Tax Analysts Blog

The Pepperdine Papers: Advice for Obama's Second Term

Posted on Jan 25, 2013

Last week, the Pepperdine Law Review hosted a unique policy forum: Tax Advice for the Second Obama Administration. The event was organized by Professor Paul Caron and cosponsored by Tax Analysts. Three of the featured papers addressed international reforms and are highlighted below. You can read a synopsis of the Pepperdine conference on Professor Caron's web site, TaxProfBlog and view the video here.

FOREIGN PROFITS

Professor Reuven Avi-Yonah (University of Michigan) segmented his advice chronologically. You can read his paper here. In the short-term, he says we need to address the under-taxation of foreign profits relative to domestic profits. He writes that the administration's proposal to apply a minimum tax to foreign-source income is "on the right track." But the minimum tax, alone, is insufficient. He recommends five additional short-term enhancements, including a revised test for determining corporate residence based on the 'managed and controlled' standard.

In the mid-term, he makes a case for moving in the direction a pure source-based taxation of corporate profits. That's because corporate residence has become less meaningful in the age of globalization. However, taxing multinationals on the basis of source-of-income requires that we fix transfer pricing. Avi-Yonah would do that by utilizing the residual profit-split method for allocating corporate income. In the long-term, he thinks a VAT is almost inevitable given our nation's bleak fiscal forecast and the likelihood that Congress will not significantly reduce entitlement spending.

Interestingly, Avi-Yonah claims his recommendations (even the minimum tax on foreign profits) do not necessarily conflict with the business sector's demand for a territorial system. It's possible, he says, to achieve territoriality via an inbound dividend exemption — but only after (i) some minimum level of tax has been paid on foreign profits, and (ii) transfer pricing leakage has been fixed. What's most thought-provoking about his paper is the notion that those two reforms might actually enable a shift to a territorial system.

TRANSFER PRICING

Professor Susan Morse (UC Hastings College of Law) placed the spotlight on aggressive transfer pricing. She says the task of allocating income and deductions among the foreign affiliates of a large multinational will remain problematic regardless of whether Congress adopts a territorial system. She warns that pressure on current transfer pricing rules will intensify under a territorial regime.

The first part of her paper (not yet published) details the contours of the current regulations under IRC section 482, including the pursuit of elusive comparables that often don't exist in any real sense. The logic of comparables, it seems, conflicts with the fundamental concept of a multinational firm. Transactions between unrelated parties are rarely accurate proxies for intra-group dealings. The current regs are so dysfunctional that they provide unintended "refuge" for noncompliant taxpayers. Morse cites the IRS' failure to win key transfer pricing disputes before our nations courts (e.g., the Xilinx and Veritas cases ).

The second part of her paper argues for a strong regulatory response. She concludes that tax administrators already possess the necessary tools to affect meaningful change; they simply need to be inspired to act and to avoid back-pedalling (e.g., the fumbling of IRS Notices 98-5 and 98-11). The way forward is to give taxpayers less discretion in methodologies. The fewer options available for tax planning, the more optimal the outcome. Like Avi-Yonah, Morse sees hope in the residual profit-split method. Although technically compliant with the arms' length standard, this approach functionally resembles an objective (i.e., formulary) allocation.

FATCA & EITI

Finally, Professor Allison Christians (McGill University) spoke of recent seismic shifts in international taxation. As she sees it, the onset of FATCA (the Foreign Account Tax Compliance Act) and EITI (the Extractive Industries Transparency Initiative) reflect the mercenary tendencies of the nation state to assert jurisdiction in ways formerly thought untenable. Christians embraces the notion of information exchange, in theory, but questions whether the compliance burdens are reasonable. Reciprocity remains a legitimate issue. It can be argued that dual-resident Canadian nationals are hard done by FATCA.

Personally, I consider her discussion of EITI as the revelation of the conference. Few tax professionals are even aware of the regime's existence. Bravo to Professor Christians for highlighting the issue and framing the issue in such an insightful manner.

EITI is not tax law. It's part of the 2010 Dodd-Frank Wall Street reform legislation. EITI requires country-by-country reporting for U.S. multinationals based in the extractive industries (oil, gas, minerals, etc.). Affected firms must disclose previously secret information about their global corporate structures, inter-company transactions, and payments of any kind to foreign governments -- including everything from taxes, to fees, to kickbacks, to bribes. In a world where stateless income is becoming the new normal, double-nontaxation of corporate profits is a legitimate problem. The type of disclosure envisioned by EITI could mitigate those concerns. The next issue for policymakers is whether EITI should be expanded to all publicly listed corporations.

Fiscal transparency lies at the heart of both FATCA and EITI. And it should be no surprise that Tax Analysts is all about greater transparency. When it comes to sanitizing an opaque and inefficient tax system, we believe sunshine truly is the best disinfectant.

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