Giving credit where credit is due: cases on state tax credits, U.S. treaties, Canadian budget, section 861 regulations, and Ontario transaction taxes draw TEI's attention.

TEI frequently commends governmental agencies whose efforts advance the goals of reducing the costs and burdens of tax administration and compliance while advancing the cause of good tax policy. TEI is also not timid about offering constructive criticism of policies, proposals, or decisions that frustrate those goals. The Institute's recent advocacy efforts demonstrate these practices. TEI has given credit where credit is due--even while suggesting improvements or seeking clarification--in advocacy efforts ranging from a submission on proposed regulations in Ontario to testimony on U.S. treaty protocols. On the other hand, TEI has also forcefully criticized the results in two state and local tax cases, both dealing, ironically enough, with credits.

Cuno v. DaimlerChrysler

A taxpayer lawsuit filed in an Ohio Court of Common Pleas challenging Ohio investment tax credits and real property tax exemptions has morphed into federal case imperiling the full panoply of state tax incentives and galvanizing the world of state and local taxation. Although the case had been dismissed by a federal district court level, a three-judge panel of the U.S. Court of Appeals for the Sixth Circuit recently decided that Ohio's investment tax credit program unconstitutionally discriminates against interstate commerce. In doing so, the court upended a statutory scheme that had prompted DaimlerChrysler to expand its plant and equipment in Ohio in order to qualify for tax incentives from the state of Ohio and the city of Toledo.

Because the reasoning of Sixth Circuit could vitiate enterprise zone legislation and other state incentive regimes across the Nation, TEI filed a brief as amicus curiae on September 23, 2004, urging the full court of appeals to reconsider the decision. The brief acknowledges the appropriate role of the Constitution's Commerce Clause in protecting out-of-taxpayers from discriminatory tax rules, but explains why state tax incentives such as Ohio's investment tax credit should withstand constitutional scrutiny. More important, the Institute's brief underscores the signal importance of the panel's decision in threatening to upend the settled expectations of taxpayers and states alike. Nearly a dozen amicus briefs from state governments, industry, and associations have been submitted to the appellate court in support of rehearing.

Read the Institute's brief in this issue, beginning at page 410.

General Motors v. California Franchise Tax Board 

In another case dealing with another state tax credit, TEI filed a letter on August 31 with the Supreme Court of California, urging the court to review a decision involving General Motors Corp. Specifically, the Institute asked the court to review the Court of Appeal's decision on the Franchise Tax Board's limiting the application of California's research and development credit to a unitary group. General Motors applied the credit proportionately among the members of its California unitary group, whereas the Franchise Tax Board determined that the credit is limited to one separate member.

In its amicus letter, TEI averred that the Franchise Tax Board's failure to adhere to the unitary business principle in administering California's research tax credit will directly affect the tax liabilities of other businesses subject to California tax, and could indirectly affect the tax systems of other states. TEI continued that the lower court's decision misapprehends the design and purpose of the unitary principle, frustrating the goal of uniform and equitable tax administration among the states.

In a related development, on September 10 California Governor Arnold Schwarzenegger sent a letter to the Supreme Court of California requesting review of this case. He noted that innovative companies have relied on this tax credit to the benefit of California's economy, and deserve a tax system that is "clear and predictable."

TEI's letter to the Supreme Court of California appears in this issue beginning on page 412.

Testimony on Dutch and Barbados Treaties

On September 24, TEI President Judith P. Zelisko testified before the Senate Committee on Foreign Relations on the proposed tax protocols with the Netherlands and Barbados. In her testimony, Ms. Zelisko noted that a fundamental purpose of America's income tax treaties is to eliminate double taxation of income earned by residents of either country from sources within the other country. Compared with more recent tax treaties, the current treaty between the United States and the Netherlands is antiquated and obstructs the free flow of trade between the two countries. The new treaty, the Institute continued, would eliminate barriers to trade and investment between the two countries, curtail abusive use of the treaty, and promote improved cooperation in international enforcement of the tax laws of both countries.

The Barbados Protocol is similarly designed to bring the current U.S.-Barbados treaty in line with U.S. policy and put adequate safeguards in place to prevent inappropriate use of the treaty, according to TEI. Although the Institute expressed reservations about expanding the Limitations on Benefits provision to the U.S. treaty network, on balance it agreed that ratification of the Barbados Protocol is in the best interest of the country and the business community.

TEI's testimony is reprinted in this issue, beginning at page 414.

Canada's Pre-Budget Consultative Process

For the third year in a row, TEI has been invited by Canada's House of Commons Standing Committee on Finance to appear at a hearing in connection with its pre-budget con sultations. A written statement is required to be submitted in advance of appearing at a hearing.

TEI's statement urges the Standing Committee to substantially narrow the scope of the Reasonable Expectation of Profit test included in draft legislation clarifying the deductibility of interest and other expenses. It further recommends that the government abandon the draft legislation in respect of Foreign Investment Entities and Non-Resident Trusts. Finally, TEI suggested that the Department of Finance expeditiously negotiate and implement a new provision in the Income Tax Convention with the United States eliminating withholding on all dividends and interest for payments to both related and unrelated parties.

The Standing Committee's hearing schedule is expected to be announced shortly after Parliament convenes on October 4. TEI will be represented at the hearing by the Institute's Vice President for Canadian Affairs, David M. Penney of the Toronto Chapter, and the Chair of the Institute's Canadian Income Tax Committee, David V. Daubaras also of the Toronto Chapter.

The full text of TEI's statement to the Standing Committee on Finance is reprinted in this issue, beginning at page 405.

More Comments on Section 861 Regulations

On September 17, TEI submitted comments to the IRS and Treasury on the allocation and apportionment of expenses under section 861, commending the government for simplifying the section 861 rules by adopting an alternative tax book value (TBV) method for depreciation expense.

In its comments, the Institute stated that the new alternative for determining the TBV of foreign and domestic assets would decrease complexity and provide greater certainty for both taxpayers and the government. As an administratively feasible method, it would also save resources by eliminating the need for taxpayers to elect the Fair Market Value method, which often results in the preparation of costly annual valuation studies and disputes between taxpayers and the government. TEI agreed that the automatic consent procedure within the regulations is appropriate and that the proposed two-year time period is reasonable. TEI also recommended that the treatment of goodwill be harmonized for U.S. and foreign assets. In respect of the effective date, the Institute suggested that, given the government's desire to encourage use of the alternative TBV method, taxpayers should be permitted to elect to apply the new rules to all open years, or at least have an election available for returns that have not yet been filed.

The Institute's letter is reprinted in this issue beginning at page 416.

Proposed Changes to Ontario Regulation

In a letter dated September 20, TEI's Toronto Chapter submitted comments to the Ontario Ministry of Finance Chapter on the province's proposed changes to Regulation 1013 of the Ontario Retail Sales Tax Act. TEI commended the Ministry's effort to modernize the retail sales tax rules relating to exempt transfers of assets between related corporations. The proposed changes will alleviate the problem of Retail Sales Tax being imposed on assets that are moved from one entity to another within a corporate group even where there has been no effective change in ownership of those assets. In addition, the proposal aligns the tax treatment on the transfer of assets among corporations with that for the transfer of assets among partnerships. The letter also seeks clarification on several specific issues. The comments were principally drafted by the Toronto Chapter's Ontario Tax Committee, whose chair is Robert G. Westlake; the letter was signed by chapter president Mary T. DiBattista.

The Toronto Chapter's letter is reprinted in this issue, beginning on page 418.

TEI ADVOCACY AT A GLANCE:

* Amicus brief in Cuno v. DaimlerChrysler (State & Local Tax Incentives), page 410.

* Amicus letter in General Motors v. Franchise Tax Board (California Research Tax Credit), page 412.

* Testimony before Senate Committee on Foreign Relations regarding Dutch and Barbados Treaty Protocols (U.S. Tax Treaties), page 414.

* Testimony before House of Commons Standing Committee on Finance (Canadian Pre-Budget Consultation), page 405.

* Comments on Allocation and Apportionment of Expenses under Section 861 (Determining Tax Book Value of Assets), page 416.

* Comments on Ontario Retail Sales Tax Act (Exempt Transfers of Assets Between Related Entities), page 418.