Pending tax treaties and protocols and benefits of arm's-length method.

On May 24, 1995, Tax Executives Institute filed the following comments with the Senate Committee on Foreign Relations, urging the Senate to ratify pending tax treaties and protocols with the following seven countries: Canada, France, Kazakhstan, Mexico, Portugal, Sweden, and Ukraine. The Institute's submission, which supplements comments filed in 1994 and earlier this year, was prepared under the aegis of its International Tax Committee, whose chair is Philip J. Bergquist of Apple Computer, Inc.

Last year President Clinton forwarded several tax treaties and protocols to the Senate for ratification in respect of the following trading partners of the United States: Canada, France, Kazakhstan, Mexico, Portugal, Sweden, and Ukraine. A hearing before the Senate Committee on Foreign Relations has now been scheduled for May 25, 1995. Because of the importance of the treaties to multinational corporations, Tax Executives Institute urges the Committee on Foreign Relations to recommend ratification by the full Senate.

Background

Tax Executives Institute is the principal association of corporate tax executives in North America. Our nearly 5,000 members represent more than 2,500 of the leading corporations in the United States and Canada. A substantial number of TEI members work for companies that engage in international trade and hence will be affected by the seven treaties and protocols now pending before the Senate.

Tax Executives Institute believes ratification of the seven tax treaties would be in the country's best interest. In our view, the primary beneficiaries of the treaties will be -- not foreign multinational corporations -- but U.S. corporations operating abroad that need a level playing field to compete effectively in the global marketplace. Hence, we do not believe that one Senator's narrow concerns should derail the United States' important treaty network, especially for an issue that is extraneous to the treaty ratification process.

The Importance of U.S. Tax Treaties

The U.S. tax treaty network is an important part of the country's framework for international trade. Bilateral treaties play a critical role in bringing certainty to the global marketplace and safeguarding multinational businesses from the threat of double taxation. TEI has long been concerned that arbitrary tax rules restrict the ability of U.S.-based companies to compete effectively abroad and deter foreign investment in the United States. In a perfect world, tax rules would not drive business decisions, but the world is far from perfect. Thus, tax rules can -- and do -- affect the decisions of multinational corporations, and the affected governments must respond accordingly.

The country's economic interests are best served when the international "playing field" is as level as possible. This goal can be advanced by removing tax barriers that impede the flow of goods across borders. Indeed, TEI believes that the principal function of income tax treaties is to facilitate international trade and investment by removing -- or preventing the erection of -- tax barriers to the free international exchange of goods and services and the unfettered international movement of capital and persons. Well-crafted tax treaties can enhance the competitiveness of U.S. businesses abroad and foster a favorable investment climate in the United States for foreign businesses and investors, thereby creating substantial economic opportunities for all Americans.

The Seven Treaties and Protocols Should Be Ratified Without Delay

The seven treaties and protocols now under consideration mark an important step in reducing the economic barriers that impede trade. Although TEI may take issue with particular provisions of certain of the treaties and protocols, the Institute strongly believes ratification is in the best interest of the business community and the country in general. Lowering the withholding rates on interest, dividends, and royalties -- which these treaties will effect -- will reduce the influence of tax considerations on decisions regarding the capital structures of multinational companies. The treaties should also stem controversies in respect of the debt-versus-equity characterization of hybrid instruments. Finally, the treaties would extend or maintain the arm's-length standard for international transfer pricing, providing two clear benefits to U.S. multinational corporations.

Given the composition of our membership, TEI is particularly interested in the expeditious ratification of the Canadian protocol. Trade with Canada -- the United States' number one trading partner -- is particularly important to U.S. businesses, and the U.S. and Canadian members of the Institute have first-hand knowledge of the need for the protocol. TEI cautions, moreover, that care should be exercised in preparing the technical explanation to ensure that the salutary reduction in the withholding tax on royalties is not so circumscribed that the core purpose of the protocol is undermined.

Senator Dorgan has suggested that ratification of the treaties and protocols be delayed, because they were negotiated on the basis of the arm's-length method for determining prices for goods flowing across borders among related entities. The Senator has been highly critical of the method and has proposed the IRS move toward a formulary apportionment method. TEI disagrees. We believe that the United States would be ill served by the use of a formulary apportionment standard, which would require the country to scrap its entire network of more than 60 treaties and thereby significantly disadvantage U.S. business.

The Arm's-Length Standard is the International Norm

The United States was instrumental in establishing the arm's-length standard as the worldwide model for transfer pricing policies. Indeed, the standard provided in the Treasury Regulations served as the model for the 1979 Report of the Organisation for Economic Co-operation and Development (OECD) on transfer pricing. The OECD guidelines, in turn, have become the international norm. See Organisation for Economic Co-operation and Development, Report of the Committee on Fiscal Affairs, Transfer Pricing and Multinational Enterprises (1979) (hereinafter referred to as "1979 OECD Report").

Formulary apportionment and minimum tax proposals have significant policy and administrative disadvantages, which have been summarized by the General Accounting Office in a 1992 report. See U.S. General Accounting Office, International Taxation: Problems Persist in Determining Tax Effects of Intercompany Prices 56-58 (GAO/GGD-92-89) (June 1992) (hereinafter referred to as "GAO Report No. 92-89"). TEI will not reiterate the discussion of these approaches in the GAO Report. For present purposes, it is sufficient to note that the formulary and minimum tax options both suffer from the same fundamental flaw: neither alternative has been accepted as the international norm.

The Arm's-Length Standard Minimizes Double Taxation

The arm's-length standard is central to our system of international taxation; it is the premise upon which the U.S. treaties were negotiated. Thus, use of this standard on a worldwide basis minimizes the risk of double taxation. GAO Report No. 92-89 at 60.

To abandon the internationally accepted standard would undermine the United States' credibility with its treaty partners and risk double taxation by other countries. See GAO Report No. 92-89 at 58 (international consensus is needed on a formulary approach to avoid double taxation and the adoption of a minimum tax may provoke retaliation by other countries). See also 1979 OECD Report at 15 (the uncoordinated use of profit allocation by' tax authorities "would involve the danger that, overall, the [multinational enterprise] affected would suffer double taxation of its profits.").

The decreased potential for double taxation cannot help but improve the ability of U.S. multinational corporations to compete abroad. International acceptance is crucial not only to avoid double taxation, but also to minimize the administrative burden on taxpayers and the government.(1) TEI strongly recommends that the Senate Foreign Relations Committee -- and the Senate as a whole -- approve the seven treaties and protocols.

Conclusion

Tax Executives Institute appreciates this opportunity to provide its views on the pending tax treaties and protocols. If you have any questions, please do not hesitate to call either me at [phone] or Timothy J. McCormally of the Institute's professional staff at [phone].

RELATED ARTICLE: U.S. Treaty Priorities

May 25, 1995

On May 25, 1995, Tax Executives Institute submitted the following comments to Joseph H. Guttentag, Treasury International Tax Counsel, concerning the Department of the Treasury's treaty priorities. The comments, which reported the results of a poll of TEI's International Tax Committee, were prepared under the aegis of its International Tax Committee, whose chair is Philip J. Bergquist of Apple Computer, Inc.

At our most recent liaison meeting with Treasury's Office of Tax Policy, you asked Tax Executives Institute's assistance in helping the Treasury Department establish a priority list of countries for treaty negotiation. The Institute has completed a survey of the members of its International Tax Committee (which includes representatives of all 47 of our chapters) on this issue. For your information, I am including a summary of the results of that survey. In particular, the survey showed:

* There was unqualified support for Senate ratification of the seven treaties now pending before the Foreign Relations Committee, although the treaties with Kazakhstan and Ukraine received less positive support than the others.

* While the survey reveals some support for all of the countries listed by Treasury as a priority, South Africa and Switzerland received the strongest endorsements.

* Responding TEI members identified Brazil, South Africa, Singapore, and Japan as the countries that should receive the highest priority from Treasury in negotiating new or revised treaties.

If you have any questions concerning the Institute's survey, please feet free to contact Philip J. Bergquist, chair of the Institute's International Tax Committee, at [phone], or Mary Lou Fahey of the Institute's professional staff at [phone]. (1) Senator Dorgan uses a recent GAO report on transfer pricing to buttress his call for a formulary apportionment standard; he notes that the report finds "massive and growing U.S. tax avoidance by large foreign corporations." 95 TNT 93-34 (May 11, 1995). The Senator's representation of the report is misleading. The GAO report concludes, "While the differences in tax payment rates between [foreign controlled corporations] and [U.S. controlled corporations] are not convincing evidence of transfer pricing abuse, transfer pricing abuse cannot be ruled out as at least a possible cause for part of the observed differences. Other factors, such as the different types of industries for the nontaxpaying FCCs and USCCs, may also account for some of the observed differences." U.S. General Accounting Office, International Taxation: Transfer Pricing and Information on Nonpayment of Tax 3 (April 13, 1995) (emphasis added).