- Good morning,
on behalf of NYU Law School and KPMG
I'd like to welcome you here
to the 15th Annual NYU/KPMG
tax lecture series.
My name is Larry Pollack
and I'm an international
tax partner with KPMG
and graduate of the LLM program
and the very proud director
of this annual symposium.
By way of background,
this program was created
to create a unique forum
that brings together
professors from NYU Law School,
distinguished members of the bar,
high level government officials
and tax partners from
KPMG to share their views
on a topic of current
interest in taxation.
Today's symposium will explore whether
the U.S. international tax
system is really broken,
or perhaps just in a state of disrepair.
Let me paint the picture.
The U.S. international
tax system is antiquated,
much of the rules and the
framework with which we operate,
were enacted by Congress some 50 years ago
when the concept of a global economy
is much different than what we have today.
The U.S. statutory tax rate
of 35% is at the highest
of all of the OECD member countries,
although the effective tax rate
for many U.S. multinationals is lower
due to creative tax planning strategies.
U.S. multinationals have
great difficulty competing
with foreign based multinationals
that are subject to
lower corporate tax rates
and they're operating under a territorial
versus a worldwide taxing regime.
U.S. multinationals initially benefit from
earning income overseas
in foreign subsidiaries
at lower tax rates
but then are penalized
when they repatriate
the profits back to the United States
causing a lockout effect
with several trillion dollars
of cash that are trapped overseas.
This paradigm has propelled the intrigue
of many U.S. corporations to explore
the concept of what we call
an inversion transaction.
Thereby converting a
U.S. multinational into a
foreign based multinational.
Through panel discussions,
debates and lectures
our agenda today will be focused
on various policy aspects
of U.S. international tax.
The program is gonna focus on
identifying the key issues,
suggesting possible solutions
and forecasting the future.
Our key note speaker today is Mark Mazur,
Assistant Secretary for Tax Policy,
United States Department of the Treasury.
Following his key note speech
Mark Mazur has graciously agreed
to join the debate session
where several propositions
concerning international
tax reform will be debated.
You will have a chance to
weigh in with your views
during that part of the program.
Our distinguished speakers today
include from NYU law school
Professors David Rosenbloom,
Daniel Shaviro, John Steines
Willard Taylor, Alan
Viard and Victor Zonana.
From Rutgers University Law School,
Professor Rosanne Altshuler.
From KPMG, Manal Corwin, Peter Blessing,
Patrick Jackman, Michael
Plowgian, Tom Stout,
Brett Weaver and Robert Wilkerson.
And from the bar, Kimberly Blanchard
of Weil, Gotshal and Manges,
Steven Edge of Slaughter and May London,
Paul Oosterhuis of Skadden,
Arps, Slate, Meagher and Flom,
and Deborah Paul of Wachtell,
Lipton, Rosen and Katz.
We plan to open up the floor for audience
questions and answers for
the last five or 10 minutes
of most of the sessions during
the course of the program.
If you wish to ask a
question, just raise your hand
and a hand-held microphone
will be brought to you.
There'll be two breaks, one mid-morning,
one mid-afternoon.
And a buffet lunch at 12 noon.
The breaks and the lunch
will be held directly
across the hall in Greenberg Lounge.
With respect to CPE and CLE,
for CPE, you just need to
complete the evaluation form
at the end of the program and hand it in,
no need to sign out.
For CLE credits, in addition to
submitting your evaluation form,
to ease the process of exiting,
all you're going to need to do is just
drop your name tag in a basket
that's going to be designed
for CLE at the end of the
program, at the end of the day.
And the CLE and CPE certificates
will be emailed to you
within two months.
With that, please put
your cell phones on mute,
and let's get started with the program.
To set the stage for the day,
our opening panel is going
to provide an overview
of the U.S. International Tax System
and the perceived issues,
of which there are many.
One of the perceived issues
is the political influence
over tax policy.
(soft piano music)
- [George] Read my lips.
(crowd screaming)
- [Bill] A research and
development tax credit,
a low income housing tax credit.
- [George] Our principal no one in America
should have to pay a more
than a third of their income.
- [Barack] I want to cut
taxes for 95% of all workers.
- On that note, I'd like
to introduce our panelists,
Paul Oosterhuis and
Professor Victor Zonana.
Paul is a Senior International Tax Partner
in the Washington, D.C.
office of Skadden, Arps.
Paul is well-known in the
international tax community.
Paul is a frequent author and lecturer
and has taught international
tax at the LLM program
at Georgetown.
And has testified before
congressional tax writing
committees on various
tax legislative issues.
Professor Zonana teaches at
courses at NYU Law School
at both the JD and LLM
in taxation programs.
In his very distinguished career,
Victor was a partner with
major law firms and KPMG
and also served as Deputy
Tax Legislative Counsel
at the U.S. Department of the Treasury.
Please welcome our panel,
Victor and Paul, over to you.
(audience applauding)
- Thank you Larry, not
only for inviting us
to participate in this program,
but for taking the
incredible amount of time,
energy and devotion to
getting this program on
and putting it together year after year.
And now the 15th year of this event.
We're delighted to be here.
Paul and I have been old-time friends,
I hate to tell you how far back we go,
but I think it was 1975,
I was at the Treasury and you
were at the Joint Committee.
We've known each other
what is now 40 years
and we're gonna carry out a conversation
about a few things related
to international tax.
Our first objective here is to simply
talk a little bit about
the current landscape
and where things stand insofar
as the U.S. is concerned
and the international tax picture.
That first slide is basically
review for all of you who
practice in this area or who know
even a smattering about this area.
I'll just go over these
points very quickly
and then we'll launch into
what the perceived issues are.
As everybody knows, we
have a system of taxation
in the United States that
imposes tax on worldwide income.
On both our U.S. Citizens, our aliens,
domestic corporations and
we provide some relief
for foreign taxes that may have been paid
on account of activities abroad.
Income that may have been
taxed in foreign countries,
through a foreign tax credit regime.
Foreign tax credit is generally limited
to the amount of U.S.
tax that would be imposed
on the foreign income.
And limitation is applied
separately, based on baskets.
Passive income on one side
and general imitation income
on the other side.
It's not an easy system to follow.
It's a relatively complex system.
Lends itself to all sorts of tax planning,
which the Congress
takes, from time to time,
steps to curb and put a stop to it.
Sometimes successfully,
sometimes not so successfully.
As far as foreign corporations
that are doing business
in the United States,
they're subject to tax
on their activities here.
Foreign persons are
subject to tax on their
U.S. source income.
And then the issues there
basically relate to,
what is effectively connected income?
What is engaged in a
U.S. trade or business?
All of which is then
modified by the application
of treaties which we have with
a large number of countries.
The interesting thing that
we're gonna be talking about
is essentially, what happens
to foreign corporations
that are subsidiaries
of U.S. corporations?
And the regime that we
have there is essentially
a deferral regime as far as the earnings
of those foreign
corporations until they are
repatriated to the United States.
We know that's a rule that
have been around since,
for a long time.
We have had anti-deferral
regimes that have been in place,
at least since, earlier than 1962 even,
but 1962 is when we saw the advent of
controlled foreign corporations
and the fact that only
certain types of income
are allowed to be deferred.
And other types are not
allowed to be deferred.
And then the other hallmark of our system
that we need to think about very briefly,
is the fact that we have
transfer pricing rules,
as do a number of the
other countries, obviously.
Those are hideously complex.
They're not easily enforceable.
And lend themselves to all
sorts of potential abuses.
But they're there and we
need to be aware of the fact
that they are there.
Turning now to, very briefly to
what we see as perceived issues,
as far as the U.S. tax
regime is concerned,
especially as it applies to
international tax issues.
The first bullet point
there is simply to tell us
that the U.S. tax regime,
as perceived by some,
is an outlier.
What do we mean by an outlier?
Well, what we have is a very
high-tax corporate rate,
at least the headline rate is 35%.
It's really 39.1% when
you factor in the fact
that there are state and local taxes
involved in the picture.
And that rate, as compared
to the rate that is
applied in other countries,
especially the OECD
countries, for example.
Their rate is effectively about 24.8%.
We're looking at a rate
of tax abroad at 24.8,
a rate of tax in the
United States at 39.1%.
That puts us out of sync
with the other countries.
The other thing that have
happened over the course
of the last several years,
which puts us at odds
with what's going on with
the rest of the world,
is that a number of the countries
have shifted to a territorial system.
We are still focusing
on worldwide taxation.
But even some of our
major trading partners
have gone in that
direction, the U.K for one,
Japan another.
The other thing that we
have seen which puts us
at a different scale with as
far as the other countries
are concerned is that there are incentives
in the foreign countries
for certain activities
in order to encourage
them to expand over there.
A classic example of that
would be patent boxes
which are now, in effect
in a number of countries
including the U.K.
The argument comes back to
there is a great burden on
repatriation, the fact that
we allowed the earnings
to be deferred as far as
our foreign subsidiaries
are concerned.
But then we have to pay the residual tax
when we bring them back
to the United States.
And the argument then goes that
this burden of repatriation
makes us less competitive.
Question one has to ask
ourselves really is,
what do we mean by less competitive?
Are our goods no longer
being sold in Europe,
or the rest of the world?
Seems to me that they are.
The question is what exactly
do we mean by competitiveness?
And insofar as the
activities are concerned.
That leads us to basically ask
some questions and that is,
is the deferral system
responsible for all that?
Is it really a dysfunctional system?
What do we contribute this
lack of competitiveness to?
- I think I would like
to focus a little less
on the term competitiveness
because that means a
lot of different things,
and more on the elements of dysfunction,
that the system creates.
And I would identify four.
One is the lock-out effect,
we'll talk about that
more on the next slide
because that clearly provides incentives
for companies to do things that
are not economically
functional, if you will.
That are dysfunctional.
But the second is that
it gives an incentive.
Ironically, notwithstanding
the lock-out effect,
it gives companies an incentive
to erode their U.S. tax bays
by migrating IP and other
activities offshore.
And of course the way our rules work,
it's hard to migrate bare IP,
you have to migrate
activities along with it.
And I think the whole BEPS
process is just strengthening
the notion that you don't
reward risk on its own.
You reward risk that is
tied with activities.
And that is gonna provide
a huge kind of leveraged
incentive to move more activities.
You're not only eroding the
U.S. tax base when you do that,
you are eroding jobs.
Sometimes from the United States,
sometimes admittedly
from Germany or the U.K.
to Ireland or Switzerland.
But nonetheless,
activities are being moved.
And the irony, it is
ironic because you'd say,
well the lockout's a problem
so then why are people
continuing to base erode?
And the answer to that is
you just think about it
from a tax planner's point of view.
You don't really know
how much of your cash
you're gonna need back
in the United States
three years from now, four years from now,
five years from now.
Your incentive to reduce
your tax rate today,
or your incentive to
migrate activities abroad,
kind of comes first.
And so you look at it as,
yes, if I can do it, I should.
I should structure myself
so that I maximize my income
that's subject to a low tax rate.
And we can then decide whether
we can take APB 23 on it
and book it at a lower tax rate.
Or it maybe creates some
deferred tax liabilities
in case money comes back,
in case we need to bring the money back.
And that's one of the things
that has fascinated me
over the last few years, it
just shows the dysfunction.
Which is the amount of
deferred tax liabilities
have been building up.
That's the worst of all worlds
because the government's
not getting the revenue,
the taxes aren't being paid,
but the companies are
bearing the financial cost
from a financial statement point-of-view.
If you had to have anything
that would tell you
the system is dysfunctional,
surely that is it.
And we do see billions of dollars
of deferred tax liabilities.
It's hard to know exactly how much it is,
the credits we, a report that
came out earlier this month
was a little disappointing
because they didn't
try to make an estimate
of deferred tax liabilities.
But my impression is that it's
10s of billions of dollars
a year and that to my
mind, is one of the main
dysfunctions of the system.
I think a third dysfunction
is the incentive to invert.
And that's not only a function of deferral
and the requirement to
have activities abroad,
and the lock-out effect.
Although all of that is
obviously a part of it,
it's also a function of
the fact that we have
relatively lax rules on stripping earnings
out of the United States
for foreign multinationals.
Our 163J rule is pretty, I think,
relatively generous to
some other countries.
And if you invert, not
only can you help yourself,
it's as everybody talks about,
the three aspects of
advantages of inverting.
You can avoid the lockout,
at least on future earnings,
now it's granted that 2014
note is limit set somewhat.
But for younger companies
that are growing,
they can see that in their future.
You can have IP abroad with
less activities associated
with it because you're not
subject to the Sub-Part F rules,
you're out from under, if you will.
And you could have more flexibility
in capitalizing your U.S. operations.
The fact that the system
provides that incentive
to invert, to my mind, is a
third element of dysfunction.
And the fourth is the one that
isn't talked about so much,
is just the hideous complexity as we say,
actually on the next slide,
Victor if you want to move it.
I think about it in terms
of some of the issues
that we as practitioners
deal with with our clients
in the foreign tax credit area,
in the foreign currency area,
in the dual-consolidated loss area,
just so many parts of
the international rules.
Where there's just no way
the service can audit it.
And effectively, the audit, if you will,
is done by your auditing
firm in reviewing it
and if they sign off on
it so you don't have to
book a reserve against it,
then you're probably fine,
because it's an unusual case,
where it's discovered.
And having a system
that is so complicated,
that that's the way it is
enforced in so many cases
seems to me to be a final
element of dysfunction.
- I think those are
very good points, Paul.
The other thing I would mention is
one of the items that's on the slide here
and that is the fact that,
we have had an anti-deferral
system in place,
at least since 1962 and the
way we know it as Sub-Part F.
But in some respects, if
you take a look at what
has happened to that anti-deferral regime,
it hasn't worked very well
or it's being eroded as we go forward.
What's started out as what might have been
a good idea to basically
make sure that we have
passive income subject to
tax and that we don't have
transactions between related parties,
creating an incentive
to move things abroad,
we have had an erosion of
that over the last few years.
- That's true, I do wonder how much,
what the impact of that is.
Let's face it, the two
biggest kinds of erosion
that come from check the box
and the C6 rules, at least,
is stripping earnings out
of relatively high-tax
foreign countries into relatively
low-tax foreign countries.
Example, a royalty that's
paid from Ireland to Bermuda,
strips income out of their 12.5% rating
gets you down to a 2% rating.
The question is, if that went away,
wouldn't you still have enough incentive
with our 35% rate to
migrate your IP to Ireland
and to move your activities to Ireland?
You don't need the 2% rate to do that.
I don't know that anybody's
done a careful study
and I'm not sure how you could do it.
To determine whether the
things that essentially
allow you to strip income, as one example,
strip income out of Ireland,
would change the calculus.
Similarly with jurisdictions
like Canada, Germany,
and other places where
we use interest to strip
it just doesn't seem to
me that that's affecting
the U.S. tax base that much.
It's more affecting their tax base,
which is a big reason why BEPS is there
and is doing what it's doing.
Because they're all getting
very concerned about that.
But, I personally think that
that has less to do with
the dysfunction from a U.S. perspective.
And maybe others disagree.
- I don't disagree with that.
I think the reason these
rules have come in,
actually, the way check
the box has been used
and 954C6, has essentially
been a way of allowing
U.S. multinationals to compete.
Whatever the word, if
you like the word or not,
to allow them to operate abroad
without having the burden of having
the passive income or the type of income
that would otherwise be
considered business income
deemed repatriated back
to the United States.
We have talked about some
of the perceived issues
and we now want to focus a little bit more
on the so-called Lock-Out Effect.
I will describe it briefly
and then Paul will launch into
what the effects of the lock-out are.
Essentially what we're
talking about here is
the fact that the
foreign subsidiaries have
had substantial earnings abroad.
They have not brought them back home.
They have not been repatriated.
And the reason they
haven't been repatriated
is because if they are repatriated,
the U.S. parent would
have to pay additional tax
based upon the 35% less the lower tax rate
that was applied in the foreign countries.
That's one of the issues related to
the operation of foreign subsidiaries.
We have some rules that basically
tell us that if the U.S.,
if the foreign subsidiary
is deemed to repatriate,
then there will be tax imposed
at the U.S. parent level
on the residual tax.
The deemed repatriation though,
can be gotten around very easily
and what we need to address right now
is what should we do or
what's the effect of the lock-out?
To what extent are we
harmed in the United States?
Or harmed in terms of what
our operations are abroad
as a result of having
these lock-out effect.
- It's interesting, both
from a practice perspective
and economists have been
talking about this more.
I think we all understand now
and certainly Senator Levin,
he was running the PSI committee,
made a big point of it that
the lock-out doesn't
mean all of these monies
are invested in Euro
dollars or something else.
They are invested in dollar accounts,
they come back to U.S. accounts,
nothing wrong with admitting that,
that's absolutely true.
And that minimizes, if you will,
some sort of macro economic impact of it.
But the company impact of it,
in terms of distorting their incentives
for how they operate their
business, are substantial.
And we're starting to get some
academic verification of that
in terms of maybe buying things abroad
that don't make as much sense,
for example.
In terms of just the
inefficiency in business models
of having billions of dollars
that are just sitting there
earning a short-term
passive return rather than
being invested in the business.
Some of the metrics that that analyst used
to analyze your business is effectively
a return on assets.
And if you have a lot of passive
investments that dilutes it
and that provides mis-incentives
for the companies.
I think the third is
one that's near and dear
to practitioner's hearts,
which is finding second best
repatriation solutions.
We've had, let's face it,
we've had a cat and mouse chase
going back to the early
2000s with killer B's
and deadly D's and F's and all of that
and it's still going on today.
The technology changes.
You've got between the
great accounting firms
and the law firms, billions
of dollars being spent
on advisors trying to figure
out holes in the system
and they're there and
sometimes they get wider,
sometimes they get narrower
but they continue to be there.
And that's dysfunctional.
It would be better if those resources were
devoted to other things, I would say.
And the final thing is the
vulnerability to acquisition
from foreign multinationals.
There's no question about
it even with a notice,
if you do an inversion combination,
yes you can't get access to the cash.
But if it's a true foreign multinational,
meaning one where the U.S. company
has less than 60% of the shares,
then you can, where the U.S.
multinational shareholders
after the deal has less
than 60% of the stock,
that (mumbles) company,
you have relatively
free access to the cash.
And that does provide an
incentive for those kinds
of companies to buy U.S. companies.
And the irony, if it's
really more of an inversion
where the U.S. company maintains
control of the company,
then from an employment and nexus,
the U.S. point of view,
not much may change.
But if it's a real foreign
multinational that buys
the U.S. multinational and
the real foreign executives
take over the company, you
can have a material impact
on things in this country.
And we tend to be steering
in that direction.
In some of the policies
that fall out from,
really from the lock-in.
- What's interesting also
is that we're also seeing
how some companies even
get around the lock-out
or are now basically
bringing those earnings back,
through DVDs, through actions
that they're about taking.
And GE is an example of that,
they're dispensing,
disposing of some of their
European operations and
they're gonna have to take
a $7 billion hit of--
- Yeah, I would say that's an exception
'cause they're getting
out of a huge business.
So it's not surprising
that you have to do it.
- And the other thing that
you do see occasionally,
is the ability of these
large multinationals
with these large cash hoards in Europe
or wherever they may be,
their ability to borrow, to have some,
to engage in some activities in the U.S.
Apple being the clear example of that.
Where they were able to
borrow several billion dollars
to do dividends or expansion
or whatever they had to do.
It's not all that bad in terms of--
- No it's not, but there
are real limits to that.
When I look through
clients that we deal with,
sure a lot of them have
done that a fair amount,
but they have limits to it.
And if we get into an
interest rate environment,
where there's a more normal interest rate,
the spread between your
borrowing and your investing
can be pretty material.
That's not a long-run solution.
That's really a patch
that allows us to say,
OK, maybe we go out to 2017,
2018 before we get this solved.
It's not a stable
solution to the lock-out.
- Let's talk about the trapped earnings,
if we want to call them trapped earnings
or locked-out earnings.
And see if there's anything
that's gonna be done about it.
We know that if we go
back to several years ago,
we had a repatriation holiday
for a brief period of time
where foreign U.S. companies
were able to bring back
foreign earnings and subject
them to a low rate of tax
about five and a quarter percent.
Allegedly for the purpose of
expanding their activities
in the United States, we
know that they were used
for other things like stock
buy-backs and dividends.
The question now is,
what is the administration
doing about this?
And low and behold, the
Obama Administration
has finally turning to
addressing the trapped earnings
and how to deal with them
as part of a dual proposal that deals with
trapped earnings on one side
and deferral on the other side.
As far as trapped earnings are concerned,
the proposal by the administration,
and we're just gonna give you
a very quick highlight here,
because there's a long panel discussion
in the latter part of the afternoon,
where Manal Corwin and her team from KPMG
and others will be addressing those issues
in far greater detail.
But in brief, just to give you the
20 thousand foot overview,
what the Obama Administration
is proposing is
imposing a one-time 14%
tax on accumulated earnings
and CFCs that have not previously
been subject to U.S. tax.
So it's a one-time 14% tax.
It's imposed immediately.
It's effective on the date of enactment.
And it's payable over a five year period.
Some of the details
that go along with that
is that there will be foreign tax credits
associated with those earnings will be
able to be applied against
the U.S. tax liability,
that 14% tax.
But only in the ratio of 14% to 35%
so you can't get more than 14% basically,
in terms of foreign tax credits.
And as I said, it's effective
on date of enactment,
payable over a five year period.
And the other thing that
to be noted is that these
revenues that are gonna be generated
and Paul will address the
(murmurs) allowed in the revenues,
will be devoted to
infrastructure projects.
At least they will be earmarked
for infrastructure projects.
That's one piece of the
administration proposal.
There's another piece to it
that deals with these issues
and that's the elimination of deferral.
- Right, and they do it
through what's called
a minimum tax which is kind of a misnomer.
We have lots of misnomers,
really deferral's a misnomer,
it's exemption until you pay a dividend,
it's not deferral.
But that's fine, we'll call
it a minimum tax for now.
It is the only tax and
it really introduces a three-tier system.
You have a complete
exemption to the extent
of your allowance for corporate equity.
Which they say is the
long-term AFR times your
bases and your assets.
That's pretty small,
smaller than in some of the other bills.
And then a 19% tax on your
profits in excess of that
unless it's Sub-Part F income and then
it's Sub-Part F income you're
paying at the 35% rate.
As Victor says, we'll
talk in a little bit about
the revenue from it.
They put a per-country
limitation in to try to keep
taxpayers from averaging
high tax and low tax
for purposes of it.
If we are going down this approach,
I think that's one area
that we all ought to be
taking a look at.
Because while a per-country
limitation will just be
mammothly complicated,
and we'll again have
a kind of a cat and mouse
game of taxpayers coming up
with planning devices to
try to deal with their
per-country limits and
where they're under 19%.
And the government trying to stop it.
There already were a
couple of anti-abuse things
in the treasury proposal
to try to deal with that.
From what I understand,
and Rosanne I think
does better than I do, Rosanna Altshuler,
but I think it would
add a couple of points
to the raid if you went
to an overall limitation
and however we end up sorting it out.
If we're going down that road,
considering having an overall
limitation would be useful.
- The minimum tax is as you
said, it's a bit of a misnomer.
What we're really saying is that,
if you're operating abroad
with a foreign subsidiary
and you're paying a tax of
at least 22.1% over there,
that's because of the interaction with the
foreign tax credit,
then there's gonna be no
further tax in the United States
as you bring those earnings back.
As long as you've paid that
minimum of 22.1% abroad
with the foreign taxes.
They're also some additional
changes that they're
recommending with regard to Sub-Part F
but I think in the interest of time,
let's move on to the other piece of the
administration proposal that we need to
just briefly highlight.
And that is inversions.
Paul addressed the fact that we have these
companies migrating abroad.
And what the administration
is recommending
is changing the basic
ground rules as far as
whether the inversion is
gonna work or not work.
And exchanging the test
basically to say that
if you have 50% or greater
ownership by the U.S. person,
the U.S. former shareholders,
then you will be treated
as a U.S. corporation
as opposed to the prior
rule, which was 80%.
We used to have 80%, you wind
up being a U.S. corporation,
80 to 60 you lose some benefits,
less than 60 nothing happens.
Now, other than the normal 367 rules,
nowadays what we're saying is that,
at least what they're proposing is that
if you have 50% continuity
by the U.S. shareholders,
you're gonna be treated
as a U.S. corporation.
So the migration will not work.
And then there is a broader definition of
what is considered to be an inversion
that is based upon the fair market value,
the domestic corporation
relative to the stock
of the acquiring corporation.
There's an expanded affiliated group,
has to be primarily
managed and controlled,
if it's primarily managed
and controlled in the U.S.,
then you're gonna be in trouble.
You want to be sure that the
expanded affiliated group
conducts activities,
substantial business activities,
in the country of the
acquiring corporation.
Otherwise, you lose the
benefit of your attempt
in expatriation.
- Why don't we go, instead
of talking directly about
base erosion, let's just
go to the next slide
with the revenue estimates,
save a little time.
And I'll talk about base
erosion in that context.
This slide shows you the
joint committee's estimates
that just came out about a month ago
of the administration's proposal.
At a 35% corporate rate,
I have to tell you,
in looking at various reform ideas,
it's very hard to get a
handle on whether all of this
can be an improvement under present law.
Unless you know how the
revenue estimates operate.
Because we don't have a lot
of visibility into that.
We know the camp revenue
estimates from last year
but that was at a 25% rate.
We now have another
insight into it which is
the President's proposals
and that's at a 35% rate.
And there's several interesting things
that come out of that.
One is when you look at the
limit on earning stripping,
which is their proposal to
say for inbound tax payers,
the amount of interest you
can deduct is the greater of
10% of your e-bit or the ratio
of your interest to assets
worldwide as applied to your U.S. assets.
I'm sorry, it's your
ratio of interest to e-bit
not assets, in the U.S.
compared to worldwide.
That raises, at a 35% rate,
that raises $64 billion
over 10 years.
It's a huge amount.
And it shows you how much,
how much leverage is in the
U.S. with foreign companies.
And it's something that hasn't
been in the tax reform debate
until inversions became
more high profile last year.
But I think will be part
of the tax reform debate
going forward.
And clearly with this
kind of revenue estimate,
now admittedly, if we were
talking about a 28% rate
or 25% rate, it would raise less
because you stack the rate cut first.
And these kinds of provisions after it.
But nonetheless, the number's big.
I think the second thing that's
very interesting about this
is the amount of revenue
that they see as being raised
by the 19% minimum tax, at
$262 billion over 10 years.
That was a surprise to me
because you do have offsetting,
I mean the lock-out effect is gone,
the income that they're
projected to get from dividends
over the next 10 years,
is now being taxed at 19%
instead of 35%.
But nonetheless, notwithstanding
that tax cut, if you will,
they're seeing it as
raising that much money.
If you're really focusing
on a system where
international is just revenue-neutral,
not counting the tax on existing earnings,
assuming that has to be a revenue raiser,
but that within the ongoing
system, it's revenue-neutral.
Instead of raising $262 billion,
it just needs to raise enough to say
offset the look-through
rules and the active finance
and taking into account the
earning-stripping piece,
we could have a minimum tax
that looks quite a bit different
you would think, than the
19% per country minimum tax.
And maybe that could be
interesting to some folks
in terms of proceeding
with international reform,
even if rates aren't gonna be reduced.
- Quite right.
I think we are just
about right out of time.
Just a couple of last
minute final observations
and that is that, what's
interesting to see
is that the issue on
deferral and inversions
has been joined by the government.
It's interesting to see
that the administration
has come forward with a
proposal of the minimum tax,
and proposals that relate to deferral.
And this is now, gonna go move forward.
And there will be more about
that later on, I'm sure.
We have just given you
just a very brief overview,
wet your appetite and we'll
move on to the next panel.
Thank you.
(audience applauding)
- Thank you Victor and Paul,
for the opening segment,
which will serve as the platform
for the rest of the program today.
Our next panel is going to
focus on the base erosion
and profit shifting,
or the BEPS initiative,
of the OECD and the impact
of the first responders
and in particular the United Kingdom
with recent enactment of
the diverted profits tax
or as is referred to the "Google Tax."
BEPS refers to tax planning strategies
that exploit gaps, mismatches
and loopholes in tax rules,
and in tax treaties that
make profits disappear
from a tax perspective or to
shift profits to locations
where there is little or no real activity,
but where the taxes are low.
This panel is going to be
chaired by Peter Blessing,
panelists include Michael
Plowgian, Brett Weaver
and Steven Edge.
From your left to right.
Peter Blessing is the head of
KPMG's Cross-Border Transactions
in the Washington National Tax Office.
Prior to joining KPMG,
Peter was a partner with
Sherman and Sterling for over 25 years
and is a past chairman of the tax section
of the New York State Bar Association.
Peter is also an author of the treatise,
"Income Tax Treaties
of the United States."
Peter earned his LLM
here at NYU Law School.
Michael Plowgian is an
International Tax Principle
in KPMG's Washington National Tax Office.
Prior to joining KPMG,
Michael was a Senior Advisor
on Base Erosion and Profit
Shifting at the OECD.
And in that role, Michael helped
lead the OECD work on BEPS.
And worked with policy
makers from the OECD
and G20 countries in order to
develop the action plan on BEPS.
Brett Weaver is an International
Tax Partner with KPMG
and is based in Seattle.
Brett's practice focuses
primarily in the technology
and telecommunications space
and on cloud computing.
Brett is the partner in charge
of KPMG's tax transparency
services and of the west area
international tax practice.
Steven Edge is a partner with
Slaughter and May in London,
and is regarded as one
of the United Kingdom's
leading authorities on
U.K. corporate tax law.
At Slaughter and May, Steve
advises on the tax aspects
of mergers, acquisitions,
disposals and joint ventures
and on business and
transaction structuring.
In 2011, Steve was called
upon to give evidence
at the U.S. Ways and Means Committee
about the U.K. experience in introducing
a territorial tax system.
Most recently, Steve has
been heavily involved
in consultations with the OECD on BEPS
and in particular, in relation
to the anti-hybrid proposals.
Steve has traveled the
furthest of our panel
to be with us today,
so a special warm welcome to Steve.
Peter, I'll turn it over to you.
- Thank you, Larry.
I would suggest that, if
you have pressing questions
during the presentation,
go ahead and ask them,
but we will be allowing
about 10 minutes at the end.
If it's easy enough for you to wait,
that would be welcome, too.
I'm gonna turn it over to Michael,
who's going to give
some general background
on the BEPS project and
then launch right into
the hybrid mismatch action, too.
- Great, thanks.
This panel is looking at the BEPS project
and an awful lot has been
said about the BEPS project.
So we're going to look at
it through the lens though
of the framing question
for this conference.
Is the U.S. tax system really broken?
And I think you see an element
of the BEPS project that
some other countries think
the U.S. tax system is broken.
I don't want to overstate that.
We all know that BEPS is primarily driven
by the political situation
in a number of OECD
and G20 countries.
But I think there are at
least two of the elements
that were talked about on the last panel,
that are reflected in the BEPS project.
One is this idea that if the
U.S. anti-deferral regimes,
the CFC regime, is not going to tax
the foreign earnings
of U.S. multinationals,
other countries want to and will.
The other piece or issue that
was raised in the last panel
is this idea that many other
countries have been moving
away from primarily
residence-based taxation,
worldwide taxation,
toward more territorial
and source-based taxation.
What you see in the BEPS
project, in the 15 action items,
is really somewhat more of
a focus on source-country
type solutions to the issues
that have been raised.
Hybrid mismatches is a little
bit of an interesting one
because it can be either source-country
or residence-country.
But that sort of, again,
goes to this idea that,
if the U.S. is not going
to be taxing this income,
another country wants to and will.
But if you're looking at
the proposed solutions for
interest deductions, that
is more of a source-country
solution, denying deductions
for interest payments.
On treaty abuse, again, that is much more
a source-based solution
for the kinds of issues
that have been raised.
On PE's and the transfer pricing,
at least in the discussion
drafts that we have seen so far,
again the emphasis is more
on source-country taxation
than on residence-country taxation.
There are some residence-country
taxation type measures
particularly in the CFC area.
But you can see the overall trend here.
That's kind of the lens through which
we're going to be looking at
the particular action items
that we discuss.
And this is not going to
be a comprehensive overview
of the BEPS action item.
It's really going to be
more about some of those
areas of tension that
we see between the U.S.
and other countries moving
forward on the BEPS project.
The first one is the anti-hybrid measures.
This was the deliverable
for Action 2 was released
in September of last year.
So it's a final, not a final report,
but it is agreed, not yet final.
There are a number of
open issues that are noted
in the report, including
the impact of CFC inclusions
on the application of the recommendations.
That the treatment of
additional Tier One capital,
regulatory capital for financial
institutions and others.
But the OECD says these
recommendations are
ready to be implemented by
countries that want to do it.
The primary feature of
the report is to set forth
recommendations for
primary and secondary rules
to address hybrid mismatch arrangements.
These are arrangements that
give rise to generally,
a deduction in one country
and no inclusion in income
in the recipient country
or a double deduction.
So think of your disregarded entity
that has a deductible payment,
can be consolidated in one jurisdiction
and included as a deduction
in the parent jurisdiction, as well.
A key feature of these
recommendations is that
they are only going after these
mismatches in tax treatment
if there is a hybrid element.
A hybrid entity, a hybrid instrument
or a hybrid transfer where two parties
are claiming ownership for tax purposes
in different countries.
And on the one hand, you
can see that as sort of a
principle distinction.
The recommendations are not going after
tax rate arbitrage.
They are not going after the primary use,
frankly, of check the box arrangements
where you have hybrid entities.
But the effect of that is really just to
turn off the U.S. CFC rules.
The recommendations
actually don't go after
those kinds of arrangements.
And what that means though is that
that can be pretty frustrating
because they capture certain arrangements
with hybrid elements.
But they don't capture
arrangements that are very similar
but don't have one of
those hybrid elements.
And it appears to be
generating a lot of work
for maybe not that much impact,
if you look at these
recommendations on their own.
- That's exactly what we predicted,
that this would be so much work
and so much compliance effort
and that at the end of the day
anybody that wanted to
do what they wanted to do
was still gonna get to be able to do it.
- And we do have to keep
in mind that there are
other actions that may impact
on alternative structures
including the treaty abuse action item,
the interest deductibility action item,
and potentially the CFC recommendations.
But the recommendations
here in that sense are
relatively narrow,
notwithstanding some of the
breathtaking jurisdictional issues.
That we'll come on to.
Another key point here is that
the government's recognized
that not everyone
will adopt these recommendations.
The idea is to give
interested countries a toolbox
to address these issues,
regardless of which side of the
transaction that they're on.
The primary rule in most cases
is to deny a deduction
if there's no inclusion
on the other side.
The secondary rule, just backing that up,
is to deny an exemption
or force an inclusion
if the payment is deductible
in the payee jurisdiction.
On top of that, and we'll
go through an example,
there is an imported
mismatch rule that says,
even if you've got a
straight debt transaction
between two jurisdiction,
no hybrid element,
if that income on the other side is offset
by another hybrid mismatch between
the second and third jurisdiction,
then the deduction can be denied
on the straight debt arrangement.
Which, I think, is
causing a lot of concern
and is very surprising
to a number of people.
And maybe we'll speak very quickly about
where the U.S. is on this.
Certainly U.S. law already
deals with a number of
the recommendations in
the Action 2 report,
with the DCL rules,
the 894 rules on domestic reverse hybrids.
And the administration has
put forward proposals that are
consistent with the OECD
anti-hybrid measures,
Chairman Bachus' proposals also include
anti-hybrid measures.
And certainly the Action 2
report is a consensus document.
The U.S. has supported
or at least not objected
to that document.
But enacting those
recommendations in the U.S.,
to the full extent would
clearly require legislation
and later panels we'll talk
more about the prospects
for that in the U.S. in the near term.
I think the idea is that regardless of
what the U.S. does here,
other countries are
moving forward with this
and the rules are
designed in a way to allow
other countries to tax
these types of arrangements
if the U.S. does not move.
And maybe we'll come directly then onto
the example that I think is perhaps
most illustrative of this.
This is a U.S. parent with
a Luxembourg finance company
that is funded by PECs, TPECs or CPECs,
treated effectively as debt in Luxembourg
and equity under U.S. tax principles.
The Luxembourg finance
company then makes a loan to
a U.K. operating company.
Straight debt, no hybrid element.
And the Action 2
recommendations would say that
in this scenario, if the
U.S. does not implement
anti-hybrid measures and
if Luxembourg does not
implement anti-hybrid
measures, then the U.K. can
deny the deduction on
the straight debt between
Luxembourg and the U.K.
These rules will have a
very significant impact
right off the bat.
The reason we use actually
the U.K. in this example
is that the U.K. has announced
at the end of last year
that it intends to adopt
these recommendations.
Which again, will have a
very significant impact
on U.S. multinationals.
Coming into effect, it's planned
starting January 1st, 2017.
There are a number of
differences between the
U.K. Consultation document and
the Action 2 recommendations.
And Steven, I don't
know if you can speak to
whether those differences are intentional
or what the U.K. plans to do.
- Of course I can.
And Michael's example
here of course illustrates
one of the fundamental design principles
that's within the BEPS process.
As Peter said, when this started out,
I asked the OECD people
whether the rules should be
that for every deduction
there shall be an inclusion.
Because if that was the
answer then it seemed to me
we were generating thousands
of jobs around the world
trying to track down where interest went
and where the people paid tax on it
and whether it was right or not.
But if you also ask
yourself the other question
which is, whose base are
you seeking to protect?
In this case, again as Peter said,
if the U.K. had borrowed
plain vanilla debt,
we'd be looking at a whole raft of rules
we've got in the U.K. to
protect the U.K. base.
But we wouldn't be looking at these rules,
nor would we be looking
at the anti-hybrid rules
the U.K. itself introduced in 2005.
And which have now been
operating for 10 years.
What is happening here with
the implementation of BEPS
is that unless the U.S. changes its system
and includes this income,
then the U.K. is going
to end up taxing more
from an equivalent operation than it would
if that debt was plain
vanilla from an outsider.
And I look at that and I think,
well that's either gonna
cause an enormous battle
to break out between
the developed countries
or alternative it's gonna give the U.K.
an unfair advantage.
Anybody who's looking at this
from a U.K. point of view
would say well that
looks like upside to us,
equal it the other way around,
U.K. companies putting
financing into the U.S.
are worried as to whether
the interest limitation rules
or indeed whether U.S.
reactions to inversions
are gonna mean that the
U.S. deductions are reduced,
the (mumbles) rules changed,
and also whether or not
it's gonna be possible
for U.K. companies to
finance their U.S. operations
through hybrid debt.
As to why the U.K. has come
up a little bit differently,
I think the U.K. would
have preferred something
that just protected the U.K. base,
and as I've said we've had
10 years of experience of
anti-hybrid rules.
And I think they've left a
little bit of wiggle room
in the way in which they've
brought in the rules,
so that they can bring in the rules,
comply with BEPS, but at the same time,
continue to have a competitive tax policy
because we're very much alert
to the fact that operating
within the European Union,
with a very open economy,
we need to attract people in
and encourage them to stay.
- The U.K. is clearly a first mover here
as it is in a number of areas in BEPS
but the other countries are
very much moving forward
on this as well.
The German government has
proposed adoption of the
Action 2 recommendations
and we'll be debating that
over the course of this year.
Many other countries have either proposed
anti-hybrid measures or implemented them
over the past two or three years.
This is clearly an area where
there's a lot of movement.
- The French brought them in as well.
And of course there's a
potential triple whammy
on that structure as well.
If you run into a state
aid problem in Luxembourg,
then you can lose in every
jurisdiction in the world
if you want to.
- Absolutely.
And I think with that we should probably,
in the interest of time,
move on to permanent establishments.
- Thank you, Michael.
This segment's called redefining PEs.
This slide gives a nice
overview of what is proposed
in Action 7, and what's not proposed.
For example, there's nothing
in the Action 7 document
about digital economy.
Which is not unexpected.
But it's interesting
that the actions proposed
are really very conservative in a sense.
They all hang on the
traditional concept of contract.
Everything centers around the contract.
One could have gone the other way,
the diverted profits tax that
Steve's gonna talk about,
did go the other way.
But this, I think of, is actually
pretty good news when we get into it.
Behind all of this is the question of,
why are they trying to
expand the definition of PE?
And some of it goes to
what Michael just said.
The source countries, some
of them are clamoring,
but more importantly,
all countries are seeing
that because of tax competition,
they can't tax on a residence basis.
Countries like, I won't use names,
but certain countries
that don't have a large
domestic tax base, are on
the other side of the fence.
And they would like things
just to stay as they are.
Naturally.
But most countries, and surprisingly,
we would think that a
country like Germany, France,
why does it want to expand
the concept of P.E.?
Simply because they're not
taxing on a residence basis.
They might as well tax on a source basis.
These proposals are not enormously broad.
The first area that we'll go talk about is
dependent agent, the
expansion of paragraph five
and six of Article 5.
And then paragraph four,
which is if you do have PE,
are you out under
preparatory and auxiliary
and there's certain
proposals in that context.
And then there's certain time requirements
for services PE or building
installation sights
and so forth.
And there's a proposal about
splitting contracts there.
And the last segment is
a proposal on insurance.
Let's just go to it.
Paragraph five, the proposal's deal,
with essentially break
it into four options.
Each of those options are composed of
two different sub proposals.
The first set of sub proposals
is trying to deal with the
what kind of activity you
need in the host state?
It used to be, or it is currently,
concluding contracts.
We shouldn't be too wedded to that term
because the current OECD commentary says,
concluding contracts
includes substantially
negotiating the terms of the contracts.
When the proposal here is
negotiate material elements,
some of the comment letters say,
that's fine but make sure it's just,
it's gotta be substantial negotiations.
The problem with that comment is,
it's already substantial negotiations.
And the second area
that the focus is on is,
what's the relationship with
the home country enterprise?
Does it have to be a morphous,
or should it be rather precise?
The precise alternative was some sort of
a legal relationship.
By virtue of a certain legal relationship
the contract was entered into.
Suffice it to say, of these four options,
the option that was most
people in the practitioner
community espouse, was
the one that had the
brightest lines and was the narrowest.
And that was option D, because option D,
in terms of activity in
the contracting state,
said negotiate material
elements of a contract.
How different is that from
substantially negotiate a contract?
And as far as the connection
with the home enterprise,
you had to have a legal relationship,
which is a pretty, at least a defined,
and it has to act for the account
at risk of the enterprise.
That's pretty close to today's loss.
If they went with option
D, I don't think that
personally, that that's a lot of change.
Let's look at one of the targets.
The only target that
truly has been announced
as a target, is the commissionaire.
In a commissionaire arrangement,
it's a product of laws of
certain European countries.
That allows basically a
agent, literally an agent,
in the home state and
that's B in this diagram.
To enter into contracts,
that basically are
for the account and risk
of the A home Enterprise.
But just not in the name of that entity.
They're in the name of the commissionaire.
This would be knocked out
under any of the four options.
And really only one piece of it is needed
to knock this out.
But it's knocked out
under all of the options.
The question comes up,
if they just want to get commissionaires,
why wouldn't they just say
commissionaires are no good?
They must want it.
They say commissionaires
in similar arrangements.
What's a similar arrangement?
We are pretty sure what we like to use
low cost distributors are
basically buy-sell arrangements
is not intended to be covered.
But the action plan does not say that.
The discussion draft does
not expressly say that.
But it's sort of implied.
There are commissionaires that are not
subsidiaries like this one is.
And so they are not exclusive,
they might be independent enterprises.
Those would not be covered.
What if the commissionaire,
there's a concept in Europe
of commissionaires del credere which
they basically have a risk of
collecting the receivables.
It's not clear that those are covered.
What if you have a broker
or a marketing agent?
Those would be covered
under two of the options
but not option D and not option B.
They'd be covered under
the options A and C.
There's some uncertainty here.
The proposal that would
actually catch a lot of things
is including marketing and
brokers and I wonder about,
would it catch low-cost
distributors in certain cases?
Possibly I guess, Steve
what would you think?
- I always think that instead of using a
rather fancy term like commissionaire,
we talk to an undisclosed agent
for an undisclosed principle
then we'd all understand
what we were talking about.
Because that's all it is.
And an undisclosed agent
for an undisclosed principle
can have to stand behind the
credit for their principle,
which is what the del credere agent is.
I do think there is a
bit of smoke and mirrors
with commissionaires, frankly.
- You're talking about a
synthetic commissionaire
and that is covered.
- On the limited risk, I
think it just depends on
the substance and the limitations.
- Yeah, limited risk I would think,
I don't know where it comes out under DPT
but maybe we'll hear that later.
Another example is a remote
seller of goods and services.
In light of time, we'll
go pretty quickly here.
But basically, B in this
example is acting as a
feeding and caring for customers
and also is hosting a website service.
And the question is
whether this is a problem.
The activity of B company
in marketing, is along the
lines of what I just said.
Under two of the options it
might actually be considered
to create a PE, under two
of the options it would not.
If it's got a hosting device
that's actually accepting orders,
that's a different story.
One would think it likely would be a PE.
There's been case law in Europe,
that whether you act without employees,
through devices or machinery
to engage in business,
it's not relevant, it's
not necessary that one
have an employee, can still be a PE.
Now I'll just go really quickly here.
- Peter, if you don't mind,
just one quick comment on that.
Your earlier lead in on
this Action 7 indicated that
there wasn't anything specific
on the digital economy.
So the concepts that were
raised in that report
such as maybe economic nexus, et cetera.
But to that point, as this illustrates,
Option A, for example, would be one
that might be a surreptitious
view of economic nexus.
Because that loosely defined interaction
that B Co has with
customers that gives rise
to a contract A Co.
It's an interesting question
as to whether this is
essentially economic nexus in disguise.
- Even A and C which
have that, as Brett says,
loosely defined economic connection.
Actually in a paragraph in the discussion
they say there's gotta be
a direct causal connection.
It seems to me it's much tighter wound
than it seems at first glance.
But I think we all agree that
that part of options A and C
is a real danger if it were to come in.
Now none of this would
be of any significance
or not much significance,
if they didn't change paragraph six
since people have been
taking more and more
aggressive or well-planned
positions depending,
to be independent and to argue that
their subsidiary is independence.
This Action 6 change would change that
and essentially say, if
you're acting exclusively
or almost exclusively then you're never
gonna be independent.
It's unclear how this comes out,
it's really an important issue.
I said at the beginning, a lot of this,
why are we going through all this?
Is revenue gonna be raised by this?
Just to, I think we're
gonna move on very quickly,
so I'm just gonna say, we
have a warehouse example.
Let's take a warehouse example.
B is operating a warehouse
on behalf of basically
the goods that are stored
are A's goods.
This is in a sense, it's a preparatory
and auxiliary example because
warehouse is one of the
protected activities.
You might not even get to
the preparatory and auxiliary
if you respect B Co as a separate
and independent enterprise.
Let's say it's not and
let's say they can say
that the warehouse is
at the disposal of A Co.
And the preparatory and
auxiliary provision is changed
to make it like it is
in a number of treaties
with asian countries.
And that says, a warehouse is OK,
it's preparatory and auxiliary.
As long as it's only for the "occasional"
delivery of goods.
But not if it's for
constant delivery of goods.
They say the warehouse is a PE,
how much value is attributable to that?
Is all of this worth the candle?
And it also brings up the question,
is it good policy to create
a further distinction
between pure digital services,
which would never have this issue,
and digital delivery of physical goods?
Which does have this issue.
And we're really
distinguishing enterprises
to a very large extent in
terms of their taxability.
And I think with that I will,
in the interest of time,
pass it on to Brett.
- Great, thanks Peter.
Lets jump into the next issue that has
certainly caused some concern,
I believe from a U.S. tax perspective
and we'll talk a little
bit about some of the
transfer pricing measures.
First up is the draft on
Risk, Recharacterization
and Special Measures.
The draft is issued in two separate parts.
The first part focusing
primarily on identifying
the transactions, what the
draft terms is delineating
the proper transaction.
Which indicates that you
start with a contract,
but it is interesting that it mentions
that's a starting point.
And then you need to
move beyond the contract,
look at the actual behavior at a parties
to proper delineate the actual transaction
between the related parties.
That's largely part one.
Part two focuses on the
application of issues
around transfer pricing
that may be outside
the arm's length standard
and focusing specifically on
special measures, et cetera.
That's roughly the issue.
And I think a good way to
illustrate some of the concerns
around the risk, recharacterization draft
would be to cover one of the examples.
This is the example in the draft that
addresses product recall risk.
The facts of the example, two affiliates,
one a manufacture the other distributor.
And between the distribution
within the distribution contract rather
with the distributor and the manufacturer,
the parties have decided to allocate
the risk of product
recall to the distributor.
And the example goes on to note that the
companies have actually never experienced
any product recall.
But having said that, since
the risk has been allocated
contractually to the distributor,
there have been some incremental returns
that have been allocated
to the distributor
because they have borne that risk.
And of course because
there's never been actually
any loss experienced.
The example goes on to
indicate that the manufacturer
is solely the person, the
party that's involved in
selecting suppliers,
dealing with quality issues,
monitors the quality process
throughout the manufacturing
process, et cetera.
And is constantly involved in improving
the manufacturing process.
The distributor on the other hand
really it goes on to indicate
that it has no capabilities
to address product quality issues,
to deal with the supply chain, et cetera.
That it's really largely customer focused.
As you can see in the
excerpt here on the slide,
the example concludes that
because the distributor
really has no capability to
manage the product recall risk
that essentially the contract
should be disregarded
and the risk of product
recall should be borne
by the distributor.
A very interesting conclusion.
Essentially it's taking
the contractual arrangement
between third parties and
throwing it out the window.
It raises some very interesting questions.
Obviously that's a step to
the allocation of the profits
related to that risk of being reallocated
back to the distributor.
And you can see why taxing authorities
may want to do that.
But an interesting question is,
what happens when we actually
experience a product recall?
Like we really have some losses.
Is jurisdiction A and the
manufacture jurisdiction
going to raise their hand and say yeah,
those losses belong over
here in this jurisdiction?
I'm somewhat skeptical with that.
It creates a really interesting position
for taxpayers to be in in
terms of trying to plan
and put in place their arrangements.
With the view that essentially
your contractual arrangements
could be second-guessed.
I don't know Steven, maybe
I'll turn to you here,
clearly there's been a lot
of concern expressed by
U.S. taxpayers and the U.S. government
on this issue of setting
aside to some degree
contractual arrangements.
How has this been received
from a U.K. perspective?
- Well we had some outbound transactions
where people transferred the U.K. phrase,
you'll probably remember it, Brett.
It was used with the Crown Jewels.
You don't transfer your
Crown Jewels offshore.
And the advantage of
having a monarchy still.
The U.K. revenue wanted
then just to ignore them.
And so that never happened.
Terrible dream, the brands
are still loaned in the U.K..
And the answer to that, I think is,
no you can't imagine.
We have not done a
transaction we've really done.
And your task then is to price it.
I very often come across
these product recall point.
And you're right on that,
that when people are trying to attribute
significant consideration to it,
the key question is, well
how often did it happen?
And I, at that point, always
mention the name Perry.
Because when it happened, it
happened big time with Perry,
who had to withdraw stock
from all over Europe.
Product recall may be a small risk.
But would I take it for
a small consideration
when it's gonna be a complete disaster?
No.
I do see, there's a bit more credibility
and that may be Andrew Hickman,
who lately of your parish
and of the revenue,
who's expressing it a bit more clearly.
But I think in order to recharacterize,
you've really got to have no substance
to the arrangements that you've done.
If you've really done
something, you've done it.
I think, and you've gotta respect it.
Sorry.
- Yeah, you can take notes,
even today a big recall was announced by
a company called Blue Bell.
They found some listeria in two of its
ice cream cookies and
they're recalling everything.
They said this is (mumbles)
just the way to do it.
Back to you, Brett.
- Great, well all interesting points.
And you mentioned the word
disregard or recharacterization,
and especially to note that
that issue that we just
walked through was within
the concept of part one
as it relates to
delineating the transaction.
There's a separate section
which really is labeled non-recognition.
And that's one where if the
transaction entered into
between related parties is
deemed to be a transaction
that as indicated here,
lacks fundamental economic attributes,
an arrangement between unrelated parties.
In other words, that's a
transaction that third parties
would never enter into.
In that instance, the entire transaction
could be disregarded.
And of course there's
concern there in terms of
how you would distinguish
those types of arrangements.
I think we've covered this
one for the most part.
I think the major concern with the draft
is this issue around
respecting the contracts.
And there has been enough
discussed about this
that the secretariat has
announced in the last
several weeks that there will be,
I'll put it my way in much
more of a, not much more,
but at least a relaxed focus compared to
what we have now in the subsequent report
that we might see kind of post comments
having been received
on this initial draft.
Excuse me.
I think the other point to note here
is the emphasis around decision making,
driving a lot of where risk
and profits ought to be allocated.
And as indicated in the final bullet here,
that's also a very
difficult issue to address.
And again comes back to this
respecting the contracts.
If the contracts allocate
risk and asset value
to a particular party but yet,
if our focus for transfer
pricing moves more toward
where are the decision-makers,
less so the contractual
party that bore that risk
or has responsibility with
respect to those assets.
Again, a very difficult
rule to actually administer.
Decision-makers, they're people.
They're mobile.
They might be in Company A today
and Company B in a different
jurisdiction tomorrow.
Does risk and rights to receive returns
move around as people move around?
Very difficult to administer that concept.
- Brett, I just mentioned in
the State A Starbucks decision,
there's some very frightening
concepts in terms of,
whether the commission
and whether if it does,
whether the ECJ upholds it,
can basically create a
different playing field
for transfer pricing.
Basically, create this
concept of independent
market operator and say,
if I'm an independent
market operator in this
particular jurisdiction, I
won't give away my profits.
I won't give my residual
profits, I just won't do that.
And that's sort of a
transformational way of thinking
about transfer pricing.
The other thing is, in the same sense,
variable royalty, paying
out the residual profits
after keeping the routine profits.
No, no, no.
It's not a royalty.
We don't think that's a royalty.
And so there's some,
that Starbucks decision, I
think, or proposed decision
is interesting.
- And there are things you would do
in the context of a joint venture,
that you might not do with
a wholly independent party.
And so it always seems to
be when the tax authorities
go into denial and say,
you wouldn't do that
with a third party, the answer is,
the third party becomes
your joint venture partner,
you would do it.
In which case then, the usual response is,
OK, well let's profit share.
And that's not necessarily a bad outcome.
- Well Steven, that's great
lead in to the next topic.
- Oh splendid.
- Which is profit-share.
You're an excellent plant.
And I think, interestingly to your point,
you stated that's not
necessarily a bad outcome
and I think, beauty is in the
eye of the beholder, right?
And a lot of that is dependent on how
it's actually implemented.
The discussion draft here, I
think it's interesting to note,
that this one is not a consensus draft.
It was designed to stimulate comments
from the business community and others.
It listed eight different scenarios
that seem to imply that
these were fact-patterns
that use of profit split would make sense.
I think it's also useful
to look at Action 10,
in terms of the directive
in the BEPS action plan,
that it highlights that
with the concerns of
highly integrated multinationals
that profit split method
may be the appropriate way to arrive
at a proper transfer price.
That's highlighted as potentially
one of the fixes here.
I think it's illustrative
as we go through the paper
and look at some of the examples,
in terms of at least the initial thinking
that the secretariat
had around profit split.
And as Steven mentioned
earlier, Andrew Hickman,
who's leading the transfer pricing effort
is very much a fan of profit split.
And I think some of the initial reaction
that the business community
had around the profit split
he mentioned it a few times,
as somewhat disappointing.
It would be interesting to
see what the next iteration
comes out with.
Having said that, a
couple of key principles.
The document seems to
indicate repeatedly that
when you have multinational enterprises
that are highly integrated,
and to some extent they've
maybe fragmented their
activities, we have
warehousing in this company,
distribution over here.
We have R and D over here.
That trying to identify
comparable transactions
using one-sided transfer pricing methods
that I can separately identify
the value that I leave behind
for contract R and D.
And I can separately identify
the value that I leave behind
for the distribution function.
Add up all the pieces and
the residual falls back
to some entrepreneur,
oftentimes located in a
lower tax jurisdiction.
That the general concept of this paper
is that those types of
approaches to transfer pricing,
which is historical transfer pricing,
really lacks comparability.
That to compare a company
that just does logistics
to an integrated multinational that really
can kinda control all of
this across the board,
across many countries,
really it's not comparable.
And therefore it lacks reliability
and a profit split is
essentially a better method.
That's largely a theme of the paper
and the examples that are included.
Let's just cover one briefly
in the interest of time
and then we'll end this section.
And that is this example,
we have a parent company
that owns intangibles,
both R and D, IP related,
and marketing intangibles.
It also manufactures
product which it sells
to it's affiliate, S Co.
And S Co is really a very
successful distribution company.
The example notes that
the industry that P and S
are actually in, is very competitive.
And that S Co is very
close to it's customers.
It helps them in terms
of integrating products.
Figuring out how to design
and configure your products.
There's a high degree of
sensitivity in terms of
being able to track
maintenance of products.
And they have kind of an automated process
to help companies get ahead
of their maintenance schedules, et cetera.
So they walk through all
of this value that S adds
and concludes basically,
at the end of the day,
that because S's
contributions to the overall
value chain here are
so unique and valuable,
that you suggest that the use
of the profit split method
would be appropriate.
What's interesting, I think,
for many tax payers in this example,
is that a lot of what was
described was S Co does,
is what you would expect
almost every distributor to do,
in my opinion.
Which is stay close to your customers,
and help them with product selection
and all the rest of that.
I think it does raise some
really interesting questions.
Is this the type of fact
pattern that would lead us
toward the use of profit split?
And even if it did, the
question then becomes one of,
would profit split really
be that much more reliable
than some of the other
transfer pricing methods?
Once I get to profit split,
how do I split the profit?
What's my key?
If one party's adding value through
bearing of risk and controlling risk
and another party's adding
value through functions
such as manufacturing,
what type of allocation
key do I come up with that?
And if the key is more
arbitrary, in terms of measuring
that value by the two contributors,
have I really added up with
a method using profit split,
that's more reliable
than any other method?
With that on profit split
and some of its concerns,
let's move forward to.
- I would suggest we jump
to diverted profits next,
in the interest of time, to
leave time for questions.
- OK, so--
- We can come back if
there are no questions.
- I'm here as chief apologist
and to take the blame.
The two key things to note
about diverted profits tax
from a U.K. point of view,
and I know it's got a certain amount of
notoriety over here,
a one that we're in the
middle of a general election
in the U.K. and it's gonna
be one of the tougher
general elections for a number of years.
The outcome is genuinely uncertain.
The chancellor asked of treasury officials
before the election campaign started,
give me something that I can point to
when the opposition
accuse me of being soft
on multinationals.
Particularly the U.S.
multinationals who've
in the rather febrile
environment we've got in the U.K.
At present have attracted some criticism
before the public accounts committee.
I don't think the treasury
called it the Google Tax,
but it's no secret that
they were not displeased
that that tag was attached.
Because that came in train
with the idea that this was
the U.K. government being
tough on U.S. multinationals.
And the people in the streets,
of course like all of us,
think that tax is great,
so long as it's paid by someone else.
And the idea of taxing
all these multinationals
who are making huge money
in the U.K., is great news.
Given the Google Tax tag to it,
gave the impression that we were also
taxing digital transactions,
which of course, we're not.
The second point, I think to note,
is that the title of diverted profits tax
along with a lot of the
publicity has been misleading.
The government at this time,
is not the least bit worried about that.
Because actually it gives
the right impression
to the people that vote.
It will become worried after the election
if it has an impact
on the government's
competitive tax policy,
which is partly designed
to keep the multinationals
that we've got, don't have as many as you,
but we do have a few.
And certainly what happened in 2007, 2008,
was that we were suffering
inversions before you did
and within the European Union,
we couldn't close the door.
We had to accept very quickly
that the only way that we
could keep people in the U.K.,
was to change our tax rules
to a territorial system.
On the inbound side, we
need to make the U.K.
an attractive place to do business
and we've changed our tax administration.
There's much more open
relationship, real time working.
But we also got a really good relationship
between business and government,
in terms of tax policy.
Most tax proposals in the last five years,
maybe more than that,
have been consulted on
announced and dealt with.
Diverted profits tax wasn't,
so it cause some annoyance in
the U.K. community, as well.
But as I said, it's an election trade.
Now diverted profits tax suggests
that profits have been
diverted from the U.K.,
they belong somewhere else
and the U.K. is reaching out
to them to try and tax them.
And that's what's given
rise to the allegation
this is a BEPS first mover.
If actually what the
government had announced
was that it was putting
in place stronger measures
with greater penalties
to improve it's transfer pricing regime,
which is actually, as you see in a minute,
I think the truth of the situation.
In the context of an election,
that would have done more harm than good.
Because immediately the opposition,
Margaret Hodges of the
public accounts committee,
was not Mrs. Thatcher returned by the way,
who's been haranguing everybody in sight,
from the revenue through
to all the multinationals
who appeared before her,
would have said, "So, you've
only just realized now,
"after I've been shouting at
you for the last five years
"that you need better
transfer pricing rules."
But interestingly, and I'll
come on just a little bit,
and then we'll finish with
questions to the detail
of the rules.
But the yield shown for
diverted profits tax,
which is a 25% rate.
So 25% higher than our U.K.
corporate 20% rate, goes up.
The first three years of the tax,
it's a relatively low yielder.
The government say they will collect
about a billion pounds,
one-half billion dollars,
from diverted profits tax.
If you've got a tax that's
coming in to discourage people
from playing the fool,
you'd expect it to go down.
The first question I asked
is, why is that going up?
And the answer is a rather revealing one,
because they say, well
what diverted profits tax
is going to do is give us more information
it gives us a car shore,
a blunt instrument
that we can use to
threaten multinationals,
to give us more information.
And therefore, actually the yield from
diverted profits tax that
we show in the announcement
is not all diverted profits tax.
It's actually improved corporation tax
from better transfer pricing.
I think the right thing
to do is to look at
diverted profits tax as an
adjunct to transfer pricing
in the same way that when
we changed our CFC rules
in 2013, we effectively brought into
our transfer pricing regime,
enter our CFC regime,
transfer pricing rules
that looked at whether the
U.K. base was being eroded.
Or whether the profits in a
CFC really belonged offshore.
If you then look at the
design principles on
diverted profits tax,
first of all, why did they
choose to have as the two
threshold entry conditions,
the fact that you've got low tax profits,
less than 80% of the U.K. rate.
And the U.K. rate is quite low already,
as you will recognize.
And insufficient economic substance
in the jurisdiction in which
those profits are accruing,
to justify the profits
that are being made there.
The answer to that is
that the treasury said,
we've only got so much time.
We can't look at everybody
all around the world.
But actually if we see
parts of untaxed income,
somewhere in the world,
then something's gone wrong somewhere.
Because capital on it's own as
Paul said earlier on,
doesn't make anything
other than a passive return.
You need to have activity
or people to manage
intellectual property and
make the super profits
that are being looked for.
If you've got (murmurs) economic substance
but large profits, something's gone wrong.
Looking at it from the U.K.
point of view, therefore,
the U.K. revenues say,
we've over the years been
frustrated by our inability
to look beyond in transfer pricing terms
the leg that comes into the U.K..
The example that was given earlier,
Bermuda into Ireland, into the U.K.
The U.K. revenue would say,
we just get told what comes into the U.K.
and all we see is the license grim
between Ireland and the U.K.
We don't get, unless
you've got a really open
and compliant client, who are all mine,
people who will give us details as to
where the R and D is done,
where the profit is really made.
And unless we get a global picture,
we won't really be satisfied
that we positively say
where profits belong as opposed to
negatively say, they don't belong here.
It's always difficult to prove a negative.
From our point of view, diverted
profits tax is intended,
so the revenue, to give us
better access to information,
because we've got this
big caush of 25% charge
and some pretty severe penalties,
to make sure that people
tell us what's going on
around the world.
And we can then work out whether or not
any of the payments that
are leaving the U.K.,
the so-called tax advantage payments,
are inflated payments
from a U.K. point of view.
So the U.K. base is being eroded.
Or whether they're justifiable payments
going out of the U.K. and
actually some other jurisdiction,
possibly the U.S., is losing
out on not taxing that income.
Very quickly, the diverted
profits tax regime,
it's that I've got two
low-threshold entry points,
instra in economic
substance, low tax profits.
It's got two limbs to
it, the avoided PE rules,
which say that if you've
designed a structure
so that you don't have a PE, then you do.
And as Peter was saying earlier on,
I found the idea of somebody
just sitting in a field,
in the middle of an island,
or in the middle of Switzerland,
and just signing every contract
that's put in front of him,
and or her, an odd one.
I don't think that attracts value.
The tax advance payments,
and this is the key thing
about the diverted profits tax,
looks at what these, is
a straight transfer vice,
and the consequence the
amount that's subject
to diverted profits tax
is the excess payment
that is being made because
you were attracted.
You've become exuberant at the possibility
of clocking out offshore income.
Actually when you do the examples,
and I worked with the
revenue on the examples
that are in the guidance
that have come out.
It's quite difficult
to find clear examples
without imputing
stupidity to your clients.
We were paying this today,
we found this great structure,
let's just put the cost up by 10%,
you're caught bang to
rights at that point.
My optimistic nature says,
I think particularly after the election,
if we have a continuation
of the current tax policies,
diverted profits tax
will not cause any damage
for inward investors and
will gradually settle down.
But there will be few people out there
who will find that when
they thought they had an APA
in the past, it gets reopened because
their revenue didn't feel that they had
full disclosure in the past.
As Brett said earlier on,
well the revenue shouldn't
have signed the agreement,
should they?
But they did.
My worry on diverted profits tax,
is that it is going to be implemented
by quite a wide number
of people across the U.K.
And just as here, there
are people who joined
the awkward brigade when they were young
and are in life to make
difficulties for others.
That could happen with an
unsympathetic regime at the top.
It could get worse.
But certainly the message at
the present from the revenue,
is that it is not a BEPS first mover,
it's just seeking to improve
the U.K.'s collection pass.
- Steven, I guess, both of
the prongs you talk about
in terms of avoiding PE and
improved transfer pricing,
are also part of the BEPS project.
Is the diverted profits tax intended to be
a temporary measure until the BEPS project
is completed on those issues?
Or how is that viewed?
- When I asked that
question the treasury said,
"Well we needed to get it in place now
"because otherwise a whole year goes by
"and we don't get the $300
million we're planning to get
"in that year.
"But we will of course
keep the interaction
"of DPT with the BEPS
project under review."
My guess is it probably won't change much.
I think, actually, I hear over here
that lots of people think
the transfer pricing rules
don't work in the U.S.
Well why not consider
a diverted profits tax?
- I was gonna say, you've
made quite the case
for our Congress to enact
a diverted profits tax.
- Because it's just a very big caush.
- That coupled with Michael's observations
and how our revenues are gonna get gored
when we're the last ones to implement
a hybrid regime, an anti-hybrid regime.
This may all cause our quiescent Congress
to spring into some legislative animal.
And what have we got here?
With that, why don't we see
if there are any comments
or questions.
We have at least five minutes.
If anyone has a comment, it's welcome.
If they don't, we'll make
Brett talk about transparency.
- You better ask a question.
(laughing)
- Brett wants a question.
I'm happy with transparency.
(laughing)
- Peter, can I ask you a
question just on the topic
you talked about on PEs?
Because personally I do believe,
and there's been a lot of
discussion in the U.K. about this,
the enacted warehouse, if
actually you've got a choice
between going online and
getting a book this afternoon
in your office, or waiting til the weekend
and going to your local bookshop,
actually if your supplier
couldn't deliver that afternoon
and it was two or three days in the post,
coming from Luxembourg, let's say.
Then you'd probably go to
the bookshop at the weekend,
'cause it's nicer.
Personally, I do think that an
enacted warehouse like that--
- Well we're just glad you're
not a transfer pricing person,
'cause I see where you're heading.
- Well, I practice a little.
(laughing)
And the other one that I
always find slightly strange,
which goes into the same area
is that actually a
purchasing agent is not a PE.
And again, actually
buying cheap is part of
selling at a decent profit, isn't it?
And having supplies.
I just wonder whether some of our concepts
and our treaties are
a little bit outdated.
And perhaps today's when
we got there by sail
rather than be steam,
rather than by plane.
- I think you're spot
on and that's certainly
a thinking of the OECD
and the members that
propose those sorts of things.
If you go to purchasing,
they're thinking the procurement office,
or it's centralized procurement.
Lot of value there, easy, it's worth,
that one's probably worth
collecting revenue from.
But if you just eliminate
the purchasing exception
altogether it becomes a
facts and circumstances test.
I personally think in some of these areas
it's good to have a safe harbor.
It's much like you have in
the diverted profits tax,
you have a small, medium-sized
enterprise exception.
And you have a revenue
exception and so forth.
I don't have a problem with eliminating it
for the big guys.
- And of course, lots
of companies are having
transfer pricing disputes
about procurement structures.
- Are we?
- We're done.
- Any questions before
we let this guy up here?
- With that, thank you Peter,
Michael, Brett and Steve.
(audience applauding)
