Volatility Elbows Out Stability in International Tax: Dealing with the dark side of competition makes for perilous tax planning

Wednesday, September 28, 2016 - 17:10
Raymond J. Wiacek

In many ways, the career of Jones Day tax partner Raymond J. Wiacek tracks the evolution of the international tax system. He started in the firm’s Washington office, became captivated by the complexities of taxation, and, as the world’s economies and the companies the firm represents became more global, so did his work. Below he discusses the good, the bad and the ugly of today’s international tax environment. His remarks have been edited for length and style.

MCC: Tell us about the scope of Jones Day’s tax practice in terms of geography and areas of concentration.

Wiacek: We span the globe. Our clients do business everywhere in the world, and our lawyers represent them everywhere, including our tax lawyers. When there is a very large transaction, involving a company doing business in more than 100 countries buying or being acquired by a comparable company, we can do the global tax planning for them.

We’re basically a large corporate law firm, so that’s the type of work that our tax lawyers do. The skill sets of our tax lawyers run the gamut from M&A and partnership taxation to transfer pricing and tax disputes. Can I say this – we’re really good.

MCC: You testified to Congress earlier this year on the need for tax reform. Are U.S. tax rates out of step with those in the rest of the world?

Wiacek: The U.S. corporate income tax system, in particular as it applies to our global companies, is broken. There is actually consensus on this in a Washington that’s otherwise quite partisan. The Republicans and the Democrats agree it’s broken and needs to be fixed. But they can’t come to a consensus because they get mixed up in other tax issues and can’t keep the focus on corporate tax reform. The Republicans say, “What about the death tax? Shouldn’t it be repealed?” The Democrats say, “What about higher rates on millionaires?” So our corporations continue to deal with a system that doesn’t work.

We have among the highest corporate income tax rates in the world – if not the highest – at 35 percent. Other countries tax at much lower rates, because they’re competing for our business. I’m not talking about islands such as the Caymans, I’m talking about real countries. The UK just announced that it’s going to a rate of 15 percent. Ireland is already at 12.5 percent, Canada is at 20 percent. Our international companies are among our most successful, and other countries want them. We need to reform our international tax rules if we want to be competitive – and keep our businesses at home.

MCC: What about the disparity between worldwide and territorial taxation?

Wiacek: That’s another fundamental difference between us and our competitors. The U.S. taxes the worldwide income of its corporations; most everybody else taxes only income earned in that country. This is called territorial taxation. The French, for example, tax a French company on its French income, but otherwise they by and large leave the French company free to compete around the world without worrying about French taxation. The U.S., in contrast, taxes income earned in the UK or Ireland or Canada, for example, at our full 35 percent rate. While we do give a credit for the tax paid in the foreign country, we tax the difference up to 35 percent. That’s not competitive. In partial relief, the U.S. doesn’t tax income earned abroad until it is returned to the U.S., which is called deferral. Lots of money is kept abroad as a result, which would be better invested in the U.S. So we have high rates and worldwide taxation in a low rate and territorial environment, tempered by a safety valve – deferral – which isn’t good for us.

MCC: Jones Day represents the U.S. Chamber of Commerce in a dispute over tax inversion. What can you tell us about that?

Wiacek: All of these issues are interrelated. Absent reform, our companies need to respond to remain competitive. One response is to accept the invitation of our competitors, by becoming, say, British, Irish or Canadian. It’s complicated, but this the essence of an inversion. We don’t want to lose our biggest and best companies, of course, so our response should be to make our international tax system competitive. I think everybody agrees that’s the right answer, but we don’t seem to be able to get it done.

Earlier this year, Pfizer, the largest pharmaceutical company in the world, announced that it was inverting. The Obama administration did not want this to happen, but it admitted it had no authority to stop it. Instead, as the lawmaking body under our Constitution, Congress needed to act. Congress didn’t. The specter of Pfizer inverting nevertheless caused the administration to draft regulations, without authority, to prevent the Pfizer inversion. Afterward, President Obama said, “It’s not that what they were doing is illegal. It’s that our laws are broken.” Challenging this statement is the essence of our suit, and the essence of the rule of law. No administration can stop legal activity, without authority and by regulation, when new laws passed by Congress are what is needed. In addition, because the administration had this particular deal in mind, the regulations were effective immediately – without notice, without hearings, without a period for comment – all of which is illegal under the law governing how federal agencies can issue regulations.

MCC: Another high-profile international tax matter is the European Commission’s tax ruling concerning Ireland and Apple. Give us some perspective on that. It’s not the only such case, correct?

Wiacek: There are other cases underway, and many more being threatened. Apple does much of its international business through Ireland, which has a competitive tax system. Apple got rulings from the Irish authorities as to how much of its business would be taxable in Ireland. Under Irish tax law, some was not considered taxable in Ireland. Eventually, the earnings involved would be taxable in the U.S. because of our worldwide system, so Apple was deferring not escaping taxation. In fact, Apple CEO Tim Cook said he’d return those earnings to the U.S. and pay U.S. tax as soon as the U.S. adopted a more competitive tax system. In the meantime, those earnings were not taxable under Irish law, nor were they taxable currently in the U.S.

Some folks in the EU could not abide this situation. They weren’t EU or Irish tax experts; they were competition lawyers. We would call them antitrust lawyers in the U.S. The EU competition lawyers looked at what Ireland and Apple did as akin to an unfair trade practice. They have the authority under the EU treaty to prevent “state aid,” which is what happens when one country in the EU competes “unfairly” with another country by granting “aid” to some companies but not all. They decided that Ireland’s rulings interpreting its own tax laws constituted state aid that provided a benefit to Apple not generally available. There is much wrong with this case, including the fact that other international companies could get a comparable ruling from Ireland.

The decision has been greeted with indignation by tax experts, and at the highest levels of our government. Treasury Secretary Jacob Lew has written letters to the EU that say – effectively but much more politely –  “Who asked you? And you don’t know what you’re doing, either.” Apple will challenge the decision, and it will take three or four years to get through the EU courts.

MCC: What lessons should U.S. companies with international operations draw from all of this?

Wiacek: That tax planning is increasingly volatile. Who would have foreseen the antitrust lawyers of the EU overturning the Irish tax authority’s ruling on its own tax system? It’s flabbergasting. The state aid cases were hard to foresee because they involve politics and other issues, such as protectionism, which are not tax issues. There are many people, including members of Congress and our treasury secretary, who think this whole thing is anti-American and a form of trade war, since most of the cases are against American multinationals. To sum this up as a practitioner, it gets ever more difficult to create a stable international tax plan. You face such questions as, What are the odds of U.S. tax reform? Should you accept the competitive tax systems offered by many EU countries? Should you fear the EU’s harsh response to its own countries in the state aid cases? And what about BEPS, which I hope we can still discuss?

MCC: OK, what is BEPS, and why should we be concerned about it?

Wiacek: BEPS stands for “base erosion and profit shifting.” It is a project of the Organisation for Economic Co-operation and Development (OECD), which is a treaty-based organization created after World War II. Through BEPS, the OECD has undertaken to update and rewrite the tax laws of the world as they apply to international commerce.

Why should we be concerned about this? Some of the things proposed are needed and very good, but the OECD is not an organization in which the U.S. is dominant. We’ve participated in BEPS, but we’ve not always prevailed. The BEPS proposals take into account the point of view of a number of countries whose self-interest isn’t always consistent with ours. There will be rules adopted that we don’t like. The safeguard is that each country has to adopt the BEPS proposals as part of its own domestic law. We’ve thought that we wouldn’t adopt whatever we didn’t like, but that’s not a sufficient answer. In multilateral economic relations where you’re trading between and among countries, all that happens when you don’t adopt a rule that several other countries have adopted is disagreement and friction. And other countries won’t adopt some of the rules either. Thus, although the goal of modernizing and unifying the rules governing international taxation is noble, execution will be problematic, and friction and disputes will continue for a long time.

MCC: Finally, how has technology changed the taxation playing field? Is our tax code outdated?

Wiacek: Our tax code is a bit outdated. Aside from high rates and worldwide taxation, it could use a good updating to reflect an economy which is more global, more digital. Our economy is more and more based on technology and intangible property. The code, in contrast, is by and large a bricks-and-mortar code. Lots of basic decisions as to where you should be taxed are answered by, “Do you have a factory or a warehouse there? Do you have employees there? Where are the decisions in your company made?” But the economies of the world are now more in the cloud. They’re electronic. That makes it much harder to conclude, as to a global stream of revenue, how much revenue should be allocated to each country through which the electrons pass. That all needs to be rethought.

In addition, more countries now have developing or developed economies, and they have different theories about what revenue can be taxed in their country. Take India, for example. It buys our products, and we tax the income. India thinks, however, that it provides customers, which should be seen as a valuable component of the income stream. So it should get – and tax – a share of that income. This is a relatively new theory of taxation called market sourcing. We haven’t fully adjusted to it yet.

Raymond J. Wiacek is a Senior Tax Partner at Jones Day. He can be reached at rjwiacek@jonesday.com.