[House Hearing, 107 Congress]
[From the U.S. Government Publishing Office]
CORPORATE INVERSIONS
=======================================================================
HEARING
before the
COMMITTEE ON WAYS AND MEANS
HOUSE OF REPRESENTATIVES
ONE HUNDRED SEVENTH CONGRESS
SECOND SESSION
__________
JUNE 6, 2002
__________
Serial No. 107-73
__________
Printed for the use of the Committee on Ways and Means
U. S. GOVERNMENT PRINTING OFFICE
80-978 WASHINGTON : 2002
___________________________________________________________________________
For Sale by the Superintendent of Documents, U.S. Government Printing Office
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COMMITTEE ON WAYS AND MEANS
BILL THOMAS, California, Chairman
PHILIP M. CRANE, Illinois CHARLES B. RANGEL, New York
E. CLAY SHAW, Jr., Florida FORTNEY PETE STARK, California
NANCY L. JOHNSON, Connecticut ROBERT T. MATSUI, California
AMO HOUGHTON, New York WILLIAM J. COYNE, Pennsylvania
WALLY HERGER, California SANDER M. LEVIN, Michigan
JIM McCRERY, Louisiana BENJAMIN L. CARDIN, Maryland
DAVE CAMP, Michigan JIM McDERMOTT, Washington
JIM RAMSTAD, Minnesota GERALD D. KLECZKA, Wisconsin
JIM NUSSLE, Iowa JOHN LEWIS, Georgia
SAM JOHNSON, Texas RICHARD E. NEAL, Massachusetts
JENNIFER DUNN, Washington MICHAEL R. McNULTY, New York
MAC COLLINS, Georgia WILLIAM J. JEFFERSON, Louisiana
ROB PORTMAN, Ohio JOHN S. TANNER, Tennessee
PHIL ENGLISH, Pennsylvania XAVIER BECERRA, California
WES WATKINS, Oklahoma KAREN L. THURMAN, Florida
J.D. HAYWORTH, Arizona LLOYD DOGGETT, Texas
JERRY WELLER, Illinois EARL POMEROY, North Dakota
KENNY C. HULSHOF, Missouri
SCOTT McINNIS, Colorado
RON LEWIS, Kentucky
MARK FOLEY, Florida
KEVIN BRADY, Texas
PAUL RYAN, Wisconsin
Allison Giles, Chief of Staff
Janice Mays, Minority Chief Counsel
Pursuant to clause 2(e)(4) of Rule XI of the Rules of the House, public
hearing records of the Committee on Ways and Means are also published
in electronic form. The printed hearing record remains the official
version. Because electronic submissions are used to prepare both
printed and electronic versions of the hearing record, the process of
converting between various electronic formats may introduce
unintentional errors or omissions. Such occurrences are inherent in the
current publication process and should diminish as the process is
further refined.
C O N T E N T S
__________
Page
Advisories announcing the hearing................................ 2, 3
WITNESS
U.S. Department of the Treasury, Pamela F. Olson, Acting
Assistant Secretary for Tax Policy; accompanied by Barbara
Angus, International Tax Counsel............................... 8
SUBMISSIONS FOR THE RECORD
AFL-CIO, statement............................................... 32
Coalition for Tax Competition; Andrew F. Quinlan, Center for
Freedom and Prosperity; Daniel Mitchell, Heritage Foundation;
Veronique de Rugy, Cato Institute; Paul Beckner, Citizens for a
Sound Economy; David R. Burton, Prosperity Institute; James
Cox, Association of Concerned Taxpayers; Stephen J. Entin,
Institute for Research on the Economics of Taxation; Tom
Giovanetti, Institute for Policy Innovation; Kevin Hassett,
American Enterprise Institute; Lawrence Hunter, Empower
America; Charles W. Jarvis, United Seniors Association; Karen
Kerrigan, Small Business Survival Committee; James L. Martin,
60 Plus Association; Edwin Moore, James Madison Institute;
Steve Moore, Club for Growth; Grover Glenn Norquist, Americans
for Tax Reform; John Pugsley, Sovereign Society; Richard Rahn,
Discovery Institute; Gary and Aldona Robbins, Fiscal
Associates, Inc.; Tom Schatz, Council for Citizens Against
Government Waste; Eric Schlecht, National Taxpayers Union; Fred
L. Smith, Competitive Enterprise Institute; Lewis K. Uhler,
National Tax Limitation Committee; Paul M. Weyrich, Coalitions
for America; Christopher Whalen, Whalen Consulting Group; joint
letter......................................................... 34
Connecticut Attorney General's Office, Hon. Richard Blumenthal,
statement...................................................... 35
DIMON Incorporated, Danville, VA, Greg Bryant, letter............ 38
Institute for International Economics, Gary Hufbauer, statement.. 41
Maloney, Hon. James H., a Representative in Congress from the
State of Connecticut, statement................................ 43
Salch, Steven C., Fulbright & Jaworski, L.L.P., Houston, TX,
statement...................................................... 45
CORPORATE INVERSIONS
----------
THURSDAY, JUNE 6, 2002
House of Representatives,
Committee on Ways and Means,
Washington, DC.
The Committee met, pursuant to notice, at 10:53 a.m., in
room 1100 Longworth House Office Building, Hon. Bill Thomas
(Chairman of the Committee) presiding.
[The advisory and revised advisory announcing the hearing
follow:]
ADVISORY
FROM THE
COMMITTEE
ON WAYS
AND
MEANS
CONTACT: (202) 225-1721
FOR IMMEDIATE RELEASE
May 30, 2002
No. FC-19
Thomas Announces a Hearing on Corporate Inversions
Congressman Bill Thomas (R-CA), Chairman of the Committee on Ways
and Means, today announced that the Committee will hold a hearing on
corporate inversions. The hearing will take place on Thursday, June 6,
2002, in the main Committee hearing room, 1100 Longworth House Office
Building, beginning at 10:00 a.m.
In view of the limited time available to hear witnesses, oral
testimony at this hearing will be from invited witnesses. Also, any
individual or organization not scheduled for an oral appearance may
submit a written statement for consideration by the Committee and for
inclusion in the printed record of the hearing.
BACKGROUND:
During recent months, several corporations have either changed
their principal place of incorporation to a foreign country or
announced their intention to do so. On May 17, 2002, the U.S.
Department of the Treasury released its Preliminary Report on Inversion
Transactions that sets out the mechanics of and reasons for U.S.
companies to undertake these transactions. The study also highlights
the disadvantages that the U.S. Tax Code imposes on U.S. companies as
compared to their foreign competitors.
In announcing the hearing, Chairman Thomas stated, ``The fact that
companies are leaving the United States for tax reasons is a serious
problem. Inversions are one symptom of the larger problems with our Tax
Code, particularly in the area of international competitiveness. As we
address the inversion issue, we must be careful not to take action that
will facilitate the foreign acquisition of U.S. companies or encourage
investment capital to flee the United States.''
FOCUS OF THE HEARING:
The focus of this hearing is to examine the mechanics of inversion
transactions and examine policy options that will deter inversions and
enhance U.S. international competition. The Committee will also hear
testimony from the U.S. Department of the Treasury concerning its May
17, 2002, Inversion Study.
DETAILS FOR SUBMISSION OF WRITTEN COMMENTS:
Please Note: Due to the change in House mail policy, any person or
organization wishing to submit a written statement for the printed
record of the hearing should send it electronically to
[email protected], along with a fax copy to
(202) 225-2610, by the close of business, Thursday, June 20, 2002.
Those filing written statements that wish to have their statements
distributed to the press and interested public at the hearing should
deliver their 300 copies to the full Committee in room 1102 Longworth
House Office Building, in an open and searchable package 48 hours
before the hearing. The U.S. Capitol Police will refuse sealed-packaged
deliveries to all House Office Buildings.
FORMATTING REQUIREMENTS:
Each statement presented for printing to the Committee by a
witness, any written statement or exhibit submitted for the printed
record or any written comments in response to a request for written
comments must conform to the guidelines listed below. Any statement or
exhibit not in compliance with these guidelines will not be printed,
but will be maintained in the Committee files for review and use by the
Committee.
1. Due to the change in House mail policy, all statements and any
accompanying exhibits for printing must be submitted electronically to
[email protected], along with a fax copy to
(202) 225-2610, in Word Perfect or MS Word format and MUST NOT exceed a
total of 10 pages including attachments. Witnesses are advised that the
Committee will rely on electronic submissions for printing the official
hearing record.
2. Copies of whole documents submitted as exhibit material will not
be accepted for printing. Instead, exhibit material should be
referenced and quoted or paraphrased. All exhibit material not meeting
these specifications will be maintained in the Committee files for
review and use by the Committee.
3. Any statements must include a list of all clients, persons, or
organizations on whose behalf the witness appears. A supplemental sheet
must accompany each statement listing the name, company, address,
telephone and fax numbers of each witness.
Note: All Committee advisories and news releases are available on
the World Wide Web at http://waysandmeans.house.gov/.
The Committee seeks to make its facilities accessible to persons
with disabilities. If you are in need of special accommodations, please
call 202-225-1721 or 202-226-3411 TTD/TTY in advance of the event (four
business days notice is requested). Questions with regard to special
accommodation needs in general (including availability of Committee
materials in alternative formats) may be directed to the Committee as
noted above.
* * * NOTICE--CHANGE IN TIME * * *
ADVISORY
FROM THE
COMMITTEE
ON WAYS
AND
MEANS
CONTACT: (202) 225-1721
FOR IMMEDIATE RELEASE
June 5, 2002
No. FC-19-Revised
Change in Time for Hearing on Corporate Inversions
Congressman Bill Thomas (R-CA), Chairman of the Committee on Ways
and Means, today announced that the full Committee hearing on corporate
inversions scheduled for Thursday, June 6, 2002, at 10:00 a.m., in the
main Committee hearing room, 1100 Longworth House Office Building, will
now be held at 10:45 a.m.
All other details for the hearing remain the same. (See Committee
Advisory No. FC-19, dated May 30, 2002.)
Chairman THOMAS. I appreciate our guests finding seats. We
probably are not going to be able to accomplish the hearing in
one setting based upon activities that will occur on the Floor.
My apologies at the beginning to those of you who plan on
testifying. It may not be as orderly or sequential as most of
us would prefer in dealing with a subject matter that, at once
seems fairly simple, and at additional examinations perhaps is
a bit more complex than we might have appreciated.
Obviously, the emphasis is that during recent months, many
U.S. companies have announced that they will move their
principal place of incorporation to a foreign jurisdiction.
Principal among those are low-tax countries such as Bermuda. In
fact, many companies have already taken this step.
Today, the Committee on Ways and Means will examine, one,
the causes behind the reincorporations, but we also want to
explore policy options to reduce the incentive for inversions
while, if possible, enhancing U.S. international
competitiveness. This, of course, builds on the initial
hearings we had on the World Trade Organization (WTO) decision
involving foreign sales corporations (FSC) and the
Extraterritorial Income Exclusion Act (ETI) debate.
Members have introduced bills, beginning with a Member of
this Committee, Scott McInnis, for example, on March 6, Mr.
Neal of this Committee, Mr. Maloney, and Mrs. Johnson. They
range from an attempt to punish behavior to a moratorium so
that we could suspend behavior and examine options.
The Chair has no idea at this point what is the most
appropriate way to go. I think that is one of the reasons we
are supposed to hold hearings. Oftentimes, people believe the
primary purpose of holding hearings is to provide an arena for
political shenanigans or for points scored, not in terms of
advancing a legislative purpose, but for even as far-ranging an
activity as attempting to influence elections.
The Chair wants to announce at the beginning of this, this
is serious business. This is obviously not the only hearing
that we will hold. We must hold additional hearings based upon
the information that Members, having received the U.S.
Department of the Treasury testimony in advance, realize that
Treasury has gone so far as to provide us with very specific
examples of potential law change.
Those of us who reside in States with high taxes
oftentimes, and perhaps properly, blame State legislatures when
companies flee our State to go to low-tax jurisdictions in
surrounding States. California has a number of examples.
Historically, the inventory tax, and we thought California was
so attractive, these large companies like Sears and others
would stay in California forever. We woke up and found out that
they had built warehouses in Nevada. I was in the State
legislature at the time. They repealed the inventory tax and
expected people then to simply move from Sparks, Nevada, where
they had invested significant money in the warehouses and come
back to California, and guess what, they did not.
So, we cannot ignore the fact that the U.S. Tax Code
creates essentially the same phenomena internationally.
Corporate inversions, I think, are a symptom of a larger
underlying problem with our tax code, and if the corporate tax
code has driven many companies to move their mailboxes to other
jurisdictions, then I think we need to examine the tax code for
suggested changes.
Now, the problem obviously is easily stated. As I said, the
solution may be more complex. As we have noted in our foreign
sales corporation hearings, competitiveness is sometimes in the
eye of the beholder, and it is not as easily assessed as we
would like. The United States has some of the world's most
complicated rules on international taxation. These rules
originate in part, I think, from a misguided belief that we can
keep capital in the United States if we just have enough
restrictive tax regimes.
We are still--the system we impose on American-based firms
sometimes provides advantages to foreign companies that want to
buy up American companies, and perhaps one of the reasons
American companies want to become foreign companies on their
own, on their own volition, is because they do not want to
become foreign companies through hostile takeovers.
First today, we will hear from the Treasury Department,
which has released a study which I would recommend to anyone as
a very useful primer on what we are talking about in terms of
corporate inversions. Beyond that, the written testimony
submitted by the Treasury, as I said, provides us with very
specific tax change suggestions.
We are then going to have a panel to, in part, give us a
practical real-world perspective on how the tax system affects
business decisions, and we have someone from State government
for their reaction, as well.
The questions before us, to a certain extent, are is there
something we can do in the short term while we are looking at
the long term? Will it be better to move what we believe to be
the long term with enough notice that, in fact, we are going to
engage in this discussion? Whether is this just one symptom of
an international tax code that probably needs to be looked at
far more extensively? The problem of inversions being simply
one example, which means perhaps, then, something like a
moratorium might be appropriate, or perhaps specific
legislation addressing the inversion question sooner rather
than later, perhaps then looking at other tax aspects on a
broader basis.
All of those are questions that are open right now as far
as the Chair is concerned. The goal, of course, is to resolve
what appears to be an immediate problem but which is
symptomatic of the more complex and broader problem initiated
by the WTO decision on the foreign sales corporation ETI
subsidy, subsequently provided additional reinforcement by the
inversion question.
So today, the Chair's hope is to lay the predicate, listen
to the concerns, focus on some of the specific suggestions, and
assure everyone that there will be more questions raised today
than answers and that we will move forward in as expeditious a
fashion as possible, perhaps utilizing the Subcommittee on
Select Revenue to allow for further expansion of concerns that
various corporations might have, foreign-based or domestic,
based upon the questions raised today as we look forward to a
solution to this problem.
With that, it is my pleasure to recognize the gentleman
from New York for any comment he might wish to make. Mr.
Rangel?
[The opening statement of Chairman Thomas follows:]
Opening Statement of the Hon. Bill Thomas, a Representative in Congress
from the State of California, and Chairman, Committee on Ways and Means
During recent months, many U.S. companies have announced that they
will move their principle place of incorporation to a foreign
jurisdiction, including such low-tax countries as Bermuda. Many
companies have already taken this step. Today, the Committee on Ways
and Means will examine the causes behind reincorporations. We will also
explore policy options to reduce the incentive for inversions while
also enhancing U.S. international competitiveness.
It is worth noting that a Republican Ways and Means Member, Rep.
Scott McInnis, introduced one of the first legislative fixes for
inversions. He introduced H.R. 2857 on March 6, 2002. Most recently,
Rep. Nancy Johnson--another Republican Committee Member--offered a
moratorium bill, H.R. 4756 on May 16, 2002. Her moratorium is an
appropriate step in the absence of a legislative solution. However, I
want to be clear. This Chairman plans to introduce and move a
thoughtful, reasonable approach to address corporate inversions, and I
plan to do so sooner rather than later. Today's hearing will help us
gather needed information to craft such a product.
Those of us who represent States with high taxes properly blame
state legislatures when companies flee to low-tax jurisdictions in
surrounding states. We can't ignore that the U.S. tax code creates the
same phenomenon internationally. Corporate inversions are a symptom of
a larger underlying problem with our tax code. The corporate tax code
has driven many companies to move their mailboxes to other
jurisdictions.
What changes must we make to keep America's competitive edge?
Competitiveness is not easily assessed, as our extensive examination of
the Foreign Sales Corporations has shown. The U.S. has some of the
world's most complicated rules on international taxation. These rules
originate, in part, from a misguided belief that we can keep capital in
the United States through restrictive tax regimes. Worse still, the
system we impose on American-based firms provides advantages to foreign
companies that want to buy up American companies.
Today, we will first hear from the Treasury Department, which
recently released a preliminary report on inversions. They are now
developing options for addressing the competitiveness issues that
inversions signal. To get a practical, real-world perspective, we will
also hear from private sector witnesses about how our tax system
influences business decisions.
This hearing is an opportunity for us to work together to develop
modern tax systems suited to a growing global economy. I hope all of us
will put aside shrill rhetoric and work in a cooperative effort to keep
our economy as competitive as possible so that we can preserve American
jobs. Before introducing our witnesses, I yield to Mr. Rangel from New
York.
Mr. RANGEL. Thank you, Mr. Chairman. Some housekeeping
questions. Mr. Chairman, one of the most important tax issues
that has come before this Committee is to make permanent the
estate tax repeal. Could you share with us whether you intend
to manage this bill on the Floor, and how do you see we are
going to maintain our attendance here at the hearing on this
most important issue and at the same time the Members be
allowed to express their concern about the bill on the Floor?
Chairman THOMAS. I appreciate the gentleman's concern. He
might have expected that the Chair expressed that same concern
to the leadership. Just let me say, it is difficult to try to
get this Committee's work done on the shortened work weeks that
are currently in front of us.
The Chair intends to continue the hearing as best we are
able during whatever events may occur on the Floor, with the
exception of multiple votes, as you know, which makes it
difficult for us to determine when we come back. If there is a
single vote, the Chair would like to try to continue the
hearing.
It is the Chair's understanding at this time that the
debate will begin, dependent upon the current procedural
discussion and probably subsequent vote on the decision of the
Chair currently going on, that the estate tax debate would
begin somewhere in the 12:30 to 1:00 vicinity. The Chair
intends to initiate the debate on the Floor, but not to be
there during the entire debate. The structure of the debate is
1 hour, equally divided, and then my understanding is the rule
made in order a substitute, which would be 1 hour, and then the
minority has, as a right of the rules under this new Republican
majority, a motion to commit, which I assume you will utilize.
That will be occurring in the 2:00 to 3:00 range.
If we can move expeditiously through this hearing, we can
lay the foundation for the additional hearings on more of the
specific alternatives, as I indicated, the direction that we
will probably go. To the degree, our goal here is to score
points beyond trying to understand what the problem is and
looking at specific legislative decisions, the Chair does not
have control over that. Perhaps the gentleman from New York has
a better idea of how long those activities would consume
Committee time.
Mr. RANGEL. Mr. Chairman, I might suggest that you might
consider recessing for 5 minutes until you and I have an
opportunity to discuss the problem that we have. I will outline
the degree of the problem.
First, the minority believes that both of these issues, the
one before this full Committee and the one on the Floor, has a
deep-seated political as well as economic significance, and
while we recognize that the decision to put these important
legislative issues in conflict was not yours, we are not
prepared to accept the leadership's position.
Second, during this 5 minutes, the question of multiple
votes, I will be glad to share with you that we might expect
multiple votes, and I do not want to put witnesses nor those
attending this hearing at ill ease, but I might just share with
you, if we do not find our way able to recess this hearing
until after the proceeding on the Floor, then I have every
reason to believe that our Members will be spending a lot of
time on procedural issues on the Floor.
In addition to that, it is my understanding, even though I
am not certain, that the Chair unilaterally decided that a
Member of the U.S. House of Representatives who sponsored a
piece of legislation which this hearing is about would not be
allowed to testify, and while this is certainly not a Democrat
or Republican issue, certain Members of my caucus believe that,
from an institutional point of view, they are not prepared to
allow that to go by.
I want to list these things to see whether or not you might
think that it is wise for you and I to just discuss these
things for 5 or 10 minutes to see whether there can be any
resolved, and I yield back to you for purpose of response.
Chairman THOMAS. I will tell the gentleman, I have been
here since 8:30. My phone number is listed. My presence is
known, but if the gentleman wants to take 5 minutes out of the
time we now have to try to move forward on this hearing, the
Chair, in recognition of the gentleman's presentation of this
offer, which the Chair appreciates the way in which it was
presented, will certainly take 5 minutes.
Mr. RANGEL. I might add that----
Chairman THOMAS. The Committee stands in recess for 5
minutes.
[Recess.]
Chairman THOMAS. If I could have your attention, please,
there is just one vote on the Floor. We will run over, cast
that vote, come back, and the Committee will resume. My goal is
to resume at 11:30.
[Recess.]
Chairman THOMAS. If our guests can find seats, please. The
first panel this morning will consist of Treasury
representatives, including Pamela Olson as the Acting Assistant
Secretary for Tax Policy at the U.S. Department of the
Treasury. My understanding is that Barbara Angus will be with
her at the table.
First of all, thank you for joining us. Thank you for the
written testimony. It will be made a part of the record and you
may address us in any way you see fit. Ms. Olson?
STATEMENT OF PAMELA F. OLSON, ACTING ASSISTANT SECRETARY FOR
TAX POLICY, U.S. DEPARTMENT OF THE TREASURY; ACCOMPANIED BY
BARBARA ANGUS, INTERNATIONAL TAX COUNSEL
Ms. OLSON. Thank you. Mr. Chairman, distinguished Members
of the Committee, I appreciate the opportunity to appear at
this hearing on corporate inversion transactions. I commend the
Committee Members for your interest in and commitment to
addressing this important issue. I also want to thank the
Committee for allowing the Treasury Department the time to
study, consider, and report on this matter to the Committee. We
look forward to working with the Committee to implement the
proposals I will outline and any other proposals we or you
identify in the course of our ongoing evaluation of the issues
presented.
I have attached to my written testimony today a copy of the
Treasury study that we released last month on the tax policy
implications of corporate inversions and I appreciate the
Committee's including that in the record for today.
This Committee is well aware of the facts that precipitated
our study and the hearing today: a series of announcements by
U.S. companies of their intent to reincorporate outside the
United States. The key reason cited for the transactions:
Substantial reductions in overall corporate taxes. Corporate
inversion transactions are not a new phenomenon, but there has
been a marked increase in the frequency, size, and profile of
the recently announced transactions. Moreover, rumors of other
companies considering the transactions abound.
The Administration has concluded an immediate response is
required that addresses the income minimization strategies
associated with inversion transactions, strategies that can be
employed to reduce the inverted company's U.S. tax on its
income from its U.S. operations. An immediate response is
required for two reasons. First, these strategies unfairly
advantage inverted or other foreign-based companies over U.S.-
based companies. Second, these strategies have a corrosive
effect on the public's confidence in the U.S. tax system.
We cannot just address strategies that inappropriately
minimize U.S. income, however. We must also address the tax
disadvantages imposed by our international tax rules on U.S.-
based companies with foreign operations. Relative to the tax
systems of our major trading partners, the U.S. tax rules can
impose significantly heavier burdens on the foreign operations
of domestically-based companies. Our objective must be to
ensure that the U.S. tax system maintains the competitiveness
of U.S. businesses. Why? Because we care about U.S. jobs.
We have identified several specific areas in which action
is needed. We believe that addressing the income minimization
opportunities conferred by an inversion will remove the juice
from the current inversion activity, eliminating the immediate
benefits of and, therefore, the impetus for, such transactions.
It would be a mistake to focus such changes solely on
inverted companies, however, since an inversion is only one
route to accomplishing the same type of reduction in taxes. A
U.S.-based start-up venture that contemplates both U.S. and
foreign operations may incorporate overseas at the outset, thus
positioning itself to achieve the same type of tax reduction.
Similarly, an existing U.S. group may be the subject of a
takeover by a foreign-based company. The resulting structure
may provide similar tax savings opportunities to those provided
by an inversion transaction.
A policy response targeted solely at the inversion
phenomenon may inadvertently result in a tax code favoring
other types of foreign ownership structures at the expense of
domestically-managed companies. In turn, other decisions
affecting location of new investment, choice of suppliers, and
jobs may be adversely affected. While the openness of the U.S.
economy has always made and will continue to make the United
States one of the most attractive and hospitable locations for
foreign investment in the world, there is no merit in policies
biased against domestic control and domestic management of U.S.
operations. Consequently, the policy response to the recent
corporate inversion activity should be broad enough to address
the underlying differences in the U.S. tax treatment of U.S.-
based companies and foreign-based companies without regard to
how foreign-based status is achieved.
There are four specific areas in which action should be
taken: Related party debt, related party asset transfers,
treaties, and information reporting.
First, related party debt. The statutory rules regarding
the deductibility of interest payments to related parties must
be tightened to prevent the inappropriate use of related party
debt to generate deductions against income from U.S. operations
that otherwise would be subject to U.S. tax. Accordingly, we
propose statutory changes to tighten the related party interest
disallowance rules of section 163(j). Specifically, we propose
replacing the current debt-equity ratio safe harbor with a test
that would deny a deduction for related party interest to the
extent the U.S. company's indebtedness exceeds its worldwide
level of indebtedness. There is no compelling policy
justification for allowing interest deductions for related
party debt where the U.S. company is more highly leveraged than
the worldwide operations.
We propose scaling back the 50 percent of income limitation
on interest deductions by revising the definition of income to
focus the test on net interest expense as a percentage of
income rather than cash flow.
Finally, we propose curtailing the rules that allow
companies to carry over to subsequent years interest deductions
subject to the limits.
Second, we are undertaking a comprehensive review of
related party asset transfers, which can be used to shift
income from the United States. We believe that substantial
improvements can be made in this area through regulatory
changes and focused enforcement. To the extent that we identify
problems during our review requiring statutory changes, we will
promptly advise the Committee.
Third, we will undertake a comprehensive review of our
income tax treaties to ensure that they do not provide
inappropriate opportunities to reduce U.S. taxes or to shift
income from the United States. Our review will ensure that all
our treaties serve the goal of eliminating double taxation, not
taxation altogether, or they will be modified to do so.
Fourth, we will require Form 1099 reporting to ensure that
inverted companies' shareholders pay the tax they owe on gain
recognized in the inversion transaction.
We are continuing to study other areas, including the
corporate organization and reorganization rules and the income
shifting issues that arise in the context of inversion
transactions involving insurance and reinsurance companies.
Finally, we must address the tax disadvantages faced by
U.S.-based companies that do business abroad relative to their
counterparts in our major trading partners. The burden imposed
by our international tax rules on U.S.-based companies with
foreign operations is disproportionate to the tax burden
imposed by our trading partners on their companies' foreign
operations. The recent inversion activity and the increased
foreign acquisitions of U.S. multinationals evidence that fact
and the significant consequences that may have for U.S.
businesses and the U.S. economy. The U.S. rules for the
taxation of foreign source income are unique in their breadth
and complexity. It is time to revisit them. Our rules should
not disadvantage U.S.-based companies competing in the global
marketplace.
Our overarching goal is maintaining the U.S. position as
the most desirable location in the world for incorporation,
headquartering, foreign investment, and business operations. In
short, that means keeping jobs in the United States, creating
jobs in the United States, and bringing jobs to the United
States.
Thank you for your attention. I would be pleased to answer
any questions.
[The prepared statement of Ms. Olson follows:]
Statement of Pamela F. Olson, Acting Assistant Secretary for Tax
Policy, U.S. Department of the Treasury
Mr. Chairman, Congressman Rangel, and distinguished Members of the
Committee, we appreciate the opportunity to appear today at this
hearing on corporate inversion transactions.
In recent months, several high-profile U.S. companies have
announced plans to reincorporate outside the United States. The
documents prepared for shareholder approval and filed with the
Securities and Exchange Commission cite substantial reductions in
overall corporate taxes as a key reason for the transactions. While
these so-called corporate inversion transactions are not new, there has
been a marked increase recently in the frequency, size, and profile of
the transactions.
On February 28, 2002, the Treasury Department announced that it was
studying the issues arising in connection with these corporate
inversion transactions and the implications of these transactions for
the U.S. tax system and the U.S. economy. On May 17, 2002, the Treasury
Department released its preliminary report on the tax policy
implications of corporate inversion transactions. (A copy of the
Treasury preliminary report is attached.) The Treasury preliminary
report describes the mechanics of the transactions, the current tax
treatment of the transactions, the current tax treatment of the
companies post-inversion, the features of our tax laws that facilitate
the transactions or that may be exploited through such transactions,
and the features of our tax laws that drive companies to consider these
transactions.
Inversion transactions implicate fundamental issues of tax policy.
The U.S. tax system can operate to provide a cost advantage to foreign-
based multinational companies over U.S.-based multinational companies.
The Treasury report identifies two distinct classes of tax reduction
that are available to foreign-based companies and that can be achieved
through an inversion transaction. First, an inversion transaction may
be used by a U.S.-based company to achieve a reduction in the U.S.
corporate-level tax on income from U.S. operations. In addition,
through an inversion transaction, a U.S.-based multinational group can
substantially reduce or eliminate the U.S. corporate-level tax on
income from its foreign operations.
The Treasury preliminary report discusses the need for an immediate
response to address the U.S. tax advantages that arise from the ability
to reduce U.S. corporate-level tax on income from U.S. operations. My
testimony today will focus on several specific actions that we believe
are urgently needed to eliminate these opportunities to reduce
inappropriately the U.S. tax on U.S. operations and thereby to ensure
continued confidence in the U.S. tax system. We believe that addressing
these opportunities will have an immediate effect on the corporate
inversion activity that is now occurring by eliminating the substantial
upfront tax reductions that can be achieved through these transactions.
This approach also addresses the similar tax reduction opportunities
that are available to companies that form offshore from the outset and
to foreign companies that acquire U.S. businesses, and therefore avoids
advantaging companies that begin as non-U.S. companies over those that
begin here in the United States.
The Treasury preliminary report also discusses the need to address
the U.S. tax disadvantages that are caused for U.S.-based companies
because of the U.S. tax treatment of their foreign operations. We must
evaluate our tax system, particularly our international tax rules,
relative to those of our major trading partners, to ensure that the
U.S. tax system is competitive.
An inversion is a transaction through which the corporate structure
of a U.S.-based multinational group is altered so that a new foreign
corporation, typically located in a low- or no-tax country, replaces
the existing U.S. parent corporation as the parent of the corporate
group. In order to provide context for consideration of the policy
issues that arise, the Treasury preliminary report includes a technical
description of the forms of the inversion transaction and the potential
tax treatment of the various elements of the transaction under current
law. The transactional forms through which the basic reincorporation
outside the United States can be accomplished vary as a technical
matter, but all involve little or no immediate operational change and
all are transactions in which either the shareholders of the company or
the company itself are subject to tax. This reincorporation step may be
accompanied by other restructuring steps designed to shift the
ownership of the group's foreign operations outside the United States.
The restructuring steps involving movement of foreign subsidiaries are
complex and varied, but, like the reincorporation itself, are
transactions that are subject to tax. When all the transactions are
complete, the foreign operations of the company will be outside of the
U.S. taxing jurisdiction and the corporate structure also may provide
opportunities to reduce the U.S. tax on U.S. operations.
Market conditions have been a factor in the recent increase in
inversion activity. Although the reincorporation step triggers
potential tax at the shareholder level or the corporate level,
depending on the transactional form, that tax liability may be less
significant because of current economic and market factors. The
company's shareholders may have little or no gain inherent in their
stock and the company may have net operating losses that reduce any
gain at the company level. While these market conditions may help
facilitate the transactions, they are not, however, what motivates a
company to undertake an inversion. U.S.-based companies and their
shareholders are making the decision to reincorporate outside the
United States largely because of the tax savings available. It is that
underlying motivation that we must address.
The ability to achieve a substantial reduction in taxes through a
transaction that is complicated technically but virtually transparent
operationally is a cause for concern as a policy matter. As we
formulate a response, however, we must not lose sight of the fact that
an inversion is not the only route to accomplishing the same type of
reduction in taxes. A U.S.-based start-up venture that contemplates
both U.S. and foreign operations may incorporate overseas at the
outset. An existing U.S. group may be the subject of a takeover, either
friendly or hostile, by a foreign-based company. In either case, the
structure that results provides tax-savings opportunities similar to
those provided by an inversion transaction. A narrow policy response to
the inversion phenomenon may inadvertently result in a tax code
favoring the acquisition of U.S. operations by foreign corporations and
the expansion of foreign controlled operations in the United States at
the expense of domestically managed corporations. In turn, other
decisions affecting the location of new investment, choice of
suppliers, and employment opportunities may be adversely affected.
While the openness of the U.S. economy has always made--and will
continue to make--the United States one of the most attractive and
hospitable locations for foreign investment in the world, there is no
merit in policies biased against domestic control and domestic
management of U.S. operations.
The policy response to the recent corporate inversion activity
should be broad enough to address the underlying differences in the
U.S. tax treatment of U.S.-based companies and foreign-based companies,
without regard to how foreign-based status is achieved. Measures
designed simply to halt inversion activity may address these
transactions in the short run, but there is a serious risk that
measures targeted too narrowly would have the unintended effect of
encouraging a shift to other forms of transactions and structures to
the detriment of the U.S. economy in the long run.
An immediate response is needed to address the U.S. tax advantages
that are available to foreign-based companies through the ability to
reduce the U.S. corporate-level tax on income from U.S. operations.
Inappropriate shifting of income from the U.S. companies in the
corporate group to the foreign parent or its foreign subsidiaries
represents an erosion of the U.S. corporate tax base. It provides a
competitive advantage to companies that have undergone an inversion or
otherwise operate in a foreign-based group. It creates a corresponding
disadvantage for their U.S. competitors that operate in a U.S.-based
group. Moreover, exploitation of inappropriate income-shifting
opportunities erodes confidence in the fairness of the tax system.
In the case of inversion transactions, the ability to reduce
overall taxes on U.S. operations through these income-shifting
techniques provides an immediate and quantifiable benefit. Because of
the cost and complexity of these transactions, the immediate and
quantifiable benefit from reducing U.S. tax on U.S. operations is a key
component of the cost-benefit analysis with respect to the transaction.
In other words, the decision to consummate the inversion often is
dependent upon the immediate expected reduction in U.S. tax on income
from U.S. operations. Accordingly, eliminating the opportunities to
reduce inappropriately the U.S. tax on income from U.S. operations will
eliminate the upfront tax reductions that are fueling the inversion
transaction activity.
We believe there are several specific areas in which changes are
urgently needed. The statutory rules regarding the deductibility of
interest payments to related parties must be tightened to prevent the
inappropriate use of related-party debt to generate deductions against
income from U.S. operations that otherwise would be subject to U.S.
tax. We must undertake a comprehensive review of the rules governing
the transfer of assets among related parties and establish a
revitalized compliance program to ensure adherence with the arm's-
length standard for related party transfers. We must undertake a
comprehensive review of our income tax treaties and make the
modifications to particular treaties necessary to ensure that they do
not provide inappropriate opportunities to reduce U.S. taxes. We must
promulgate reporting requirements to provide the IRS with information
to ensure that shareholders are paying the tax owed on the gain
recognized in an inversion transaction. We also are working on other
areas where further study is needed.
In addition, we must continue to work to address the U.S. tax
disadvantages faced by U.S.-based companies that do business abroad
relative to their counterparts in our major trading partners. We look
forward to working closely with the Committee on this important issue.
Interest on Related Party Debt. One of the simplest ways for a
foreign-based company to reduce the U.S. tax on income from U.S.
operations is through deductions for interest payments on intercompany
debt. The U.S. subsidiary can be loaded up with a disproportionate
amount of debt for purposes of generating interest deductions through
the mere issuance of an intercompany note, without any real movement of
assets or change in business operations. Interest paid by a U.S.
subsidiary to its foreign parent or a foreign affiliate thereof gives
rise to a U.S. tax deduction but the interest income may be subject to
little or no tax in the home country of the foreign related party
recipient. It is important to recognize that a U.S.-based company could
not achieve such a result. Indeed, the rules governing the allocation
of interest expense to which U.S.-based companies are subject can
operate effectively to deny a U.S. company deductions for interest
expense incurred in the United States and paid to an unrelated third
party.
The potential to use foreign related-party debt to generate
deductions that reduce taxable income in the United States is not
unique to inversion transactions, and concern about this technique is
not new. Section 163(j) of the Internal Revenue Code was enacted in
1989 to address these concerns by denying U.S. tax deductions for
certain interest expense paid by a corporation to a related party.
Section 163(j) as it currently exists applies only where (1) the
corporation's debt-equity ratio exceeds 1.5 to 1, and (2) its net
interest expense exceeds 50 percent of its adjusted taxable income
(computed by adding back net interest expense, depreciation,
amortization and depletion, and any net operating loss deduction). If
the corporation exceeds these thresholds, no deduction is allowed for
interest in excess of the 50-percent limit that is paid to a related
party and that is not subject to U.S. tax. Any interest that is
disallowed in a given year is carried forward indefinitely and may be
deductible in a subsequent taxable year. Section 163(j) also provides a
four-year carryforward for any excess limitation (i.e., the amount by
which interest expense for a given year falls short of the 50 percent
of adjusted tax income threshold).
A revision of these rules is needed immediately to eliminate what
is referred to as the real ``juice'' in an inversion transaction. The
prevalent and increasing use of foreign related-party debt in inversion
transactions demonstrates the importance to these transactions of the
tax reductions achieved through interest deductions and the need to act
now to eliminate this benefit. Accordingly, we propose statutory
changes to tighten the interest disallowance rules of section 163(j) in
several respects. Moreover, the opportunities for generating interest
deductions that reduce U.S. taxable income are not limited to inversion
transactions. These U.S. taxable income minimization strategies, which
are not available to U.S.-based companies, are possible as well in
cases where a U.S. business is structured from the outset with a
foreign parent and in cases where a foreign corporation acquires a U.S.
operating group. Therefore, we believe these revisions to section
163(j) should not be limited to companies that have inverted but should
apply across the board. There is no reason to allow companies to reduce
income that would otherwise be subject to U.S. tax through deductions
generated simply by putting in place debt owed to related parties.
The fixed debt-equity test of current law effectively operates as a
safe harbor for corporations with debt-equity ratios of 1.5 to 1 or
lower. We propose replacing the safe harbor protection currently
available under the fixed 1.5 to 1 debt-equity test with a test that
would deny a deduction for related party interest to the extent that
the corporate group's level of indebtedness in the United States
exceeds its worldwide level of indebtedness. This worldwide test would
compare (i) the ratio of indebtedness incurred by the U.S. members of
the corporate group to their assets, with (ii) the ratio of the entire
corporate group's worldwide indebtedness (excluding related party debt)
to its worldwide assets. Interest that is paid to related parties and
that is not subject to U.S. tax would be denied deductibility to the
extent it is attributable to indebtedness in excess of the worldwide
ratio.
With this approach, the 50-percent of adjusted taxable income test
would operate as a second, alternative test applicable in cases where
the U.S. debt-to-assets ratio does not exceed the worldwide ratio. We
propose modifying the 50-percent test by revising the definition of
adjusted taxable income to eliminate the addback of depreciation,
amortization and depletion. This would have the effect of appropriately
focusing the test on net interest expense as a percentage of income
rather than cash flow.
We also propose curtailing the carry over rules applicable under
section 163(j). Although the current carryforwards appropriately
provide relief to those taxpayers whose interest-to-income ratio may be
subject to unanticipated fluctuations due to business fluctuations, an
indefinite carryforward has the effect of dampening the impact of the
deduction denial. This consequence is further exacerbated by the
ability under current law to carry forward excess limitation to shelter
additional interest deductions in future years. Accordingly, we propose
eliminating the carryforward of excess limitation and limiting the
carryforward period for disallowed deductions to 5 years.
Income Shifting and Transfers of Intangibles. Another way for a
foreign-based company to reduce the U.S. tax on income from U.S.
operations is through related-party transactions for other than arm's
length consideration. Many inversion transactions involve the movement
of foreign subsidiaries out of the U.S. group so that they are held
directly by the new foreign parent. Some inversion transactions involve
transfers of intangible or other assets, or business opportunities, to
the new foreign parent or its foreign subsidiaries. This type of
movement of foreign subsidiaries, assets, and opportunities is not
unique to inversion transactions. The same sort of restructuring
transactions are common whenever a multinational group is acquired or
makes an acquisition. Cross-border transfers of subsidiaries and assets
can give rise to significant valuation issues, and the ongoing
transactions between the various entities can give rise to significant
income allocation issues.
The outbound transfer of subsidiaries and assets to a related
person in a taxable transaction is subject to the transfer pricing
rules of section 482 and the regulations thereunder, which provide that
the standard to be applied is that of unrelated persons dealing at
arm's length. In the case of transfers of intangible assets, section
482 further provides that the income with respect to the transaction
must be commensurate with the income attributable to the intangible
assets transferred. The magnitude of the potential tax savings at stake
in substantial outbound transfers of assets, especially intangible
assets, puts significant pressure on the enforcement and application of
the arm's length and commensurate with income standards. Where the
arm's length standard is not properly applied or enforced, the
inappropriate income shifting that results can significantly erode the
U.S. tax base.
Treasury will undertake a comprehensive study focusing on the tools
needed to ensure that cross-border transfers and other related party
transactions, particularly transfers of intangible assets, cannot be
used to shift income out of the United States. This will include a
review and appropriate revisions of the contemporaneous documentation
and penalty rules and of the substantive rules relating to transfers of
intangible property and services and cost sharing arrangements. It also
will include an administrative compliance initiative. While there is
much that can and will be accomplished in this area through regulatory
guidance and enhanced enforcement efforts, Treasury will report to the
Congress on any need for statutory changes or additions.
Treasury and the IRS will undertake an initiative to review current
practices related to the examination of transfer pricing issues and the
imposition of transfer pricing penalties, with a particular emphasis on
transactions in which intangibles are transferred. The volume and
complexity of cross-border related party transactions have grown
significantly in recent years, and a number of U.S. trading partners
have undertaken broad compliance initiatives relative to transfer
pricing. The purposes of this comprehensive review will include
ensuring that contemporaneous documentation from taxpayers is utilized
effectively by the IRS and that transfer pricing penalties are imposed
where warranted on a fair and consistent basis. This focused review
also will help identify potential improvements to existing rules,
including the provisions regarding penalties, reporting, and
documentation, that would enhance transfer pricing compliance.
We will revise the current section 482 cost sharing regulations
with a view to ensuring that cost-sharing arrangements cannot be used
to facilitate a disguised transfer of intangible assets outside the
United States in a manner inconsistent with the arm's length standard,
as reinforced by the commensurate with income standard. The purpose of
the cost sharing regulations is to facilitate the allocation among
related taxpayers of future income attributable to future intangible
property in a manner that reasonably reflects the actual economic
activity undertaken by each related taxpayer to develop that property.
This work will focus initially on the effectiveness of the current
rules intended to apply the arm's length standard to taxpayers that
contribute to the cost sharing arrangement the right to use existing
intangible property, such as know-how or core technology, which often
constitutes the most important and valuable input into the development
of future intangible property.
We also will review the section 482 regulations applicable to
transfers of intangible assets to ensure they do not operate to
facilitate the transfer of intangible property outside the United
States for less than arm's length consideration. These regulations
relating to the transfer of intangible assets implement the arm's
length and commensurate with income standards by allowing periodic
adjustments to transfer prices in limited circumstances based on
objective standards. While these objective standards have provided
certainty and minimized disputes in this otherwise contentious area,
focus is needed on ensuring the proper operation of the periodic
adjustments provisions.
Finally, as part of an ongoing project to update the 482
regulations applicable to services, we will work to mitigate the extent
to which the structuring or characterization of a transfer of
intangible assets as the provision of services can lead to
inappropriate transfer pricing results. The differences between the
section 482 regulations relating to the provision of services and those
relating to the transfer of intangible property could be exploited
through the characterization of a transfer of intangible property as a
provision of services. While a transfer of intangibles through a
license in return for royalty payments and the provision of technical
services utilizing the intangibles in return for a service fee, for
example, may be similar from an economic perspective, the transfer
pricing results may differ depending on whether the transfer pricing
regulations related to services or intangible property are applicable.
The transfer pricing rules should reach similar results in the case of
economically similar transactions regardless of the characterization or
structuring of such transactions.
Because the potential to use related party transactions to reduce
the U.S. tax on income from U.S. operations is not unique to inversion
transactions, our proposals in this area are not limited in scope to
corporations that have inverted.
Income Tax Treaties. The United States imposes a withholding tax at
a rate of 30 percent on payments of interest and royalties (as well as
dividends) from a U.S. corporation to a foreign affiliate. This
withholding tax may be reduced or eliminated in certain circumstances
under an applicable income tax treaty. The cost advantage achieved by
shifting income by means of deductible payments to foreign related
parties is most effective when the payments are to a foreign related
party that is eligible for benefits under a comprehensive U.S. income
tax treaty and, in addition, is not subject to significant local tax on
the income.
Most inversion transactions have involved a reincorporation into a
foreign jurisdiction either that does not have a tax treaty with the
United States or whose treaty with the United States does not generally
reduce U.S. withholding tax rates. However, many of the newly created
foreign parent corporations may be considered resident for treaty
purposes in a country that has a comprehensive tax treaty with the
United States and that does not subject certain payments received by
its corporations to significant local income tax. Through such a
structure, the cost advantage achieved by shifting income can be
maximized. Similar results may be obtained through the use of finance
subsidiaries located in certain treaty jurisdictions.
We must review and evaluate our tax treaties to identify any
inappropriate reductions in U.S. withholding tax that provide
opportunities for shifting income out of the United States. U.S. income
tax treaties are intended to prevent the double taxation by the United
States and its treaty partner of income earned by residents of one
country from sources within the other. Thus, the United States does not
enter into income tax treaties that lower the rates of U.S. withholding
tax on U.S.-source income (e.g., U.S.-source interest and royalties)
with jurisdictions that do not have a comprehensive income tax system.
In such a case, there is no need to reduce the U.S. withholding tax
because there is no risk of double taxation. We must make certain that
the operation of our treaties is consistent with the expectation of the
United States and its treaty partners that treaties should reduce or
eliminate double taxation of income, not eliminate all taxation of
income. If a current or prospective treaty partner does not tax a
particular category of U.S.-source income earned by its residents,
either because of a general tax exemption or a special tax regime,
reduction of U.S. withholding tax on that category of income may not be
appropriate.
We also must consider whether anti-abuse mechanisms already within
our treaties are operating properly. Because U.S. tax treaties are
intended to benefit only residents of either the United States or the
treaty partner, U.S. income tax treaties include detailed limitation on
benefits provisions, to prevent the misuse of treaties by residents of
third countries. Those limitation on benefits provisions are important
for ensuring that a resident of a third country cannot benefit
inappropriately from a reduction in U.S. withholding tax by structuring
a transaction, including a transaction designed to generate deductible
payments, through a treaty country. One of Treasury's key tax policy
goals in modernizing our network of existing tax treaties is to bring
the limitations on benefits provisions in all our treaties up to
current model standards so as to remove the opportunity for such
misuse.
Reporting Requirements. In many inversion transactions the
company's shareholders are required to recognize gain. Current Treasury
regulations generally require Form 1099 reporting to the IRS of the
gross proceeds from any sale for cash effected by a broker in the
ordinary course of its business. However, there are no similar
reporting obligations in the case of an inversion where a shareholder
exchanges stock of one corporation for stock in another corporation. We
intend to establish a Form 1099 reporting requirement for stock
transfers in inversions and other taxable reorganization transactions.
Requiring reporting of these transactions will increase the IRS's
access to information about the transactions. It also will serve to
remind shareholders of the tax consequences to them from the company's
transaction and of their obligation to report any gain.
Other Areas of Further Study. There are two other areas where we
believe that further study is needed and we have begun careful
consideration of these areas.
A comprehensive review of the corporate organization and
reorganization rules is needed in light of the increasing pressure put
on these rules through the larger and more complicated international
restructuring transactions that are becoming commonplace. The corporate
organization and reorganization rules, as well as the other related
rules affecting corporations and their stock and option holders, were
written largely for purely domestic transactions. Section 367, and the
lengthy regulations there under, modify those rules for application in
the case of cross-border transactions. With the increasing
globalization of both U.S. companies and foreign companies, these rules
are being applied more frequently and to larger and more complicated
cross-border transactions. It is critical that the rules governing
cross-border reorganizations keep up with these developments. The
current cross-border reorganization rules are something of a patchwork,
developed and revised over the last twenty years. One focus in this
reconsideration of the current-law rules will be on achieving greater
consistency in treatment across similar transactions, in order to avoid
both traps for the unwary and opportunities for taxpayers to exploit
the rules to reach results that are not intended. Moreover, clearer
rules will help provide greater certainty to taxpayers and the
government in this complex area.
A careful review also is needed of the income-shifting issues that
arise in the context of the several inversion transactions that have
involved insurance and reinsurance companies. The initial
reincorporation outside the United States typically has been
accompanied by a shift of some portion of the existing U.S. insurance
business through reinsurance with a related foreign affiliate. An
evaluation must be made as to whether the use of related party
reinsurance permits inappropriate shifting of income from the U.S.
members of a corporate group to the new foreign parent and its foreign
affiliates, and whether existing mechanisms for dealing with such
related party transactions are sufficient to address these
opportunities. In this regard, further analysis is appropriate to
consider and evaluate the approaches used by our trading partners in
taxing insurance companies, including, for example, the use by some
countries of a premium-based tax that captures within the country's tax
base all business written on risks within the country.
Finally, we must continue our work to address the U.S. tax
disadvantages for U.S.-based companies that do business abroad relative
to their counterparts in our major trading partners. The U.S.
international tax rules can operate to impose a burden on U.S.-based
companies with foreign operations that is disproportionate to the tax
burden imposed by our trading partners on the foreign operations of
their companies. The U.S. rules for the taxation of foreign-source
income are unique in their breadth of reach and degree of complexity.
Both the recent inversion activity and the increase in foreign
acquisitions of U.S. multinationals are evidence that the competitive
disadvantage caused by our international tax rules is a serious issue
with significant consequences for U.S. businesses and the U.S. economy.
A comprehensive reexamination of the U.S. international tax rules and
the economic assumptions underlying them is needed. As we consider
appropriate reformulation of these rules we should not underestimate
the benefits to be gained from reducing the complexity of the current
rules. Our system of international tax rules should not disadvantage
U.S.-based companies competing in the global marketplace.
As we work to address these important issues, we must keep our
focus on the overarching goal of maintaining the attractiveness of the
United States as the most desirable location in the world for
incorporation, headquartering, foreign investment, business operations,
and employment opportunities, in order to achieve an ever higher
standard of living for all Americans.
[The attachment is being retained in the Committee files.]
Chairman THOMAS. Thank you very much, Ms. Olson. As I said
in my opening remarks, one, for the fact that you issued a
study which may or may not have been serendipitous in terms of
its timing, but it was still, nevertheless, very useful.
Second, your testimony is very specific, and again, that is
refreshing, because you have offered some very specific
remedies to a specific problem.
You also state in your testimony on page two, the first
full paragraph there, that the Treasury preliminary report also
discusses the need to address the U.S. tax disadvantages that
are caused for U.S.-based companies because of U.S. tax
treatment of their foreign operations. We must evaluate our tax
system, particularly our international tax rules, relative to
those of our major trading partners to ensure that the U.S. tax
system is competitive. That sounds like a fairly broad
statement about the need to examine far more fundamentally our
tax code than the specifics that you provided in your testimony
focused on inversions.
As you know, we have embarked on trying to put together a
tax package to respond to, because we are required to respond
to the WTO decision on the fact that our foreign sales
structure is considered a subsidy. Could you give us some
specifics of what you meant by that paragraph in terms of what
it is that we should be focusing on, and are there other areas
in which, for want of a better term, inversions have occurred
or might occur that would not necessarily be captured by the
specifics that you have provided, or that since we are looking
at the way in which we deal with corporations that are involved
internationally, other tax aspects that perhaps we should at
least begin to lay on the table?
I know that is a very broad question, and obviously, the
Chair will appreciate whatever verbal response you can give,
but I am anticipating that this may involve a more extensive
written response to the question, which you will provide us
with over the next few days.
Ms. OLSON. All right. Thank you. First of all, of course,
the U.S. operates a worldwide system of income tax, which means
that U.S. companies with foreign operations are subject to tax
in the United States on the income from those foreign
operations. The double tax that can result from that is
addressed by our foreign tax credit system, but the foreign tax
credit system is extremely complicated. It has a number of
limitations and many companies find that they are not able to
make full use of the foreign tax credits to offset the double
taxation.
In addition, we have subpart F of the tax code, under which
we impose current U.S. tax on a number of foreign activities of
U.S. companies with foreign subsidiaries without regard to
whether or not that income is actually distributed to the U.S.
parent. That is another area of the Tax Code that requires a
look, because in that realm in particular, a number of our
major trading partners do not tax that income at all, let alone
tax it currently.
In addition, we need to look at our interest allocation
rules, which function almost opposite of the way that the
interest rules function with respect to foreign-owned
companies, and they sharply limit U.S. companies' ability to
use foreign tax credits.
Chairman THOMAS. That means, then, that obviously, if we
are looking at this one particular example which has come to
the attention, for want of a better term, of the popular press,
it is more or less on the cliche of the tip of the iceberg of
things that we need to look at, which then takes me to the
bottom of page two in terms of your testimony in which you say
a narrow policy response to the inversion phenomenon may
inadvertently result in a tax code favoring the acquisition of
U.S. operations by foreign corporations and the expansion of
foreign-controlled operations in the United States at the
expense of domestically managed corporations.
Would it not be ironic if we are attempting to resolve the
problem of U.S. companies going foreign to remain U.S.
companies if we created a change in the law which made it more
advantageous for foreign corporations to acquire U.S.
corporations. What did you mean specifically and to what
reference is this a narrow policy response directive?
Ms. OLSON. Well, if we passed legislation, for example,
that only imposed sharper rules, stricter rules on companies
that had inverted, then that would mean that companies that
started, for example, in Bermuda or Luxembourg or some other
foreign country or currently foreign-owned companies would have
tax advantages over U.S. companies that might seek to invert.
So if we just focus on the inverted companies, we may create
some real discontinuities in the tax code that would advantage
foreign-owned companies and we want to avoid that.
I want to mention one other thing on the question that you
asked previously. You asked about inversion transactions that
might be occurring that might not be caught by the proposals
that we have laid out today and one of those is the insurance
transactions, which have been occurring for some time,
involving inversion transactions into Bermuda. Those would not
be captured by the rules that we have talked about here because
that is not a problem associated with mis-pricing. At least so
far as we know, the transactions have been priced at arms'
length market prices. What we try to capture within the U.S.
tax base is income, and so we try to appropriately measure
income in making sure that we have got arms' length prices.
So long as those transactions, which include a move to
Bermuda followed by reinsurance of U.S. risks into Bermuda, are
appropriately priced, they would not be captured by the current
rules in the tax code, and so for that we need to perhaps take
a more fundamental look at the direction of the tax code and
whether or not it makes sense in that area to continue to try
to tax on the basis of income or whether we should be looking
at something more along the lines of what some of our trading
partners do, which is to focus a tax on premiums.
Chairman THOMAS. If I understand what you are saying, as
companies involve themselves internationally or international
companies involve themselves in the United States, if you base
your tax system on the income, you are going to be chasing
these corporations all over the world and examining the
structures that they offer amid different taxing structures
around the world to try to figure out how we would extract what
would be an appropriate tax on the income, and maybe that is
probably not the best way to go in terms of trying to produce
revenue in an appropriate amount and that we should look at a
different way of dealing with companies that are dealing with
insurance.
Would this be unique to insurance or would it have
relevance to other corporations as well? That is, that pursuing
the income of the corporations may not be the most meaningful
way to raise appropriate revenue on U.S. activities?
Ms. OLSON. In many ways, our study and the Internal Revenue
Code, in general, the complexity of it reflects our continuing
dissatisfaction with our attempts to define income. We keep
slapping new rules on to chase this, that, or the other thing
and it makes it extremely complicated, and in the end, somebody
always finds a way around it and then we come back to try once
again to define income so that we feel that we have
satisfactorily captured within the U.S. base the amount that we
want captured.
Chairman THOMAS. At least in terms of the example that you
raised, insurance companies, just give me a brief review again
of what might be suggested. I do not believe you are offering
this as a policy today, but you are using it as an example of
the difficulty of trying to tax income. What could be an option
that would replace the corporate income tax on insurance
companies would be what?
Ms. OLSON. It would be a tax on the premiums written by the
insurance companies, which is the way that some of our trading
partners tax the insurance business.
Chairman THOMAS. Premiums in the United States?
Ms. OLSON. Premiums written within the United States, and
that way, what you would capture within the tax base is all of
the risks written in the United States.
Chairman THOMAS. Your concern about too narrow a response
obviously means we would lead perhaps to some unanticipated
consequences because of the ongoing drive to be the lowest-
price competitor, and where the tax code comes into place, we
had better be careful of making a change in one area because it
may have repercussions in other areas that we have not
anticipated, and that, of course, requires, then, a broader
look to make sure that if we do make a move, we understand what
are the relevant ancillary consequences of decisions that we
make, which means we have a bit of a dilemma because we have a
relatively immediate problem in dealing with these corporate
inversions as we have begun to understand them, especially with
the Treasury Department study, and the need, as you indicate,
to look at a number of other areas that taxes might be changed,
which clearly would not be a short-term response to the
immediate problem, and that is part of the dilemma, I think.
How do you deal with the immediate problem while you are
looking at the larger concerns that may require a more in-depth
and a more broadly-based tax modification?
Thank you very much for your testimony. Does the gentleman
from New York wish to inquire?
Mr. RANGEL. Thank you, Mr. Chairman.
I regret, as much as you would have wanted to avoid the
conflict that we have today between the full Committee hearing
testimony on what is a complex tax issue and what is a real
important tax issue on the Floor. Through no fault of your own,
the Members of this Committee find ourselves before this panel,
recognizing that a lot of U.S. companies have announced that in
order to avoid U.S. income taxes during a time of war, that
they will leave the United States and seek a tax haven
elsewhere. So there has to be long- and short-term
consequences, and we had thought this matter was going to be in
front of the subcommittee. The Chair has decided it is
important enough to be in front of the full Committee.
We also thought that since at least two Members of the
Congress had information that they could bring to us to say
what impact this would have, both of them being from
Connecticut, Mrs. Johnson and Mr. Maloney, that they would be
able to share some light on this subject matter, and we have
learned that notwithstanding the request made by Congressman
Maloney, that has been denied and he will not be allowed to
testify in front of the full Committee.
I have been here 32 years. I have never heard of a Member,
a sitting Member of this body's request to testify being turned
down. It is an election year and it is probably a good reason,
but we will find out what it is about.
Second, we have a bill on the Floor to make permanent the
estate tax repeal, which I have been advised in the next 10
years, if you include debt service, is going to cost us $1
trillion. We all are trying to find ways to preserve Social
Security, Medicare, prescription drugs, but in this political
year, make no mistake about it, to Members of this Committee,
it is a very, very important issue because we have
jurisdiction.
So we really think--we beg you to reconsider, because of
the witnesses, because of the audiences, and because this is
not going to work, that just because we are in the minority
that you expect us to be two places at one time. I am supposed
to manage the bill on the estate tax repeal at the same time. I
feel some sense of responsibility as the senior Member to see
which way the testimony is going on this complex issue before
us.
Now, I know you do not want it to have this conflict, and I
do not either, but I will ask you to consider postponing this
meeting until after we complete our work on the Floor, and
before I put it into a motion, I will ask you to respond
whether you would consider it.
Chairman THOMAS. I appreciate the gentleman's presentation.
I do want to make sure that all of us understand what the facts
are and what the time line is.
The Chair intended to have a full Committee hearing on this
subject just as we had a full Committee hearing on FSC, to set
the tone so that we could then examine the more specific
aspects of areas, as we are now doing on the foreign sales
corporation. We had an initial hearing. There was no Member
panel at that particular hearing, and we moved forward,
notwithstanding the fact there is legislation in dealing with
foreign sales corporation tax changes. There was no appeal by
the minority at that time about how unfair it was that Members
were not allowed to testify.
The letter from Members requesting testimony arrived at the
majority office after the minority staff was notified that, as
was the case in the foreign sales corporation hearing, there
would be no Member panel. I want to emphasize that. The hearing
requesting testimony was received after we notified the
minority staff that there would be no Member panel, and the
assumption clearly is, once we decided that was not going to be
the case, then you tried to get a letter in, which you now just
used as justification for the requirement that the Members be
heard.
The Chair said in his opening statement that we are
obviously going to have a series of hearings on this. I am
quite sure if I turn to the Chairman of the Select Revenue
Subcommittee that he would respond in a positive way to the
desire to have Members in front of the Subcommittee because we
are not denying anyone who wants to be heard.
In addition to that, this hearing is similar to every other
hearing that we have had in which the Committee call for the
hearing indicates written testimony can be received from any
individual, entity, Member, or otherwise, and it will be made a
part of the record, so that the record would never be less than
complete unless, of course, individuals wished not to submit
the written testimony.
We are holding this initial hearing in exactly the same
format as we held the foreign sales corporation full Committee
hearing. We have the same structure that we had at that time
and then we will move forward examining the specifics just
exactly the same way that we are doing with the foreign sales
corporation.
Mr. RANGEL. Mr. Chairman, I ask unanimous consent that this
Committee allow Congressman Maloney to testify.
[Objections were voiced.]
Chairman THOMAS. Objections are heard.
Mr. RANGEL. Mr. Chairman, I move that this Committee allow
Congressman Maloney to testify.
Chairman THOMAS. There is no such thing as a motion.
Mr. RANGEL. Mr. Chairman, I----
Chairman THOMAS. There is a unanimous consent of the
Committee rules being in order, but there is not a motion that
is in order at a hearing.
Mr. RANGEL. I ask unanimous consent that the Committee
recess until such time as the conflict that we have with the
business on the Floor and the business before this hearing is
resolved.
[Objections were voiced.]
Chairman THOMAS. Hearing objection, and the Chair would
note that there is no conflict. The measure that is the
jurisdiction of this Committee is not now in front of the Floor
and that it is entirely appropriate for this Committee to
continue to meet. The Ranking Member's concern about Members
managing their time would probably be more appropriate when, in
fact, the measure is before us on the Floor. It is not before
us on the Floor, and we could be moving forward with the
hearing rather than continuing this discussion.
Mr. KLECZKA. Will the Chairman yield on that point?
Mr. RANGEL. Mr. Chairman, as we talked, the rule which sets
the guidelines in which this important Committee on Ways and
Means tax issue before the Floor is being debated, as you know,
you and I participate in testifying before the Rules Committee,
so that is of concern to us. In addition to that, we really
think that notwithstanding the request, when it was made, that
allowing a Member 5 minutes to testify, whether it is a man or
woman, Republican or Democrat, is just a courtesy. If we are
not going to get any consideration at all, then I have to be
forced to move to adjourn formally this hearing.
Chairman THOMAS. The gentleman has moved to adjourn. There
is no debate on the motion to adjourn but there is a vote. All
those in favor, say aye.
Those opposed?
In the opinion of the Chair, the noes have it. The noes
have it----
Mr. RANGEL. I ask for a roll call vote.
Chairman THOMAS. The Clerk will call the roll.
The CLERK. Mr. Crane?
Mr. CRANE. No.
The CLERK. Mr. Crane votes no.
Mr. Shaw?
Mr. SHAW. No.
The CLERK. Mr. Shaw votes no.
Mrs. Johnson?
Mrs. JOHNSON OF CONNECTICUT. No.
The CLERK. Mrs. Johnson votes no.
Mr. Houghton?
[No response.]
The CLERK. Mr. Herger?
[No response.]
The CLERK. Mr. McCrery?
Mr. McCRERY. No.
The CLERK. Mr. McCrery votes no.
Mr. Camp?
Mr. CAMP. No.
The CLERK. Mr. Camp votes no.
Mr. Ramstad?
[No response.]
The CLERK. Mr. Nussle?
[No response.]
The CLERK. Mr. Johnson?
[No response.]
The CLERK. Ms. Dunn?
[No response.]
The CLERK. Mr. Collins?
Mr. COLLINS. No.
The CLERK. Mr. Collins votes no.
Mr. Portman?
Mr. PORTMAN. No.
The CLERK. Mr. Portman votes no.
Mr. English?
Mr. ENGLISH. No.
The CLERK. Mr. English votes no.
Mr. Watkins?
Mr. WATKINS. Pass.
The CLERK. Mr. Watkins passes.
Mr. Hayworth?
Mr. HAYWORTH. No.
The CLERK. Mr. Hayworth votes no.
Mr. Weller?
[No response.]
The CLERK. Mr. Hulshof?
Mr. HULSHOF. No.
The CLERK. Mr. Hulshof votes no.
Mr. McInnis?
Mr. McINNIS. No.
The CLERK. Mr. McInnis votes no.
Mr. Lewis?
Mr. LEWIS OF KENTUCKY. No.
The CLERK. Mr. Lewis votes no.
Mr. Foley?
Mr. FOLEY. No.
The CLERK. Mr. Foley votes no.
Mr. Brady?
[No response.]
The CLERK. Mr. Ryan?
Mr. RYAN. No.
The CLERK. Mr. Ryan votes no.
Mr. Rangel?
Mr. RANGEL. Aye.
The CLERK. Mr. Rangel votes aye.
Mr. Stark?
Mr. STARK. Pass.
The CLERK. Mr. Stark passes.
Mr. Matsui?
Mr. MATSUI. Aye.
The CLERK. Mr. Matsui votes aye.
Mr. Coyne?
[No response.]
The CLERK. Mr. Levin?
Mr. LEVIN. Aye.
The CLERK. Mr. Levin votes aye.
Mr. Cardin?
Mr. CARDIN. Aye.
The CLERK. Mr. Cardin votes aye.
Mr. McDermott?
[No response.]
The CLERK. Mr. Kleczka?
Mr. KLECZKA. Aye.
The CLERK. Mr. Kleczka votes aye.
Mr. Lewis from Georgia?
[No response.]
The CLERK. Mr. Neal?
Mr. NEAL. Aye.
The CLERK. Mr. Neal votes aye.
Mr. McNulty?
Mr. McNULTY. Aye.
The CLERK. Mr. McNulty votes aye.
Mr. Jefferson?
[No response.]
The CLERK. Mr. Tanner?
Mr. TANNER. Aye.
The CLERK. Mr. Tanner votes aye.
Mr. Becerra?
Mr. BECERRA. Aye.
The CLERK. Mr. Becerra votes aye.
Mrs. Thurman?
Mrs. THURMAN. Aye.
The CLERK. Mrs. Thurman votes aye.
Mr. Doggett?
Mr. DOGGETT. Aye.
The CLERK. Mr. Doggett votes aye.
Mr. Pomeroy?
[No response.]
The CLERK. Mr. Houghton?
[No response.]
The CLERK. Mr. Herger?
[No response.]
The CLERK. Mr. Ramstad?
[No response.]
The CLERK. Mr. Nussle?
[No response.]
The CLERK. Mr. Johnson?
[No response.]
The CLERK. Ms. Dunn?
[No response.]
The CLERK. Mr. Weller?
[No response.]
The CLERK. Mr. Brady?
[No response.]
The CLERK. Mr. Coyne?
[No response.]
The CLERK. I'm sorry, Mr. Watkins passed.
Mr. WATKINS. No.
The CLERK. Mr. Watkins changes his vote from pass to no.
Mr. McDermott?
[No response.]
The CLERK. Mr. Lewis from Georgia?
[No response.]
The CLERK. Mr. Jefferson?
[No response.]
The CLERK. Mr. Pomeroy?
[No response.]
The CLERK. Mr. Chairman?
Mr. STARK. Clerk?
The CLERK. Yes?
Mr. STARK. How am I registered?
The CLERK. Mr. Stark is recorded as pass.
Mr. STARK. Off pass, please, onto aye.
The CLERK. Mr. Stark changes from pass to aye.
Mr. Chairman?
Chairman THOMAS. No.
The CLERK. Mr. Chairman votes no.
Chairman THOMAS. The Clerk will announce the vote.
The CLERK. Sixteen noes, twelve ayes.
Chairman THOMAS. There being 16 noes, 12 ayes, the motion
is not agreed to.
Mr. KLECZKA. Mr. Chairman?
Chairman THOMAS. The gentleman from Wisconsin?
Mr. KLECZKA. Inquiry of the Chair. You indicated to Ranking
Member Rangel that the bill to repeal the estate tax was not
currently on the Floor, and the Chairman is correct. We are
debating the rule which precedes the bill. Is it the Chairman's
intention that once the bill proper comes up, the Committee
will recess so we can participate in the debate on this
legislation?
Chairman THOMAS. I would tell the gentleman that any Member
who wishes to participate in a debate or go somewhere else is
not required to attend this hearing.
Mr. KLECZKA. Well, but Mr. Chairman, this----
Chairman THOMAS. This hearing will go forward.
Mr. KLECZKA. This hearing is important enough that the
Members should be here, also. I am at a loss as to why the
Chairman would schedule this hearing and send the bill to the
Floor at the same time. I am somewhat suspect that maybe this
hearing should overshadow what we are doing on the Floor so the
public does not know we are providing a big giveaway to the
wealthy of the wealthy on the House Floor. That is my
suspicion----
Chairman THOMAS. I tell----
Mr. KLECZKA. Nevertheless, Mr. Chairman----
Chairman THOMAS. I tell the gentleman----
Mr. KLECZKA. We might think we are powerful on this
Committee, but we still----
Chairman THOMAS. Get your point out.
Mr. KLECZKA. Despite that, cannot be in two places at once.
Chairman THOMAS. I understand that. This is a very
difficult job----
Mr. KLECZKA. This is a pretty big Committee, but we have
not mustered that trick.
Chairman THOMAS. It is a complex job and oftentimes we are
forced to make decisions on a priority basis, and----
Mr. KLECZKA. Priority schmiority, Mr. Chairman. We could
have had this hearing yesterday.
Chairman THOMAS. I understand----
Mr. KLECZKA. We could have had it tomorrow. We could have
had it Tuesday.
Chairman THOMAS. I will respond to the gentleman that this
hearing has been scheduled for some time. The Chair is not in
control of the scheduling of the Floor.
Mr. KLECZKA. Oh, do not give us that. You knew damn well
when that bill was coming up.
Chairman THOMAS. I understand the gentleman's difficulty in
dealing with the complex world.
[Laughter.]
Mr. KLECZKA. No, the problem is being in two places at
once, okay? Now, maybe Mr. Thomas can do that and walk on water
at the same time, but I think the bulk of this Committee has
not been able to do that.
Chairman THOMAS. If the gentleman has finished----
Mr. KLECZKA. The truth does hurt, sir, and I----
Chairman THOMAS. If the gentleman is finished with his
parliamentary inquiry, which it was not, and the Chair would--
--
Mr. KLECZKA. It was only an inquiry of the Chair. It was
not parliamentary.
Chairman THOMAS. Fine. The Chair has responded to the
inquiry.
Now, does anyone wish to ask questions of the Treasury
Department based upon what the Chair considers some of the
finest testimony that has been offered under any Administration
as a specific guide to assist this Committee in dealing with
the very difficult problem in front of us?
The gentleman from Illinois?
Mr. CRANE. Thank you, Mr. Chairman.
Ms. Olson, has the Treasury Department surveyed any of the
companies that have inverted or been acquired by a foreign
company and asked them what changes to our tax laws would have
kept them a domestic company?
Ms. OLSON. Yes, Mr. Crane, we have spoken with a number of
companies over the course of our study of the inversion
transactions to learn what was motivating the transactions and
have identified some of the things that I discussed in response
to my question from Mr. Thomas regarding the subpart F rules,
the complexity of the foreign tax credit rules, the interest
allocation rules. Those are things that particularly complicate
and make it expensive for U.S. companies to compete against
their foreign competitors in the same lines of business.
Mr. CRANE. Would you not agree that current tax law, like
the 30 percent withholding tax on the dividend income received
by offshore investors in U.S. mutual funds has the effect of a
punitive export tax, and does this force U.S. mutual funds
offshore in order to be competitive against foreign investment
funds?
Ms. OLSON. That is an issue that we are looking at and we
will continue to look at that and I appreciate you raising the
question.
Mr. CRANE. I understand that some of the highest average
worker wages are paid by the investment management industry
here in the United States. As a matter of national public
policy, would we not prefer as a Nation to employ those workers
in financial services firms here in the United States rather
than shipping high-quality jobs offshore? By keeping this
economic activity in the United States, would we not enhance
the collection of U.S. tax revenues? Instead of exporting
products, we are exporting high-paying jobs. What kind of
national public policy is that?
Ms. OLSON. It sounds to me like one we should change
quickly.
[Laughter.]
Mr. CRANE. Finally, in light of the economic devastation
from September 11 that hit the financial services industry
particularly hard, would not correcting this flaw in U.S. tax
policy assist in putting some of the victims back into quality
jobs?
Ms. OLSON. That is certainly something we can take a look
at.
Mr. CRANE. Thank you.
Chairman THOMAS. Does the gentleman from California, Mr.
Stark, wish to inquire?
Mr. STARK. Thank you, Mr. Chairman.
Ms. Olson, if the Chair had allowed Congressman Maloney to
testify, you would have learned that the Boston Globe, in
referring to Congresswoman Johnson, suggested that her proposal
for a moratorium was so sneaky and pernicious that no one could
argue that it was anything but a phony way to avoid taxes and
could not argue that it was good for the United States or
anybody except the executive officers of companies who do it,
or like the Stanley Works, plan to do it. So why should we have
a temporary basis when a flat-out ban was needed?
Then, of course, Mr. Maloney speaks to the workers and the
common people in his district, unlike Mrs. Johnson, who only
talks to the executives and stockholders, of which she is one
of the Stanley Works. In talking to one of the retirees,
Congressman Maloney determined that this retiree at the Stanley
Works would be facing a tax bill of $17,000. As any retiree
could tell you, that is a huge amount to pay, and particularly
in the face of Mrs. Johnson supporting the privatization of
Social Security and the privatization of Medicare. That would
leave this Stanley Works machinist with precious little.
Now, again, as I say, because you did not have the
opportunity to hear from Congressman Maloney, who is concerned,
vitally concerned about the people in his new district, could
you tell me why we would allow the Stanley Works machinist to
wait with this hanging over his head like the Sword of Damocles
while the Republicans privatize Social Security and Medicare
and then subject him to a tax bill which for him is
substantial, while the executives at Stanley would be getting
$30 and $40 million in extra compensation? Can you explain why
the Boston Globe would have called Mrs. Johnson's moratorium
sneaky and pernicious?
Ms. OLSON. First, I would say that I think that trying to
put up a Berlin Wall in response to these transactions is
something that is unlikely to work and likely to have harmful
effects on the U.S. economy. If we were unable to craft a
response to the inversion transactions that would take the
juice out of the transactions, remove the reasons for doing
them quickly, then it would seem to me that approaching it from
the standpoint of a moratorium, a temporary move in that
direction might be appropriate.
What we have put forward today is what we think is a set of
proposals that will go a long ways toward eliminating the
impetus for the inversion transactions and so we think that is
a preferable route to a moratorium. A moratorium would be
preferable to putting up a complete block on these kinds of
transactions because they are just not going to work, and they
are going to have other effects that are going to be harmful
for the economy.
Mr. STARK. What is not going to work, Ms. Olson?
Ms. OLSON. I am sorry?
Mr. STARK. What will not work?
Ms. OLSON. An approach such as saying companies just cannot
move. Number one, people will find ways to get around it, and
number two, if you target something solely at inversion
transactions, what you are then ignoring is the fact that
companies can start offshore, that foreign companies can
acquire U.S. companies and achieve the same results, and that
is not good for the economy.
Mr. STARK. Is it better for the economy to have them
invert?
Ms. OLSON. No. We definitely do not want them inverting.
That is why we have tried to come up with a----
Mr. STARK. So we could stop that. We could eliminate that
permanently, could we not?
Ms. OLSON. That is definitely what we would like to see
happen.
Mr. STARK. So if we followed Congressman Maloney's
approach, and the approach that most of us feel would be much
more certain to prevent the harm coming to these workers in
Connecticut than we would under some moratorium which might
last for 16 or 18 months. Then we would be right back in the
soup, would we not?
Ms. OLSON. No, I do not think we would be back in the soup
because the reason to do a moratorium is to have time to
consider fully what you ought to do to----
Mr. STARK. Nothing gets considered in this Congress, Ms.
Olson----
Ms. OLSON. I am afraid there is, Mr. Stark----
Mr. STARK. You are seeing that. They will not even allow
Members of Congress who are experts in this field, who have a
concern for the workers in Connecticut, like Congressman
Maloney, to testify, only to protect the inadequacy of the
representation that is given to them by Congresswoman Johnson.
That is the problem we have in this Congress.
Chairman THOMAS. The gentleman has the right to say
whatever he chooses to say.
Mr. STARK. Thank you, Mr. Chairman. I wish that that were
extended to all Members of Congress.
[Laughter.]
Chairman THOMAS. The gentleman can get on the Committee. If
the gentleman is willing to give up his seat to allow the other
Member on the Committee, he can express himself right now.
Mr. STARK. We could operate with a certain amount of
courtesy and decency and get rid of the fascist----
Chairman THOMAS. The gentleman's time has expired. Does
anyone else wish to respond? That comment does not need to have
a response.
The gentleman from Florida?
Mr. SHAW. Ms. Olson, I would join the Chairman in
complimenting you on a very clear and precise description of
the problem. I think Mr. Stark was getting into it. Clearly
stated, does the legislation filed by Mr. Maloney, H.R. 3922,
solve the problem that we are trying to solve?
Ms. OLSON. No, we do not believe it does solve the problem
we are trying to solve. We think it would miss a lot of things.
It would have other effects, and those other effects could be
very harmful for the economy.
Mr. SHAW. Thank you. I think, Mr. Chairman, some of the
comments that have been made from the other side of the aisle,
I think fully explain why we should not turn these hearings
into political contests between someone on the Committee and
someone not on the Committee. It would absolutely, I think, be
a tragedy if hearings of this Congress were to stoop to that
level so that we ended up having these type of spats every
other year during election years. I think that is very
unfortunately. I would, frankly, compliment the Chairman for
holding firm on that.
I have a question regarding the stock transactions. This is
the trading of American incorporated stock for foreign
incorporated stock. As I recall from your comments, that is a
taxable gain, is that not correct?
Ms. OLSON. Yes, it is. There is tax on the shareholders
when they exchange the stock in the U.S. company for stock in a
Bermuda company.
Mr. SHAW. Would it result in a stock loss, also, if the
stock was below what the stockholder paid for it?
Ms. OLSON. No. The loss is not recognized.
Mr. SHAW. The loss is not recognized. How about stock
options held by corporate employees? Is that taxable if the
exchange is made for an option on a foreign stock?
Ms. OLSON. Assuming it is an option covered by section 83,
no, it is not treated as property, so it would not be treated
as a taxable exchange.
Mr. SHAW. We could clearly make it taxable?
Ms. OLSON. Yes, we could.
Mr. SHAW. Thank you. Thank you, Mr. Chairman.
Chairman THOMAS. I thank the gentleman. Does the gentleman
from California, Mr. Matsui, wish to inquire?
Mr. MATSUI. Thank you, Mr. Chairman.
Ms. Olson, one of the concerns that I have regarding the
testimony you just gave--first of all, let me just say this.
Mr. Neal and Mr. Maloney's bill basically, and correct me if I
am wrong, but just the bare essentials would be that if a
company reincorporates offshore but maintains essentially its
shareholders and there is no change or very little change in
shareholders, that company then will be treated for tax
purposes as a U.S. company? It seems to me that that is pretty
straightforward. It does not add a lot of complications in it,
which seems to make a lot of sense, given the kind of offshore
reincorporation that is being anticipated now. I say that and
perhaps when you answer some of my questions, you might want to
respond to that.
The concern I have is that in Mr. O'Neill's comments in the
press release when the Treasury Department's preliminary report
was issued, I will just quote. ``When we have a Tax Code that
allows companies to cut their taxes on their U.S. business by
nominally moving their headquarters offshore, then we need to
do something to fix the Tax Code.'' It sounds like we either
move to a value-added tax or a national sales tax or perhaps
lower U.S. corporate taxes as a way to do this, and, of course,
that would do it. We can eliminate U.S. corporate taxes and
there is no question in that situation that you would probably
not see inversion.
On the other hand, I could see a lot of corporations 6
months later saying our environmental laws are just too
stringent and it might be better just to take companies
offshore and have them open up there because we can save
hundreds of millions of dollars over the next decade by doing
that, or labor standards, or any other standards. Maybe our
antitrust laws are too stringent, so we will just move some of
the businesses offshore for that purpose.
I guess that is a consequence of globalization, and we all
recognize that is happening. We cannot change that. We do not
want to change it. It obviously lifts all boats.
I think the answer you are giving basically will allow
corporations to make that case of lower taxes for almost every
other U.S. regulation or U.S. law that we have to maintain U.S.
standards in terms of our country and what we stand for,
national character. We are playing, to some extent by making
this argument, right into the hands of those people that I
disagree with that demonstrated in Seattle, Washington.
I would hope that, somehow, you can try to come up with
something that might have a little bit more weight to it,
because I am afraid that that argument will be used by
everybody. I mean, it is a very dangerous position, I think, if
you extend it beyond where we are.
I would like some of your thoughts on this, because I think
there is a value in discussing the larger issue of the impact
of globalization on U.S. regulations and U.S. laws. There is no
question that at the National Oceanic and Atmospheric
Administration discussions, this will be a major issue. We are
going to get into competition policies, obviously with the GE-
Honeywell deal, with the recent European Union complexity in
terms of how they view antitrust laws and how we do with
respect to Microsoft.
I think we are going to have to discuss these things, and
somehow, the Congress and the American public is going to have
to be well aware of the direction we are going. I think this is
just the tip of the iceberg that we are seeing, and to suggest
that we just eliminate U.S. corporate taxes or we lower U.S.
taxes is not the answer because we can make that case for
almost everything in terms of what we stand for as a Nation.
Ms. OLSON. Thank you, Mr. Matsui. You are absolutely right.
I want to first address the Neal and Maloney bill. We are not
enthusiastic about any kind of a bill that would just kind of
erect a blockade against companies going because we think that
it would produce other ways of doing the same thing.
This bill--you have heard said before, I am sure, that tax
lawyers are among the most creative people alive and if you
erect some kind of a rule, they will find their way around it.
The Neal-Maloney bill, I think, is one that people would fairly
quickly find their way around, and because of that and because
of the other ways of achieving the same effects that the
inverted companies are achieving, we do not think that is the
right direction to go. So we think it is better to focus on the
underlying problems and try to fix the underlying problems.
With respect to the questions about our tax system in
general, I am sure you have read the press about the Secretary
directing us to begin thinking about tax reform, and that is
something that we have underway. One of the things that is
clear when you spend a lot of time looking at the tax code is
that basing our tax system on income is something that is
inherently very difficult to do. It is a very complicated
process to figure out how you appropriately measure income.
What I know the Secretary wants us to do is not to think
about anything that reduces revenues, but rather to find the
most efficient way of collecting for the government the
revenues that it needs to operate. So one of the things that we
may want to explore is whether there are alternatives to an
income tax on business tax that might more efficiently collect
the revenues that we need from that sector of the economy to
fund government, and when we do that, I think it is critically
important that we look at what is going on in our major trading
partners.
I think that the quality of life that we have here in the
United States is surpassed nowhere and that is a natural magnet
for business to the United States. I think the concern about
quality of life also means that the countries that we have to
be most concerned about are our major trading partners and
whether our rules are in step with our major trading partners.
Professor Michael Graetz in a book that he wrote a few
years ago observed that in looking at our tax system and in
particular international tax reform, we could no longer merely
contemplate our own navel, and I think that is exactly right.
We have to think more broadly, as you have suggested, about how
other countries tax things, what their other rules are like on
the antitrust side, the environmental side, et cetera. I think
our focus will be mainly on our major trading partners whose
systems are, in many respects, similar to ours, but in
important respects differ from ours.
Mr. MATSUI. Thank you.
Chairman THOMAS. The gentleman's time has expired.
Mr. MATSUI. Mr. Chairman, reluctantly, given what Chairman
Rangel has said earlier, or Ranking Member----
Chairman THOMAS. The gentleman's time has expired.
Mr. MATSUI. I want to make a preferential motion.
Chairman THOMAS. Does the gentlewoman from Connecticut wish
to inquire?
Mr. MATSUI. Mr. Chairman, I make a preferential motion. Mr.
Chairman, I would like to make a preferential motion, a
privileged motion at this time, in that----
Chairman THOMAS. All you have to do is move.
Mrs. JOHNSON OF CONNECTICUT. Thank you, Mr. Chairman.
Mr. MATSUI. I move to adjourn, Mr. Chairman.
Chairman THOMAS. The gentleman from California moves to
adjourn. All those in favor, say aye.
Those opposed.
In the opinion of the Chair, the ayes have it. The
Committee is adjourned.
[Whereupon, at 12:26 p.m., the hearing was adjourned.]
[Questions submitted from Mr. Neal to Ms. Olson, and her
responses follow:]
U.S. Department of the Treasury
Washington, DC 20220
1. Henry Paulson, the chief executive officer of Goldman Sachs,
this week lamented the fact that faith among U.S. investors in
corporate executives is at an all-time low, and that this lack of
confidence was forestalling a recovery in our U.S. financial markets.
Paulson said, ``I cannot think of a time when business over all has
been held in less repute.'' However, his concerns are not necessarily
shared by other corporate executives. John Trani, the chief executive
officer of Stanley Tools also said this week of his decision to move
Stanley to Bermuda, ``If you are taking your stewardship seriously, I
think you have to do what I did.'' And he added if he had it to do over
again, he would have done it earlier.
Does the Treasury Department share the concerns of Mr. Paulson?
Does the Treasury Department believe that corporations fleeing for
offshore tax havens will harm the image of corporate America? Further,
does Treasury believe that any such perceptions of greed or disloyalty
will lead to a lack of investor confidence hurting our U.S. financial
markets?
The Treasury Department is very concerned about U.S.-based
multinational companies moving their place of incorporation to outside
the United States in order to reduce their U.S. income taxes. These so-
called inversion transactions provide a substantial reduction in taxes
through a transaction that is complicated technically but virtually
transparent operationally. Our tax law should not operate to permit
that to occur. As Secretary O'Neill has said, ``When we have a tax code
that allows companies to cut their taxes on their U.S. business by
nominally moving their headquarters offshore, then we need to do
something to fix the tax code.''
An immediate response is needed to eliminate the juice from these
inversion transactions. We must eliminate the ability to engineer ways
to inappropriately reduce the U.S. tax on income earned in the United
States. The response to these transactions should be broad enough to
address the underlying differences in the U.S. tax treatment of U.S.-
based companies and foreign-based companies, including the ability to
reduce the U.S. corporate-level tax on income from U.S. operations.
Inappropriate shifting of income from the U.S. companies in the
corporate group to the foreign parent or its foreign subsidiaries
represents an erosion of the U.S. corporate tax base. It provides a
competitive advantage to companies that have undergone an inversion or
otherwise operate in a foreign-based group. Moreover, exploitation of
inappropriate income-shifting opportunities erodes confidence in the
fairness of the tax system.
2. This week's major newspapers feature the scandal enveloping
Tyco, a former U.S. company now headquartered in Bermuda. Back in 1999,
Tyco argued before the SEC that it should not be bound by SEC rules
with regard to shareholder proposals because it was not incorporated in
the U.S. More recently, a Stanley public statement warns, ``It may be
difficult for you to enforce judgments obtained against Stanley Bermuda
in the U.S. courts.
Does the Treasury Department have a concern that U.S. investor
rights, including those of state pension funds and employee
organizations, may be diminished by the exodus of former U.S.
corporations to tax havens?
Because this question regarding investor protections involves
matters outside of my area of expertise, I would refer you to the
Securities and Exchange Commission.
3. The SEC filing of Stanley states, ``It is intended that Stanley
Bermuda's business will be centrally managed and controlled in
Barbados.'' However, Stanley has stated that the move to Bermuda is to
lower U.S. taxes on U.S.-source income.
Does Treasury have a concern that the use of Barbados in this
situation will be in order to exploit treaty provisions which might
allow a company to avoid U.S. taxes on U.S.-source income as well? Does
Treasury have the same concern with the use of Luxembourg by Accenture
and PWC, in addition to being based in Bermuda?
The Treasury Department is concerned about the possible use of
income tax treaties to inappropriately reduce U.S. taxes on U.S. source
income. To address this concern, we are reviewing and evaluating our
tax treaties to identify any inappropriate reductions in U.S.
withholding tax that provide opportunities for shifting income out of
the United States. We must ensure that our treaties serve the intended
purpose of reducing or eliminating double taxation of income, not
eliminating all taxation of income. Treaties that do not operate
consistently with this goal will be modified to do so. We also must
examine whether anti-abuse mechanisms already within our treaties are
operating properly. Because U.S. tax treaties are intended to benefit
only residents of either the United States or the treaty partner, U.S.
income tax treaties include detailed provisions to prevent the misuse
of treaties by residents of third countries. One of Treasury's key tax
policy goals in modernizing our network of existing tax treaties is to
bring the limitations on benefits provisions in all our treaties up to
current standards so as to remove the opportunity for such misuse.
4. The reinsurance transaction to tax haven parent corporations is
designed specifically to avoid U.S. tax on U.S.-source income. This is
true regardless of whether there has been an inversion by the insurance
companies involved. This is distinguishable from other cases where
companies are primarily avoiding U.S. tax on foreign-source income. So
in the case of reinsurance, there is no broader tax policy question of
whether our tax code should permit foreign-based reinsurers to avoid
U.S. tax on U.S.-source income.
Does the Treasury Department share the concern that insurance
companies are using related-party reinsurance transactions to avoid
U.S. tax on U.S.-source income, a clear an egregious tax avoidance
situation? Do you agree that a general fix on inversions will not solve
the problems of tax avoidance by reinsurance? And, after 3 years of
study and evaluation of this specific issue, what specifically do you
recommend to eliminate the reinsurance abuse if you do not support the
provisions of the Johnson-Neal bill, H.R. 1755?
The Treasury Department is concerned about the use of related party
reinsurance to avoid U.S. tax on U.S.-source income. In particular, the
use of related party insurance may permit the shifting of income from
U.S. members of a corporate group to a foreign affiliate. Existing
mechanisms for dealing with insurance transaction are not sufficient to
address this situation. In this regard, further analysis may be
appropriate to consider and evaluate approaches to address the problems
presented by related party reinsurance. Such analysis should include an
examination of methods used by our trading partners in taxing insurance
companies, including, for example, the use of some countries of a
premium-based tax that captures with the country tax base all business
written on risks within the country.
[Submissions for the record follow:]
Statement of the AFL-CIO
The AFL-CIO is pleased to have the opportunity to express our
concerns about American companies reincorporating to tax havens such as
Bermuda. We commend Chairman Thomas and Ranking Member Rangel for
holding these important hearings.
A growing number of companies are seeking to ``reincorporate'' from
the U.S. to tax haven countries to avoid paying taxes on non-U.S.
income. In general, the disadvantages of these reincorporations
outweigh the advantages for shareholders because these reincorporations
reduce the legal protections given to shareholders and also reduce
shareholders' ability to hold companies, their officers and directors
accountable in the event of wrongdoing.
In light of highly-publicized recent events at other publicly
traded companies such as Enron and Tyco International, worker pension
funds have become more sensitive to issues of corporate accountability.
We want to be sure we are able to seek appropriate legal remedies on
behalf of our worker beneficiaries in the event of any corporate
wrongdoing--when companies elect to incorporate in Bermuda our ability
to do so is limited.
We believe this trend represents a significant threat to
shareholders and the pension funds of working people. These
reincorporations can diminish shareholders' rights, and set in motion a
``race to the bottom'' that generally lowers the standards of corporate
accountability.
On June 14th, Nabors Industries is seeking shareholder approval to
reincorporate to Bermuda. A coalition of institutional investors--the
Amalgamated Bank, the AFL-CIO, the Central Laborers' Pension Fund and
the Laborers' International Union of North America--are opposing the
move based on concerns about its adverse impact on shareholder rights
and doubts over the economic benefits of the reincorporation. The
principle reason Nabors gives for reincorporating is lower tax bills,
although Nabors does not quantify the savings. In our effort to
preserve shareholder rights and corporate accountability at Nabors, we
have gained the support of several influential public pension funds,
and investment management community is becoming increasingly concerned
about the effects of these reincorporations on shareholder rights.
Delaware is the state of incorporation for 60% of Fortune 500
companies, according to the Delaware Division of Corporations. We
believe that so many companies choose to incorporate in Delaware
because it has an advanced and flexible corporate law, expert
specialized courts dealing with corporate-law issues, a responsive
state legislature and a highly-developed body of case law that allows
corporations and shareholders to understand the consequences of their
actions and plan accordingly. Bermuda, by contrast, does not even have
published reports of legal cases, making it difficult to determine how
the courts have ruled on corporate law issues. It is also difficult to
obtain access to books on Bermuda law, since public law library
resources are almost non-existent. We believe the stability,
transparency and predictability of Delaware's corporate-law framework
are superior to Bermuda's and provide advantages to shareholders.
While many investors have concerns about aspects of corporate law
statutes and the interpretation of those statutes in Delaware, and
shareholder activists have long worried that incorporation in Delaware
represented a race to the bottom, Delaware law is clearly superior to
Bermuda law from a shareholder perspective.
Reincorporation in Bermuda substantively reduces shareholder rights
and corporate accountability. In those areas of the law under which
shareholders continue to enjoy the same rights--for example federal
securities law--shareholder's substantive rights may not be effected by
the reincorporation, but their procedural ability to enforce those
rights is weakened.
By incorporating in Bermuda companies may make it more difficult
for shareholders to hold companies, officers and directors legally
accountable in the event of wrongdoing. It is crucial that shareholders
have ability to pursue legal remedies to deter wrongdoing. If a company
reincorporates to Bermuda, it may be more time consuming and expensive
to hold that company or its officers and directors accountable in U.S.
courts for several reasons.
A judgment for money damages based on civil liability rendered by a
U.S. court is not automatically enforceable in Bermuda. The U.S. and
Bermuda do not have a treaty providing for reciprocal enforcement of
judgments in civil matters. A Bermuda court may not recognize a
judgment of a U.S. court if it is deemed contrary to Bermuda public
policy, and Bermuda public policy may differ significantly from U.S.
public policy.
Unlike Delaware, Bermuda does not generally permit shareholders to
sue corporate officers and directors derivatively--on behalf of the
corporation--to redress actions by those persons that harm the
corporation. Shareholder derivative suits recognize that a corporation
is unlikely to pursue claims against the same officers and directors
who control it and provide, we believe, a critical mechanism for
remedying breaches of fiduciary duty, especially breaches of the duty
of loyalty. Derivative litigation also, in our opinion, serves to
protect the market for corporate control and thus promotes efficiency
and accountability.
Bermuda law differs from Delaware law in ways that may limit
shareholders' ability to ensure accountability and participate in
corporate governance. Bermuda law requires unanimous written consent of
shareholders to act without a shareholders' meeting. Delaware law
contains no such prohibition, although it allows companies' charters to
limit the right. In the event a Delaware company does elect to include
such a provision in its charter, shareholders can request that the
board initiate a charter amendment to remove it.
Unlike Delaware law, Bermuda law does not require shareholder
approval for a corporation to sell, lease or exchange all or
substantially all of the corporation's assets. Thus, a Bermuda company
can significantly change its business without seeking shareholder
approval.
At Bermuda companies like Tyco and Global Crossing, shareholders
appear to have been unable to assert the kinds of legal claims for
breach of fiduciary duty one would expect to see given what has
occurred at those companies.
In addition, when worker funds have attempted to exercise basic
shareholder rights under federal securities laws, Tyco has taken the
position that those laws did not apply to Tyco in the same way they
applied to U.S. incorporated companies.
It concerns us that many of these transactions have been structured
in a way that executives receive large payments in connection with the
reincorporations. The combination of these structures and reduced
accountability suggest that management may have other reasons to
reincorporate besides tax benefits.
We understand there is bi-partisan support for a legislative
response to this problem, and we encourage Congress to take swift
action. The AFL-CIO is in full support of the legislation introduced by
Rep. Neal (H.R. 3884).
Beyond our shareholder concerns, we believe that it is unpatriotic
for corporations to place a larger burden on other taxpayers while
still benefiting from the stability and privileges this country
provides. America's working families pay their taxes, and expect that
American corporations will do the same. Simply put, reincorporation is
a poor decision and should be reevaluated by all who promote good
corporate citizenship and governance.
The AFL-CIO urges this Committee and this Congress to support
legislation that puts a stop to these corporate inversions. The AFL-CIO
looks forward to working with you in the coming days on this important
task.
Coalition for Tax Competition
Alexandria, VA 22310-9998
April 24, 2002
The Honorable William Thomas
Chairman
Committee on Ways and Means
United States House of Representatives
1102 Longworth House Office Building
Washington, DC 20515
Dear Chairman Thomas:
American-based companies must pay tax to the IRS on income earned
in other nations. This ``worldwide'' system of taxing corporate income
is very anti-competitive, causing many companies to give up their U.S.
charters and instead become foreign-based companies. These
``expatriations'' are legal, but have become controversial. Lawmakers
likely will choose from two options in deciding how best to respond to
this development.
One option is tax reform. Lawmakers could take a number of steps to
make the internal revenue code more competitive. The U.S. corporate
income tax rate, for instance, is the fourth highest in the developed
world. Lower tax rates would make America more attractive. Policy
makers also could eliminate the corporate alternative minimum tax.
Another option is to reduce the tax bias against investment by shifting
from ``depreciation'' to ``expensing.'' Last but not least, Congress
could junk ``worldwide'' taxation and instead shift to a
``territorial'' system that would tax companies only on their U.S.
income.
The other option is to preserve ``worldwide'' taxation and instead
impose restrictions on the ability of companies to re-charter in other
jurisdictions.
The first option--tax reform--is the correct answer. If bad tax law
is driving companies to re-charter in other jurisdictions, the obvious
solution is to improve U.S. tax law. This market-based approach will
make America more competitive. Fiscal protectionism, by contrast, is
bad policy. We all understand that high-tax California should not be
allowed to stop companies from moving to low-tax Nevada. We also should
understand that the federal government should not be able to stop
companies from escaping bad U.S. tax law.
This issue already has been clouded by demagoguery. Some assert
that companies choosing to re-charter in other jurisdictions will evade
or avoid U.S. tax. This is not true. All corporations, regardless of
where they are based, pay tax to the IRS on all profits they earn in
the United States. Some also claim that ``expatriation'' is unpatriotic
and hurts America. This is nonsense. Re-chartering helps U.S. workers
and U.S. shareholders since the newly formed company still maintains
its U.S. operations, but now is able to more effectively compete with
businesses that operate overseas.
Corporate relocation is yet another reason why lawmakers should fix
the internal revenue code. Companies are relocating because excessive
tax burdens and worldwide taxation make it very difficult for U.S.-
chartered firms to compete. Instead of making a bad system even worse
by imposing more burdens on U.S.-based companies, lawmakers should
reform the tax system. Lower tax rates and territorial taxation are
just two of many options that would improve the internal revenue code.
Sincerely,
Andrew F. Quinlan, President, Center for Freedom and Prosperity
Daniel Mitchell, Senior Fellow, Heritage Foundation
Veronique de Rugy, Fiscal Policy Analyst, Cato Institute
Paul Beckner, President, Citizens for a Sound Economy
David R. Burton, Senior Fellow, Prosperity Institute
James Cox, Executive Director, Association of Concerned Taxpayers
Stephen J. Entin, President, Institute for Research on the
Economics of Taxation
Tom Giovanetti, President, Institute for Policy Innovation
Kevin Hassett, Resident Scholar, American Enterprise Institute
Lawrence Hunter, Chief Economist, Empower America
Charles W. Jarvis, Chairman, United Seniors Association
Karen Kerrigan, Chairman, Small Business Survival Committee
James L. Martin, President, 60 Plus Association
Edwin Moore, President, James Madison Institute
Steve Moore, President, Club for Growth
Grover Glenn Norquist, President, Americans for Tax Reform
John Pugsley, Chairman, Sovereign Society
Richard Rahn, Senior Fellow, Discovery Institute
Gary and Aldona Robbins, Fiscal Associates, Inc.
Tom Schatz, President, Council for Citizens Against Government
Waste
Eric Schlecht, Director of Congressional Relations, National
Taxpayers Union
Fred L. Smith, President, Competitive Enterprise Institute
Lewis K. Uhler, President, National Tax Limitation Committee
Paul M. Weyrich, National Chairman, Coalitions for America
Christopher Whalen, Whalen Consulting Group
* Organizational affiliations are included for identification
purposes only.
cc. Senate Majority Leader Trent Lott
Senator Max Baucus
Senator Charles Grassley
House Majority Leader Richard Armey
Representative William Thomas
Secretary Paul O'Neill
Dr. Glenn Hubbard
Dr. Larry Lindsey
[Identical letter was sent to Ranking Member Rangel.]
Statement of the Hon. Richard Blumenthal, Connecticut Attorney General,
Hartford, Connecticut
I appreciate the opportunity to speak on the issue of corporate
inversions, a hyper-technical term for corporations exploiting tax law
loopholes and corporate directors and management profiting and
protecting themselves from proper accountability.
I urge your support for legislation such as H.R. 3884, the
Corporate Patriot Enforcement Act that would permanently close a
loophole in our laws that permits corporations to abandon America and
abrogate their moral responsibility to this country.
Long-time American corporations with operations in other countries
can avoid paying tens of millions of dollars in federal taxes by the
device of reincorporating in another country, thereby becoming a
``foreign company'' under our tax laws that does not pay taxes on
profits from its foreign operations. How do they become a ``foreign
company''? They simply file incorporation papers in a country with
friendly tax laws, open a post-office box and hold an annual meeting
there. They need have no employees in that country or investments in
that country--in short, no financial stake there at all. It is a sham,
a ``virtual'' foreign corporation--and our tax laws not only allow this
ridiculous charade, they encourage it. This is a tax law that has run
amok. It is a tax loophole that must be slammed shut.
Bermuda may seem close geographically and familiar in language and
customs, but it might as well be the moon in terms of legal rights and
protections for shareholders. In pitching reincorporation, management
has repeatedly misled shareholders--failing to reveal the real long
term costs, and concealing even the short term financial effects.
Apologists for this loophole say that the corporation must do this
to ``compete'' on a global scale with foreign-based corporations whose
countries do not assess the same level of corporate taxes as American
companies. What they ignore is the fact that those countries do not
provide the kinds of governmental services and legal protections as the
United States does. So these corporations become ``foreign'' companies
in name only to reduce their federal taxes, yet keep their businesses
in the United States to benefit from the very services and protections
those taxes pay for.
These ``foreign competition'' arguments are the same ones used to
weaken our tough air and water pollution standards and worker
protections and benefits. The bottom line: America should not
compromise its standards just so corporations can earn higher profits,
and certainly America should not have tax laws that encourage
corporations to move a few filing cabinets to other countries and call
them a corporate headquarters.
Connecticut has learned this lesson the hard way from Stanley
Works, the most recent--and potentially the most notorious--corporation
to attempt to avoid taxes through this corporate shell game. Stanley
Works is a proud American company that is based in the industrial town
of New Britain, Connecticut. For more than 150 years, it has been a
manufacturer of some of the best-known American-made tools.
Over the past 20 years, however, it has moved a lot of its
manufacturing overseas where cheaper labor means more profits. In fact,
it has moved so much of its operations that it was in danger of losing
its ability to claim that its products were made in America, a major
selling point. Several years ago, there was an attempt to weaken the
standards for claiming products are ``made in the USA''. This proposed
rule would have allowed corporations to use the ``made in the USA''
label on products that were mostly made in other countries, with only
the finishing touches applied here. It was nothing less than an attempt
to create the ``veneer'' of American craftsmanship. I, along with many
others, strongly opposed this weakened standard and it was eventually
withdrawn.
It is no surprise then that this same company would attempt to sell
its American citizenship for $20-30 million pieces of silver. By
reincorporating in Bermuda, hundreds of millions of dollars in profits
from its foreign divisions would be tax-exempt in the United States.
Stanley Works, of course, is not the only company to use this tax law
loophole. Cooper Industries, Seagate Technologies, Ingersoll-Rand and
PricewaterhouseCoopers Consulting, to name but a few others, have also
become pseudo-foreign corporations for the sole purpose of saving tax
dollars.
While profits may increase as a result of this foreign
reincorporation gimmick, there are some significant disadvantages to
shareholders that may not be readily apparent to them. Shareholders
must exchange their stock in the corporation for new foreign
corporation shares--generating capital gains tax liability. So while
the corporation saves taxes, employees and retirees who hold shares are
now unexpectedly facing significant capital gains tax bills. Some must
sell many of the new shares in order to pay the capital gains tax--
reducing the dividend income they were counting on for their
retirements.
At the same time, corporate executives and other holders of
thousands of shares of the corporation will receive huge windfalls in
stock options as the stock price rises because of increased profits.
Stanley Works estimates that its stock may rise by 11.5% after re-
incorporation in Bermuda. That increase results in a $17.5 million gain
in CEO John Trani's stock option value while shareholders are facing
$150 million in capital gains taxes. Smaller shareholders, of course,
do not have huge stock option gains that they can use to pay the
capital gains tax.
Incorporating in another country may also restrict shareholder
rights because that country's laws may not be as protective of
shareholders as the United States. This issue is not apparent to many
shareholders because they may look at re-incorporation as a merely
technical move with only corporate tax implications. The company's
headquarters remains in the United States so shareholders may think
that American laws will still apply. Management has been in no rush to
clarify the weakening, even eviscerating of shareholder rights to hold
management accountable.
Taking advantage of corporate tax loopholes, corporations,
including Stanley Works, typically reincorporate in Bermuda. Bermuda
law differs from the corporate law of most states in several very
important respects.
First, there is the simple problem of the opacity of Bermuda law.
Even sophisticated shareholders may have extreme difficulty in
obtaining information about Bermuda law and evaluating the impairment
of their rights under Bermuda law. Bermuda does not even maintain an
official reporter of its court decisions. We have learned from the
Enron scandal the danger for shareholders, employees and regulators of
shielding important corporate information from public scrutiny. The
movement of corporations to a place where the legal rights of
shareholders are severely constrained and confused--indeed at best
unclear--is a matter of grave concern.
Corporations proposing to move their place of incorporation from
the United States to Bermuda, such as Stanley, often tell shareholders
that there is no material difference in the law. But from what we have
been able to learn about Bermuda law--and divining Bermuda law is no
easy task--this claim is certainly not accurate. There are several
important aspects of Bermuda law that greatly diminish shareholder
rights.
For example, Bermuda law lacks any meaningful limitations on
insider transactions. Connecticut law, like the law of most states,
imposes significant restrictions on corporate dealings with interested
directors of the corporation--the kind of restrictions that appear to
have been violated in the Enron debacle. Those protections appear to be
absent under Bermuda law.
Bermuda law also fails to provide shareholders with any decision-
making authority on fundamental changes in the corporation. Connecticut
law, like statutes of most states, requires that shareholder approval
be obtained before the corporation may sell or dispose of a substantial
portion of the assets of the corporation. Bermuda law contains no such
requirement.
Similarly, Bermuda law permits shareholder derivative lawsuits in
only very limited circumstances. Derivative lawsuits are an essential
protection for shareholders. In the United States, shareholders may
bring actions on behalf of the corporation against officers and
directors seeking to harm the corporation. The availability of
derivative lawsuits is a profoundly important tool to protect
shareholders from the malfeasance and self-interest of officers and
directors. It is a central tenet of American corporate governance. This
form of protection is apparently all but unavailable under Bermuda law.
In addition, there are serious questions about the enforceability of
U.S. judgments in Bermuda. There is presently no treaty with Bermuda
that ensures the reciprocity of judgments. Thus, a person who has
successfully prosecuted a federal securities claim or products
liability lawsuit in the United States against the corporation, for
example, may be unable to enforce that judgment against the corporation
in Bermuda. Bermuda courts have the right to decline to enforce an
American judgment if they believe it is inconsistent with Bermuda law
or policy. Bermuda may be not just a tax haven, but also a judgment
haven.
Finally, a Bermuda incorporation will greatly impede my office or
any state Attorney General in protecting the public interest and
safeguarding shareholder rights including the state's--stopping a
shareholder vote, for example, if shareholders are provided with
misleading information. Earlier this year in Connecticut, Stanley Works
had issued conflicting statements to 401k shareholders. The first
statement said that failure to vote would be counted as a ``no'' vote.
The second one said that failure to vote would allow the 401k
administrator to cast a ballot consistent with the 401k plan. My
office, representing the state of Connecticut as a shareholder, filed
an action in state court that halted the vote because of the tremendous
confusion caused. Whether I could have taken a similar action had
Stanley Works been incorporated in Bermuda is at best unclear.
The misstatements made by Stanley Works management were so
misleading and potentially deceptive, that I have requested a full
investigation by the Securities and Exchange Commission (SEC) and an
order delaying any revote until such an investigation is complete. I am
awaiting a response from the SEC.
Some corporation proxy statements may seek to assure shareholders
that the new corporation bylaws will restore some of these lost
shareholder rights. This substitute is simply inadequate. If corporate
bylaws were sufficient to protect shareholder rights, we would not need
federal and state securities laws.
In sum, reincorporation in another country like Bermuda is not in
the best interests of American shareholders. Corporate CEOs, whose
compensation is typically tied to short-term gains in stock price or
cash flow, often gain millions in additional pay stemming directly from
the tax savings obtained by these moves and will be better able to
engage in insider transactions. They are less exposed to shareholder
derivative lawsuits and federal securities action. They are shielded
from shareholders seeking to hold them accountable for misjudgments or
malfeasance. The incentive for corporate officers to make the move to
Bermuda is obvious. But it is patently detrimental to the interests of
ordinary shareholders, and to the United States, to leave this loophole
available for exploitation.
I urge the Committee to first approve legislation that will
permanently close this loophole and then determine whether our tax laws
need to be changed to address inequity concerns that have been raised.
The Treasury Department's preliminary report listed several areas for
review, including rules limiting deduction for interest paid on foreign
related debt, rules on valuations on transfers of assets to foreign
related parties and cross-border reorganizations. I do not endorse any
specific proposal for tax law change, or even necessarily general
change itself. What I endorse strongly and unequivocally is the need
for closing this destructive loophole, as HR 3884 would do. The status
quo is unacceptable.
DIMON Incorporated
Danville, Virginia 24543-0681
June 4, 2002
Via e-mail
[email protected]
Congressman Bill Thomas
Chairman of the Committee on Ways and Means
c/o Committee on Ways and Means
1100 Longworth House Office Building
Washington D.C.
Gentlemen:
[1] I am writing you concerning your review of corporate inversions
and U.S. international competition.
[2] I am Vice President of Taxes for DIMON Incorporated
(``DIMON''). DIMON is a NYSE multinational tobacco leaf dealer (symbol
``DMN''). We source, process and trade in tobaccos from more than 40
countries all over the world. I am a CPA and lawyer and have an LLM in
Taxation from Georgetown Law Center. Prior to joining DIMON, six years
ago, I was a Senior Manager in the Washington National Tax Practice of
PricewaterhouseCoopers LLP in Washington DC for ten years.
[3] I have been following the recent corporate inversions with some
interest because I am aware of how our U.S. corporate tax system
punishes U.S. based multinational companies. Every day DIMON competes
with non-U.S. tobacco traders who have the ability to move funds and
structure transactions more efficiently than DIMON can because DIMON is
a U.S. corporation and they are not. This punishment arises from
Congressional fiat. Specifically, the source of the trouble can be
found in three places in the Internal Revenue Code (Title 26): (1)
Subpart F (Sections 951 through 972), (2) Foreign Tax Credit rules
(Sections 901 through 908) and (3) Corporate Alternative Minimum Tax
rules (Sections 55 through 59). The collective force of these
provisions have driven U.S. companies, such as McDermott, Helen of
Troy, Tyco, White Mountain, and Stanley Works to consider
reincorporating outside the U.S.A.
[4] What concerns me especially is the hysterical reaction by
members of Congress regarding these corporate inversions. Some members
of Congress have referred to corporate inversions as ``unpatriotic''.
Other members refer to inversions as a ``tax loophole''. In a press
release accompanying the announcement of proposed remedial legislation,
Senator Charles E. Grassley said ``These expatriations aren't illegal,
but they're sure immoral. During a war on terrorism, coming out of a
recession, everyone ought to be pulling together. If companies don't
have their hearts in America, they ought to get out.'' Representative
Richard E. Neal's anti-inversion Bill, introduced on March 6, 2002, was
proposed to be effective immediately for those corporations that
expatriate after an effective date clearly chosen for political
reasons-- September 11, 2001. Similarly, a recently proposed Bill to
combat inversions was introduced as the ``Uncle Sam Wants You Act of
2002.'' The controversy over inversions may also become an issue in
upcoming Congressional elections.
[5] What as been ignored in these comments is that corporate
inversions are fully taxable events under I.R.C. Section 367(a). White
Mountain, for example, estimated that their inversion into Bermuda
would generate a current tax expense of approximately $40m. Stanley
Works estimated it would cost its shareholders approximately $120m.
These significant short-term costs are generally justified as necessary
to allow the inverting company to position themselves to compete better
in the international arena. Specifically, the long-term benefit is that
an inversion allows the inverted company to reinvest every dollar of
profit earned in growing their business outside the U.S.A., instead of
paying 35 cents to the U.S. Treasury and only having 65 cents to invest
in growth. This is because the existing rules under Subpart F are
overreaching.
[6] Most people who are not tax professionals are surprised to
discover that if a subsidiary of a U.S. based company sells a product
manufactured in Brazil to a customer in Poland, for example, the profit
on that sale is fully and currently taxable in the U.S., even if U.S.
management had no involvement in the transaction and if the funds are
permanently reinvested outside the U.S.A. This strange outcome results
from the Subpart F rules concerning Foreign Base Company Sales Income,
which can be found in I.R.C. Section 954(a)(2). If the U.S.
multinational corporation wants to reinvest those profits in growing
their markets outside the U.S.A., it must do so after paying 35% in
taxes to the U.S Treasury. The U.S. taxpayer's non-U.S. competitor does
not have that added cost. Therefore, due to the U.S. tax rules the cost
of capital for a U.S. company is 35% greater than their competitor. In
order to invest $1 the U.S. company must earn $1.54, while its foreign
competitor only needs to earn $1.
[7] If the U.S. taxpayer corporation wants to repatriate the
profits from abroad to provide for growth in the U.S. in theory foreign
tax credits are available to offset any U.S. taxation on the
repatriation of dividends. The problem is that under corporation
alternative minimum tax rules (I.R.C. Section 59) the foreign tax
credits can only offset 90% of the alternative minimum tax. Therefore
the corporation will always have to pay tax if it repatriates profits,
even if those profits are being taxed under the nondeferral rules of
Subpart F (in other words, the money is not in the U.S. to pay the
tax). This also sounds strange and unusually complex to a non-tax
professional, and it should. Additionally, the basketing rules under
Section 904 create many traps whereby there can be U.S. taxation if the
timing of the dividend is not carefully planned.
[8] Why punish U.S. based multinational corporations? What is the
policy behind laws that encourage companies to leave the U.S? Why
encourage great American companies like IBM and Coca Cola to move out
of the United States? Members of both the House of Representatives and
the Senate thus far have introduced six separate Bills to combat the
perceived abuses related to inversion transactions. All of the Bills
rely primarily on the technique of treating the new foreign corporate
parent as a domestic corporation for United States federal tax
purposes, although one of the most recent Bills also uses other
measures to combat ``limited'' inversion transactions. All of the Bills
focus on a hypothetical transaction where (1) a foreign corporation
acquires stock or substantially all of the property of a domestic
corporation or partnership, and (2) more than 50% or 80% of the stock
of the foreign corporation, determined by vote or value, is held by
former shareholders of the domestic corporation or partnership. Several
of these bills provide an exception if substantial business operations
also leave the United States. Four of the Bills were introduced by
House Members and two of the Bills were introduced by Senators. They
are as follows:
H.R. 3857, introduced by Representative McInnis on March 6,
2002, effective for transactions after December 31, 2001.
H.R. 3884, introduced by Representative Neal and others on
March 6, 2002, effective for transactions completed after
September 11, 2001, and would also apply after 2003 to
transactions completed on or before September 11, 2001. This
Bill is known as the ``Corporate Patriot Enforcement Act of
2002.''
H.R. 3922, introduced by Representative Maloney on March 11,
2002, effective for transactions completed after September 11,
2001 (and certain pre-September 11, 2001, transactions).
H.R. 4756, introduced by Representative Johnson on May 16,
2002, effective for transactions completed after September 11,
2001 and not to apply to transactions beginning after December
31, 2003. This Bill is known as the ``Uncle Sam Wants You Act
of 2002.''
S. 2050, introduced by Senator Wellstone and others on March
21, 2002, effective for taxable years of any ``inverted
domestic corporation'' beginning after December 31, 2002,
without regard to whether the corporation became an inverted
domestic corporation before, on, or after such date.
S. 2119, introduced by Senators Baucus and Grassley and others
on April 11, 2002, effective for transactions occurring on or
after March 21, 2002 (and the pre-approval process would be
effective for certain transactions occurring before March 21,
2002). This Bill is known as the ``Reversing the Expatriation
of Profits Offshore Act `` (the ``REPO Bill'').
[9] The House Bills and the Bill introduced by Senator Wellstone
are essentially the same, in that they all seek to prevent a
transaction whereby a domestic corporation or partnership expatriates
in order to avoid U.S. income tax. Each of these Bills provides that a
foreign corporation will be treated as a domestic corporation if (1) a
foreign corporation acquires directly or indirectly substantially all
of the properties held directly or indirectly by the domestic
corporation, and (2) former shareholders of the domestic corporation
receive more than 80% of the foreign corporation's stock. The 80%
threshold is reduced to 50% if the foreign corporation has no
substantial business activities in the country of its organization and
is publicly traded and the principal market for the public trading is
in the United States. The way to avoid the lower threshold is to move
assets and jobs to a foreign location and re-list the Corporation on
the London Stock Exchange. This, of course, promotes an even more
radical exodus from America. The Bills also cover transactions in which
a foreign corporation acquires directly or indirectly substantially all
of the properties constituting a trade or business of a domestic
partnership and the foregoing requirements are otherwise satisfied.
[10] The REPO Bill introduced by Senators Baucus and Grassley is
more comprehensive and appears to build on the concepts used by the
others. This Bill targets two types of transactions--``pure'' inversion
transactions and ``limited'' inversion transactions. In a ``pure''
inversion transaction, (1) a foreign incorporated entity acquires,
directly or indirectly, substantially all of the properties of a
domestic corporation (or a domestic partnership) in a transaction
completed after March 20, 2002; (2) after the acquisition, the former
shareholders (or partners) of the domestic corporation (or partnership)
hold 80% or more of the vote or value of the stock of the foreign
corporation; and (3) the foreign corporation, including its ``expanded
affiliated group,'' does not have substantial business activities in
its country of incorporation. Under the REPO Bill, in a ``pure''
inversion transaction, the new foreign parent corporation would be
deemed a domestic corporation for U.S. tax purposes. The solution is to
move ``substantial business activities'' out of the United States into
the country of incorporation.
[11] A ``limited'' inversion transaction is similar to a ``pure''
inversion transaction except that the shareholders of the domestic
corporation obtain more than 50% and less than 80% of the vote or value
of the stock of the foreign corporation. ``Limited'' inversion
transactions also include a ``pure'' or ``limited'' inversion
transaction completed on or before March 20, 2002. Under the REPO Bill,
in a ``limited'' inversion transaction, the foreign corporation will
not be treated as a domestic corporation, but there are a number of
other consequences: (1) no offsets such as NOLs or other credits could
be applied to reduce tax on gain realized by a domestic corporation on
the inversion transaction or on subsequent transfers of stock or
property to related foreign persons; (2) for 10 years after the date of
the inversion transaction (or, if later, January 1, 2002) the domestic
corporation and its U.S. affiliates would be required, at such time as
may be specified by the IRS, to enter into annual pre--approval
agreements as specified by the IRS to ensure the integrity of the
earnings stripping, gain and loss and intercompany pricing rules of
Sections 163(j), 267(a)(3), 482, and 845 for each taxable year within
that 10-year period; and (3) the earnings stripping rules would be
revised in order to eliminate the 1.5 to 1 debt-to-equity threshold and
reduce the taxable income offset from 50% to 25%. The REPO Bill would
also amend Section 845 to expand the reallocation authority of the IRS
over related party reinsurance agreements to include adjustments
necessary to reflect the proper ``amount,'' as well as ``source and
character,'' of taxable income of each of the parties. The Section 845
amendment would apply whether or not an inversion transaction has
occurred, effective for risks reinsured in transactions after April 11,
2002.
[12] These bills promote bad policy. They would not only encourage
American companies to reincorporate outside the U.S.A., they would also
encourage the headquarters and jobs to leave with the corporation. The
reason they would encourage American companies to reincorporate abroad
is because none of these bills address the problem. Companies are not
inverting to non-U.S.A. locations because their management is
unpatriotic and immoral. They are inverting because the U.S. tax code
is punishing them. None of these bills address the overreaching effect
of Subpart F and the costs of corporate alternative minimum tax.
[13] The solution is not to further tax fully taxable transactions.
It is to make the U.S. corporate income tax regime less punitive to
multinational corporations. The way to do this is as follows:
LRepeal corporate alternative minimum tax,
LRepeal or significantly reduce the reach of Subpart F
LGreatly simplify the basket rules under the foreign
tax credit provisions Section 904, or change the rules to
exclude foreign income from taxation, similar to the
``participation exemption'' most European countries use.
[14] These changes could be funded, at least partially, from the
windfall from repealing the ETI regime, which has been deemed to
violate GATT.
* * * * *
[15] I hope these comments are helpful in your efforts to stem
corporate inversions and enhance U.S. international competition. Please
do not hesitate to contact me at (434) 791-6734, or via e-mail at
[email protected], to discuss this matter further.
Respectfully submitted,
Greg Bryant
Vice President of Taxes
Statement of Gary Hufbauer, Reginald Jones Senior Fellow, Institute for
International Economics
Chairman Thomas and members of the Committee, thank you for
inviting me to comment on ``corporate inversions''. An inversion occurs
when a U.S. parent corporation with foreign subsidiaries (controlled
foreign corporations, or CFCs) reorganizes itself in the following
manner. First it creates a new foreign parent corporation (FP), based
in a low-tax country such as Bermuda. The U.S. operations then become a
subsidiary corporation to FP. The former foreign subsidiaries (CFCs) of
the U.S. parent corporation also become subsidiaries of FP. Ingersoll
Rand, Noble Corporation and Stanley Works are among recent corporate
inversions.
Inversions are motivated both by the U.S. parent corporation's
desire to reduce the burden of U.S. taxation on the activities of its
foreign subsidiaries and by its desire to partake in the delights of
earnings stripping. The core issue is not U.S. taxation of income from
business activity transacted entirely within the United States; rather
the core issues are U.S. taxation of income from business activity
entirely outside the United States (the extraterritorial income
problem) and the U.S. deduction for interest paid by U.S. corporations
to foreign parent corporations (the earnings stripping problem).
Back in 1975, when I was Director of the International Tax Staff in
the U.S. Treasury Department, J.L. Kramer and I co-authored an article
titled ``Higher U.S. Taxation Could Prompt Changes in Multinational
Corporate Structure''.1 Congress was then debating severe
limits on the foreign tax credit for oil and gas income, and
elimination of deferral. We argued that such changes might prompt
corporate expatriation (now called corporate inversion) on a large
scale--thus defeating the purpose of the proposed tax laws. The
proposals died in the Congress, and corporate expatriation drifted from
the public policy debate. But it did not drift from the minds of clever
tax attorneys. Every time tax regimes change in the United States or
abroad, tax advisors take a fresh look at corporate structures to see
whether reorganizations could save a pot of money.
---------------------------------------------------------------------------
\1\ International Tax Journal, Summer 1975.
---------------------------------------------------------------------------
Sure enough, over the last three decades, the United States has
created a tax atmosphere that encourages inversions, but not in the way
we feared back in the 1970s. Instead, other legislative changes in the
1980s and 1990s gradually made the United States less desirable as a
location for parent corporations (the extraterritorial income problem).
Meanwhile, foreign corporations with U.S. corporate subsidiaries
discovered that the best way to gather income from their U.S.
operations was through interest payments, not dividends (the earnings
stripping problem). Lately, some U.S. corporations have decided that
they, too, would like to take advantage of earnings stripping.
In the Reagan era, the United States sharply lowered its corporate
tax rate, initially making the United States a very attractive place to
do business. But other industrial countries soon got smart, and lowered
their corporate tax rates as well. Today, the United States is the
fourth highest corporate tax rate country in the OECD (counting both
federal and sub-federal taxes), exceeded only by Japan, Belgium and
Italy.2 If all OECD countries had the same system for taxing
foreign subsidiaries, this fact alone would make the United States an
undesirable location for parent corporations. If the same parent
corporation were located not in the United States, but in another
industrial country such as Canada, the United Kingdom, or the
Netherlands, the parent country tax burden on foreign subsidiary income
would be lower.
---------------------------------------------------------------------------
\2\ Chris Edwards, ``New Data Show U.S. Has Fourth Highest
Corporate Tax Rate'', Cato Institute Tax and Budget Bulletin, April
2002.
---------------------------------------------------------------------------
Other tax facts reinforce this basic point. Most importantly, the
norm among industrial countries is de jure or de facto exemption
systems for dividends received by parent corporations from most of
their foreign subsidiaries (those that are actively engaged in
business, not just off-shore pocketbooks). By contrast, the U.S.
worldwide tax system taxes the dividends received from foreign
subsidiaries, but allows a foreign tax credit. This is a lot more
complicated, and often results in additional tax paid by the parent
corporation.
Peculiar features of the U.S. foreign tax credit limit also make
the United States a less desirable location for parent corporations.
The United States has an absurd method for allocating parent company
interest expense to foreign source income, and the net result is to
reduce the parent corporation's allowable foreign tax credit. Unlike
other countries, the United States attributes a substantial portion of
R&E expense to foreign source income, and this too reduces the
allowable foreign tax credit.
Continuing the list of disadvantages, the United States disallows
deferral for so-called ``base company income''--income earned by a
foreign subsidiary for handling export transactions between members of
a corporate family. In other words, base company income is taxed
currently under Subpart F of the Internal Revenue Code. Other
industrial countries, for the most part, either exempt base company
income from home country taxation, or permit deferral.
Meanwhile, the WTO has ruled against the Foreign Sales Corporation
and Extraterritorial Income Exclusion Act. If these provisions are
simply repealed, that will be another negative score for the United
States.
Finally, there's the competitive tax disadvantage to the U.S.
parent corporation that competes, in the U.S. domestic market, with a
foreign parent corporation that conducts its business through a U.S.
subsidiary. The foreign parent can ``strip'' the earnings of its U.S.
subsidiary by using a capital structure high in debt and low in equity.
Interest paid to the foreign parent is a deductible expense for the
U.S. subsidiary; and after interest is paid, hardly any earnings may be
left for the U.S. corporate tax. The U.S. parent can't play the same
game, because it files a consolidated return with its U.S.
subsidiaries, and interest payments within the corporate family simply
net out. But if the U.S. parent inverts, the newly created foreign
parent can strip the earnings of its U.S. subsidiaries.
With all these tax disadvantages, it's not surprising that some
U.S. parent corporations are jumping ship. Inversions are just the tip
of the iceberg. Less noticeable, but more important, foreign
multinationals are acquiring U.S. companies at a much faster clip than
the other way around. Taxes are not the only reason, but they are a
contributing force. So long as the U.S. tax system is unfriendly to
parent corporations, and friendly to foreign parent corporations, there
will be a strong tendency for multinational companies to locate their
headquarters elsewhere. This will show up in the way mergers and
acquisitions are structured, the balance between debt and equity in
U.S. subsidiaries, the headquarter choices made by firms of the future,
and in more U.S. corporate inversions. Purely from a tax standpoint,
few attorneys today would recommend putting the headquarters of a
multinational firm in the United States. Why subject your foreign
subsidiaries to the U.S. worldwide tax system? Why deny yourself the
advantages of earnings stripping?
Congress can make inversions more difficult by ``look-through''
provisions, such as those proposed by Senator Baucus and Senator
Grassley, or by raising the toll-taxes under Sections 351 and 367.
Congress can deter earnings stripping by applying a stricter debt/
equity ratio to inverted corporations under Section 163(j). But such
remedies do not address the underlying problem--the fact that, from a
tax standpoint, the United States is not a good location for
headquartering a multinational corporation.
The extraterritorial income dimension of the underlying problem can
only be addressed by centering U.S. corporate taxation on business
activity within the territorial borders of the United States, and
exempting the activities of foreign subsidiaries engaged in trade or
business abroad. The earnings stripping dimension can only be addressed
by applying the same debt/equity ratio test to all U.S. subsidiaries of
foreign parent corporations, whether the foreign parent is an inverted
U.S. parent, or a foreign parent home-grown in another country.
In my opinion, it's far more important for the United States to
retain its position as the nerve center for multinational corporations
than to collect whatever revenue is gathered from the activities of
foreign subsidiaries by the cumbersome U.S. system of taxing worldwide
income. And it would be foolish for the United States to enact new tax
provisions (such as a discriminatory earnings stripping rule) that
would give foreign multinationals a leg up when competing in the U.S.
market.
Where headquarters are located, key corporate functions of
strategy, law, finance, distribution and R&E activity are likely to
follow. For the high-skilled, high-tech society of 21st
century America, these are critical functions. Corporate inversions are
not the fundamental problem; they are simply the wake-up call.
Statement of the Hon. James H. Maloney, a Representative in Congress
from the State of Connecticut
Chairman Thomas, Ranking Member Rangel, and members of the
Committee, thank you for holding this hearing. It is my sincere hope
that the Committee will move quickly to pass H.R. 3884, the ``Corporate
Patriot Enforcement Act of 2002'' (commonly referred to as the Neal-
Maloney bill), bring it to the floor of the House, and end the
outrageous corporate expatriation tax dodge, both immediately and
permanently.
So called ``corporate expatriates'' are former US companies who set
up paper headquarters in tax havens in order to avoid US taxes. For
little more than the cost of a post office box in an offshore tax haven
like Bermuda, US companies are trying to avoid millions of dollars in
federal income taxes. Some of these expatriates are even using third
countries, with which the US government has tax treaties, in order to
avoid paying virtually ALL of their tax obligations.
These companies continue to reside in the United States, take
advantage of our infrastructure, our education system, our water
systems, federal, state, and local services such as police, fire, and
public schools, and, of course, they still rely on the protection of
our courageous Armed Services, here at home, and around the world. The
only difference is: they now get it all for free, while US citizens and
loyal US companies are paying the bill. Some of America's largest
corporations have engaged in such transactions, including Tyco,
Ingersoll-Rand, and Global Crossings. Ironically, some of these same
companies have large contracts to provide goods and services to the
Federal Government. Now they are saying they don't want to pay their
fair share of US taxes. This is outrageous, and must be permanently
stopped.
These Bermuda tax avoidance schemes are especially unpatriotic in
light of our current economic and national security situation. We are
now seeing a major, growing budget deficit. The Wall Street Journal
reported on June 4, 2002 that the federal deficit could total as much
as $200 billion next year. The huge federal surplus we had only a year
ago has been wiped-out. Corporate expatriates contribute to the
growing, long-term budget deficit problem. Critical programs like
Social Security and Medicare are in serious jeopardy just as the
largest generation in the history of this country is getting ready to
retire. In addition, as our country continues its war on terrorism, and
makes efforts to improve homeland security, all or our citizens,
elected officials, and corporations should remain united and committed
to defending our homeland and eliminating terrorism. Corporate
expatriates are saying that profit gained from tax avoidance is more
important than the security and well-being of our country.
As I am sure you have heard, this tax scheme outrage is happening
in my home state of Connecticut. In September 2001, Stanley Works
announced that it was closing its last hardware manufacturing facility
in New Britain and moving it to China. In February, Stanley Works
followed-up with an announcement that its board had approved a plan to
re-incorporate in Bermuda.
More and more companies are contemplating such moves as aggressive
consultants and legal firms try to sell their clients this unpatriotic
tax dodge. In an effort to stem the tide, Congressman Richard Neal of
Massachusetts and I introduced legislation on March 6, 2002, to close
the expatriate tax loophole. Our legislation is quite simple. It states
that if you are, in fact, a domestic US corporation, you are subject to
US corporate income tax, wherever you locate your nominal headquarters.
Importantly, our legislation, with an effective date of September 11,
2001, will end this unfair tax dodge permanently.
A second important provision of our legislation would restore the
tax obligations of those companies that expatriated before 9/11. Our
legislation would give such companies until 2004 to come into
compliance. This provision, in turn, ensures that all US corporations
play by the same rules, with no one having a tax advantage.
The US Treasury Department, while recognizing the problem, has
argued that we need to study the issue. Others have proposed a tempoary
measure that would only extend through the end of 2003.
We must not wait. Certainly, the tax system needs to be reformed.
But there is no reason that fixing the immediate problem needs to be
contingent upon reforming the entire system. If your house, which may
be in need of remodeling, also has a fire in the attic, you don't do
the remodeling first. Instead, you put out the fire immediately, and
then move on to the longer range tasks. This is precisely the case
here: we need to put out the raging fire of this expatriate tax abuse--
and then move on to remodel our tax code. The calls for delay or a
study are nothing but sham excuses for failing to take the action so
obviously and urgently required.
So also in regard to any temporary measure: a nationally-syndicated
Boston Globe columnist recently wrote, ``. . . the proposal for a
moratorium is so sneaky and pernicious. . . . No one can argue why
phony expatriation to avoid taxes is good for the US or good for
anybody except the executive officers of companies who do it. So why
have a moratorium when a flat-out ban is what's needed?'' (May 28,
2002). I strongly agree. These tax schemes are a cancer on the American
tax code. They need to be eliminated now. Every day we wait, the
situation only gets worse. And you certainly would not start treatment
for cancer and then abruptly stop after 12 months. You work to get rid
of the problem once and for all! Of course, a temporary measure may
seek to serve as an election year gimmick--but it does not solve the
problem. A temporary measure is a clear breach of our responsibility to
act effectively in the interest of the American people.
In addition, the proposed temporary legislation would not apply to
those companies that expatriated before September 11, 2001. Why would
we allow those who expatriated before September 11, 2001, to continue
to escape their tax obligations? We certainly should not allow
expatriated companies to maintain indefinitely a tax advantage over
American companies that are loyal to our country. In contrast to the
temporary measure, the Neal-Maloney bill fixes the problem permanently,
and restores all US corporations to a uniform, level tax policy.
It should be stressed that these expatriate tax schemes are
seriously detrimental to many of the companies' own shareholders.
Corporations are supposed to act in the interests of their
shareholders; here they are not. Under these expatriation schemes,
individual shareholders will have to recognize capital gains taxes on
the value of their shares at the time of reincorporation, and make
immediate payment of those taxes to the IRS. For example, Stanley Works
has admitted that if they were to reincorporate in Bermuda it would
cost their shareholders $150 million in immediate capital gains taxes.
Thus, Stanley is merely shifting its tax burden to individual
shareholders. The New York Times recently reported on the scope of this
slight-of-hand, stating, ``[e]ven if their shares rose 11.5%, they [the
Stanley shareholders] will barely break even after taxes'' (May 20,
2002).
For the smaller investors, retirees, and those nearing retirement,
this will be an especially onerous burden--one they cannot afford. One
retired Stanley Works machinist shared with me that he would face an
estimated tax bill of $17,000. As any retiree will tell you, having to
pay a bill of that magnitude threatens their financial security when
they need it most. For those facing these payments, where will they get
the resources to pay the tax? They will be forced to borrow the money
from a bank, take out a second mortgage, dip into their 401Ks (thereby
incurring additional taxes and penalties), or take other detrimental
action This tax shift from corporations to individuals is patently
unfair and must be stopped now and permanently.
Finally, the New York Times recently reported that the Stanley
Works CEO ``. . . stands to pocket an amount equal to 58 cents of each
dollar the company would save in corporate income taxes in the first
year.'' (May 20, 2002) That is $17.4 million of an estimated $30
million in `savings' out of the US Treasury, and into the CEO's
personal checking account. In the same story, the NY Times reported
that the Stanley CEO is also eligible for additional stock options
under the current plan, and that he could gain another $385 million by
exercising those options.
Let's close this loophole and stop this unfair shift of taxes from
corporations to individuals. The Neal-Maloney bill is the solution to
the problem. The legislation is straight-forward: if you are, in fact,
a domestic US corporation, you are subject to US corporate income tax,
wherever you locate your nominal headquarters. Secondly, our
legislation would recapture those companies that have already
expatriated by giving them until 2004 to come into compliance. This
provision ensures that all US corporations are playing by the same
rules, and that no one has a tax advantage. Our legislation will end
this unpatriotic tax dodge once and for all. I urge immediate action on
H.R. 3884, the Neal-Maloney bill.
Statement of Steven C. Salch, Partner, Fulbright & Jaworski, L.L.P.,
Houston, Texas
Mr. Chairman and Members of the Committee:
My name is Steven C. Salch. I sincerely appreciate the invitation
to appear before you today and discuss with you the subject of
corporate inversions. The statements and views I will express today are
my own personal views and do not represent the views of the law firm,
its clients, or any association or professional organization of which I
am a member.
Later this month, I will celebrate my 34th anniversary as a lawyer
with the Houston, Texas office of Fulbright & Jaworski L.L.P. Prior to
joining that firm, I was a tax accountant for a major energy company
then located in Dallas, Texas. I am a former Chair of the Section of
Taxation of the American Bar Association and am currently the Fifth
Circuit Regent of the American College of Tax Counsel. I have been
involved with international commercial, regulatory, and tax issues
since I entered into the private practice of law in 1968. As you might
expect from a Texas lawyer, a good deal of my practice has focused on
the energy industry and financial and service sectors relating to that
industry. However, over the years I have represented both domestic and
foreign clients in the agriculture, construction, manufacturing,
distribution, financial, and service sectors regarding their operations
in this country and abroad. My testimony today is predicated on that
experience and background.
This Committee and its Subcommittee on Select Revenue Measures have
undertaken a formidable task: rationalizing the U.S. income tax
system's treatment of foreign operations in an era of globalization of
business and financial resources and the enhanced competition that
creates for contracts, sales, financial services, and jobs.
Looking back today, it is hard to imagine that the United States
once imposed restrictions of direct foreign investments by U.S.
businesses and an interest equalization tax on foreign borrowings.
Forty years ago, the Congress, at the urging of the Kennedy
administration, enacted Subpart F of the Code,1 which in its
original form essentially eliminated deferral for U.S. businesses that
utilized certain foreign business structures to reduce their foreign
tax liability while simultaneously deferring the lower-taxed foreign
income from current U.S. income tax. Starting a decade later in 1971,
the Congress and the Executive Branch have endeavored to level the
playing field between U.S. businesses and their foreign competitors
within the constraints presented by our income tax system, multilateral
international agreements, and bilateral treaties, while concurrently
endeavoring to preserve the U.S. income tax base, through a variety of
statutory mechanisms.
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\1\ Unless otherwise noted, references to the ``Code'' are
references to the Internal Revenue Code, 26 USC, then in effect, and
references to ``section'' are to sections of the Code.
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As we all know, the export incentive elements of those efforts have
consistently been found to be contrary to GATT or WTO, in large measure
because of the different manner in which those trade agreements regard
the application of territorial tax systems employed by most other
countries, as contrasted to the worldwide tax system the United States
employs to tax the income of resident business taxpayers. Consequently,
a U.S.-based business with multinational operations today generally
faces a higher rate of worldwide income taxation of its net income than
does a foreign-based competitor with the same operations, business
locations, and employee locations. The reason for this difference
generally is that the foreign competitor will not be subject to U.S.
federal income tax on its income from sources without the United States
that is not effectively connected with a U.S. trade or business or
attributable to a U.S. permanent establishment and also will not be
subject to income taxation in its base country on foreign business
income (income from business operations outside its foreign base
company).
Under a pure territorial tax system the business revenues derived
from outside the foreign residence country of the foreign business do
not sustain taxation by its country of residence. More significantly,
perhaps, many foreign countries do not share the same concern about
external structures that permit their resident businesses to minimize
their business income tax burden in other countries in or with which
they do business.2 Over two decades ago, one of my foreign
friends from what was then a fairly popular base country characterized
his country's exemption of income from direct foreign business
investments as ``pragmatic'' and intended to ``facilitate the expansion
of both the base country revenue and employment by attracting base
companies and at the same time permit resident companies to be
extremely competitive in foreign markets.''
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\2\ That low level of concern about business taxation does not
extend to individual taxation or passive investment income taxation,
however.
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For over 34 years, I have worked with U.S. businesses seeking to
minimize their cost of capital and maximize their net after-tax
earnings by managing the combined U.S. and foreign effective tax rate
on their business income. During that same period, I have worked with
foreign businesses seeking to achieve the same goals by minimizing the
U.S. income taxation of their U.S. operations or foreign taxation of
their third-country business operations. On one hand, the latter group
of clients is generally easier to serve since in many instances their
U.S. and foreign business revenues were not taxed in their home
countries, while on the other it is somewhat more challenging to
explain that the U.S. will tax foreign operating revenues of their U.S.
subsidiaries or foreign subsidiaries of those subsidiaries. It doesn't
take foreign clients a long time to appreciate that, as a general rule,
they should not have operating foreign subsidiaries below their U.S.
subsidiaries or conduct non-U.S. operations through U.S. subsidiaries.
At the same time, it has always been trying to explain to a U.S.
businessperson or entrepreneur that they will be competing with foreign
businesses that enjoy the benefits of VAT rebates on exports and what
are explicitly or effectively territorial systems with largely
unrestricted opportunities to minimize foreign taxation of their
business income. As economies become more intertwined and competition
increases around the globe, these experiences have become more trying.
Here is an example of a typical situation and concerns that the
Code's approach to income taxation of foreign business operations
produces.
Company X and its subsidiaries, domestic and foreign, are in a
service industry. Over the years, their customers' activities have
become increasingly focused on foreign business opportunities. As a
result, the percentage of the gross revenue and income that Company X
and its subsidiaries derive from performing services outside the United
States has grown. It now is more than 50% of their gross revenue from
operations and generally is projected to either remain at that level or
increase over the foreseeable future. Company X competes with other
U.S. firms and with foreign-based companies. Within the last six
months, Company X was unable to achieve an acquisition of substantially
all the assets of Company A, a domestic company whose business would
complement Company X's operations with over 60% of its operating income
from foreign operations, because foreign Company Z offered a cash price
that was substantially more than the price Company X thought was
feasible based on its targeted goals for return on capital and concerns
about maintaining share value in an equity marketplace environment that
is becoming increasingly discriminating. Company X's Board asks its
management to analyze the situation and report back on the failed bid.
Company X's analysis indicates that Company Z has a lower tax rate
on operations than Company X, or indeed any of Company X's U.S.
competitors. One of the reasons is that Company Z does not pay tax in
its home country on income from foreign operations or foreign
subsidiaries. Another reason is that Company Z's home country's
exemption of Company Z's foreign operational income from tax permits
Company Z to conduct its foreign operations in the manner that
minimizes taxation by other countries. While other factors, such as
higher employment taxes and office rental, partially offset the tax
savings, Company Z has a higher rate of return on invested capital than
Company X, largely because of the tax differential.
When Company X's personnel applied Company Z's after-tax rate of
return from operations to Company A, the result was a price that was
actually higher than the price Company Z paid for Company A. Thus, if
Company Z is able to achieve its pre-acquisition rate of return with
respect to Company A's business, the acquisition should actually
increase the value of Company Z since the acquisition price, though
higher than Company X could pay, was based on a lower rate of return
than Company Z actually achieves. Company X's analysis showed that
under Company Z's ownership the only portion of the operations of
Company A that would continue to pay U.S. corporate income tax were
those that served the U.S. market exclusively.
In that regard, since Company Z had purchased Company A's assets,
all the intellectual property of Company A was now owned by a foreign
corporation that would charge and receive an arm's length royalty from
Company A's U.S. operations (determined pursuant to the section 482
regulations) that would be deductible for federal income tax purposes
and be exempt from U.S. withholding tax by virtue of a bilateral income
tax treaty. The income derived from the foreign operations of Company A
would no longer by subject to U.S. federal income tax or state income
tax.
Company X's CEO reported to the Board that Company Z was in the
process of downsizing Company A's U.S. workforce by terminating
personnel in the research, engineering and design, procurement, and
administrative areas because those tasks would be performed by existing
staff of Company Z in foreign locations for a fee paid by the U.S.
operations. Manufacturing jobs in Company A would remain in the U.S. as
needed to serve the U.S. plants. What was not known was how long those
plants would all remain active to provide goods for foreign markets, as
well as the domestic U.S. market. The CEO commented that it was likely
Company X would see a decline in sales to what was Company A as Company
Z's foreign engineers and procurement specialists began specifying
foreign supplier's components, including those of Company Z and its
affiliates, whenever customers did not specifically request open
sourcing or Company X components.
Company X's Board quickly grasped the concept that Company X's rate
of return on invested capital, and presumably its share price, would
increase if Company X could restructure so that it's income from
foreign operations was not subject to U.S. corporate income taxation.
The question was whether that could be achieved. That's when the
outside tax and investment banking experts were brought into the
picture.
They suggested to Company X's Board that it should effectively
reincorporate itself as a Bermudian company and utilize a domestic
holding company to own its U.S. operations. The transaction would
involve the U.S. shareholders exchanging Company X shares for shares of
a Bermuda company (``BCo''). That exchange would trigger realization of
any built-in gain in the Company X shares, but not loss. While precise
data were not obtainable, in view of the decline in the stock prices
over the past several years, the investment bankers advised that it was
probable that there were a great many shareholders who had losses and
the amount of gain for stockholders who had held Company X shares for
more than three years would be relatively low.
Company X's foreign subsidiaries would be held by a foreign
subsidiary of BCo. The existing intercompany pricing policies of
Company X and its affiliates would continue to be observed by BCo and
its foreign subsidiaries and the U.S. holding company. The U.S. holding
company would continue to operate the U.S. fixed facilities. With
proper attention to the Code provisions regarding effectively connected
income, the income produced by BCo and the foreign subsidiaries should
not be subject to U.S. corporate income tax, other than withholding on
dividends distributed by the U.S. holding company. The savings achieved
by eliminating U.S. corporate income taxation on BCo and its foreign
subsidiaries significantly enhance BCo's return on capital and
hopefully, its share price. It also makes BCo more competitive with
Company Z and other foreign firms.
This example is what I refer to as the classic or straight
inversion. It was employed for the first time approximately 70 years
ago. Approximately 30 years ago I obtained from the IRS a private
letter ruling that dealt with inversion issues. For various non-tax
reasons that transaction did not go forward. Subsequently McDermott did
invert and Congress tightened the Code to assure that there was an exit
fee for similar transactions. Subsequent inversions have likewise
generated legislative amendments designed to prevent others from
pursuing a similar transaction without additional cost.
The recent increase in proposed inversion transactions and
corresponding publicity have caught the attention of the Treasury
Department and both the House and the Senate. One result is that a
number of members and senators have proposed legislation to address or
suppress inversions in several different ways.
I respectfully submit that one of the problems with several of the
pending anti-inversion legislative proposals is that they have
effective dates that would extend to transactions that were done
decades ago. Not all inversion transactions in the past were undertaken
solely or perhaps even principally for U.S. tax reasons. To go back
into the past and attempt to determine which ``old and cold''
inversions that were entirely legal when they were implemented, should
now be penalized, strikes me as unfair, unsound, and overkill.
I also submit to you that the classic or straight inversion is not
a ``tax shelter,'' ``abusive transaction,'' ``job loser,'' or
``unpatriotic.'' As the foregoing example illustrates, the classic
inversion generally is motivated by systemic features of the Code and a
discontinuity between those features of our law and comparable features
of the tax laws of other countries. The classic inversion does not
reduce U.S. tax on U.S. source business revenue, except insofar as
section 482 dictates that there be an arm's length charge for
intercompany transactions in which the foreign affiliate is a provider
to a U.S. business.
The example also shows that in the simplest terms, the classic
inversion is all about numbers that investors and investment bankers
translate into stock prices or purchase prices of businesses. In that
context, preserving U.S. ownership of business, a classic inversion can
also directly and indirectly save U.S. jobs and business that would be
lost if the same business came under foreign ownership.
I realize that Congress needs time to study and develop solutions
to the systemic issues, including the export issue and the WTO.
However, I am concerned that unless Congress can also enact a
moratorium on foreign purchases or acquisitions of U.S. businesses, a
moratorium on inversions that precludes U.S. businesses with
substantial foreign operations from engaging in the classic inversion
will merely provide foreign purchasers an opportunity to extend their
present competitive advantage in purchasing and operations during the
moratorium period. No matter what your views may be on inversions, I
hope you can all agree that result would not be desirable.
If classic or straight inversions were the only type of inversion
transaction that we are seeing, I'm not sure we would all be here today
for this purpose. We are also seeing transactions that are derivative
of the classic inversion in some respects but go beyond it. One such
derivative generally involves companies that do not have or reasonably
anticipate substantial business income from foreign sources. A simple
inversion does not produce a tax benefit for those companies because
the systemic issue is not present in the absence of foreign source
income. Thus, any tax savings that are achieved are a result of
something else and are achieved with respect to U.S. source income.
Transactions that fit that description are the transactions I believe
the Committee and the Treasury Department should scrutinize carefully.
However, any solutions should apply equally to both domestically and
foreign owned U.S. businesses, in order to avoid the inadvertent
creation of an additional competitive advantage for foreign owned
businesses.
Some inversion transactions implicate bilateral income tax
conventions to which the United States is a party. If in scrutinizing
those transactions, the Congress determines that there are issues that
require action, I hope the Congress will provide the Treasury
Department with an opportunity to address those issues in negotiations
with the other countries that are parties to the treaties in question,
rather than unilaterally overriding those treaties. Treaties work for
U.S. businesses and are beneficial to international business and
financial transactions. Thus, it is in everyone's best interest to
permit the normal treaty negotiation or renegotiation process to occur
in an orderly fashion, rather than jeopardize an entire treaty over any
single issue or transaction.
It is a part of our American culture that we will compete on a
level playing field with anyone, anytime, and anyplace. Once the
playing field was local. Then it became regional, and later it became
national. Today the playing field is international, and our rules are
not the only rules in play. Thus, we need to be vigilant that others do
not adopt rules that unfairly penalize our businesses seeking to
operate abroad. We also need to be vigilant that our rules neither
penalize U.S. businesses operating abroad nor grant an unfair advantage
to foreign businesses operating here.
Mr. Chairman, classic inversions are not ``the problem.'' They are
symptoms that indicate a systemic problem exists. I urge the Committee
and the Congress to seek a solution that cures those systemic problems
as the best means of alleviating the symptoms. At the same time,
Congress and the Treasury should also address variations of classic
inversions that achieve savings by reducing taxation of U.S. source
business income and assure that any remedial measures apply equally to
domestic and foreign investors.
Mr. Chairman, thank you again for the opportunity to appear today.
I will be pleased to respond to any questions.