Copyright 1999 Federal Document Clearing House, Inc.
Federal Document Clearing House Congressional Testimony
June 22, 1999
SECTION: CAPITOL HILL HEARING TESTIMONY
LENGTH: 2926 words
HEADLINE:
TESTIMONY June 22, 1999 STAN KELLY VICE PRESIDENT-TAX WARNER-LAMBERT COMPANY
HOUSE WAYS AND MEANS OVERSIGHT INTERNATIONAL TAX LAW
BODY:
Statement of Stan Kelly, Vice President-Tax,
Warner-Lambert Company Testimony Before the Subcommittee on Oversight of the
House Committee on Ways and Means Hearing on the Current U.S. International Tax
Regime June 22, 1999 Good afternoon, Chairman Houghton and members of the
Committee, I am pleased to testify today about the impact of the current U.S.
tax system on the competitiveness of U.S. multinationals. I will also comment on
your effort to improve and simplify the U.S. tax system, specifically H.R. 2018,
the "International Tax Simplification for American Competitiveness Act of 1999."
Warner-Lambert: A Global Leader Building Global Brands I am Stan Kelly, Vice
President of Tax for Warner-Lambert Company. Warner-Lambert is a U.S.
multinational company headquartered in Morris Plains, New Jersey, which employs
approximately 41,000 people devoted to developing, manufacturing and marketing
quality health care and consumer products worldwide. The members of the
Subcommittee may be familiar with some of Warner-Lambert's brand name products,
such as Listerine, Sudafed, Benadryl, Schick and Wilkinson Sword shaving
products, Tetra, Rolaids, Halls, Trident, Dentyne and Certs. Our Pharmaceutical
sector is comprised of three parts: Parke-Davis, which has been engaged in the
pharmaceutical business for 127 years; Agouron, a wholly owned subsidiary of
Warner-Lambert, an integrated pharmaceutical company engaged in the discovery,
development and commercialization of drugs for treatment of cancer, viral
diseases, and diseases of the eye; and Capsugel, the world leader in
manufacturing empty, hard gelatin capsules. Warner-Lambert's leading
pharmaceutical products, Lipitor, Rezulin, Neurotin, Accupril, and Agouron's
Viracept were developed to treat patients suffering from high cholesterol,
diabetes, epilepsy, heart failure, and AIDS. It is an honor to appear before the
Ways and Means Committee and to continue our company's participation in the
trade and tax policy-making process. Our Chairman and CEO, Lodewijk de Vink,
testified two years ago before the Subcommittee on Trade. Warner- Lambert is
proud to be a leader in promoting free trade policies and my remarks today
regarding the U.S.'s international tax regime are closely intertwined with those
same policies. In 1998, Warner-Lambert had total revenues of approximately $10.2
billion ($4.3 billion, or 40% from international sales) and sold product in over
150 countries. Warner-Lambert has approximately 78 production plants in its six
lines of business worldwide. The Biomedical Century Senator Daniel Patrick
Moynihan (D-NY) recently said that the 21st century would be the "Biomedical
Century." At the heart of this statement are the significant potential
biomedical advances that Warner-Lambert and other companies in the
pharmaceutical industry will make in the next decade. Scientists will soon
complete a project started in 1990, to map the code of life itself, the Human
Genome. Within five years, the number of targets for drug therapy will increase
from 500 today, to more than 15,000, as scientists apply the findings of this
project. That is a thirty-fold increase at a time when even 500 drug targets
keeps the global pharmaceutical industry going at full bore. So, for this reason
and others, we agree with Senator Moynihan's statement. We are on the brink of a
revolution in research and development that will lead to new forms of
prevention, new cures, and new treatments. This revolution is global and U.S.
companies need to compete aggressively in product discovery, development,
manufacturing, marketing, and delivery with equally talented and driven foreign
competitors primarily from Europe and Japan. U.S. trade policy and U.S.
international tax policy must keep pace with these changes in order to mitigate
competitive disadvantages facing U.S.-based companies. Let me emphasize this
last part: the global pharmaceutical industry is highly competitive, with many
of the world's largest pharmaceutical corporations headquartered outside the
United States. These competitors such as Glaxo-Wellcome, Novartis, Astra Zeneca,
Roche, Hoechst Marion Roussel, and SmithKline Beecham are not subject to the
worldwide tax system similar to that used by the United States. The U.S. has
long recognized the importance of open global markets in the continued growth of
the U.S. economy. The U.S. trade policy is evolving to ensure that U.S.
companies are able to remain competitive in a global economy. Conversely, U.S.
tax policy, particularly as it relates to the taxation of international
activities, has not kept pace with changes in the global market place in helping
to promote U.S. competitiveness. Simply stated, U.S. tax policy is out of step
with the broader objectives of our country's evolving trade policy. Mr.
Chairman, your bill and this hearing are important steps towards harmonizing
these two important and related policy areas. Before I turn to my specific
comments on your bill, let me give you an example of how well the system can
work when U.S. businesses and the Government work together toward a common
objective. Last year Warner-Lambert and others had the opportunity to work with
the U.S. Treasury Department and foreign revenue officials in coordinating the
tax consequences of the conversion to the Euro. The policy asserted by U.S.
business was tax neutrality, i.e., the U.S. tax cost of converting to the Euro
should be the same to a U.S. multinational corporation operating in Europe as
the foreign tax cost to a foreign multinational corporation operating in Europe.
By maintaining tax neutrality, the competitiveness of U.S. multinational
corporations operating in Europe was maintained. The U.S. Treasury should be
complimented for quickly developing a practical policy that enabled a smooth
transition to the Euro. Turning now to your bill. Warner-Lambert Strongly
Supports H.R. 2018 Warner-Lambert strongly supports H.R. 2018 because it
promotes three sound overall international tax policies: (i) reversing the
growth of anti-deferral rules in our tax system by narrowing the scope of
subpart F; (ii) improving the operation of the foreign tax credit system by
reducing double taxation; and (iii) simplifying tax compliance. Reversing
Anti-Deferral rules: The proposed changes would restore aspects of deferral that
have been eliminated since the enactment of subpart F in 1962. This is an
important contribution to the continued effort to improve the competitiveness of
American industry. I refer to Sections 103 (expansion of the de minimis rule
under subpart F) and 107 (look-through treatment for sales of partnership
interests) of the bill as examples of this policy. In addition, even though not
of direct interest to Warner- Lambert, I also refer to Section 101 of the bill
(permanent subpart F exemption for active financing income) as an example of
this policy. Improving the Operation of the Foreign Tax Credit System By
Reducing Double Taxation: The foreign tax credit system is the United States'
attempt at fairness to U.S. multinationals (as compared to the exemption system
used by many countries), with the intention of eliminating double taxation of
income earned outside the United States. Eliminating double taxation through the
foreign tax credit system is a fundamental objective of U.S. international tax
policy. Accomplishing this objective is critical to the competitiveness of
American industry. I refer to Sections 201 (extension of period to which excess
foreign taxes may be carried) and 207 (repeal of limitation of foreign tax
credit under alternative minimum tax) of the bill as examples of this policy.(1)
Simplifying Tax Compliance: Simplifying the administration of tax compliance is
another important element in improving the competitiveness of American industry.
U.S. tax compliance is generally considered much more burdensome than tax
compliance under the laws of many of our principal trading partners. I refer to
Section 306 of the bill (instructing the Treasury to issue regulations to the
effect that agreements which are not legally enforceable are not intangible
property for various purposes) as an example of this policy. Warner-Lambert
supports this provision, which mandates a bright-line test in an area where
Treasury has not exercised regulatory authority given to it more than 15 years
ago. I would like to direct your attention to one section of H.R. 2018 that is
of particular interest to Warner-Lambert. Section 107(a) would amend Section
954(c) of the Internal Revenue Code (the "Code") to provide a look-through rule
for the sale of a partnership interest by a controlled foreign corporation
("CFC"). If a CFC disposes of an interest in a partnership, the CFC would be
deemed to have sold its pro rata share of the underlying assets of the
partnership. This look-through rule only applies if the CFC has a 10% or greater
interest in the partnership. This rule makes sense for three reasons. First,
with the proliferation of international joint ventures there are instances where
a transfer of a partnership interest is deemed to be a sale and gain recognized
for U.S. tax purposes. Thus, the U.S. tax treatment of gain from the sale of a
partnership interest by a CFC is becoming a more common issue. Second, under the
present law the gain on the sale of a partnership interest is treated as passive
subpart F income. That is the case even if 100% of the income generated by the
partnership in its business is otherwise treated as active non- subpart F
income. Thus, under this amendment gain from a partnership interest is treated
in a manner similar to the income earned from the partnership, which is a
rational tax policy. Third, under current law the transfer of a partnership
interest is frequently treated as a deemed transfer of a pro rata share of the
partnership's underlying assets, such as under Code Section 367(a)(4). Thus,
this change enhances consistency in the treatment of a sale of a partnership
interest in the international tax area. Overall H.R. 2018 is clearly a step in
the right direction. It should be noted, however, that there are confusing
signals from Congress. For example, Section 201 of H.R. 2018 expands the
carryover period for foreign tax credits, but, in contrast, the Senate Finance
Committee earlier this year once again approved a proposal to reduce the
carryback period.(2) Request for Clarification There are two provisions of your
bill, Mr. Chairman, that need further clarification. Section 102(a) of the bill
authorizes the Secretary of the Treasury to conduct a study on the feasibility
of treating all countries included in the European Union as one country for
purposes of applying the same country exceptions under subpart F. That aspect of
Section 102 represents a positive step, which Warner-Lambert strongly supports.
That provision is attractive to us because it would lessen the gap between
ourselves and our European based pharmaceutical competitors in that market. But
then Section 102(a) provides as follows: Such study shall include consideration
of methods of ensuring that taxpayers are subject to a substantial effective
rate of foreign tax in such countries if such treatment is adopted. The policy
represented by this sentence is unclear. Should the policy of the United States
be that non-U.S. business activities of a U.S. multinational corporation must be
subject to "substantial" foreign tax? If so, how did we reach this point? Mr.
Chairman, I strongly urge you to reconsider the language in Section 102(a) of
your bill and in particular ask that you do so in light of the recent National
Foreign Trade Council's (the "NFTC") report on international tax policy for the
21st century. Also Section 310 in H.R. 2018 appears to be inconsistent with the
notion of "International Tax Simplification for American Competitiveness."
Section 310 would amend the so-called "earnings stripping" rule in Section
163(j) of the Code. The earnings stripping rule imposes a limitation on the
amount of interest expense that may be deducted by a foreign-owned domestic
corporation. This subsection was enacted to stop the practice by foreign
multinationals of "stripping" the earnings out of their domestic subsidiaries
through related-party loans. Many other developed countries have similar
restrictions, frequently in the form of debt/equity ratio requirements. I
believe that this provision might potentially facilitate earnings stripping by
our foreign competitors. Warner-Lambert could not identify a benefit to U.S.
multinationals of Section 310. Let us make certain that Section 310 is not an
instance where by unilateral action the United States indirectly imposes a
competitive tax disadvantage on its own multinational corporations. Although
this amendment to Code Section 163(j) may have merit, I ask this Committee to
take into account the treatment accorded U.S. multinationals in the reverse
situation before proceeding with this subsection. I would also point out that
Section 310 incorporates what may be considered a subjective test, i.e.,
satisfying the Secretary that a loan would have been made without a parent
guarantee. A number of years ago the subjective test in the high-tax exception
of Code Section 954(b)(4) (no tax avoidance intention) was repealed because of
alleged administrative difficulties in applying the test. The NFTC Report Before
I conclude, I would like to comment on a recent report issued by the NFTC, an
organization of which I am pleased to be a member of the Board of Directors.
This report, The NFTC Foreign Income Project: International
Tax Policy for the 21st Century (the "Report"), is the first of
a series of studies commissioned by the NFTC to evaluate our international tax
policies in light of the globalization of the world's economy. The first report
focused on the subpart F rules of the Code, which provide a number of exceptions
to the principal U.S. international tax policy of deferral of U.S. taxation on
foreign earnings until distributed. The Report highlights the slow breakdown of
deferral. Your bill focuses on and addresses this trend. The Report concludes
that (1) the economic policy justification for the current structure of subpart
F has been substantially eroded by the growth of a global economy; (2) the
breadth of subpart F exceeds the international norms for such rules, adversely
affecting the competitiveness of U.S.-based companies; and (3) the application
of subpart F to various categories of income that arise in the course of active
foreign business operations should be substantially narrowed. When subpart F was
enacted in 1962, 18 of the 20 largest corporations in the world (ranked by
sales) were headquartered in the U.S. Now there are eight. In 1962 over 50 % of
worldwide cross-border direct investment was made by U.S. businesses. Now that
number is 25%. U.S. gross domestic product as a percentage of the world total
has gone from 40% to 26%. As these figures suggest, the competitive environment
in 1962 and the competitive environment today are completely different. Thus,
international tax policy should reflect this change to a global economy. In 1962
subpart F included a de minimis test where a CFC was deemed to have no subpart F
income if certain designated categories of income constituted 30% or less of
total gross income. That test over time has been reduced to the lesser of 5% of
gross income or $1,000,000. As a result, we have reached the point where
incidental interest income earned on normal levels of working capital used in an
active business constitutes subpart F income. In 1962, the "high-tax exception"
referred to the alternative of a specified effective tax rate or establishment
of no tax avoidance intent. Now a mechanical effective tax rate test creates
anomalous situations in which, for example, a CFC organized in Italy (with a
statutory tax rate in excess of the U.S. rate) may fail the high-tax exception
because U.S. and Italian capital recovery rules are not identical. Also, the
U.K. now constitutes a low-tax jurisdiction under our subpart F rules and,
therefore, a CFC doing business in the U.K may no longer qualify for the
high-tax exception of Code Section 954(b)(4). A subsequent NFTC report will
focus on the functioning of the second principal U.S. international tax policy -
avoidance of double taxation through the foreign tax credit system. Conclusion
In conclusion, I commend and thank you Mr. Chairman for introducing H.R. 2018
and holding a hearing on what is a highly technical but extremely important area
of our tax laws. Warner- Lambert supports the bill but more can be done in the
international tax area to improve the competitiveness of U.S. multinationals. I
encourage this Committee to continue its efforts in this regard. Warner-Lambert
is ready to offer its assistance in your efforts. Finally, I urge you to include
the important provisions in H.R. 2018 in the tax bill the Committee will be
marking up early next month. Mr. Chairman, I am pleased to answer any questions.
1 Section 207 of H.R. 2018 is identical to H.R. 1633 (introduced on April 29,
1999 by Chairman Houghton and 25 other members of the Ways and Means Committee)
and S. 216 (introduced on January 19, 1999 by Sens. Moynihan and Jeffords
(R-VT)). 2 A reduction in the carryback period from two years to one year was
most recently approved by the Senate Finance Committee on May 19, 1999 as
Section 401 of S. 1134, the Affordable Education Act of 1999.
LOAD-DATE: June 23, 1999 
