The Internal Revenue Service (IRS) estimates that over the past 30 years, the tax gap has fluctuated in a narrow range—15 to 18 percent of total tax liability. In 2016, the IRS provided data for 2008-2010, showing a tax gap of $458 billion. For 2006 the tax gap is estimated to be $450 billion.Read More
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IRS Statement on the Tax Gap Update
The IRS periodically estimates the tax gap, which gives a broad view of the nation’s compliance with federal tax laws. The new study covers tax years 2008-2010. The report finds that there has been no significant change in the amount of the tax gap or the rate of compliance since the last report was issued for tax year 2006.
The average annual tax gap for 2008-2010 is estimated to be $458 billion, compared to $450 billion for tax year 2006. IRS enforcement activities and late payments resulted in an additional $52 billion in tax paid, reducing the net tax gap for the 2008-2010 period to $406 billion per year. The voluntary compliance rate is now estimated at 81.7 percent compared to the prior estimated rate of 83.1 percent. After accounting for enforcement and late payments, the net compliance rate is 83.7 percent.
The small increase in the estimated size of the tax gap and small decrease in the voluntary compliance rate are largely attributable to improvements in the tax gap estimation methodology, and do not represent a significant change in underlying taxpayer behavior. The changes also reflect the overall decline in the nation’s tax revenues due to the severe recession during the time period covered by this study, as well as changes in the mix of income sources that have different compliance rates.
A high level of voluntary tax compliance remains critical to help ensure taxpayer faith and fairness in the tax system. Those who don’t pay what they owe ultimately shift the tax burden to those who properly meet their tax obligations. The new tax gap estimate updates long-standing research findings that information reporting and withholding are strongly associated with higher levels of voluntary compliance.
The IRS continues to look for ways to keep the voluntary compliance rate high, including educational efforts aimed at preparers and taxpayers, ongoing efforts to improve compliance in the international tax arena, and working with businesses on employment tax issues.
Report: Tax Gap Estimates for Tax Years 2008–2010
Apple and the EU: Summary of the EU's latest ruling against Apple and the EU's proposed reforms of corporate taxation.
As previously covered in this blog, the EU ruled against Ireland granting tax benefits of up to €13 billion to Apple in violation of the State aid rules. In their law review article, "Apple State Aid Ruling: A Wrong Way to Enforce the Benefits Principle?", Professor Reuven S. Avi-Yonah (Michigan Law) and Gianluca Mazzoni (SJD Candidate, Michigan) detail how Apple was able to utilize Ireland in reducing its tax liabilities. The most notable facts of Apple's Irish arrangement as uncovered by the article are:
- Apple's market capitalization as of October 7, 2016 was $614.61 billion dollars (or $612.66 billion as of the third quarter of 2016)
- Apple used cost sharing agreements to shift profits from U.S. Developed intangibles to its Irish subsidiaries.
- The article briefly discusses how cost sharing agreements (as used in pharmaceutical companies) should deter transfer pricing/revenue shifting because in pharmaceutical companies it is a gamble as to whether a particular drug will be a blockbuster drug and the pharmaceutical companies would risk losing R&D costs shifted to its offshore subsidiary if the drug didn't have profits generated in the offshore subsidiary.
- The article states that this is not the case in technology companies, like Apple, because of Apple's track record of producing blockbuster technological products.
- Apple utilized licenses of Apple's brand and intellectual property by its Irish subsidiary's (Apple Sales International, ASI's) subsidiary retail locations throughout Europe to shift royalty payments from the retail locations to ASI instead of paying taxes on the income in the European countries.
- The article notes that the profits from other EU nations are paid to the Irish subsidiary as royalty fees for licensing Apple's logo and branding to the EU subsidiaries.
The article also discusses the reason why Apple was able to utilize its Irish structure to shield income from taxation. The primary reason for Apple's ability to set up this structure are as follows:
- Ireland and EU's lack of withholding tax on receipts fro EU member states.
- The article highlights that the commentary regarding EU's position to not implement a withholding tax on receipts from EU member states could create a tax haven for EU profits to be shielded from tax because the countries where the profits are earned do not impose a withholding tax on the profits leaving that country and coupling that with certain countries (Ireland and Cyprus) that do not tax money not directly earned in that country's borders allows a sophisticated company to avoid tax on profits made in EU countries.
- In 1997 U.S. adoption of Check the Box regulations.
- The article points out that in 1997 under the direction of the U.S. Treasury and the Clinton Administration, Congress adopted the "check the box" regulations. Check the box regulations allowed U.S. multinational corporations to treat (for US tax purposes) foreign subsidiary corporations as transparent and not separate taxable entities. This also allowed the foreign subsidiaries to transfer royalties and interest payments between each other without generating tax (called Subpart F) on the transfers.
- The article also makes the point that at the adoption of the check the box rules, the U.K. and Germany objected to this position because it would allow U.S. multinational corporations to utilize earnings stripping to reduce taxable income in their respective countries. Congress at the urging of the U.S. multinational companies (namely the argument that reducing the taxable income in foreign countries would lead to larger amounts of tax paid in the U.S.) enacted the check the box regulations.
- The article also, with the advantage of hindsight, makes the argument that the check the box regulation over time has shown that the U.K. and German objections were warranted because U.S. multinational corporations have stripped earnings from EU countries and have not resulted in more U.S. taxes paid by the sameU.S. multinational corporations.
- The article points out that the check the box regulations created such a huge loophole (estimated $86.5 billion over a ten year period) that early on President Obama and the U.S. Treasury advocated for the reformation of the check the box regulation. However, after intense lobbying by business associations, the Obama administration has since abandoned the check the box regulation reforms and extended the check the box regulation treatment for another 5 years.
- Exploitation of difference between Irish and U.S. tax residency rules
- As stated in the article, Irish laws taxes corporations for only income earned in Ireland. U.S. law taxes income earned worldwide for companies that are resident in the United States. This creates a gap in taxation for an Irish company with income earned outside Ireland, which as the article points out was exploited by Apple by also negotiating a corporate rate of less than 2% for its Irish income.
Finally, the article discusses how the EU Commission reached its determination that Ireland provided improper state aid by granting Apple such a sweetheart deal. The article summarizes the EU Commission position as follows:
- Was there state aid provided by Ireland to Apple?
- The EU Commission concluded yes, because a benefit was conferred on Apple, and was not conferred on all other companies.
- The article states that the EU Commission found fault with the Irish determination because it was a result of a negotiation and not merely a summary of the comparable transactions.
- The article also stated that the EU Commission questioned the methodology (Transactional Net Margin Method) chosen to determine the appropriate transfer price because the terms were not defined.
- The article then stated that the EU Commission questioned the inconsistencies in the transfer methodology selected by Apple; and
- The article stated that the EU Commission challenged the open ended duration of the ruling in Apple's favor.
Note: Apple has utilized this structure since the 1980s and as Tax Justice discusses, Apple continues to use this structure in 2016 to shield income from taxation in the U.S. based on Apple's most recent quarterly earnings report.
However, there might be a change to this structure starting in 2020, as Ireland has passed legislation in 2013, which took effect in 2015 for newly incorporated companies and in 2020 for existing companies, that in order to incorporate in Ireland the company must also be a resident of Ireland (meaning that the income received by Apple's Irish subsidiaries from its EU subsidiaries would be taxed in Ireland at 12.5%). See this Guardian article.
Additionally, the EU Commission has also proposed corporate tax reforms to address continued tax avoidance by multi-national corporations. The EU Commission's proposals are as follows:
- Common Consolidated Corporate Tax Base
- The EU Commission is proposing to treat all profits earned in EU countries as one taxable base, so that multi-national won't be taxed separately by each EU member nation. This proposal purportedly allows a corporation to offset losses in one EU country with profits in another EU country and provides one joint tax on the profits. This proposal also attempts to address profit shifting from one EU country to another in an effort to seek a lower or advantageous tax rate.
- Improved Mechanisms to resolve double taxation disputes
- Currently the EU has a double taxation dispute resolution only addressing transfer pricing. This proposal by the EU Commission hopes to provide a timely response to companies seeking relief from EU members double taxing the same income in both EU member nations.
- Measures to tackle tax loopholes with non-EU countries.
- EU Commission proposes to address tax gaps between EU nations and non-EU nations which have been exploited by companies to reduce tax. One key example is the Irish-US tax gap implemented by Apple to avoid taxation on its EU revenues.
Whether these proposals will curb aggressive tax avoidance by multi-national corporations is questionable. But the real question is: What are Congress and the IRS/U.S. Treasury proposing to address the existing tax gap (much of which is due to U.S. multinational corporations and their profit shifting (earnings striping)/transfer pricing/base erosion/inversions practices)?
If you have specific and credible evidence of a corporation's use of transfer pricing to avoid paying its tax liabilities you should consider filing a tax whistleblower claim. Contact us to see if your information would permit you to receive a 15-30% award of the amount of taxes, penalties and interest collected by the IRS on your transfer pricing tax whistleblower claim.