Keeping the Oil Flowing: a Hypothetical Question

I must say when I heard this I was kind of shocked:

“We will ensure the free flow of energy from the region to the world. Although America is steadily reducing our own dependence on imported oil, the world still depends upon the region’s energy supply, and a severe disruption could destabilize the entire global economy,” Obama said in a speech to the United Nations.

I just have one question - a hypothetical question - that I would like the President or someone in the administration to answer:  Suppose some oil-producing country in the Middle East makes the following announcement:

We are utter shocked at the announcements made at the meeting of the Intergovernmental Panel on Climate Change.  It is apparent to us that the continued consumption of fossil fuels is going to result a global calamity.  We will no longer participate in this self-destructive course.  Henceforth, this country will no longer extract or export oil from anywhere within our territory, and it will be illegal for any private party, foreign or domestic, to extract or export oil from anywhere within our territory.

How, exactly, would the United States respond to such an announcement?

"Anonymous" Employee Surveys

I just finished completing an employee survey of my company which was presented as an anonymous survey. The survey was voluntary, so we could refuse to participate if we wanted to.  And I gave some thought to not participating after I read this privacy disclaimer:

Personal data that you submit, and other data about you, will be compiled and aggregated and may be transmitted in anonymous, aggregate form to other [Employer] departments, companies, or third parties for the purposes of the administration, evaluation and management of [Employer] human resources. Some of these departments, companies, or third parties may be situated outside of your country of residence.

Now recognize that this doesn't tell me the most essential question I have when I participate in these surveys.  I don't want to know how you're going to use the information.  I want to know how you're not going to use the information. Note that it says they will do X with the information and they may do Y with the information.  But it doesn't say they won't do A through W with the information.

Also note that my employer used an outside consultant to conduct this survey.  So they have possession of this information as well, and there appears to be no restriction on their use of the information either.  No doubt there is something about the use of the data collected in the agreement between my employer and the consultant.  But I don't know what that agreement says.

So recognize that when you participate in a survey like this one, chances are nothing you say is secret.

The Levin Bill: Repealing the "Check-the-Box" Rule, Part 1

One of the provisions of the Levin bill changes the rules for determining whether a foreign business entity is to be treated as a corporation.  This is something I have touched upon in prior posts - it's one of the "deficiencies" raised by Herman Bouma that I discuss here, and something I get into a bit here.  

Looking back I'm not so sure I've really explained the issue being addressed by the bill.  And I'm going to take a little time to do this, because being a tax geek I find the whole thing rather amusing in a cynical sort of way. So in this post I'll tell the story of how we got to where we are (which is the amusing part), and I'll follow up  another post explaining what the bill does.

There are basically two kinds of taxpayers - individuals and corporations. Section 1 of the Internal Revenue Code taxes individuals, estates and trusts, and section 11 taxes corporations. That's it. Now I say there are only two kinds of taxpayers, because an estate is really just a continuation of the individual after he dies and until his property has been distributed to his heirs, and a trust is...well, a trust is a special animal that collects income and distributes it to beneficiaries, and unlike a corporation it's income isn't taxed twice (so it's really the beneficiaries - which are usually individuals - that pay the tax). So for now let's just focus on the two - individuals and corporations.  

As I noted here, the income of a corporation is taxed twice - once when earned by the corporation, and a second time when dividends are paid to shareholders or the shareholders dispose of their stock.  An individual is only taxed once when the income is earned.

So what is a corporation?  

Seen on the Little Screen

In the building where I work they have these little TV monitors in the elevators which flash headlines from the Wall Street Journal, ostensibly so we can all keep current on what's going on in the world.  I am often amused at the headlines I see, such as this one:

Iran's foreign minister and Kerry plan to meet at the U.N. General Assembly, in the highest-level meeting between the U.S. and Iran in 30 years.

[Note: this same headline appears on the WSJ webpage as I type this.]

So I read this and I think to myself...

30 years....30 years...what were we doing with them 30 years ago....oh yeah, I remember now...

The Reagan Administration was secretly selling them arms for use in there war with Iraq....

And using the proceeds to fund the contras in Nicaragua who were fighting against the elected government there...

In violation of a law specifically prohibiting the administration from helping the contras...

While at the same time arming the Iraqis as well....

In a war where ultimately more than a million people died....

Good times.....

I Bet This Didn't Go Over Well

From today's Daily Tax Report (subscription only):

Two former Joint Committee on Taxation officials agreed the government must increase taxes to deal with the demographic reality of a grayer America.

The issue is where to get the money to fund rising Social Security and Medicare commitments, Alan Auerbach, a former deputy JCT chief of staff and current economics professor at the University of California at Berkeley, and Edward Kleinbard, a former JCT chief of staff and current law professor at the University of Southern California, told a Sept. 21 forum at the American Bar Association Sections of Taxation and Real Property Fall CLE Meeting in San Francisco.

Relative to other nations, the U.S. is a low-tax country, Auerbach said. The U.S. is ahead of only Chile and Mexico for taxes as a share of gross domestic product among the 34 member nations of the Organization for Economic Cooperation and Development, Auerbach said.

That gives the U.S. room to increase taxes to fund the growing imbalance.

In today's climate, it's no wonder they are former officials....

The Levin Bill - The New Corporate Residence Rule

I'm going to create a series of separate posts describing the provisions of the Levin Bill, which I discussed here. First off, the change in corporate residence rules. 

I should start off by saying why these rules are important. Under the tax law, US persons, meaning US citizens, noncitizens resident in the US and "domestic corporations," are taxed on all of their income regardless of where they earn it. Foreign persons are only taxed on income connected to the US. This makes sense of course - the idea that the US can tax some bloke in England that never sets foot in the US is kind of ludicrous.  This has been fundamental to our system since 1913 (actually it was part of the income tax law passed in 1894, which the Supreme Court struck down in the infamous Pollock case, leading to the passage of the 16th Amendment).

So whether a corporation is a domestic corporation is key for how it is taxed.  Under the US tax law, the residence of a corporation is determined by where it is organized.  A corporation can be organized simply by filing a piece of paper with a government agency. Every state in the US and virtually every country around the world lets you do this and usually the country doesn't care who is filing the certificate or where they come from.  The bottom line is that it's very easy to manipulate the residence of a corporation under the US tax law when you form it.  Actually, it's not that difficult to change the residence of a corporation after it's been formed either.

A multinational corporation in reality is a whole group of corporations, each essentially taxed only in the country in which it is resident. Of course, many of these individual corporations do business in other countries, but for the most part a main goal of setting up these structures is to limit the number of countries that can tax a particular item of income. The group is generally owned by a single corporation - the parent corporation - that owns the stock of all the other corporations that are members of the group, either directly or by having other members of the group own the stock.  Some multinationals have hundreds or even thousands of corporations that are members of their "group."

The parent is the corporation whose stock is owned by the public and traded on the stock exchanges.  This is the key of course, because ultimately the goal of the enterprise is to make profits that are distributed to the investors as dividends. The parent gets those profits by having its subsidiary corporations - the ones that actually sell the goods and services that make the profits - pay dividends to it. Those dividends are income, and wherever that parent company is resident, that's the country that ultimately gets to tax the income before it's paid as dividends to the shareholders.  

Now different countries have different rules for taxing these dividends paid up to the parent corporation.  In the U.S., if the parent receives a dividend from a domestic subsidiary, it is not taxed (because the subsidiary has already paid tax on the income - and we only double tax corporate income, not triple-tax it).  If the parent receives a dividend from a foreign subsidiary, generally it is taxed, but the parent can take a credit for any income tax paid by the subsidiary in its home country.  Again, the idea is that we don't have two levels of corporate tax on the same income.  Of course, if the subsidiary has paid very little tax on the income when it was earned, the parent will pay a substantial tax on the income when it receives the dividend.  If the subsidiary pays a high rate of tax on the income, the U.S. tax paid by the parent will be low, often zero.

One of the trends we've seen over the years is for multinationals to try and move the residence of parent companies outside of the US, mostly because, over the years, multinationals have become quite adept at reducing the taxes they pay in other countries.  Some of this is due to the countries themselves, which generally have been lowering their tax rates (the race to the bottom, as I like to call it).  And a lot of it has to do with ever more sophisticated schemes to move income into lower tax countries and tax havens, some of which I discussed here.  As a result of these tax reductions abroad, it is becoming more expensive to bring offshore profits back to the US.  If the parent isn't a US company, however, then no US tax is paid when it receives dividends from foreign subsidiaries.  Doing that doesn't eliminate the tax on income earned in the US (although there are a lot of mechanisms used to shift income overseas, some of which are discussed here) - that income is taxed when earned by the parent's domestic subsidiaries. It eliminates the tax on income earned outside the US. If the residence of the parent is outside the US, foreign income isn't taxed at all. 

Some people may remember a decade or so ago the controversy regarding Stanley, the tool maker. It earned a lot of blowback for proposing to reincorporate itself offshore. Eventually the publicity was so bad it abandoned its plans, but eventually the furor faded, and these kinds of structures continue to be used. There are mechanisms in place that are designed to discourage this sort of thing - by making the tax cost for established corporations very high. But with good planning a business can get itself into this position - especially before it goes public. 

So that's the background. So what does the Levin bill do?  It changes the rules for determining the residence of a corporation. Instead of looking solely at where the corporation is organized, it looks at where it is "managed and controlled". This means looking at the location of the corporation's senior management.

The "managed and controlled" test is interesting because that is generally the test used by other countries (especially most European countries) to determine residence. The US is fairly unique in determining residence solely by place of organization. This has lead to the formation of so-called "dual resident corporations" - corporations organized in one country but managed and controlled in another. I won't even begin to describe the kind of tax shenanigans that can be achieved using DRCs. 

The bill only applies to publicly traded corporations and certain other large corporations (those with more that $50 million in assets).  Because of this limitation, I don't think the rule will have that much of an impact. US corporations excel now at keeping their income outside the US so they can avoid tax on dividends from theirsubsidiaries - remember, paying dividends is purely voluntary on their part. Besides, a public company doesn't need to receive dividends from its subsidiaries to pay dividends to its shareholders. Earlier this year Apple issued a large amount of bonds for the purpose of buying back stock, which is effectively the same thing as paying dividends. It wasn't as if Apple didn't have the money to do it without borrowing , but to access the money they would have to report it as income. It was cheaper to borrow it.

So treating these foreign corporations as domestic isn't as big a deal as one would think.  Now if they applied the new residence rule to all foreign corporations, that would be a different matter....

By the way, in case you hadn't noticed, the US excels at having rules in the tax law that differ from the rules of most other countries. These "disconnects" create all sorts of opportunities for mischief. It's nice to see some movement towards conformity on our part, but really this is just a baby step. The next part of the bill I will discuss - the change in the so-called "check the box" rules - addresses another one of these disconnects. A much bigger one, actually.

Levin's Bill

Levin's tax haven bill has been released.  Here is a link to the bill summary, where you can download a copy of the bill.

There is a lot of interesting stuff here.  I'm not an expert in FATCA and so won't pay close attention to those provisions, but from a purely tax perspective these items are the most interesting:

• New rules for determining the residence of corporations,
• Deferring deductions related to foreign income until the income is taxed in the US,
• Changes in the foreign tax credit rules,
• New rules on taxing foreign intellectual property income,
• Repealing "check-the-box" rules for foreign entities (this is a biggie!), and
• Limiting the the ability to use intercompany loans to access foreign income.

There is also a provision for requiring SEC-registered companies to disclose their employees, gross revenues and tax payments on a country-by-country basis.  This will go a long way to helping the public know how they are structuring themselves to avoid taxes.

There's lots to digest here.  I will have more this evening (have to get back to my day job....)

I Can't Wait

This news flash just popped up:

Sen. Carl Levin (D-Mich.) said Sept. 19 that he would introduce legislation today that would close so-called offshore tax havens.

The bill will “try to end those abuses and loopholes which are costing us so much,” Levin said at an event sponsored by the newspaper The Hill.

These revenue losses allow companies such as Apple Inc. to avoid paying U.S. taxes, said Levin, who as chairman of the Senate Homeland Security and Governmental Affairs Permanent Subcommittee on Investigations, has focused on the issue for years.

He said the nearly $250 billion in revenue that his legislation would raise should be used to offset indiscriminate spending cuts under sequestration. Cosponsors include Sens. Sheldon Whitehouse (D-R.I.), Mark Begich (D-Alaska) and Jeanne Shaheen (D-N.H.). 

$250 Billion?

I'm on pins and needles...

More after it's released.

You Get What You Pay For

IRS collections from enforcement actions decline:

Enforcement actions by the Internal Revenue Service yielded $50.2 billion in fiscal year 2012 -- a 9 percent drop in part because of budget cuts, the U.S. tax agency’s inspector general said in a report today.

The IRS shed 8,000 full-time positions between 2010 and 2012 including 5,000 front-line enforcement workers, which is about a 14 percent reduction, said the report from the Treasury Inspector General for Tax Administration. 

Republicans are proposing a 24% reduction in the IRS enforcement budget for 2014.

Well, they want to cut taxes.  Helping people evade them by cutting enforcement is one way to do that.

Taxing Multinationals, Part 2

Over the weekend Dave Johnson had a post up with a proposal for taxing corporate profits earned overseas.  It was interesting, but I have a lot of problems with it.

The issue is just one facet of the way we tax corporate income.  We need to do a drastic re-think of how we tax business income generally.  Nibbling it at the margins just won't do as far as I am concerned.

So let's start by talking about the issue Dave is addressing. As I've noted before here and here, a fundamental aspect of our tax system is that each corporation is a separate "person". When a U.S. corporation engages in business in another country, it will often do so by setting up a corporation (a subsidiary) in that country. The subsidiary's income is generally subject to tax in the country where it earns its income, and pay U.S. tax on the income at that time. [Normally, if the subsidiary has paid tax on its income in the foreign country, it will get a credit for the tax when its computes the U.S. tax on the dividend - but this is a complicating feature we can ignore for the time being.]

So when Dave says that corporations "are allowed to "defer" paying taxes on profits earned outside of the country until they "repatriate" those profits, which means bringing the money back into the country", this is shorthand for saying that the profits aren't taxed until dividends are paid, "repatriation" being the payment of those dividends. Given that the U.S. parent corporation has total control over when dividends are paid, this means that the parent can delay the payment of dividends - and the payment of tax on those dividends - indefinitely.

Now Dave tries to give a logical reason for this situation

There are solid reasons to allow corporations to do this. Simply put, they might need to put that money to good use, which will benefit the company, which in theory will later benefit our country.

This is really BS.  As far as I know (and I've been at this for a long time), there has never been a good reason for this situation other than inertia.  It is simply a product of the fact that we treat corporations as "persons" separate from their stockholders, something that has been a feature of our income tax system since 1913. Nobody has ever announced a seriously considered policy reason for having a tax system that works this way.

It has long been recognized that this system can be abused. Over the years we have passed a number of amendments to the tax Code that are designed to combat the abuse: rules involving "foreign personal holding companies," "controlled foreign corporations," and "passive foreign investment companies" were all designed to prevent people and corporations from avoiding tax on income earned overseas by placing the income earning assets overseas. 

Even more pernicious than the deferral if taxation by placing income in a foreign corporation is the fact that companies can avoid the deferral when it serves their interest to do so. For example, companies that invest in businesses that lose money in the first few years can organize it in such a way as to be able to deduct the losses in the US, then later when the business becomes profitable they can avoid tax on the income. They can manipulate the way they earn their foreign income so that they can use foreign tax credits - which are designed to prevent double taxation of income earned abroad - to reduce tax on income earned here at home. And I've already discussed how they can manipulate their internal pricing to place their income in countries that have little or no tax.

But avoiding tax by refusing to pay dividends is not just a foreign issue. Years ago it was recognized as a domestic issue as well. There are rules that impose a penalty tax on US corporations that refuse to pay dividends. David Cay Johnston referred to them in a recent article. These rules haven't been enforced in decades.

The real problem lies in treating corporations as persons separate from their shareholders. This is the issue. My feeling is that we should abandon this rule altogether. 

And I have some ideas about how we can do this in a workable fashion which I'll be discussing in future posts.