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Treasury secretary & key lawmakers weigh in on EU state aid, inversions & tax reform

Letter to European Commission President Jean-Claude Juncker (Feb. 11, 2016).

Treasury Secretary Jacob Lew has written a letter to European Commission President Jean-Claude Juncker objecting to the use of European Union (EU) State aid investigations as a way to retroactively tax earnings that rightfully belong to the U.S. He also expressed support for immediate U.S. business tax reform and stopping corporate inversions at a Ways and Means Committee hearing.

EU State aid investigations. State aid is defined as an advantage in any form that is conferred on a selective basis by national authorities. The “Treaty on the Functioning of the European Union” generally prohibits EU State aid, unless it is justified by reasons of general economic development. The European Commission is in charge of ensuring that State aid complies with EU rules.

Since June 2013, the European Commission has been investigating the “tax ruling” practices of EU Member States. Tax rulings are essentially comfort letters issued by tax authorities to provide a company clarity on how its corporate tax will be calculated or the use of special tax provisions. They include advance pricing arrangements (APAs), which are arrangements that determine in advance an appropriate set of criteria for the determination of the transfer pricing of certain intra-group transactions over a fixed period of time. According to the European Commission, tax rulings are legal, but they may not use methodologies that would give a company an unfair competitive advantage over other companies. Unless the selective advantage is justified by reasons of general economic development, it may violate EU State aid rules.

In June 2014, the European Commission opened formal EU State aid investigations in three cases — Apple in Ireland, Starbucks in the Netherlands, and Fiat Finance & Trade in Luxembourg. It has since added Amazon and McDonald’s to its list and extended the State aid inquiry to all EU Member States.

In January of 2015, the European Commission shared its preliminary view that the tax benefits granted by Luxembourg to Amazon in a 2003 transfer pricing ruling constituted illegal EU State aid. Thereafter, in October 2015, it ruled against Starbucks in the Netherlands and Fiat Finance & Trade in Luxembourg, ordering the two countries to recover €20 to €30 million in back taxes from each of these companies. The Dutch and Luxembourg Ministry of Finance have both stated that they will appeal the European Commission’s decision. Final decisions in the EU State aid cases against Apple in Ireland and Amazon in Luxembourg are expected soon.

On Dec. 1, 2015, the Senate Finance Committee held a hearing on “International Tax: OECD BEPS and EU State Aid.” At this hearing, Treasury Deputy Assistant Secretary of International Tax Affairs Robert Stack testified that Treasury is concerned that the European Commission’s investigations and potential decisions:

  • Appear to disproportionately target U.S. companies;
  • Potentially undermine U.S. rights under its bilateral tax treaties with EU Member States;
  • Are taking a novel approach in applying EU State aid rules and applying that approach retroactively rather than prospectively;
  • Could give rise to U.S. companies paying EU Member States billions of dollars in tax assessments that may be creditable foreign taxes, resulting in U.S. taxpayers “footing the bill”; and
  • Substantively amount to EU taxation of historical earnings that, under internationally accepted standards, no EU Member State had the right to tax.

In January 2016, four top Senate Finance Committee members (Chairman Orrin Hatch (R-UT), Ranking Member Ron Wyden (R-OR), Rob Portman (D-OH) and Charles Schumer (D-NY)) wrote a letter to Secretary Lew expressing “strong concerns” with how these EU State aid cases “could pave the way for the EU to tax the historic earnings of many more U.S. companies.” They suggested that Secretary Lew consider the U.S.’s retaliatory authority under Code Sec. 891, which permits the U.S. president to authorize the doubling of the U.S. tax rates for citizens and corporations of a foreign country that subjects U.S. citizens and corporations to “discriminatory or extraterritorial taxes.”

Later that month, Mr. Stack met with members of the European Commission to express the U.S.’s criticisms of the EU State aid investigations. According to reports, European Commissioner of Competition Margrethe Vestager, who did not attend the meeting, later told reporters that the criticisms were “the same arguments that we have heard before” and that “just as it is an obvious right for U.S. tax authorities to tax revenues when they are repatriated, it is also for European tax authorities to tax money that is made in the EU Member States.”

In a February 11 letter to European Commission President Juncker, Secretary Lew again described the U.S. concerns with the EU State aid investigations. That same day, House Ways and Means Committee Chairman Kevin Brady (R-TX), at a hearing with Secretary Lew to discuss the President’s FY 2017 budget proposal, characterized the EU State aid investigations as a “money grab” that makes it more difficult for U.S. MNEs to compete overseas.

At the hearing, Congressman Charles Rangel (D-NY) grilled Secretary Lew about the letter. He asked Secretary Lew to explain why the EU should not take advantage of the U.S. tax system by taxing the earnings of U.S. MNEs that have left the U.S. and settled abroad (i.e., inverted U.S. companies).

Clarifying that his letter was not in reference to inverted companies, Secretary Lew explained that U.S. MNEs that keep their earnings overseas are still subject to U.S. taxes. Secretary Lew stated that his letter to the European Commission essentially provides that the U.S. still needs to enact U.S. business tax reform, such as lowering the U.S. corporate tax rate and requiring that U.S. MNEs repatriate their foreign earnings.

“The fact that Congress has not yet enacted international tax reform does not change the basic principles of what is subject to tax in the U.S.,” said Secretary Lew. “If the intellectual content and the innovation are in the U.S., there is a substantial tax due in the U.S. when that money comes home. Because the money has not been repatriated, it is sitting for the moment not taxed. We have said that money should come home in our tax reform proposal, it would all come home and be taxed at 19%.” (For more details on the international tax and other provisions in the President’s FY 2017 budget proposal, see Weekly Alert ¶ 7 02/11/2016.) While acknowledging that there is skepticism about the U.S. enacting tax reform, Secretary Lew said “that is not a basis, I think, for reaching in and asserting authority for taxing U.S. income.”

Inversions & tax reform. At the same hearing, referencing Tyco and Johnson Controls (see Weekly Alert ¶ 3 1/28/2016), Ways and Means Committee Ranking Member Sander Levin (D-MI) suggested that corporate inversions be tackled first, rather than lumped in as part of the greater U.S. business tax reform.

Secretary Lew responded that the best way to tackle corporate inversions is to proceed with U.S. business tax reform. However, Secretary Lew conceded that if the U.S. cannot agree on U.S. business tax reform, stopping corporate tax inversions may need to be tackled separately — and soon.

In response, Chairman Brady cautioned that more and more U.S. MNEs are worried about hostile takeovers and engage in corporate inversions to avoid being a ripe target for foreign takeover. Since becoming the chairman of the House Ways and Means Committee in late 2015, Chairman Brady has maintained that having a competitive, pro-growth tax code is the best way to stop U.S. companies from moving abroad.

In a speech delivered at the Tax Council Policy Institute’s 17th Annual Tax Policy & Practice Symposium, Chairman Brady continued to emphasize the need for corporate tax reform, starting with the U.S.’s worldwide tax system, stating that “our antiquated international tax system and the highest corporate tax rate among OECD countries are forcing many American companies to move their headquarters abroad through foreign mergers.” He said that his Committee “will move forward immediately to draft international tax reform legislation” as part of comprehensive tax reform, which he hopes to enact in 2017.

Chairman Brady outlined his vision for comprehensive tax reform as one that encourages businesses to locate their operations in the U.S. and replaces the existing worldwide tax system with a “permanent modern territorial-type system that helps American companies compete and win overseas.”

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Meet Paul Raymond

Meet Paul Raymond

Mr. Raymond is a sought after speaker in tax controversy law by many attorney, accountant, and business groups and at the request of the Internal Revenue Service, has presented programs at the IRS Nationwide Tax Forum, attended by tax professionals throughout the United States.

Additionally, he continues to be an active member in the Section of Taxation, American Bar Association, where he was the Past Chair of the Employment Taxes Committee.

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