On Taxes, Can Obama Do More Unilaterally?

After months of high-pitched public debate, the White House acted on his own last month to curb corporate tax inversions, as President Obama claimed the issue is too grave to wait for a gridlocked Congress to resolve. And the tactic might have worked--since the announcement, three planned inversion plans have run aground and blamed the Obama administration's actions.

By now it's a familiar tactic from Obama, who has announced plans to use his powers under existing law to pursue legislative goals on climate change and immigration after facing stiff Republican opposition in Congress. But in regard to international taxes, is there more Obama could do?

Certainly. In fact, the recent action on inversions just scratches the surface of the possibilities for executive or regulatory action in the tax arena. Tax law tends to be written broadly, with plenty of ambiguities to be filled in through administrative interpretation. But the possibilities all have significant challenges, and pitfalls.

Checking The Box

Among tax experts, the most obvious area where Obama could look to act unilaterally is toward the so-called check-the-box loophole, which critics claim is used to create exploitive tax structures such as the Double Irish arrangement, which shields income from U.S. taxation. Those structures are very popular with companies in the tech and pharmaceutical fields, which rely on highly mobile assets such as patents or copyrights. The Double Irish is soon to be extinct, but the alleged loophole is still vexing the Department of Treasury. This is the product of regulations issued in 1996--and therefore could be undone through further regulations. At least, in theory.

Check-the-box refers to an administrative procedure to declare the tax status of subsidiaries. A quirk in how this works lets a U.S. corporation to declare a subsidiary as a "disregarded entity"---essentially, it no longer exists as a separate entity at all, as far as the Internal Revenue Service is concerned. (Normally, this means that the disregarded entity is viewed as a branch of another subsidiary.) But what's crucial is that the foreign countries where these subsidiaries are located still see the legal division, even if the U.S. doesn't. In tax parlance, this is called a "hybrid entity," although I like to think of it as a Rorschach company. It looks different ways to different jurisdictions, based on how their laws work.

This discrepancy allows those subsidiaries to engage in transactions to lower their tax rates--for instance, they might license out the rights to use valuable patents from a low- or no-tax jurisdiction--without triggering the U.S. law meant to discourage these specific kinds of transactions.

These transactions are used to lower the amount of foreign taxes paid, not U.S. taxes. But from the point of view of the law, this shouldn't matter. Subpart F, the Kennedy-era legal regime that this concerns, doesn't distinguish between U.S. and foreign tax evasion. Rather, it identifies specific transactions that, its writers believed, are inherently involved in artificially moving profits from the jurisdiction where they are created to a low-tax jurisdiction.

Today, the avoidance of foreign taxes is certainly a concern for U.S. policymakers--especially as long as companies can defer U.S. taxation by keeping money overseas. The less a corporation pays in foreign taxes, the more powerful the disincentive for ever bringing that money back home.

Almost immediately after the regulations were issued in 1996, controversy about their potential misuse arose. Treasury proposed revised regulations to deal with some of the issues, but those were met with heavy opposition from Capitol Hill.

"The Treasury Department is not only making policy that it has no right to make, it is also making bad policy," said then-Rep. Connie Mack (R.-Fla.). Under threat of legislation reining in Treasury's powers, Congress and the administration in 1999 reached an agreement not to change the regulations until at least 2006, and it has remained substantially unchanged. The provision, according to Treasury, costs the government about $10 billion per year in revenue. 

In his first year in office, President Obama proposed nixing the loophole in his 2010 budget request. But that item was dropped from subsequent requests after another round of furious lobbying.

Could the Obama administration just dust off the revised regulations Treasury dropped in 1999 and ratify them? They could--but experts aren't sure whether they would stick. Does the informal truce between Treasury and Congress, mentioned above, indicate some sort of Congressional directive on check-the-box? (In 2006, Congress also passed the similar but distinct look-through rule, which some have interpreted as another Congressional sanction of the concept underlying check-the-box.)

And, furthermore, Treasury would need to craft regulations to deal with the gigantic corporate structures that have been built up around check-the-box. This would not be an easy task, as nearly 20 years of history behind check-the-box has made it that much harder to remove from the corporate landscape.

"You'd have all sorts of transitional issues that would be literally mind-blowing," said David Rosenbloom of Caplin & Drysdale. "The problem with check-the-box is, it cuts very deep at this point. It's been around for a long time, people have relied on it. Undoing it would be quite a task."


Another area where Obama could look to his executive authority is in regard to intangibles.

Intangible assets--things that are valuable, but are not physical goods--are at the heart of most transfer pricing disputes today. By their very nature, they are difficult to value, which means they are often ripe for manipulation.

Some intangibles are easy to define--they're legally ownable properties, such as patents, trademarks or copyrights. Others, though, are more nebulous--say, the value of a business that is up and running, over the same assets in a static state. ("Going concern value," in tax parlance.) Or, for instance, a business's good reputation--is that something you can separate from its brand trademarks and operations? ("Goodwill.")

As it stands now, these concepts are not legally recognizable as intangible assets. If they were, the U.S. (and other countries) could claim they were created in their jurisdictions, and that they are entitled to some or all of the returns from their value. It may or may not be a substantial amount of money, but it gives the tax collectors one more lever to use when evaluating complex international structures.

In past budget requests, including the 2015 budget released in March, the Obama administration has proposed ensuring that goodwill, going concern value and "workforce in place" (another difficult-to-define concept) as legally defined intangibles. According to Treasury, this would raise $3 billion over the next 10 years.

While legal authority to implement these definitions unilaterally probably doesn't exist, the White House likely has some leeway to broaden the current legal definition of intangibles, which includes terms such as "know-how," "process" and "method." An aggressive reading of this law could help achieve some of the administration's goals. But critics could also claim, as before, that such a process would disregard the legislative history and past practice of the law.

In all of these cases, a strict legal reading of Treasury's power runs up against more nuanced considerations of historical perspective--and political reaction.

Alex M. Parker, staff writer, Transfer Pricing Report