Jensen on the costly politics of tax competition

Nate Jensen recently published an op-ed of note, asking "Why Are Your State Tax Dollars Subsidizing Corporations?" Nate has studied tax and corporate decision making for some time, and recently published "Incentives to Pander: How Politicians Use Corporate Welfare for Political Gain", which is on my reading list. This is, of course, a favourite topic of mine. A few excerpts from the op-ed:

Politicians are using public policies, from renaming a city to offering billions of dollars in grants, infrastructure improvements and tax abatements, to take credit for companies’ location decisions. ...

In all likelihood, incentives are overpaying firms, leading to lost resources that could be used for other purposes. If the incentives don’t pay for themselves, they must be paid for by either higher taxes or decreases on government spending. Local school districts are vocal opponents of incentives; they see their tax base being given away in the name of economic development. 

But in fact it is most likely the quality of the work force that will be the deciding factor for Amazon, not the billions in incentives. Proponents of incentives often claim that these subsidies pay for themselves, and voters often support these efforts, believing the promises of good jobs. But this is possible only if governments perfectly target the companies that require incentives and pay just enough, and not a penny more, to sway a company’s decision.

...Political pandering is behind this explosion. But there is also some of what Brink Lindsey of the Niskanen Center and the political scientist Steven Teles call the “captured economy.” In between these politicians and corporations are economic incentive consultants, tax professionals and lobbyists all providing ways for businesses to maximize their take, and getting a percentage of these incentives in return.

There is a role for government in economic development. State and local governments can help businesses without access to finance survive and expand, provide worker training that is valuable to residents and companies, and invest in traditional education from pre-K to college. There are certainly worthy investments that can be made. But $7 million for Carrier, $3 billion for Foxconn and billions for Amazon is just using the public coffers for political theater.  

Highly recommended reading in full for anyone interested in tax competition.

Uncle Sam Wants...Who? At UBC Law This Week

This week I will be in Vancouver to present a paper at the UBC Allard School of Law. The paper, "Uncle Sam Wants...Who? A Global Perspective on Citizenship Taxation," is now available in draft form on SSRN. Here is the abstract:

Across the globe, banks are flagging accounts with indicia indicating their owners may be “US Persons,” making it possible for the United States to enforce its taxation of nonresident citizens extraterritorially for the first time in history. The indicia method constitutes a mining expedition for US citizens carried out by foreign banks and governments. Establishing a tax jurisdiction in this manner is unprecedented and has significant practical and normative consequences. In the case of so-called “accidental Americans,” it violates one of the most fundamental and universally- acknowledged tenets of taxpayer rights, namely, the right to be informed about what the law requires. Third party indicia-searching should be universally rejected as a means of identifying a taxpayer population. Instead, the United States itself is responsible for cataloguing, informing, and educating its global population of taxpayers. Those who don’t belong in the system should be allowed to opt out without cost.

I welcome comments on this work in progress.

Presumption against Extraterritoriality: Win for foreign insurers in Validus Reinsurance case

Tim Todd had an article in Forbes yesterday on the Court of Appeals grant of summary judgment in Validus Reinsurance Ltd. v. United States, decided May 26. This was a de novo review; the district court had granted summary judgment for Validus in 2014 (Mem. Op. Feb 5, 2014), and the government appealed on grounds that the district court had "adopted an overly narrow interpretation." From the Court of Appeals decision:

Because both parties offer plausible interpretations, we conclude that the text of the
statute is ambiguous with respect to its application to wholly foreign retrocessions [a type of insurance product at issue in the case]. The ambiguity is resolved upon applying the presumption against extraterritoriality because there is no clear indication by Congress that it intended the excise tax to apply to premiums on wholly foreign retrocessions. Accordingly, we affirm the grant of summary judgment, albeit on narrower grounds, on Validus’s refund claims. 

Tim explains the jargon in the case so I won't repeat that here, but his point of note is that:

Generally, courts presume that legislation operates only within the territorial jurisdiction of the United States. Thus, unless Congress expresses an “affirmative intention,” statutes have no extraterritorial effect. 

Here, the retrocessions were extraterritorial: wholly foreign parties issued policies that were “negotiated, executed, and performed outside of the United States.” And, the court noted, the “government has identified no clear indication by Congress that it intended the excise tax to apply to wholly foreign retrocessions, and we have found none.”

This is an interesting area of law that I have not studied enough but would like to. I note that the Appeals Court observed that "At first glance, the plain text of section 4371 appears to extend the reach of the IRS Commissioner to any casualty and life insurance policy issued by a foreign insurer anywhere in the world," but that read in conjunction with its definitions clauses, the scope is more modest. The court engages in a step by step statutory analysis (always fun) and ends up engaging in a fairly detailed discussion of what it means to "cover" something. Having hauled out a few dictionaries, the Court decides that the language is ambiguous, hence the need to turn to the general presumption against extra-territoriality.

In the context of a globally networked financial system, it is sometimes hard to tell the difference between something that is territorial and something that is extra-territorial in scope and reach. Here, the government had argued that the necessary nexus to the United States lay in the the underlying risks ultimately being insured--that is, "indirect" risk coverage. It seems that was one bridge too far for the DC Circuit.

UPDATE: China does NOT follow US lead, taxing its global diaspora. (If they did, it would be a terrible idea).

This is an update of an earlier post. Earlier today I wrote that the NY times reported that China is embracing US-style citizenship-based taxation, by enforcing "a little-known and widely ignored regulation: Citizens and companies must pay domestic taxes on their entire worldwide incomes, not just on what they earn in China." The update is that this is entirely wrong, and that the NY Times just completely mangled this story by failing to understand the difference between defining income and defining residence (a distinction to which I alluded in my original post, below).

The reality is discussed at length by Eric over at Isaac Brock, who explains that "No, China does not have citizenship-based taxation." Eric's interpretation has been confirmed to me by a couple of people I know who are Chinese tax experts. So, I invite you to go there to read the full account, which I won't repeat here except to quote the takeaway, which is:

China as a country has many flaws and lacks many freedoms, but at least it uses the same basic system of taxation followed by nearly every democracy and dictatorship: a system which avoids placing unreasonable barriers in the way of the basic human right to leave a country.

Thanks to Eric and thanks to my colleagues who took the trouble to write me personally to correct the record. I hope that the Times acknowledges the errors and writes a new article on the subject to confirm that yes, the US is alone in its comprehensive treatment of non-residents as if resident solely on the basis of legal status as nationals.

In my earlier post I noted that last year when reviewing constitutional articulations of the taxing power, I noticed that China's constitution would suggest that its tax authority could have a global reach:

Article 56: It is the duty of citizens of the People's Republic of China to pay taxes in accordance with the law.

Accordingly, though it seems that China's constitution leaves open the possibility for China to follow the flawed US approach, it thankfully does not. The Times reported that the move would "[put] China on the same side as the United States in a global debate over whether taxation should be primarily national or global," and then says "On the other side of the issue are European nations, Japan, Australia and Canada, all of which tax people within their borders but exempt most expatriates and overseas subsidiaries from paying income taxes in their home countries."

This is not quite right. There is a global debate about taxing multinational companies on their worldwide (group) incomes, or not. However, there is no global debate about taxing individuals on the basis of their nationality. There is the United States, and then there is the rest of the world, with a very few and very limited number of exceptions (discussed below). If China were to align with the United States on this, it would be very big news not just for the global Chinese diaspora, but also for the ongoing OECD project on automatic exchange of information and for FATCA, because both regimes will struggle to implement the impossible demands of birthright tracing, which is necessary to enforce citizenship taxation.

The taxation of citizenship is about the definition of tax residence, rather than the definition of income.  Many or perhaps most developed countries tax all individual residents, regardless of nationality, on their worldwide incomes. This makes sense because taxation is the pooling of resources for shared expenditures, and nationality and citizenship are irrelevant to this project. It would be absurd to only require citizens and nationals to pay for health care, schools, roads, police, courts, financial systems, etc, when the population using all of these goods and services includes noncitizens and nonnationals. Likewise,  it is absurd to expect individuals to pay taxes in your country merely because your citizenship laws have conferred a legal status on them.

As a result, the OECD's AEoI project envisions a global system to identify the tax residence of every individual that owns virtually any financial asset, anywhere in the world, so that governments can assess their residents' tax obligations. The US project on FATCA goes further, requiring the global system to identify the nationality of every individual that owns virtually any financial asset, anywhere in the world. It won't be easy to build the OECD's residence identification database, but it is perhaps possible, with the help of tax treaties that resolve dual-residence problems. On the other hand, if the whole world gets into the business of nationality identification, we are going to have problems. This involves tracing bloodlines and will quickly become extraordinarily complicated, if not impossible, as we have already seen with FATCA.

Every income tax system necessarily has extensive residence assignment rules, including the United States; it is just that the United States also includes nationality in its definition, while almost every other country does not. The United States does this even if such persons achieved US nationality through the accident of birth, even if they never stepped foot in the United States and have never used any US goods or services of any kind, even if they are also citizens and permanent residents of other countries from their birth, even if they have never has a social security number or a US passport, even if they do not know that that they are US nationals, and even though the claiming of persons as subjects by birth by a distant sovereign was the foundation for America's war for independence.

All other nation-states tax on the basis of residence, not nationality, with a few minor and limited exceptions. Here they are:

• Eritrea taxes nonresident citizens permanently, at a reduced flat rate of 2% of worldwide income. It does this to finance an ongoing war, and had been denounced by the United States and the UN for the practice.
• Finland treats nonresident citizens as tax resident for three years after the emigrate unless they demonstrate that they no longer have any ties to Finland. 
• France treats nonresident citizens as permanent tax residents if they move from France to Monaco, per a treaty between the two nations.
• Hungary treats nonresident citizens as permanent tax residents of Hungary, unless they also have another nationality or reside in a country which has a tax treaty with Hungary. 
• Italy treats nonresident citizens as permanent tax residents if they move to a blacklisted tax haven unless they demonstrate lack of ties to Italy. 
• Spain treats nonresident citizens as tax residents for five years following a move to a blacklisted tax haven.
• Turkey treats nonresident citizens as permanent tax residents if they work for the Turkish government or Turkish companies but exempts income that is taxed by the country where it is earned. 

Some countries used to but no longer practice citizenship-based taxation:

• Bulgaria used to treat nonresident citizens as permanent tax residents, but ended the practice with the adoption of a new income tax in 1998. 
• Mexico used to treat nonresident citizens as permanent tax residents, but ended the practice with the adoption of a new income tax law in 1981.
• Myanmar used to tax the foreign income of nonresident citizens at a flat rate of 10% but ended the practice in 2012. 
• The Philippines used to tax the foreign income of nonresident citizens at reduced rates of 1 to 3% but ended the practice with the adoption of a new tax law in 1998.
• The Soviet Union used to treat nonresident citizens as permanent tax residents, but after the country was dissolved in 1991, none of its successor states continued the practice. 
• Vietnam used to used to treat nonresident citizens as permanent tax residents but ended the practice in 2009. 

We can easily see how global AeOI might make it possible to reverse this trend. If China was to adopt citizenship taxation and exert the same pressure as the US has with FATCA to achieve it, two very important countries would be stretching the residence definition beyond the OECD's global AEoI database. Bearing the extra costs and burdens of these extra measures would surely convince other countries to consider following suit.

That's why I think this would be a terrible idea. Fundamentally, taxing on the basis of citizenship is wrong from a normative point of view. But it is also a terrible idea for practical reasons. First, it's invasive (to say the least) to make access to basic bank accounts contingent on tracing bloodlines. Second, doing so globally, including forcing the world's poorest countries to play along, is a huge waste of administration resources by everyone. Third, creating global asset databases for tax exchange purposes creates massive security issues that have not been assessed in light of the fact that this will be done on the basis of nationality rather than residence. Finally, and in the long run, taxing on the basis of citizenship effectively restricts labour mobility, serving a goal I have not heard explained by anyone.

In a world in which state's tax subjects include their globally dispersed diasporas, global asset information exchange will make it a duty of every state to sort its population for differential treatment according to the birthright laws of the other states. This has never been an agenda item on any of the discussions I have seen regarding tax information exchange. It should be.

The power to tax

The start of a new semester means the return to fundamentals in taxation for me, which always begins with a discussion of the power to tax. Yesterday I asked my students: could Queen Elizabeth say hey Canadians, I notice you still have my face on your dollar and you've got a nice surplus shaping up; over here in England it's all austerity and program cuts. Mind helping out a bit? General consensus: she might as a legal matter be able to tax Canadians to help the Brits out, but she won't. Hmmm. During the discussion a student informed me that Canadians pay more for monarchical services than the Brits do. Well, sharing is caring.

Relatedly and on a more scholarly note, a recent twitter conversation brought me to a chapter in a book on socio-legal tax research (thanks to Martin Hearson for starting that conversation and Judith Freedman for making this recommendation). The book is called Taxation: a Fieldwork Research Handbook, edited by Lynne Oats, and the chapter I had my eye on today is entitled Tea Parties, Tax, and Power, by Rebecca Boden. Boden writes:

History...points to a longstanding power relationship between rulers and those they rule that is articulated through tax regimes. States, whether feudal or modern, need money to operate, to pursue their various programmes, from war to welfare, As citizens may be unwilling to relinquish their money voluntarily, the state must have powers to require payment, with sanctions for non-compliance. By the same token, this power is held in balance in democracies by the principle of consent, exercised through representation. Ultimately, taxpayers give their consent to be dominated and have their money taken away from them.

This contingent nature of the state's powers in taxation - taxation by "consent"- chimes with Foucault's notion that power can never be absolute (Foucault 1977). No, Foucault argues, is power only hierarchical or structural, rather it works in a capillary fashion. As such, the analysis of such power relationships is central to the critical tax project - only by viewing tax structures, policies, and practice through the prism of power relationships that change them can we understand how and why they are constituted and what their effects are likely to be.

There is much more in the chapter to reflect upon, but I found this intro intriguing. In my view a lot of mischief takes place in the subtle--maybe you missed it--transition from the use of the word "citizen" to the use of the word "taxpayer." This is a transition all too many scholars make without even noticing it, yet it masks a world of ideology and assumption that frame and define how we think about tax today.

The power to define the taxpayer permeates contemporary tax policy discussion. The question of who can tax whom is one that could or should involve theory but while the scholars talk it over, reality plays out in economic might. In an intro to tax policy principles that I recently prepared for my tax policy course, I wrote:

Perhaps because taxation has been so connected to state-building, most scholars closely associate the act of taxation with the state. Some even go so far as to argue that taxation is a fundamental right belonging to the state as sovereign, often citing Thomas Hobbes for the proposition that “[t]hese are the rights which make the essence of sovereignty … the power of raising money”. None have offered theoretical grounds for the claim that states are in fact holders of rights, however.

We observe throughout history that states exercise powers (mostly through military and economic might), and only declare rights for themselves upon successful domination (such as in constitutions and charters). This observation leads to the likelihood that taxation is not anyone’s right but rather it is a constructed reality, coming about solely by and through human experience. This would explain why so much has to be done to both justify as a matter of theory - and entrench as a matter of custom - the state’s authority to tax.

We don't have to work too hard to think of a few examples where defining the taxpayer is an exercise in claiming authority, which fundamentally depends on power. FATCA is an obvious one; anti-inversions, BEPS, and the OECD common reporting standard are less obviously but equally so.

With FATCA, the US is using its sheer economic clout to get the whole world involved in chasing what it deems to be "US persons" for their tax tribute, without any discussion about whether the state's unilateral conferring of citizenship constitutes consent to (permanent and worldwide) taxation. Indeed, it continues to erect ever-higher barriers to shedding that status, without a single policy discussion at any level of government about the merits of this action. Those who think not can be expected to resist per Foucault, or, if it suits your taste better, Locke:

[People] therefore in society having property, they have such a right to the goods, which by the law of the community are their's, that no body hath a right to take their substance or any part of it from them, without their own consent: without this they have no property at all; for I have truly no property in that, which another can by right take from me, when he pleases, against my consent.

At the OECD, the common reporting standard, ostensibly modeled on FATCA but in fundamental principles not at all like FATCA, is all about making sure the "right" government gets the info it needs to exert its power over "its" taxpayers. Same idea: a state claims the authority to tax people that live within its territory, but other states have the power to thwart that exercise. (Different in fundamentals than FATCA for two reasons: (1) finding implied consent to tax is a given for residents of a state and (2) the OECD is not currently suggesting countries use economic sanctions to force others to cooperate).

The anti-inversion and BEPs issues are similarly about exerting power over a "taxpayer." Despite bemoaning their apparent helplessness in preventing corporate US persons becoming corporate non-US persons, US lawmakers clearly claim the authority to intervene and they likely have the power, too. But, this involves erecting higher and higher walls to keep the "taxpayers" inside. Internationally, discussions about the global problem of multinational tax dodging focus on the failure of the state to tax corporate persons that come in to the jurisdiction to do business. At the OECD, the BEPS project is very much about who belongs to who, so we can decide what belongs to who. Source and residence as tax concepts have always been about power and they have always been explained with ideas about authority and consent.

Globally, discussions about both corporate and personal income taxation are being forced to focus more and more on unanswered questions about the power to tax, and the issues of authority and consent that are raised when power is exerted and when it is resisted. The full Boden chapter is thus definitely recommended reading and I'm working my way through the rest of the book, which looks promising in several respects. More to come on this subject.

Filed Today: Lawsuit challenging constitutionality of FATCA in Canada

Noted Canadian constitutional lawyer Joseph Arvay filed suit today to challenge the constitutionality of Canada's implementation of FATCA. The statement of the claim is laid against the Attorney General of Canada in the Federal Court of Canada. It seeks a declaration by the Court that the relevant parts of recently enacted Bill C-31, referred to as the "Impugned Provisions," are beyond Parliament's authority and of no force and effect under the Constitution. The claim makes four claims about Canada's attempt to implement FATCA:

(1) it violates the Constitution by creating federal power over a provincial domain;
(2) it violates s. 7 of the Charter, guaranteeing individual rights to life, liberty & property;
(3) it violates s. 8 of the Charter, preventing unreasonable search & seizure; and
(4) it violates s. 15 of the Charter, prohibiting discrimination based on national origin etc.

The complaint concludes that none of these infringements can be justified by section 1 of the Charter, which provides for only "such reasonable limits prescribed by law as can be demonstrably justified in a free and democratic society."

The lawsuit is the product of efforts by a small, grassroots group formed for this purpose, calling themselves the Alliance for the Defence of Canadian Sovereignty. They have issued a press release, here. The two named plaintiffs are taking a major risk in being exposed as "non-compliant US Persons" in this lawsuit. On the other hand the IRS may not wish to get in the middle of this fight and prove the plaintiff's case, which is succinctly stated here.

I look forward to following the case, which I expect to wind its way toward the Supreme Court. As I've said many times, there are massive problems with FATCA that have nothing to do with tax evasion and everything to do with the basic injustice that is citizenship taxation and all global efforts to enforce it for the US. The US Congress is reluctant to act on this antiquated and unjust regime and the IRS must plow ahead, as I explained recently. But that certainly does not mean that other countries must do the job of the IRS, most especially when doing so is inconsistent with their own laws.

Christians on Regulating Tax Preparers: A Global Problem for the IRS

I have a new column this week in Tax Analysts: Regulating Tax Preparers: A Global Problem for the IRS, in which I discuss the challenges of protecting a global taxpayer population from fraud and abuse and make (yet another) plea for sanity in the form of abandoning citizenship taxation and turning to residence-base taxation. Here is the gated published version; here is the SSRN version (ungated). And here is a brief abstract:

The IRS recently announced that its mandatory registration regime for paid tax return preparers, struck down in the Loving decision, would henceforth be offered as a voluntary program. But the authors of this program appear to have forgotten that the US system is perfectly global in reach, thanks to its permanent inclusion of citizens and others with legal residence status no matter where in the world they live. Protecting a global taxpayer population from fraud and abuse is an enormous task, with massive legal, administrative, and even diplomatic factors to consider. Citizenship taxation plagues the project of tax return preparer regulation, just as it does all aspects of US tax law. Accepting the universally practiced norm of residency-based taxation is the only viable solution. If Congress cannot do so, it will always be the case that for the IRS, thinking locally truly means acting globally.

Just as this was published, a friend sent me an email about a growing problem of FBAR fraud, in which criminals attempt to get personal & financial information from people by sending them serious looking notices. Here's an example, from Tax-Expatriation blog:

I'm sorry I didn't see this before I published my column, as I would have mentioned it as a significant issue. Capitalizing on the ignorance and fear of regular (non-rich) US persons outside the United States will be all too easy for criminals, I am afraid. I hope that the IRS and FinCEN can figure out a way to warn people--but I don't see how they can really do that on a global scale, especially since FATCA's job is to funnel information about millions of people to the IRS, and not the other way around. At minimum, every government that signs an agreement to implement FATCA should be sending out the warnings, since each is undertaking a huge responsibility in implementing US citizenship taxation on their own residents.

IRS's "Super creditor" status

Bryan Skarlatos recently testified to the House Ways & Means Committee about the IRS's "Super creditor" status via its federal tax lien power. Given the global nature of the US tax jurisdiction over nonresidents with US person status, the powers of the IRS to seize assets in satisfaction of tax debts is of increasing interest. I think this power is very likely to be ill-understood by those outside the United States. Looking ahead at life under FATCA, consider that soon the IRS will have the information to start assessing tax debts on its global diaspora, and then we will see what happens.

 WRITTEN TESTIMONY OF BRYAN C. SKARLATOS, ESQ.

The Internal Revenue Service (the “Service”) is a “Super Creditor” because Congress has given it powers to collect money and property that far exceed those of any ordinary creditor. Typically, a creditor who is owed money cannot just take property of the debtor. Instead, the creditor must first bring a lawsuit, obtain a judgment, and then invoke the power of the court to execute on the judgment by seizing the debtor’s property, usually with the help of a court order or a public servant such as a marshal. In contrast, when taxes are assessed, the Internal Revenue Code automatically creates a lien in favor of the Service in a taxpayer’s property. Then, the Service has the unique and powerful ability to levy on or seize property that is subject to a federal tax lien. In addition, the Service can sue in federal court to collect taxes. 

Assessment 

The first step in the tax collection process is the assessment. In general, the Service cannot attempt to collect from a taxpayer until a tax has been assessed.
The Internal Revenue Code gives the Secretary of the Treasure the authority to assess tax. A tax is assessed when it is recorded as a liability, or account receivable, on the Service’s records. 

Once a tax has been assessed, the Service is required to notify the taxpayer that the tax has been assessed and to demand payment of the tax. The notice and demand for payment must be made within sixty days of the assessment. The notice and demand must be left at the taxpayer’s home or place of business, or sent to the taxpayer’s last known residence. Failure to pay an assessed tax after notice and demand for payment has been made gives rise to a federal tax lien and the Service’s ability to collect through levy or seizure of property. 

Federal Tax Lien 

If any person liable to pay a tax fails to pay after notice and demand, the amount not paid, including interest and penalties, becomes a lien in favor of the United States upon all property and rights to property belonging to such person. The tax lien is the mechanism that gives the Service rights to the taxpayer’s property. However, the lien itself does not transfer any value to the Service. As discussed below, a levy is the tool used to transfer the actual property to the possession of the Service. 

A federal tax lien arises against any person liable for the tax and attaches to any interest in property that the person may have. A tax lien also attaches to any property the taxpayer may acquire in the future. This is another way of saying that the tax lien attaches to after acquired property. 

The law of each individual state determines whether and when a taxpayer has an interest in some type of property. Federal law determines the extent to which the federal tax lien attaches to that interest. For example, the tax lien attaches to a taxpayer’s interest in a joint bank account to the extent that the taxpayer can withdraw money from the account. Similarly, if under state law, one spouse has a right to community property, then the tax lien attaches to that spouse’s interest in community property. Or, if one spouse has an interest in property held as tenants by the entirety, then the federal tax lien can attach to that interest. A federal tax lien attaches to interests in personal or real property, bank accounts, retirement accounts, Social security benefits, alimony (but not child support) payments, beneficial interests in trusts, contingent interests, future interests, and intangibles such as accounts receivable, trademarks, licenses, royalties and franchise rights.  

The federal tax lien relates back to the date of assessment. However, a federal tax lien does not have priority over purchasers for value, holders of security interests, mechanics lienors or judgment creditors until a Notice of Federal Tax Lien (a “Notice of Lien”) is filed. The Service may file a Notice of Lien to obtain priority over these holders of interests through the general rule of “first in time, first in right.” The interest that is perfected first has priority if and when the property rights are sold or seized. 

State law determines where a Notice of Lien must be filed to be effective. Generally, Notices of Lien are filed with clerk of the court in the county where real property is located, with the clerk of the court in the county where the taxpayer is located in the case of personal property, or with the clerk of the federal district court in the district where the real property or taxpayer is located. Filing the Notice of Lien provides constructive notice to anyone else who may hold or acquire an interest in property and gives rise to the “first in time, first in right” rule. 

The Notice of Lien is merely a device that provides deemed notice to other interested parties for purposes of establishing priority. The federal tax lien exists independently from the Notice of Lien and there is no requirement that the Service even file the Notice of Lien. However, if the Service does file a Notice of Lien, it must give the taxpayer written notice that the Notice of Lien is being filed with five days of the filing and give the taxpayer an opportunity to request a Collection Due Process hearing (a “CDP Hearing”) to contest the filing of the Notice of Lien. Requesting a CDP Hearing does not stop the filing of the Notice of Lien; it just gives the taxpayer a forum to request that the lien be lifted. 

Once a federal tax lien arises, it generally is valid until the taxpayer’s liability is satisfied or until the time for enforcing the lien expires. Generally, an assessment may be collected by levy or court proceeding within ten years after the date of assessment. The ten-year period can be extended under limited circumstances.The filing of a Notice of Lien, by necessity, is open to the public and can harm a taxpayer’s credit standing and can affect business relationships by, for example, triggering a default under certain credit agreements, etc. 

Levy and Seizure 

If any person liable to pay a tax fails to do so within ten days after notice and demand, then the Service may collect the tax by levying on all property owned by that taxpayer, or on which there is a federal tax lien for the payment of such tax. Levies and seizures are ways in which the Service takes possession of property or rights to property. Levies and seizures are essentially the same thing. The term “levy” is typically used when the Service takes possession of intangible property or rights to property and the term “seizure” is typically used when the Service takes possession of real or personal property. A levy or seizure is a provisional collection device, meaning that disputes over ownership, priority or even liability for the tax can still be disputed after the levy or seizure. 

Two notices must be issued before the Service can execute a valid levy or seizure. First, the Service may not attempt any collection until ten days after a notice and demand for payment of the tax. This notice and demand can be the same notice and demand that must be made within sixty days after the assessment as described above. Typically, the Service sends two or three notices and demands for payment of taxes before it proceeds with the levy process. 

Second, the Service must notify the taxpayer in writing of its intention to levy on the taxpayer’s property or rights to property at least 30 days before the date of the levy (the “Notice of Intent to Levy”). The Notice of Intent to Levy must be given either in person, left at the taxpayer’s dwelling or usual place of business, or sent by certified or registered mail, return receipt requested, to the taxpayer’s last known address.Like the Notice of Tax Lien, the Notice of Intent to Levy must inform the taxpayer of the right to request a CDP Hearing within 30 days of the Notice of Intent to Levy. At the CDP Hearing, the taxpayer can challenge the appropriateness of the collection activity and, in some cases, the validity of the underlying tax liability. If the taxpayer timely requests a CDP Hearing, the Service may not proceed with levy until the CDP Hearing is complete. 

The Service can use a levy to take any property subject to the federal tax lien. This includes just about any kind of property in the possession of the taxpayer or property in the hands of a third party to which the taxpayer is entitled. The Service can levy property from a third party simply by serving the levy on that third party. No special notice or procedure is required to levy property from a third party. 

Typically, a levy only reaches property in possession or rights in existence as of the date the levy is issued. Unlike a federal tax lien which attaches to after-acquired property, most levies do not reach after acquired property. Thus, a levy served on a bank will reach the balance in the account on the day of the levy and does not reach a deposit made the day after the levy. However, there is an exception to this rule. A continuing levy can be issued on salary and wages. A continuing levy is like a vacuum cleaner that continues to sweep up money as it is paid to the taxpayer. 

There are very few types of property that are exempt from a levy. State laws that provide homestead exemptions, protect certain types of retirement accounts, or limit the amount of a person’s salary that can be garnished, do not trump the federal levy laws and are ineffective against the Service’s power to levy. Federal law provides limited exemptions for things like school books, tools of trade, wearing apparel, fuel, provisions, furniture and personal effects, unemployment or workers compensation benefits and a minimum amount of wages.As noted above, the Service typically has ten years from the date of assessment to collect a tax by levy. 

Judicial Proceedings 

In addition to the administrative lien and levy procedures described above, the Service can also request the Tax Division of the Department of Justice to sue a taxpayer in federal court to collect a federal tax liability. Federal courts have subject matter jurisdiction over suits to obtain judgments pursuant to the Internal Revenue Laws. While an assessment and lien are not necessary prerequisites for such suits, there usually is an assessment and related federal tax lien. The Service sometimes uses the judicial remedy to reduce a federal tax lien to judgment when the statue of limitations for collecting administratively by levy is about to expire. If the Service obtains a judgment against the taxpayer, a whole new statute of limitations for collection on the judgment begins to run. 

The Service also uses judicial remedies to sue third parties who have failed to turn over property in response to a levy, to establish liability against a transferee of property, or to recover a refund of taxes that was mistakenly paid to a taxpayer. 

Taxpayer Defenses 

There are many ways that a taxpayer can defend against the collection of taxes. The CDP Hearing requests referred to above are some of the most powerful tools that a taxpayer can use because, while a CDP Hearing request does not stop the filing of a Notice of Lien, it can stop a levy pending the outcome of the CDP Hearing. Of course, if the Service collects money or property improperly, the taxpayer can sue for a refund. 

The World According to FATCA, In 3 Maps

As of 8 June 2014, this is the world according to FATCA:

Countries that have actually signed an intergovernmental agreement.

Countries treated as having signed an intergovernmental agreement.

Countries with no agreement, actual or implied; FATCA applies unilaterally.

There really isn't any doubt that some of the poorest countries in the world will be most unfairly treated in any multilateral regime for global information exchange which excludes the United States because it acts unilaterally to attain solely its own goals, with no regard for the price others must pay or the appropriateness of imposing that cost where no wrong has ever been accused much less proven.

Prof. Karen Brown wrote an important and influential article in 2002 called Missing Africa on the topic of US tax and trade policy toward developing countries in general, Sub-Saharan Africa in particular. Her article starts with a quote: "We're the... United States. Do we need Africa?"' (from a former World Health Organization official who resigned over the lack of commitment to control AIDS in Africa).

Here the pattern repeats itself: even if they wanted to, many of the countries in the third map cannot forestall the present threat of economic sanctions. The United States simply doesn't need them. Yet many, many of these countries suffer far more from bank secrecy provided by the US and elsewhere than the other way around.

The unjustified and virtually-ignored perfection of US citizenship taxation is one part of FATCA's unexamined legacy, the dismantling of comity in international taxation another; so, too, the repeated exclusion of the developing world from an institutional order that is becoming increasingly unjust.

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.

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.

Taxing the Corporation: Home Depot and the State's Claim of Right

The Arizona Court of Appeals recently issued a decision in the Home Depot case, which involves determining when the state has jurisdiction to tax a corporation. The case is about a domestic multi-state business but it has interesting implications for the taxation of multinationals. In brief, Home Depot (a Delaware corporation headquartered in Georgia) formed a subsidiary in 1991 to hold its trademarks. It then entered into a licensing agreement with the sub, Homer, under which it paid a royalty for the use of the trademarks. The royalty started at 1.5% of gross sales, and increased to 4% in the years at issue. The Arizona Department of Revenue decided that Homer and Home Depot constituted a unitary business for Arizona state tax purposes, the Arizona Tax Court agreed, and the Court of Appeals affirmed.

So here we have a Delaware corporation, headquartered in Georgia, doing business in Arizona through retail stores, but stripping its income out of the state in order to avoid the state level corporate income tax. That is, of course, the basic modus operandi of Google, Apple, Starbucks, GE, Amazon, et al, each of which sells products and services around the world yet pays low single digit corporate tax rates in each jurisdiction by stripping out its income in the form of license fees, interest, and other inter-company payments to subsidiaries located in low-tax jurisdictions.

Internationally the defense that countries employ against this behavior is the arm's length standard, under which each government that claims jurisdiction over any part of the multinational treats that part as if it was an independent party acting at arm's length with respect to the rest of the company. Indeed Home Depot raised its compliance with the arm's length standard as a reason for the court to dismiss the Arizona revenue authority's jurisdictional claim over Homer. But the Court points out that compliance with arm's length is not the issue in a question about establishing a jurisdictional claim:

Home Depot, nevertheless, argues its transactions with Homer have been at arm’s length, and points out that the Department has not challenged the appraisal establishing the legitimacy of the royalty it pays Homer. [Under prior case law] the principle [is] that unitary treatment will be imposed or allowed whenever the activities of the affiliated organizations affect the other(s) in ways that are "so pervasive as to negate any claim that they function independently from each other."

Under a statutory regime that allows for unitary taxation, in other words, the state can claim jurisdiction to tax with respect to any corporation anywhere, if it can establish pervasive links among affiliated corporations, or "operational integration." And what are the marks of such operational integration, such that the state's jurisdiction to tax is established? The Court lists fifteen, pursuant to Arizona state law:

1. The same or similar businesses conducted by components;
2. Vertical development of a product by components, such as manufacturing, distribution, and sales;
3. Horizontal development of a product by components, such as sales, service, repair, and financing;
4. Transfer of materials, goods, products, and technological data and processes between components;
5. Sharing of assets by components;
6. Sharing or exchanging of operational employees by components;
7. Centralized training of operational employees;
8. Centralized mass purchasing of inventory, materials, equipment, and technology;
9. Centralized development and distribution of technology relating to the day-to-day operations of the components;
10. Use of common trademark or logo at the basic operational level;
11. Centralized advertising with impact at the basic operational level;
12. Exclusive sales-purchase agreements between components;
13. Price differentials between components as compared to unrelated businesses;
14. Sales or leases between components; and
15. Any other integration between components at the basic operational level. 

Not every listed factor must be present in order to establish operational integration. Having established its jurisdictional claim, the state does not claim all of the income of the entire multistate operation, but rather applies its own internal formula for determining what portion of the whole is attributable to the group's Arizona operations. 

Herein lies the lesson for international taxation: corporate taxation of a multi-state group is possible on a unilateral basis--a state need only stake its own jurisdictional claim and have the werewithal to enforce it. Arizona's Court of Appeals seems to be suggesting that the state's jurisdictional claim need not be hampered by any artificial constructs, whether these be rules assigning corporate residence or contracts allocating rights. Presumably the allocation formula cannot be 100% but also relies on some decision about the extent of the jurisdictional claim--although this has not been argued or established here. The decision further implies that enforcement is possible as a practical matter, presumably on the basis of the operations and assets that are currently in the state. The question raised is whether the Arizona market will continue to be attractive to Home Depot, such that it will accept unitary taxation by the state in order to continue to do business there. These are empirical questions, and the economic evidence I have seen so far suggests that the business will not leave solely as a result of the tax (especially if there is no alternative market that would deliver the same profits at a lower tax cost: here is a short summary that covers some of the bases on this question).

Substituting nation-state for state in these assumptions, these are big normative claims about the right of the state to assert a jurisdictional claim to tax, as well as its ability to follow through once the claim of right has been established. These assumptions raise even bigger normative claims about the fairness and efficiency of any system that fails to exercise a jurisdictional claim where it exists, since failure to exercise a claim in one sector forces the other sectors to take up the slack thus distorting tax outcomes on the basis on noneconomic factors.