Services a Possible Sticking Point in GOP Cash Flow Tax Plan

The Tax Management Transfer Pricing Report ™ provides news and analysis on U.S. and international governments’ tax policies regarding intercompany transfer pricing.

By Alex M. Parker

Income from services—consulting, legal representation, advertising, finance and the like—could throw a monkey wrench into the destination-based tax overhaul plan being promoted by House Republicans.

Proponents of the plan claim it would end complex profit-shifting transactions overnight by tying income to where a final good is consumed. But services, especially intercompany or business-to-business, may present vexing challenges in determining that location. When global conglomerates pay millions for advertising, or legal representation, the final destination of those sales isn’t easily identified.

“If a New York City-based law firm provides advice on a merger between a U.S. and a foreign multinational, is that an export or an import?” Reuven Avi-Yonah, a tax law professor at the University of Michigan, asked in an e-mail to Bloomberg BNA.

The cash flow tax operates by exempting exports but fully taxing imports as well as domestic sales, while disallowing deductions for foreign expenses. The end result is something many tax practitioners consider akin to a value-added or consumption tax—albeit with some particular quirks, such as a full deduction for expenses and U.S. labor.

It’s received full-throated support from House Speaker Paul Ryan and Ways and Means Chairman Kevin Brady (R-Texas), but has faced skepticism from Republican senators and opposition from retailers who fear price surges.

Where Was Service Provided?

The trickiness may come when distinguishing whether a service has been provided to a U.S. or a foreign entity.

“If the service provider is in the U.S., the question is whether the sale is to a U.S. consumer or a foreign consumer,” said Clark Armitage, a transfer pricing lawyer with Caplin & Drysdale Chartered in Washington. “That’s certainly more flexible than for tangible goods. It’s easier to trace those, more difficult to game.”

Armitage imagined a U.S. firm that provides research and development to a foreign pharmaceutical firm on a drug created overseas. It might seem like a clear-cut exported service—but suppose the purpose of the R&D was to gain approval to the U.S. market?

Law firms—which provide representation and advice to multinational corporations and themselves have offices around the globe—also present tough questions about the location of a service’s origin and destination. Would the tax be based on the location of the lawyers who charge billable hours?

The issue could become a flash point with services in the financial sector, such as hedge fund management, which many have seen as a significant potential loophole. Managers could argue their services are exports if the hedge funds are in a low-tax jurisdiction.

Is VAT a Solution?

Many value-added tax systems have developed solutions to the complex questions posed by service providers. The credit-invoice-method VAT, for instance, requires companies to track not only their sales but the amount of tax already paid by providers in order to claim a credit, ensuring that the deductions and inclusions match up. But that path may present a political cost, especially to VAT-averse Republicans.

“There are ways to fix this. But it’s not clear it’s being fixed,” said Daniel Hemel, an assistant professor of law at the University of Chicago. “You start to look very European. House Republicans don’t want this to look like a credit-invoice VAT.”

The plan could also rely on an analysis of the service’s nature and who it benefited—which could provide flexibility but would introduce the same kind of complex factual questions the plan was supposed to eliminate.

“If the whole idea is simplification, we’re fast running away from that,” Hemel said.

To contact the reporter on this story: Alex M. Parker in Washington at

To contact the editor responsible for this story: Molly Moses at

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