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By Herman B. Bouma, Esq.
Buchanan Ingersoll & Rooney PC, Washington, D.C.
The greatest impediment to a rational international tax system
(either for the United States or for the world) is the obsession
among tax policymakers and tax technicians with assigning residency
to corporations.1 There is no
logical way to do it. Thus, if you insist on doing it, you end up
with an illogical rule at the foundation of the system - and thus
have a house built upon the sand, not upon the rock.2
Many jurisdictions, including the
United States, assign
residency to corporations based on place of incorporation.3 Place of incorporation
is clearly inappropriate since it elevates form over substance and
plays right into the hands of tax havens. It is because of this
residency rule that a U.S.-parented multinational group can change
to a foreign-parented multinational group (in the absence of §7874)
and radically change its U.S. tax consequences without
significantly changing its worldwide business operations.
There has been quite an uproar
recently about such corporate
"expatriations," particularly because Pfizer seriously considered
expatriating (and would have expatriated had AstraZeneca been
cooperative4), Walgreens is under
pressure to expatriate,5 and Medtronic has
announced it is expatriating.6 A number of U.S.
politicians have expressed outrage that a U.S.-parented
multinational group can dramatically change its U.S. tax position
simply by becoming a foreign-parented multinational group.7 To this I am tempted
to respond, "Excuse me, sir (or madam).8 You're in charge
of the Code which has the place of incorporation rule as the rule
for determining corporate residency, which in turn determines
fundamental corporate tax consequences. If you are so upset
with what's happening, you should change that illogical rule. If
instead you keep that illogical rule and lock U.S. corporations
into U.S. status,9 you might very
well render them non-competitive, causing them to go out of
business, and what is to be gained by causing U.S. corporations to
go out of business?10 To remain
competitive, some U.S. corporations might seek to merge with a
larger foreign corporation,11 and what
is to be gained by causing U.S. corporations to be taken over by
One of the main concerns of
the OECD's Base Erosion and Profit
Shifting (BEPS) project is the so-called "cash-box," set up in a
tax haven, which acquires valuable intangible property and then
reaps huge profits that are subject to little or no tax. The
OECD is viewing this problem as a transfer pricing problem
(see Actions 8-10 of the BEPS Action Plan, released July
19, 2013) and is seeking to develop "special measures" to reduce
the amount of income to which such a cash-box is entitled under the
arm's-length principle. However, the problem is not a transfer
pricing problem - the amount of income that is allocated to the
cash-box under the traditional arm's-length method is perfectly
appropriate given its ownership of the valuable intangible
property. The problem is really with the whole notion of corporate
residency. Because the cash-box is incorporated in a tax haven (or,
alternatively, has its place of effective management and control
there), it is considered a resident of the tax haven and the tax
haven is thus considered to have the residual right to tax all of
the corporation's income. Thus, the real problem is one of
stated above, place of incorporation is an illogical rule for
determining corporate residency and plays right into the hands of
tax havens. Place of effective management and control is not much
better since this is also easy for taxpayers to manipulate to
achieve the desired residency. (Obviously, manipulation is even
easier if the residency criterion is the place where the Board of
Directors meets.) Attempting to determine corporate residency by
looking to the residency of the corporation's shareholders is also
problematic since a corporation's shareholders may reside in
multiple jurisdictions. Moreover, such a rule can become
unadministrable when a corporation has thousands of shareholders
all over the world. In fact, all proffered indicia of residency for
a corporation are problematic and the whole notion of corporate
residency should be abandoned.
One of the
mysteries of the universe is why so many intelligent
international tax practitioners don't see the absurdity of
continuing to assign residency to a corporation. Once tax policy
makers and tax technicians (including U.S. policy makers, staff on
the Hill and at Treasury, and staff at the OECD) realize there is
no logical way to assign residency to a corporation, they should
dispense with corporate residency and go on to ask, "OK, what do we
do now?" 13 Once they move
on to that question, chances for a rational international tax
system will significantly improve.14
Having jettisoned the notion of residency for
option is to mandate "disregarded entity" treatment for wholly
owned business entities15 and adopt
worldwide formulary apportionment.16 In this
way, all corporations would be treated the same, regardless of
place of incorporation or any other "indicium" of residency, and
thus "U.S. corporations" would have no disadvantage (or advantage)
over "foreign corporations."
This commentary also
will appear in the July 2014 issue of
the Tax Management International Journal. For more
information, in the Tax Management Portfolios, see Isenbergh, 900
T.M., Foundations of U.S. International Taxation, and in
Tax Practice Series, see ¶7120, Foreign Persons -- Gross Basis
Taxation, ¶7150, U.S. Persons -- Worldwide Taxation.
1 See, e.g., the OECD's Base Erosion and
Shifting (BEPS) Action Plan released on July 19, 2013, Chairman
Baucus' international tax reform discussion draft released on Nov.
19, 2013, and Chairman Camp's tax reform discussion draft released
on Feb. 26, 2014, all of which continue the practice of assigning
residency to corporations.
3 Under §7701(a)(4), a corporation is "domestic"
(U.S.) if it was "created or organized in the United States or
under the law of the United States or of any State …." The Code
uses the terms "U.S. person" and "foreign person," rather than
"U.S. resident" and "foreign resident." All section references,
unless otherwise stated, are to the Internal Revenue Code, as
amended, and to the regulations promulgated thereunder.
5 Sachdev and Frost, "Walgreen Pressured
Headquarters to Europe," Chicago Tribune (Apr. 14,
2014); "Walgreens Inversion Could Cost Billions, U.S. Senator
Says," 2014 WTD 113-25 (June 12, 2014); Velarde,
"News Analysis: Walgreens Inversion Would Escalate Danger to U.S.
Tax Base," 2014 TNT 120-3 (June 23, 2014).
6 Mider, "Medtronic Is Biggest Firm Yet
U.S. Tax Citizenship," 116 Bloomberg BNA Daily Tax
Rpt. G-1 (June 17, 2014); "U.S. Medical Device Company
Announces Merger, Move to Ireland," 2014 WTD 116-23 (June
9 Legislation has been introduced in both the
and the Senate to lock U.S. corporations into U.S. status.
See "U.S. House Democrats Announce Bill to Tighten
Inversion Restrictions," 2014 WTD 99-16 (May 22,
2014); "U.S. Senators Announce Bill to Reduce Corporate Inversion
'Loophole'," 2014 WTD 99-18 (May 22, 2014). Senator Henry
"Scoop" Jackson (D-WA, 1959-1983) railed mightily against the
Soviet Union for not allowing its citizens to expatriate. He
probably would not look kindly on the U.S. Congress for not
allowing U.S. corporations to expatriate. After all, as Mitt Romney
said, "Corporations are people, my friend."
(Aug. 11, 2011). See also Citizens United v.
Federal Election Commission, 558 U.S. 310 (2010),
and Burwell v. Hobby Lobby Stores, Inc., No.
13-354, 2014 BL 180313 (U.S. June 30, 2014)..
10 Alibaba, which bills itself as the
online and mobile commerce conglomerate in the world, maintains its
headquarters in Hangzhou, China, conducts most of its operations
there, and derives more than 80% of its revenue from Chinese
operations. However, the parent corporation, Alibaba Group Holding
Ltd., is incorporated in the Cayman Islands and conducts its
Chinese operations through subsidiaries and variable interest
entities (VIEs). SEC filings indicate its worldwide effective
tax rate is 9.9%. Athanasiou, "Chinese E-Commerce Giant's IPO
Filing Exposes Tax Risks," 2014 WTD 90-2 (May 9, 2014).
Clearly, a U.S. corporation competing against such a corporation
has one hand tied behind its back. It's not clear what the U.S.
Congress accomplishes by making U.S. corporations
11 To remain competitive and avoid the
legislation, some U.S. corporations might arrange to be taken over
by foreign corporations so that the shareholders of the foreign
corporation own more than 50% of the new foreign parent corporation
and thus the new foreign parent corporation is not treated as a
12 In order to avoid the lock-in
effect in the
first place (otherwise known as the "Hotel California" effect - you
can check out but you can't leave - or the "Roach Motel" effect -
you can check in but you can't check out), it appears that more and
more start-up companies organized by Americans are being set up
ab initio as foreign corporations.
13 Once a residency rule is abandoned,
no longer need to get upset about corporations that do not have
residency anywhere. See section III.C.2. of "Offshore
Profit Shifting and the U.S. Tax Code - Part 2 (Apple Inc.)," a May
21, 2013 memorandum prepared by Senator Carl Levin (D-MI), Chair of
the Permanent Subcommittee on Investigations (PSI) of the U.S.
Senate Homeland Security and Government Affairs Committee, and by
Senator John McCain (R-AZ), Ranking Minority Member of the
Subcommittee (hereinafter, "the PSI Apple report"). 2013
WTD 98-42 (May 21, 2013).
to Masatsugu Asakawa, Deputy Vice
Minister for International Affairs of Japan's Ministry of Finance
and Chair of the OECD's Committee on Fiscal Affairs, the OECD's
BEPS project is intended to develop "a more ideal international
taxation system." "OECD Chair Emphasizes Progress of 'More Ideal'
International Tax System in G-20 Symposium Remarks," 2014
WTD 93-26 (May 13, 2014). To really make progress in
this regard, it is necessary to abandon the notion of corporate
15 Thus, a parent corporation and all of its
owned subsidiaries would be treated as one tax unit (person) for
tax purposes and its taxation would be the same regardless of
whether the parent has set up three subsidiaries or 300. This would
deal with the concern of some politicians that multinational groups
can change their worldwide tax burden simply by setting up entities
in different jurisdictions. See section III.C. of the
PSI Apple report.
16 See Bouma, "12 Major Deficiencies
of the Code Which Should Be Rectified as Part of Tax Reform," 42
Tax Mgmt. Int'l J. 426 (July 12, 2013). See
also Durst, "Analysis of a Formulary System, Part VIII:
Suggested Statutory, Regulatory Language for Implementing Formulary
Apportionment," 23 Tax Mgmt. Transfer Pricing Rpt. 70
(May 1, 2014). Worldwide formulary apportionment would deal with
politicians' concern with "abusive" transfer pricing.
See section III.C.3. of the PSI Apple report.
The OECD could
aid in the implementation of worldwide formulary
apportionment by developing a Model Apportionment Formula. The
existing OECD/Council of Europe Multilateral Convention on Mutual
Administrative Assistance in Tax Matters (which, despite its name,
is open to all countries) could be used to resolve inconsistent
applications to a particular taxpayer. The Convention was opened to
all countries in 2011. Mitchell, "OECD Tax Transparency Forum Plans
Rating System; Critics Express Skepticism," 216 Bloomberg BNA
Daily Tax Rpt. I-1 (Nov. 8, 2012).
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