Chairman Wyden, Ranking Member Hatch, and distinguished members of the Committee, I appreciate the opportunity to appear today to discuss some key international tax issues, including the G-20's Base Erosion and Profit Shifting (BEPS) project. We appreciate the Committee's interest in these issues and the great amount of attention and effort the Committee has devoted toward reforming the international tax system in a way that would improve its sustainability and improve the U.S. system of taxation
I would like to begin by describing the work we are doing in the BEPS project and then link that discussion to a consideration of the need for general corporate and international tax reform, as well as measures to address U.S. base stripping and inversion transactions that are outlined in the Administration's FY2015 budget proposals.
The BEPS Action Plan adopted last year outlines 15 specific areas where governments need to work to change the rules of the road that encourage companies to shift their income at the expense of the global tax base. The action items are generally aimed at developing recommendations to help countries combat BEPS. Ultimately, these recommendations will require changes to countries' domestic laws and changes to the OECD model income tax convention, and there is even discussion of a multilateral treaty to address BEPS. The BEPS project is expected to release its first set of recommendations on policies related to transfer pricing documentation and country-by-country reporting, transfer pricing with respect to intangibles, treaty abuse, hybrid mismatch arrangements, harmful tax practices, and the digital economy this fall. The BEPS project is set to conclude at the end of 2015 with final recommendations under all of the action items.
To provide some context for the BEPS project, I would like to discuss a number of factors that gave rise to the need for the BEPS project. First, the interaction of various countries' rules for taxing cross-border income creates incentives for companies to let tax decisions drive corporate policy in order to pay very low rates of tax or even to entirely avoid paying tax anywhere on large portions of their income. Public frustration arises when companies that do business in one country pay low or no tax there or anywhere else. While it is national governments that write the tax laws, and companies should not be expected to pay more tax than they owe, much of the global interest nonetheless centers around the activities of U.S.-based multinational companies because, as global household names, their activities have received the most publicity perhaps and also because various government inquiries here and abroad have focused on them. This frustration on the part of the public and also national governments, in turn, is not surprisingly reflected in the political arena such that, as noted above, the G-20 leaders came together in an effort to rein in this activity through the
The principal target of the BEPS project is so-called "stateless income," basically very low- or non-taxed income within a multinational group. Low and non-taxed income located in various jurisdictions around the world is an inviting fiscal target for other countries. The existence of large amounts of stateless income in a time of global austerity has put pressure on the longstanding, widely accepted international tax rules. This pressure is increased in a global economic environment in which superior returns can accrue to intangibles that can be easily located anywhere in the world and that are often the result, for example, of intensive research and development activities that a single multinational may conduct in many countries, or marketing intangibles can be exploited in one country but owned and financed from another, often low-tax, country. Some countries with large markets believe that some of these premium profits enjoyed by multinationals should be taxed in those market countries, whereas current international norms attribute those profits to the places where the functions, assets, and risks of the multinational firm are located - which are often not in the market countries.
The G-20/OECD BEPS project is made even more challenging by the reality that some of the gaps in the international tax rules are created by countries intentionally seeking to attract mobile income through various special tax regimes. Left unchecked, these regimes could result in an unproductive race-to-the-bottom in tax competition. When otherwise legitimate practices, such as the desire to subsidize research and development, drop any pretense linking the tax break to activity in the country itself, these regimes become no more than open invitation to strip more highly taxed income from countries like
I am happy to report that the OECD BEPS project has had a promising beginning and there are areas where commendable work is being done to resolve gaps in existing international rules and where broad consensus should be possible. These areas include minimizing potential for hybrid mismatches (situations in which a multinational issues an instrument that gives rise to a tax deduction in one country without a corresponding inclusion in another); helping countries minimize abuse of their bilateral income tax treaties, including through so-called "treaty shopping"; requiring country-by-country reporting of profits and taxes by multinationals so that they can be made available to tax administrators for purposes of risk assessment; designing interest limitation rules that can be applied across borders; updating the transfer pricing rules on the application of the "arm's length" standard to intangibles and endorsing "special measures" when those rules produce stateless income; and updating the rules on permanent establishment to minimize the artificial avoidance of those rules.
As the work moves into 2015, there is more that can be achieved, and also several areas where we must guard against bad outcomes. One of the key 2015 action items will focus on making dispute resolution more efficient, which we hope will include a significant broadening of the use of mandatory arbitration to resolve tax disputes between the tax authorities of the two countries. When countries know that tax disputes will be settled by a neutral arbitrator, it improves the dispute resolution process from beginning to end. In 2015, we will also work closely with other countries to limit the base stripping that results from excessive interest deductions, a topic of strong interest to
We must also work hard in several areas to preserve our national interest in rules based on principles and not merely individual country revenue interests. Let me highlight just a few. In the area of transfer pricing, we must ensure that the currently-used arm's length standard is clearly articulated and that profits are attributable to the place of economic activity - that is, where the assets, functions, and risks of the multinational are located. We must further ensure that any "special measures" agreed at the OECD are firmly anchored in these principles, and that legal and contractual relationships are ignored in determining intercompany prices only in unusual circumstances. The arm's length standard has been a bedrock of international taxation for over 50 years, and while it is not perfect, it is the best tool available to deal with the difficult issue of pricing among affiliates of a multinational group. We must steadfastly avoid turning longstanding transfer pricing principles into a series of vague concepts easily manipulated by countries to serve their revenue needs at the expense of the U.S. tax base and our multinationals.
With respect to country-by-country reporting by multinationals of income and tax information, we must strongly support measures that ensure that the information is used by countries' tax administrators solely as a risk assessment tool. Country-by-country data is useful to tax administrators because it will permit them to identify companies that have shifted income into low- or no-tax jurisdictions. In those cases, countries may appropriately feel that such a company deserves a closer look on audit to determine whether income has been shifted out of their jurisdiction through non-arm's length pricing. Given the potentially sensitive nature of this information, we must ensure that information of U.S.-based multinationals is made available only through our treaty and information exchange networks so as to ensure its confidentiality and appropriate use by our treaty or information exchange partners. Finally, this work should contain a remedy in the event countries misuse the information to make tax adjustments that do not conform to agreed international standards.
In the area of digital businesses, we must guard against the desire of some countries to use new business models as a pretext for taxing income beyond that which arises from the functions, assets, and risks located in those countries. We continue to believe that long standing, widely accepted rules that require a physical presence in another country before that country receives the right to impose an income tax is the most administrable and appropriate rule even in a digital age, and we are very encouraged by the work at the OECD to further adapt the rules concerning value added taxes to the digital age - so that countries with a VAT can have a revenue source from the digital economy without resorting to new, exceedingly complex and difficult to administer income tax solutions. Finally, as a matter of U.S. tax treaty policy,
While the international negotiations over BEPS progress, it is worth acknowledging steps
As the President has proposed, we should reform our business tax system by reducing the rate and broadening the base. It is frequently noted that
But it would only be a start, because even with lower rates U.S. multinationals would continue to aggressively seek ways to lower their tax bills by shifting income out of
First, in the international arena specifically, the President's framework for business tax reform proposes a minimum tax on foreign earnings. Other recent tax reform plans have included similar proposals, which would improve on the current complex and porous international tax rules by requiring that companies pay tax on all foreign earnings, but at a somewhat reduced rate.
Whether as part of tax reform or in the context of our current tax system, we should also take a close look at interest deductibility, noting that in this area our thin capitalization rules are inadequate and that our system actually gives an overall advantage to foreign-owned multinationals in this regard. Foreign-owned multinationals typically lend funds into
Another Administration FY 2015 budget proposal would limit the deduction of interest expense of U.S. multinationals related to deferred foreign subsidiary income. Our own multinationals typically do all of their borrowing in
In addressing stripping of the U.S. base, it is also important to consider so-called "hybrid arrangements," which may allow taxpayers to claim U.S. deductions with respect to payments that do not result in a corresponding income item in the foreign jurisdiction. These arrangements serve little function other than to produce stateless income and could easily be reined in. To neutralize these arrangements, the Administration's FY 2015 budget proposal would deny deductions for interest and royalty payments made to related parties under certain circumstances involving hybrid arrangements. For example, the proposal would deny a U.S. deduction where a taxpayer makes an interest or royalty payment to a related person and there is no corresponding inclusion in the payee's jurisdiction, or where the taxpayer is able to claim a deduction with respect to the same payment in another jurisdiction.
Additionally, it has been well documented that shifting intangibles outside
Finally, and as underscored by Secretary Lew's
An anti-inversion provision has been part of the Internal Revenue Code since 2004, but experience has shown that this provision insufficiently deters inversion given the large tax rate and other tax disparities between
To reinforce the existing anti-inversion statute, the Administration, in the FY 2015 Budget, has proposed to broaden the scope of inversion transactions subject to the statute. As amended, where shareholder continuity in the inverted company after a transaction is more than 50 percent, or where the inverted company meets certain criteria demonstrating that it retains a close connection to
In closing, I would like to acknowledge the tireless work and dedication of the office of the International Tax Counsel at the
Thank you for the opportunity to speak to you today. I look forward to answering your questions.
Read this original document at: http://www.finance.senate.gov/imo/media/doc/Testimony%20of%20Robert%20Stack.pdf
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