At this writing we are in the middle of some of the most significant changes to the international tax landscape in a generation. Many of the coming changes are well reported and obvious, others less so. Although busy professionals have precious little time to consider trends and to plan for changes, now is a good time to do so. Tax executives would do well to find a moment to pause, take in the big picture, and think through potential adjustments to their approach in running the tax function. This article is intended as an aid to start that thought process. In it we note some of the ongoing developments in international tax and some steps that are worth considering in response.
In almost every major economy and region, governments are revising their tax laws to meet their revenue needs, encourage growth, adjust to increasing tax competition, and respond to concerns about base erosion.
For U.S.-based multinationals, the most significant changes are, of course, being proposed in the United States. After years of stalled legislative proposals, Republicans now control both chambers of Congress and the Oval Office, leading many to speculate that the long-awaited overhaul of the U.S. federal income tax system will finally come to fruition. Although budget reconciliation puts the Republican-controlled Congress on something of a fast track to move legislation without bipartisan support, the question remains as to which reform proposals are most likely to survive the lobbying gauntlet and receive a signature from President Donald Trump.
The “A Better Way” white paper, released June 24, 2016, by House Speaker Paul Ryan (more widely known as the “Blueprint”), broadly outlines several individual and business tax reform proposals and has been generally viewed as the package most likely to form the starting point, at least, for legislation. The Blueprint’s most significant corporate tax proposals include: (1) reducing the corporate tax rate to 20 percent; (2) changing the corporate income tax to a border-adjustable, destination-based cashflow tax, whereby corporate taxpayers (wherever organized) exclude revenues from exports but do not deduct costs for imports when calculating their taxable base; (3) granting an immediate deduction for capital investments (other than land) while denying interest expense deductions to the extent that they exceed interest income; (4) moving from a worldwide to a (mostly) territorial taxation system; (5) requiring a one-time deemed repatriation of earnings accumulated in foreign subsidiaries of U.S. owners, taxed at 8.75 percent for earnings held in cash or cash equivalents and at 3.5 percent for noncash assets; and (6) repealing the corporate alternative minimum tax (AMT).
Executives and their teams also are being even more thoughtful about the documentation they create, in tax department files and when documenting intercompany transactions, with a view to how they would appear to any tax authority or the public.
President Trump’s own high-level business tax reform plan contains some features similar to those of the Blueprint—e.g., reducing the corporate tax rate to 15 percent, elective immediate expensing coupled with denial of interest deductions, repealing the corporate AMT, and imposing a one-time deemed repatriation of accumulated offshore earnings, taxed at 10 percent for cash and cash equivalents and 4 percent for noncash assets. As of this writing, it is unclear to what extent the Trump administration also supports two of the most significant elements of the Blueprint, namely, border adjustability and territoriality.1 While it would seem that the Blueprint’s incentives for firms to expand U.S.-based manufacturing and jobs align with Trump’s campaign platform of bringing industrial vigor back to America, the president in the earliest days of the administration issued statements suggesting that he may not be sold on the Blueprint. More recent statements, however, have suggested the administration’s openness to the idea.
While the United States seems poised to make its tax system more competitive, the European Union has made a series of moves in the other direction. The European Commission (EC) has been at work developing new rules that take aim at perceived taxpayer abuses, particularly hybrid mismatches. In an early step, the EU Council, in 2015, amended the EU Parent-Subsidiary Directive to include a binding de minimis general anti-abuse rule (GAAR) and required member states to adopt similar anti-abuse provisions as domestic law.
In January of last year, the EC presented a series of proposals intended to prevent tax avoidance and evasion within the EU. These proposals included an anti-tax avoidance directive, recommendations on tax treaties, a revised administrative cooperation directive, and a communication on external strategy to guide the EU’s approach to working with non-EU countries on tax matters. On July 12, 2016, the EC adopted the Anti-Tax Avoidance Directive (ATAD 1), “laying down rules against tax avoidance practices that directly affect the functioning of the internal market,” and containing five provisions: (1) a controlled foreign company (CFC) rule to deter profit shifting to low- or no-tax jurisdictions; (2) an exit tax to prevent tax avoidance upon the relocation of assets cross-border; (3) an interest expense limitation to prevent the use of “excessive interest payments to minimize taxes”; (4) a broadly worded GAAR to empower EU countries to tackle “aggressive tax planning” if other specific rules do not adequately address the abuse; and (5) a hybrid mismatch rule targeting hybrid mismatches among member states. The implementation date for ATAD 1’s provisions is January 1, 2019.2
The Economic and Financial Affairs Council (ECOFIN) at the same time instructed the EC to expand ATAD 1 to include hybrid mismatches with non-EU countries, and the EC responded on October 25, 2016, with ATAD 2, which contains a proposal to amend ATAD 1 to limit deductions (or force inclusions) arising from hybrid entity mismatches between member state corporate taxpayers and third-country residents, including permanent establishment mismatches.3
As empowering as these rules might be to EU member states, some EU countries have expressed reservations about the broad sweep of the application of ATAD 2’s hybrid mismatch provisions to third countries. The Netherlands, for example, has objected to the 2019 implementation date, citing concerns that U.S. multinational companies would have insufficient time to consider and respond to the effects on Dutch CV-BV structures. At the ECOFIN meeting on December 6, 2016, several EU member states withheld their approval of the provisions pending further review, and it is anticipated that negotiations and further revisions of ATAD 2 will continue into 2017.
Engaging in the Legislative Process
The discussion above barely scratches the surface of the changes that are being proposed or enacted around the world. How are tax executives responding? As a very general rule, the different approaches might be grouped into three categories. The first approach is to follow the progress of developments, react as they come to pass, and otherwise rely on other multinationals to help ensure that the organization’s interests are protected. The second is to follow the developments and engage indirectly in the process through an industry group or a coalition. The third, most active approach is to engage directly in conversations with the relevant decision-makers, through personal visits or via a government affairs group. In most years, the first two approaches have the advantage of being more economical (in terms of time and expense) and have probably served many tax executives well.
This year may be different. As lobbyists like to say, “If you are not at the table, you are on the menu.” Faced with the prospect of fundamental change in the United States, the most proactive companies have been busy modeling the impact of different proposals on their rates and advising their management and boards about the same. While U.S. tax reform retains momentum, the current environment presents an opportunity for many multinationals to realize favorable law changes that may dramatically reduce their effective tax burdens. Thus, every tax department head would be well-advised to examine the proposals and legislative language carefully to assess impacts and then collaborate with the company’s government relations personnel and outside advisors to develop a strategy, work together with like-minded taxpayers in the appropriate coalitions, and focus lobbying firepower.
This effort is not easily undertaken while the precise scope and mechanics of the proposed legislation remain uncertain, but taxpayers can take some steps now to better position themselves, given the information currently available. Of all the proposed changes, it is prudent to plan for the possibility of a significant reduction in the corporate rate. Assuming that any such rate reduction will not be effective retroactive to the start of 2017, it would benefit companies to identify opportunities for deferring income and accelerating deductions and credits, which typically will have a higher tax-effected value at the present 35 percent federal corporate rate. Of all of the various levers that people have identified to date to convert timing differences into permanent ones, the acceleration of pension contributions has been one of the most discussed. Experience, however, has shown that there are no easy answers even in this area, and careful consideration of the tradeoffs and risks is advised.
In addition to a rate reduction, some version of a mandatory deemed repatriation of deferred foreign earnings seems likely. In fact, depending on budget estimates and scoring (and depending on which other revenue-costly measures may be implemented), the tax rate on such deemed repatriation could end up higher than the ones proposed in the Blueprint. For example, the ability to use entity-level deficits in calculating the amount of repatriated earnings is unclear as of this writing. The investment of positive earnings in cash or cash-equivalent assets, however, appears to be a sure way to pay a higher tax rate on a deemed repatriation. Thus, tax executives may want to work with their treasury groups to consider the steps that they would take to either remove excess cash from their foreign subsidiaries or convert it into noncash assets (“cash” for this purpose presumably will include some cash equivalents and other highly liquid assets, but so far a definition has not been provided). Likewise, if we extrapolate from previous proposals (keeping in mind the probable need for at least some “pay-for” items in the federal budget), it seems likely that U.S. taxpayers will be denied the benefit of foreign tax credits to offset the tax cost of onshoring earnings. Thus, foreign tax credits and other deferred tax assets, whose futures are unclear, are probably best used as soon as possible. And, to the extent that there are economic losses embedded in a U.S. multinational’s foreign structure, tax departments can explore how best to recognize them and mitigate the net amount of earnings in the foreign group.
Optimal positioning in the face of tax reform also depends on how well the tax function can collaborate with other departments in the company. The government relations group can be an invaluable resource in securing audiences with key legislative representatives, committee members, and staffers, and a robust communication channel between the tax group and the government affairs group can smooth the path to more productive interactions with representatives. Even if these resources are not readily available for a particular organization, early and frequent communication with industry groups can provide an effective way for smaller companies to make their voices heard in the political process.
The tax group also needs to maintain effective communication with the board of directors, with the tax function operating, when necessary, in an educational capacity to bring the board up to speed on the anticipated impacts of reform and strategic imperatives. With a view toward fulfilling this role and properly aligning the company’s various stakeholders, the tax group should team with economists to model potential outcomes—as and when details are available—and thereby offer data that inform which proposals to support or ways to best modify the business structure to anticipate changes.4
Given the trends, it is reasonable to ask when and where the move toward transparency will lead beyond greater information gathering and sharing among governments, to the release of information to the public.
The taxation of multinationals continues to garner more coverage in the press than at any time in recent memory. The so-called Lux Leaks, Panama Papers, and other unauthorized releases of taxpayer information grabbed the attention of the public and their politicians, with effects that continue to reverberate. In September 2016, the trend continued with a leak of more than a million documents from the Bahamas corporate registry.
It is no coincidence that “transparency” has become a rallying cry of nongovernmental organizations and many others. There may be something of a circular aspect to all of this, where unauthorized releases of taxpayer information, through leaks or otherwise, lead to increased public outcry, which in turn leads to increased information reporting and sharing of information among governments. And as more data is gathered and shared more widely among governments, the likelihood of additional leaks, or mandatory public disclosure of information, increases.
The 2017 World Economic Forum in Davos included a panel titled “Taxation Without Borders: A Fair Share From Multinationals.”5 In it, participants discussed, among other topics, the Panama Papers leaks and the need to capture the $240 billion of revenue allegedly lost because of profit shifting by multinationals. The panelists noted the adoption of new reporting requirements and information sharing, with more to come. Comparatively fewer voices are heard making counterarguments in favor of privacy rights, protecting trade secrets and supply chain information, the attorney-client privilege, and the importance of predictability and certainty in the tax law.
In January of this year, thirty revenue authorities met in a Paris gathering of the Joint International Taskforce on Shared Intelligence and Collaboration. At the meeting, the participants reviewed findings from the Panama Papers and other investigations, in what was described as the “the largest ever simultaneous exchange” of tax information under treaties and legal instruments.6
Examples of law changes in this area are as familiar as they are numerous. More than one hundred governments have agreed to exchange information under the OECD’s common reporting standard. More than thirty have passed final or draft legislation adopting country-by-country reporting under Action 13 of the OECD’s BEPS initiative. U.S. Treasury regulations issued last year adopt country-by-country reporting requirements for U.S.-parented multinational groups.7 Not long after, the Treasury adopted final regulations requiring additional information reporting for foreign-owned disregarded entities, placing them on a more equal footing with foreign-owned corporations.8 A U.S. Government Affairs Office report, issued in January of this year, considers the effects of country-by-country reporting. One of the more noteworthy, and understated, portions of the report notes that the requirements will “Improve Transparency for Tax Authorities but May Have Unintended Consequences.” In the report, taxpayers’ familiar concerns about the potential misuse of country-by-country data, the potential for double taxation, and the likely increase in audits and disputes at least are acknowledged.
Another example of expanded information reporting comes from the world’s second-largest economy, the People’s Republic of China. In 2016 the State Administration of Taxation (SAT) issued Bulletin 42, adding country-by-country reporting requirements to the PRC’s transfer pricing rules, along with additional reporting requirements for certain companies that are parties to a cost-sharing agreement or are thinly capitalized. Around the same time, the SAT added an anti-avoidance division to its ranks, including a fifty-plus-person team focused on transfer pricing.
Given the trends, it is reasonable to ask when and where the move toward transparency will lead to public reporting of taxpayer data. In April 2016 the European Commission proposed public reporting of country-by-country information, although it is currently uncertain the proposal will be adopted in final form. In Australia, the Australian Tax Office (ATO) has adopted a voluntary public disclosure initiative, the Tax Transparency Code (TTC). The TTC is intended to “encourage greater transparency within the corporate sector, particularly by multinationals, and to enhance the community’s understanding of the corporate sector’s compliance with Australia’s tax laws.” The TTC sets standards to guide businesses on the disclosure of tax information and generally would apply to years ending after May 3, 2016. Although the TTC is a voluntary measure at the moment, it raises confidentiality concerns for multinationals including, especially, the potential disclosure of country-by-country reporting information.
What are tax executives considering in light of this trend of increased information gathering, sharing of information across jurisdictions, and tax transparency? First, they are of course carefully evaluating the information that will be disclosed on a global basis, and how that information aligns with their existing and prior transfer pricing documentation. Where choices are available in how data is reported, what choices should be made when you consider the much more complex equation of disclosure to multiple jurisdictions at once? At its most basic, this concern can be a question of how the tax authorities in, say, China, will respond to the information disclosed about an affiliate’s operations in Europe and vice versa. In such an environment, it is almost inevitable that tax authorities will perceive discrepancies in situations where there are simply different measures and reporting standards. It’s important in this regard to be ready to present the right picture of the global business consistently and to anticipate questions proactively to explain or reconcile perceived inconsistency. Second, tax executives are asking their advisors about the potential exposure, in terms of adjustments or penalties, if a company discloses something that is less than satisfactory in the eyes of a local tax authority. Tax executives are weighing the risks, on the one hand, of failing to adequately satisfy some jurisdiction’s information reporting requirements against the administrative burden and other tradeoffs.
Executives and their teams also are being even more thoughtful about the documentation they create, in tax department files and when documenting intercompany transactions, with a view to how they would appear to any tax authority or the public. As an example, companies have been asking for more assistance in reviewing their documents and practices from a permanent establishment perspective. Even the best documentation and planning, however, can be undercut by a single, less-than-thoughtful email. In theory, almost everyone in an executive’s tax department “knows” to work under the assumption that any document created could become public. In practice, however, the best intentions are sometimes forgotten given time pressures and the great ease of modern communication.
Last but not least is staying ahead of the trend of data breaches in public and private organizations. It goes without saying that tax departments are privy to some of the most sensitive and at-risk information in a company. Recent press reports attest to the increasing numbers of malicious attempts to obtain taxpayer data. An increasingly common technique among hackers is to impersonate a corporate executive in an elaborate, carefully detailed email. In a recent example, a hacker, pretending to be a CEO, managed to obtain completed W-2s for the company’s employees. In response to these incidents, tax executives are working more closely than ever with their management and IT departments to protect against data loss.
Jeff Maydew and Julia Skubis Weber are partners at Baker & McKenzie in Chicago.
- Previous versions of Trump’s tax plan also eliminated all deferral on U.S. multinationals’ foreign earnings, but this proposal seems no longer to be part of the Trump plan. See James R. Nunns et al., “An Analysis of Donald Trump’s Revised Tax Plan,” Tax Policy Center, October 18, 2016, www.taxpolicycenter.org/publications/analysis-donald-trumps-revised-tax-plan/full.
- “Council Directive EU 2016/1134 of 12 July 2016 Laying Down Rules Against Tax Avoidance Practices That Directly Affect the Functioning of the Internal Market,” Official Journal of the European Union, July 12, 2016, http://eur-lex.europa.eu/legal-content/EN/TXT/?uri=OJ:L:2016:193:TOC.
- “Proposal for a Council Directive Amending Directive (EU) 2016/1164 as Regards Hybrid Mismatches With Third Countries,” European Commission, October 25, 2016, https://ec.europa.eu/taxation_customs/sites/taxation/files/com_2016_687_en.pdf.
- The above discussion focuses on the United States but is generally applicable to other jurisdictions, with changes in the manner of approach and the focus of efforts.
- “Taxation Without Borders: A Fair Share From Multinationals,” World Economic Forum, January 19, 2017, www.weforum.org/events/world-economic-forum-annual-meeting-2017/sessions/taxation-without-borders-a-fair-share-from-multinationals.
- Murray Griffin, “No More Tax Secrets as Authorities Share Panama Papers’ Data,” Bloomberg BNA, January 31, 2017, https://www.bna.com/no-tax-secrets-n57982083079.
- Treas. Reg. § 1.6038-4 (T.D. 9773, June 29, 2016).
- Treas. Reg. § 1.6038A-1 et seq. (T.D. 9796, December 19, 2016).