Should the US Lower Tax Rates on US Multi-National Corporations?

Should the US lower its tax rates to allow US multi-national corporations (USMNCs) to repatriate earnings allegedly re-invested offshore?

In the news, several USMNCs are lobbying the President and Congress to further lower the tax rate on repatriation of earnings allegedly re-invested in offshore operations that was proposed by the White House to be taxed at 15%.  This Reuter's Article, suggests that the USMNCs are seeking to lower the current 35% tax rate on repatriation of earnings to 3.5% tax rate on earnings already invested abroad in illiquid assets, such as factories, and 8.75% tax rate on earnings cash and liquid assets.

The Reuter's article speculates that the repatriated earnings/cash and taxes raised from the repatriated earnings/cash could raise tax revenues and funds the expansion of the US economy:  "If the $2.6 trillion overseas were repatriated at once, two things would happen.  First, Washington would get a big jolt of tax revenue.  Second, repatriated profits not collected by the Internal Revenue Service could be put to use in the economy."

The last time the US had a "tax repatriation holiday" was in 2004-2005, and the results of the tax repatriation holiday show that the alleged reinvestment into the US economy by the USMNCs that took advantage of the 5.25% lowered rate on the repatriation of earnings did not occur.  In 2001, as noted in the Reuter's article, the Senate held a hearing into the effects of the 2004 repatriation holiday and determined that the repatriation cost the US treasury at least $3.3 billion in net revenue over 10 years and produced no appreciable increase in U.S. jobs or domestic investment.  Instead, the repatriated funds were used to buy back shares and to pay executive bonuses.

Finally, the Reuter's article notes that this may be an effort of lobbyists for the USMNCs to signal the log fight ahead to achieve the new repatriation tax holiday by initially setting the percentages low, and therefore reaching a "compromise" at a slightly higher percentage.

The Reuter's article raises a fundamental question, namely: Should Congress and the President be considering passing tax reform implementing a reduced tax rate for the repatriation of earnings, or should we be looking at other ways to reform the current corporate tax "imbalance" problems, when there are no benefits (as reflected in the most recent tax repatriation holiday)?

This Bloomberg article suggests that the benefits of a tax repatriation holiday touted by USMNCs are just myths as follows:

1. The article stats by quoting Trump's economic advisor touting that the repatriation of earnings will cause a boost to the U.S. economy.  Contrast this statement with the Senate PSI findings of fact in its 2001 study on the 2004 tax repatriation holiday, where the Senate PSI determined that after repatriation over $150 billion dollars, the top 15 USMNCs actually reduced its workforce by 20,931 jobs.  Also there was no new R&D expenditure by the top 15 USMNCs that took advantage of the tax repatriation.
2. The article then states that companies have been borrowing funds in the US at historic rates and that any perceived additional tax revenues would have to be low enough to incentivize the companies to forego borrowing the money and repatriating the offshore earnings/funds.  Contrast this point with the Senate PSI findings that the repatriation holiday actually reduced tax collection by $3.3 billion over 10 years, and leads to the conclusion that a tax repatriation holiday would not generate tax revenue because the tax rate would have to be so low, and historically speaking there would be a net loss over 10 years of taxable revenue attributable to the tax holiday.
3. The article points out that the borrowed funds by USMNCs have been used for stock buy backs and executive bonuses.  Compare the use of the repatriated funds from the 2004 tax holiday which were almost exclusively used to fund stock buy backs and executive compensation with the current use of borrowed funds by the top USMNCs and this suggests that any repatriation holiday will continue this trend.
4. Finally, the article points out that clearing a supposed hurdle to the repatriation of offshore earnings (lowering the tax rate) may not incentivize USMNCs to repatriate the funds because they have operations overseas, or may continue to benefit from the sequestering of offshore earnings in lower tax jurisdiction.  Compare this myth with the Senate PSI findings that post 2004, more USMNCs increased, not decreased, their offshore earnings accumulation rate.

Both articles suggest that repatriation of offshore earnings at a lower rate for USMNCs, when coupled with the Senate PSI findings, reflect unsound US tax policy.  However, it appears as if Congress and the White House continue to buy into the myth that the USMNCs are perpetuating that a repatriation tax holiday is the remedy that will increase the US economy, generate more US tax dollars and spur economic growth.  Despite the message the USMNCs are sending, Congress and the President should look at historical data to see that the myth of a one quick fix solution (repatriation tax holiday) is a failure.

If you know of any company or individual that has sheltered funds offshore, and would like assistance in assessing and filing your IRS whistleblower claim, please CONTACT US.  The IRS Whistleblower Program pays between 15-30% if collected proceeds when the IRS proceeds based on a whistleblower's substantial and credible information.

Recent Developments

This blog will attempt to re-cap the following newsworthy stories:

1. Transfer Pricing Backlash?
2. Amazon v. IRS

Transfer Pricing Backlash?

As Previously discussed in this Blog, United States Multi-National Corporations (USMNCs) have been using transfer pricing to stash profits overseas and to avoid U.S. and State taxation.

Recently, one state treasurer is attempting to fight against the USMNCs.  In his April Newsletter, Illinois State Treasurer Michael Frerichs advocates for accountability for USMNCs that interact with his office.  Mr. Frerichs states that he is in the process of sponsoring a bill in the Illinois legislature that would prohibit companies from doing business with Illinois if it utilizes offshore accounts to avoid paying taxes.

Mr. Frerichs proposal raises several questions including:

1. Are more states willing to undertake such measures to ensure that USMNCs pay their fair share?
2. Is Illinois willing to enforce this law against companies that are based in Illinois and notorious for using foreign subsidiaries and accounts to hide profits from taxation?
3. Why isn't the federal government utilizing this method to ensure better compliance by the USMNCs?
4. Will this matte if the US lowers the corporate tax rate to permit USMNCs to bring back the amounts stashed offshore at a reduced rate?

While the answers to these questions are mere conjecture at this point, given the fact that the proposed law has not been passed to ensure compliance by USMNCs doing business with Illinois, it is still refreshing and a welcomed change of pace to the usual rhetoric of allowing USMNCs to continue to stash taxable income offshore.

Amazon v. IRS

In a recent Tax Court opinion (Amazon.com, Inc. v. Commissioner of Internal Revenue, 148 T.C. No. 8 (2017)), the Tax Court held that IRS overstepped its authority in applying a discounted cash flow method to value a cost sharing arrangement between Amazon and its subsidiaries.

This cash involved whether Amazon properly valued an intangible it sold to its offshore subsidiary. The IRS felt that Amazon did not properly value the intangible and sought to apply the discounted cash method to value the intangible.  Why did the IRS take this approach? Simple, because it meant that Amazon would have had to recognize more income from the sale of intangible in the US and therefore would also have had to pay more taxes.

Amazon disagreed with the IRS. Amazon stated that the IRS' method violated established precedent in Veritas Software v. Commissioner, 133 T.C. No. 14 (2009).  In Veritas, the issue before the Court was the proper buy in the subsidiary was required to pay as a result of a cost sharing arrangement.  In Veritas, the Court held that comparable uncontrolled transaction (CUT) was the proper valuation method.  Similar to Veritas, Amazon stated that the proper method utilized in its case should have been the CUT method.

The Court held in favor of Amazon.  See this synopsis of the case through the Journal of Accountancy.

TRANSFER PRICING DEBATE Part 1

Is transfer pricing broken? Does the IRS/Congress need to adopt a new model to tax U.S. Multinational Corporations’ income earned worldwide?

Through this Blog, I have previously written about how US Multinational Corporations (USMNCs) have routinely utilized “tricks of the trade” (Transfer Pricing, Inversions and Earnings Striping) to minimize their U.S. tax liabilities.  I have also suggested some changes to the existing system (i.e., expatriation tax etc.)

Perhaps change is on the horizon.  In one of the keynote addresses at the 16th Annual Global Transfer Pricing Forum held in New York (September 22-23, 2016), Professor Edward Kleinbard (USC Gould School of Law, and the former chief of staff of the Joint Committee on Taxation), advocates for “The End of Transfer Pricing”.  See the Presentation slides here.

Professor Kleinbard begins his presentation by discussing the Apple “facts” as examined by the EU Commission in the recent Irish state aid case.  He highlights the following facts:

• APPLE had $115 billion of income over a 10 year period;
• APPLE paid Ireland only .05% per year during the same period;
• APPLE paid other EU countries roughly $385 million in taxes over the same period;
• APPLE’s effective tax rate was 3.5% not the statutory rate of 35%.
• APPLE had pre-tax profits of $91.5 billion. 

Professor Kleinbard concludes that the arm’s length standard is no longer viable if APPLE can receive such beneficial treatment through its subsidiaries in Ireland.

Professor Kleinbard then discusses how the world is aware of the abusive nature of transfer pricing and that progressing with the fiction of transfer pricing and the arm’s length model is untenable, specifically, he cites the following examples:

• U.S. Treasury’s laughable response to the European Commission’s inquiry into whether Ireland gave Apple state aid;
• Countries sharing tax information with each other;
• Apple and other US MNC transfer pricing backlash;
• Congressional backlash/proposed tax reforms; and
• Base Erosion and Profit Shifting Project’s (BEPS) inability to reverse the transfer pricing inequality.  (See this blog describing the BEPS)

Because of this pushback, Professor Kleinbard advocates for a change to the existing system.

More specifically, he advocates for the following changes to the Corporate tax rate:

1. Statutory Rate reduced to 25%;
2. Repealing Section 199 (deduction for income attributable to domestic production activities;
3. Repealing the Alternative Minimum Tax (AMT;
4. Destination Based Cash Flow Tax

He states that by reducing the corporate rate to 25% will eliminate the need for transfer pricing games, because US tax rate will be in the middle of the pack, and playing games will be unnecessary. 

Note: Professor Kleinbard has stated, “Transfer pricing is dead” since 2008.  See this Tax Analyst Article about his debate with Willard B. Taylor of Sullivan & Cromwell LLP at the International Tax Institute.

To Clarify, Professor Kleinbard actually stated that Transfer Pricing enforcement has been dead since 2007.  See this article by Michigan Law Professor Reuven S. Avi-Yonah.  Professor Avi-Yonah proposes three different approaches for Congress to revitalize transfer pricing enforcement:

• adopting a unitary taxation regime;
• ending deferral; and
• adopting anti base erosion measures.

Unitary Taxation Regime:  This proposal suggests that Congress can adopt a unitary tax system, namely, treating each USMNCs as a single unit and disregarding the “formal distinctions” among the subsidiary corporations.  The advantages are: 1) a better model for taxing USMNCs because of the way they currently operate; and 2) the unitary tax applies the same treatment to all USMNCs and does not depend on the location of the parent corporation.

Professor Avi-Yonah believes that this is the best solution, but pragmatically speaking will be difficult to achieve.

Abolishing Deferral:  This proposal proposes to prevent USMNC from parking profits offshore (something subpart F of the Internal Revenue Code was originally designed to accomplish, but has failed to do so).

Professor Avi-Yonah believes this is a good approach, but that it will require countries to adopt this goal, which may be difficult to achieve.

Adopting Anti-Base Erosion Measures:  This proposal suggests limiting deductible payments to related foreign parties, including cost of goods sold, interest and royalties.

Professor Avi-Yonah believes adopting this proposal in conjunction with abolishing deferrals will eliminate the impetus to undertake transfer pricing by USMNCs.

Finally Professor Avi-Yonah advocates for the adoption of a mixture of these measures, similar to Senator Baucus’ proposal with option Y.  See analysis of Senator Baucus’ proposals here. (NOTE: Senator Baucus is now the U.S. Ambassador to China).  Under Option Y, income from foreign sales would be taxed at 80% of the US rate with a credit for foreign taxes paid.  This would ensure tax would be geared toward the ultimate destination of the sale of the goods (i.e. taxing where the goods are ultimately sold, or similar to Kleinbard’s destination cash flow tax.)

It will be interesting to see if any of these proposals will gain traction with the pending presidential election and with one of the key backers now a U.S. ambassador to China. 

If you have specific and credible information of a company undertaking transfer pricing and want to report the company for shifting its profits offshore, CONTACT US, to discuss your tax whistleblower claim.  The IRS is paying an award (between 15-30% of the collected taxes, interest, penalties, and additional amounts) for information it utilizes in adjusting a corporation’s income tax due to information provided by a whistleblower.