Substance Matters

Despite much debate in Washington, the hundreds of gallons of ink spilled and pounds of paper consumed – not to mention the billions of 1s and 0s expended in cyberspace – nowhere does the Obama administration’s Green Book or other tax-legislative proposals provide for a national sales tax. The focus is entirely on increasing the federal wage tax base.

Kenneth Baer, a spokesman for White House Budget Director Peter Orszag, told the Washington Post in May that “while we do not want to rule any credible idea in or out as we discuss the way forward with Congress, the VAT tax, in particular, is popular with academics but highly controversial with policymakers.”

It would seem that at some point in the not-too-distant future employees will be faced with an increasing burden on their wages with little hope of receiving the benefit such taxes promise. Social Security is on shaky ground at best. With some form of nationalized healthcare in the offing (increasing the burden on employees and their employers) Congress should be considering a national sales tax or consumption-based tax.

NOTE: We could devote an entire series of blogs to the differences between and benefits and drawbacks of a true sales tax verses a value-added (or goods and services) tax. We’re not going to do that. Mostly because it would be pretty dull for all but the most hardcore tax wonks. Suffice it to say that if you really, desperately want to read more about it. Go here, here or here.

Consider that the U.S. is the only OECD member state that does not have some form of nationalized healthcare or a consumption tax at the federal level. Other OECD member states that have enacted nationalized healthcare have resorted to consumption-based tax systems to pay for those benefits.

Such systems are tax-neutral for businesses for the most part and are borne by the consumer. They also have the added benefit of allowing exemptions and /or reduced rates of taxation for certain classes of products, e.g., ethical pharmaceuticals, children’s clothing, etc., thereby constraining the regressive nature of the tax with regard to social causes. Individual states in the U.S. have managed to provide a sales-tax base that is fair for the most part. Why not at the federal level too?

From the perspective of preserving the dwindling corporate tax base, a consumption tax should allow the U.S. to reduce the corporate tax rate – currently the second highest amongst the OECD member states.

U.S.-based multinational enterprises are increasingly moving their operations out of the U.S. to lower-tax jurisdictions. High corporate tax rates affect Foreign Direct Investment (“FDI”) into the U.S.; which provides jobs and other opportunities for American workers.

Examples abound. Currently the Japanese have the world’s highest corporate tax rate and have suffered economically for almost two decades. By contrast, Ireland suffered significant unemployment and declining FDI in the early ‘80s. By reducing the corporate tax rate (now at 12.5%), the country generated a significant increase in FDI leading to historic employment levels and economic growth. Closer to home, Canadian corporate taxes have been steadily reduced and are expected to be around 25% in 2012. The Canadian economy has grown.

It’s time for the US Congress to bring U.S. tax law into the 21^st century. Apparently it is more politically expedient to tax the working class with an outmoded payroll tax without any regard to the longer-term implications of having the second highest corporate tax burden in the OECD.

Treasury published final regulations (T.D. 9456) regarding the treatment of controlled services transactions under §482 of the Internal Revenue Code on August 4, 2009. This post is our second in a series discussing key points of interest in the final regulations.

Reviewing the final regulations, two key areas of clarification jumped out at us.

Services Cost Method clarification. The application of Services Cost Method (SCM) has been clarified and the regulations revised to provide that the tests for SCM are conjunctive rather than disjunctive, as some had perhaps hoped. That is, all four of the requirements must be satisfied to apply the SCM:

1. The service must be a “covered service;”
2. The service must not be an “excluded activity;”
3. The service cannot be precluded from being a “covered service” by operation of the business judgment rule; and
4. Adequate books and records must be maintained with respect to the service.

As a result, it seems likely that the scope of services to which the exception would apply will be somewhat diminished. To what extent remains to be seen. However, most taxpayer-favorable exceptions tend to be narrowly construed. We doubt this will be an exception.

Business Judgment Rule clarification. The Preamble reiterates that the Business Judgment Rule (BJR) should be determined on a controlled group basis and the final regulations clarify this by noting that, “it is determined by reference to a trade or business of the controlled group.” In applying the BJR, the Preamble to the final regulations contains a helpful clarification with regard to evidencing the BJR. The final regulations answer the question of whether an executive’s representation must be preferred to the tax director’s, by clarifying that the BJR is applied on a case-by-case basis and takes into account the taxpayer’s facts and circumstances. Therefore the rank of the representative making the representation is a secondary consideration to the basis for that representation. It appears that IRS and Treasury carefully considered the comments received from the tax community in finalizing the services regulations. Only time will tell how the regulations will apply in the real world.

The final services regulations are effective for tax years beginning on or after July 31, 2009.

Treasury published final regulations (T.D. 9456) regarding the treatment of controlled services transactions under §482 of the Internal Revenue Code on August 4, 2009. This post is one in a series discussing key points of interest in the final regulations.

While the preamble to the final regulations is chock-full of helpful information, it does not really address one of the most controversial aspects of the new regulations: Shareholder Activities.

Instead of the kinder, gentler stewardship concept, taxpayers must now contend with Treas. Reg. § 1.482-9(l)(3)(iv) which provides that an activity is a Shareholder Activity if “the sole effect of that activity is either (i) to protect the render’s capital investment in the recipient or in other members of the controlled group, or (ii) to facilitate compliance by the renderer with reporting, legal, or regulatory requirements applicable specifically to the renderer or both.” (Emphasis added.)

Not surprisingly, IRS and Treasury received numerous comments on the “sole effect” language from a variety of commentators, apparently to no avail. In keeping with tradition, the eight examples provided in the final regulations with respect to Shareholder Activities are simple, straightforward and benign – rendering them useless to evaluate the subtleties and nuances of the real world. Taxpayers and practitioners are left to wonder how narrowly the Service will interpret the new language. At least as far as tax law is concerned, examples do not create rules of law.

What may be especially difficult is distinguishing between day-to-day activities related to operations undertaken by the senior management team (not Shareholder Activities) and oversight and regulatory, legal and/or reporting requirements (could be treated as Shareholder Activities). This area merits extra attention particularly since stock based compensation is expressly included in the cost base for purposes of intragroup allocations.

- EAS & RBJ

By now you’ve probably heard about the U.S. Government’s high profile victory in overcoming Swiss bank secrecy laws — at least partially — to obtain account information for wealthy Americans with offshore bank accounts that were presumptively used to evade U.S. tax. While the IRS and DOJ personnel should be lauded for their dogged determination and perseverance in this matter, many important questions remain unanswered. Chief among these questions is whether this case will be an aberration or whether it will usher in a new degree of cooperation among governments aimed at thwarting unscrupulous banking practices, tax evasion, and other narishkeit.

While the jury is still out on this matter (sorry, just couldn’t help myself), anecdotal evidence seems to suggest that if the IRS has its way the trend will be toward greater information sharing among the G20 tax authorities. So what, you ask? Well, think about this: IRS Commissioner Schulman is working diligently with the Leeds Castle Group to promote coordinated examinations of multinationals. If the IRS is successful in its bid to promote cooperation among the tax authorities of major U.S. trading partners, one of the likely outcomes will be increased scrutiny of cross-border planning and transactions, especially transfer pricing. Consequently, documentation of cross-border planning will need to be consistent among jurisdictions and will need to align more closely with business operations. Otherwise, there will be significant enterprise risk. While it remains to be seen if the IRS will be successful in its endeavors, early indications show that they likely have the momentum to succeed. If the global economy continues to contract, it seems probable that cooperation will increase among tax authorities if for no other reason than resource constraints. However, it’s not likely to take them long to conclude that, working collaboratively, taxpayer information can be leveraged across multiple jurisdictions to reduce the amount of time and effort required to audit a multinational enterprise. Only time will tell whether the cooperation seen in the UBS Case is an aberration or a paradigm shift.

- RBJ