The Tax Management Transfer Pricing Report ™ provides news and analysis on U.S. and international governments’ tax policies regarding intercompany transfer pricing.
Nov. 17 — An election that turned the globe upside down may leave the international tax world changed overnight as well.
After Donald Trump’s surprising win in the 2016 presidential election, the chances of a system-wide tax overhaul—once seen as years away—is now possible in a matter of months.
The unexpected development has stopped international tax planning in its tracks, and has practitioners pondering the possibly diminished goal of transfer pricing and multinational tax planning going forward.
“We have a number of transactions we’re considering doing now, involving outbound transfers and cost-sharing, and basically what we’re thinking is that we’re not going to do anything now because of all of the uncertainty,” said Alan Granwell of Sharp Partners PA in Tampa. “In the areas of transfer pricing and deferral, all of this stuff is just totally up in the air.”
The attractiveness of moving out of the U.S. tax system may disappear very soon.
“Why would you go to extensive planning measures to try to do something that tries to get you out, when maybe there’s an incentive that would keep you in?” asked David Bowen, a principal at Grant Thornton in Washington.
Congress may consider not only Trump’s tax plans—which evolved throughout his campaign—but also Republican proposals announced in June that would dramatically restructure U.S. corporate income tax. If enacted, those plans would not only change tax practices at home, they could have significant consequences for the Organization for Economic Cooperation and Development’s tax norms and tax practices around the globe.
“Even with the players being announced, you don’t know how it’s all going to come out on the Hill. There’s just total uncertainty from one week to another,” said Granwell. “Some regimes are going to be totally different from what they are now.”
Like much of his campaign rhetoric, Trump’s tax proposals are simple in their approach and broad in their reach. He calls for reducing the corporate rate to 15 percent, and—in initial drafts—for ending the deferral of overseas profits, requiring companies to pay worldwide taxes immediately rather than allowing them to delay the payment by refusing to repatriate. A more recent version of Trump’s plan announced in September dropped the anti-deferral plank, leading to confusion as to whether he was endorsing a territorial system, which exempts all income except what is generated within U.S. borders.
Trump’s plan also calls for currently deferred offshore income to be repatriated and taxed at 10 percent.
Competing with Trump’s plan is the House Republican “blueprint” introduced in June 2016, which introduces a novel destination-based principle that reminds many experts of a value-added or consumption tax. The proposal would reduce the corporate rate to 20 percent and apply an exemption for exports, but would tax foreign imports.
The blueprint claims the tax adjustment for exports and imports—“border adjustability”—negates an effective penalty borne by U.S. companies that operate in countries with a VAT, which are also normally border-adjustable.
“This will eliminate the incentives created by our current tax system to move or locate operations outside the United States,” the blueprint said. “It will allow U.S. products, services, and intangibles to compete on a more equal footing in both the U.S. market and the global market.”
The plan would also eliminate most of the Subpart F rules, which have been in place since the 1960s and protect against base erosion by ending deferral for certain kinds of inactive income. In a territorial, destination-based system, they would have little use.
The new destination-based cash flow tax would likely change transfer pricing overnight, as incentives to shift high-cost intangibles overseas would be heavily negated. They would require a new look at U.S. tax treaties with permanent establishment clauses, and would cast new light on the OECD’s project to combat tax base erosion and profit shifting, as one of its key participants moves away from the arm’s-length principle and toward a system similar—though hardly identical—to formulary apportionment.
The hybrid nature of the proposed tax has left many wondering if it will run afoul of World Trade Organization rules against border adjustments for income taxes—an issue the blueprint itself addresses, claiming that as a cash flow-through tax it wouldn’t apply.
While the importance of transfer pricing could be diminished, tax practitioners would soon have almost the reverse task of allocating deductions instead of allocating income for multinational corporations, to see which can be claimed in the U.S.
“You still have to determine what is incurred where,” said Michael Mundaca, co-director of the national tax department and the Americas tax center for Ernst & Young LLP in Washington.
“The first pressure point is how serious we are about actually not allowing expenses that relate to foreign-source income to be deducted in the U.S.,” said Brett Wells, a professor of tax law at the University of Houston.
Profit shifting through the pricing of intangible assets, one of the key debates in international taxes for the past decade, may soon become a thing of the past.
“In essence, many of the base erosion proposals that we saw in more traditional tax reform, in the Camp draft, would be irrelevant,” said Mundaca, referring to a tax overhaul proposal unveiled by then-House Ways and Means Committee Chairman Dave Camp in 2014 that included both territoriality and stronger Subpart F proposals to fight the shifting of intangibles income. “In some ways, the U.S. would be out of that debate.”
The simplicity of taxing income based on the location of sales is one reason why many critics of the current system look to the proposal with some wary optimism.
“In some ways I like it. It’s not making this distinction that everything has to be based on where the parent is located,” said Reuven Avi-Yonah, a professor of international taxation at the University of Michigan.
But it would soon open yet another difficult tax enforcement question—how to determine the location of sales in a digital and complex global economy.
“For goods, it’s relatively easy to see, you have Ireland selling iPhones,” Avi-Yonah said. “For services and intangibles, all of the countries that have VATs have problems with that. In our case there’s no credit invoice system.”
Many are skeptical that a new administration facing an array of legislative challenges will be able to implement such a radical change into the corporate income tax.
“Given that the general mood is that we’re going to move tax reform in the first year of the Trump presidency, can you get this radical reform through that quickly?” asked Mundaca. “Or will the efforts on tax reform almost necessarily revert to a more traditional tax reform, given the time pressures?” he asked.
“I find it hard to believe they can do something this radical in the early days,” said Avi-Yonah. “There will be a lot of losers. Anybody who is a significant importer.”
If Congress opts for a simpler tax overhaul, territoriality will likely be a key component, which will make transfer pricing all the more important.
“The problem with territoriality is transfer pricing, because then you’re never paying tax,” said Kimberly Blanchard, a partner with Weil, Gotshal & Manges LLP.
Territoriality would likely require significant anti-base erosion measures to protect the U.S., such as the options included in Camp’s plan, which also include a global minimum rate.
John Warner, a shareholder at Buchanan Ingersoll & Rooney PC, noted that Trump’s campaign focused on keeping jobs—particularly manufacturing jobs—from moving overseas.
“One possibly overriding dynamic—at least if the new administration is able to reduce the corporate income tax rate significantly—is the likely need to preserve the tax base through enforcement of transfer pricing and anti-abuse statutes and doctrines in an effort to keep any budget deficits relatively manageable,” he said.
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