Copyright 1999 Federal Document Clearing House, Inc.
Federal Document Clearing House Congressional Testimony
June 30, 1999
SECTION: CAPITOL HILL HEARING TESTIMONY
LENGTH: 2559 words
HEADLINE:
TESTIMONY June 30, 1999 WILLIAM W. CHIP CHAIRMAN HOUSE WAYS AND
MEANS INTERNATIONAL TAX RULES
BODY:
Statement of
William W. Chip, Chairman, Tax Committee, European-American Business Council,
and Principal, Deloitte & Touche LLP Testimony Before the House Committee on
Ways and Means Hearing on Impact of U.S. Tax Rules on International
Competitiveness June 30, 1999 My name is Bill Chip. I am a principal in Deloitte
& Touche, an international tax, accounting, and business consulting firm. I
have been engaged in international tax practice for 20 years. I am testifying
today as Chairman of the Tax Committee of the European-American Business Council
(EABC). The EABC is an alliance of 85 multinational enterprises with
headquarters in the United States and Europe. A list of EABC members is
attached. Because the EABC membership includes both US companies with European
operations and European companies with US operations, the EABC brings a unique
but practical perspective on how the US international tax rules impact the
competitiveness of US companies operating in the European Union (EU) -- the
world's largest marketplace. The points I would like to make today may be
summarized as follows: 1. US international tax rules foster tax neutrality
between US companies, but not between US companies and foreign companies. 2. In
order for US-parented companies to be truly competitive in a globalized economy,
the US should not impose a corporate income tax on
income from foreign operations. 3. The enhanced power of the
IRS to police transfer pricing has eliminated the most important rationale for
the subpart F rules, which should therefore be relaxed. 4. The anticompetitive
flaws in the US system cannot be fully corrected without attending to other
problems, such as the taxation of dividends with no credit for corporate-level
taxes. 5. Certain changes are urgently needed pending more fundamental reforms:
(1) the EU should be treated as a single country under the subpart F rules; (2)
the US should agree to binding arbitration of transfer pricing disputes; and (3)
the rules for allocating interest between US and foreign income should be made
economically realistic. 6. Many problems faced by US companies operating
internationally cannot be resolved by US tax policy alone, and the US should
take the lead in erecting an international tax system that does not impede
cross-border business activity. The EABC welcomes the Chairman's interest in
reforming this country's international tax rules. Those rules have always had a
negative impact on the ability of US companies to compete overseas. However,
this anticompetitive impact has been masked during most of this century by
several US business advantages, including the world's largest domestic economy
as a base, a commanding technological lead in many industries, and sanctuary
from the destruction of two world wars. However, 50 years of peace and the rapid
spread of new technologies have leveled these advantages and exposed the
anticompetitive thrust of our international tax regime. I would go so far as to
say that the US rules with respect to income produced overseas were written
without any regard whatsoever for their impact on competitiveness. Their goal
instead was to ensure that any income controlled by a US person was eventually
subject to US tax. Thus, income of foreign subsidiaries is
taxed at the full US corporate rate when distributed to the US parent (with a
credit for any foreign income taxes) and then taxed again (with
no credit for either US or foreign income taxes) when
distributed to the US shareholders. The imposition of US tax is accelerated when
foreign earnings are redeployed from one foreign subsidiary to another and also,
under subpart F, when the foreign income is one of the many types that Congress
feared could otherwise be "sheltered" in a "tax haven." These rules do have the
effect of neutralizing the impact of foreign taxes on competition between US
companies. Because all foreign earnings must eventually bear the full US tax
rate, a US company that produces in a low-tax foreign jurisdiction enjoys at
most a temporary tax advantage over one that produces in the US. Likewise,
because all earnings of US companies eventually bear the same US corporate tax
rate, the presence or absence of a shareholder-level credit for corporate taxes
is immaterial in a shareholder's decision to invest in one US company rather
than in another. In contrast, the US tax system does not neutralize the impact
of taxes on competition between US and foreign companies. At the shareholder
level, the absence of a credit for corporate-level taxes favors investments in
low-taxed foreign companies over their US equivalents. At the corporate level,
if the costs of producing a product, including tax costs, are lower in a foreign
country such as Ireland than they are in the US, our free trade rules will
likely result in US customers purchasing the Irish product rather than the
equivalent US product. However, if a US owner of an Irish enterprise must also
pay the excess of US over the Irish tax rate, then the Irish enterprise will
likely end up being owned by a foreign company whose home country does not tax
the Irish earnings, taxes them later, or provides a more liberal foreign tax
credit. These competitive disadvantages are aggravated by business
globalization. Owing to the internationalization of capital markets, an
ever-larger percentage of US shareholders are able and willing to invest in
foreign corporations and mutual funds, impairing the ability of US companies to
raise capital for their overseas operations even in the US capital markets. The
electronic revolution in communications and computing has also globalized the
economic production process. Economic output is increasingly the consequence of
coordinated activity in a number of different countries, expanding the range of
products impacted by anticompetitive tax rules. If the Irish enterprise in the
foregoing example is an integral part of a global activity, US companies may
lose the opportunity to sell, not only the Irish product, but also any integral
US products. The US system leads to very anomalous results. Consider a US
company with a German and Irish subsidiary, then consider three identical
companies, except that the US and Irish companies are subsidiaries of the German
company. The US would never dream of trying to tax the income of the Irish
subsidiary in the second case, but in the first case insists on taxing it when
the income is repatriated, if not sooner. There is no reason why this should be
so. Most countries, like the US, have a progressive income tax for individuals
and, above a certain level, a virtually flat income tax for corporations. That
being the case, there is a reason for imposing shareholder-level taxes on
dividends received from local and foreign corporations (although there should be
a credit for taxes paid at the corporate level). There is no reason for imposing
a local corporate tax on foreign earnings as they make their way from the
foreign subsidiary to the ultimate individual shareholders. Nowhere is the
anti-competitive burden imposed by US tax rules more evident and damaging than
in the application of the US "subpart F" rules to US-owned enterprises in the
EU. The subpart F rules were intended to prevent US companies from avoiding US
taxes by sheltering mobile income in "tax havens." The impact of these rules is
exacerbated by the fact that since 1986 any country with an effective tax rate
not more than 90% of the US rate is effectively treated as a tax haven. Even the
United Kingdom, an industrialized welfare state with a modern tax system, is
treated as a tax haven by subpart F because its 30% corporate rate is only 86%
of the US corporate rate. (If the US corporate tax rate when subpart F was
enacted were the benchmark, the US today would itself be considered a tax
haven.) Because Congress perceived that selling and services were relatively
mobile activities that could be separated from manufacturing and located in tax
havens, the "foreign base company" rules of subpart F immediately tax income
earned by US- controlled foreign corporations from sales or services to related
companies in other jurisdictions. Consider the impact of this rule on a US
company that already has operations in several EU countries but wishes to
rationalize those operations in order to take advantage of the single market.
Such a company may find it most efficient to locate personnel or facilities used
in certain sales and service activities in a single location or at least to
manage them from a single location. While a number of factors will affect the
choice of location, all enterprises, whether US- owned or EU-owned, will favor
those locations that impose the lowest EU tax burden on the activity. However,
if the enterprise is US-owned, the subpart F rules may eliminate any locational
tax efficiency by immediately imposing an income tax effectively equal to the
excess of the US tax rate over the local tax rate. Thus, US companies are
penalized for setting up their EU operations in the manner that minimizes their
EU tax burden (even though reduction of EU income taxes will increase the US
taxes collected when the earnings are repatriated). It makes as little sense for
the US to penalize its companies in this way as it would for the EU to impose a
special tax on European companies that based their US sales and service
activities in the US States that imposed the least tax on those activities. The
subpart F rules were enacted mostly out of concern that certain types of income
could readily be shifted into "tax havens." However, the term tax haven is
misleading. Taxes are only one of many costs that enter into the production
process and into the decision where to conduct a particular activity. Some
countries have low taxes, but others have low labor or energy costs or a
favorable climate or location. If an enterprise is actually conducted in a
low-tax jurisdiction, it is anticompetitive for the US to impose (let alone
accelerate) corporate taxes on the income properly attributable to that
enterprise, just as it would be anticompetitive to impose a charge equal to any
excess of US over foreign labor or energy costs. The imposition of taxes or
other charges that offset the competitive advantage of the foreign enterprise
will simply cause the enterprise to be owned by a non-US competitor that does
not have subpart F rules. When subpart F was enacted, Congress seemed to be
concerned that US companies might arbitrarily attribute excessive amounts of
income to their low-taxed foreign operations. Whether or not such concern was
warranted then, it is not warranted now. Since 1994 US companies have been
subject to draconian penalties on any substantial failure to price their
international transactions at arm's length. Moreover, most of our competitors,
and even less developed countries such as Mexico and Brazil, have followed suit
and greatly enhanced their enforcement of the arm's length standard. Having
endowed the IRS with "weapons of mass destruction" in the field of transfer
pricing, Congress can now afford to retire much of the obsolete subpart F
armory. I would be remiss not to acknowledge that the globalization of business
poses important challenges to tax administrators in the US and elsewhere. Ever
greater shares of the nation's income derives from cross-border activity, while
ever increasing integration of cross-border activity makes it harder to
determining the source of business income. The IRS and most
foreign tax authorities are well aware of these challenges and
are working to surmount them. Indeed, the enhanced attention to transfer pricing
is one of the more important and obvious responses to the globalization
challenge. The efforts of the US and other countries to ensure receipt of their
"fair share" of global tax revenues through transfer pricing enforcement points
also to a need for increased international cooperation. For example, each
country is likely to view arm's length transfer pricing as the pricing that
maximizes the amount of local income. Hence the need for international
mechanisms which ensure that the calculation of national incomes under national
transfer pricing policies does not add up to more than 100% of a company's
global income. Unfortunately, although all tax treaties provide a mechanism for
reaching agreement on transfer pricing, very few require that the countries
actually reach agreement, meaning there is no guarantee against double taxation.
Even more unfortunately, the US is opposing such requirements. For example,
while the EU countries have entered into a convention that requires arbitration
of international transfer pricing disputes, the US has declined to exchange the
notes that would effectuate the arbitration clauses of the few US tax treaties
that have them. For that reason the EABC strongly recommends that the US enter
into negotiations with the EU members states to extend the principles of the EU
convention to transfer pricing disputes between the US and EU members.
International cooperation does not mean that tax rates should be harmonized or
even that the calculation of taxable income should be harmonized. In fact,
unharmonized tax rates are a good thing, because tax competition is a useful
counterweight to the many pressures on government to increase taxes and
spending. For that reason the EABC shares many of the concerns outlined in the
response of the Business and Industry Advisory Committee (BIAC) to the report on
"Harmful Tax Competition" by the Organization for Economic Cooperation and
Development (OECD). There is genuine alarm within the business community that
some OECD members are responding in an anticompetitive way to the challenges of
globalization. Rather than working cooperatively to construct an international
tax system that ensures income is properly attributed to the jurisdiction where
it originates and not taxed more than once, some countries seem more interested
in maximizing the reach of their tax jurisdiction and capturing any income under
the control of companies that are headquartered locally. The efforts of the
present US Administration to expand the scope of subpart F by regulation and
legislation reflect such an approach and should be rejected by the Congress. I
am worried about a deep and growing divide between the business community and
the tax authorities in many industrialized countries on how to manage the fiscal
challenges of business globalization. At the EABC's recent Transatlantic Tax
Conference, officials of the US, EU, and OECD discussed "harmful tax
competition" and other current issues with tax leaders from BIAC and from
leading US and EU business organizations. EU business was as frustrated with the
inability of the EU member states to eliminate obstacles to cross-border
business integration and dividend/royalty payments as was US business with IRS
Notices 98- 11 and 98-35. All business representatives were concerned that the
OECD seemed less intent on eliminating tax obstacles to an efficient
international economy than on attempting to freeze in place existing revenue
sources. The EABC welcomes attention by the US Congress to how the US tax system
impacts business decisionmaking and is ready to work with your Committee to
identify urgently needed reforms.
LOAD-DATE: July 6,
1999 
