Wednesday, May 13, 2009

Avi Yonah on US tax cheating

Guest blogger: Prof. Sol Picciotto, TJN Senior Adviser

Reuven Avi-Yonah, who is probably the leading US tax academic, has an article in the current issue of Tax Notes International called “Obama's International Tax Plan a Major Step Forward.”

It's a little surprising he is so optimistic, because the Obama proposals (presumably originating from Larry Summers) aim to strengthen residence taxation of multinational enterprises (MNEs), while Avi-Yonah favours source taxation. (Source taxation means that tax is levied where the profits arise, the “source” of the profits; residence taxation means that tax is levied where the MNE has its residence, usually the parent company’s headquarters. It's not a question of either-or, however: as Avi-Yonah puts it, "effective source taxation requires residence taxation, and effective residence taxation requires source taxation." See more in this briefing paper – as it happens, prepared by Avi-Yonah for TJN.)

Avi-Yonah argues that source taxation has been undermined by low-tax jurisdictions - evidenced by data that in 2003 about a third of the profits of U.S. MNEs were in Ireland, Bermuda and the Netherlands; and of the top 10 locations of such profits 7 had effective tax rates below 10%. He points out that the Obama proposal is less radical than the proposal made in 2000 when Summers was Treasury Secretary, presumably because of feared MNE opposition, though they are anyway opposing this one too.

MNEs can avoid attempts to strengthen residence taxation by moving their corporate headquarters to a lower-tax jurisdiction, as many have done and are threatening to do. He says US MNEs can be prevented from moving their corporate headquarters by rules to prevent this enacted in 2004, but suggests that the provisions in the Stop the Tax Haven Abuse Act on 'managed and controlled' companies should be enacted to try to stop companies claiming to set up headquarters in low-tax countries such as Ireland or the Netherlands, as well as accummulating their worldwide profits there (which the anti-deferral rules would block).

But he says he still favours source taxation and so sees this should be as just a first step in protecting the US tax base from erosion.

He also supports the moves on the Qualified Intermediary (QI) procedures for the same reasons, as strengthening taxation of US citizens. A qualified intermediary is an institution, typically a bank, that makes payments such as interest to non-residents. The US rules allow a QI to keep the identity of the payee secret if it certifies that they are both non-resident and non-US citizens. This allows such banks to manage the investments of various tax cheats and purchase, say, portfolio-interest bonds on their behalf. The QI rules allowed banks to help foreign tax cheats, so long as they weren’t evading US taxes. Unfortunately, as the UBS case has shown, many of them also helped US tax cheats, by advising them how to use companies or trusts in havens to own the assets. See more on pages 3-4 here explaining what can go wrong.

As a next step aimed directly against havens his Avi-Yonah’s proposal is that rich countries could:

"eliminate the tax havens' harmful activities overnight by, for example, imposing a refundable withholding tax (for example, at 35 percent) on all payments to noncooperating tax havens, or more broadly, to all nontreaty countries, and insisting on effective automatic exchange of information with treaty countries. The withholding tax would be refunded on a showing that the income was reported to the residence country. This idea is similar to, but much broader than, the refundable withholding tax proposal in the Obama plan."


He added:

"The financial services industry would no doubt lobby hard against such a step on the grounds that it would induce investors to shift funds to other OECD member countries. However, the EU and Japan have both committed themselves to taxing their residents on foreign-source interest income. The EU savings directive, in particular, requires all EU members to cooperate in the exchange of information or impose a withholding tax on interest paid to EU residents. Both the EU and Japan would like to extend this treatment to income from the United States. Thus, this would seem an appropriate moment to cooperate with other OECD member countries by imposing a withholding tax on payments to tax havens that cannot be induced to cooperate in exchanging information, without triggering a flow of capital out of the OECD."


We think this is an optimistic view of the Obama plan, which on the face of it is a unilateral move by the US to protect its tax base. However, Avi-Yonah is well-informed, and has good contacts with the Obama administration, so let's hope he is right.

TJN’s Action Plan "End the Offshore Secrecy System" supports a stronger multilateral approach, including unitary taxation of MNEs. Since Avi-Yonah was co-author of a paper in June 2007 advocating exactly this, presumably he agrees.

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