(playful music)
- Okay.
Welcome back from the break
to our program on corporate inversions.
It's rare that a technical tax matter
finds itself at the center
of mainstream news media
in the way that corporate inversions
have in the recent past.
President Obama recently referred to
prospective inverters
as corporate deserters,
and called for economic
patriotism from those companies.
The strategy of corporate
inversions is not new,
although it had not occurred
at such a frequent pace
until recently.
Our next panel will discuss
the phenomenon of corporate inversions
and whether the recent flurry
of activity in this area
is perhaps a symptom
that the US international
tax system is in fact broken.
The panel will be chaired by Deborah Paul
and panelists include Patrick Jackman,
and professors John
Steines and Willard Taylor.
From your left to right,
Deborah Paul is a tax partner
at Wachtell, Lipton, Rosen and Katz,
where she focuses
on the tax aspects of
corporate transactions
including mergers and acquisitions,
joint ventures, spin offs
and financial instruments.
Debbie Paul is a frequent speaker
at the Practicing Law Institute,
American Bar Association,
the New York State Bar,
New York City Bar and the
International Tax Institute
on various aspects of corporate taxation.
Pat Jackman is an
international tax principal
at KPMG Washington national tax office
where he specializes
in cross border international
corporate acquisitions,
mergers, internal restructurings,
business formations,
and joint ventures.
Pat is a frequent speaker, writer
and is co-author of the
leading M&A tax treaties
US Taxation of International Mergers,
Acquisitions, and Joint Ventures.
Professor John Steines
teaches several tax
classes at NYU law school
including those on international tax.
John frequently testifies
as an expert in tax related controversies.
A former Editor-in-Chief
of the Tax Law Review,
his scholarship includes
a case book called
The International Aspects of US
Income Taxation.
Professor Steines served
as the sole author
of the most famous, Bittker
and Eustice treatise
on federal income taxation of
corporations and shareholders
from 2011
to 2013.
Willard Taylor was a partner
with Sullivan and Cromwell
for 35 years
and remains of counsel to the firm.
Willard is a former
chairman of the tax section
of the New York State Bar Association
and as an adjunct professor at NYU Tax
LL.M program.
Debbie, over to you.
- Thank you very much.
Well, we're delighted to be here
to talk about inversions this morning.
Now inversions are a topic
where much ink has been spilled,
much has been said about them.
But Larry has helpfully given us a focus
for our conversation,
which is whether inversions
by US multinationals
constitute voting by your feet
voting by your feet for
a territorial tax system.
Now that's kind of a loaded question.
Voting with your feet suggests
that there's something
wrong with the US system,
and that other regimes are
more hospitable to businesses,
and that the US should
really take note of this,
this is an alarm, this is
a symptom, as Larry said,
and that the US really are to align itself
with other regimes that
are more business friendly.
And we'll talk about that
or whether perhaps
inversions are a fad,
maybe a cyclical fad,
but nonetheless a fad
that shouldn't drive tax policy
and
the design of our tax system.
And also another theme
is whether if we do move
to a territorial system,
can we appropriately
allocate the tax burden
among businesses
in a way where they are paying
for what they get
out of the US system
with all the economic,
cultural, social, legal and other factors
that help foster business in this country.
So those are some of the broad themes
inherent in this topic.
Now let's just say a word
about what a territorial system is.
A territorial system is generally a system
that taxes only
income that is sourced
in that jurisdiction.
It's in contrast with a worldwide system
that taxes a taxpayer
on income it earns
no matter what source that income is from.
Now in the US,
we're generally thought
to have a worldwide system
for taxing businesses, and it is,
but it's a system that reflects
an understanding or
compromise that was reached
on the order of 100 years ago,
which says that where income
is sourced in one country
but earned by a resident
of another country,
the source country primes,
the source country gets to tax that,
and in an effort not to
double tax that income,
the resident country will
cede jurisdiction to tax that.
So we have a worldwide system,
but one that has a foreign tax credit,
which is designed not to double tax
and to acknowledge
this compromise that says
the source country should get to tax.
So one way of thinking
about the difference
between a territorial system
and a worldwide system
is that in a worldwide
system, such as ours,
reflecting this grand compromise
that countries reached
a century ago or so,
this source country is prime,
the source country has
primary jurisdiction to tax
whereas in a territorial system,
the source country would have
exclusive jurisdiction to tax.
There are of course hybrids in between.
So now
to talk about inversions
and how they fit in and
give you sort of an overview
before our panel goes into a deeper dive,
there are generally three reasons
that companies are thought to invert.
The first
is
a desire to
reduce
US tax
on US earnings.
This is sometimes called
earning stripping,
a US company that's a
subsidiary of a foreign parent
will find a way to make
deductible payments like interest
to a related person,
thereby reducing US tax
on US earnings.
The main US limitation on
doing that is in 163(j)
but it doesn't prevent it
all together in many cases.
So that's the first reason,
reducing US tax on US earnings
which doesn't sound like it has much to do
with seeking a territorial system,
because a territorial system
is about not having US
tax on foreign earnings.
Now, the second reason
that companies are often thought to invert
is to eliminate US tax
on cash
that is held in foreign subsidiaries.
There's thought to be about
a $2 trillion worth of cash
sitting in foreign subsidiaries
of US multinationals
that has built up
as earnings of those
foreign multinationals.
Further the portion of
profits
that a US multinational
a US parented multinational earns
has increased over time.
That's what the blue line
on that chart is showing
that the aggregate earnings over time
have been more and more foreign,
which wouldn't surprise you
as the economy has become,
as globalization has
occurred over the decades.
So that's the second reason
trying to get access to cash
in foreign subsidiaries.
The third reason that
companies are thought to invert
is to protect future
foreign earnings
from US tax.
The US has
one of the highest statutory tax rates
in the OECD.
And people don't like the idea
that if a subsidiary,
if a portion of their business
in a foreign jurisdiction
earns income that it's
eventually going to be taxed
at our 35% federal rate plus state.
So trying to protect
future foreign earnings
from
US tax
is a third reason companies
are thought to invert
ans that speaks most closely
to the idea of seeking
a territorial regime.
That's really what a
territorial regime is all about.
If we had a territorial regime it wouldn't
it wouldn't tax foreign earnings of
of
foreign earnings.
That's the idea of a territorial regime.
So how does,
how does
an inversion
achieve these three goals mechanically,
in a nutshell.
Well, in a typical inversion case,
the existing structure
is that you have a US company
with foreign subsidiaries,
and it's got shareholders who may be
or who may be US people
they may be foreign people
the US shareholder
designation
they are just means they are the holders
of the US company stock.
And they exchange their US company stock
for stock in a foreign
company in this example,
a UK company.
Under Section 7874,
the inversion fails
if the former holders of the US company
own 80% or more of the combined company,
but if you're underneath
that 80% threshold
then the UK parent is
respected as a foreign company,
otherwise, generally, it
isn't and the inversion fails.
But that still leaves a lot of room
for a successful inversion.
Now, how do we achieve earning stripping?
How do we achieve that reduction
of US tax on US earnings
that people sometimes
seek in an inversion?
Well, the US company may distribute a note
to the UK company,
and your initial reaction might be
well, what about withholding
tax, US withholding tax
on that dividend.
That can be ameliorated
if there's a good treaty
between the US and the parent
in the case of the treaty with the UK,
if you wait a year,
generally there's no
withholding under the treaty
on that distribution,
and so what you've set up
is interest deductions in the US,
interest income in the UK,
and that interest income in the UK
may be undesirable
'cause the UK may impose
significant tax on that,
so sometimes people will drop
the receivable side of that note
down into a Luxembourg company,
the US is still getting
the interest deductions
albeit subject to section 163(j)
there may not be withholding tax under the
on the interest under
the US Luxembourg treaty,
and Luxembourg may not impose a lot of tax
on the interest income.
So that's mechanically how an inversion
achieves the earning stripping goal.
In terms of accessing cash
and foreign subsidiaries,
as you may have heard,
there was a notice that the
IRS put out in September
2014-52
that really clamped down
on the ability to access
cash in foreign subsidiaries.
But before that notice came out
the typical
technique
was one of them may be
simply for the CFCs,
the foreign subsidiaries
to lend money to the UK parent.
That's a lot more difficult
and may not even be
possible after the notice.
In terms of protecting
future foreign earnings,
the way people may do that
is that growth, foreign acquisitions
of foreign businesses or organic growth
of foreign businesses,
what occur where that green foreign box
is namely underneath the UK company,
not underneath the US company.
And potentially there may be ways
of migrating the historic
foreign business
that's in the orange
boxes
over to a place that's
underneath the UK company
and not the US company.
Alright, so that's the overview.
Let me now turn it over to John,
who's gonna talk about
how inversion transactions
have evolved over time
and how the rules have evolved over time.
- Thank you, Debbie.
Our thought is that when we
finally get to the causal link,
or to see if there is a causal link
between the reluctance
of the United States
to adopt the territorial system,
and the wave of inversion activity,
it will be helpful to keep in mind
a history of how we got
to where we are today.
So my job is to to take you through
the history of how the deals have evolved
and how the law has responded to it.
The stuff I'm gonna talk about
is captured in the next nine slides.
And basically, you can divide them
into three sub topics.
First I'm gonna talk about
efforts to tax shareholders
under Section 367.
Then, what section 7874 does
in the way of taxing the
corporations that invert,
and finally, I'm going to focus on
some of the recent activity
under Section 7874,
including the notice
that Debbie talked about.
So let me begin with shareholder taxation
and the theme here is historical.
You can think of the book of inversions
as having an Old Testament
and New Testament.
The Old Testament, we quickly
forget goes way back to 1982,
and it involves an inversion
of a company named McDermott.
The shareholders gave up their
shares in the parents company
in exchange for shares
of a pre-existing Panamanian subsidiary,
and the government got
irritated about the deal.
They were probably irritated
more at the company
than they were at the shareholders,
but they went after the shareholders
and said that the stock they received
in the Panamanian company
was a dividend under Section 304.
And the court said no it's not.
A couple years later,
Congress enacted a part of Section 1248,
that had it been in effect
at the time of the deal
would have taxed McDermott
itself, but it came later.
That's the Old Testament.
The New Testament starts
about 12 years later, in 1994,
with the Helen of Troy inversion,
they moved to Bermuda as I recall
with no change of shareholder ownership.
The government got irked
at this deal as well,
they knew though
that nothing in the
current law at that point
authorized taxing
either the shareholders
or the corporation.
So they quickly issued a notice 94-46
that said things are going to change.
We'll soon issue regulations
that will tack shareholders
under Section 367,
which they did and which we often refer to
as the Helen of Troy regulations.
Under these regulations if US shareholders
and I emphasize US because it's different
when we get to Section 7874.
If US shareholders end up with
more than 50% of the stock
of the foreign acquiring company,
and in those deals, it was 100%,
then their taxable on their stock gains.
This turned out over the course of time
to be not a very effective impediment
to inversion transactions
for a couple of reasons.
First, there was nothing that prevented
the US company from downsizing
prior to the transaction,
to enable its shareholder base
to be under the 50% hurdle.
More important shareholder level gain
just didn't seem to get much traction.
Exempt shareholders, foreign
shareholders didn't care,
they weren't going to pay tax anyway,
US shareholders may have had to pay tax
but there was a lot of churning
of shares in the market,
so that by the time a deal
that had been known about
actually came to fruition,
there wasn't that much gain left to tax.
So for a variety of reasons,
the shareholder level
tax under Section 367
didn't amount to much,
the deals kept going
and the prototypical structure involved
a company organized either in
Bermuda or the Cayman Islands,
tax resident in Barbados
by virtue of management and control there
and the significance of that
is that it gave the inverted US company
access to the Barbados US treaty,
which meant, speaking
of earning stripping,
that the inverted US company
could borrow from its
Bermuda/Barbados parent,
pay interest and there would
be no withholding tax on it.
So things kept rolling along
and then came a new period in history,
which I'm gonna call the
age of enlightenment.
Long about 9-11 time,
the pace of inversion
activity had picked up
and there was a lot of resentment
and 9-11 fueled the resentment.
Congress said we should
do something about this
maybe we'll enact tougher
earnings stripping rules,
but what they gave us was section 7874.
In broad strokes, it says
that if a foreign corporation
acquires substantially
all of either the assets or
the stock of a US company,
and if the shareholders
regardless of whether
they're US or foreign
of the US company end up
with at least 60% ownership
of the combined company,
then section 7874 will apply
unless the combined group can demonstrate
that it conducted
substantial business activity
within the country of the foreign parent.
Now, a word has to be said
about the level of stock ownership.
If the owners of the combined entity
by virtue of their prior
ownership in the domestic company,
were over the 80% hurdle, as
Debbie talked about earlier,
tremendously bad results ensued.
The foreign company was
treated as a US company,
which meant that all of the US
tax planning was obliterated,
and that there was significant potential
for multiple international taxation.
So staying below 80% was
absolutely mandatory in all cases.
In the 60% case,
there was a strange remedy in the statute.
If the domestic company
earned something called
inversion gain
at any time during the 10
years following the deal,
it would have to pay a tax on that gain
write a cheque to the
United States Treasury,
even if it had otherwise
available tax attributes
that would have sheltered the gain.
It turned out that this punishment
was an acceptable punishment
because many inversions
that happened after that
stayed between the 60 and 80%
zone of ownership.
Another thing that is
important in this development
is that along with section 7874,
Congress enacted an excise tax 15%
imposed on stock based compensation
of the officers, directors
and significant shareholders
of the target company.
It turns out that in many cases,
this tax has been paid
by the inverted company,
and the payments have been grossed up
so that the employees with
the stock based compensation
are made whole at a very expensive cost
which has not gone unnoticed
in the ranks of shareholder
activist groups.
So that was section 7874,
and it slowed things down a bit,
and now I want you to move forward
to the last period in history,
which I'll call the age of desperation.
Where around 2010
it's not coincidental that
by this point in time,
companies had loads of
cash, as has been mentioned,
stored in their offshore subsidiaries
and loads of earnings,
and so they were desperate
for a way to get the money back home,
finding a merger partner,
sufficiently large enough
so that the shareholders
of the domestic company
could remain under 80% was
possibly a ticket to Nirvana.
So that's how the deals ensued,
and lots of tax planning went into keeping
the ownership percentage,
certainly below 80%,
ideally, below 60, but that
was often hard to achieve.
So between 60 and 80, was the sweet spot.
To make things worse,
the treasury issued regulations
that made it virtually impossible
for a company to demonstrate
that it conducted
substantial business activity
in the jurisdiction of the foreign parent,
it's the 25% test that you may know about,
virtually no company can satisfy it.
So as we sat in 2012,
when these regulations came out,
the only thing that
mattered under Section 7874
was the ownership percentage.
Tax lawyers and other
advisors got involved,
expended great efforts,
came up with lots of clever strategies
to make sure that the ownership percentage
would be diluted sufficiently
to stay under 80%.
Notice 2014-52 was the
government's answer.
I won't get into the details now,
but it did essentially two things.
It made it harder to avoid section 7874
by focusing on various conditions
in the acquiring company
or the target company,
and it said in addition to that,
that if you're stuck with section 7874,
the popular forms of
post inversion planning
would no longer succeed.
No more hopscotch loans,
no more diluting the ownership
of the once CFC to below 50%,
and no more attempts to extract cash
out of the inverted companies
controlled foreign corporations
by virtue of Section 304.
So now things seem to have
slowed down a bit more,
they certainly haven't ground to a halt,
and we're waiting to see what
the next (mumbles) will be.
There's proposed legislation
to drop the 7874 hurdle
down to 50%,
and of course, there's the
threat of earning stripping rules
coming out of treasury.
- Willard.
- Okay, so without
repeating what you've already been told,
although there's a little
bit of overlap here,
let me first of all,
make a point
not all of these transactions
are what we would call
inversions or expatriation.
I mean, there are true mergers of equals
in which tax may play a role,
and an important role in where you are
but
end up
but that's not the driver of the deal.
The transaction we're
really talking about,
you know, are much more 75-25.
Much, much bigger US company,
smaller foreign company
there's little doubt
that it's driven by tax
and I think Debbie has laid out
the drivers being the build
up in foreign earnings
that you can't bring back
although how important that is
depends a little bit
on how APB 23 applies,
the future earnings and
then earnings stripping.
So why do you go to the jurisdictions
that seemed to be predominant?
There are
non tax factors
that come into this
such as you know, they will say a rumor
that Switzerland might
adopt
proposals to cap the pay of executives.
That made Switzerland rather
unpopular as a choice,
as you can imagine,
there would be transactions in which
a US company and a Japanese company
moved to the Netherlands
although from a tax point of view,
the company was resident in the UK.
Why did they do that strange thing,
because Dutch law was
perceived to be more flexible,
in things like share buybacks than UK law.
So there are non tax considerations,
certainly that affect
the choice
of the country you go to
but taxes
is again a driver.
Why do you go for example to Ireland,
which is where a great many
of the farmers have ended up
including some companies that started out
in Bermuda and then move to
Switzerland and then to Ireland,
and again,
they have a no tax on
on foreign income,
the 12.5% corporate tax and other income,
they also by the way
have no withholding tax
on dividends paid to foreign shareholders.
There is a tax on foreign earnings
but in effect because
of the very flexible
foreign tax credit rules,
it's not consequential.
So, that is
a driver for the UK,
the Netherlands
and for Switzerland.
Now earning stripping
to go back to the debate subject
is this voting with your feet.
If voting with your feet
implies a choice between territorial
and worldwide earnings stripping
is a totally different point.
It really has nothing to do with
with that choice.
And yet earnings stripping is very clearly
a major major driver to these transactions
and this is not a new news,
this is something that we've known
from the very beginning,
the Treasury Department in 2007,
did a study of expatriation
and they concluded that
the inverted corporations
are shifting substantially
all of their income out
of the United States.
So a big item and as Paul
Easterhouse pointed out today,
there are proposals to tighten
the earning stripping rules,
which have very major revenue
implications if you did it,
so a lot of money involved.
One thing that obviously
has to be kept in mind
in evaluating those proposals
is that they would apply
not only to US companies that expatriated
but most of them would also apply
to foreign companies
with big us operations
where like Nestle's
where there's huge
earning stripping, as well
and that's probably a big piece of the,
of the revenue item.
We mentioned one of the earnings
stripping proposals here,
which was in the
administration's budget a year ago,
they now have a new one.
But basically, they're all
designed to tighten 163(j)
and limit the interest deduction.
I think a legitimate
question in this area,
is that if you
if you do something
about earning stripping,
whether you shouldn't look
beyond the interest deduction,
to also look at royalties
and service payments,
and whether that's not also an issue.
So,
if you look at
the
firms that have gone abroad
the,
and you look at their financial statements
describing the transactions that
they expect to take after they invert,
you will come up with some
marvelous euphemistic terms
like for example,
this will improve our
global cash management,
it will enable us
to be involved in capital
structure planning,
what are they talking about?
They're talking about taking
that equity of the US company
and converting it into debt.
They will also tell you that
they're gonna rationalize,
therefore an asset ownership,
what does that mean?
That means that the controlled
foreign corporations
will no longer be controlled
foreign corporations.
So
it's
the proxy statements are,
are interesting to read with that in mind.
Treaties are a big piece of all of this.
Debbie pointed this out
when she talked about the
zero withholding tax rate
that you get after a year on
parents subsidiary dividends
in the UK.
Equally important are the fact that
the countries that have predominated
as being the place to
where companies invert
have treaties which allow you
to be regarded as eligible
under the limitation on benefits article,
if you are publicly traded,
not in that country, but
in the United States.
And that is not the model treaty,
the model treaty since 2006
has always said, has said,
if you're a publicly
traded in the United States
and that's why you get treaty benefits,
then you have to have
your real principal place
of management control,
not just the treasurer passing
through from time to time,
but your real day to
day operational control
in the other country.
But that is not in the Irish treaty,
the Swiss treaty or the UK treaty.
And, you know, certainly
one question is whether
in the long run treaties,
we shouldn't push harder to
get those treaties conformed.
The, is all of this
post inversion planning
risk free?
Or is something you
should be worried about.
The government generally
has not been very successful
and this is, goes back to,
you know, the Nestle
case years and years ago.
It's not been successful in
challenging intercompany debt
as not being real debt.
And most recently in a case
not involving an inversion,
but involving a leverage purchase
and restructuring of the US company,
which is referred to on the slide
they lost again.
But they are challenging
some of the structures,
they are challenging,
Tycho,
which has been split into
several different companies
in the interim on debt equity,
and they're challenging in the tax court,
Ingersoll Rand, and part of
the Ingersoll Rand argument
is that the way in which they move
the intercompany debt around
from you know, Luxembourg to here to there
was treaty shopping,
which is sort of an unusual argument
in terms of the way in
which the treaties apply.
So Patrick.
- Sure.
So I'm gonna try to take
this to the finish line
and see if we can stimulate
some debate up here.
So we've kind of walked through
a history of inversions.
John, I liked some of his terms,
I might describe this
as kind of whack-a-mole,
that inversions sort of there's a wave,
and then a set of rules come out
people figure out a
way to get around rules
and more inversions happen.
And in Debbie setup what
the particular benefits are,
what we're gonna try to do
is take a step back
and look at kind of a broader perspective,
look at kind of a future situation
where we'll explore two things really.
One is, if we have US tax
reform, in particular,
if we move from a worldwide system
to some version of a
territorial tax system,
what would that do for inversions.
And we'll try to evaluate that
not surprisingly, by looking at
you know what are the reasons
why people are inverting,
how much does that change
in a territorial tax system.
The other thing that we're
going to try to take a look at
is I'll call it global tax reform
BEPS.
How does activity
in BEPS
how does that impact
whether US multinationals
continue with inversions.
So,
Debbie already kind of set out
the basics of a territorial tax system,
some amount of it, one
focuses on foreign earnings,
although I will say that
to the extent that you're
focused on foreign earnings,
and giving someone an exemption,
your US tax base becomes
that much more important.
So if you're doing
if you're giving folks a
break on foreign earnings,
you have to be that
much more careful about
not allowing excess leverage in the US.
In terms of
trying to have some
system that we can have some
further discussion around,
we thought maybe it was useful to give
really just the basics
of the camp proposal
because I know there's subsequent panels
that are going to get
into the camp proposal
in a lot of detail.
So again, I said,
think about territorial
system, like the camp proposal
through the lens of what the
benefits are for an inversion.
So first question is,
what would a territorial system do
for future foreign earnings?
And so the camp proposal
really kind of has roughly
three buckets of income.
It's got active foreign earnings,
it's got IP
related profits,
and then it's got, you know,
passive, highly mobile income,
think about it in those
you know, rough strokes
of three categories.
With respect to the active earnings,
you get to the point where with a 95% DRD,
that you're looking at
a one and a quarter.
This is also assuming
that the corporate rate
goes from 35% down to 25%.
But you're looking at
with respect to active foreign earnings,
one and a quarter percent
tax on those earnings.
Yeah, that seems
pretty good.
I think we'll have to evaluate
whether other territorial
systems might be better,
but we'll come back to that.
But if you look at what
the camp proposal does
with IP related income,
or other passive income,
then as compared with
and I am getting a bit ahead of myself,
but with respect to IP income,
when you're kind of sort through and,
you know, don't worry about
how it's being phased in,
essentially you're getting
to IP related income
being subject to a minimum tax of 15%.
So, you know, obviously
better than the 35%
that could apply in a worldwide system,
but 15% is still a pretty high rate.
And then the last category
is passive income,
which continues to be
subject to a subpart F regime
with 960 credits
and again, with a corporate rate at 25%,
you've got, you know,
a maximum rate of 25%
on passive income.
So that's, that's sort of your future
foreign earnings picture.
We talked about how access to foreign cash
is another big driver for inversion.
So what about this
the so called 2 trillion of offshore cash,
how does that play into moving
into a territorial system?
Well,
the camp proposal proposes
to have a mandatory
effectively a mandatory
repatriation of those earnings,
that does get a reduced rate,
but it splits it into
sort of two categories
and this is all based off of the 35% rate.
The notion is you have
this mandatory repatriation
before you move
to a territorial tax system.
And you sort of split between
eight and three quarters percent
and sort of cash that's coming back
to the extent that you're talking about
non cash, offshore earnings,
then you can get down to a 3.5% tax.
So that's where we are with
existing earnings.
And then the last piece which I agree,
a territorial system
speaks to foreign earnings
but with respect to the camp proposal,
not only US multinationals
that would continue to
be US parented companies
there's a focus on excess of leverage,
and sort of
a thin cap notion
to limit how much leverage a
US multinational could take on,
but also, there's revisions
proposed 163(j), as well,
which don't necessarily go
with territorial by itself,
but there's tighter standards
for inverted companies as well,
or companies that would
consider inverting.
So that's kind of where we
are in the territorial system.
So maybe we'll quickly touch on BEPS
and then we'll get to that debate.
So, US tax reform, or at
least a territorial system
that is focused on what
the US tax system would do
with respect to foreign earnings
now we'll shift our focus
and obviously BEPS is the
US's part of BEPS as well,
but we might think of BEPS
as more focused on what are
non-US jurisdictions doing
in terms of some of the
strategies that are available
to reduce the non US tax with
respect to foreign earnings.
And so I suspected in here the prior panel
but the BEPS initiative,
there's 15 action plans.
We are here just kind of
focusing on three aspects
that seem particularly relevant
to the inversion debate.
One is what happens with respect
to related party financing
and, you know, to date,
some of the focus would be on
certain hybrid arrangements
that ultimately lead to
related party financing
where there is no
relatively little tax paid
on the interest income.
As we talked about,
this is more focused on the US source.
But to the extent that you're
currently not picking up
local tax and interest income
if you were to increase
that might make inversions less appealing.
The other aspects transfer pricing an IP,
Debbie talked a little bit about
out from under planning
that usually goes along with an inversion
part of inversions that attractive is
placing IP and in
particular the profits of IP
in a low tax jurisdiction.
Again, if that dynamic changes
might make conversions less attractive,
and maybe the third category,
which Willard alluded to
is treaties
certainly from you know,
US source payments,
treaties make inversions very attractive,
to the extent that we're talking about
foreign base eroding payments,
treaties become relevant there as well
to ensure there's no US source
or there's no foreign source
withholding on those payments.
So maybe with that as some background,
we can start debating.
- Sure.
So I'm just to start that discussion,
one question I would
have for the panel is,
if we did switch to some
version of a territorial system,
do you think we would still
see inversions occurring?
- Well, I'll try a stab at that.
I think the answer is we don't know.
(congregation laughs)
It's a bit like dating,
you're with somebody,
and maybe somebody else
looks a little better
but you can't really decide
whether to leave partner one
until you know who partner two is like.
So we might adopt an exemption system,
and the systems in other countries
might still look a lot better,
and depending what we would do
to curtail earning stripping,
you might see a continued
wave of inversions.
I think it's impossible to know,
because it's a comparative judgment.
What's the system here?
What's the system someplace else?
And until you have all of those inputs,
I think it makes for
interesting newspaper reading,
but not really a very intelligent
way to go about analyzing,
should we or should we not
adopt the territorial system.
- And John, I know you sort of slipped it
because the focus is, okay,
what's happening with
respect to foreign earnings?
What system would be better?
And I know you slipped in,
well, assuming that they did something
with respect to earning stripping.
If you didn't do anything with
respect to earning stripping,
then one would think that
territorial system wouldn't do much
to slow down inversions at all,
you can still erode your US tax base.
- Right.
- And I think it's probably distortive
to view the question of
should we have a territorial system or not
based solely on inversions.
I mean, it's a much bigger issue
and it shouldn't be driven
by inversions alone so.
- What else do you think
should be a factor?
- Well, you could
you know the whole tax system
has to be looked at,
including inward investment
and outward investment.
But it shouldn't be simply
an anti-inversion proposal
- Sure.
- That's my only point.
- I mean, I suppose if you
had a pure territorial system,
then with at least one caveat,
it might not matter if a company inverted
because either way their US source income
would be taxed in the US,
regardless of whether
they're a US resident
or a foreign resident.
The one caveat, I suppose is that
the way in which US
there may be earning
stripping opportunities
if you're foreign that
wouldn't be available in
if you're still US parented.
The nature of how we, how
us income would be taxed
might be different
depending on your residency,
although that too, depends
on how BEPS works out here,
how much we do to shore
up earning stripping.
And, and by the same token,
BEPS could impact the
attractiveness of the
the other, the potential
host country where,
a company might go.
So,
you know, the concept of
voting with your feet,
as I mentioned at the beginning,
suggests that the scenario is that
the US is in a competitive environment,
all these different countries
are sort of vying for businesses,
and that, you know, when you say,
gee, people are gonna
vote with their feet,
what that sort of says to the people,
the institution that they're voting on is,
you better listen to that
and there's sort of a race
could become a race to the bottom,
and you gotta kind of align
with the other you the US
and this is sense have to kind of align
with the other competitors,
otherwise, you're
you gonna..
- Yeah, but is this voting with your feet
just a PR statement?
I mean it just a way of
it came out in the beginning of,
you know, oh, we're fed up
with Congress is constipated
so we have nothing to do,
we're perfectly honorable
patriotic people but
it just so frustrating
to have to deal with this Congress.
I'm not saying that inversions are evil
or bad or anything like that
but I always thought that
voting with your feet
was just a way of glossing over
you know what's really involved in..
- Of glossing over the idea
- Certainly glossing
over earnings stripping
completely glossing
over earnings stripping.
And, also presenting
and also for companies that were concerned
that people would say
you're committing some
sort of unpatriotic sin,
which was part of the debate, you know,
for the last 10 years, as
somebody pointed out, 9-11 and all
was a way of deflecting that criticism.
- Yeah, so, you know, so,
so getting to that
what I think getting at,
you know, people, the US has done a,
you know,
a phenomenal job of fostering businesses
over several centuries.
I mean, I think most people would agree
there's something about the
social, economic, cultural,
legal, political environment here
that really has allowed
businesses to flourish in
and in the big picture.
And people also might think that
people should pay for what
they get the businesses
that most benefit from that
should should pay for it.
And one could further
argue that
a worldwide system a
worldwide system of taxation,
even one with deferral that cedes,
cede taxing jurisdiction
to a source country
that arguably, that that type of system
best
best allocates the tax
burden to businesses that
enjoy the advantages of being here
that worldwide income is a proxy
for how much benefit you get
from being in the US.
And one could further argue
that a territorial system doesn't
address that allocation fairness
of sharing the tax burden
as well.
What do you think of that?
Is that a part of this debate
or is it all about just
Keeping up with
the other countries
in terms of tax competitiveness.
- Well, I think the subtext behind
the argument that we
better adopt territorial
to stop the wave of inversions,
if you unpack it is that
we better give up residence based taxation
because if we don't we're gonna lose
residence based taxation.
It's kind of circular.
To put it more crudely, we
better race to the bottom
along with somebody else.
I think the one persuasive thing
that can be said about the argument
in favor of territorial taxation,
the one of many things
can be said in favor of it
is that if the present trend does continue
forgetting about the tax base altogether,
if we do lose white collar R&D type jobs
just because for good or bad companies
decide to move offshore
that's obviously not a good thing.
- Other thoughts on this
allocating the burden
does territorial system..
- (mumbles) very well but
- Do a good (laughs)
So does that..
- Well the strange thing is that
when people say it they don't
realize how silly it is.
Right?
- So where does that leave you?
Do you think that...
- If I were king, I would just sit
and wait and see how BEPS unplays.
- I don't know what
- You have to have a long life
- Maybe so.
(congregation laughs)
- No seriously, because..
- Waiting for retirement is hard John.
- I mean when you think that we can't even
when was the last treaty the US ratified,
five years ago?
And we're talking about maybe BEPS treaty
will solve the problem I mean, good gosh!
- Well, I just don't think you can know
what's intelligent to do right now
until you have a better understanding
of what's gonna happen in other countries.
So I wouldn't do anything quick like
just to stop inversions.
I think that notice did a lot of damage.
Certainly if they come out with something
that makes it more difficult
to deduct outbound interest
that will do more damage.
And I would stay in a holding pattern
until things clear up a bit.
- So you'd keep with
these stopgap measures
as best one could see how things came out
and then make a..
- Until it became clear what
the intelligent response was.
- Right the one other factor
that maybe plays in here,
there's this government contractor issue,
which the government contract
issue as I understand it,
basically following 7874
which is to say if you're not inverted
for that purpose,
you're not inverted for purposes
of government contracts,
which means that if you
move to the Bahamas,
and then move to Switzerland,
you're not an inverted company now,
because you didn't move
from the United States.
I mean, so there are other measures,
that could have a big impact
on inversions that don't
have anything to do with tax
like reforming that.
- At least in some industries (mumbles)
- In some industries.
- Affect others.
- But, yeah, in some industries,
but you know,
pharmaceuticals is certainly.
- Well, what if,
Willard you mentioned that
you didn't think inversions
should drive the tax reform debate.
Do you think they're just sort of fad
and we shouldn't pay
much attention to them,
or are they more like
the tip of the iceberg
you know, to use many metaphors,
we got all sorts of metaphors going here,
you know, the canary in the coal mine
telling us that there
is really a big problem
or they just sort of
a kind of a thing that's off,
not too significant in
terms of the debate.
- Well, I think that you know,
I think the debate on what
kind of tax system we have,
which involves a whole bunch of things
other than worldwide versus territorial
involves corporate versus pass through,
and lots and lots of other things
ought to be a broader subject
and we shouldn't say,
well, we have to move to territorial
just because of
inversions
you know, it's all to
be only one piece of it.
You know, it's certainly from
a practitioners point of view,
which one of the most fascinating
aspects of the international tax system
but you know, if you were
making policy that's different.
- Pat, you started to talk about BEPS
and its
impact on
inversions.
And did you want
explain how you thought things
could conceivably play out
John had talked about
waiting and seeing what
the big picture is,
and I think you had a thought about
- Yeah, sure.
- One possible path
that that could go down.
- So yeah this is a strong man
to be challenged for sure,
but you know one scenario
just to throw darts at
would be,
you know, BEPS,
you know, really gets some traction.
You get local countries adopting
various BEPS inspired measures.
And as a consequence, there's
less foreign base erosion.
Does that mean that now our
foreign parented companies
now look for opportunities
to acquire US companies?
No, I'll call it real M&A transactions,
but they see an opportunity
to erode the US tax base.
All of this is presuming
we haven't done anything
to limit us earnings stripping.
Now we have you know, US multinationals
that are worried about being gobbled up
maybe having a competitive disadvantage
when it comes to M&A transactions.
So they obviously living within the rules
try to do kind of their
self help inversions,
still real M&A transactions
but maybe looking for foreign
targets to combine with
to satisfy 7874.
So then we get to the point,
which we've seen this through history,
we get lots and lots of political pressure
US companies
leaving,
and there's a wave,
and so we get some modest,
let's say tax reform,
but we don't get
either we look at it
somewhat cynically and say,
well, even you know, gain tax reform
really wasn't part of why
people were inverting anyways,
it's not enough
and so we still have inversions.
And then we're sort of back to where, then
the theory would be,
we'll just be back to where we are today,
which is, how do I
there's a twin approach to limiting
through stopgap measures.
One, I make them less attractive,
a lot of that aspects in the notice,
and I come up with stricter rules
that prevent US
multinationals from inverting.
So that's kind of one scenario that says,
even though BEPS doesn't seem like
it should be impacting inversions,
because it's not about,
arguably, it's not about how US taxes
foreign earnings or US earnings,
but you can see how it could
have an impact on inversions.
- So you're saying if other countries
enact BEPS type measures
and thereby protect their own source
income,
but we don't do anything 'cause
we're kind of gridlocked,
that's gonna encourage inversions
because the one
base left to erode is the US tax base.
That'll put more pressure on
'cause you'll see an even
bigger wave of inversions
and that might in turn finally
cause Congress to do something which might
which might be just
further stopgap measures
or could be
including limitations
on earning stripping.
I mean John, do you have any
given that you said,
hey, let's kind of wait
and see what makes sense,
do you have any reaction to that?
I don't mean tom put you
on the spot but (laughs)
- No, no immediate,
strong reaction to that,
it does, I mean, we're into
the realm of the political now,
and probably no one in this room
is capable of predicting
such a treacherous subject.
But I do find it unlikely
no matter how bad our Congress is,
there has to be some bottom.
(congregation laughs)
If the if the rest of the world
or most of the rest of the world
does follow the lead that
the BEPS project is taking,
I just don't see the United
States sitting on the sidelines.
- Okay, are there questions
from the audience?
There's gotta be somebody with a question.
- Here's one.
- Is there one?
- Have there been any studies about
what the actual impact of
employment
has been
on these companies that have inverted?
I mean, the US is still the
biggest market in the world,
and people are still doing business here.
And once a company inverts
not all of its employees leave.
How has it impacted all of these companies
that have actually inverted?
- I don't think there have
been any real studies of that.
I think they've been more studies
of the impact of the lockout effect,
which is related to this obviously,
on corporate behavior and
the incentive it gives
to make foreign rather
than domestic acquisitions.
But I'm not aware of any studies
that have counted the number
of heads that have moved
that would not have moved,
had you not inverted.
- There's anecdotal information
when executives of
pharmaceutical companies
have been asked about
the extent of operations
that are gonna go to wherever
the companies have inverted to
the usual response, and
I'm not making this up is
we love New Jersey.
- Yeah, we're still, Ohio we're
still in it, yeah exactly.
- I mean, that said,
I think there are jurisdictions
like Ireland for instance,
that, you know, that have gotten
employment
because of inversions to
the local jurisdiction
I mean, there are
- Well the tax system is a
great source of employment,
whether or not you're
talking about inversions but.
- But there may be some
migration where some
notion that companies
do put employees in
the local jurisdiction.
- Well I think that that's more
- Sometimes.
- a reflection of this CFCs,
but not necessarily inversions.
- I mean, yeah, it could be both.
- Because remember what
we were talking about
for the most part,
at least initially,
is we're just talking
about the parent company
and the parent company is, you know,
typically a holding company,
yeah, maybe some executives,
you know, move to the UK or Ireland,
but we're just talking about executives,
then the question is,
do you follow that up
by changing your operating
company structure.
And then the question is,
do you now, you now,
either want to or need to
move those folks.
And I think today, for the most part,
I'm not sure that people felt
the need to move those people.
- One other quick question.
This whole discussion started
with the US rate being 35%
but nobody really talked
about the effective rates
- Of course, yeah.
- Of all of these companies,
which is much, much lower.
- Absolutely, yeah.
- Okay.
- One quick question.
- [Congregant] You spoke
about the 2014 Notice,
I was just curious if people had a sense
of whether the administration
thought that was a success.
And if there's more to come there
on the regulatory front if you know,
there's no legislation pending.
- My answer is their interested
in finding out if it's a
success from by asking around,
I don't think they know,
I don't know what you've heard,
but they're curious about that.
And, you know, on the question
of whether there's more coming
I mean, nobody knows they are
they keep saying they're
thinking about earning stripping,
but nobody really knows.
- Okay, thank you, Debbie
and Pat and John and Willard.
(congregation applauding)
It's now time for us to vote with our feet
by walking across the
hall to Greenberg lounge
for buffet lunch.
Please make sure to be back at one o'clock
for the keynote speech.
Thank you very much.
