Top Ten Items of Tax Policy Interest for 2015 - #8

Continuing with my list of ten news items and activities from 2015 that I think have particular tax policy relevance.  Today, for number 8 is the OECD's BEPS project. It looks at how tax systems may need to change to address the digital economy, such as advertising revenue generated by Google or trademark income generated by Starbuck's and other companies that can be separated from the economic activity to be taxed in lower tax rate jurisdictions. Something not easily done or possible when the economy was mostly about moving widgets between countries.

Background: At the G20 meeting in June 2012 in Mexico, the group prepared a declaration. One of the items in it stated: 

“48. In the tax area, we reiterate our commitment to strengthen transparency and comprehensive exchange of information. We commend the progress made as reported by the Global Forum and urge all countries to fully comply with the standard and implement the recommendations identified in the course of the reviews, in particular the 13 jurisdictions whose framework does not allow them to qualify to phase 2 at this stage. We expect the Global Forum to quickly start examining the effectiveness of information exchange practices and to report to us and our finance ministers. We welcome the OECD report on the practice of automatic information exchange, where we will continue to lead by example in implementing this practice. We call on countries to join this growing practice as appropriate and strongly encourage all jurisdictions to sign the Multilateral Convention on Mutual Administrative Assistance. We also welcome the efforts to enhance interagency cooperation to tackle illicit flows including the outcomes of the Rome meeting of the Oslo Dialogue. We reiterate the need to prevent base erosion and profit shifting and we will follow with attention the ongoing work of the OECD in this area.”

The OECD responded with a study on how the new economy was leading to base erosion and profit shifting (BEPS) and possible actions to address it. .

Concerns included shifting profits to tax havens which did not correspond to where the company’s economic activities took place. This is more easily done when a company derives income from services (such as advertising) and intangibles (such as licensing). The initial study released in February 2013 stated: “Global solutions are needed to ensure that tax systems do not unduly favour multinational enterprises, leaving citizens and small businesses with bigger tax bills.” [OECD, Addressing Base Erosion and Profit Shifting, 2/12/13]

Also, per the OECD FAQs: “The BEPS Project is not about increasing corporate tax rates. Non- or low-taxation is not itself the concern, but it becomes so when it is achieved through practices that artificially separate taxable income from the activities that generate it. These strategies may increase tax disputes as countries fight against tax strategies that defy common sense. Implementation of the recommendations coming out of the BEPS Project will reduce those disputes, giving business greater certainty, and reinforcing the fairness and consistency of international tax system.” [Q&A 127]

Action Items: Soon after the project began, the OECD released its 15 action items of study and recommendations. This included examining the digital economy and issues of transfer pricing. Details and links (from the OECD BEPS website):

	Explanatory Statement 2015 (EN)
‌	Action 1: Addressing the Tax Challenges of the Digital Economy
‌	Action 2: Neutralising the Effects of Hybrid Mismatch Arrangements
	Action 3: Designing Effective Controlled Foreign Company Rules
	Action 4: Limiting Base Erosion Involving Interest Deductions and Other Financial Payments
	Action 5: Countering Harmful Tax Practices More Effectively, Taking into Account Transparency and Substance
	Action 6: Preventing the Granting of Treaty Benefits in Inappropriate Circumstances
	Action 7: Preventing the Artificial Avoidance of Permanent Establishment Status
	Actions 8-10: Aligning Transfer Pricing Outcomes with Value Creation
	Action 11: Measuring and Monitoring BEPS
	Action 12: Mandatory Disclosure Rules
‌	Action 13: Guidance on Transfer Pricing Documentation and Country-by-Country Reporting
	Action 14: Making Dispute Resolution Mechanisms More Effective
	Action 15: Developing a Multilateral Instrument to Modify Bilateral Tax Treaties

 
Final Package – On 10/5/15, the OECD released the “final BEPS package.” Per the press release: ““The OECD presented today the final package of measures for a comprehensive, coherent and co-ordinated reform of the international tax rules to be discussed by G20 Finance Ministers at their meeting on 8 October, in Lima, Peru.  The OECD/G20 Base Erosion and Profit Shifting (BEPS) Project provides governments with solutions for closing the gaps in existing international rules that allow corporate profits to disappear or be artificially shifted to low/no tax environments, where little or no economic activity takes place.

“Revenue losses from BEPS are conservatively estimated at USD 100-240 billion annually, or anywhere from 4-10% of global corporate income tax (CIT) revenues. Given developing countries’ greater reliance on CIT revenues as a percentage of tax revenue, the impact of BEPS on these countries is particularly significant.”

Actions addressed include multi-country reporting for transfer pricing, eliminating treaty shopping, and rationalizing VAT collection in the digital economy. For details of the recommended actions, a short video and links to lots of background materials and recommendations, see the OECD’s main BEPS website - http://www.oecd.org/tax/beps.htm.

What will happen next? Some action can be taken by the IRS, such as their release of proposed regulations on 12/23/15 calling for country-by-country reporting REG-109822-15.  Other items will await congressional action, likely as part of tax reform - so likely not until 2017 although Congresmen Ryan and Brady might want to work on international tax reform in 2016. We'll see.

What do you think?

My list so far of news and activities of 2015 with tax policy relevance (no ranking involved):

1. Congress can alter our tax system via a lot of non-tax bills - here
2. IRS funding challenges - here 
3. Justice Kennedy called for a review of the 1992 Quill decision - here 
4. IRS disagreeing with a court decision via a proposed regulation - here 
5. Why not let the Internet Tax Freedom Act just expire - here
6. A growing amount of non-binding "guidance" from the IRS - here 
7. Due date changes starting for 2016 returns to improve tax administration - here

French Task Force Report on Taxation of the Digital Economy

In January 2013, a task force commissioned by the French Finance Ministry, released a "thinking outside of the box" report on new suggestions for taxation in the digital era. This 188 page report was only recently translated into English. Co-author of the report, Nicolas Colin, has allowed me to post this English version on my blog - here.  You may have seen Mr. Colin's summary of the report he posted on Forbes blog in January 2013 ("Corporate Tax 2.0: Why France and the World Need a New Tax System for the Digital Age").

I'm still reading through the English report, but wanted to share an introduction to the report now. I refer to the report as "out-of-the-box" thinking because the authors raise some points that I have not heard discussed elsewhere. Also, an economic shift, such as from the industrial era into the digital or knowledge era, should lead to some rethinking of tax systems - are they are in need of modernization (hence the title of my blog - 21st century taxation).  When we have bits and bytes moving across borders, perhaps the tax rules need to be different from the existing ones focused on moving widgets across borders.

I think the report will lead to a broader discussion of what international taxation should look like today.  Certainly, there is a lot of discussion going on regarding this topic in Congress and the OECD.  For example, Congressman Camp, chair of the House Ways and Means Committee, has a proposal to move to a territorial system. In February 2013, the OECD issues its BEPS report (Base Erosion and Profit Shifting) which should get further discussion by the G-20.

Well, back to the French report ... Three key themes/ideas:

•  Today, some companies, such as Google, can gather lots of data from citizens and companies in a country, but do not have tax liabilities there, even though it looks like they are at least virtually present. So, consider redefining permanent establishment for the digital age. Perhaps places where data is generated for use by the company should be a PE.

• Alternatively or prior to a PE change, consider a Pigovian tax on use of resident’s data if the company does not “comply with stronger privacy and user empowerment requirements” (aim is also to encourage the company to so comply so they won’t owe the tax).

• Reform R&D tax rules and definitions to better focus on the digital economy and its growth.

I had the opportunity to talk with Mr. Colin in October 2012 when he visited Silicon Valley to meet with people to discuss his ideas and learn more about the digital economy from perspectives of folks here. We had a very enjoyable discussion.  And it helped me think of a few tax ideas to explore. Be sure to see Annex 2 of the report for a long list of people the authors consulted with including the tax director of Google.

I encourage you to review the report. It addresses issues that we will likely hear more about from Congress and the OECD and that are important for reform of the U.S. tax system.

What do you think? Any "out of the box" ideas you have for a sound tax system for the digital era?

 

Tax policies for multijurisdictional income

On March 1, the SJSU MST Program, Santa Clara Valley TEI chapter and the Tax Policy Committee of the California Bar Taxation Section held their 3rd annual Tax Policy Conference. The theme - Tax Policies for Multijurisdictional Income.  This is a hot topic at both the international and national levels. Presenter materials are available here - but they can't replace the excellent presentations and ideas that were presented and discussed.

A few observations from the day's presentations:

• Despite occasional calls for formula apportionment at the international level, it likely would not work. It would be more difficult to get all countries to agree on this approach than it has been for the U.S. states. The diversity of economies and needs of developed versus even emerging countries are too great to think that a consensus approach can be reached. Transfer pricing will likely remain the standard, although countries may tighten the rules.
• There will be challenges in creating a territorial system in the U.S. In addition to politics of reaching a consensus, there is the issue of revenue neutrality and whether it is wise to employ a system different from other industrialized countries that tend to use a dividend exemption approach.
• Focus of governments will continue to be on taxing intangibles.
• The Mayo decision of the US Supreme Court likely gives the IRS greater authority on how it writes transfer pricing rules.
• The OECD BEPS (Base Erosion and Profit Shifting) report issued earlier this year should be reviewed.
• Many factors play a role in how multistate income is apportioned among states - nexus, sourcing, throwback, apportionment factors, and reporting system (combined/unitary or separate).
• Given the numerous complexities in apportioning multistate income in some economically or accounting-wise justifiable manner and the relatively low amount of tax it generates, perhaps states should just repeal their corporate income taxes. 

And economist Jon Haveman helped provide a broader picture of the economy in which tax reform would take place, should any significant changes actually occur. He noted that sequestration will hurt the economy for some time and that failure to adequately invest in infrastructure will hurt our economy for years.  That is all important to consider because reasons why Congress is exploring a more to a territorial tax system and a lower corporate tax rate is to improve competitiveness of US firms and to help the economy. But overlooking other big influences on the economy might limit the possible gains from reform.

What do you think?

Information on other conferences of the SJSU MST Program - http://www.tax-institute.com.

Equity, improve investment and reduce the mortgage interest deduction

This is a follow up on my post of 8/23/12 on various reasons to reform (and reduce) the mortgage interest deduction. In June 2012, the OECD (Organization for Economic Co-operation and Development) issued an Economic Survey of the United States. Per an OECD summary:

"The Survey also highlights rising income inequality in the United States. The trend owes mainly to rising skill premiums and disproportionate income growth for top earners over the past two decades. ... Providing equal access to high-quality elementary and secondary education is essential to addressing this challenge. The Survey also notes that the U.S. tax and benefits system is much less effective in reducing relative poverty than that of other OECD countries. This is largely the result of the limited and poorly targeted financial transfers to low-income households. The Survey suggests that broadening the tax base through reduced tax expenditures, such as for mortgage interest, as well as harmonizing the tax treatment of different forms of capital income while simultaneously lowering the corporate tax rate could help to reduce income inequality and at the same time boost investment and long-term growth."

I suspect that the mention of the home mortgage interest deduction as one tax expenditure to be reduced is because the deduction is broader than in other countries and a significant cost in terms of reduced tax liabilities less than 1/3 of individuals get due to the deduction. The cost is about $90 billion per year which, along with dollars from other reduced tax expenditures could be used to reduce the deficit, provide more equitable benefits, such as to education as suggested by the OECD, and improve investment in other industries (besides housing) by equalizing the after-tax cost of all types of investments.

What do you think?