Kluwer law has recently published Tax Sovereignty in the BEPS Era, a collection of contributions I co-edited with Sergio Rocha, in which we and a slate of authors from a range of countries explore the impact of the BEPS initiative on "tax sovereignty"--which I take to mean the autonomy that nations seek to exercise over tax policy. Here is the description:
Tax Sovereignty in the BEPS Era focuses on how national tax sovereignty has been impacted by recent developments in international taxation, notably following the OECD/G-20 Base Erosion and Profit Shifting (BEPS) Project. The power of a country to freely design its tax system is generally understood to be an integral feature of sovereignty. However, as an inevitable result of globalization and income mobility, one country’s exercise of tax sovereignty often overlaps, interferes with or even impedes that of another. In this collection of chapters, internationally respected practitioners and academics reveal how the OECD’s BEPS initiative, although a major step in the right direction, is insufficient in resolving the tax sovereignty paradox. Each contribution deals with different facets of a single topic: How tax sovereignty is shaped in a post-BEPS world.And here is the table of contents:
Part I The Essential Paradox of Tax SovereigntyAnd finally, here is a brief description:
- CH 1: BEPS and the Power to Tax, Allison Christians
- CH 2: Tax Sovereignty and Digital Economy in Post-BEPS Times, Ramon Tomazela Santos & Sergio André Rocha
- CH 3: Justification and Implementation of the International Allocation of Taxing Rights: Can We Take One Thing at a Time?, Luís Eduardo Schoueri & Ricardo André Galendi Júnior
- CH 4: An Essay on BEPS, Sovereignty, and Taxation, Yariv Brauner
Part II Challenge to the Foundational Principles of Source and Residence
- CH 5: Evaluating BEPS, Reuven S. Avi-Yonah & Haiyan Xu
- CH 6: Jurisdictional Excesses in BEPS’ Times: National Appropriation of an Enhanced Global Tax Basis, Guillermo O. Teijeiro
- CH 7: Taxing the Consumption of Digital Goods, Aleksandra Bal
Part III Acceptance and Implementation of Consensus by Differently-Situated States
- CH 8: The Birth of a New International Tax Framework and the Role of Developing Countries, Natalia Quiñones
- CH 9: The Other Side of BEPS: “Imperial Taxation” and “International Tax Imperialism”, Sergio André Rocha
- CH 10: Country-by-Country Over-Reporting? National Sovereignty, International Tax Transparency, and the Inclusive Framework on BEPS, Romero J.S. Tavares
- CH 11; How Are We Doing with BEPS Recommendations in the EU?, Tomas Balco & Xeniya Yeroshenko
- CH 12: U.S. Tax Sovereignty and the BEPS Project, Tracy A. Kaye
The book unfolds in three parts. The first, The Essential Paradox of Tax Sovereignty, features four chapters.
- In chapter 1, Christians introduces the topic by demonstrating how BEPS arose from the paradox of tax sovereignty and analyzing why multilateral cooperation and soft law consensus became the preferred solutions to a loss of autonomy over national tax policy. The chapter concludes that without meaningful multilateralism in the development of global tax norms, the paradox of tax sovereignty will necessarily continue and worsen, preventing resolution of identified problems for the foreseeable future.
- Tomazela &; Rocha pick up this thread in chapter 2, where they demonstrate that BEPS addresses the symptoms, but not the problems, of the sovereignty paradox. In their view, the central defining problem of this paradox is an ill-defined jurisdiction concept. The chapter demonstrates why tax policymakers need to change the conventional wisdom on sovereignty in order to incorporate new nexus connections due to the changing nature of trade and commerce.
- In chapter 3, Schoueri & Galendi further the inquiry by providing a detailed analysis of the interaction of contemporary cooperation efforts with the sovereignty of states in light of historical claims in economic allegiance, economic neutrality and now cooperation against abusive behaviour.
- Brauner rounds out this first part in chapter 4, which establishes the evolution of the concept of tax sovereignty. The chapter proposes an instrumental role for sovereignty in the process of improving cooperation and coordination of tax policies among productive (non-tax haven) countries, to balance claims and serve as a safeguard against political (in this case international) chaos. Brauner concludes that such a change to the business of international tax law would ensure at least an opportunity for all participants to succeed on their own terms.
Part Two of the book, Challenge to the Foundational Principles of Source and Residence, takes an in depth look at why residence and source continue to be the two essential building blocks of tax sovereignty and the backbone of the international tax system, surviving BEPS but still subject to multiple challenges in theory and practice.
- In chapter 5, Avi-Yonah & Xu argue that BEPS simply cannot succeed in solving the sovereignty paradox because BEPS follows the flawed theory of the benefits principle in assigning the jurisdiction to tax. Avi-Yonah and Xu therefore make a compelling argument that for the international tax regime to flourish in the face of sovereign and autonomous states, countries must commit to full residence-based taxation of active income with a foreign tax credit granted for source-based taxation.
- In chapter 6, Tejeiro continues the analysis of the fundamental jurisdictional building blocks, demonstrating that by resorting to legal fictions within BEPS and beyond it, states are attempting to enlarge the scope of their personal or economic nexus, or to grasp taxable events and bases beyond their proper reach under well-settled international law rules and principles.
- Bal furthers the discussion in chapter 7, with an analysis of how digital commerce has upended traditional notions of source and residence. Bal advocates the consumer's usual residence as a good approximation of the place of actual consumption and therefore the best-justified place of taxation.
Part Three of the book, Acceptance and Implementation by Differently-Situated States, considers tax sovereignty after BEPS from a range of perspectives. Chapters 8 through 10 focus on perspectives from lower income or developing countries, while chapters 11 and 12 review the landscape from the perspective of Europe and the United States, respectively.
- In chapter 8, Quinones explores how developing countries might take advantage of the new international tax architecture, developed for purposes of coordinating the BEPS action plans, to ensure that their voices are truly shaping the standards. She argues that the knowledge gap between developing and developed is getting narrower instead of wider, with major negative impacts expected for the international tax order.
- Rocha continues this discussion in chapter 9, with a proposal: instead of simply accepting the BEPS Project’s recommendations and their reliance on historical decisions about what constitutes a country’s “fair share of tax”, developing countries should join in the formation of a Developing Countries’ International Tax Regime to focus discourse on the rightful limits of states’ taxing powers.
- Furthering the theme of autonomous priority-setting, in chapter 10 Tavares focuses in on a key part of the BEPS consensus, exploring whether implementing the CBCR standard, without a deeper transfer pricing reform, should be viewed as a priority in every country. He further questions whether this particular initiative, even if important, is worthy of mobilization of the scarce resources of developing countries. Tavares concludes with an incisive review of the role of the inclusive framework in prioritizing some needs over others.
- Balco & Yeroshenko then consider BEPS implementation from the very different perspective of the EU in chapter 11. The chapter demonstrates that even within the EU, BEPS implementation is not straightforward, as the interests of member states sometimes conflict and the basic notion of tax sovereignty remains fundamental even while tax coordination and harmonization across the EU expands. However, the authors note that the progress made in the last several years on key cooperation norms, which was largely inspired by BEPS, has been unprecedented.
- Finally, Kaye provides a capstone to the book in chapter 12, where she makes the convincing case that although some in the United States saw the BEPS Project as a threat to US tax sovereignty, this project was in fact necessary in order for the United States to effectively wield its tax sovereignty. Kaye’s chapter thus ends the book with a clear picture of the ongoing paradox of tax sovereignty in the world after BEPS.
Tagged as: BEPS scholarship sovereignty tax competition tax policy
My own view is that a switch to deductibility would increases pressure on capital importing countries to reduce their source-based taxes (a deduction does not fully offset the foreign tax, so it would make such taxes more costly to US firms as compared to fully creditable foreign taxes), and therefore transfer revenues from poor to rich countries. Deferral already places tremendous tax competition pressure on host countries, while ending it might enable some countries (to which US capital is a major source of inbound investment) to increase their source-based taxation (as explained in this paper). Therefore I was happy to see this FP&S paper give additional support to the beleaguered tax credit while still recognizing that there is such a thing as giving too much credit.
I was also intrigued to see FP&S begin their paper by picking up Reuven Avi-Yonah's premise that taxation on the basis of residence and source is customary international law. That is not only a relatively unusual argument to find in a US-authorized tax paper, but it is a potentially controversial perspective, which I am exploring in a paper of my own (making the international law case against citizenship based taxation). So, thank you Fleming, Peroni and Shay, for the additional citation support for my arguments.
It is also worth noting that FP&S include in this paper a defense of the corporate income tax in the form of footnote 200, which spans more than a page in tiny but useful print. It summarizes the main points regarding why corporate tax is necessary as a backstop to individual income taxation, citing to the main arguments for and against, thus serving as a valuable micro treatise on the subject.
Finally, I note that FP&S only give the FTC two cheers instead of three because they feel that it conflicts with the principle of ability to pay, an argument I have not seen before and that gives me pause. Their argument is that foreign taxes are a cost to individuals attendant to investing abroad, and that crediting these taxes is too generous from the perspective of fairness, that a deduction would sufficiently account for the cost in terms of measuring ability to pay. I can understand that argument where the FTC is itself too generous, allowing cross-crediting and not restricting its application to double taxation. But I do not understand that argument applied to an FTC that restricts itself to a dollar for dollar credit of actual taxes paid, which I believe is the argument being advanced here. That's something to think about a little more.
In any event, abstract below and paper at the link above. Well worth a read.
Reform of the U.S. international income taxation system has been a hotly debated topic for many years. The principal competing alternatives are a territorial or exemption system and a worldwide system. For reasons summarized in this Article, we favor worldwide taxation if it is real worldwide taxation; that is, a nondeferred U.S. tax is imposed on all foreign income of U.S. residents at the time the income is earned. However, this approach is not acceptable unless the resulting double taxation is alleviated. The longstanding U.S. approach for handling the international double taxation problem is a foreign tax credit limited to the U.S. levy on the taxpayer’s foreign income. Indeed, the foreign tax credit is an essential element of the case for worldwide taxation. Moreover, territorial systems often apply worldwide taxation with a foreign tax credit to all income of resident individuals as well as the passive income and tax haven income of resident corporations. Thus, the foreign tax credit also is an important feature of many territorial systems. The foreign tax credit has been subjected to sharp criticisms though, and Professor Daniel Shaviro has recently proposed replacing the credit with a combination of a deduction for foreign taxes and a reduced U.S. tax rate on foreign income.
In this Article, we respond to the criticisms and argue that the foreign tax credit is a robust and effective device. Furthermore, we respectfully explain why Professor Shaviro’s proposal is not an adequate substitute. We also explore an overlooked aspect of the foreign tax credit—its role as an allocator of the international tax base between residence and source countries—and we explain the credit’s effectiveness in carrying out this role. Nevertheless, we point out that the credit merits only two cheers because it goes beyond the requirements of the ability-to-pay principle that underlies use of an income base for imposing tax (instead of a consumption base). Ultimately, the credit is the preferred approach for mitigating international double taxation of income.
In September, Donald Trump started calling for the US to tax imports from Mexico and China etc, on various theories having to do with his vision of what fair trade policy involving the United States would require. Democratic lawmaker Bill Pascrell appears to have seized the moment to re-introduce a bill that has failed multiple times in the U.S. Congress over the years, namely, the so-called Border Tax Equity Act. The idea of this act is simple: tax US consumers on imports and give the money to US companies that export things. If you find it amazing that anyone anywhere could support a tax and redistribute scheme like this, blame it on the pitch: Pascrell (and others) laud this as an answer to what they have characterized as a discriminatory practice, namely the exemption of exported products from value added taxes (VAT) by the 160+ countries that have federal consumption taxes. The argument is that "[t]he disparate treatment of border taxes is arbitrary, inequitable, causes economic distortions based only on the type of tax system used by a country, and is a primary obstacle to more balanced trade relations between the United States and its major trading partners."
This argument is specious and I don't expect the bill to pass but this issue is one that just does not seem like it will go away, I think because it is too easy to pitch the VAT border tax adjustment as "unfair." I had an exchange with trade expert Simon Lester almost ten years ago on this very subject, and re-reading my response today, it seems to cover the bases so I thought I would re-post it. You can see his original post here including a discussion in the comments between myself, Simon, and Sungjoon Cho on the matter. Sungjoon helpfully linked to a GATT working party report from 1970 but his original link is dead, however you can find that report here. Here is what I said (highlights added):
The great fallacy here is that the foreign exporter to the U.S. is somehow subject to no tax while the U.S. exporter is subject to two taxes. This is simply not the case. Other countries, especially our biggest trading partners (e.g. Canada) have both a federal corporate income tax and a federal consumption tax, while the U.S. has only a federal corporate tax. You cannot honestly assess the impact of the VAT in the context of only one country’s corporate income tax, and supporting this legislation this way is dishonest. The Textileworld site you reference conveniently ignores foreign corporate taxes in its analysis—I will leave you to decide for yourself why they might do that.Further...
...I will give a drastically oversimplified example. Assume a U.S. person manufactures a product in the U.S. which it will sell in Canada. The company’s profit on the sale is subject to federal income tax in the U.S., plus VAT in Canada (there called a general sales tax). Let us assume a Canadian company makes a similar product. With the same profit margin as the U.S. company on that product, the big issue here is the different rates of federal corporate taxes each company pays to its home country, because both pay an equal amount of VAT tax in that market. What the export credit in the U.S. would do is lower the U.S . company’s federal income tax burden relative to the Canadian one.
Now flip the scenario, the U.S. manufactures and sells a product in the U.S., where there is no VAT, and the Canadian company manufactures a product in Canada to sell in the U.S. Now each company again will pay its income tax to its home country but what happens to the VAT? Well there is no U.S. federal sales tax, and Canada’s VAT only applies to sales in that market, so the VAT is not imposed on the Canadian product coming in to the U.S.—it is exempt from their VAT. Again, in the U.S. market, there is no price distortion other than the difference in corporate income tax burdens—neither product is subject to VAT. If the U.S. imposes a border tax, I think you might now see that as distortionary (to the extent you believe that a tariff is distortionary in any event). Now you might say yeah, but many states have state sales taxes, wouldn't that equalize the incoming product, exempted from sales (VAT) tax in its foreign country? The answer is, of course, yes. But you don’t see very many people complaining if New York does not impose its sales tax on a product being shipped out of New York for sale in Canada—that is a (much-ignored) direct corollary to the VAT exemption.
I could go on but this argument has been made many times before. I appreciate that tax is complex and there are many alternative taxes and scenarios in which they apply differently, so that it is easy to be swayed by something that “seem unfair.” The bottom line is that people will continue to compare VAT to income taxes when it suits their purposes (i.e., supports protectionist policies like the border tax), and not when it doesn’t (i.e, when they want to pressure a government to lower its corporate tax rate to align with other nations’ corporate tax rate). But don’t be fooled by someone who tries to get you to look at one piece of a complex puzzle and guess what the image is.
[I]f you seek a level playing field, border taxes and rebates do not achieve that, and in fact, I doubt anyone could ever be confident about how to go about getting it via tax breaks for some and tax penalties for others (I have some ideas about where I would start, but I'll restrain myself). A border tax/rebate does not operate like an inverse VAT or offset an extra cost imposed by a VAT. A border tax is a tariff and a rebate is a subsidy, plain and simple, and I would expect many of our trading partners to oppose it if enacted.Today, I am less convinced that the income tax is worth saving and more open to a federal VAT, but that's a discussion for another day. To the above I would only add that in 2009 the US Congressional Research Service undertook a study called International Competitiveness: An Economic Analysis of VAT Border Tax Adjustments, well worth reading--the authors were Maxim Shvedov (now tax policy expert at AARP) and Donald Marples, whose more recent work on inversions with Jane Gravelle is also of interest. Their conclusion:
Incidentally, abolishing all income taxes might solve the problem of the income tax competition, but then you have a much different problem. By some estimates, if the U.S. were to abolish the income tax entirely in favor of a sales tax, the rate could be as high as 50%. More likely scenario: we keep the income tax just like it is and ADD a 10-20% federal VAT. This would get rid of the erroneous "VAT as distortion" complaint but I personally would rather keep the debate and take a pass on the VAT.
Economists have long recognized that border tax adjustments have no effect on a nation's competitiveness. Border tax adjustments have been shown to mitigate the double taxation of cross-border transactions and to provide a level playing field for domestic and foreign goods and services. Hence, in the absence of changes to the underlying macroeconomic variables affecting capital flows (for example, interest rates), any changes in the product prices of traded goods and services brought about by border tax adjustments would be immediately offset by exchange-rate adjustments. This is not to say, however, that a nation's tax structure cannot influence patterns of trade or the composition of trade.In summary: No, taxing at the border for the reasons given does not introduce "equity." It introduces WTO-prohibited tariffs and export subsidies. One could imagine that if the tariffs so raised were used to fund public goods, the possibility for an equitable outcome could be increased. But taking the money out of the pockets of US consumers and putting it in the pocket of US exporters in no way fulfills the stated policy goal.
Tagged as: fairness politics tax policy VAT
Céline Azémar and Dhammika Dharmapala recently posted "Tax Sparing, FDI, and Foreign Aid: Evidence from Territorial Tax Reforms," of interest. Tax sparing refers to the intentional exemption of income from tax by two countries working cooperatively. The idea of tax sparing is to ensure that tax incentives granted to investors by source countries are not “cancelled out” by income taxation in the residence country. This is typically accomplished by ensuring that the residence country gives credit for the amount of tax that would have normally been paid to the source country, instead of a reduced (or eliminated) amount that was actually paid according to an incentive scheme. In other words, tax sparing is treaty-based double nontaxation.
Here is an example of tax sparing from Article 21 of the 1993 tax treaty between Indonesia and the United Kingdom,:
For the purposes of paragraph (1) of this Article, the term “Indonesian tax payable” shall be deemed to include any amount which would have been payable as Indonesian tax for any year but for an exemption or reduction of tax granted for the year….”In this type of provision, an amount of tax would be credited by the taxpayer’s home country (presumably the UK) in accordance with the standard double tax relief provisions of the treaty even though not ultimately paid to the source country (presumably Indonesia).
If the residence country does not tax foreign income (i.e., is an exemption or territorial system as the UK is now), tax sparing would be pointless since the incentive in the source country accomplishes the desired result of nontaxation unilaterally. Yet this paper finds a surprising result: tax sparing increases FDI even after a treaty partner switches to a territorial system.
Here is the abstract:
The governments of many developing countries seek to attract inbound foreign direct investment (FDI) through the use of tax incentives for multinational corporations (MNCs). The effectiveness of these tax incentives depends crucially on MNCs' residence country tax regime, especially where the residence country imposes worldwide taxation on foreign income. Tax sparing provisions are included in many bilateral tax treaties to prevent host country tax incentives being nullified by residence country taxation.
We analyse the impact of tax sparing provisions using panel data on bilateral FDI stocks from 23 OECD countries in 113 developing and transition economies over the period 2002-2012, coding tax sparing provisions in all bilateral tax treaties among these countries. We find that tax sparing agreements are associated with 30 percent to 123 percent higher FDI. The estimated effect is concentrated in the year that tax sparing comes into force and the subsequent years, with no effects in prior years, and is thus consistent with a causal interpretation.
Four countries - Norway in 2004, and the U.K., Japan, and New Zealand in 2009 - enacted tax reforms that moved them from worldwide to territorial taxation, potentially changing the value of their preexisting tax sparing agreements. However, there is no detectable effect of these reforms on bilateral FDI in tax sparing countries, relative to nonsparing countries.
These results are consistent with tax sparing being an important determinant of FDI in developing countries for MNCs from both worldwide and territorial home countries. We also find that these territorial reforms are associated with increases in certain forms of bilateral foreign aid from residence countries to sparing countries, relative to nonsparing countries. This suggests that tax sparing and foreign aid may function as substitutes.The link to foreign aid is intriguing: it looks like compensation for the loss of a benefit. The OECD's Action Plans to counter BEPS are specifically designed to eliminate benefits like those created by tax sparing provisions. Is BEPS the end of tax sparing? If so, will BEPS also result in increased foreign aid?
Tagged as: BEPS scholarship tax policy treaties
Eric Kroh of Tax Analysts has a story today [gated] on the basic nonsense that is the FBAR (foreign bank account report) e-filing system. As he reports, in defiance of common sense, FinCEN's system does not work for normal users. It does not work on a mac at all, and it does not work on a PC if you have Adobe Acrobat installed (the user must uninstall and use adobe reader instead). So now in addition to frightening people by forcing them to register themselves for monitoring by "Financial Crimes Enforcement," making them feel like criminals just by visiting the website, the US Treasury is all about making sure the user encounters error after error, frustration without end, with no alternative because e-filing is required.
I'll make two points here. First, I think the entire FinCN experience violates the Taxpayer Bill of Rights recently adopted by the IRS, and second, I think the e-filing requirement is susceptible to legal challenge under the recent decision of the Massachusetts Appellate Tax Board in Haar v Commr. Let's look at the TBOR first.
Kroh's article demonstrates that FinCEN's FBAR system pretty clearly violates provision 2 of the Taxpayer Bill of Rights, which guarantees taxpayers a right to quality service. Kroh describes how ridiculous it is to have a form-filing system that conflicts with one of the most ubiquitous pieces of software out there, namely, Adobe Acrobat. He notes that the FinCEN website fails to explain the known issues and offers no promises about maybe fixing this very basic problem. IRS: no blaming things on FinCEN to get out of your obligations. You're administering this mess. (FinCEN is a bureau of Treasury separate from the IRS, but IRS has responsibility for enforcing FBAR by levying penalties for non-compliance.)
The FinCEN experience also violates provision 10 in my view. Provision 10 says taxpayers have the "right to a fair and just tax system." It is neither fair or just in my view to force individuals to register and transmit sensitive personal information on a website that is built for the sole purpose of detecting money laundering, terrorist financing, and other financial crimes, where no evidence exists that the individuals have perpetuated or are planning to perpetuate any such crimes. This process constitutes an intimidation tactic. If you don't believe it, I invite you to visit the FinCEN website, register yourself, and file an FBAR form as a civics lesson.
I am not saying Treasury doesn't need the information FBAR requires (though much or most of it is egregiously duplicative with IRS forms that non-resident US persons already have to file). But I am saying there is no way that Treasury needs to extract this information by making individuals register on a website that so clearly transmits the message: "you are a suspected criminal and we are watching you."
Remember, we are talking about millions and millions of people who have "foreign" bank accounts because they live in foreign countries; most are citizens of those foreign countries where they live; and their banks are local to them. Congress treats these people as if they live in the United States, when they do not. But Congress does not similarly treat their local bank accounts as local (Congress should do so, and would fix many problems if they did, as I argued in a Tax Analysts column in 2012). This mismatch of fiction against fact does not make people money launderers or tax evaders. Many, many of these individuals are unjustly caught up in the US tax net because of the madness of citizenship taxation. Also: consider that the FBAR instructions even say that kids ought to fill out their own FBAR forms. Come on.
Taxpayer Rights, yes. But remedies? Not so Clear.
Whether violating the taxpayer bill of rights creates grounds for a lawsuit remains to be seen; I think Congress' continuous failure to codify the TBOR is precisely to prevent this possibility (I discussed the issue here). But the recent case of Haar v Commissioner suggests that a lawsuit challenging the requirement that FBAR forms be filed electronically would have merit. I note from Kroh's article:
According to a FinCEN FAQ, failure to comply with the electronic filing mandate could result in civil penalties, including a $500 fine for each negligent currency transaction. Exceptions to the mandate are allowed only in some limited circumstances, according to the agency.Now comes Haar:
This appeal involves the Commissioner’s assessment of a $100 penalty... because of the appellant’s failure to electronically submit [a payment in connection with an extension of time to file]...
Mr. Haar maintained that the Commissioner’s electronic payment mandate is a “serious invasion of both [his] privacy and [his] personal business practices,” as it exposes his finances to risk of cyber attack. On his abatement application, Mr. Haar explained, “I intentionally do no electronic banking nor direct bill paying, I have none of my credit cards linked to my bank accounts directly and I think anyone who does any of the above is exposing themselves to multiple risks of cybercrime and identity theft.” At the hearing, Mr. Haar testified that he does not link his “bank account information in any electronic way to any other electronic medium” because he believes it is a “very foolish thing to do.” Mr. Haar further expressed doubts as to the security of the computer systems used by the Department of Revenue (“DOR”), noting that “if the Pentagon can be hacked,” he had little confidence that DOR could protect his – or any other taxpayer’s – personal data from theft.To which the Commissioner responded:
It was the Commissioner’s position ... that... she has the authority to mandate electronic filing and payment and to assess penalties if, after notice, a taxpayer failed to comply with the prescribed filing and payment mandates. While ... penalties may be abated if a taxpayer can demonstrate “reasonable cause” for non-compliance, the Commissioner maintained that the appellant did not establish reasonable cause because Administrative Procedure 633 (“AP 633”) provides that “[t]he fact that a taxpayer does not own a computer or is uncomfortable with electronic data or funds transfer will not support a claim for reasonable cause.” AP 633(II)(D).But the Appellate Tax Board saw things differently, noting that Treasury has steadily expanded e-filing requirements, but that there is no federal requirement that individual e-file their annual tax returns, and that reasonable cause is an objective standard that can't be eliminated by a mere declaration by Administrative Procedure. The ATB concluded:
On the facts of this appeal, particularly the appellant’s credible testimony concerning his consistent practice of avoiding the payment of his bills electronically, the Board found and ruled that the appellant exercised the degree of care that an ordinary taxpayer in his position would have exercised when he made his timely payment by check, contrary to the Commissioner’s electronic payment mandate. The Board therefore found and ruled that the appellant met his burden of proving reasonable cause under § 33(g) for his failure to remit payment electronically in connection with his extension application for the tax year at issue.
Accordingly, the Board issued a decision for the appellant in this appeal and granted an abatement of the $100 penalty, along with statutory additions.I note that Haar represented himself in that appeal. When I saw that FinCEN had made e-filing mandatory, I wondered if it would spark lawsuits. The Haar case suggests that such lawsuits might prevail if the facts and legal standards align.
Lawsuits are not the only way to protect taxpayer rights in this case, however. If the US practiced residence based taxation like the rest of the world, the universe of US taxpayers who have foreign bank accounts but who aren't rich enough to employ others to deal with complex US filing obligations will shrink to a negligible number and the issue all but goes away. Until then, Treasury can act, and act quickly to resolve the technical problems here, even if we have to wait for Congress to fix the underlying defect of citizenship taxation.
The solution is clear: Treasury should abolish FinCEN registration for FBAR purposes alone and the FBAR should be treated like other tax forms since it is administered by the IRS. The IRS should make the FBAR form available as a regular pdf on the IRS website like all the other tax forms, and have a link so people who choose to e-file can do so.
Tagged as: FBAR governance IRS rule of law u.s.
- FATCA is the Foreign Account Tax Compliance Act. It is law in the United States, enacted as part of the Hiring Incentives to Restore Employment Act, (HIRE Act), which was signed into law by President Obama on March 18, 2010. (It is found at §§ 501-531, Pub. L. No. 111-147, 124 Stat. 71 (2010). It has been codified in scattered sections of the Internal Revenue Code.
- In brief, the law requires foreign financial institutions (broadly defined) to identify any of their accounts (also broadly defined) held by "US persons" (expansively defined) and then furnish the US with periodic reports on those accounts including identifying information and amounts of transfers in and out of the accounts. Targeted institutions that fail to comply are to be penalized with a 30% toll charge on all of their US-source payments (again expansively--not just payments connected to targeted accounts).
- There are numerous rules and exceptions and exceptions to the exceptions applicable to the above statement.
- "US person" includes everyone in the world who is a US citizen, whether or not that person lives or has ever lived in the US and whether or not that person is also a citizen of somewhere else. The US is the only country in the world that taxes its citizens on this basis. Citizenship-based taxation violates the membership principle as well as the global standard of residence-based taxation, and has therefore been denounced as unjust or bad economic policy or both by most academics, including Reuven Avi-Yonah and myself among others.
- The US considers any account to be foreign if it is not in the US, so for people who live in other countries, their neighbourhood bank where they have their checking account in the local currency is "foreign."
- The HIRE Act was a jobs bill that included payroll tax holidays and other credits for employers. FATCA was unrelated to this purpose, but was included in the form of revenue-raising “Offset Provisions”. The Chair of the House Budget Committee claimed that the HIRE Act was a responsible piece of legislation that “was fully paid for… by cracking down on overseas tax havens." Congressional Record (4 March 2010) page H1152 (statement of Sen. Allyson Schwartz). However, no cost-benefit analysis appears to have been undertaken, and pursuant to CBO projections, the sums to be raised under FATCA could do little by way of offset, even if they were fully implemented (see below, What is the cost/benefit of FATCA).
- The placement as a revenue raiser tacked onto a bill aimed at unrelated objectives has been viewed by opponents of FATCA as a sign that its passage was undertaken with some degree of stealth. See, e.g., Recovery Partners, “FATCA: The Empire Strikes Back” (4 July 2011); Koshek Rama Moorthi, “FATCA: Obama’s New Year Surprise Against American Expats” (30 November 2012), The Examiner; American Citizens Abroad, “ACA’s Voice in the News” (October 2012) online. The addition of unrelated riders and last minute addenda, especially revenue raisers, is a standard feature of US lawmaking, though it may appear anomalous to observers from other countries. For a brief discussion of how reconciliation and pay-as-you-go rules and standards affect tax policymaking in the US, see Center on Budget and Policy Priorities, “Policy Basics: Introduction to the Federal Budget Process” (3 January 2011).
- Presented as a revenue offset at the tail end of a long, complex, and contested piece of legislation did allow FATCA to pass with minimal debate or discussion in 2010. But the seeds for FATCA had been sown in earlier (failed) legislative attempts, both in Senator Levin’s Stop Tax Haven Abuse Act of 2009 and Senator Baucus’ stand-alone FATCA Act of 2009. See Carl Levin, “Summary of the Stop Tax Haven Abuse Act” (2 March 2009); H.R. 3933 (111th): Foreign Account Tax Compliance Act of 2009 (27 October 2009); See also Douglas Shulman, “Prepared Remarks of Commissioner Douglas Shulman before the 22nd Annual George Washington University International Tax Conference” (10 December 2012) (stating that “the Administration and the IRS are focused on a multi-year international tax compliance strategy…to put a serious dent in offshore tax evasion” and expressing support for the FATCA Act of 2009).
- The clear impetus for FATCA was the UBS scandal, involving thousands of bank accounts held in Switzerland by Americans living in the United States. It seems clear the target was rich tax cheats who live in America but don't want to pay taxes there, and who have been helped in that quest via unscrupulous sales pitches by offshore bankers offering banking secrecy as a shield against taxation by the USA. The legislation failed twice as stand alone bills (see above), and was tacked on to another, unrelated bill in 2010 (the HIRE act) as a revenue raiser, without any discussion or much analysis by US legislators. Many appear to have never even heard of FATCA.
- A lot of people seem to think FATCA was intended to smoke out and punish Americans who live permanently in other countries and who have not kept up with their US tax obligations out of ignorance or otherwise. I do not think that is the case. I think these Americans have become collateral damage of FATCA.
- To my knowledge, no cost analysis has been undertaken with respect to FATCA.
- Amounts expected to be raised by FATCA were projected to be $343 million, $448 million, and $710 million, for 2010, 2011, and 2012, respectively. See Congressional Budget Office (18 February 2010) “Letter and Table Outlining Budgetary Effects of HIRE Act” ). The HIRE Act was expected to produce a revenue deficit in the amount of $4,380,000 despite the bold claim that it was "was fully paid for… by cracking down on overseas tax havens." See Congressional Record (15 April 2010) page S2368 “Budget Scorekeeping Report: Table 2: Supporting Detail for the Current Level Report for On-Budget Spending and Revenues for Fiscal Year 2010, as of April 9, 2010.
- This precarious budgetary situation was aggravated by the fact that while the spending provisions of the HIRE Act were apparently immediately implemented, most of the FATCA provisions have yet to be enforced. For example, the disclosure of US accounts by foreign financial institutions was, according to the statute, to begin after December 2012, but the enforcement has been delayed more than once. See IRS, “Notice 2012-42” (24 October 2012) (which delayed the implementation of information reporting until 31 March 2015 and gross withholding until 1 January 2017); see also chart of initial and revised implementation times, DLA Piper, “Comparison of FATCA Timeframes” (October 2012).
- I have not found any information about whether any amount of taxes or penalties has been collected pursuant to FATCA to date.
- An IGA is an "intergovernmental agreement." The US has been signing these with some countries and is looking to sign a lot more with a lot more countries.
- There are two categories of IGAs. In one category, the foreign country agrees to change whatever domestic law exists that might bar their financial institutions from complying with FATCA (e.g., consumer privacy protection laws). In the other category, the foreign country agrees to act as intermediary, collecting the info the US wants and handing it over as a government-to-government exchange. This typically bypasses any privacy protection regimes that might exist as people don't generally have privacy protection as against their own government's tax authority.
- IGAs are from the US perspective, in fact, just what exactly they are is a mystery. Treasury has implied that to the extent the US undertakes anything in these IGAs (in fact, precious little), they are "interpretive" in nature that is, they interpret existing tax treaties. Hence perhaps some confusion: if a country wants an IGA which involves the US providing anything in return, Treasury is suggesting a treaty will be needed for the IGA to "interpret." In my own view the idea that IGAs are interpretive in nature is a stretch: IGAs look like sole executive agreements to me. Treasury will not be putting them through any ratification procedures. Other countries have been typically (but not universally) treating these as they are, which is to say they are new treaties that require internal ratification procedures to place in force.
- In general the purpose of the IGA is to override the statutory structure of FATCA, making the unilateral statute less onerous than it otherwise would be, and to overcome domestic consumer privacy protections to enable institutions in other countries to pass personal financial information to the IRS. Thus, IGAs are a way of reducing both the administrative and the political burden Congress created for Treasury with FATCA.
- I can only speculate on this as I am not a compliance expert. However, it is to be expected that at minimum, compliance costs and risk of penalty from the US goes up, and if other counties implement their own regimes as the UK is currently doing, the costs and risks will be multiplied.
- It seems to me possible that financial institutions face litigation risk with respect to customers who are mistakenly identified as having US indicia and whose information is turned over to the IRS, or whose accounts are closed, or who are asked for personal information that is not required to be asked or not allowed to be shared with third parties under domestic banking laws, whatever those may be. It seems possible that this risk might make an IGA seem more palatable than direct compliance with FATCA, from the perspective of a financial institution.
How will FATCA impact consumers?
- Again I can only speculate, based on what people tell me.
- First, a generalized fear seems to be setting in about US surveillance and a powerful and determined IRS that is interested in imposing, anywhere it can, enormous penalties all out of proportion to any taxes that might have been owed. The US Taxpayer's Advocate has expressed dismay at this state of affairs.
- Second, it is likely that everyone will see increased costs for financial services across the globe, even for those with no ties to the US of any kind, as compliance will have to be done on every account and institutions can be expected to pass on these costs in the form of higher fees and charges.
- Third, it seems that data security risks rise as bulk data including social security numbers, account numbers, financial transactions, and other personal information is collected and shared with the IRS. If the info will be shared with other US federal agencies, as Senator Levin has suggested ought to be the case, this seems to compound the data security risk.
- Fourth, there appears to be no remedy for error, compounding the problems noted above. If an institution flags a person as a "US person" in error, that person seems to be caught in a system with little or no review mechanisms in place. I am not sure how a person manages a case of mis-characterization.
- Finally tax compliance is extremely costly when you live in another country, so as more Americans try to get compliant the global personal compliance industry (e.g. tax accountants and lawyers with US expertise) stands to profit handsomely. This is another payoff in the form of rent seeking courtesy of the regulatory state. This is also a boon to the institutional compliance industry, i.e., software and systems designers, auditors, risk assessors, and so on, who will benefit from selling their products and services to financial institutions. It also seems to be a boon to people who know how to help one expatriate from the US--which is neither a straightforward nor cheap option.
- I cannot and do not give legal advice on this. I urge those who are or may be harmed by the injustice of US citizenship-based taxation on themselves, their children or parents or other loved ones, to contact their local government representatives and the senators and congress members of any state to which they have any ties in the USA, to tell their stories and ask why the USA wants to tax their children's education savings plans or other government-sponsored savings plans in the countries where they live, why it is in the interest of the US to make life so difficult for Americans and dual citizens who engage in small businesses in other countries, why the US is so hopelessly out of step with international standards which impose taxation based on actual residence rather than inherited nationality, and why the US expects all of its citizens no matter where they live to fulfill tax obligations yet withholds tax benefits that help the poorest, such as the earned income tax credit.
Tagged as: FATCA
Lee Sheppard has an update in Tax Notes [gated] on the US "anti-inversion" rules--designed to treat corporations that in effect expatriate by reincorporating offshore--as if they were still US persons in some cases.
Reporting on a recent meeting hosted by the International Tax Institute on "Corporate Inversions - Will They Ever End? Is There A Solution?," and featuring John Merrick (Special Counsel to the Associate Chief Counsel (International)); Lew Steinberg (Managing Director - Head of Strategic Advisory, Credit Suisse Securities (USA) LLC); and Willard Taylor (Adjunct Professor, NYU Law School), Lee says the consensus is that:
The anti-inversion statute, section 7874, doesn't work very well at its stated goals, and Congress hasn't bothered to fix section 163(j), the ineffectual interest-stripping rule. And there's not a whole lot the IRS can do about it, except treat the departed corporations the same way it treats real foreign parents.For the uninitiated, in an inversion a U.S.-based multinational company restructures its corporate group so that after the transaction the ultimate parent is foreign. After this flip, shareholders of the former U.S. parent company now hold stock of the foreign parent company. Everything else stays the same, e.g. business as usual at the operations level. Here is a nice explanation from Mayer Brown.
This kind of expatriation is susceptible to a charge of being done for tax dodging purposes only, and Congress doesn't like it. Accordingly Congress enacted 7874 to throw various obstacles in the way of inversion and, most drastically, to ignore the expatriating attempt all together--i.e., to treat the foreign parent company as a US person--if U.S. shareholders retain 80% ownership. Lee says:
[N]o one is silly enough to allow them to retain more than 80 percent, in which case the surviving corporation would be re-domesticated. So most recent deals fall in the 75 percent range of retained U.S. ownership, Steinberg explained.
...In June 2012 the IRS issued new proposed ... and temporary regulations... [which] require that the expatriated corporation have at least 25 percent assets, employees, and income in its new country of residence. Merrick admitted that the 25 percent threshold is "a bit on the high side" and "inflexible." The IRS is open to constructive comments but will not return to the easier tests of the 2006 proposed regulations, he said.Lee asks, "Is the third try a charm?" She says practitioners complain that "no company can possibly meet the 25 percent test, particularly the income/sales factor," but:
Merrick demurred. The statute is not designed to allow each U.S. multinational to flee to some other country, he explained. "Our view is that it requires a concentrated center of gravity," he said.Interesting remark: a concentrated center of gravity seems like a qualitative, rather than quantitative, measure, more akin to a mind/management standard for corporate residence than the formalistic place of incorporation rule the US currently uses. Perhaps in time the US will adopt the mind & management rule either in addition to or to replace the current regime. If mind & management plays a replacement role instead of a supplementary one, that opens the door for also considering what individual residence looks like if one employs "a concentrated center of gravity"as the organizing principle. It seems that looks a lot more like the residency tests used by 99% of the rest of the world's countries.
Leaving aside the concentrated center of gravity remark, the 25% test itself is an interesting turn toward formulary apportionment. There has been a lot of discussion in international circles about whether the current standard for allocating revenues among countries based on the arm's length transfer pricing standard, which involves a lot of shenanigans, could be profitably replaced with a more formulaic approach to revenue sharing. As the two papers I linked to yesterday suggest, under formulary apportionment countries would look to assets, employees and sales revenues to devise a formula for allocation among countries. The OECD has in effect rejected even the discussion of formulary apportionment as a policy matter, but I have suggested that I do not think they can suppress this discussion much longer. If we have the US looking at these factors of income production for purposes of determining corporate residence, can formulary apportionment really be so far off the horizon?
Finally, noting that the ownership fraction seems to be the only factor the IRS wishes to consider in analyzing inversions at the moment, Lee states that the priority guidance in this area involves "regulations addressing dilution of shareholdings and manipulation of the ownership fraction. Future regulations will disregard certain shares of the new foreign corporation in determining the U.S. ownership fraction. The government had become aware of transactions designed to minimize U.S. ownership, such as issuance of 21 percent of the new foreign corporation to a friendly investor."
The obvious goal here is to continue to make it harder for US corporations to expatriate, on the theory that expatriation is highly suspect because tax avoidance is a main reason (and some believe the only reason) why a corporation would want to leave the US. This, I think, is consistent with the current US view toward expatriating individuals: their motives are also highly suspect, and so their exit may only be accomplished by means of complex and expensive administrative mechanisms. In the case of individuals, however, expatriation is a final act--once given up, US citizenship will be almost impossible to reacquire. Not so for corporations, at least, so far.
Tagged as: corporate tax MNCs Tax law tax policy u.s.
The IRS has issued its latest SOI reports, including the 2011 Individual Income Tax Returns (Publication 1304). These are always interesting. This year's data shows that 145 million individual income tax returns were filed in 2011, about 108M showing a taxable income amount, and 95M showing income tax, for total revenues of just over $1 trillion from the individual income tax. Some highlights:
- salary or wage income: 119M returns, $6T
- unemployment comp: 13M returns, $92B
- social security benefits: 25M returns, $490B
- foreign earned income (i.e. residents of other countries): 445K returns, $28B
- gambling earnings: 1.9M returns, $26B
Tagged as: information IRS u.s.
The PPL decision was released yesterday and taxprof posted initial thoughts from Reuven Avi Yonah and myself. I'm not convinced as Prof. Avi-Yonah is that the decision is correct, but I am interested in a few of the interpretive advances presented in the case. My comments:
The Supreme Court unanimously decided in favor of the taxpayer with respect to the creditability of a foreign tax in PPL Corp & Subsidiaries v. Commissioner, released yesterday. In an opinion authored by Justice Thomas with a concurrence from Justice Sotomayor, the Court held that PPL Corp., a US company that owned a large interest in a UK energy company, is allowed to credit against its US income tax an amount paid as a “windfall tax” to the UK government in 1997. The ruling reverses the judgment of the Court of Appeals for the Third Circuit, siding instead with the Tax Court and the Court of Appeals for the Fifth Circuit in Entergy Corp. & Affiliated Subsidiaries v. Commissioner, 683 F. 3d 233.
The case settles a circuit split but it leaves unresolved interpretive issues concerning Reg § 1.901-2(a)(1), which defines when a foreign tax is creditable for US purposes. The most discussed interpretive issue will likely be that involving the role of “outliers” in determining the predominant character of a tax, which Paul Clement focused on in his oral argument on behalf of PPL Corp. and which amici argued on both sides.
The outlier issue is fairly simple to understand but, despite receiving direct attention in the decision in this case, is perhaps not wholly resolved. The issue turns on what the regulations mean when they say that “a tax either is or is not an income tax, in its entirety, for all persons subject to the tax.”
According to a tax professors’ amici brief led by Prof. Anne Alstott, this language means that no one taxpayer can be dismissed as an outlier: that a tax can only be an income tax if it acts as an income tax with respect to every taxpayer. But according to the taxpayer, and now according to the Supreme Court, some “outliers” can apparently be ignored so long as, for the most part, the tax acts like an income tax with respect to most taxpayers. At oral argument, Justice Kagan appeared to strongly disagree with this position, as discussed here, but she contributed no written opinion in the case. Justice Sotomayor also appeared disinclined to this position at oral argument, and her concurring opinion in the PPL decision leaves plenty of room for speculation as to how the Government might try to distinguish a future case from PPL.
But even though it will likely be the most discussed feature of the case, the outlier issue is not the only interpretive gloss to emerge here. Justice Thomas also introduced a small but potentially interesting twist on the habitual presentation of the last clause of the “predominant character” rule; namely, the part that requires the foreign tax to be an income tax “in the US sense.”
Justice Thomas explains in the decision that this clause means that “foreign tax creditability depends on whether the tax, if enacted in the US, would be an income, war profits, or excess profits tax” [emphasis added]. These italicized words present what might be viewed as a hardly noteworthy deviation from past jurisprudence, which generally seems to simply repeat verbatim the regulatory language before going on to discuss the longstanding doctrine starting with Biddle v. Commissioner, as Justice Thomas does in the present decision.
Thus, it is quite possible that the slight reworking of the language is completely immaterial. One could well argue that there is no meaningful difference between a tax that is an income tax “in the US sense” and one that would be an income tax “if enacted in the US.” But we in tax know how much can turn on a single word in a statute or a regulation, and even in a single punctuation mark. Perhaps it does not strain credulity too much to take this new language seriously as a gloss, and query what it might mean.
Justice Thomas looks at the tax in question and effectively asks, would it look like an income tax if it were enacted in the US? It is not too far of a leap to go from asking that question to asking whether, if Congress enacted a tax like this, it could survive constitutional challenge as an allowable tax under the 16th amendment, whether it is a direct tax or an indirect tax, and what the constitutional implications of that decision might turn on, and so on, down the rabbit hole of constitutional parameters and permissions on taxation in America. We can well imagine that many tax law professors and perhaps many practitioners as well could choose to have a lot of fun with the UK windfall tax if Congress tried to enact it as an income tax. Thus it is at least arguable that Justice Thomas’ suggestion that the tax would have to be an income tax if it were enacted in the US might ultimately prove to be a more, rather than less, strict analysis than that traditionally accorded to the “US sense” language.
Thus a small and perhaps insignificant interpretive step it may be, but fortunes have been made and lost on less distinction, as we in the tax community are all too aware.
I will have more extensive opinion recap on SCOTUSblog some time later in the day today.
Tagged as: tax policy u.s.
David Cameron has a fresh take on the PPL case which is worth a read, in yesterday's Tax Notes [gated]. He's wondering why no one has raised the US-UK tax treaty, which he thinks would resolve the creditability issue with ease. He says:
... Because neither PPL nor Entergy raised the treaty issue, the Tax Court, the Third Circuit, and the Fifth Circuit relied solely on the requirements of section 901 and the regulations that define a creditable tax. The complete lack of any reference to the U.K.-U.S. tax treaty is extremely curious because the treaty provided more than adequate grounds to conclude that the windfall tax was creditable under U.S. law.
...The [applicable] U.K.-U.S. tax treaty identified specific existing taxes imposed by the United Kingdom and designated them as income taxes for which a credit would be available (covered taxes).
Importantly, covered taxes may well include foreign taxes that would not qualify as income taxes under domestic law....
...[T]he language describing the indirect credit under article 23(1) does not specifically refer to an "income tax" but only to a "tax paid to the United Kingdom by that corporation with respect to the profits out of which such dividends are paid."
... The failure of the taxpayers in PPL and Entergy to raise the treaty issue is all the more curious given the IRS's recognition in a coordinated issue paper that the windfall tax involved a treaty issue.[The IRS claimed that the Windfall Tax would not be creditable because it was a one-time levy imposed on appreciation in value, but the] IRS's analysis of the treaty issue is not ... convincing.
... The Supreme Court need not decide whether a formalistic or substantive analysis applies under section 901 because the U.K.-U.S. tax treaty provides an alternative argument -- a definition of an income tax at least as broad as that under section 901 and the application of a substantive analysis to determine if a tax satisfies that definition -- to conclude that the windfall tax is creditable based on the Tax Court's findings.
...By ignoring the existence of the U.K.-U.S. tax treaty, the parties and the lower courts in PPL have overlooked a significant aspect of the case. The Supreme Court should not repeat their mistake.I agree with David that the treaty argument should have been made, even though I am less convinced than he is that on substance the "windfall tax" is really even a tax at all--I think it looks like a purchase price adjustment. But that was also not an argument brought up by anyone at trial, instead the IRS conceded that the "tax" was in fact a tax. Having done so, the treaty does seem to present the more permissive regime.
But a big part of this story is David's puzzlement about the treaty being overlooked by all the parties and all the judges, despite the IRS having previously articulated a treaty-based position on the very tax in question. Can it be that the parties just assumed the treaty did not apply, or if it did apply, did not provide a different result? Can it be that they all made those assumptions without undergoing a close analysis, without doing any research?
If so David is suggesting that a big mistake has potentially been made, and if the Supreme Court rules against the taxpayer in PPL, it may have been a quite costly mistake. That's bad for the taxpayer and bad form on the part of the lawyers, but intriguingly, it also suggests that even in a top fight litigation situation like this, it is possible that the tax law experts on both sides overlooked an applicable legal regime, most likely because the regime in question involved international law rather than a statute in the tax code.
That is a fascinating observation for those of us who like to think about the rule of law as the product not of legal texts by themselves but of their dynamic implementation in practice. If a legal text exists but is ignored by the legal system, can it really be said to be law at all? David is suggesting that the US-UK treaty is a tree falling in a forest, unheard by anyone. Usually I am worried that people will imagine that they hear trees falling in forests when there are no trees at all--that is, I worry about non-legal assertions being treated as equivalent to law (for example, OECD guidelines). David's article suggests that the opposite may have happened in this case.