2015-Issue 39—I began my career with the Big 4 back in 2001. As with any public accounting practice, there was natural attrition. The rationale back then was that folks left because they needed a slower pace; they needed more work-life balance. And so the natural way of things was for them to go in-house and leave public accounting. Almost 15 years later, when you survey the current landscape facing corporate tax departments, it no longer seems like a place where one goes to rest after years of public accounting. In the last decade and a half, the rate and volume of financial and tax regulation both at home and abroad have put corporate tax departments under constant strain. To boot, U.S. corporate tax reform is looming on the horizon.
On the financial accounting front, the Financial Accounting Standards Board (FASB) has been hard at work not only codifying existing standards but revamping some of its major components (e.g., business combinations, accounting for income tax contingencies, revenue recognition, etc.). A few years ago, the adoption of International Financial Reporting Standards (IFRS) seemed imminent and dominated the conversation; now that seems like a remote possibility. In its place we have convergence between U.S. GAAP and IFRS. Corporate tax departments have to continue dealing with evolving U.S. GAAP rules and assess the impact of them on their corporate provisions and returns.
The Treasury and the IRS, on their end, have been unrelenting in their efforts to increase transparency and shut down perceived tax loopholes. At the turn of the millennium, the IRS took aim at corporate tax shelters through the issuance of the tax shelter regulations and litigation that culminated with the codification of the economic substance doctrine in 2010. In 2004, the IRS introduced Schedule M-3 to the dismay of many tax professionals who could little imagine the advent of FIN 48 and Schedule UTP just a few years later. Treasury and the IRS also resumed their assault on corporate inversions via the enactment of Section 7874 in 2004. More recently, the Foreign Account Tax Compliance Act (FATCA) was introduced and implemented. A few intergovernmental agreements later, the world was deputized to help ensure voluntary tax compliance by U.S. persons. In the midst of protecting the U.S. tax base, the IRS also made time for relatively less controversial parts of the U.S. tax code. For example, final regulations were issued on the capitalization of intangible and tangible assets, cost-sharing arrangements for the development of intangibles, and the computation and availability of foreign tax credits. All in all, the tax side of the equation has not remained static by any measure.
The environment abroad in which U.S. multinationals compete also experienced various changes. Some of these changes would have been difficult to predict prior to the financial recession of 2008, such as the collapse of bank secrecy in Switzerland, the decreased availability of favorable tax rulings in Luxembourg and other perceived taxpayer-friendly European jurisdictions, and the momentum that has gathered behind the OECD’s base erosion and profit shifting (BEPS) project and its focus on source-country taxation and transparency. As foreign countries continue to face budgetary constraints as a result of the financial recession, it makes sense for them to seek out additional tax sources, and profitable U.S. multinationals are an invariable part of that analysis. However, at the same time, countries continue to take steps to entice the same foreign multinationals to set up shop in their respective countries, seeking local investment and jobs — for example, through the use of patent-box regimes and substantially lower corporate tax rates. Given these recent developments, it is difficult to ascertain if we are experiencing a paradigm shift in international taxation or if the pendulum is just swinging back toward taxing authorities.
So Where Do We Go From Here? What Can and Should Corporate Tax Departments Do?
At this juncture, with so many uncertainties at home and abroad, it is a bit difficult to assess what challenges corporate tax departments will be facing five years from now. At home, U.S. tax reform is coming for multiple reasons (i.e., curtailing the U.S. deficit, stimulating the U.S. economy and increasing the international competitiveness of U.S. multinationals, updating the tax code to reflect the lesser role manufacturing now plays in the U.S. economy, closing perceived corporate tax loopholes, etc.). With presidential elections at hand, corporate tax reform is at least two or three years out. That is not soon enough to be a priority, but soon enough to be a concern that should not be ignored. Likewise, abroad BEPS is likely to continue its forward march; the OECD is already advocating that country-by-country reporting kick off next year, and some countries have already adopted domestic legislation to that end.
Against this trend of budgetary deficits, increased tax and financial compliance burdens, and uncertainty as to what future tax legislation may look like, corporate tax departments must plan for the future. Corporate tax departments that have not already done so should devote a portion of their resources to assessing the potential impact that tax reform at home and abroad could have on their company’s earnings and how they will cope with increased compliance obligations. This assessment could take shape around the various pressure points that form the backdrop of publications and reports published to date (whether by the Senate Finance Committee, House Ways and Means Committee, Treasury, the OECD or various think-tanks and academics). For example:
- Broader Tax Base: A broader tax base and lower corporate rate may have a favorable connotation, but there will be winners and losers. A broader tax base, for example, may entail the elimination of the Section 199 domestic production deduction, LIFO inventory method and availability of certain tax credits. Corporate tax departments need to consider whether they stand to win or lose from a broader tax base and plan accordingly.
- Intellectual Property: Any reform effort will likely take aim at the taxation of intellectual property. The stakes are just too high for all stakeholders; Treasury wants to protect the tax base, corporations want to secure a lower tax rate for the increasing portion of corporate earnings derived from the exploitation of IP, and nations want high-skilled jobs. Some challenge the contractual allocation of risk and capital contributions for the development of IP that is at the heart of IP tax planning and ask “can a piece of paper earn billions?”(See 2013 Tax Notes Today 132-8, 06/24/2013.) But do we really want to encourage Apple to move its proposed spaceship campus to Ireland or to any one of the EU countries that has introduced a patent-box regime (i.e., Belgium, France, Hungary, Luxembourg, Netherlands, Spain or the U.K.) in the past 10 years? Will the U.S. follow through with its own patent box?
- Transfer Pricing: Chances are slim that the arm’s-length standard, the cornerstone of U.S. transfer pricing rules, will be going anywhere in the next major rewrite of the U.S. tax code. However, the valuation of IP and allocation of risks remains a challenge. The IRS’s focus on, as well as audits of, transfer pricing is only likely to increase, as it is one of the top two uncertain positions on Schedule UTP filings. Accordingly, companies should anticipate changes in this area. This issue will only be compounded by BEPS’s country-by-country reporting initiative.
- End of APB 23: The Securities and Exchange Commission continues to show interest in APB 23. Given the 2008 financial recession, the weak recovery that has followed and the rise of private equity, the SEC’s focus is understandable, since these factors militate toward the repatriation of earnings. However, some folks in Congress are also taking note of APB 23 and wondering to what extent companies keep earnings abroad mainly for financial statement purposes (i.e., the idea is, if the corporation already took the hit for purposes of earnings, it may be more likely to repatriate). In light of FIN 48 and Schedule UTP, would it be difficult to imagine a world without APB 23?
- Hybrid Entities and Instruments: International tax arbitrage is born of different treatment that domestic and foreign tax laws give the same entity or instrument. International tax arbitrage has been with us since the beginning, but the advent of the check-the-box regulations, the challenges entailed in debt versus equity classifications, and the rise of multinational corporations created unprecedented opportunities for international tax planning based on arbitrage. Obviously, this has not been lost on the Treasury and IRS at home and abroad. The check-the-box rules were introduced to increase certainty and reduce litigation, but now that we have lived with these rules for nearly 20 years, have the Treasury and IRS gained enough experience that they ready to modify them accordingly?
- Earnings Stripping: Multinational companies arrange their business operations across multiple jurisdictions to capture synergies available to the group, but also with the goal of reducing their worldwide effective tax rate (i.e., via IP holding companies, financing companies, private equity companies, manufacturing companies, shared service centers, etc.). Again, this is something that has not been lost on the Treasury and IRS. Since many of these planning techniques are well established under current U.S. tax rules, a rewrite of the tax code would be required if Congress were to find fault with intercompany transactions as they currently stand and thus something else to consider.
- Anti-Deferral Regimes: Some proposals seek to modify the current Subpart F rules to either end deferral for controlled foreign corporation earnings or curtail the benefits by imposing a minimum tax, broadening the definition of Subpart F income. Other proposals entail broadening the reach of the passive foreign investment company (PFIC) rules to include holding companies that may be organized in a low-tax jurisdiction and that have little substance. The anti-deferral rules serve as a backstop to the existing transfer pricing rules and can play a similar role for any potential territorial tax system. Accordingly, it is pretty certain that the anti-deferral rules will continue with us, but how will they evolve?
- Territorial Tax System & Corporate Inversions: Controversy regarding several high-profile corporate inversions led to the enactment in 2004 of the anti-inversion rules under Section 7874. Some question whether Section 7874 has stemmed the tide of corporate inversions or simply forced inversions to be undertaken via merger and/or acquisition transactions. (See 2013 Tax Notes Today 155-3 Economic Analysis: Another Pharmaceutical Inversion to Ireland; More on the Horizon.) That raises the question, will the U.S. move to a territorial system? Would there be a transition tax and how would we compute it? What would be the impact on the U.S. anti-deferral rules?
- OECD’s BEPS Project: The OECD through its BEPS project has tackled many of the pressure points mentioned above. Whether the G20 commissioned this project in an effort to harmonize global efforts to fight tax abuse or whether certain EU members did so for political and budgetary reasons, the BEPS will likely trigger a wave of tax reform abroad. It is highly unlikely that OECD member countries that stand to gain will decline to adopt reform proposals issued by the OECD.
To the extent that any of these items are relevant, corporate tax departments should assess how they can adapt and capitalize on the challenges and opportunities that change will bring. To do so, corporate tax departments should consider the following steps:
- Establish a corporate tax profile if you have not already done so. This may entail accurately determining the company’s corporate tax attributes via foreign tax credit and earnings and profit studies. An inventory of your company’s intellectual property should also be undertaken and relevant transfer pricing analysis brought up to date.
- Consider the impact of the elimination of certain tax expenditures (i.e., Section 199 domestic production deduction, LIFO, etc.); would it be sufficient to change the way the corporation does business?
- Analyze the impact on the financial statements (e.g., effect on earnings from measuring deferred tax assets at a lower corporate tax rate, impact from modification to APB 23 rules, etc.).
- Coordinate with IT to ensure that the company can timely meet additional compliance obligations, for example those that country-by-country reporting will bring about. Currently, many corporate tax departments focus on “substantial compliance” (i.e., doing the best they can with the information available). However, this approach may not be sustainable as compliance obligations continue to grow.
- Fill any vacancies in the tax department and consider creating new positions that may be necessary. Alternatively, consider if outsourcing certain functions is the way to go.
- Keep the whistleblowing rules in mind. The U.S. tax system is based on voluntary compliance and has various backstops to ensure said compliance. Stiff penalties are the mainstay, but the IRS does have a program to financially reward whistleblowers. Corporations should always be cognizant of these rules, but in the current environment they take on heightened importance.
Alvarez & Marsal Taxand Says:
Corporate tax departments this day and age face more demands than ever before, and the best is yet to come. At home the U.S. tax code is overdue for a major rewrite, and abroad countries are jumping at the opportunity that BEPS has provided to rewrite their own tax code and plug chronic budgetary deficits leftover from the 2008 financial recession. For corporate tax departments that lack a strategic plan, now is the time to engage in a conversation with your tax advisors.
The information contained herein is of a general nature and based on authorities that are subject to change. Readers are reminded that they should not consider this publication to be a recommendation to undertake any tax position, nor consider the information contained herein to be complete. Before any item or treatment is reported or excluded from reporting on tax returns, financial statements or any other document, for any reason, readers should thoroughly evaluate their specific facts and circumstances, and obtain the advice and assistance of qualified tax advisors. The information reported in this publication may not continue to apply to a reader's situation as a result of changing laws and associated authoritative literature, and readers are reminded to consult with their tax or other professional advisors before determining if any information contained herein remains applicable to their facts and circumstances.
About Alvarez & Marsal Taxand
Alvarez & Marsal Taxand, an affiliate of Alvarez & Marsal (A&M), a leading global professional services firm, is an independent tax group made up of experienced tax professionals dedicated to providing customized tax advice to clients and investors across a broad range of industries. Its professionals extend A&M's commitment to offering clients a choice in advisors who are free from audit-based conflicts of interest, and bring an unyielding commitment to delivering responsive client service. A&M Taxand has offices in major metropolitan markets throughout the US., and serves the U.K. from its base in London.Alvarez & Marsal Taxand is a founder of Taxand, the world's largest independent tax organization, which provides high quality, integrated tax advice worldwide. Taxand professionals, including almost 400 partners and more than 2,000 advisors in nearly 50 countries, grasp both the fine points of tax and the broader strategic implications, helping you mitigate risk, manage your tax burden and drive the performance of your business.