House Subcommittee examines potential impact of BEPS project on U.S. companies
House Subcommittee examines potential impact of BEPS project on U.S. companies
On December 1, the House Ways and Means Subcommittee on Tax Policy held a hearing to examine the final recommendations recently issued by the Organization for Economic Co-operation and Development (OECD) to combat base erosion and profit shifting (BEPS). Robert Stack, Treasury Deputy Assistant Secretary for International Tax Affairs, responded to a number of questions about his department’s role in negotiating the final BEPS recommendations. Testimonies from expert witnesses confirmed that there is a troubling indication of a desire by some countries to target American companies and erode the U.S. tax base. The participants discussed a few long-term and short-term solutions, including a U.S. value added tax (VAT), an increase in the individual capital gains rate, and making the research and development (R&D) credit permanent, among other things.
Background—BEPS project. According to the OECD, the current international tax rules have revealed weaknesses that create opportunities for BEPS, requiring policy makers to restore confidence in the system and ensure that profits are taxed where economic activities take place and value is created.
Undertaken at the request of the G20 leaders, the work to address BEPS is based on the 2013 G20/OECD BEPS action plan, which identified 15 Actions to combat international tax avoidance.
- New minimum standards that are intended “to tackle issues in cases where no action by some countries would have created negative spill overs (including adverse impacts of competitiveness) on other countries”—for example, country-by-country (CbC) reporting under Action 13;
- Reinforced international standards on tax treaties and transfer pricing—for example, revising the OECD model treaty definition of a permanent establishment and the transfer pricing approach with respect to hard-to-value intangibles;
- Common approaches and best practices for domestic law measures—for example, strengthen the controlled foreign corporation (CFC) rules;
- Analytical reports with recommendations concerning the digital economy and multilateral instruments; and
- A detailed report on measuring BEPS.
In November 2015, G20 leaders formally endorsed the OECD’s final package of BEPS reports at the tenth annual G20 Leaders Summit in Antalya (Turkey) (Weekly Alert ¶ 21 10/15/2015).
Background on global tax controversies involving American companies. Since June 2013, the European Commission has been investigating the tax ruling practices of European Union (EU) Member States. Tax rulings are essentially comfort letters issued by tax authorities to give a company clarity on how its corporate tax will be calculated or on the use of special tax provisions. According to the European Commission, tax rulings are legal, but they may not use methodologies that would give a company an unfair competitive advantage over other companies. Unless the selective advantage is justified by reasons of general economic development, it may violate EU State aid rules.
The European Commission is in charge of ensuring that State aid complies with EU rules. On June 11, 2014, the European Commission opened formal State aid investigations in three cases: Apple in Ireland, Starbucks in the Netherlands, and Fiat Finance & Trade in Luxembourg. hereafter, in November 2014, International Consortium of Investigative Journalists (ICIJ) made public the confidential Luxembourg tax rulings of over 300 multinational enterprises (MNEs) dating from 2002 to 2010; these rulings are often referred to as the “Luxleaks.” The Luxleaks “revealed the extent of the use of secret deals featuring complex financial structures designed to obtain drastic tax reductions.” In December 2014, the European Commission extended its State aid inquiry to all EU Member States.
On Oct. 21, 2015, the European Commission decided that a 2008 Dutch transfer pricing tax ruling gave a selective advantage to Starbucks, resulting in the reduction of the entity’s Dutch tax burden by €20 to €30 million and ordered the Netherlands to recover the unpaid tax from Starbucks. On the same day, it reached a similar conclusion about Italian-headquartered Fiat Finance & Trade with respect to Luxembourg. The European Commission has not announced its decision in the State aid case against Apple in Ireland.
The Hearing. On Nov. 24, 2015, Chairman Charles Boustany (R-LA) announced that the Tax Policy Subcommittee (formerly known as the Select Revenue Measures Subcommittee) would hold a hearing on Dec. 1, 2015 to discuss the OECD BEPS project final recommendations and its effect on worldwide American companies.
At the hearing, Chairman Boustany said that “[t]he BEPS project may have been motivated by an underlying belief that creating a business-friendly tax regime to attract business investment to one’s country is itself an illegitimate and harmful practice that must be eliminated; but the BEPS project ended up making recommendations that will achieve the opposite result by encouraging countries to create patent boxes, which will effectively force worldwide companies to shift their business operations out of the United States. Moreover, the exposure of American companies’ highly sensitive information through the country-by-country reporting requirements within the BEPS recommendations are not constrained by any rationale for the breadth of information required, and also lacking appropriate protections for the highly sensitive nature of this information.” He further stated that the “final recommendations issued this year, coupled with the present European Commission investigation into the alleged receipt of illegal state aid by mostly American companies, expose what appears to be an extremely disturbing and multi-faceted attack, targeted specifically at American companies. ”
Finally, Chairman Boustany concluded that it is time to take the tough, but necessary steps to reform the U.S. tax rules. “We have had nearly three decades of procrastinating on tax reform,” said Chairman Boustany.
Congressional representatives David Reichert (R-WA), Patrick Tiberi (R-OH), Thomas Reed (R-NY), George (Mike) Kelly (R-PA), James Renacci (R-OH), Kristi Noem (R-SD), George Holding (R-NC), Richard Neal (D-MA), John Larson (D-CT), Linda Sanchez (D-CA), and Charles (Mike) Thompson (D-CA) joined Chairman Boustany at the December 1 hearing. Written testimonies were provided by Robert Stack, Ernst & Young (E&Y) Principal Barbara Angus, The Software Coalition Counsel Gary Sprague, Vice President for Tax Policy of the National Foreign Trade Council Catherine Shultz, and Tax Notes Chief Economist Martin Sullivan.
At the hearing, the participants discussed the impact of the following on U.S. taxpayers:
- The final BEPS recommendations;
- The EU State aid investigations;
- Pfizer Inc.’s plan to merge with Ireland-based Allergan Plc and corporate tax inversions in general;
- Patent boxes and other incentives offered by other countries—specifically, the U.K. and Ireland; and
- Short term and long term solutions.
Final BEPS recommendations. At the hearing, concern was expressed about the impact of a number of the final BEPS measures on American companies, including country-by-country (CbC) reporting, the revised permanent establishment (PE) rules, and the lack of mandatory binding arbitration.
As Stack explained, the CbC report is essentially a template with “six to seven economic indicators” that MNEs with consolidated group revenue of €750 million or more in a fiscal year would file with their U.S. income tax returns. The Treasury Department would exchange such informations with other countries under applicable tax treaties. Under the BEPS recommendations, American companies would exchange master files directly with foreign authorities, rather than through the Treasury Department. Furthermore, the final BEPS measures do not include a de minimus threshold on the exchange of the master files with foreign tax administrations.
Rep. Holding asked Stack whether the BEPS project took into consideration recourse measures in the event that American company information is misused and what the Treasury Department is doing to protect U.S. multinational enterprises (MNEs). Stack responded that American companies may decide what information to provide in the master files and that they already deal with foreign tax administrations that may “misbehave.” However, Rep. Noem pointed out that many small American businesses invest overseas, and they may be subject to the requirement to exchange master files with foreign tax administrations. These small American businesses may not have the experience or the resources necessary to deal with foreign tax administrations that may “misbehave.”
In addition, E&Y Principal Angus expressed concerns about vagueness of certain BEPS measures (particularly, the revised PE rules under Action 7) that may allow multiple countries to lay claim to the same item of income. Rep. Noem expressed concerns that small American businesses may not have the experience or resources to deal with the PE rules.
Finally, in response to concerns about the lack of mandatory binding arbitration measures in the final BEPS recommendations, Stack explained that the OECD operates under a consensus approach, so that even the objection of one country to a particular outcome is taken under consideration. According to Stack, some countries were not ready to move forward with mandatory binding arbitration.
EU State aid investigations. Rep. Tiberi expressed outrage that the EU is retroactively targeting U.S. MNEs in State aid cases. Chairman Boustany had spoken with Apple and shared that the company is “very concerned.”
Chairman Boustany asked Stack what the Treasury Department is doing to protect the interests of the U.S. Stack responded that no one expected a State aid analysis, on top of the tax ruling process of the EU Member States in question. In Stack’s view, a prospective remedy would be more appropriate.
Stack also pointed out that the U.S. does not have a tax treaty with the EU, but rather, individual EU Member States. In this regard, if the European Commission is substituting its own views on behalf of the EU Member States, Stack questioned what effect this may have with respect to bilateral treaties between the U.S. and the EU Member States.
The participants also discussed whether any retroactive tax paid in the EU would be creditable in the U.S.–i.e., whether the U.S. would effectively foot the bill.
Inversions. On the topic of corporate inversions, concern was expressed about Pfizer Inc.’s recent decision to invert. The participants acknowledged that American companies invert to reduce their overall operating costs, which includes their tax costs.
As Representative Kelly stated, U.S. companies are “not stupid.” When the price of a good artificially increases because of tax, it is time to look at the tax, he said.
Patent boxes and other incentives. Concern was expressed that the final BEPS measures have lead to a number of countries offering preferential intangible property (IP) regimes (so-called “patent boxes”) to incentivize MNEs to migrate their R&D functions into these jurisdictions.
Specific reference was made to the Irish Knowledge Development Box (6.25% rate) and the U.K. Modified Patent Box (10% rate). However, it was also noted that these countries have extremely high individual tax rates and a VAT regime.
Chairman Boustany asked if such preferential IP regimes may incentivize U.S. MNEs to move certain operations outside the U.S. The Software Coalition Counsel Sprague indicated yes, as these are “powerful incentives.” He further cautioned that transfer pricing changes may result in U.S. MNEs putting high value jobs outside the U.S.
Short-term and long-term solutions. Throughout the hearing, numerous references were made to the need for comprehensive U.S. tax reform, including establishing a U.S. territorial tax system and reducing the U.S. corporate tax rate. Stack noted, however, that the U.S. would not join a “race to the bottom.”
Rep. Reed asked about short-term solutions, as he was not confident that comprehensive U.S. tax reform would happen soon—at least not in the next six months. Suggestions included U.S. value added tax (VAT), increase in the individual capital gains rate, and making the research and development (R&D) permanent, among other things.
JCT report. In connection with the House Subcommittee’s hearing (and the Senate Committee on Finance hearing, “International Tax: OECD BEPS and EU State Aid”), the Joint Committee on Taxation (JCT) had prepared a report that concluded that the BEPS project has uncertain implications for U.S. multinational companies and U.S. cross-border taxation: namely, that it’s possible that for some operations of some U.S. multinational companies, foreign taxation will increase, while for other operations of the same or other U.S. multinational companies, foreign taxation will decrease.
- U.S. multinational companies might face increased foreign taxation of their non-U.S. operations because, among other reasons, governments will introduce domestic rules and treaty provisions that restrict opportunities for shifting profits to low-tax or zero-tax countries. Governments of countries in which U.S. multinational companies operate might reform transfer pricing, controlled foreign corporation, interest deductibility, and other rules in ways intended to ensure that those governments collect more tax at the prevailing statutory rates on income attributable to activities in those countries than they do under present law.
- U.S. multinational companies might face decreased taxation of their non-U.S. operations as governments of various countries use tax incentives such as preferential tax rates for some intellectual property income to encourage multinational firms to move existing operations to, or locate new operations in, those countries. Joint Committee on Taxation, “Background, Summary, and Implications of the OECD/G20 Base Erosion and Profit Shifting Project” (Nov. 30, 2015).