An excerpt:

Singapore today signed a protocol with France that brings the two countries’ bilateral tax treaty into line with the OECD standard on transparency and exchange of information for tax purposes. This is the twelfth agreement it has signed in accordance with the OECD standard, thereby moving Singapore into the category of jurisdictions deemed to have substantially implemented the standard. This required that Singapore pass legislation to enable its authorities to exchange information, including bank and fiduciary information, with tax authorities in other countries.

Tax havens. Tax havens are not merely jurisdictions with nil or low tax rates; many countries attract business in this way. Explicit appellation is also misleading: for example, the OECD has never defined Singapore, nor Switzerland, as a ‘tax haven.’ The critical aspect of a tax haven is non-cooperation with other jurisdictions in the realm of tax information, and implicitly offering a refuge for tax evaders and money-laundering.

G20. The big economies are now pressing for compliance in transparency as a tool to put pressure on tax and asset-management aspects of tax havens. In practice, the main issue is use of tax havens for aggressive tax competition and homes for asset management in offshore funds:

• In 2009, the US Government Accountability Office (GAO) estimated that 83 of the largest 100 US corporations were doing business in tax havens.
• The US Treasury estimated it was losing 100 billion dollars in revenue per annum.

Market fundamentalism. Growth of tax havens was possible mainly because, in the absence of global cooperation, piecemeal regulatory efforts would merely push business from one tax haven to another. In the prevailing climate of market fundamentalism, banks successfully argued that they needed freedom to organise their affairs. That time is over. The list of those who had not made “substantial progress” (ie had not signed twelve individual tax information exchange agreements with other jurisdictions) shrank by 15 in the April-November period:

• All jurisdictions of relevance have committed to tax transparency standards.
• About 20 small states remain to implement their commitments and seven larger economies have yet to do so.

There’s no question that OECD and G20 countries see tax havens as the enemy of their tax revenue. However, dismantling those regimes may have an unexpected, adverse effect on the capital markets. In the short-run, the cost of capital will likely rise in real terms impeding economic expansion as business and consumers find they are unable to afford the capital markets’ prevailing rates. Under this scenario an increase in inflation would also be likely as businesses would have to raise prices to obtain needed capital. Perversely, the very governments in the vanguard of the movement to dismantle tax havens would likely find themselves the most adversely impacted. Governments who have been running deficits will find the cost of funding those deficits as a percentage of their GDP will increase sharply, due to constraints being placed on the capital markets.

Ultimately, tax havens are a symptom of a much larger problem. Developed countries’ governments have grown to such gargantuan proportions that they must continually squeeze taxpayers to fund themselves. Corporations and individuals are essentially paying for the privilege of being taxed. Tax havens exist because there is a market for them. Contracting government, creating and implementing tax policies which align corporate and governmental interests, and efficient enforcement of existing rules is the better, albeit less sexy, answer.

Section 561: Limitation on Treaty Benefits for Certain Deductible Payments

• What it says: “In the case of any deductible (U.S. source item of fixed, determinable, annual, or periodic (“FDAP”) income ) related-party payment, directly or indirectly, any withholding tax imposed under chapter 3 (and any tax imposed under subpart A or B of this part) with respect to such payment may not be reduced under any treaty of the United States unless any such withholding tax would be reduced under a treaty of the United States if such payment were made directly to the foreign parent corporation.” [Emphasis added]
• What it means: 1) The stock ownership threshold for what it means to be a controlled party under IRC section 1563(a)(1) is reduced from “at least 80 percent” to “more than 50 percent”, 2) Withholding taxes cannot be reduced under a U.S.-treaty, unless a direct-payment to the foreign parent corporation would also qualify for such reduced rate of withholding tax. Clearly, the aim is to shut-down inverted companies with inbound financing structures. Given the broad nature of the proposal, however, the collateral consequences may not have been fully considered, as it appears to be a “super-limitation-on-benefits” provision to redress real or perceived abuses in cross-border financing structures. It will likely be more of a clarion call for U.S. trading partners to cry foul, akin to the FIRPTA provisions on the 1980s with respect to treaty benefits. At a time when multinational enterprises are seeking certainty in their cross-border affairs it will likely throw a monkey-wrench in planning and (as currently drafted) have unintended consequences.

Section 562: Codification of Economic Substance Doctrine, Penalties

• What it says: “In the case of any transaction to which the economic substance doctrine is relevant, such transaction shall be treated as having economic substance only if – (A) the transaction changes in a meaningful way (apart from Federal income tax effects) the taxpayer’s economic position, and (B) the taxpayer has a substantial purpose (apart from Federal income tax effects) for entering into such transaction.”
• What it means: The Economic Substance Doctrine, heretofore an amorphous standard molded by the judiciary, would now be on the books as law. Essentially, the government would have a weapon to combat perceived tax shelters even if the taxpayer was technically compliant with relevant law and historical precedent. The language is highly subjective and ambiguous. Given that taxpayers already have the burden of proof, codification of the Economic Substance Doctrine raises the bar even higher, requiring justification not only of the transaction from a legal standpoint, but also from a business and economic position as well both qualitatively and qualitatively and leaves the door open to questions in the event the non-tax aspects of the transaction are unrealized or realized to a lesser degree than anticipated. In addition, the “Reasonable Cause and Good Faith” exceptions under IRC section 6664, would be amended to exclude transactions for which “Economic Substance” was lacking and for tax-shelters. In addition, IRC section 6662 would be amended to increase the 20 percent penalty, to 40 percent for non-disclosed non-economic substance transactions.

Section 563: Certain Large or Publicly Traded Persons Made Subject to a More Likely Than Not Standard for Avoiding Penalties on Underpayments

• What it says: “In the case of any specified person, paragraph (1) shall apply to the portion of an underpayment which is attributable to any item only if such person has a reasonable belief that the tax treatment of such item by such person is more likely than not the proper tax treatment of such item.”
• What it means: Instead of the “substantial authority” standard or reasonable basis plus disclosure test of current law, transactions would be subject to a “more likely than not” (“MLTN”) test. If this proposed legislation is made law in its current form, companies may have to accrue for additional penalties under FIN 48 for positions taken on a tax return where the position did not meet MLTN under the proposed legislation. It effectively raises the bar on affected taxpayers with respect to the current penalty regime under section 6662 by amending the “Reasonable Cause” provisions of section 6664. As currently drafted, the proposed change would pick up privately held corporations with $100 million or more of gross receipts and publicly traded persons.

In a move sure to raise systolic and diastolic numbers everywhere, Caroline Silberzstein, head of the Transfer Pricing Unit in the OECD Centre for Tax Policy and Administration, went on the record last week at the OECD transfer pricing and treaties conference in Paris supporting the proposition that there was no need to define “intangible” for treaty purposes.

Huh? We’re confused.

In other words, if we don’t have a standard definition of an intangible asset what is to prevent different jurisdictions from asserting their own definition and wreaking havoc on transfer pricing? Nothing. That’s what. Without a definition, tax authorities could argue that a given piece of intellectual property is or is not an asset and therefore (based on the more favorable treatment for the tax authority) deny or force an arm’s length payment. Sounds like open season on taxpayers with significant cross-border transactions involving intangibles.

For example, U.S. law defines “intangible” for purposes of Section 482 – the transfer pricing statute – as “an asset that has substantial value independent of the services of any individual if it derives its value not from its physical attributes but from its intellectual content or other intangible properties.” (Treas. Reg. § 1.482-4(b)).

Other countries differ as to the definition of “intangible.” Case in point, India believes that an “intangible” asset should have human intelligence and uniqueness to be recognized. Given this construct, query then to what extent “distribution rights” would be valued in the U.S. versus India? Clearly the U.S. definition of intangible would include a distribution right as an intangible, as the right has value from its “other intangible properties,” notwithstanding that there may be no employees as yet. India, apparently, would reach an inapposite conclusion in the absence of employees. Apparently the ability to distribute vis-à-vis current employees is paramount from an Indian point of view. Given the dichotomy of views as to what constitutes an “intangible” for transfer pricing purposes, it will be difficult at best for tax authorities to agree on what an arm’s length result should be in the absence of a definitional framework as to what constitutes an “intangible” asset for treaty purposes.

This should be a clarion call for the OECD and its member states to put forth a common definition of “intangible” for treaty purposes or if not a definition, at least agree on the indicia of an “intangible” so that taxpayers and tax authorities alike will have a framework to foster negotiation. Moreover, in light of convergence of financial reporting standards there will likely be differences between what is reported for financial accounting purposes, statutory accounting purposes (the starting point for the tax return) and tax reporting in the U.S. versus non-U.S. jurisdictions. Thus leading to a further mudding of the waters as to intangibles that may or may not be reported for financial accounting purposes, but may nevertheless exist for tax purposes.

Absent a definition or at least an agreement as to the indicia of intangible asset(s) for treaty purposes, we will be left with the so-called Pornography Standard: You’ll know it when you see it. The OECD can and should do better.