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IRS
Commissioner Speech about the Uses and Abuses of International Tax Planning
Strategies by US Corporations
IRS Newswire Issue Number: IR-2008-137
December 8, 2008,
Remarks of Commissioner Douglas
Shulman before the 21st Annual George Washington University International
Tax Conference
WASHINGTON — Thank you for that kind introduction and warm welcome. It’s a
pleasure and an honor to be in the company of so many experts as we discuss
some of the emerging trends in international tax administration and what we
are doing both domestically and globally to respond to them.
Let me begin by saying that
the dialogue that will take place today is very different from one that
would have occurred a year ago.
Although there were some
ominous clouds on the economic horizon in August 2007, few could have
predicted the battered and bruised financial landscape we see today.
As the great English
statesman and philosopher Edmund Burke said, “An event has happened, upon
which it is difficult to speak and impossible to be silent.”
Tax administrators and tax
professionals find themselves with a new, heightened and highly visible
global role.
It’s fair to say that U.S.
taxpayers’ attitudes and perceptions about the taxes they pay reflect the
changing world around them.
We must recognize that many
taxpayers are now looking at the world through a new economic prism – one
that draws sharp lines in the taxpayer spectrum, such as global corporations
versus the typical family filing a 1040 return with a W-2 attached to it.
Call it Wall Street versus
Main Street.
We must recognize that U.S.
multinational corporations shopping for the best tax deals across the globe
will come under increased public scrutiny back home.
Let me be
clear. Some of these tax strategies can be legal. And many US corporations
and their legal and tax advisors are genuinely trying to comply with the
myriad of international tax laws they face and to avoid double taxation.
Legitimate
practices to minimize tax exposure are also essential for U.S. corporations
to operate and remain competitive in the global marketplace where
foreign-based corporations have such tools at their disposal.
However, we have also seen
some corporations constructing transactions to avoid tax entirely on certain
income, or trying to go beyond the avoidance of double taxation and engage
in “double-dip” transactions whereby they get a deduction or credit for the
same amount in two countries.
To borrow a line from
Hamlet, “There’s the rub.”
U.S.-based corporations more
than tripled their foreign profits between 1994 and 2004, rising from $89
billion to $298 billion – with 58 percent of that profit earned in low tax
or no tax jurisdictions
And this gives pause to some
U.S. taxpayers and policymakers who want to be sure that that these
corporations are paying their fair share at home.
Even before the current
economic crisis, this concern was evident. A 2007 Taxpayer Attitude Survey
found that 80 percent of respondents believe that it is very important that
IRS “ensure that large corporations are reporting and paying their taxes
honestly.” Compare this to 68 percent for small businesses.
Fast forward to today. The average American taxpayer who is being buffeted
daily by fierce economic winds also feels they have been asked to shoulder
most of the risk associated with rescuing the economy.
Call it what you will –
fallout or consequences – but I believe that the events of the past year
will create increased public pressure on corporate taxpayers to adhere to
not only the letter of the law, but the spirit of their home country law.
Global corporations based in
the U.S. pay taxes in countries throughout the world, but recent events have
shown that when it comes to tax jurisdictions, not all are created equal.
In our current economic environment, when major multinationals need a
helping hand from government, they don’t seek a pro-rata portion from each
of the dozens of jurisdictions around the world where they claim to do
business.
Now, I don’t want to give
the impression that it’s just corporate taxpayers who are increasingly under
the microscope. Given the ease with which capital moves around the world,
the IRS must and will remain vigilant to ensure that wealthy individuals
don’t use offshore accounts to avoid paying their U.S. taxes. But that’s
just the beginning.
We must constantly adapt to
this evolving, dynamic and sometimes dizzying global environment in which
multinational enterprises increased from 3,000 in 1990 to more than 63,000
in 2007 and the value of foreign tax credits being claimed increased by more
than 25 percent in just two years from 2005 to 2007.
It’s clear that no one – not
the IRS or any tax administration system in the world – can afford to fall
behind this fast pace. Nor can we afford a go-it-alone strategy.
To this end, I am committed
to engaging with my counterparts across the globe and pushing forward what I
see as the collective and shared enterprise of fair and effective tax
administration.
In the corporate arena,
we’re starting to make progress in our international efforts by focusing on
three specific areas which are most on our minds these days and which I
believe will best assist our efforts to reign in those corporations who are
pushing the envelope and also to help those corporations who play by the
rules.
First is Transfer Pricing.
This is one of the most difficult areas for both tax authorities and
taxpayers. I recognize that transfer pricing is not easy to manage – even
for those taxpayers that aim to steer clear of any grey area.
Although there are many
transfer pricing topics, I want to mention three that may be of current
interest to the audience. Specifically, cost sharing, contract
manufacturing, and global dealing.
Cost sharing involves those
taxpayers aggressively pursuing transfer pricing schemes to shift income out
of the US to low or no tax jurisdictions. One of the most common is to
transfer a valuable intangible for less than arms-length compensation. The
IRS has been vigorously attacking many of these transactions where we see
corporate taxpayers crossing the line. In addition to pursuing cases in the
audit and exam cycle, we are also working on temporary regulations related
to cost sharing.
Contract manufacturing is
about taxpayers trying to avoid subpart F income in foreign locations that
do not have sufficient manufacturing activity. The IRS and Treasury are also
working on regulations in this area that will make it more difficult for
taxpayers to use this abusive tax planning.
Global dealing is somewhat
analogous to the transfer of intangibles such as research and development
related to a new drug, but it is applicable to financial institutions.
Specifically, financial institutions will attempt to book transactions such
as loans and swaps in low-or-no tax jurisdictions and then argue that a
disproportionate amount of the profit should be allocated to the low-or-no
tax jurisdiction.
The second big area is
hybrid structures. These can include hybrid entities or hybrid instruments.
Regardless of the form, their underlying purpose is to either exclude income
from taxation or obtain double deductions/credits in various jurisdictions.
One of the most problematic
of these structures are Foreign Tax Credit generators. In my opinion, FTC
generator transactions are examples of situations where certain taxpayers
may be trending toward the “bad actor” end of the spectrum. Without
venturing into the legal nuances, I view this issue very simply. Foreign
tax credits were designed by Congress to help U.S. taxpayers avoid double
taxation. Common sense would indicate that, where a single payment of
foreign tax generates credits for two taxpayers, these transactions deserve
closer scrutiny. As many of you know, one case has been docketed and there
are a few other cases in the process of being designated for litigation.
Third and lastly are
withholding taxes. Today, the IRS will add withholding taxes to the Tier I
list of issues. The tier issue process will provide the needed
organizational priority and coordination to ensure taxpayer compliance with
the U.S. withholding tax provisions. Our compliance efforts will span
efforts to ensure individual, business and corporate taxpayers understand
and fulfill their withholding tax filing obligations to addressing
transactions that attempt to circumvent withholding taxes or claiming
improper tax treaty withholding rates.
Let me also point out that
this past September, the Senate Permanent Subcommittee on Investigations
held a hearing looking into how the IRS has been investigating certain
investment banks who have been trying to help their clients – mostly hedge
funds – avoid dividend withholding tax. During the hearing, there was also
extensive discussion about securities lending transactions and Notice 97-66.
Let me bring you up to date on the issue.
IRS is reviewing the notice.
However, in the interim, we’re examining very carefully those transactions
whose primary purpose is to avoid dividend withholding tax and will propose
adjustments as needed.
Turning now to the individual area, our current focus is on unreported
off-shore accounts. Here too we have a combination of tools at our disposal
– all of which we’re using simultaneously.
Think of a detective working
a case who may employ everything from eyewitness accounts, physical
evidence, paper trails and the cooperation of law enforcement officials in
other states. That’s similar to what we’re doing with the following tools.
One of our best is the
Qualified Intermediary Program. QI gives the IRS an important line of sight
into the activities of foreign banks and other financial institutions. It
also provides detailed information reporting that the IRS did not receive
before this program was implemented.
Indeed, the QI program is
critical to facilitating sound tax administration in a global economy. By
bringing foreign financial institutions more directly into the U.S. tax
information reporting system, we can better ensure that U.S. persons are
properly paying tax on foreign account activity, and that foreign persons
are subject to the proper withholding tax rates.
Admittedly, the QI program
is a maturing, and complex program and there are flaws that must be
addressed. I became convinced early in my tenure that we need to shore up
the QI program and continuously enhance, improve and strengthen it. And we
are.
In mid-October, we issued a
set of proposed QI amendments for comment which I believe will make QI
audits more useful and help give us that clear line of vision and
transparency we need in tax administration.
Under the proposed changes,
financial institutions that are QIs must provide early notification of
material failure of internal controls. They must also improve evaluation of
risk of circumvention of U.S. taxation by U.S. persons. And they must
include audit oversight by a U.S. auditor. I certainly look forward to your
comments and suggestions after you review this important proposal.
Using informants is another
part of our toolkit. Since the inception of the Whistleblower Office in
2007, the IRS has received hundreds of tips on financial institutions and
individuals with foreign accounts and international compliance issues. Some
of these have become big money cases.
Dozens of these tips involve
the names of individuals with offshore accounts; others involve the names
and practices of financial institutions in those countries that typically
have strict bank secrecy laws.
And keep in mind the value
here is far greater than just the names of specific individuals. With work,
these tips provide the information the IRS needs to pursue John Doe
summonses – our next important tool.
The IRS generally uses the
John Doe summons authority to identify individuals, groups or classes of US
taxpayers whose member identities are unknown, who are involved in specific
areas of tax noncompliance and who cannot be identified through other means.
For example, we would use
this type of summons when we know that taxpayers use offshore bank accounts
to avoid paying taxes, but we do not know their identities. A John Doe
summons served on a domestic processor of offshore bank records would give
us their names, addresses and other identifying information.
The IRS requested and
received court approval to serve over 150 John Doe summonses in connection
with its Offshore Credit Card Project. And we received court approval from
multiple US District Courts on every John Doe summons request made.
These leads are part of
another important tool at our disposal – our criminal investigation
function. The IRS is increasing our resources devoted to investigating the
misuse of foreign entities and the use of foreign bank accounts to hide
taxable income and is currently pursuing hundreds of criminal investigations
of U.S. taxpayers for offshore tax evasion. The numbers speak for
themselves.
In Fiscal Year 2008, the IRS
initiated 49 investigations that involve foreign and offshore issues. We
also had 55 indictments information filed in foreign/offshore cases.
There were 61 convictions, and the average term for those going to jail was
32 months.
I want to repeat that
undisclosed foreign bank accounts are, and will remain, a top priority for
the IRS. Those taxpayers who are hiding assets overseas should be concerned,
and would do well to come in and voluntarily disclose their offshore
accounts. According to long-standing IRS policy, taxpayers who voluntarily
disclose in most cases avoid criminal prosecution.
Now, as I mentioned earlier,
we cannot afford a go-it alone strategy. The IRS knows all too well that we
have to be at the top of our game when playing in the international business
arena. And we currently have cooperative agreements for information
exchanges with over 70 jurisdictions and have expanded the program in recent
years to even include some famous offshore ones, such as the Cayman Islands
and the Bahamas.
The Joint International Tax
Shelter Information Center – or JITSIC – has also proved to be another
important arrow in our quiver to combat abusive international tax shelter
activity on a real-time basis.
JITSIC’s primary focus has
been on the bilateral exchange of specific abusive transactions and their
promoters and investors. The results, to date, have been promising. The
U.S. has received information regarding some transactions of which it had
not been previously aware.
Indeed, in light of the
complexity of the transactions, and considering the inherent difficulty
normally associated with obtaining taxpayer-specific shelter information
from foreign countries, it is unlikely that these transactions would have
been uncovered and understood, but for JITSIC.
We need to redouble our
commitment to international cooperation, and explore new and different ways
to work with our counterparts overseas. That’s why I’ve asked our
international team to develop a multi-year proposal for expansion of JITSIC
beyond its roots in combating tax shelters. I intend to engage my
colleagues around the world in this discussion in the coming months.
I will continue to build
stronger relationships with our tax treaty partners to improve our mutual
agreement process to relieve double taxation and to improve tax compliance.
It is important that the IRS provide leadership to enhance capabilities for
increased joint examination activities with our treaty partners, improve our
compliance risk assessment capabilities and improve our capacity to identify
and share information on potential aggressive international tax
transactions. Also, we will continue to support the important work of the
OECD, Forum on Tax Administration and CIAT.
So what else lies ahead for
the IRS when it comes to international tax administration?
First, we know that we must
match resources to the challenge. That means hiring more financial product
specialists, valuation experts, actuaries, economists, revenue agents,
special agents, and attorneys.
And I’d like to make an
appeal to all of you. If you know of someone who wants to make a real
difference during a difficult economic time for this country, please
encourage them to consider a career with the IRS. I can promise you, it’s a
decision they will not regret.
Second is the international
tax gap. So how big is it? $10 billion? $100 billion? It’s hard to say as
I haven’t seen any solid research to arrive at conclusive numbers.
Difficulties arriving at one
include the complexity of cross-border audits, and the inherent complexity
of the tax code in this area.
But in some ways, whatever
the size of the international tax gap, our commitment to this issue would be
unchanged. That is because our international compliance efforts are much
more about protecting the $2.7 trillion base of revenue that we collect
today rather than just the incremental enforcement revenue that we collect
from these efforts. Nevertheless, we are committed to aggressively pursuing
the international tax gap – whatever amount it may ultimately be.
What I’m speaking about is blunting the broader effect of this race to the
bottom by those who deliberately seek to avoid their legal tax obligations.
We cannot allow an
environment to develop where wealthy individuals can go offshore and avoid
tax without consequence.
We cannot allow an
environment where large corporations can pay hefty fees and salaries for top
talent to engage in overly aggressive shifting of taxable activities to low
tax jurisdictions.
We cannot allow this
corrosive behavior to undermine the fundamental confidence in the fairness
of the tax system which could prompt more and more taxpayers to cross over
that dangerous line into non-compliance.
In this arena we will devote
whatever resources are at our disposal to ensure that our citizens are
confident that we’re all playing by the same set of rules.
Next month I will be
attending the next Leeds Castle meeting of 10 Commissioners. As I touched
upon earlier, the Leeds Castle group of countries came together in 2006 to
deal with the burgeoning problem of tax shelters and increased
globalization. And to a large degree we have been successful. Now is the
time to use this same model of international cooperation and apply it to
some of the emerging issues, such as transfer pricing.
In conclusion, I believe
that we’re up to tackling these unprecedented global challenges. It will
require unprecedented cooperation between tax administration systems across
the globe. And it will require professionals like you standing up for the
integrity of these systems. I know we can and must succeed.
Thank you again for allowing
me to share some thoughts with you today and I wish you the very best for
the holidays and a happy new year.
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