Copyright 1999 Federal Document Clearing House, Inc.
Federal Document Clearing House Congressional Testimony
June 30, 1999
SECTION: CAPITOL HILL HEARING TESTIMONY
LENGTH: 4037 words
HEADLINE:
TESTIMONY June 30, 1999 KEVIN CONWAY VICE PRESIDENT HOUSE WAYS
AND MEANS INTERNATIONAL TAX RULES
BODY:
Statement
of the Kevin Conway, Vice President, Taxes, United Technologies Corporation,
Hartford, Connecticut, and Vice Chairman, International Tax Subcommittee,
National Association of Manufacturers Testimony Before the House Committee on
Ways and Means Hearing on Impact of U.S. Tax Rules on International
Competitiveness June 30, 1999 I. INTRODUCTION Chairman Archer, members of the
committee, my name is Kevin Conway. I am the vice president of taxes for United
Technologies Corporation. I thank you for this opportunity to testify on behalf
of the National Association of Manufacturers (NAM). The National Association of
Manufacturers - "18 million people who make things in America" - is the nation's
largest and oldest multi-industry trade association. The NAM represents 14,000
members (including 10,000 small and mid-sized companies) and 350 member
associations serving manufacturers and employees in every industrial sector and
all 50 states. Headquartered in Washington, D.C., the NAM has 11 additional
offices across the country. The NAM has long advocated international tax
simplification, which would greatly improve the international competitiveness of
U.S. manufacturers and the U.S. economy overall. There are many opportunities to
improve the international provisions of the Internal Revenue Code (IRC), and the
NAM strongly supports H.R. 2018, the "International Tax Simplification for
American Competitiveness Act of 1999," by Representatives Houghton (R-31st NY)
and Levin (D-12th MI). However, due to time constraints and more extensive
coverage of several important issues by other members of this panel, I will
confine my remarks to four particular areas of concern: 1) look-through for
10/50 companies; 2) the 90 percent limitation on foreign tax credits applicable
to companies in AMT status; 3) advance pricing agreement (APA) disclosure; and
4) the 50 percent limitation on foreign sales corporation (FSC) benefits
applicable to defense exports. II. LOOK-THROUGH FOR 10/50 COMPANIES Until 1997,
a separate foreign tax credit (FTC) limitation (i.e., a separate "basket")
computation was required for dividends received from each "noncontrolled Section
902 corporation." A "noncontrolled Section 902 corporation" is a foreign
corporation that satisfies the stock ownership requirements of IRC section
902(a), yet is not a controlled foreign corporation (CFC) under IRC section
957(a). More simply stated, these are companies in which U.S. shareholders own
at least 10, but no more than 50, percent of the foreign corporation, hence the
name "10/50 company." This rule imposed a tremendous compliance burden on
multinationals by requiring extensive, separate bookkeeping. Additionally, it
severely constrained the ability of U.S.-based multinationals to use their FTCs
in the most efficient manner to alleviate double taxation. Only foreign taxes
directly associated with a 10/50 company's dividends could be credited against
the U.S. tax on that 10/50 company's income, i.e., excess FTCs from other
sources could not offset FTC shortfalls of 10/50 companies, and excess FTCs
generated by 10/50 companies could not offset shortages incurred by other
companies, even other 10/50 companies. This is a deviation from the general
rules, which allow "look-through" treatment, as in the case of CFC dividends.
Furthermore, there is no tax accounting or policy reason for differentiating
between income earned by noncontrolled corporations versus CFCs. Look-through
rules allow dividend income to be re-characterized in accordance with the
underlying sources of the payor corporation's income. Thus, dividends associated
with overall limitation income would be eligible for inclusion in the overall
limitation income basket. Under the rules in place before 1998, however,
taxpayers were not allowed to "look-through" dividends received from 10/50
companies, even though 10/50 company dividends are generally derived from
overall limitation income and would otherwise be eligible for inclusion in the
overall limitation income basket under the look-through rules. The 1997 Tax
Relief Act corrected this inequity by eliminating separate baskets for 10/50
companies. Instead, 10/50 companies are treated just like CFCs, and taxpayers
can utilize look- through rules for re-characterizing dividend income in
accordance with the underlying sources of the payor corporation's income. The
1997 act, however, did not make the change effective for such dividends unless
they were received after the year 2003 and, even then, required two sets of
rules to apply for dividends from earnings and profits (E&P) generated
before the year 2003, and dividends from E&P accumulated after the year
2002. The ongoing requirement to use two sets of rules on dividends before the
year 2003 has been a concern of taxpayers, members of Congress, and the
Administration. Thus, to address the complexity created by this much-delayed
effective date, the Administration has, as part of both its FY1999 and FY2000
budget proposals, recommended accelerating the effective date of the 1997 Tax
Act change. The proposal would apply the look-through rules to all dividends
received in tax years after 1998, no matter when the E&P constituting the
makeup of the dividend was accumulated. This change would result in a tremendous
reduction in complexity and compliance burdens for U.S. multinationals doing
business overseas through foreign joint ventures. It would also reduce the
competitive bias against U.S. participation in such ventures by placing U.S.
companies on a much more level playing field from a corporate tax standpoint.
Finally, this proposal epitomizes the favored policy goal of simplicity in the
tax laws and will go a long way toward helping the U.S. economy by strengthening
the competitive position of U.S.-based multinationals. III. FOREIGN TAX CREDIT
LIMITATIONS ON AMT COMPANIES A multinational corporation with a U.S. parent and
foreign subsidiaries can be double taxed on income earned by its foreign
subsidiaries when the income is repatriated to the U.S. parent as a dividend.
The U.S. government, recognizing that these multiple levels of tax hurt the
competitiveness of U.S. corporations, alleviates this multiple tax burden by
allowing the U.S. company foreign tax credits (FTCs) for the
income taxes paid to foreign governments.
These credits are allowed for taxes paid by subsidiaries on
dividends which are distributed to the U.S. parent. Foreign tax credits are
dollar-for-dollar credits that offset U.S. tax liability. However, the number of
these credits that can actually be used to offset the U.S. parent tax liability
is determined by whether the parent corporation has regular tax liability or
alternative minimum tax (AMT) liability. Under a regular tax computation, the
U.S. parent company can use foreign tax credits to offset 100 percent of its
U.S. tax liability on the dividends it receives from the foreign subsidiary.
However, a similar company in AMT status would not be permitted to alleviate all
of its double taxation. The resulting multiple taxation occurs because of a
provision added to the tax code as part of the Tax Reform Act of 1986, providing
that only 90 percent of the amount of AMT liability can be offset by foreign tax
credits. The intent of this limitation was to ensure that a U.S. corporation
that earned U.S.-source income and was profitable on its U.S. operations from a
book perspective would incur a minimum amount of U.S. taxes. In operation,
however, U.S. corporations that have a substantial amount of foreign source
income relative to their U.S.-source income or that have taxable losses on their
U.S. operations are forced to pay U.S. taxes on income already heavily taxed
outside the United States. This result contravenes the very purpose for which
foreign tax credits were created. AMT liability by its very nature actually
represents a prepaid double taxation. Because AMT is a prepayment of taxes, the
law allows corporations to accumulate credits for AMT taxes that have been paid.
Theoretically, these credits can ultimately be used when the corporation is no
longer in AMT status and has fully utilized all other available credits such as
foreign tax credits and research and development credits. In reality, a
corporation that has substantial U.S.-source losses over a number of years or
that has substantially more foreign source income than U.S. source income may
never actually recover the taxes it prepaid. In this regard, the provision
operates in a punitive manner not anticipated when the provision was enacted.
IV. ADVANCE PRICING AGREEMENT (APA) DISCLOSURE The Advance Pricing Agreement
(APA) program of the Internal Revenue Service (IRS) began in 1991 as an
innovative way for taxpayers, the IRS, and foreign tax agencies to avoid costly
litigation and uncertainty over international transfer pricing - i.e., the
appropriate arm's length price for sales, services, licenses and other
transactions between related parties. The program has been extremely successful
and is often cited as a model for how the IRS should interact with taxpayers.
From the beginning of the program, the IRS assured taxpayers, Congress, and
foreign governments that any information "received or generated" by the IRS
during the APA process was "subject to the confidentiality requirements of secc.
6103." (See Rev. Proc. 91- 22 and Rev. Proc. 96-53). Indeed, written assurances
of confidentiality have often been included in the APA itself. However, in
January of this year, as a concession in a lawsuit seeking public disclosure
brought by the Bureau of National Affairs (BNA), the IRS unexpectedly reversed
its long-standing policy and notified taxpayers that APAs are subject to
disclosure under IRC secc. 6110 - which requires disclosure of any IRS "written
determination." Regardless of the outcome of the pending lawsuit, the IRS is
proceeding with redaction and release of APAs (now scheduled for October 1999)
in contravention of both its own prior assurances of confidentiality to
taxpayers and the express intent of Congress (in 1993) that secc. 6103 protects
APAs from disclosure. First of all, APAs are not "written determinations" under
IRC secc. 6110. In 1976, when Congress enacted secc. 6110 to allow disclosure of
written determinations, negotiated taxpayer agreements, such as closing
agreements, were specifically excluded because "a negotiated settlement...as
such, does not necessarily represent the IRS view of the law." (S. Rep. No. 938,
94th Cong. 2d Sess. 306-7 (1976); H.R. Rep. No. 658, 94th Cong., 2d Sess. 316
(1976)). APAs are not written determinations (such as private letter rulings)
that are unilaterally issued to the taxpayer by the IRS and consist of facts,
law and the application of the law to the facts. Rather, APAs are customized,
binding, written contracts that determine specific tax results and are carefully
negotiated between the taxpayer and the IRS, like closing agreements, which are
not subject to disclosure (Id). APAs are highly factual in nature, making a
fact-intensive economic determination, not a legal one. Second, APAs are
protected return information under IRC secc. 6103. In 1993, when Congress
amended secc. 6103 to add secc. 6103(l)(14), which permits disclosure of certain
return information to the Customs Service, the Congress expressly exempted APAs
from such disclosure. This was done because APAs were viewed as return
information in the first instance. The legislative history states: "The
effectiveness of the APA program relies on voluntary disclosure of sensitive
information to the Internal Revenue Service; accordingly, information submitted
or generated in the APA negotiating process should remain confidential." See
H.R. Report. No. 103-361, Vol. I, at 104 (1993). Treasury regulations
implementing this provision also expressly describe APAs as "return
information." See Treas. Reg. 301.6103(l)(14)-1(d). Public disclosure of APAs is
contrary to congressional intent and Treasury's own regulations. Third,
redaction of APAs under IRC secc. 6110 will strain IRS and taxpayer resources.
Prior to release of any APAs under secc. 6110, the IRS will be required to
redact any identifying taxpayer information. In addition, the "background files"
will be subject to disclosure under IRC secc. 6110(b)(2). These background files
are voluminous and contain highly sensitive proprietary data that will have to
be reviewed and redacted. Redaction, especially of these background files, will
strain the resources of the IRS and be yet another cost, and likely deterrent,
for taxpayers participating in the APA program Ironically, release and redaction
of APAs under IRC secc. 6110 will create costly disputes and litigation. The APA
program was instituted specifically to curtail audit disputes and litigation
over transfer pricing, but the redaction process required under IRC secc. 6110
allows taxpayers and third parties to challenge proposed redactions in court,
creating a significant risk of even more disputes and litigation. Disputes will
arise not only between the taxpayer and the IRS over what should be redacted,
but also between the taxpayer and third parties seeking disclosure, and over
what is or is not a background file. Release and/or redaction of APAs and the
background files would be disastrous for both the IRS and the taxpayer, as well
as for our treaty partners. Furthermore, confidentiality is essential to protect
taxpayer privacy and to assure continuation of the APA program. The APA program
has worked because taxpayers have trusted the IRS and agreed to voluntarily
submit sensitive pricing information to the IRS in advance of an audit -- based
on a promise of confidentiality. Release and redaction of APAs and background
files would be a betrayal of taxpayers who voluntarily submitted sensitive
information in the past and a significant deterrent to taxpayers contemplating
participation in the APA program in the future. In addition, an increasing
number of APAs are bilateral or multi-lateral involving foreign tax authorities
and making confidentiality even more important. Our treaty partners are very
concerned about possible breach of the promise of confidentiality in the APA
program. If taxpayers cannot obtain bilateral APAs because foreign tax
authorities refuse to participate, many taxpayers may decide not to pursue an
APA at all. IRS's concession has jeopardized the APA program, which has been
such a successful tool in helping the IRS and taxpayers resolve difficult
factual issues without litigation. Finally, disclosure of APAs could jeopardize
the confidentiality of competent authority proceedings and U.S. relationships
with foreign governments. When a taxpayer's income is potentially subject to tax
by both the United States and a foreign jurisdiction, the IRS can enter into a
negotiation with the foreign "competent authority" to determine how much tax
should be paid to each jurisdiction. These Competent Authority proceedings are
confidential under our tax treaties. Although these proceedings involve the
elimination of any type of double taxation, they often resolve double taxation
problems arising from transfer pricing disputes - just like bilateral APAs. If
APAs are subject to disclosure, there is a real risk Competent Authority
proceedings could also be disclosed. Any suggestion that Competent Authority
proceedings should be subject to disclosure would be viewed with tremendous
concern by our treaty partners and could seriously impair our ability to resolve
claims regarding double taxation in the future. Congress should promptly confirm
that APAs are protected taxpayer information under IRC secc. 6103 and not
subject to disclosure under IRC secc. 6110. Congressional action is needed to
prevent the IRS from breaching its solemn assurances to taxpayers, the Congress,
and foreign governments that these agreements are confidential taxpayer
information. Failure to take immediate action in this regard will severely
cripple, if not destroy, the APA program. V. FOREIGN SALES CORPORATION (FSC)
BENEFITS FOR DEFENSE EXPORTS The Internal Revenue Code allows U.S. companies to
establish foreign sales corporations (FSCs), under which they can exempt from
U.S. taxation a portion of their earnings from foreign sales. This provision is
designed to help U.S. firms compete against foreign companies relying more on
value-added taxes (VATs) than on corporate income taxes. When products are
exported from such countries, the VAT is rebated, effectively lowering their
prices. U.S. companies, in contrast, must charge relatively higher prices in
order to obtain a reasonable net profit after taxes have been paid. By
permitting a share of the profits derived from exports to be excluded from
corporate income taxes, the FSC in effect allows companies to compete with
foreign firms that pay less tax. In 1976, Congress reduced the Domestic
International Sales Corporation (DISC) tax benefits for defense products to 50
percent, while retaining the full benefit for all other products. The limitation
on military sales, currently contained in IRC secc. 923(a)(5), was continued
when Congress enacted the FSC (which replaced the DISC) in 1984. The rationale
for this discriminatory treatment -- that U.S. defense exporters faced little
competition -- no longer exists. Regardless of the veracity of that premise 25
years ago, today military exports are subject to fierce international
competition in every area. In the mid-1970s, roughly half of all the nations
purchasing defense products benefited from U.S. military assistance. Today, U.S.
military assistance has been sharply curtailed and is essentially limited to two
countries. European and other countries are developing export promotion projects
to counter the industrial impact of their own declining domestic defense budgets
and are becoming more competitive internationally. In addition, a number of
Western purchasers of defense equipment now view Russia and other former Soviet
Union countries as acceptable suppliers, further increasing the global
competition. Circumstances have changed dramatically since the tax limitation
for defense exports was enacted in 1976. Total U.S. defense exports and
worldwide defense sales have both decreased significantly. Over the past 15
years, the U.S. defense industry has experienced spending reductions unlike any
other sector of the economy. During the Cold War, defense spending averaged
around 10 percent of U.S. Gross Domestic Product, hitting a peak of 14 percent
during the Korean War in the early 1950s and gradually dropping to 6-7 percent
in the late 1980s. That figure has now sunk to 3 percent of GDP and is projected
to go even lower, to 2.8 percent, by Fiscal Year (FY) 2001. Since FY85 the
defense budget has shrunk from 27.9 percent of the federal budget to 14.8
percent in FY99. As a percentage of the discretionary portion of the U.S.
Government budget, defense has slid from 63.9 percent to 45.8 percent over the
same time. Moreover, the share of the defense budget spent on the development
and purchase of equipment -- Research, Development, Test and Evaluation
(RDT&E) and procurement -- has contracted. Whereas procurement was 32.2
percent and RDT&E 10.7 percent of the defense budget in FY85 - for a total
of 42.9 percent; those proportions are now 18.5 percent and 13.9 percent,
respectively - - for a total of 32.4 percent. Obviously, statistics such as
these are indicative that the U.S. defense industry has lost much of its
economic robustness. This is additionally evidenced by massive consolidation and
job loss in the defense industry. Of the top 20 defense contractors in 1990,
two-thirds of the companies have merged, been sold or spun off, and hundreds of
thousands of jobs have been eliminated in the industry. Budget issues are always
a concern to lawmakers. The Joint Tax Committee estimates that extending the
full FSC benefit to defense exports will likely cost about $340 million over
five years. However, this expense is justified by both overriding policy
concerns and sound tax policy. With the sharp decline in the defense budget over
the past 15 years, exports of defense products have become ever more critical to
maintaining a viable U.S. defense industrial base. Key U.S. defense programs
rely on international sales to keep production lines open and to reduce unit
costs. Repeal will benefit not only the large manufacturers of military
hardware, but also the smaller munitions manufacturers, whose products are
particularly sensitive to price fluctuations. The recent decision to transfer
jurisdiction of commercial satellites from the Commerce Department to the State
Department illustrates the fickleness of Section 923(a)(5). When the Commerce
Department regulated the export of commercial satellites, the satellite
manufacturers received the full FSC benefit. Since the Congress transferred
export control jurisdiction to the State Department, the identical satellites,
manufactured in the same facility, by the same hard-working employees, no longer
receive the same tax benefit. Because these satellites are now classified as
munitions, their FSC benefit has been cut in half. This result demonstrates the
inequity of singling out one class of products for different tax treatment than
every other product manufactured in America. The Cox Committee, recognizing the
absurdity of the situation, recommended that the Congress take action to correct
this inequity as it applies to satellites. The Administration has agreed with
this recommendation. Section 303 would not only correct the satellite problem,
but would also change the law so that all U.S. exports are treated the same
under the FSC. Repeal of Section 923(a)(5) of the tax code does not alter U.S.
export licensing policy. Military sales will continue to be subject to the
license requirements of the Arms Export Control Act. Exporters will be able to
take advantage of the FSC only after the U.S. Government has determined that a
sale is in the national interest. Decisions on whether to allow a defense export
sale should continue to be made on foreign policy grounds. However, once a
decision has been made that an export is consistent with those interests, our
government should encourage that such orders are filled by U.S. companies and
workers, not by our foreign competitors. Discriminating against these sales in
the tax code puts our defense industry at great disadvantage and makes no sense.
Removing this provision of the tax code will further our foreign policy
objectives by making defense products more competitive in the international
market. VI. CONCLUSION In conclusion, the NAM has long advocated overhaul of the
overly complex and arcane international tax provisions in the Internal Revenue
Code and complete repeal of the punitive alternative minimum tax (AMT). While
the opportunities for improvement in the code are numerous, the NAM strongly
endorses H.R. 2018, the "International Tax Simplification for American
Competitiveness Act of 1999," and the simplification provisions therein as a
significant step toward improving the competitiveness of U.S.- based
manufacturers. However, we would also urge the committee to address the
impending disclosure by IRS of advance pricing agreements (APAs) by clarifying
their status as return information under I.R.C. secc. 6103. With only about four
percent of the world's population residing in the United States, international
trade is no longer a luxury but necessary to the survival and growth of
U.S.-based manufacturers. While U.S. negotiators have actively pursued an
increasing number of trade agreements to improve access to overseas markets, a
major impediment to trade sits in our own backyard, namely the U.S. tax code.
The NAM thanks the Committee on Ways and Means for recognizing the barriers our
tax code imposes and the decreased competitiveness that results. Hearings such
as this one are the first step to achieving significant reform. Thank you for
scheduling this hearing to address these important issues and for allowing me to
testify today on the NAM's behalf.
LOAD-DATE: July 6,
1999 
