbard agreed with Camp that U.S. corporate tax rates should be reduced and suggested that a 25 percent tax rate coupled with worldwide tax consolidation would remove base erosion and profit-shifting incentives. Implementing a lower domestic tax rate is fundamental, he said.
Oosterhuis suggested instead a rate ranging from 10 to 15 percent.
Bringing Offshore Income Back to U.S.
Responding to a question from Rep. Kevin Brady, R-Texas, Oosterhuis said that the worst part of the system is that multinational corporations are forced to leave income offshore. Kleinbard disagreed that money was trapped offshore and argued that the money is invested in U.S. banks and bonds and is "at work in the U.S. economy."
Rep. Todd C. Young, R-Ind., asked whether there are economic benefits to repatriating offshore income. Oosterhuis said repatriation is essential and that although the income may be in U.S. banks, those banks aren't lending. According to Oosterhuis, the money is sitting unused and corporate behavior is being distorted because firms have excess cash on their balance sheets that isn't being used productively.
Kleinbard agreed that repatriation of offshore income would provide an economic benefit but was skeptical of using preferential tax rates to encourage repatriation.
Rep. Linda T. Sánchez, D-Calif., asked whether targeted incentives should be used to encourage multinationals to bring offshore income back to the United States. Kleinbard said domestic tax expenditures are essentially expensive and poorly targeted subsidies. Oosterhuis was also dubious about the use of incentives but said corporations would use cash brought back to the U.S. to pay dividends, which would put that money to work in the U.S. economy.
- Opening statement from Ways and Means ranking minority member Sander M. Levin, D-Mich.
- Release from Ways and Means member Allyson Y. Schwartz, D-Pa.
- Testimony from Pascal Saint-Amans, OECD.
- Testimony from Edward D. Kleinbard, University of Southern California Gould School of Law.
- Release from the Alliance for Competitive Taxation.