Partnerships and the problem of Inversions

The Levin brothers (one in Senate, one in the house), have proposed a bill to increase the possibility for tax penalties for companies that start out as American and then 'invert' by merging with a foreign company, when too many of their shareholders are still American (existing rule: 20%, they want to go to 50%). But with the below ruling in place, one can imagine avoiding the inversion rule and getting to the intended result anyway, which is moving income-producing assets offshore at low or no cost and then having all the future income be foreign-source and therefore tax-deferred, ideally forever. 

LTR 201305006

Third Party Communication: None

Date of Communication: Not Applicable

Person To Contact: * * *, ID No. * * *

Telephone Number: * * *

Index Number: 7701.02-02

Release Date: 2/1/2013

Date: October 15, 2012

Refer Reply To: CC:PSI:B01 - PLR-140969-11

LEGEND:

Taxpayer = * * *

Parent = * * *

Affiliate = * * *

State = * * *

Country = * * *

Entity = * * *

Region = * * *

X = * * *

Courts = * * *

Dear * * *:

This letter responds to a letter, dated September 30, 2011, written by Taxpayer's authorized representative on behalf of Taxpayer, requesting a private letter ruling concerning the classification for federal tax purposes of a joint venture between Taxpayer and Affiliate.

According to the information submitted, Taxpayer is a corporation organized under the laws of State, and is a wholly-owned subsidiary of Parent. Affiliate is an Entity organized under the laws of Country A and is wholly owned by Taxpayer.

Taxpayer intends to enter into a joint venture with Affiliate by executing a Profit Participation Agreement (the "Agreement") under which Affiliate will acquire a X% interest in the capital of all of Taxpayer's branches in Region in return for a cash investment equal to X% of the overall fair market value of the Region branches. Affiliate will also acquire a X% interest in the profits and losses from all business operations of the branches in the Region.

No separate juridical legal entity will be created as a result of the agreement and thus Taxpayer will retain legal ownership of all assets, liabilities, and contractual obligations of the Region branches.

Taxpayer has provided the following representations in connection with its request for a private letter ruling.

(a) The Agreement will be signed outside the United States.

(b) The Agreement will provide that it will be governed by the laws of Country (the "Governing Law Provision").

(c) The Agreement will provide that Taxpayer and the Affiliate consent to the exclusive jurisdiction of Courts with respect to any matter or action arising out of or in connection with the Agreement (the "Exclusive Jurisdiction Provision").

(d) The rights and obligations of Taxpayer and the Affiliate under the Agreement will be legally binding under the laws of Country and will be enforceable in Courts. The performance of such obligations will not conflict with the laws of Country.

(e) The Governing Law Provision will be valid and legally binding under the law of Country and would be recognized by the courts of Country in a legal action brought by Taxpayer or Affiliate against the other party.

(f) The Exclusive Jurisdiction Provision will be valid and legally binding under the law of Country and would be recognized by the courts of Country in a legal action brought by Taxpayer or Affiliate against the other party.

(g) The Affiliate will be entitled to nominate one member of a 10-member committee that will oversee the operations and management of the Region branches (the "Management Committee"). All meetings of the Management Committee will take place outside of the United States.

(h) Taxpayer will elect to treat the resulting separate business entity as a corporation pursuant to § 301.7701-3(c).

(i) For all applicable federal tax purposes, Taxpayer will report the formation of the resulting separate business entity and its ongoing operations in a manner consistent with the rulings set forth below, including, but not limited to, the filing of, and furnishing of all required information on, Form 926 (Return by a U.S. Transferor of Property to a Foreign Corporation) and Form 5471 (Information Return of U.S. Persons with Respect to Certain Foreign Corporations).

Section 301.7701-1(a)(1) provides, in part, that whether an organization is an entity separate from its owners for federal tax purposes is a matter of federal tax law and does not depend on whether the organization is recognized as an entity under local law.

Section 301.7701-1(a)(2) provides, in part, that a joint venture or other contractual arrangement may create a separate entity for federal tax purposes if the participants carry on a trade, business, financial operation, or venture and divide the profits therefrom.

Section 301.7701-2(a) provides in part, that a business entity is any entity recognized for federal tax purposes (including an entity with a single owner that may be disregarded as an entity separate from its owner under § 301.7701-3) that is not properly classified as a trust under § 301.7701-4 or otherwise subject to special treatment under the Internal Revenue Code.

Section 301.7701-5(a) provides in part, that a business entity (including an entity that is disregarded as separate from its owner under § 301.7701-2(c)) is domestic if it is created or organized as any type of entity (including, but not limited to, a corporation, unincorporated association, general partnership, limited partnership, and limited liability company) in the United States, or under the law of the United States or of any State. A business entity that is created or organized both in the United States and in a foreign jurisdiction is a domestic entity. A business entity (including an entity that is disregarded as separate from its owner under § 301.7701-2(c)) is foreign if it is not domestic. The determination of whether an entity is domestic or foreign is made independently from the determination of its corporate or non-corporate classification.

A joint venture or separate business entity may exist for federal tax purposes where business is not carried out in the name of the separate entity, property of the business is not held in the name of the separate entity, and one of the participants in the venture is not disclosed to third parties. Taxpayer and Affiliate plan to execute the Agreement in order to engage in an active business in Region, sharing in the profits and losses as well as the management of all activities in Region.

Accordingly, based solely on the facts submitted and the representations made, we find that:

1. The Agreement between Taxpayer and Affiliate will create a separate business entity within the meaning of § 301.7701-2.

2. All items of income and expense properly allocable to the business carried on by the separate business entity created by the Agreement will be treated as the income and expense of the separate business entity for federal income tax purposes.

3. The separate business entity created by the Agreement will be a foreign business entity within the meaning of § 301.7701-5.

Except as specifically set forth above, no opinion is expressed or implied concerning the federal tax consequences of any aspect of any transaction or item discussed above under any other provision of the Internal Revenue Code and the regulations thereunder. Specifically, no opinion is expressed as to: (1) how § 367 of the Code and the regulations thereunder apply to the facts described in this ruling or (2) whether the separate business entity created by the Agreement is an eligible entity under § 301.7701-3.

This ruling is directed only to the taxpayer requesting it. Section 6110(k)(3) of the Code provides that it may not be used or cited as precedent.

In accordance with the Power of Attorney on file with this office, a copy of this letter is being sent to your authorized representative.

Sincerely,

David R. Haglund

Branch Chief, Branch 1

Office of Associate Chief Counsel

(Passthroughs & Special Industries)

Enclosures (2)

Copy of this letter

Copy for § 6110 purposes

New GAO Report on Exemption for Foreign Earnings of Nonresident "US Persons"

The GAO likes to call the foreign earned income exemption a tax expenditure, on grounds that a deviation from the norm of income inclusion is in effect a subsidy. Under this theory, exempting a nonresident US person's foreign earned income constitutes a deviation from the normal rule that for US persons, income means "income from whatever source derived."

But exempting foreign income earned by nonresident persons is absolutely not a tax expenditure. 

This is because the potential inclusion of foreign income earned by nonresident individuals in the first place is itself an anomaly that exists only in the US income tax. All other countries exempt foreign income earned by nonresident individuals as a foundational principle. It is only the US that does not do this. If the US sensibly followed the rest of the world, it would have no need for a foreign earned income exemption.

The anomaly of taxing nonresidents as if resident is what falsely leads the GAO to the conclusion that an exemption for foreign income constitutes a deviation from the normative baseline. When the true source of the deviation is correctly located in the extraterritorial definition of resident instead, it is clear that an exemption of foreign income earned by a nonresident individual does not constitute a subsidy or expenditure but rather a limited correction of a category error. 

In any event, read the whole report here. 

Are Sole Executive Agreements Next on the Roberts Court Chopping Block?

Peter Spiro has a post up over at opinio juris on a pending US constitutional challenge to FATCA, of interest. No surprise, I agree with him that the strongest case is likely to be found in the violation of the treaty power (and not just because he points to my own work on the subject!) He says:

The Treaty Clause argument is a plausible one, the doctrinal terrain at least unsettled. The FATCA agreements enjoy implied congressional authorization, at best, in the form of prior tax treaties. ...There is a lot of history behind sole executive agreements but not much judicial precedent. ... Could this be another platform for the Supreme Court to advance its formalist turn in foreign relations law?

A very good question.

Next Tuesday: Appearance at Parliamentary Committee on Finance to Discuss FATCA

I will appear in front of the Standing Committee on Finance to discuss Canada's undertakings with respect to FATCA as presented in Bill C-31, next Tuesday at 3:30 pm or thereabouts. You can find the information here.

Here are links to the meetings so far in which Bill C-31 has been discussed:

May 1 2014

• Minutes
• Recording

May 6 2014

• Minutes
• Recording 

May 8 2014

• Recording

I have not found transcripts to these.

You can read some of the submissions people have made regarding Bill C-31 here. Submissions are limited to five pages. I hope to make a submission soon, as the submission that I made with Prof. Cockfield is too long. But please read it anyway.

It's like the left hand does not know what the right hand is doing

But that might be too charitable.

Global business tax clamp-down could sting U.S. -IRS official

The FATCA Tax Hunt is for Anyone – not just the Rich!

Ireland To Analyse Tax System's Impact on Developing Nations

This is a story to watch: Ireland is going to "review the impact its tax system may have on the economies of developing countries" with a "spillover analysis" research project that "will be conducted by consultants and overseen by a steering group consisting of officials from the Finance and Foreign Affairs Departments."

This is a fascinating development. I have long argued that tax competition is as much or more a supply side phenomenon as a demand side one, that is, it is nonsense to tell developing countries to lay off the tax incentives and get serious about taxing multinationals without looking at those MNC's home countries that are not effectively taxing these flagship companies and are therefore sending them out into the world looking for the best tax deals they can find. It seems patently obvious that anyone who is thinking about the connection between taxation and development really has to look at taxation as a globally integrated system even though it's more or less a Hobbesian war of all against all when it comes to setting national tax policy.

As a result, Ireland's request for research proposals is of great interest. From the story linked above:

The Government has published a request for Proposal/Tender outlining its aims and asking that prospective consultants provide details of suitable methodologies for their work. A public consultation document has also been released, and invites interested parties to make submissions. The initiative forms part of a broader effort to clarify Ireland's approach to international corporate tax issues. ... Ireland is further pledged to support such countries in raising domestic tax revenues in an efficient way, to promote good governance and equitable development, and enable them to eventually exist independently from official development assistance. The Department has also described the spillover analysis as a response to calls from the Group of 20 nations and civil society groups for all countries to be aware of these issues when formulating their own tax policy.

I look forward to watching this unfold.

FATCA non-delay delay

Treasury playing a little game here: keep driving forward yet refrain from actually imposing FATCA's sanctions, except in those countries it is publicly acceptable to sanction. As an important aside, if there was ever any doubt as to the nature of FATCA's "withholding tax" before, that should now finally be put to rest. This is not a tax, it is an economic sanction to coerce persons outside the jurisdiction to comply with domestic information gathering goals, which can also be used to inflict punishment for other, unrelated offences. But what does it mean for the rule of law and for taxpayer expectations to have the threat of economic sanctions held steady with the release trigger depending on the IRS' 'sense' of taxpayer efforts? How will withholding agents interpret their obligations as of July 1? The below notice will require some very close reading by a great number of people.

Notice 2014-33; 2014-21 IRB 1 

Further Guidance on the Implementation of FATCA

and Related Withholding Provisions

I. PURPOSE

This notice announces that calendar years 2014 and 2015 will be regarded as a transition period for purposes of Internal Revenue Service (IRS) enforcement and administration with respect to the implementation of FATCA by withholding agents, foreign financial institutions (FFIs), and other entities with chapter 4 responsibilities, and with respect to certain related due diligence and withholding provisions under chapters 3 and 61, and section 3406, that were revised in regulations issued earlier this year as referenced in section II of this notice. This notice also announces the intention of the Department of the Treasury (Treasury) and the IRS to further amend the regulations under sections 1441, 1442, 1471, and 1472, as applicable, to provide: (i) that a withholding agent or FFI may treat an obligation (which includes an account) held by an entity that is opened, executed, or issued on or after July 1, 2014, and before January 1, 2015, as a preexisting obligation for purposes of sections 1471 and 1472, subject to certain modifications described in section IV of this notice; (ii) additional guidance under section 1471 concerning the requirements for an FFI (or a branch of an FFI, including a disregarded entity owned by an FFI) that is a member of an expanded affiliated group of FFIs to be treated as a limited FFI or limited branch, including the requirement for a limited FFI to register on the FATCA registration website; (iii) a modification to the standards of knowledge for withholding agents under § 1.1441-7(b) for accounts documented before July 1, 2014; and (iv) a revision to the definition of a reasonable explanation of foreign status in § 1.1471-3(e)(4)(viii). Prior to the issuance of these amendments, taxpayers may rely on the provisions of this notice regarding these proposed amendments to the regulations.

The transition period and other guidance described in this notice is intended to facilitate an orderly transition for withholding agent and FFI compliance with FATCA's requirements, and responds to comments regarding certain aspects of the regulations under chapters 3 and 4.

II. BACKGROUND

A. Final and Temporary Regulations under Chapter 4

On March 18, 2010, the Hiring Incentives to Restore Employment Act of 2010, Pub. L. 111-147 (H.R. 2847), added chapter 4 to Subtitle A of the Code. Chapter 4 generally requires withholding agents to withhold at a 30 percent rate on certain payments to an FFI unless the FFI has entered into an agreement (FFI agreement) to obtain status as a participating FFI and to, among other things, report certain information with respect to U.S. accounts. Chapter 4 also imposes on withholding agents certain withholding, documentation, and reporting requirements with respect to certain payments made to certain non-financial foreign entities (NFFEs). 

On January 17, 2013, Treasury and the IRS published final regulations under chapter 4 (TD 9610, 78 Fed. Reg. 5873) (final chapter 4 regulations). Following the publication of the final chapter 4 regulations, Treasury and the IRS issued Notice 2013-43 (2013-31 I.R.B. 113) to preview, among other things, a revised timeline for implementation of the FATCA requirements. On February 20, 2014, Treasury and the IRS released temporary regulations under chapter 4 (T.D. 9657, 79 Fed. Reg. 12,812) (temporary chapter 4 regulations) that clarify and modify certain provisions of the final chapter 4 regulations, including incorporating the revised timeline for the implementation of FATCA set forth in Notice 2013-43. The temporary chapter 4 regulations accordingly require that withholding agents (including participating FFIs, qualified intermediaries, withholding foreign partnerships, and withholding foreign trusts) begin withholding with respect to withholdable payments made on or after July 1, 2014, unless the withholding agent can reliably associate the payment with documentation upon which it is permitted to rely to treat the payment as exempt from withholding under chapter 4. On February 20, 2014, Treasury and the IRS also released temporary regulations under chapters 3 and 61, and section 3406 (T.D. 9658, 79 Fed. Reg. 12,726) (temporary coordination regulations), to coordinate those regulations with the requirements provided in the final and temporary chapter 4 regulations.

To date, the IRS has published updated final versions of all forms in the Forms W-8 series and certain instructions to these forms to incorporate the documentation requirements of chapter 4. The IRS expects to publish all of the remaining instructions in this series in the near future.

B. Intergovernmental Agreements (IGAs)

During 2012, Treasury first released Model 1 and Model 2 intergovernmental agreements (IGAs) to facilitate the implementation of FATCA and to avoid legal impediments under local law that would otherwise limit an FFI's ability to comply with the requirements under chapter 4. On April 2, 2014, Treasury and the IRS published Announcement 2014-17 (2014-18 I.R.B. 1001), providing that the jurisdictions treated as having an IGA in effect would include jurisdictions that, before July 1, 2014, have reached agreements in substance with the United States on the terms of an IGA and that have consented to be included on the Treasury and IRS lists of such jurisdictions, in addition to jurisdictions that have already signed IGAs. An FFI that is resident in, or organized under the laws of, a jurisdiction that is included on the Treasury and IRS lists as having an IGA in effect is permitted to register on the FATCA registration website and is permitted to certify to a withholding agent its status as an FFI covered by an IGA. As of May 1, 2014, Treasury had signed 30 IGAs, and had agreements in substance with 29 jurisdictions. A complete list can be found on Treasury's website, available at http://www.treasury.gov/resource-center/tax-policy/treaties/Pages/FATCA.aspx.

III. TRANSITION PERIOD FOR ENFORCEMENT AND ADMINISTRATION OF COMPLIANCE

Calendar years 2014 and 2015 will be regarded as a transition period for purposes of IRS enforcement and administration of the due diligence, reporting, and withholding provisions under chapter 4, as well as the provisions under chapters 3 and 61, and section 3406, to the extent those rules were modified by the temporary coordination regulations. With respect to this transition period, the IRS will take into account the extent to which a participating or deemed-compliant FFI, direct reporting NFFE, sponsoring entity, sponsored FFI, sponsored direct reporting NFFE, or withholding agent has made good faith efforts to comply with the requirements of the chapter 4 regulations and the temporary coordination regulations.

For example, the IRS will take into account whether a withholding agent has made reasonable efforts during the transition period to modify its account opening practices and procedures to document the chapter 4 status of payees, apply the standards of knowledge provided in chapter 4, and, in the absence of reliable documentation, apply the presumption rules of § 1.1471-3(f). Additionally, for example, the IRS will consider the good faith efforts of a participating FFI, registered deemed-compliant FFI, or limited FFI to identify and facilitate the registration of each other member of its expanded affiliated group as required for purposes of satisfying the expanded affiliated group requirement under § 1.1471-4(e)(1).

An entity that has not made good faith efforts to comply with the new requirements will not be given any relief from IRS enforcement during the transition period. Further, the IRS will not regard calendar years 2014 and 2015 as a transition period with respect to the requirements of chapters 3 and 61, and section 3406, that were not modified by the temporary coordination regulations. For example, the IRS will not provide transitional relief with respect to its enforcement regarding a withholding agent's determinations of the character and source of payments for withholding and reporting purposes. The transition period for compliance provided in this notice is similar to other transition periods that the IRS has provided when it has introduced or significantly revised due diligence, reporting, and withholding rules. See, e.g., Notice 98-16 (1998-15 I.R.B 12), Notice 99-25 (1999-20 I.R.B 75), and Notice 2001-4 (2001-2 I.R.B. 267).

IV. TREATMENT OF CERTAIN ENTITY OBLIGATIONS ISSUED, OPENED, OR EXECUTED ON OR AFTER JULY 1, 2014

A. Chapter 4 Regulations

Under the chapter 4 regulations, withholding agents (other than participating FFIs and registered deemed-compliant FFIs) are generally required to implement new account opening procedures beginning on July 1, 2014. A participating FFI is required to implement new account opening procedures on the later of July 1, 2014, or the effective date of its FFI agreement, and a registered deemed-compliant FFI is required to implement new account opening procedures on the later of July 1, 2014, or the date on which the FFI registers as a deemed-compliant FFI and receives a global intermediary identification number (GIIN). 

Comments received after the publication of the temporary chapter 4 regulations have indicated that the release dates of the final Forms W-8 and accompanying instructions present practical problems for both withholding agents and FFIs to implement new account opening procedures beginning on July 1, 2014. In consideration of these comments, Treasury and the IRS intend to amend the chapter 4 regulations to allow a withholding agent or FFI to treat an obligation held by an entity that is issued, opened, or executed on or after July 1, 2014, and before January 1, 2015, as a preexisting obligation for purposes of implementing the applicable due diligence, withholding, and reporting requirements under chapter 4. The proposed amendments to the chapter 4 regulations described in this section IV will be available only to obligations held by entities. The proposed amendments to the chapter 4 regulations will not be available for obligations held by individuals because the procedures for documenting individual accounts are less complex than those for documenting entities for chapter 4 purposes and the Form W-8BEN (for withholding agents to document individuals) and its accompanying instructions were published in final form on March 3, 2014.

More specifically, the proposed amendments will allow withholding agents and FFIs to treat any obligation held by an entity that is issued, opened, or executed on or after July 1, 2014, and before January 1, 2015, as a preexisting obligation for purposes of the due diligence and withholding requirements applicable to preexisting obligations described in §§ 1.1471-2(a)(4)(ii), 1.1472-1(b)(2), and 1.1471-4(c)(3), except that an FFI may not apply the documentation exception under § 1.1471-4(c)(3)(iii).

As a result, a withholding agent that treats an obligation described in this section IV as a preexisting obligation will have the additional time provided in § 1.1471-2(a)(4)(ii) or § 1.1472-1(b)(2) in order to document an entity that is a payee or account holder of the obligation to determine whether the entity is a payee subject to withholding under chapter 4. For example, a withholding agent may document an entity that is a payee of an obligation issued, opened, or executed on or after July 1, 2014, and before January 1, 2015, by December 31, 2014, if the payee is a prima facie FFI, or by June 30, 2016, in all other cases (as provided in § 1.1471-2(a)(4)(ii)). A withholding agent would otherwise be required to document the entity by the earlier of the date a withholdable payment is made or within 90 days of the date the obligation is issued, opened, or executed.

An FFI that is a participating FFI or registered deemed-compliant FFI may also treat an obligation held by an entity that is issued, opened, or executed on or after July 1, 2014, and before January 1, 2015, as a preexisting obligation to document the obligation for chapter 4 purposes within the period permitted under § 1.1471-4(c)(3)(ii) as if the effective date of its FFI agreement or the date on which the FFI registers as a deemed-compliant FFI and receives a GIIN is June 30, 2014, and may not exclude such accounts from review under § 1.1471-4(c)(3)(iii).

The proposed amendments to the chapter 4 regulations described in this notice will not otherwise affect the timelines provided in the final and temporary chapter 4 regulations for due diligence, reporting, or withholding and will not modify the starting date for an FFI to implement new account opening procedures with respect to accounts maintained by the FFI that are held by individuals. For example, if a withholding agent treats an obligation held by an entity that is issued, opened, or executed on or after July 1, 2014, and before January 1, 2015, as a preexisting obligation and receives a Form W-8BEN-E from the entity to document its status as a nonparticipating FFI, the withholding agent must begin withholding and reporting under chapter 4 when otherwise required for a preexisting obligation under the chapter 4 regulations.

B. Intergovernmental Agreements

The Model 1 and Model 2 IGAs contain a provision that allows a partner jurisdiction that has entered into an IGA to receive the benefit of certain more favorable terms that are set forth in a later signed IGA, including revisions to the procedures under Annex I of an applicable IGA, unless the partner jurisdiction declines in writing to adopt the update (the "most-favored nation" provision). With respect to FFIs covered by an IGA, Treasury intends to update the due diligence procedures described in Annex I of the Model 1 and Model 2 IGAs to incorporate due diligence procedures consistent with this notice.

Thus, it is expected that Annex I of future Model 1 and Model 2 IGAs will include a new due diligence procedures for an entity account opened on or after July 1, 2014, and before January 1, 2015, to allow an FFI covered by a Model 1 IGA or Model 2 IGA to treat such an account as a preexisting entity account, but without permitting application to such accounts of the $250,000 exception for preexisting entity accounts that are not required to be reviewed, identified, or reported. A partner jurisdiction with an IGA that has been signed or that has reached an agreement in substance will be permitted to adopt the revised due diligence procedures described above pursuant to the most-favored nation provision contained within its IGA, once an IGA with the revised procedures has been signed with another partner jurisdiction.

Annex I of the Model 1 IGA contains a provision that allows a partner jurisdiction to permit a reporting Model 1 FFI to rely on the procedures described in relevant U.S. Treasury regulations to establish whether an account is a U.S. reportable account or an account held by a nonparticipating financial institution. Annex I of the Model 2 IGA contains a provision that allows a reporting Model 2 FFI to rely on the procedures described in relevant U.S. Treasury regulations to establish whether an account is a U.S. reportable account or an account held by a nonparticipating financial institution. Prior to the publication of the proposed amendments to the chapter 4 regulations, a partner jurisdiction may rely on the provisions of this notice to permit a reporting Model 1 FFI to apply the due diligence procedures for documenting entity accounts described in this section IV. Similarly, prior to the publication of the proposed amendments to the chapter 4 regulations, a reporting Model 2 FFI may rely on the provisions of this notice to apply the due diligence procedures for documenting entity accounts described in this section IV.

V. MODIFICATION OF THE STANDARDS OF KNOWLEDGE RULES UNDER CHAPTER 3

A. Background on Reason to Know

The temporary coordination regulations, among other things, revised the reason to know standard under § 1.1441-7(b) to provide that a withholding agent will have reason to know that documentation establishing the foreign status of a direct account holder is unreliable or incorrect if the withholding agent has a current telephone number for the account holder in the United States and no telephone number for the account holder outside the United States, or has a U.S. place of birth for the account holder. See § 1.1441-7(b)(5) and (8). The addition of rules concerning a U.S. telephone number and a U.S. place of birth as U.S. indicia to the standards of knowledge for withholding agents was made in the temporary coordination regulations to coordinate with the standards of knowledge applicable to a withholding agent's reliance on a payee's claim of foreign status for chapter 4 purposes. The temporary coordination regulations also provide a transitional rule to allow a withholding agent that has previously documented the foreign status of a direct account holder for chapters 3 and 61 purposes prior to July 1, 2014, to continue to rely on such documentation without regard to whether the withholding agent has a U.S. telephone number or U.S. place of birth for the account holder. The withholding agent would, however, have reason to know that the documentation is unreliable or incorrect if the withholding agent is notified of a change in circumstances with respect to the account holder's foreign status or the withholding agent reviews documentation for the account holder that contains a U.S. place of birth. See § 1.1441-7(b)(3)(ii).

B. Modification of the Standards of Knowledge

Commentators have noted that the transitional rule for preexisting obligations described in § 1.1441-7(b)(3)(ii) has limited use for withholding agents because it is tied to a withholding agent's reliance on documentation obtained from an account holder prior to July 1, 2014, and may therefore not include cases in which a withholding agent renews a withholding certificate or documentary evidence on or after July 1, 2014, under the requirements of § 1.1441-1(e)(4)(ii)(A) (referring to the time period for renewal of certain withholding certificates or documentary evidence). Commentators further note that because of the extension until December 31, 2014, provided in the temporary coordination regulations for withholding agents to renew withholding certificates and documentary evidence that would have otherwise expired on December 31, 2013, withholding agents will have a significant number of accounts that were documented prior to July 1, 2014, but that will need to be re-documented by December 31, 2014, at which time they will no longer be able to rely on the transitional rule in § 1.1441-7(b)(3)(ii) even if the renewal documentation does not include any information indicating a change in circumstances. See § 1.1441-1(e)(4)(ii)(A) for the extended renewal allowance for withholding certifications and documentary evidence otherwise expiring on December 31, 2013.

Accordingly, Treasury and the IRS intend to amend the temporary coordination regulations to provide that a direct account holder will be considered documented prior to July 1, 2014, without regard to whether the withholding agent obtains renewal documentation for the account holder on or after July 1, 2014 pursuant to the requirements of § 1.1441-1(e)(4)(ii)(A). Therefore, a withholding agent that has documented a direct account holder prior to July 1, 2014, is not required to apply the new reason to know standards relating to a U.S. telephone number or U.S. place of birth until the withholding agent is notified of a change in circumstances with respect to the account holder's foreign status (other than renewal documentation that is required under § 1.1441-1(e)(4)(ii)(A)) or reviews documentation for the account holder that contains a U.S. place of birth. See § 1.1441-7(b)(3)(ii).

VI. REVISION OF THE DEFINTION OF REASONABLE STATEMENT UNDER CHAPTER 4

A. Background on Reasonable Explanation Supporting a Claim of Foreign Status

The final chapter 4 regulations in § 1.1471-3(e)(4)(viii) and the temporary coordination regulations in § 1.1441-7(b)(12) each provide that a withholding agent may rely on the foreign status of an individual account holder irrespective of certain U.S. indicia if, in certain cases, the account holder provides a reasonable explanation supporting the account holder's claim of foreign status. Section 1.1441-7(b)(12) describes a reasonable explanation supporting a claim of foreign status for chapter 3 purposes as either a written statement prepared by an individual or a checklist provided by a withholding agent stating that the individual meets the requirements described in § 1.1441-7(b)(12)(i) through (iv). Section 1.1471-3(e)(4)(viii) also describes a reasonable explanation supporting a claim of foreign status by an individual account holder for chapter 4 purposes, and it is substantially similar to the description under § 1.1441-7(b)(12), except that it limits the contents of a reasonable statement provided by an individual account holder to the explanations permitted on the checklist. Thus, unlike the description provided in the temporary coordination regulations, the description provided in the final chapter 4 regulations does not permit an individual to provide a written explanation other than an explanation that the individual meets the requirements described in § 1.1471-3(e)(4)(viii)(A) through (D).

B. Revision of Reasonable Explanation Prepared by an Individual

Commentators have noted that the description of a reasonable explanation of foreign status in the final chapter 4 regulations differs from the description provided in the temporary coordination regulations. Treasury and the IRS intend to amend the final chapter 4 regulations to adopt the description of a reasonable explanation of foreign status provided in the temporary coordination regulations, which permit an individual to provide a reasonable explanation that is not limited to an explanation meeting the requirements of § 1.1471-3(e)(4)(viii)(A) through (D). 

VII. LIMITED FFIS AND LIMITED BRANCHES

A. Background

The final and temporary chapter 4 regulations require that for any member of an expanded affiliated group (as defined in § 1.1471-5(i)(2)) to obtain status as a participating FFI or registered deemed-compliant FFI, each FFI member of the expanded affiliated group must have a chapter 4 status of a participating FFI, deemed-compliant FFI, exempt beneficial owner, or limited FFI. The final chapter 4 regulations also provide in § 1.1471-4(e)(2)(iv) and (3)(iii) that an FFI or branch of a participating FFI must be registered with the IRS and agree to certain conditions in order to be treated as a limited FFI or limited branch. The conditions for limited FFI or limited branch status include, among other things, that the FFI or branch not open accounts that it is required to treat as U.S. accounts or accounts held by nonparticipating FFIs, including accounts transferred from any member of its expanded affiliate group.

The IRS's FATCA registration website, available at www.irs.gov/FATCA, serves as the primary way for FFIs to register for status as a participating FFI, registered deemed-compliant FFI, or limited FFI. The FATCA registration website allows FFIs that are members of an expanded affiliated group to designate a lead financial institution (Lead FI) to identify member FFIs that will register as participating FFIs, registered deemed-compliant FFIs, or limited FFIs and to perform certain functions with respect to member FFIs. A Lead FI is not, however, required to act as a Lead FI for all FFIs within an expanded affiliated group.

B. Relief from Limited FFI and Limited Branch Restrictions on Account Opening.

FFIs and other stakeholders continue to express strong support for IGAs as a way to facilitate effective and efficient FATCA implementation while avoiding conflicts with local law. While Treasury stands ready and willing to negotiate IGAs based on the published models, commentators have expressed practical concerns about the status of FFIs and branches of FFIs in jurisdictions that are slow to engage in IGA negotiations and that have legal restrictions impeding their ability to comply with FATCA, including the conditions for limited FFI or limited branch status under the chapter 4 regulations. Specifically, comments have noted that the restrictions imposed by the final chapter 4 regulations on a limited branch or limited FFI on opening any account that it is required to treat as a U.S. account or as held by a nonparticipating FFI hinders the ability of an FFI to agree to the conditions of limited status due, for example, to requirements under local law to provide individual residents with access to banking services or to the business needs of the FFI to secure funding from another FFI in the same jurisdiction with similar impediments to complying with the requirements of FATCA.

In response to these comments, Treasury and the IRS intend to amend the final chapter 4 regulations to permit a limited FFI or limited branch to open U.S. accounts for persons resident in the jurisdiction where the limited branch or limited FFI is located, and accounts for nonparticipating FFIs that are resident in that jurisdiction, provided that the limited FFI or limited branch does not solicit U.S. accounts from persons not resident in, or accounts held by nonparticipating FFIs that are not established in, the jurisdiction where the FFI (or branch) is located and the FFI (or branch) is not used by another FFI in its expanded affiliated group to circumvent the obligations of such other FFI under section 1471. This modification is consistent with the treatment of related entities and branches provided in the model IGAs.

C. Registration of Limited FFIs.

Commentators have also stated that certain jurisdictions are explicitly prohibiting an FFI resident in, or organized under the laws of, the jurisdiction from registering with the IRS and agreeing to any status, including status as a limited FFI, regardless of whether the FFI would otherwise be able to comply with the requirements of limited FFI status. Treasury and the IRS intend to amend the final chapter 4 regulations to provide that, if an FFI is prohibited under local law from registering as a limited FFI, the prohibition will not prevent the members of its expanded affiliated group from obtaining statuses as participating FFIs or registered deemed-compliant FFIs if the first-mentioned FFI is identified as a limited FFI on the FATCA registration website by a member of the expanded affiliated group that is a U.S. financial institution or an FFI seeking status as a participating FFI (including a reporting Model 2 FFI) or reporting Model 1 FFI. In order to identify the limited FFI, the member of the expanded affiliated group will be required to register as a Lead FI with respect to the limited FFI and provide the limited FFI's information in Part II of the FATCA registration website. If the Lead FI is prohibited from identifying the limited FFI by its legal name, it will be sufficient if the Lead FI uses the term "Limited FFI" in place of its name and indicates the FFI's jurisdiction of residence or organization. 

By identifying a limited FFI in the FATCA registration website pursuant to this subsection VII.C, the Lead FI is confirming that: (1) the FFI made a representation to the Lead FI that it will meet the conditions for limited FFI status, (2) the FFI will notify the Lead FI within 30 days of the date that such FFI ceases to be a limited FFI because it either can no longer comply with the requirements for limited status or failed to comply with these requirements, or that the limited FFI can comply with the requirements of a participating FFI or deemed-compliant FFI and will separately register, to the extent required, to obtain its applicable chapter 4 status, and (3) the Lead FI, if it receives such notification or knows that the limited FFI has not complied with the conditions for limited FFI status or that the limited FFI can comply with the requirements of a participating FFI or deemed-compliant FFI, will, within 90 days of such notification or acquiring such knowledge, update the information on the FATCA registration website accordingly and will no longer be required to act as a Lead FI for the FFI. In the case in which the FFI can no longer comply or failed to comply with the requirements of limited FFI status, the Lead FI must delete the FFI from Part II of the FATCA registration website and must maintain a record of the date on which the FFI ceased to be a limited FFI and the circumstances of the limited FFI's non-compliance that will be available to the IRS upon request.

VIII. DRAFTING INFORMATION

The principal author of this notice is Tara N. Ferris of the Office of Associate Chief Counsel (International). For further information regarding this notice, contact Ms. Ferris at (202) 317-6942 (not a toll-free call).

For a couple of instant reactions from the compliance industry: KPMG; Deloitte.
In the media: Accounting Today; Reuters.

Irony from the IRS

From the purveyors of FATCA, this is pretty rich.

Report on outsourcing public services to for-profit corporations

I've expressed doubts before about whether it makes sense to turn to private companies to provide public goods, but I missed this paper when it was published last December. Introduction:

Eager for quick cash, state and local governments across America have for decades handed over control of critical public services and assets to corporations that promise to handle them better, faster and cheaper. Unfortunately for taxpayers, not only has outsourcing these services failed to keep this promise, but too often it undermines transparency, accountability, shared prosperity and competition – the underpinnings of democracy itself. As state legislatures soon reconvene, policy makers likely will consider more outsourcing proposals. Out of Control: The Coast-to-Coast Failures of Outsourcing Public Services to For-Profit Corporations serves as a cautionary tale for lawmakers and taxpayers alike. 

Too often, outsourcing means taxpayers have very little say over how tax dollars are spent and no say on actions taken by private companies that control our public services. Outsourcing means taxpayers cannot vote out executives who make decisions that hurt public health and safety. Outsourcing means taxpayers are contractually stuck with a monopoly run by a single corporation – and those contracts often last decades. And outsourcing too often means a race to the bottom for the local economy, as wages and benefits fall while corporate profits rise. 

This report highlights the failed experiences of cities and states across the country that recently experimented with outsourcing in a variety of sectors. Organized by failures in transparency, accountability, shared prosperity and competition, these stories will show how hastily and ill- conceived outsourcing deals fail to protect taxpayers and the public interest. The last section will provide recommendations of responsible contracting practices, including implementation of ITPI’s Taxpayer Empowerment Agenda, which can mitigate the risks of outsourcing and ensure that public dollars are not blindly funneled into corporate coffers, but used to further a communities best interest.

Bartering services is about desperation in the face of labor market failure

Kevin Roose published The Sharing Economy Isn’t About Trust, It’s About Desperation in NY Magazine last week, in response to the Wired Story on How Airbnb and Lyft Finally Got Americans to Trust Each Other. Roose says not so fast:

[T]he sharing economy has succeeded in large part because the real economy has been struggling. A huge precondition for the sharing economy has been a depressed labor market, in which lots of people are trying to fill holes in their income by monetizing their stuff and their labor in creative ways.

He takes a look at labor's share of economic growth and provides a couple of alarming charts...

how many full-time jobs have been replaced by part-time jobs since the recession of 2008:

what's happened to real wages:

Roose concludes:

A narrative about labor-market weakness isn't as uplifting as one about strangers learning to trust enough other with the help of ride-sharing apps. But it's a necessary piece of the puzzle. Tools that help people trust in the kindness of strangers might be the thing pushing hesitant sharing-economy participants over the threshold to adoption. But what's getting them to the threshold in the first place is a damaged economy, and harmful public policy that has forced millions of people to look to odd jobs for sustenance.

Diane Ring on The Influence of Experts

Diane Ring has a post up over at Jotwell reviewing Mai'a Cross' Rethinking Epistemic Communities Twenty Years Later, which was published last year. Professor Ring says:

Rethinking Epistemic Communities emerges from one broad strand of IR theory, cognitivism, which explores how we know what we want, what we value, and what we seek. That is, even if much of international relations activity concerns the use of power and/or bargaining games to secure “desired” outcomes, how do countries and other key actors determine what they want? Certainly in some cases the parameters of what a country seeks to achieve may seem relatively clear, but in many others the outcome or at least its particular form, is less obvious. 

...As Cross articulates, the study of epistemic communities, particularly in the context of transnational global governance highlights how both state actors and the increasingly important non-state actors are affected by epistemic communities and the constructions of norms, goals, and shared understandings. She acknowledges certain criticisms of the concept but sees them not so much as a constraint on further research but rather a road map of the important questions that future scholarship should address.

Head over to jotwell to read the rest.

Recent items of interest on citizenship, immigration, and taxation

• The Times of Monaco: Toward Tax Exemption for French born in Monaco, changes coming in France's citizenship-based tax regime for residents of Monaco
• Patrick Weil: Citizenship, Passports, and the Legal Identity of Americans: Edward Snowden and Others Have a Case in the Courts, lacking the ability to revoke citizenship, the state department is revoking passports instead
• Fulbright Canada blog has a post on its 19th Annual Nineteenth Annual International Studies Symposium, featuring interviews with five of the conference participants, including Arthur Cockfield who spoke on FATCA
• Adam Geller has an AP story on "More renounce citizenship but deny stereotype"--I think that they meant "defy" there
• Victoria Ferauge has posted Two Faces of American Emigration/Expatriation, comparing contrary public consciousness around expatriators Ed Saverin and Tina Turner

Blank on Collateral Compliance

Josh Blank has a new paper available on U.S. tax penalties, which is of broad interest given the increasing role of penalties in corralling a global diaspora into the US tax net. Abstract:

As most of us are aware, noncompliance with the tax law can lead to tax penalties, which almost always take the form of monetary sanctions. But noncompliance with the tax law can have other consequences as well. Collateral sanctions for tax noncompliance—which apply on top of traditional tax penalties to revoke or deny government-provided benefits—increasingly apply to individuals who have failed to obey the tax law. They range from denial of hunting permits to suspension of driver’s licenses to revocation of passports. Further, as the recent Supreme Court case Kawashima v. Holder demonstrates, some individuals who are subject to tax penalties for committing tax offenses involving “fraud or deceit” may even face deportation from the United States. 

When analyzing sanctions as incentives for tax compliance, tax scholars have focused almost exclusively on the design and implementation of monetary penalties. This Article, in contrast, introduces the collateral tax sanction as a new form of tax penalty that does not require noncompliant taxpayers to pay the government money and that does not require a taxing authority to implement it. Drawing on behavioral research and experiments in the tax context and other areas, I argue that collateral tax sanctions can promote voluntary tax compliance more effectively than the threat of additional monetary tax penalties, especially if governments increase public awareness of these sanctions. Governments should therefore embrace collateral tax sanctions as a means of tax enforcement, and taxing authorities should publicize them affirmatively. 

After considering the effects of collateral tax sanctions under the predominant theories of voluntary compliance, I propose principles that governments should consider when designing collateral tax sanctions. These principles suggest, for example, that initiatives to revoke driver’s licenses or professional licenses from individuals who fail to file tax returns or pay outstanding taxes would likely promote tax compliance. However, whether the sanction of deportation for tax offenses involving fraud or deceit will have positive compliance effects is far less certain. Finally, I suggest how taxing authorities should publicize these sanctions to foster voluntary compliance.

The paper includes an interesting, if brief, section entitled "Why do People Pay Taxes" that is of note.

European Commission Seeks Input on Tax Issues of Cross-Border Citizens

The European Commission is seeking consultation through 3 June 2014 on the problems faced by "cross-border citizens."  They desire input from "[a]ll stakeholders – citizens, EU countries, tax administrations, governmental and business organisations, tax practitioners and academics." Some background:

Individuals exercising cross-border activities within the EU are often confronted with different/ additional tax issues compared to individuals who are active only within a single EU country. The issues that can arise may include complex administrative procedures in one or both countries involved that make tax compliance difficult; language barriers; different interpretations of tax treaties by the EU countries involved; difficulties in accessing relevant tax information; and difficulties in identifying officials responsible in national tax administrations. The problems often stem from the fact that two or more EU countries may have the right to tax the income in a cross-border case. Even if procedures exist in theory to prevent double or multiple taxation, the application of those procedures may be very complicated in practice. 

Some EU countries have adopted measures to address these cross-border tax problems. ... 

Although these measures are good, more may need to be done and other countries may still need to take steps in this direction. 

The Commission services are launching this public consultation with a view to inviting all interested parties to contribute to the exercise of providing information on current problems and identifying good practices applied by some EU tax administrations that go some way towards addressing these problems. This will allow the Commission to come up with solutions such as to recommend that all EU countries adopt certain good practices.

You can find links for various types of submissions at the link above.

My favorite part: "Received contributions will be published on the Internet." Yes! Very frustrating when a public consultation ends in the deafening silence of black box decsion-making based on undisclosed inputs. By making this truly public, the EC is providing a data source for researchers that could lead to more creative thinking in the long run. Lessons about the impact of tax issues on intra-European activity from this consultation might help inform our thinking about the taxation of cross border citizens more generally.

Racking Up the Money: RICO and the Revenue Rule

I am pretty sure the Revenue Rule will not survive the current era, so this paper by Kye Handy is of interest. Abstract:

The Revenue Rule, a common law rule from British court systems, prevents foreign countries from bringing claims in the United States to enforce or adjudicate tax claims that did not happen in the United States. The Supreme Court in Pasquantino v. United States held that Canada’s right to collect imported liquor taxes was not barred by the Revenue Rule. However, the 2nd Circuit in European Community v. RJR Nabisco Inc., ruled the European Union and Colombia could not recover lost tax money or enforcement costs from cigarette smuggling under RICO because of the Revenue Rule. The European Community petitioned the Supreme Court. After accepting the Community’s petition, the Court reversed and remanded the case back to the 2nd Circuit to be reheard in light of Pasquantino. The 2nd Circuit did not change its ruling citing Pasquantino as a criminal case brought by the U.S. government. With no distinction between criminal and civil RICO cases in current jurisdiction, this comment seeks to provide a solution to the split between the Second Circuit and the Supreme Court. This comment argues in favor of limitations being placed on the Revenue Rule so that it can never trump RICO claims in United States courts. In the alternative it argues if limitations cannot be placed upon the Revenue Rule then the only option is abolition. Lastly this comment provides that if limitations and abolition are not the answer, then foreign countries should appeal to the United States government to bring the RICO claims on their behalf.

And from the paper:

The Racketeering Influence and Corrupt Organizations Act (RICO) allows foreign countries to bring suit in America for illegal acts committed by American citizens. Unfortunately for these foreign countries, a common law rule denies them the remedies they seek. The Revenue Rule bars foreign RICO claims because of an almost 300 year old doctrine which states that “no country ever takes notice of the revenue laws of another.”

The author calls the rule an "injustice" and suggests it should be limited or abolished; I'd say that 300 years of history suggests there must be some good reason for the limitation, but I applaud the effort to make an argument: it is certainly more than we have seen in the context of FATCA even though it almost goes without saying that FATCA is itself, or at minimum portends, the end of the Revenue Rule as we know it. The comment gives a too-brief overview of the history but at least provides some useful sources; worth a read.

 

Netherlands Bank prohibited from discriminating against "US persons"

Here is an interesting development for FATCA: a case in which a small Dutch bank pre-emptively shuttered the accounts of 150 persons in order to avoid having to fulfill US FATCA information sharing requirements. Of course, as we well know, denying accounts to "US persons" does not exempt anyone or any entity from FATCA, but only saves the cost of annual information gathering and reporting. From the story:

BinckBank N.V. (h.o.d.n. Alex), een beleggingsbank, maakt verboden onderscheid op grond van nationaliteit door een man vanwege zijn Amerikaanse nationaliteit uit te sluiten van zijn dienstverlening.

Which very roughly translates to "BinckBank NV (DBA Alex), an investment bank, may not discriminate on grounds of nationality by denying services to a man with American citizenship."

From the case, again, very roughly translated:

A man with Dutch nationality lived most of his life in the Netherlands. He is a U.S. citizen because he was born in America. That makes him liable to tax in America, as a "U.S. person." The man has an investment account with Alex. ... Following an agreement between the Netherlands and the United States to exchange financial data, the Bank terminated the services of the man and all other (150) U.S. persons on 1 December 2013. In the course of 2014, [a law to implement an IGA with the United States was] submitted to parliament. The aim of the law is to ensure that U.S. persons who live outside of America file their tax returns with the IRS. As of July 1, 2014, Dutch financial institutions must provide information on U.S. persons to the IRS. Alex does not want to comply with the obligation to provide all transaction data by U.S. persons, because to do this, the bank must make significant adaptations to its administrative systems. Given its small number of U.S. person clients, this adaptation would impose disproportionate costs, with additional disclosure services producing a loss-making operation. According to the bank, the discrimination is not banned because it is based on a generally binding regulation. The bank also argues that the discrimination be allowed to continue, because the financial consequences are unacceptable. 

Verdict

The Board for the Protection of Human Rights ruled against BinckBank, finding that terminating service to the man constituted unlawful discrimination on grounds of nationality.

Reasoning

The bank states that U.S. persons can no longer hold accounts. The bank therefore denies its services to people with U.S. citizenship. This is direct discrimination on grounds of nationality. Direct discrimination is prohibited, unless the law makes an exception, such as in a generally binding regulation that compels a distinction. The Board considers that the bank does not oblige the agreement and the law envisaged does not allow for exclusion of individuals with U.S. citizenship. The bank has merely chosen for commercial reasons to deny service to Americans. The Board therefore dismisses the bank's statutory exception. The Board also considers that there is no reason to make the ban on the use of direct discrimination on grounds of nationality. This decision was made on the grounds of reasonableness and fairness.

My informal translator had a little trouble with the last paragraph; suggestions welcome.

From this we can see that small institutions are between a rock and a hard place, at least in the Netherlands and likely many other places as well, but only to the extent that foreign governments employ their human rights regimes to step in and protect Americans from the skewed incentives created by American law. I note that the Netherlands, along with most other IGA partner countries (but not Canada) has included an express provision forbidding discrimination, but this applies only to institutions that are not required to register because they are exempt:

Annex II: Non-Reporting Netherlands Financial Institutions And Products
II. Deemed-Compliant Financial Institutions.
A. Deemed-Compliant Financial Institutions
1. Financial Institutions with a Local Client Base
j) The Financial Institution must not have policies or practices that discriminate against opening or maintaining accounts for individuals who are Specified U.S. Persons and who are residents of the Netherlands.

I had assumed this meant that it would be ok for FIs that are required to comply with FATCA to turn away US customers, as appears to be a growing practice. Not so, if foreign governments can be relied upon to force their own institutions to bear the costs of lending assistance to the United States in perfecting its extraterritorial tax claims, under the mantle of protecting US persons' rights against discrimination in these foreign territories. 

I note that in this case the discrimination claim was mounted by the accountholder to preserve his right to banking services. I await the inevitable barrage of cases that surely must arise as individuals assert other discrimination-based claims in connection with the highly problematic U.S. tax regime.

As a not insignificant aside, it is worrying to me that here we have a foreign court explaining that the purpose of FATCA is "to ensure that U.S. persons who live outside of America file their tax returns with the IRS." I have seen absolutely no evidence that this is the case; I have seen absolutely nothing in any iteration of FATCA to suggest that the idea behind this legislation was to perfect US taxation on those living abroad with US status as citizens or otherwise. Rather, the aim of FATCA was to stop Swiss bankers selling tax evasion to Americans living in America. 

This may seem like an insignificant point but I believe it is important because one day we will look back and reflect upon what will surely turn out to have been a spectacular mistake: that FATCA induced governments around the world into a headlong rush into global automatic information exchange on the strength of an unexamined idea about which taxpayers belong to which countries. One day we are going to have that discussion, and it will need to be remembered that when the world jumped on the FATCA bandwagon, no official in any government apparently considered whether it was right, or good, or just, for the US to impose its income taxation on the basis of legal status. I think when that discussion finally takes place, that omission will be seen as fatal.

In Slovakia, Real Lottery Prize Goes to Tax Man

This is a novel idea, at least, new to me:

Over the last 10 years, Slovakia’s revenue from value-added taxes, a type of sales tax, has declined. But hiring auditors and pursuing individual merchants and service providers in court is expensive and slow. So last fall, the government decided to put a lottery in the mix.

The idea is to enlist average citizens to collect receipts from their purchases and register them with the government, creating a paper trail for transactions and forcing restaurant and shop owners to pay the sales taxes they owe. As Slovakians register their receipts for the lottery, a computer will also tell them if a merchant has issued a receipt with a fake tax identification number, so they can report suspected fraud. 

For any purchase worth more than 1 euro, or about $1.38, Slovakians can enter their receipts in a monthly lottery to win €10,000, a car or a chance to be a contestant on the Slovakian version of “The Price Is Right.” 

Tax officials say the lottery is already having a big impact, and other European countries that are also struggling with the collection of value-added taxes have considered it — including Portugal, which started its own tax lottery on Thursday. In Slovakia, about 450,000 people have taken part, registering about 60 million receipts, officials said. 

As we well know, third party reporting is an excellent way to induce honesty in taxpayers. Winning a lottery is a long shot but its very existence promotes a certain culture to develop around the reporting of taxable sales. And the winners make for good tv.

Webcourse on Cayman Islands

Andrew Morriss presents a webcourse of interest, starting May 5. The objective:

"explore the rich history of the islands and talk to local experts about the institutional, legal, and regulatory frameworks, predicated on property rights and a rule of law, that led to this mass wealth creation and complete economic transformation in only 20 short years."

Professor Morriss wrote up his research with Tony Freyer on how the Caymans became an offshore financial center, which I posted and discussed briefly here. That paper pushed buttons and I am sure the webcourse will do the same, as the international taxation landscape is undergoing some serious growing pains of late and governments around the world are reconsidering the promises and perils of regulating behavior in a globally integrated economy.

From the NYT: Lessons for International Tax from Oregon's Role as Sales/Use Tax Haven

Today's NYT has an article entitled "Buyers Find Tax Break on Art: Let it Hang Awhile in Oregon." The artful dodge is accomplished via simple arbitrage between a source, an intermediary, and a residence jurisdiction, so the story gives a nice illustration of a phenomenon we see play out on the international stage every day, only we have generally been taught to associate tax avoidance arbitrage with the likes of GE, Google, Apple, etc. Here is the simple pattern:

1. The collector lives in state A (the residence state)--in this example, California. 
2. The collector buys an expensive work of art in state B (the source state), in this case, New York. As the source state, state B could extract a tax purely on the occurrence of the sale, but chooses not to, rather basing its sales tax on place of use. 
3. State A generally imposes use taxes on items purchased from outside the state and brought into the state (this is to treat external sales the same as internal ones, which would be subject to sales taxes). But there is an exception: if an item is "used" in another state first, it is not subject to the use tax when it finally makes its way to state A.
4. To avoid the use tax, the collector can't keep the item in state B because then state B's sales tax will apply.
5. In comes state C, with no sales or use tax, in this case, Oregon. State C is a safe haven. Collector parks the asset in state C long enough to satisfy the residence state's exemption. 
6. Hey presto, neither sales nor use tax. 

Nothing illegal has occurred, as the NYT is very quick to point out. But it is also clear that this is a story for a reason, and the reason suggested by the headline is this outcome produces unfairness. 

After all, these are rich people dodging around helpless tax states with the help of sophisticated tax planners. This seems worth examining further given the parallels to corporate social responsibility and international tax planning à la Caterpillar as we have seen recently in the news, and in light of the actions of some states to try to curb international tax planning ... and please do not let it escape notice that this list includes Oregon. 

Let's identify a few problems and a few solutions in the overall tax regime created by the conflicting rules in the three independent states as suggested above. The problems seem to be:

1. residents of state A will likely object that it is not fair for state A to tax sales occurring in the state and not sales occurring outside the state (violates horizontal equity).
2. some residents of state A will likely object that it is not smart to tax sales occurring in the state and not sales occurring outside the state (people will react accordingly and the sales tax base will disappear). 
3. on the other hand, some residents of state A will argue it is smart to do this because it means more people will buy nice things and ultimately bring them into the state C, causing other spillover benefits in the long run. (If so we should question why state A has a use tax at all.)
4. state A cannot control either state B or state C but unless strict capital or other regulatory controls are applied against state A's population, state A's rules necessarily interact with B and C.
5. residents of state B might object that it is not fair for state B to tax sales only if the assets purchased stay in the state and not if they leave the state (violates horizontal equity)
6. on the other hand residents of state B will likely view it as smart for state B to tax sales only if the assets purchased stay in the state and not if they leave the state, because then more sales will occur in state B and with those sales come jobs and other spillover benefits.
7. state C just doesn't tax these things and so would seem to be neutral, acting without fault in the arbitrage.
8. state C residents likely view this neutrality as smart because the state benefits by facilitating the arbitrage between states A and B, and it can be expected to defend this benefit.
9. but what is smart for either states B or C or both creates an unqualifiedly unfair situation in state A.

So much for the problems. Are there solutions?  Again the illustration is enlightening.

1. A, B, and C could get together and demand a federal regulation to stop the arbitrage amongst the states. They could, but they won't (cooperation fails).
2. State A could threaten states B and C to stop facilitating the arbitrage or else (coercion). But what, exactly, does state A want? Does it want to force state B to tax on the basis of source? Does it want state C to tax as the conduit? Either of those would produce fairness in that the individuals would pay tax somewhere, but in neither case would it be state A collecting the tax. Also, depending on state C's political, economic, and social power relative to state A, the strategy could yield results, or not; certainly if harsh tactics are used, state A will be resented by its neighbors, and for what? No revenue, but a globally fairer system that neither B nor C wanted.
3. State A could change its own law to repeal the first use rule, which would eliminate the benefit of the arbitrage. No more icing on the cake per the collector routing through Oregon. (when people say tax planning is icing on the cake as the person did in this article, I picture a tiny cake with a tower of icing. So much icing that by the time you eat it all, there isn't any room for cake. But I digress.)

Now does it not seem that state A has the most power to fix the situation if it chooses to change its own law to nullify the arbitrage? Is this not what Oregon and other states are doing vis à vis the foreign earnings of state-registered companies?

This is what I am talking about when I say that tax avoidance is as much a supply side as a demand side problem. We can blame states B and C all day long for facilitating tax avoidance. But State A often holds the power to solve the problem itself. If state A does not do that, then we should be looking at why state A does not do that rather than why state B or state C stand by and allow or encourage and benefit from the arbitrage. Are democratic decisions being made to ignore the fairness problem in order to achieve a solution some people in state A consider to be smart, and if they are doing so, who are those people who think this is smart and have the people in state A who do not think it is so smart been allowed access to lawmaking in the same manner and capacity of those who do think it is smart?

Note that in this case there is no discussion about the problem of information asymmetry--that is, we are not looking at state B or C hiding the fact of the sale from state A. That is a different problem which state A might not be able to solve on its own (actually I believe it could but that is another story). But in terms of legal tax avoidance, I think this story is a wonderful illustration of the argument I often make, for example here and here, about who we should be looking to when facilitating legal tax avoidance becomes the central defining characteristic of a tax regime created by the interaction of multiple jurisdictions.

Thanks, New York Times, for inadvertently covering international tax policy in a fun story with pictures and even a graphic.

Call for Papers: Tax Justice & Human Rights Symposium, McGill, June 2014

We invite paper proposals for a Tax Justice and Human Rights Research Collaboration Symposium, to be held at the McGill Faculty of Law, Montreal, Quebec, from Wednesday to Friday, 18-20 June 2014.

The symposium will explore the fundamental connections between taxation and human rights by providing a forum for collaboration among students/emerging scholars, academics, civil society organization representatives, tax justice advocacy groups, tax policy makers, and researchers from around the world. The symposium seeks especially to bring developing-world perspectives into the discourse and to foster scholarly work for dissemination both within and beyond the academic setting.

The plurality of experience, in terms of training, background, country of origin, and area of expertise, will ensure that discussions and activities at the conference will have real-world impact. Indeed, there is a need within the tax-policy world for more cross-pollination between academic researchers and on-the-ground decision-makers. The connections and networking that we envision will take place at this conference should allow for meaningful discussions for years to come.

Paper proposals must be between 300-500 words in length and should be accompanied by a short résumé.

Please submit your proposal to the conference convener Professor Allison Christians, at [allison dot christians at mcgill dot ca].

Deadline for submissions: 30 April 2014. Successful applicants will be notified in early May 2014.

An initial 3-5 page sketch of the paper must be submitted by the end of May for circulation among panelists and feedback from the conference committee, but completed papers are not required; rather, we seek a readiness to collaborate and develop new heuristics for thinking about taxation and human rights. 

Conference fees for presenters will be covered by the conference organizers; travel and accommodation bursaries may be available to scholars and tax justice advocates from the Global South in connection with support from the Tax Justice Network, Canadians for Tax Fairness, Halifax Initiative, and other partners.

Please visit the Symposium's page on the Stikeman Chair in Tax Law website for more information. 

Avoidance, Evasion, and Taxpayer Morality

In light of the current sacrificing of Caterpillar on the altar of political posturing by lawmakers who are ultimately responsible for designing a global system that ensures US multinationals a world of tax-favorable opportunities, my latest SSRN post, Avoidance, Evasion and Taxpayer Morality appears à propos. It explores the difficult terrain we traverse when, confronted with the parade of household names apparently paying little or no taxes anywhere, we start talking about ethics and morality instead of law. Abstract:

In popular discourse, tax evasion by wealthy individuals is conflated with tax avoidance by multinational corporations to tell a single story about tax dodging and its negative impact on society. But conflating avoidance and evasion muddies the tax policy waters in important ways by turning legal obligations into moral ones. This Essay, prepared in connection with the Washington University School of Law colloquium on “Conceptualizing a New Institutional Framework for International Taxation,” makes the case for caution in using morality as a stop-gap measure to avoid drawing a regulated line between tax evasion and tax avoidance, while still meting out punishment within the undefined space between these two poles. It acknowledges the political gains derived from the rhetoric of morality but argues that the alternate view — that taxpayer behavior must ultimately be managed by law rather than social sanction — has the best chance of driving tax policy toward greater coherence in the long run because it makes the best case for more transparency in both lawmaking and the consequences of legislative decisions.

As always I welcome comments.