What does it mean to implement BEPS?

Today I took part in a panel discussing the topic of "Life After BEPS," at which I laid out the three categories of BEPS commitments in three slides. These categories are "minimum standards" (there are four), "recommendations" (there are several) and "best practices" (there are many). These are defined terms in BEPS world but it is already fascinating that there is some category blurring going on in the discourse surrounding implementation. I'm interested in that blurring because of course we are in the midst of a major cycle of law- and norm-making in international tax, and "what countries actually agreed upon" is really going to matter pretty soon, as the difference between convergence and divergence depends on a meeting of the minds at the level of rulemaking. This will play out through conflict and resolution at the domestic and international level in the form of both hard law (multilateral and bilateral agreements and domestic law changes) and soft law (OECD models, guidelines, and peer monitoring). In case they are of interest, I thought I would post my three slides here.

Kill Switches in the New US Model Tax Treaty

I posted previously on the new US Model, which was released in February of this year; I've now posted my article, co-written with McGill PhD student Alex Ezenagu, on the "kill switch" provisions in the new model. These provisions are found in the new articles and definitions involving special tax regimes and subsequent law changes, which would allow countries to switch on and off specified treaty benefits if their treaty partners get too aggressive in the ongoing race to the bottom on tax.

Here is the abstract:

The new US model income tax treaty contains an unusual addition: mechanisms for the parties to unilaterally override the negotiated treaty rates in specified circumstances. Previewed last year in proposed form—a first for Treasury—these new mechanisms work as kill-switches, partially terminating the treaty as to one or both treaty partners. The idea is to forestall a more problematic outcome, such as an enduring breach of one of the parties’ expectations, or the opposite, a complete termination of all the treaty terms in the face of such a breach. Yet embedding a kill-switch in a treaty creates distinct legal, procedural, and political pressures in the tax-treaty relationship that implicate treaty negotiation, ratification, interpretation, and dispute resolution. Kill-switches also communicate a defensive tenor in the tax treaty relationships among many countries. This Article analyzes the new kill-switch provisions and concludes that their introduction in the U.S. Model reflects the steady deterioration of tax treaties from essentially diplomatic documents premised on the good faith of the parties to detailed contracts drafted in anticipation of the opposite.

It has long been assumed that tax treaties are uncontroversially technical agreements that no one outside of tax circles cares about or pays attention to--including, it seems, all too many lawmakers tasked with adopting these agreements into law. But with the US Treasury and the EU competition commissioner trading barbs over the fence about what seems right or fair when it comes to global tax competition and coordination, this assumption might be changing. The consensus built up over decades by OECD nations is under stress as the pressure for coherence in the international tax realm increases. Treasury released these provisions in draft from last fall, expressly in order to influence the OECD's work on BEPS. Now that the provisions are in the model, it remains to be seen how they will play out as BEPS, currently at a mid-cycle of norm making, moves from the articulation of principles to the implementation phase. This article doesn't provide answers or predictions about the future but it examines one aspect of the ongoing contestation and tries to situate it in historical and contemporary terms.

Tax Coop 2016: "Winning the Tax Wars" May 23-24

Tax Coop and the World Bank are hosting a conference on tax competition and cooperation to be held in Washington DC on May 23-24. As last year, I've constructed the debate, which this year will be livestreamed on May 23 at 16:15 EST.  I'll post the link when I have that information. At last year's conference, Dan Mitchell (Cato) and Richard Murphy (TJN) put corporate taxation on trial, debating the continuing viability of this tax in the face of technological innovation and economic globalization. This year's debaters are Alison Holder of ActionAid and Veronique de Rugy of the Mercatus Center at George Mason University.

They will debate the following:

What’s Better for Developing Countries: 

Tax Competition or Tax Cooperation?

This question will be explored through a series of three resolutions, as follows:

1. First, be it resolved that: tax competition harms developing countries by reducing their capability to raise fiscal revenue to finance physical and social infrastructure needed for economic growth and social inclusion.
2. Second, be it resolved that: tax competition increases developing countries’ reliance on foreign aid, making them more vulnerable to aid volatility. 
3. Third, be it resolved that: tax competition aggravates existing income disparities between developed and developing countries.

Arguing the “affirming side” of each resolution will be Alison Holder of ActionAid. Arguing the “opposing side” of each resolution will be Veronique de Rugy of the Mercatus Center at George Mason University. Evidence from all jurisdictions will be admissible. The emphasis will be on persuasive, clear, and logical argumentation. The debate will proceed in four rounds and will be moderated and judged by Louise Otis of McGill University and Jay Rosengard of Harvard University. Last year's debate was definitely a highlight of the conference and I look forward to hosting Ms. Holder and Ms. DeRugy for this year's event. 

The full conference program features a slate of distinguished speakers from around the world and across public, private, and academic sectors.  Registration is free; additional program and speaker information available here and you can follow @taxCoop on twitter for updates and links. 

Citizenship-based Taxation and FATCA

I am occasionally asked for a list of the things I've written or presented about FATCA and citizenship-based taxation, and decided I may as well post it here. I have a newer article on the adoption of the IGA in Canada, will post that soon and add to this list.

On the personal impact of CBT/FATCA:

• Uncle Sam Wants...Who?  A Global Perspective on Citizenship Taxation (explaining the expansive US tax jurisdiction and its consequences on citizens abroad)
• Understanding the Accidental American—Tina’s Story (describing the “gotcha” of CBT and FATCA)
• Paperwork and Punishment: It’s Time to Fix FBAR (explaining FBAR, its mission creep, and its effects on USPersons living abroad)
• Taxpayer Rights, On and Off-shore (exploring tax complexity and compliance for nonresident US Persons)
• Regulating Tax Preparers: A Global Problem for the IRS (exploring the problem of regulating the tax compliance industry outside the US territory)
• Could a Same Country Exception Help Fix FATCA and FBAR? (calling for exemption of local accounts held by nonresident US Persons from FATCA reporting; third item in a compilation; scroll to p. 7 of the document).
• Two expert reports in connection with the Hillis v. Attorney General of Canada litigation. 

Providing Legal Analysis of FATCA and the IGAs:

• Submission to Finance Department on Implementation of FATCA in Canada (discussing legal issues with proposed adoption of IGA)
• What You Give And What You Get: Reciprocity under a Model 1 IGA (explaining asymmetrical account disclosure and sharing requirements)
• Tax Cooperation: Past, Present and Future (explaining why FATCA is a tax treaty override & the IGAs do not “cure” it)
• The Dubious Legal Nature of IGAs and Why it Matters (arguing that the IGAs violate the US constitution regarding the treaty power, and thereby implicate public international law as to the treaties they ostensibly interpret)
• Interpretation or Override: Introducing the Hybrid Tax Agreement (further analysis on the public international law problems created by the IGAs)
• Putting the Reign Back in Sovereign: Advice to the Second Obama Administration (analyzing FATCA’s unilateral nature and its implications for international tax policy)

Videos and Podcasts:

• Interview with Tax Analysts (November 2015)
• Podcast with the McGill Law Journal (February 2014)
• Testimony to Finance Committee (March 2014)
• Interview with CBC News (January 2014)
• Interview with CBC Radio "All in a Day" (July 2014)
• Explaining the basic structure and issues surrounding FATCA (2012-prior to the IGA era)

Tax competition redux: the Kansas-Missouri tug-of-war

Although I dislike the use of quasi-military imagery to describe tax competition, I think "tug-of-war" is more commonly used than "rope-pulling contest" and this is, I think, a good image to describe the phenomenon. This Planet Money podcast brilliantly captures the rope-pulling contest that characterizes tax competition among US states, which is a version of the same game playing out among the nations of the world. It should not escape attention that the taxes at stake in this story are those on property, but the two states are also involved in a race to the bottom on corporate tax--Kansas was featured in a prior Planet Money podcast (The Kansas Experiment) because its Governor is a true believer in a Laffer curve that tips at single-digits. 

The ending to this story is only surprising to those not paying attention to tax competition. Like any good rope-pulling contest, it ends with most of the people laying in the mud or on each other, and a short-lived victory for the last ones standing since there is always someone else willing to pick up the rope and tug again.

Azémar and Dharmapala on Tax Sparing and Foreign Aid

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?

This Friday in London: Conference on The Changing Shape of Tax Avoidance

This Friday, I'll be in London participating in a conference on tax avoidance and evasion, hosted by the Journal of Tax Administration. Here is the program:

11.00 – 11.15 Welcome and Introduction

11.15 – 11.50 Matthew Rablen: Optimal Income Tax Enforcement in the Presence of Tax Avoidance

11.50 – 12.25 Maya Forstater: Can Stopping ‘Tax Dodging’ by Multinational Enterprises Close the Gap in Development Finance?

12.25 – 13.00 Allison Christians: Tax Avoidance in a World of Aggressive Tax States

13.00 – 13.45 Lunch

13.45 – 14.15 Federica Bardini: The “Ius Commune Europeum” on Tax Avoidance

14.15 - 14.45 Shu-Chien Chen: The Common Pattern of the “Tax Avoidance Concept” in the EU and USA

14.45 – 15.00 Discussion

15.00 – 15.20 Break

15.20 – 15.55 David Duff: Tax Avoidance – Causes, Consequences and Responses

15.55 – 16.30 David Quentin: Tax Risk Mining and Corporate Responsibility for Human Rights

The venue for this conference is Friends House, 173 – 177 Euston Road, London.

Here is the abstract for my presentation:

Tax Avoidance in a World of Aggressive Tax States 

Media coverage of tax “dodging” by high profile elites and multinational companies leads the public to believe that tax avoidance happens when individuals act to thwart the efforts of the state. Confined to the domestic arena this may be an apt description, and a problem anti-avoidance regimes are designed to solve. But on an international scale, tax avoidance is not a one-person show. Instead, it involves interactions among four types of actors: individuals, home states, host states, and intermediary states. International tax avoidance persists largely because home, host, and intermediary states intentionally use their tax systems to lure investment away from other jurisdictions that impose higher tax burdens, and individuals do their best to exploit available opportunities to the fullest. In deciding whether and how law should be used to prevent international tax avoidance, the goals and interests of each of the four actors must be examined.

Kadet and Koontz: Are US MNCs profit shifting their way to "accidental partnership" status?

Jeffery Kadet and David Koontz have posted a new paper on SSRN entitled Profit-Shifting Structures and Unexpected Partnership Status, in which they argue that the way US-based MNCs share profits and risks with their global subsidiaries might actually result in their being in partnership with these companies for tax purposes, thus triggering interesting potential US tax consequences for the whole group.  Here is the abstract:

Many U.S.- and foreign-based MNCs that have implemented carefully researched tax strategies to reduce their income taxes are coming under increased scrutiny. Most MNC tax strategies involve businesses they conduct worldwide, but which are managed from the U.S. These strategies have several factors in common: 

(i) Companies established in tax havens or otherwise structured to attract little if any tax;
(ii) Intercompany agreements placing commercial risk and intangibles in such companies, thereby shifting profits to such companies;
(iii) Conduct of centralized activities and functions in the U.S. (in addition to group senior management), which are integral to and which critically benefit all MNC group members conducting that line of business (examples of such activities include product development, product sourcing, management of contract manufacturing process, management and control of internet platforms, etc.); and
(iv) No significant changes made to their business operations when tax strategies were implemented, meaning potentially that these structures lack economic substance.
This article suggests that in their haste to create these profit-shifting structures, the MNCs and their advisors may have overlooked two important weapons in the IRS’s arsenal to attack profit-shifting strategies. 

First, because of the centralized activities and functions within the U.S. that are integral to the business conducted by various group members (including both U.S. and foreign group members), an MNC may inadvertently create through its actions and intercompany contracts a partnership that is recognized solely for U.S. tax purposes. Once such a partnership exists for tax purposes, the various group members become its partners and the partnership conducts the applicable worldwide line of business. 

Secondly, because the partnership conducts a portion of its activities through U.S. offices and other facilities, the foreign group member partners are treated by statute as being engaged in a trade or business in the U.S. This makes them subject to U.S. taxation on their share of effectively connected income (ECI) earned by the partnership. U.S. taxation will be imposed at effective rates of 54.5% or higher. (The effective rate could be 38.25% or higher if a tax treaty applies.) 

In the absence of a partnership, whether a foreign group member is engaged in a U.S. trade or business is a factual determination that may be difficult for the IRS to establish. However, to their collective detriment, MNCs whose factual situations support the existence of a partnership that conducts such a U.S. trade or business have made it a slam-dunk for the IRS to conclude that the foreign group member partner is so engaged. The U.S. tax rules are clear – if a foreign corporation is a partner in a partnership engaged in a U.S. trade or business, then that partner will be so engaged. All MNCs with this general fact pattern and their auditors should re-examine existing profit shifting structures to determine if they could withstand an IRS charge asserting both the existence of a partnership and taxable ECI.

An interesting perspective and worth a read.