TEI Roundtable No. 13: Ethics and Tax Planning
In the end, tax planners must be comfortable explaining to taxpayers how they report transactions

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Tax planning and ethics. For some corporate tax practitioners, the combination is not exactly like the perfect martini, but more like the perfect storm. However, like it or not, both are extremely important when advising clients about tax issues. For this roundtable, we convened a group with a world of experience dealing with these issues, in academics and in practice, including Peter Barnes, of counsel to Caplin & Drysdale, Chartered, and a senior fellow at Duke University, Duke Center for International Development; Linda Galler, professor of law at the Maurice A. Deane School of Law at Hofstra University; and Paul Oosterhuis, of counsel at Skadden, Arps. The discussion was moderated by Senior Editor Michael Levin-Epstein.

Michael Levin-Epstein: When you think of tax planning and ethics, what’s the first thing that comes to your mind?

Peter Barnes: When you talk about tax planning and ethics, the key issue I believe is that the tax planner must be comfortable explaining what they have done and how they are reporting a transaction to both or all of the tax jurisdictions that are affected by the matter. I’m a big believer that if the tax planner is comfortable saying, “Here’s what I did, and here’s why I did it,” that you are going to get an answer that’s fair to the taxpayer and most likely fair to the tax jurisdictions.

Paul Oosterhuis: I totally agree with the premise that you have to be able to explain a position consistently in one jurisdiction and another, and that includes if you are talking about different treatment that gives you an arbitrage, like in a repo transaction, explaining to the two jurisdictions honestly that there is just a different treatment of when a party is treated as owning stock as opposed to when is a party treated as holding the stock as collateral to a debt instrument, and that the rules differ in the two jurisdictions, and you’re taking advantage of that and there’s nothing wrong with that. It seems to me that is one of the first ethical premises of tax planning. Similarly, in transfer pricing, if you’ve got income in a low-tax jurisdiction, you need to be able to explain to high jurisdictions why it is that there’s economic substance to the position you’re taking that is fair to both jurisdictions.

Barnes: Paul makes a very important point: tax rules do differ around the world. Many times if you explain to a country why you are fully consistent with their rules, that’s really all they want to hear. But you’ve got to be willing to do it in open conversation with all the parties interested in that transaction.

Oosterhuis: And of course it doesn’t always work. We’ve had a history with repo transactions, for example, between France and the U.S. where both sides have decided that maybe the settled law in their jurisdiction shouldn’t apply when the other jurisdiction has different treatment. In other words, the fact that the other jurisdiction has a different view should alter the law in the home jurisdiction, which to a lawyer doesn’t make any sense unless there is a statute or some other provision that builds that into the law. But we’ve certainly seen tax authorities take that view, and that can give taxpayers problems, which just opens up the whole area of, these days in particular, the tax law is not about identifying rules and following them solely. It’s also about what tax authorities are inclined to do and positions they’re inclined to take that may or may not be well justified by their own laws.

Levin-Epstein: Is there anything different between planning for taxes and planning for other corporate costs, like wages and materials and transportation?

Barnes: The only difference I see is that with respect to taxes and multinational companies, you are very frequently going to have two countries that have an interest, whereas many of the other kinds of expenses for which you plan you have only one country involved. But to me, in each of those instances—environmental laws, labor laws, your relationships with suppliers—you have to be totally comfortable that what you’re doing will withstand public scrutiny, because there will be public scrutiny. But beyond that, I think the notion that somehow taxes just are what they are, and that there should not be any focus on structuring in order to be tax-prudent, is a silly notion. You don’t just hire people and pay them whatever they want; you have a thoughtful wage structure and labor structure for your business. That includes what you pay your tax lawyers. To me, planning for taxes is no more morally suspect than planning for any of the other elements of running a business.

Oosterhuis: I totally agree with that. I do think there is a difference in terms of when you’re dealing with another contract party, you’re dealing with a commercial environment, and contracts can kind of set out the rules. It’s a little more straightforward than when you’re dealing with a tax authority where they may not feel themselves so bound by whatever rules exist, and they may feel that they want to try to negotiate an increase in the amount you’re paying without a lot of regard to what the rules are. You just have to be aware that that’s part of the whole process.

Barnes: Corporate responsibility matters. It’s not just a slogan. Corporate responsibility applies to all the things you do within your operations, including tax and including these other functions. I don’t see that your responsibility with respect to tax is significantly different in kind than your responsibility in other areas. For all areas of operation, corporate responsibility applies.

Rule Changes

Levin-Epstein: What rules have changed recently that most dramatically affect tax planning?

Linda Galler: I would mention two things there. One is that there’s been case law that calls into question the validity of large portions of Circular 230, which are the regulations governing practice before the IRS. We think about those as sort of being ethics rules specifically prescribed by the IRS. In the Loving case and in the Ridgely case, parts of Circular 230 were invalidated as they apply outside the context of direct interactions with the IRS. Loving characterized return preparation by “registered tax return preparers,” who were neither accountants nor lawyers, as not constituting practice before the IRS and therefore as outside of the IRS’ authority to regulate. Based on Loving, Ridgely characterized a contingent fee arrangement in connection with a refund claim as not constituting practice before the IRS. So, tax planning and issues relating to tax planning arguably are similarly implicated. I don’t think that most reasonable people do anything or would do anything differently in their tax planning practices with or without Circular 230, because I suspect that most accountants and lawyers are ethical professionals, but I think that the implications of both cases are in the background and could become an issue at some point if any activities are looked at a little bit more carefully by the IRS at any point. The second thing I think has changed in the last few years is there have been a number of cases—the Schaeffler case in the Second Circuit, and the AD Investment and Eaton cases in the Tax Court—that I see as changing the confidentiality or privilege protection of opinion letter rules. I think one has to assume that many documents that are created during the course of transactional or tax planning could well end up in the hands of the IRS if and when a transaction is reviewed by the IRS. I don’t know—you all would have to comment—to what degree if any these cases change current practices or whether people are thinking about them in practice. Again, I think that there is a significant question as to whether or not various kinds of written memoranda, emails, and opinion letters would have to be produced on examination or in litigation.

Oosterhuis: From my perspective, the evolution of what you can protect hasn’t really affected the planning side, because I think from a planning point of view clients should go into it thinking that they shouldn’t do a transaction unless everything that comes out is not bothersome. Otherwise, you shouldn’t really be doing it. I do think the privilege is helpful in practice because when you provide opinions, what you typically do is come up with every conceivable argument about why what you’re doing could be wrong, and then come up with reasons why those arguments themselves are wrong, and that effectively gives the tax authority creative avenues to attack the transaction that hinders resolution of the controversy. So, you would prefer not to give the tax authority some of those types of documents, but in the end you have to be comfortable that you win those arguments or you shouldn’t be doing the transaction in the first place.

“Many times if you explain to a country why you are fully consistent with their rules, that’s really all they want to hear. But you’ve got to be willing to do it in open conversation with all the parties interested in that transaction.” —Peter Barnes

Barnes: Let me come at the question from a slightly different angle. I think there has been one notable change over the last few years, and that is the fact that country tax administrations are looking at multinational companies, and especially the digital economy companies, the same way we look at artists and athletes on the individual tax side. In tax treaties and tax laws, we have rules for when there will be tax nexus and tax liability for individuals, but we throw those rules out the window for artists and athletes. The reason is simply that we don’t want Beyoncé or U2 to come in, give a concert, perform in an athletic event, make millions of dollars and leave and not be subject to tax because they were only in the jurisdiction for three days. With multinational companies, and again, especially the digital economy companies, country tax administrations are saying, “I know we have nexus rules. I know there’s a century-long history of how we think about when tax jurisdiction attaches to corporate activities. But just like artists and athletes, we think you’re making too much money without triggering those traditional nexus rules, so we’re going to tax you anyway.” I think this is an unfortunate development, although it is understandable. If multinationals are going to be treated differently than they have been treated in the past, and the traditional nexus concepts and the traditional concepts of income attributable to a permanent establishment are not going to apply, then the countries need to be forthcoming about that change and explain what their new rules are and how they intend to apply them. So, I don’t mind having the conversation about whether the traditional nexus rules should not apply and whether multinationals should be treated like artists and athletes, but I think the discussion has to be an honest discussion. Right now, it’s proceeding simply by having country tax administrations attack one company after another.

The Retroactivity Issue

Galler: What, if anything, does one do in light of the retroactive imposition of, or the attempt to retroactively impose, a tax on a multinational?

Barnes: That’s part of what really bothers me, Linda. This idea that the companies were following the rules—the rules the countries agreed to—and now with audits that extend back a number of years, countries are saying, “Well, that just doesn’t feel right.” Just as countries complain if an artist or athlete swoops in, earns several million dollars, and leaves again. So, I think the retroactivity just highlights the unfairness of changing the rules without having an open dialogue and clear direction for where the new rules are headed.

Oosterhuis: But, Peter, isn’t that part really of a broader pattern of countries reacting to structures that clients have put in place over the last fifteen years that try to limit risk and limit returns in local jurisdictions? I know some of the internet companies are on the forefront of that, and some of them have very large amounts, but we see it also with physical goods companies, where they structure limited risk distribution in a country—not necessarily a commissionaire arrangement but a buy-sell arrangement—and countries are increasing their arguments about transfer pricing and about what valuable activities are being conducted in the market country and what intangibles are there. I think it’s the most aggressive with some of the internet companies, because the rules maybe were a little clearer for them given the lack of needing to have the same kind of boots on the ground, but it is part of a broader phenomenon, at least from what I see.

Barnes: I agree, Paul; the changing attitude certainly can be traced back at least to the supply-chain reorganization and principal company restructuring of fifteen years ago. But the fact remains, you’ve got a set of rules and the governments are saying, “We don’t like those rules; we want more tax.” That’s fine; I get that. If the countries want to pursue different tax approaches than they have in the past, that’s fine, too. I think it needs to be on the top of the table in a robust discussion. What’s happening instead, I think, is that countries purport to stick with their traditional nexus rules but then in a specific case with a specific taxpayer try to find a different result. That’s not healthy for the system.

“Based on Loving, Ridgely characterized a contingent fee arrangement in connection with a refund claim as not constituting practice before the IRS. So, tax planning and issues relating to tax planning arguably are similarly implicated.” —Linda Galler

Oosterhuis: Right.

Barnes: The international tax system needs to have a robust discussion that says, “I want more tax, and here’s how I’m going to figure out how to get that more tax.” Maybe it’s through the use of consumption tax arrangements or other ways of tackling this. What I find difficult is that a set of rules is on the books, but that’s not the set of rules that countries are always using when faced with a specific taxpayer and a specific taxpayer’s tax pattern.


Galler: Aren’t those robust discussions going on now? Isn’t the OECD having those discussions?

Barnes: They are, and I salute the OECD and the BEPS project, but I don’t think either taxpayers or governments are putting all their cards on the table. Maybe it’s too sensitive for one taxpayer to lead that discussion, but we need to have it in a more robust way than we’re having it right now.

Oosterhuis: OECD, fundamentally I think, given the views of some of the important members, decided early on that when they apply a value creation concept, they’re focusing on product development and not on the market side of value creation. So, when you go through the new guidelines, you see a lot of examples about who is in charge of product development, who is in charge of risks that relate to all of that. You see very little about who is in charge of marketing and how valuable that is, and who’s developing the goodwill of the business if it’s a consumer business. There’s very little of that, and that was a more or less intentional choice because some of the key members who were exporters; the French, the Germans, for example, didn’t want to have the process help the country where products are sold grab a larger share of the global system profit by treating value as being allocated there. And that, I think, has meant that countries who want to grab, if you will, a larger share, who believe they deserve a larger share of the profits of inbound multinationals, multinationals selling into their jurisdiction, are tending to do it either by enacting a diverted profits tax, like we have in the U.K. and Australia, or by doing what Peter is saying, just on audit making the arguments. But it’s not happening systematically, and I think part of the reason is that OECD decided not to step up to the plate and do anything on a rules basis.

Barnes: Traditionally we have used consumption taxes to ensure that the market country gets the revenues it thinks it’s entitled to—we haven’t used income taxes. But the perception now is, “I want income tax from you as well, even if you have nothing to do in my jurisdiction except sell to my consumers.” That may be a fair approach; I have concerns about it, but it may be fair. We have to talk about it; we have to set up principles for it. We don’t help ourselves if we just do it covertly through audits.

Oosterhuis: Or through a diverted profits tax-type approach; that’s not really systematic, wouldn’t you say, Peter?

Barnes: Absolutely, because I don’t know the contours of the diverted profits tax. Is the diverted profits tax saying the fact that I planned my business to not create tax nexus was itself creating tax nexus?

Oosterhuis: In practice, when the diverted profits tax first came in, we were assured by Her Majesty’s Treasury and HMRC [Her Majesty’s Revenue and Customs], and indeed some practitioners there, that this was only going to be used in outlier cases, and I think the experience of my clients, at least, is that cases that we don’t think are outliers are now being pretty aggressively pursued by HMRC. Not a surprise, but not what we were told when the tax was first put in place.

Barnes: And, to the extent other countries that are perhaps not as rule-bound as the U.K. take this same approach, the results are going to be even more disconcerting.

Levin-Epstein: If you’re talking to a relatively new tax planner at a multinational taxpayer firm, what advice would you give?

Oosterhuis: You can’t paint by the numbers with tax planning. You will always have outside advisors who come to you and say, “Here’s the way the rules work, here’s the way we can read those rules to get to a certain result that is favorable, and we can give you an opinion or whatever that you should be comfortable with.” You have to go beyond that type of paint-by-the-numbers analysis. I think we’ve learned over the last twenty years that many transactions from a technical perspective work; many planning strategies work. But you have to ask, what’s the governmental response to it going to be? You can’t always predict what the governmental response is going to be. Over my career, there have been some planning transactions that I discouraged taxpayers from doing because I thought the IRS response was going to be pretty aggressive, but the service never touched it; they ended up changing the rules. There are other planning strategies that the government knew about for a long time but thought there wasn’t anything they could do about it, for example in the foreign tax credit area, and then a commissioner said, “I don’t care if we don’t think we can do anything about it; we’re going to try to do something about it.” Sure enough, the IRS won a whole bunch of cases that I think ten years earlier few would have dreamed that they would have won. So, you really live in a world, if you’re doing tax planning that the government might object to, where you have to think about whether you’re going to “stir the beast,” as I say. If it ends up stirring the beast, you could be in trouble even though the tax planning is not, under the law as practitioners see it, that aggressive.

“I think from a planning point of view, clients should go into it thinking that they shouldn’t do a transaction unless everything that comes out is not bothersome. Otherwise, you shouldn’t really be doing it.” —Paul Oosterhuis

Barnes: Let me build on Paul’s comment. My advice to the tax planner would be to recognize that the relationship between a multinational company and the governments of the countries where it does business is like a very, very long-term marriage with no practical opportunity for divorce. You’re going to be in that jurisdiction for a long time, and it has to be the case that your tax planning, your tax compliance, your tax relationship with the government is accommodating to both sides. There is never a one-off transaction, because the relationship is going to be there, and it’s going to be there for decades.

Tax planners tend to be transactional: “Here’s an opportunity, here’s what I can do to maximize my situation.” I think it’ll work; I hit and run, and then I go back to my office, and some tax official will look at it three years later and the taxpayer will deal with it five years later. That’s not life. The tax planner has to recognize that they are a key person in a long-term marriage, and the situation has to withstand scrutiny, hold up when it is exposed to sunlight, and lead to a situation in which both the company and the government can feel good for a long, long time. Otherwise, even if you win the short-term battle, you’re going to lose the war, and that’s not healthy for either the taxpayer or the government.

Galler: I would go in a somewhat different direction in advising a young person, which is to say advise them to listen to your gut, that if something feels like it’s wrong or it feels like there’s something not right about it, something’s not sitting right, that it probably isn’t right, and you need to really think about whether or not the company that you’re advising should go forward with it, or maybe you want to tweak things in a way that feels a little better. The flip side is, I think as you get seasoned, if something does feel right, that you ought to be able to find a way to move forward with that. I think sometimes people forget that that’s the case, and I think you ought to know in your heart that what you’re doing is ethical and consistent with the rules or it’s not, and trust your inner self to tell you that.

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