In the News

Conference Highlights International Taxation Issues

Lee O. Upton, III, a Principal at IIC, Inc., recently returned from Washington, DC, where he attended the 24^th Annual Institute on Current Issues in International Taxation. The two-day conference featured a variety of federal government and private sector speakers discussing a wide range of issues facing multinational corporations and government revenue agencies. Key panels included discussions of competent authority, efficiency in transfer pricing enforcement and compliance, foreign tax credits and updates on a variety of soon-to-be released updates to the Internal Revenue Code.

The panel discussing competent authority noted the increasing reliance on Advanced Pricing Agreements (APAs) with national taxing authorities to establish transfer pricing policies designed to achieve consistency among countries and eliminate double taxation. Michael Danilack, Large Business & International (LB&I) Deputy Commissioner of the Internal Revenue Service (IRS), discussed a shift in how the IRS will approach the intersection of Competent Authority and APAs, where the previously separate APA team will join forces with the Competent Authority team under the Advanced Pricing and Mutual Agreement (APMA) program. 1 This shift will allow U.S. Competent Authority staff to negotiate APAs directly throughout the process, eliminating the need for multinational corporations to engage in negotiations first with the APA team, then subsequently with the Competent Authority team.

The integration of the APA and Competent Authority mutual agreement programs is a step in the right direction – from both the perspective of the multinational corporation and the government. Multinational corporations should benefit from a single team of IRS personnel handling the complex negotiations inherent in dealing with foreign taxing authorities on both APAs and mutual agreements. Ideally, the unification of the Competent Authority/APA negotiation process will alleviate the administration burden on multinational corporations, while solving the problem of having to deal with a Competent Authority team that may have had little or no knowledge of the APA negotiations. From the U.S. government perspective, the immediate benefit is found in increased efficiency and greater deployment of resources to handle an increasing number of APAs. In addition, the integration will allow greater focus on transfer pricing enforcement and compliance, a topic touched upon at the conference by Samuel Maruca, Director of Transfer Pricing Operations, LB&I, IRS.

One area where potential uncertainty remains involves the potential role of IRS economists operating within the new framework where the Transfer Pricing Operations division oversees the APMA program. Multinational corporations often feel that transfer pricing issues are handled primarily by economists, with insufficient recognition of the specific fact pattern attributable to the particular taxpayer. As a result, adjustments are largely determined based on economic theory instead of taxpayer’s facts. During the conference, Mr. Maruca indicated a desire to align economic theories with specific fact patterns for a taxpayer. This is common sense, as in our experience, we approach every Section 482 transfer pricing analysis with the goal of a full understanding of the facts prevalent to the specific case – consistent with the economic perspective that employing the arm’s-length standard to assess intercompany transactions relies on appropriately selecting the best method to match economic theory with the realities of the intercompany transaction.2 Integrating the APMA program under the transfer pricing division should alleviate some of the concerns expressed by multinationals, but also reinforces our belief that multinational companies need sound and reliable economic transfer pricing documentation to justify intercompany transfer prices.

The IRS also indicated that forthcoming guidance can be expected concerning Internal Revenue Code (IRC) section 367(a)(5) (concerning international mergers and acquisitions), section 6038B (concerning outbound transfers), sections 1297/1298 (concerning passive foreign investment company and special rules), and section 7874 (concerning inversion transactions). The IRS also recently noted the release of the Section 892 proposed regulations involving the taxation of foreign governments.3 The IRS avoided setting definitive dates when we can expect the forthcoming guidance, but reiterated in numerous instances that significant progress had been made in developing the guidance.

Mr. Upton is director of IIC, Inc.'s Orlando, Florida office where he specializes in a variety of transfer pricing issues including cost sharing, valuation of intangibles, analysis of services and issues relating to 936 exit strategies.

Endnotes

1. As part of the restructuring, the APA was moved from the Office of Associate Chief Counsel – International to the LB&I, Director of Transfer Pricing Operations office. The Mutual Agreement Program (MAP), negotiated by the U.S. Competent Authority team was also moved to the same office. For more information on the July 2011 introduction of the APMA program, visit http://www.irs.gov/businesses/article/0,,id=242980,00.html

2. Section 482-1(c) discusses the best method rule, including the language, “The arm’s length result of a controlled transaction must be determined under the method that, under the facts and circumstances, provides the most reliable measure of an arm’s length result” (1.482-1(c)(1)) (emphasis added)

3. For more information and discussion, see Internal Revenue Bulletin 2011-48, available at http://www.irs.gov/irb/2011-48_IRB/ar14.html

Pitching Corporate Tax Reform to Business

In a 2011 speech before the U.S. Chamber of Commerce, President Obama discussed a key responsibility of government: breaking down barriers that limit the successfulness of U.S. businesses.1 One area the President focused on was alleviating a “burdensome corporate tax code with one of the highest rates in the world.” Specifically, the President stated:

You know how it goes: because of various loopholes and carve-outs that have built up over the years, some industries pay an average rate that is four or five times higher than others. Companies are taxed heavily for making investments with equity; yet the tax code actually pays companies to invest using leverage. As a result, too many businesses end up making decisions based on what their tax director says instead of what their engineer designs or what their factory produces. This puts our entire economy at a disadvantage. That’s why I want to lower the corporate rate and eliminate these loopholes to pay for it, so that it doesn't add a dime to our deficit. And I am asking for your help in this fight. [emphasis added]

The United States has the third highest statutory tax rate and one of the most complex tax codes, therefore, it should come as no surprise that President Obama’s words ring true concerning the influence of multinational tax directors on global corporate strategy.2 Effective tax management has become a cornerstone of enhancing shareholder value for U.S. multinational corporations. The goal of effective tax management is to increase the bottom line – but doing so under the legal framework of the U.S. tax code.

Often these objectives are accomplished through the use of transfer pricing mechanisms to defer income flowing to the United States and transfer profits offshore to low tax jurisdictions, thereby lowering the domestic tax burden. There are a variety of transfer pricing mechanisms available to a U.S. multinational to achieve this result, including:3

Centralizing ownership and development of intellectual property rights in a foreign jurisdiction with an advantageous tax structure;
Establishing the legal entity responsible as the multinational’s “risk taker” in a low tax jurisdiction; and
Organizing corporate structure such that more routine and less profitable functions are located in jurisdictions where the average tax rate may be higher.

For example, Company X could develop a pharmaceutical product in the United States, manufacture the product in Ireland, and perform field testing, registration and distribution globally. The flow of goods and services between these different countries offers the multinational corporation significant discretion in allocating costs – and gives rise to a potential transfer pricing investigation by tax authorities. Assume that Company X licenses the U.S.-developed intellectual property associated with the pharmaceutical compound to the manufacturing subsidiary in Ireland. As a result, the Irish subsidiary pays a royalty to the U.S. entity. Given the advantageous tax structure in Ireland (12.5 percent tax rate versus 40 percent in the United States), companies have an incentive to shift profits from the United States to Ireland – one way this can be achieved is through the licensing mechanism described above. However, taxing authorities may seek to audit the level of the royalty payment and assess whether the royalty payment is in fact, arm’s-length and not too low (thereby shifting income from the United States to Ireland). A sound transfer pricing analysis will either justify the arm’s-length nature of the royalty payment (e.g., a payment one would expect between unrelated parties) or alternatively, shed light on whether the royalty payment is too low, thereby requiring an adjustment by tax authorities.

As taxing authorities devote more resources to investigate transfer pricing strategies, an overhaul of the corporate tax code may provide tangible benefits to U.S. multinationals as well as benefits to taxing authorities. A simpler tax code would reduce the burden on and costs to both tax authorities and multinationals regarding compliance and should result in a more equitable form of taxation. However, the true challenge remains convincing U.S. multinational corporations that savings from a lower domestic corporate tax rate will more than offset the potential advantages inherent in aggressive transfer pricing behavior. If the President can effectively eliminate the tax loopholes and simplify the tax code, then aggressive transfer pricing behavior should subside. In addition, a reduction in the corporate tax rate will be a welcome addition to alleviating the burden U.S. multinationals face in complying with the U.S. tax code.

IIC, Inc. provides economic analysis, expert testimony, and advice to both taxpayers and taxing authorities on a wide range of issues related to taxation such as transfer pricing, valuation, tax shelters, licensing arrangements, property taxes, natural resource taxes, characterization of taxes, unitary taxation, allocation of interest expense for tax purposes and tax incidence analysis.

Endnotes

1 February 7, 2011 speech, full text available at http://www.whitehouse.gov/the-press-office/2011/02/07/remarks-president-chamber-commerce.

2The current U.S. statutory corporate tax rate is 40 percent.

3 In a July 20, 2010 publication entitled “Present Law and Background Related to Possible Income Shifting and Transfer Pricing,” the Joint Committee on Taxation identified and discussed a number of potential transfer pricing strategies. The publication is available at http://www.jct.gov/publications.html?func=startdown&id=3692.


What’s New Recently Completed Assignments Press Releases In the News You are surrounded by simple, obvious solutions that can dramatically increase your income, power, influence and success. The problem is, you just don’t see them. Jay Abraham		In the News Conference Highlights International Taxation Issues Lee O. Upton, III, a Principal at IIC, Inc., recently returned from Washington, DC, where he attended the 24^th Annual Institute on Current Issues in International Taxation. The two-day conference featured a variety of federal government and private sector speakers discussing a wide range of issues facing multinational corporations and government revenue agencies. Key panels included discussions of competent authority, efficiency in transfer pricing enforcement and compliance, foreign tax credits and updates on a variety of soon-to-be released updates to the Internal Revenue Code. The panel discussing competent authority noted the increasing reliance on Advanced Pricing Agreements (APAs) with national taxing authorities to establish transfer pricing policies designed to achieve consistency among countries and eliminate double taxation. Michael Danilack, Large Business & International (LB&I) Deputy Commissioner of the Internal Revenue Service (IRS), discussed a shift in how the IRS will approach the intersection of Competent Authority and APAs, where the previously separate APA team will join forces with the Competent Authority team under the Advanced Pricing and Mutual Agreement (APMA) program. 1 This shift will allow U.S. Competent Authority staff to negotiate APAs directly throughout the process, eliminating the need for multinational corporations to engage in negotiations first with the APA team, then subsequently with the Competent Authority team. The integration of the APA and Competent Authority mutual agreement programs is a step in the right direction – from both the perspective of the multinational corporation and the government. Multinational corporations should benefit from a single team of IRS personnel handling the complex negotiations inherent in dealing with foreign taxing authorities on both APAs and mutual agreements. Ideally, the unification of the Competent Authority/APA negotiation process will alleviate the administration burden on multinational corporations, while solving the problem of having to deal with a Competent Authority team that may have had little or no knowledge of the APA negotiations. From the U.S. government perspective, the immediate benefit is found in increased efficiency and greater deployment of resources to handle an increasing number of APAs. In addition, the integration will allow greater focus on transfer pricing enforcement and compliance, a topic touched upon at the conference by Samuel Maruca, Director of Transfer Pricing Operations, LB&I, IRS. One area where potential uncertainty remains involves the potential role of IRS economists operating within the new framework where the Transfer Pricing Operations division oversees the APMA program. Multinational corporations often feel that transfer pricing issues are handled primarily by economists, with insufficient recognition of the specific fact pattern attributable to the particular taxpayer. As a result, adjustments are largely determined based on economic theory instead of taxpayer’s facts. During the conference, Mr. Maruca indicated a desire to align economic theories with specific fact patterns for a taxpayer. This is common sense, as in our experience, we approach every Section 482 transfer pricing analysis with the goal of a full understanding of the facts prevalent to the specific case – consistent with the economic perspective that employing the arm’s-length standard to assess intercompany transactions relies on appropriately selecting the best method to match economic theory with the realities of the intercompany transaction.2 Integrating the APMA program under the transfer pricing division should alleviate some of the concerns expressed by multinationals, but also reinforces our belief that multinational companies need sound and reliable economic transfer pricing documentation to justify intercompany transfer prices. The IRS also indicated that forthcoming guidance can be expected concerning Internal Revenue Code (IRC) section 367(a)(5) (concerning international mergers and acquisitions), section 6038B (concerning outbound transfers), sections 1297/1298 (concerning passive foreign investment company and special rules), and section 7874 (concerning inversion transactions). The IRS also recently noted the release of the Section 892 proposed regulations involving the taxation of foreign governments.3 The IRS avoided setting definitive dates when we can expect the forthcoming guidance, but reiterated in numerous instances that significant progress had been made in developing the guidance. Mr. Upton is director of IIC, Inc.'s Orlando, Florida office where he specializes in a variety of transfer pricing issues including cost sharing, valuation of intangibles, analysis of services and issues relating to 936 exit strategies. Endnotes 1. As part of the restructuring, the APA was moved from the Office of Associate Chief Counsel – International to the LB&I, Director of Transfer Pricing Operations office. The Mutual Agreement Program (MAP), negotiated by the U.S. Competent Authority team was also moved to the same office. For more information on the July 2011 introduction of the APMA program, visit http://www.irs.gov/businesses/article/0,,id=242980,00.html 2. Section 482-1(c) discusses the best method rule, including the language, “The arm’s length result of a controlled transaction must be determined under the method that, under the facts and circumstances, provides the most reliable measure of an arm’s length result” (1.482-1(c)(1)) (emphasis added) 3. For more information and discussion, see Internal Revenue Bulletin 2011-48, available at http://www.irs.gov/irb/2011-48_IRB/ar14.html Pitching Corporate Tax Reform to Business In a 2011 speech before the U.S. Chamber of Commerce, President Obama discussed a key responsibility of government: breaking down barriers that limit the successfulness of U.S. businesses.1 One area the President focused on was alleviating a “burdensome corporate tax code with one of the highest rates in the world.” Specifically, the President stated: You know how it goes: because of various loopholes and carve-outs that have built up over the years, some industries pay an average rate that is four or five times higher than others. Companies are taxed heavily for making investments with equity; yet the tax code actually pays companies to invest using leverage. As a result, too many businesses end up making decisions based on what their tax director says instead of what their engineer designs or what their factory produces. This puts our entire economy at a disadvantage. That’s why I want to lower the corporate rate and eliminate these loopholes to pay for it, so that it doesn't add a dime to our deficit. And I am asking for your help in this fight. [emphasis added] The United States has the third highest statutory tax rate and one of the most complex tax codes, therefore, it should come as no surprise that President Obama’s words ring true concerning the influence of multinational tax directors on global corporate strategy.2 Effective tax management has become a cornerstone of enhancing shareholder value for U.S. multinational corporations. The goal of effective tax management is to increase the bottom line – but doing so under the legal framework of the U.S. tax code. Often these objectives are accomplished through the use of transfer pricing mechanisms to defer income flowing to the United States and transfer profits offshore to low tax jurisdictions, thereby lowering the domestic tax burden. There are a variety of transfer pricing mechanisms available to a U.S. multinational to achieve this result, including:3 Centralizing ownership and development of intellectual property rights in a foreign jurisdiction with an advantageous tax structure; Establishing the legal entity responsible as the multinational’s “risk taker” in a low tax jurisdiction; and Organizing corporate structure such that more routine and less profitable functions are located in jurisdictions where the average tax rate may be higher. For example, Company X could develop a pharmaceutical product in the United States, manufacture the product in Ireland, and perform field testing, registration and distribution globally. The flow of goods and services between these different countries offers the multinational corporation significant discretion in allocating costs – and gives rise to a potential transfer pricing investigation by tax authorities. Assume that Company X licenses the U.S.-developed intellectual property associated with the pharmaceutical compound to the manufacturing subsidiary in Ireland. As a result, the Irish subsidiary pays a royalty to the U.S. entity. Given the advantageous tax structure in Ireland (12.5 percent tax rate versus 40 percent in the United States), companies have an incentive to shift profits from the United States to Ireland – one way this can be achieved is through the licensing mechanism described above. However, taxing authorities may seek to audit the level of the royalty payment and assess whether the royalty payment is in fact, arm’s-length and not too low (thereby shifting income from the United States to Ireland). A sound transfer pricing analysis will either justify the arm’s-length nature of the royalty payment (e.g., a payment one would expect between unrelated parties) or alternatively, shed light on whether the royalty payment is too low, thereby requiring an adjustment by tax authorities. As taxing authorities devote more resources to investigate transfer pricing strategies, an overhaul of the corporate tax code may provide tangible benefits to U.S. multinationals as well as benefits to taxing authorities. A simpler tax code would reduce the burden on and costs to both tax authorities and multinationals regarding compliance and should result in a more equitable form of taxation. However, the true challenge remains convincing U.S. multinational corporations that savings from a lower domestic corporate tax rate will more than offset the potential advantages inherent in aggressive transfer pricing behavior. If the President can effectively eliminate the tax loopholes and simplify the tax code, then aggressive transfer pricing behavior should subside. In addition, a reduction in the corporate tax rate will be a welcome addition to alleviating the burden U.S. multinationals face in complying with the U.S. tax code. IIC, Inc. provides economic analysis, expert testimony, and advice to both taxpayers and taxing authorities on a wide range of issues related to taxation such as transfer pricing, valuation, tax shelters, licensing arrangements, property taxes, natural resource taxes, characterization of taxes, unitary taxation, allocation of interest expense for tax purposes and tax incidence analysis. Endnotes 1 February 7, 2011 speech, full text available at http://www.whitehouse.gov/the-press-office/2011/02/07/remarks-president-chamber-commerce. 2The current U.S. statutory corporate tax rate is 40 percent. 3 In a July 20, 2010 publication entitled “Present Law and Background Related to Possible Income Shifting and Transfer Pricing,” the Joint Committee on Taxation identified and discussed a number of potential transfer pricing strategies. The publication is available at http://www.jct.gov/publications.html?func=startdown&id=3692.