Is transfer pricing broken? Does the IRS/Congress need to adopt a new model to tax U.S. Multinational Corporations’ income earned worldwide?
Through this Blog, I have previously written about how US Multinational Corporations (USMNCs) have routinely utilized “tricks of the trade” (Transfer Pricing, Inversions and Earnings Striping) to minimize their U.S. tax liabilities. I have also suggested some changes to the existing system (i.e., expatriation tax etc.)
Perhaps change is on the horizon. In one of the keynote addresses at the 16th Annual Global Transfer Pricing Forum held in New York (September 22-23, 2016), Professor Edward Kleinbard (USC Gould School of Law, and the former chief of staff of the Joint Committee on Taxation), advocates for “The End of Transfer Pricing”. See the Presentation slides here.
Professor Kleinbard begins his presentation by discussing the Apple “facts” as examined by the EU Commission in the recent Irish state aid case. He highlights the following facts:
- APPLE had $115 billion of income over a 10 year period;
- APPLE paid Ireland only .05% per year during the same period;
- APPLE paid other EU countries roughly $385 million in taxes over the same period;
- APPLE’s effective tax rate was 3.5% not the statutory rate of 35%.
- APPLE had pre-tax profits of $91.5 billion.
Professor Kleinbard concludes that the arm’s length standard is no longer viable if APPLE can receive such beneficial treatment through its subsidiaries in Ireland.
Professor Kleinbard then discusses how the world is aware of the abusive nature of transfer pricing and that progressing with the fiction of transfer pricing and the arm’s length model is untenable, specifically, he cites the following examples:
- U.S. Treasury’s laughable response to the European Commission’s inquiry into whether Ireland gave Apple state aid;
- Countries sharing tax information with each other;
- Apple and other US MNC transfer pricing backlash;
- Congressional backlash/proposed tax reforms; and
- Base Erosion and Profit Shifting Project’s (BEPS) inability to reverse the transfer pricing inequality. (See this blog describing the BEPS)
Because of this pushback, Professor Kleinbard advocates for a change to the existing system.
More specifically, he advocates for the following changes to the Corporate tax rate:
- Statutory Rate reduced to 25%;
- Repealing Section 199 (deduction for income attributable to domestic production activities;
- Repealing the Alternative Minimum Tax (AMT;
- Destination Based Cash Flow Tax
He states that by reducing the corporate rate to 25% will eliminate the need for transfer pricing games, because US tax rate will be in the middle of the pack, and playing games will be unnecessary.
Note: Professor Kleinbard has stated, “Transfer pricing is dead” since 2008. See this Tax Analyst Article about his debate with Willard B. Taylor of Sullivan & Cromwell LLP at the International Tax Institute.
To Clarify, Professor Kleinbard actually stated that Transfer Pricing enforcement has been dead since 2007. See this article by Michigan Law Professor Reuven S. Avi-Yonah. Professor Avi-Yonah proposes three different approaches for Congress to revitalize transfer pricing enforcement:
- adopting a unitary taxation regime;
- ending deferral; and
- adopting anti base erosion measures.
Unitary Taxation Regime: This proposal suggests that Congress can adopt a unitary tax system, namely, treating each USMNCs as a single unit and disregarding the “formal distinctions” among the subsidiary corporations. The advantages are: 1) a better model for taxing USMNCs because of the way they currently operate; and 2) the unitary tax applies the same treatment to all USMNCs and does not depend on the location of the parent corporation.
Professor Avi-Yonah believes that this is the best solution, but pragmatically speaking will be difficult to achieve.
Abolishing Deferral: This proposal proposes to prevent USMNC from parking profits offshore (something subpart F of the Internal Revenue Code was originally designed to accomplish, but has failed to do so).
Professor Avi-Yonah believes this is a good approach, but that it will require countries to adopt this goal, which may be difficult to achieve.
Adopting Anti-Base Erosion Measures: This proposal suggests limiting deductible payments to related foreign parties, including cost of goods sold, interest and royalties.
Professor Avi-Yonah believes adopting this proposal in conjunction with abolishing deferrals will eliminate the impetus to undertake transfer pricing by USMNCs.
Finally Professor Avi-Yonah advocates for the adoption of a mixture of these measures, similar to Senator Baucus’ proposal with option Y. See analysis of Senator Baucus’ proposals here. (NOTE: Senator Baucus is now the U.S. Ambassador to China). Under Option Y, income from foreign sales would be taxed at 80% of the US rate with a credit for foreign taxes paid. This would ensure tax would be geared toward the ultimate destination of the sale of the goods (i.e. taxing where the goods are ultimately sold, or similar to Kleinbard’s destination cash flow tax.)
It will be interesting to see if any of these proposals will gain traction with the pending presidential election and with one of the key backers now a U.S. ambassador to China.
If you have specific and credible information of a company undertaking transfer pricing and want to report the company for shifting its profits offshore, CONTACT US, to discuss your tax whistleblower claim. The IRS is paying an award (between 15-30% of the collected taxes, interest, penalties, and additional amounts) for information it utilizes in adjusting a corporation’s income tax due to information provided by a whistleblower.