Senate Finance Hearing on International Tax and Inversions
Senate Finance Committee
The U.S. Tax Code: Love It, Leave It or Reform It!
July 22, 2014
Key Topics & Takeaways
Tax Reform & Inversion: Senator Wyden urged for action on inversions and emphasized that the issue is moving faster than tax reform.
- Not retroactive or punitive: Senator Hatch stipulated that action in the interim should not be retroactive or punitive. He called for a revenue-neutral reform that moves toward a territorial tax system, does not impede progress toward comprehensive tax reform, and remains consistent with the House approach.
- American Competitiveness: Senator Portman discussed his fear that action on inversions, absent tax reform, could make it harder to be an American company, and advocated for waiting for tax reform. Senator Thune also had concerns regarding short-term anti-inversion legislation and advocated for reforming the tax code instead.
Witnesses
Mr. Robert B. Stack, Deputy Assistant Secretary for International Tax Affairs, U.S. Department of the Treasury, Washington, DC
Mr. Pascal Saint-Amans, Director, Centre for Tax Policy and Administration, Organisation for Economic Co-operation and Development (OECD), Paris, France
Dr. Mihir A. Desai, Mizuho Financial Group Professor of Finance & Professor of Law, Harvard University, Cambridge, MA
Dr. Peter R. Merrill, Director, National Economics and Statistics Group, PricewaterhouseCoopers, Washington, DC
Dr. Leslie Robinson, Associate Professor of Business Administration, Tuck School of Business, Dartmouth College, Hanover, NH
Mr. Allan Sloan, Senior Editor at Large, Fortune, New York, NY
Opening Remarks
In his opening remarks, Chairman Ron Wyden (D-Ore.) discussed the growing trend in which American companies move their headquarters abroad. He highlighted that investors even suggest inversions to stay competitive and that Congress has been aware of the problem for some time now. While emphasizing the complexity of the tax code, Wyden said that those seeking tax shelters feed off of the “anticompetitive mess,” costing American taxpayers billions each year.
With this problem in mind, Wyden called for the Senate Finance Committee to respond now by first working together to “cool down the inversion loophole,” then applying comprehensive tax reform. He reminded the Committee that the legislation he produced with senators Mark Begich (D-Ala.), Dan Coats (R-Ind.), and Judd Gregg (R-N.H.) remains the Senate’s only bipartisan federal income tax overhaul in years. Without immediate comprehensive tax reform, Wyden urged, a solution to the “inversion virus” is critical to protecting the economy.
Ranking Member Orin Hatch (R-Utah) stated that the primary goal should be to more effectively allow American companies to compete. Hatch contended that the Organisation for Economic Co-operation and Development (OECD) base erosion and profit shifting (BEPS) project is a way for other counties to increase taxes on American companies. According to the OECD, “BEPS refers to tax planning strategies that exploit gaps and mismatches in tax rules to make profits ‘disappear’ for tax purposes or to shift profits to locations where there is little or no real activity but the taxes are low resulting in little or no overall corporate tax being paid.” With this in mind, Hatch called for the U.S. Treasury to consult with the OECD on the BEPS project and stated that the United States should not rush into accepting a bad deal “for the sake of reaching an agreement.”
Although Hatch acknowledged that the BEPS discussion is important, he said “the most high profile topic seems to be inversions.” He raised the concern that the approach in the anti-inversion legislation is misguided. In order to support a solution, Hatch provided the following stipulations: 1) Reforms cannot be retroactive or punitive; 2) Legislation should move the U.S. “towards, or at least not away from” a territorial tax system; 3) Solutions should not enhance the bias toward foreign acquisitions; 4) Efforts should not impede overall progress toward overall tax reform; and 5) Senate version cannot be inconsistent with the House approach. In essence, he foresees this as a “political wedge issue” and would like to work together with his colleagues.
Witness Testimony
In his testimony, Stack described his work on the OECD BEPS project and the need for tax reform as well as measures in the Administration’s budget for base stripping and inversions. Since the U.S. provides a foreign tax credit and has a strong interest in rules that have a broad international consensus, he emphasized the implications of the BEPS project in the U.S. If the BEPS project fails, Stack said double taxation and costs to Treasury could result. He acknowledged Hatch’s key stipulations and listed the following areas where the U.S. must guard against bad outcomes: 1) International norms that could increase tax disputes; 2) International norms that could erode the U.S. tax base or increase double taxation; 3) The U.S. must fully engage in moving the BEPS project forward by the end of 2015.
In addition, Stack referred to the G20 OECD BEPS project’s action plan that outlines 15 specific areas, including inversions, where governments need to change their tax codes. Stack continued that President Obama stated tax reform would only be a start and that lower U.S. rates would allow multinationals to continue shifting income out of the country. Stack recalled the July 15, 2014 letter from U.S. Treasury Secretary Jacob Lew to Hatch as another call to action on inversions.
In his testimony, Saint-Amans stated that the U.S. is the largest of the 34 OECD members and explained that decisions in the OECD are made by consensus. According to Saint-Amans, the OECD has consulted on the project in various ways, including its issuance of discussion drafts, review of more than 3,000 comment letters, and release of webcasts. He explained that the common set of standards were developed in the 1920s and updated in the 1950s, but the rules have not kept pace with changes in the economy. The lack of change to the system since the 1950s, in his opinion, has resulted in non-taxation.
Saint-Amans thinks these unintended consequences are an issue for governments around the world because corporate income taxes are not paid by all taxpayers, making U.S. companies less than a quarter of the global Fortune 500 companies due to an uneven playing field. He said the BEPS project is a response by governments to come together to find ways to address issues within the tax framework by consensus and reduce the risk of uncertainty. He raised the importance of a principled and cost-effective approach to reduce the compliance burden while ensuring consistency on cross-border taxation, improving the way disputes are resolved, and forming a response that is widely shared by all OECD countries.
Desai, in his testimony, outlined the origins of the merger transaction, the range of alternative solutions, guidelines for evaluations of alternative reforms, and some reforms that should be avoided. He contended that merger transactions that facilitation the expatriation of U.S. corporations highlight the increased mobility, de-centering of firms, and growing importance of markets outside the U.S. In his findings, he said, evidence suggests that firms expand abroad expand in the U.S. as well. Revenue producing, he said, should be a secondary issue given that the current international code produces little revenue.
Notably, Desai distinguished legislation that is narrowly-focused on inversions or specific transactions as “risky.” Instead, Desai recommended other reforms, including moving to a territorial regime and replacing the corporate tax with a consumption tax. He criticized previous anti-inversion legislation as the likely cause of recent issues and warned legislation replacing inversions would lead to unintended consequences.
In his testimony, Merrill discussed the economic effects of tax policy. By comparing the U.S. rules on international taxation with the rules of other countries, he found that two key areas are outside the norms in the U.S. – the corporate rate and the worldwide system of taxation. In his view, these two factors “make it more difficult for U.S. companies to compete.”
Merrill explained that the estate tax in the U.S. is the highest among major economies and that the effective tax rate is also high by international standards. Additionally, Merrill stated that foreign income owned by foreign subsidiaries is also subject to U.S. taxes. As long as the U.S. remains on a worldwide international taxation system, Merrill affirmed, the U.S. will continue to face competitors that are taxed under a territorial system. He mentioned that the United Kingdom (UK), Japan, and New Zealand adopted a territorial system and a similar change for the U.S. would increase annual repatriation and new jobs, enhancing the abilities of U.S. companies to compete abroad and at home.
In her testimony, Robinson articulated that it is clear reform is needed because the international system of the U.S. tax code raises little revenue. The 35% corporate tax rate, in her view, is the highest of the OECD countries and leaves U.S. firms at a competitive disadvantage. She explained that she is unaware of any evidence which would suggest that the global tax burden of a firm depends on the tax system in the firm’s home country. In addition, she argued that anti-abuse provisions narrow the tax base and prompt firms to allocate resources in an inefficient manner because anti-abuse provisions are difficult to administer and enforce. Her recommendations for reform include limits on deferral and a lower statutory rate.
In his testimony, Sloan called inversions “un-American” and a problem that must be solved by both Democrats and Republicans. He likened the inversion discussion to the dotcom bubble because of the scare tactics and untraditional solutions used. While acknowledging that he is a journalist, not a legislator, Sloan said he would adopt the Levin legislation with a timeline because as time goes on it will be hard to do anything revenue-neutral in tax reform.
Question and Answer
Inversions and Tax Reform
Wyden asked the witnesses to assume that tax reform does not occur and consider whether or not inversions are “a bad thing for America.” Stack responded that the cost of waiting for tax reform is very high. Saint-Amans said inversions are bad overall and an issue in the tax code. Desai said it is good to act in the short-term, but not in the long-term., which Wyden said understood as a “no.” Merrill explained that these transactions are a symptom of a larger problem and the only way to act on inversions is through overall reform due to the risk of unintended consequences. Robinson agreed with Wyden that inversions are a bad for America. Sloan said letting 25 companies invert in order to later correct the tax code creates a disastrous scenario.
Sen. Chuck Schumer (D-N.Y.) said that if Congress waits for tax reform then more inversions will occur and waiting is an excuse for inaction. While Schumer mentioned his concerns regarding the management and control proposal encouraging jobs moving abroad, he supports the legislation and would like a provision that limits the interest expense deduction. He asked Stack if the administration agrees that interest expense and deduction limits should be included in any legislation on this issue. Stack agreed that this provision is a critical piece to reform.
Sen. Bob Portman (R-Ohio) recalled work on inversions when he served on the super committee and the trend of foreign-owned companies owning U.S. companies as a result of inaction. He asked Stack how to respond to the trend. Stack stated that it is important to keep companies competitive and that tax reform must also seek to lower the rate in order to level the playing field.
U.S. Corporate Tax Rate
Hatch asked Robinson to comment on the U.S. multinationals’ tax rate as compared to other countries. Robinson responded that Merrill’s study might be a difference of how tax rates are measured and that she is unaware of evidence that U.S. tax rates are higher. Merrill said the studies he references look at U.S. companies compared to foreign companies and the U.S. companies had a higher-than-average effective tax rate. He continued to say that all studies he has seen, other than Robinson’s, show the U.S. in the top percentile.
Sen. Debbie Stabenow (D-Mich.) asked Stack to discuss priorities, other than lowering the rate, that are important to staying competitive internationally. Stack suggested broadening the base in order to truly level the playing field. He added that countries with lower tax rates will always exist.
Capital Ownership Neutrality
Hatch said capital ownership neutrality is a new concept and he asked the witnesses if U.S. corporations are at a disadvantage if a U.S. company acquires a foreign corporation. Desai responded that it is a clear manifestation of the patterns supporting a territorial system.
U.S. Treasury Study on 2004 Inversion Legislation
Sen. Chuck Grassley (R-Iowa) asked Stack when Treasury plans to complete its study of the 2004 inversion legislation. Stack did not respond.
Preventing Arbitrage Inversions
Sen. Sherrod Brown (D-Ohio) asked the witnesses how Congress should act right now to create a “temporary tripwire to prevent arbitrage inversions.” Stack responded that even without reform, these arbitrage inversions occur now. He continued that addressing these issues would protect the tax base.
Rewards to Wall Street
Brown asked Sloan to comment on Sen. Carl Levin’s (D-Mich.) Permanent Subcommittee on Investigations work regarding the rewards to Wall Street and the role of private equity funds for short-term focused investors. Sloan said that as long as the inversion temptation exists and the practice is legal, investors will invert.
Territorial System
Hatch asked Merrill about why Japan and the UK adopted a territorial system in 2006 and about the results five years later. Merrill responded that the UK has many companies that only earn a small part of their total income in the UK and have taken various actions to make it more attractive for companies to be in the UK.
Sen. John Thune (D-S.D.) asked the witnesses about the tax implications for a U.S. company competing in foreign markets. Merrill responded that a U.S. company faces very different home-country taxation and is limited by building up cash abroad even if it prefers to invest in the U.S.
Repatriation
Wyden asked Merrill and Robinson if repealing deferral would go a long way toward corporate tax simplification and eliminate today’s complicated system. Robinson responded that the costs associated with avoiding repatriation for long period of time is what makes the tax system uncompetitive, but he is largely in favor of ending deferral and lowering the corporate rate.
For more information on this meeting and to view an archived webcast, please click here.
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Senate Finance Committee
The U.S. Tax Code: Love It, Leave It or Reform It!
July 22, 2014
Key Topics & Takeaways
Tax Reform & Inversion: Senator Wyden urged for action on inversions and emphasized that the issue is moving faster than tax reform.
- Not retroactive or punitive: Senator Hatch stipulated that action in the interim should not be retroactive or punitive. He called for a revenue-neutral reform that moves toward a territorial tax system, does not impede progress toward comprehensive tax reform, and remains consistent with the House approach.
- American Competitiveness: Senator Portman discussed his fear that action on inversions, absent tax reform, could make it harder to be an American company, and advocated for waiting for tax reform. Senator Thune also had concerns regarding short-term anti-inversion legislation and advocated for reforming the tax code instead.
Witnesses
Mr. Robert B. Stack, Deputy Assistant Secretary for International Tax Affairs, U.S. Department of the Treasury, Washington, DC
Mr. Pascal Saint-Amans, Director, Centre for Tax Policy and Administration, Organisation for Economic Co-operation and Development (OECD), Paris, France
Dr. Mihir A. Desai, Mizuho Financial Group Professor of Finance & Professor of Law, Harvard University, Cambridge, MA
Dr. Peter R. Merrill, Director, National Economics and Statistics Group, PricewaterhouseCoopers, Washington, DC
Dr. Leslie Robinson, Associate Professor of Business Administration, Tuck School of Business, Dartmouth College, Hanover, NH
Mr. Allan Sloan, Senior Editor at Large, Fortune, New York, NY
Opening Remarks
In his opening remarks, Chairman Ron Wyden (D-Ore.) discussed the growing trend in which American companies move their headquarters abroad. He highlighted that investors even suggest inversions to stay competitive and that Congress has been aware of the problem for some time now. While emphasizing the complexity of the tax code, Wyden said that those seeking tax shelters feed off of the “anticompetitive mess,” costing American taxpayers billions each year.
With this problem in mind, Wyden called for the Senate Finance Committee to respond now by first working together to “cool down the inversion loophole,” then applying comprehensive tax reform. He reminded the Committee that the legislation he produced with senators Mark Begich (D-Ala.), Dan Coats (R-Ind.), and Judd Gregg (R-N.H.) remains the Senate’s only bipartisan federal income tax overhaul in years. Without immediate comprehensive tax reform, Wyden urged, a solution to the “inversion virus” is critical to protecting the economy.
Ranking Member Orin Hatch (R-Utah) stated that the primary goal should be to more effectively allow American companies to compete. Hatch contended that the Organisation for Economic Co-operation and Development (OECD) base erosion and profit shifting (BEPS) project is a way for other counties to increase taxes on American companies. According to the OECD, “BEPS refers to tax planning strategies that exploit gaps and mismatches in tax rules to make profits ‘disappear’ for tax purposes or to shift profits to locations where there is little or no real activity but the taxes are low resulting in little or no overall corporate tax being paid.” With this in mind, Hatch called for the U.S. Treasury to consult with the OECD on the BEPS project and stated that the United States should not rush into accepting a bad deal “for the sake of reaching an agreement.”
Although Hatch acknowledged that the BEPS discussion is important, he said “the most high profile topic seems to be inversions.” He raised the concern that the approach in the anti-inversion legislation is misguided. In order to support a solution, Hatch provided the following stipulations: 1) Reforms cannot be retroactive or punitive; 2) Legislation should move the U.S. “towards, or at least not away from” a territorial tax system; 3) Solutions should not enhance the bias toward foreign acquisitions; 4) Efforts should not impede overall progress toward overall tax reform; and 5) Senate version cannot be inconsistent with the House approach. In essence, he foresees this as a “political wedge issue” and would like to work together with his colleagues.
Witness Testimony
In his testimony, Stack described his work on the OECD BEPS project and the need for tax reform as well as measures in the Administration’s budget for base stripping and inversions. Since the U.S. provides a foreign tax credit and has a strong interest in rules that have a broad international consensus, he emphasized the implications of the BEPS project in the U.S. If the BEPS project fails, Stack said double taxation and costs to Treasury could result. He acknowledged Hatch’s key stipulations and listed the following areas where the U.S. must guard against bad outcomes: 1) International norms that could increase tax disputes; 2) International norms that could erode the U.S. tax base or increase double taxation; 3) The U.S. must fully engage in moving the BEPS project forward by the end of 2015.
In addition, Stack referred to the G20 OECD BEPS project’s action plan that outlines 15 specific areas, including inversions, where governments need to change their tax codes. Stack continued that President Obama stated tax reform would only be a start and that lower U.S. rates would allow multinationals to continue shifting income out of the country. Stack recalled the July 15, 2014 letter from U.S. Treasury Secretary Jacob Lew to Hatch as another call to action on inversions.
In his testimony, Saint-Amans stated that the U.S. is the largest of the 34 OECD members and explained that decisions in the OECD are made by consensus. According to Saint-Amans, the OECD has consulted on the project in various ways, including its issuance of discussion drafts, review of more than 3,000 comment letters, and release of webcasts. He explained that the common set of standards were developed in the 1920s and updated in the 1950s, but the rules have not kept pace with changes in the economy. The lack of change to the system since the 1950s, in his opinion, has resulted in non-taxation.
Saint-Amans thinks these unintended consequences are an issue for governments around the world because corporate income taxes are not paid by all taxpayers, making U.S. companies less than a quarter of the global Fortune 500 companies due to an uneven playing field. He said the BEPS project is a response by governments to come together to find ways to address issues within the tax framework by consensus and reduce the risk of uncertainty. He raised the importance of a principled and cost-effective approach to reduce the compliance burden while ensuring consistency on cross-border taxation, improving the way disputes are resolved, and forming a response that is widely shared by all OECD countries.
Desai, in his testimony, outlined the origins of the merger transaction, the range of alternative solutions, guidelines for evaluations of alternative reforms, and some reforms that should be avoided. He contended that merger transactions that facilitation the expatriation of U.S. corporations highlight the increased mobility, de-centering of firms, and growing importance of markets outside the U.S. In his findings, he said, evidence suggests that firms expand abroad expand in the U.S. as well. Revenue producing, he said, should be a secondary issue given that the current international code produces little revenue.
Notably, Desai distinguished legislation that is narrowly-focused on inversions or specific transactions as “risky.” Instead, Desai recommended other reforms, including moving to a territorial regime and replacing the corporate tax with a consumption tax. He criticized previous anti-inversion legislation as the likely cause of recent issues and warned legislation replacing inversions would lead to unintended consequences.
In his testimony, Merrill discussed the economic effects of tax policy. By comparing the U.S. rules on international taxation with the rules of other countries, he found that two key areas are outside the norms in the U.S. – the corporate rate and the worldwide system of taxation. In his view, these two factors “make it more difficult for U.S. companies to compete.”
Merrill explained that the estate tax in the U.S. is the highest among major economies and that the effective tax rate is also high by international standards. Additionally, Merrill stated that foreign income owned by foreign subsidiaries is also subject to U.S. taxes. As long as the U.S. remains on a worldwide international taxation system, Merrill affirmed, the U.S. will continue to face competitors that are taxed under a territorial system. He mentioned that the United Kingdom (UK), Japan, and New Zealand adopted a territorial system and a similar change for the U.S. would increase annual repatriation and new jobs, enhancing the abilities of U.S. companies to compete abroad and at home.
In her testimony, Robinson articulated that it is clear reform is needed because the international system of the U.S. tax code raises little revenue. The 35% corporate tax rate, in her view, is the highest of the OECD countries and leaves U.S. firms at a competitive disadvantage. She explained that she is unaware of any evidence which would suggest that the global tax burden of a firm depends on the tax system in the firm’s home country. In addition, she argued that anti-abuse provisions narrow the tax base and prompt firms to allocate resources in an inefficient manner because anti-abuse provisions are difficult to administer and enforce. Her recommendations for reform include limits on deferral and a lower statutory rate.
In his testimony, Sloan called inversions “un-American” and a problem that must be solved by both Democrats and Republicans. He likened the inversion discussion to the dotcom bubble because of the scare tactics and untraditional solutions used. While acknowledging that he is a journalist, not a legislator, Sloan said he would adopt the Levin legislation with a timeline because as time goes on it will be hard to do anything revenue-neutral in tax reform.
Question and Answer
Inversions and Tax Reform
Wyden asked the witnesses to assume that tax reform does not occur and consider whether or not inversions are “a bad thing for America.” Stack responded that the cost of waiting for tax reform is very high. Saint-Amans said inversions are bad overall and an issue in the tax code. Desai said it is good to act in the short-term, but not in the long-term., which Wyden said understood as a “no.” Merrill explained that these transactions are a symptom of a larger problem and the only way to act on inversions is through overall reform due to the risk of unintended consequences. Robinson agreed with Wyden that inversions are a bad for America. Sloan said letting 25 companies invert in order to later correct the tax code creates a disastrous scenario.
Sen. Chuck Schumer (D-N.Y.) said that if Congress waits for tax reform then more inversions will occur and waiting is an excuse for inaction. While Schumer mentioned his concerns regarding the management and control proposal encouraging jobs moving abroad, he supports the legislation and would like a provision that limits the interest expense deduction. He asked Stack if the administration agrees that interest expense and deduction limits should be included in any legislation on this issue. Stack agreed that this provision is a critical piece to reform.
Sen. Bob Portman (R-Ohio) recalled work on inversions when he served on the super committee and the trend of foreign-owned companies owning U.S. companies as a result of inaction. He asked Stack how to respond to the trend. Stack stated that it is important to keep companies competitive and that tax reform must also seek to lower the rate in order to level the playing field.
U.S. Corporate Tax Rate
Hatch asked Robinson to comment on the U.S. multinationals’ tax rate as compared to other countries. Robinson responded that Merrill’s study might be a difference of how tax rates are measured and that she is unaware of evidence that U.S. tax rates are higher. Merrill said the studies he references look at U.S. companies compared to foreign companies and the U.S. companies had a higher-than-average effective tax rate. He continued to say that all studies he has seen, other than Robinson’s, show the U.S. in the top percentile.
Sen. Debbie Stabenow (D-Mich.) asked Stack to discuss priorities, other than lowering the rate, that are important to staying competitive internationally. Stack suggested broadening the base in order to truly level the playing field. He added that countries with lower tax rates will always exist.
Capital Ownership Neutrality
Hatch said capital ownership neutrality is a new concept and he asked the witnesses if U.S. corporations are at a disadvantage if a U.S. company acquires a foreign corporation. Desai responded that it is a clear manifestation of the patterns supporting a territorial system.
U.S. Treasury Study on 2004 Inversion Legislation
Sen. Chuck Grassley (R-Iowa) asked Stack when Treasury plans to complete its study of the 2004 inversion legislation. Stack did not respond.
Preventing Arbitrage Inversions
Sen. Sherrod Brown (D-Ohio) asked the witnesses how Congress should act right now to create a “temporary tripwire to prevent arbitrage inversions.” Stack responded that even without reform, these arbitrage inversions occur now. He continued that addressing these issues would protect the tax base.
Rewards to Wall Street
Brown asked Sloan to comment on Sen. Carl Levin’s (D-Mich.) Permanent Subcommittee on Investigations work regarding the rewards to Wall Street and the role of private equity funds for short-term focused investors. Sloan said that as long as the inversion temptation exists and the practice is legal, investors will invert.
Territorial System
Hatch asked Merrill about why Japan and the UK adopted a territorial system in 2006 and about the results five years later. Merrill responded that the UK has many companies that only earn a small part of their total income in the UK and have taken various actions to make it more attractive for companies to be in the UK.
Sen. John Thune (D-S.D.) asked the witnesses about the tax implications for a U.S. company competing in foreign markets. Merrill responded that a U.S. company faces very different home-country taxation and is limited by building up cash abroad even if it prefers to invest in the U.S.
Repatriation
Wyden asked Merrill and Robinson if repealing deferral would go a long way toward corporate tax simplification and eliminate today’s complicated system. Robinson responded that the costs associated with avoiding repatriation for long period of time is what makes the tax system uncompetitive, but he is largely in favor of ending deferral and lowering the corporate rate.
For more information on this meeting and to view an archived webcast, please click here.