Caterpillar v Comm'r and the Rule of Law in International Tax

James P. Fuller has an interesting summary of the recently-filed Caterpillar case in his latest U.S. Tax Review [gated], in which he laments the competent authority breakdown and argues that the case would have been better off going to treaty-based arbitration, rather than to domestic judicial decision-making channels. I disagree with this conclusion because, given the structure of tax treaty arbitration today, it would--at best--provide a remedy for only one taxpayer at great cost, while the judicial route potentially creates rule of law upon which all can rely. If competent authority arbitration were instead to create a publicly viewable resolution, I could agree with Fuller because what is needed is (1) a multilateral solution to a multilateral problem and (2) a solution with precedent-making force.

Per Fuller:

Caterpillar Inc. has petitioned the Tax Court for a redetermination of income tax deficiencies that resulted from the IRS's allocation of royalty income to it from its Belgium and French subsidiaries. 

While the case was only recently docketed and has not yet been decided, I thought it worth discussing the case as it results from a breakdown in the competent authority process. It is, of course, the very process that is designed to prevent the consequences faced by Caterpillar. There should be no need for the taxpayer to litigate in one country or the other when treaty relief is an available remedy and the countries involved can settle the issue between themselves. 

Following a 1990 reorganization that pushed management power, responsibility, and accountability to subsidiaries such as Caterpillar Belgium and Caterpillar France, the taxpayer entered into amended license agreements with those subsidiaries limiting the maximum royalty in any given year to each subsidiary's net income from the sale of Caterpillar products. Also, if the subsidiary suffered a post-effective-date net operating loss, it would pay no royalty for that year and could carry the loss forward as a negative adjustment to future years' income for purposes of the royalty calculation. 

... The IRS ... concluded that the relief-from-royalty provision in the Belgian and French license agreements did not comport with the arm's-length standard under section 482.

 Fuller points out that there are "several Tax Court cases that permitted related-party license agreement provisions" like Caterpillar's, and as to which the IRS subsequently acquiesced. He goes on to discuss Caterpillar's attempt to obtain competent authority relief, which failed because the French and Belgian tax authorities disagreed with the US position, and US Appeals simply went along with the IRS decision despite these other rulings that would suggest reconsidering the issue, for litigation hazard purposes at minimum:

The Belgian and French tax authorities, having a thorough knowledge of the local operations of the Caterpillar subsidiaries in their respective countries, looked at the same facts that were addressed by the IRS exam team and found that Caterpillar's royalty limitation provision required no adjustment. Caterpillar subsequently had the adjustment reviewed in an IRS Appeals office proceeding. The IRS Appeals officer simply accepted the IRS exam team's economist's report. 

...it appears from Caterpillar's Tax Court petition that the IRS exam team's economist simply used that agreement as grounds for asserting that such a relief-from-royalties' provision is inappropriate, and not at arm's length.

Fuller notes the dual-bureaucracy created by two simultaneous review procedures, i.e., competent authority and internal appeals, and concludes that binding arbitration of the competent authority procedure, rather than resort to the US judiciary, would have been the better approach:

If the two countries' competent authority negotiators cannot reach an agreement, then there should be some form of compelled arbitration to bring about an agreement. Otherwise, the taxpayer is stuck in the middle. A taxpayer should not have to litigate its case in one country or the other (or both) simply because the U.S. competent authority negotiators could not reach an agreement with the foreign country's competent authority negotiators. This is especially true in a situation such as that faced by Caterpillar: The Tax Court has already held that such provisions are appropriate in related-party license agreements.

I appreciate Fuller's argument about the taxpayer's bind, but as I have noted before, if the case went the way of binding arbitration, in the long run the issue could potentially never be settled, since the decision in arbitration would be completely confidential and therefore not accessible or applicable to other taxpayers. That makes international tax dispute resolution much more expensive than it has to be, all because the powers that be have prioritized absolute taxpayer confidentiality over the rule of law. I think that is a miserable trade-off as well as being an unnecessary one: as this case shows, the taxpayer is willing to sacrifice some measure of its own confidentiality in order to get resolution in domestic law, so it is not clear why international law should be so different. (The arguments for difference are weak--see my analysis in the link above.)

The competent authority route, which (by being duplicative as in this case) already increases costs for producing the rule of law, would only be exacerbated by arbitration, because Caterpillar's problem would be perfectly preserved for another day, another taxpayer, and another expensive litigation involving multiple parties and governments.

Therein lies the conundrum for international tax law in the current status quo: either we can get taxpayer-specific outcomes but no rule of law (arbitration) or we can get unilateral rule of law but no international resolution (domestic appeals). I am not sure which to prefer, since both are bad for international tax law.

Accordingly, I am glad to see the Caterpillar case go forward in a forum which is open to public view and that, if not settled in the interim, then becomes a part of the body of law, creating more certainty for taxpayers going forward. However, I am unhappy that the forum is unilateral and potentially preserves an unsolvable problem for the taxpayer if the Court agrees with the US position, since France and Belgium will not be consulted in the process and can be expected to continue to disagree with the IRS view of things.

As a result, I can only agree with Fuller that the better route would be bilateral/multilateral decision-making via arbitration if that decision-making is, like internal judicial decision-making, open and accessible to public view.

Manal Corwin, now at KPMG, to discuss Reputational Risk Deriving from the Tax Transparency Movement

Fresh out of Treasury, Manal Corwin and some of her new/old colleagues will present a webcast next Tuesday on Tax Transparency and OECD Initiative on Base Erosion and Profit Shifting:

KPMG's Tax Governance Institute will host a webcast that addresses the implications of tax transparency and the potential impact of the OECD initiative on base erosion and profit shifting. Board and audit committee members, CFOs, tax directors and other business professionals interested in attending the program – one in a series of KPMG presentations on this timely topic – can register at: www.taxgovernanceinstitute.com.

The webcast will focus on "the debate over the shift of taxable business income out of the United States and high-tax jurisdictions around the world and into low or no-tax jurisdictions, and the resulting issue of tax base erosion." I'm not sure if debate is the right word there.  Is there a debate about these two phenomena existing as a factual matter? I think no.  Is there a debate about the appropriateness of such shifting and base erosion? I think decidedly yes.

Interestingly, however, KPMG suggests this is a debate about neither the existence nor the appropriateness of profit shifting and base erosion, but rather it is specifically about transparency, namely, the extent to which the public will gain a right to know about the existence and legal sanction of these practices:

The global debate on tax transparency has sparked both public interest and concerns among many companies, and the spotlight will grow brighter in coming weeks as the OECD prepares to deliver its coordinated action plan on base erosion and profit shifting and the European Commission moves forward with announced plans to address issues around tax fairness. With potentially significant changes in future tax obligations and reputational risks at stake, senior executives and board members at multinational companies should find this webcast, and those that will follow, especially useful as they formulate how their organizations should respond to the debate and possible outcomes.

[Emphasis mine.]  This statement is from Brett Weaver, who is described as "tax partner in KPMG's International Corporate Services practice and the firm's partner-in-charge of Tax Transparency" and a member of KPMG's "Tax Transparency Steering Committee," along with Corwin, who is described by KPMG as:

national leader of KPMG's International Corporate Services practice, principal-in-charge of International Tax Policy in the firm's Washington National Tax practice, and former deputy assistant secretary for Tax Policy for International Tax Affairs in the U.S. Treasury Department and U.S. delegate/vice chair to the OECD's Committee on Fiscal Affairs. 

The other participant on the webcast will be Philip Kermode, "director of the Directorate-General for Taxation and Customs Union of the European Commission".

It seems very clear to me that the "reputational risk" Weaver identifies is going to be something corporate tax managers and their legal & accounting advisers will be forced to price in going forward. The last paragraph illuminates this:

...the [KPMG] Tax Governance Institute ... provides opportunities for board members, corporate management, stakeholders, government representatives and others to share knowledge regarding the identification, oversight, management, and appropriate disclosure of tax risk.

I think it is safe to attribute the creation of reputational risk (or what some might call an internalizing of a cost that heretofore has been externalized thanks to strong corporate tax confidentiality laws), as well as any potential that may currently exist for systemic change to occur in the OECD's approach to the taxation of multinationals, to the international tax activist movement. As a result this should be a very informative webcast.

Webcast of McGill Roundtable on Tax Justice-now online

Last week the McGill Faculty of Law hosted a public roundtable on Tax Justice featuring John Christensen, James Henry, Diana Gibson, and Frédéric Zalac. If you missed the live webcast, you can now view the archived version online here.

Employee Mobility & Assignments Abroad-Conference at McGill Law-May 29

The Canadian Tax Foundation will host a conference at McGIll Law next Wednesday on the (timely!) topic of taxing workers when they go abroad. Eminent McGill law grad and former McGill chancellor Richard Pound will deliver the lunchtime address. Info below and on the CTF website.

EmployeeMobility - Assignments Abroad 

Wednesday, May 29, 2013 

8:45 a.m.  –  4:45 p.m.

Followed by a cocktail reception sponsored by Stikeman Elliott 

McGill University, Faculty of Law
3660 Peel Street (library entrance)
Montréal

[Register online] [Registration form - PDF]

This year, the theme for the Canadian Tax Foundation’s annual Journée d’études fiscales, is employee foreign assignments. Speakers at this conference will be discussing the various taxation considerations which arise, both from the perspective of the employee and of the employer, when Canadians choose to temporarily or permanently move their place of work abroad. Various aspects of taxation will be analyzed during the course of the day by experts in the field.

Click here for program & registration info.

After the cocktail, stick around for a Roundtable on Tax Justice, info here and more to come soon.

CTF Conference on Tax & Employee Mobility-McGill Law School, May 29 2013

Si vous avez de la difficulté à lire ce courriel, s.v.p. visionner la version en ligne. Afin de vous assurer de bien recevoir nos courriels, ajouter ctf-fcf@ctf.ca à votre carnet d'adresses.

Bureau 2935 1250, boul. René-Lévesque ouest Montréal, QC H3B 4W8 Téléphone : (514) 939-6323 Télécopieur : (514) 939-7353 Inscrivez-vous avant le 4 mai pour profiter du tarif "oiseau matinal" Journée d'études fiscales Mobilité des employés à l'étranger (English below) Le mercredi 29 mai 2013 8 h 20 à 16 h 45 Suivi d'un cocktail gracieusement offert par Stikeman Elliott Université McGill, Faculté de droit 3644 rue Peel Montréal [Inscrivez-vous en ligne] [Formulaire d'inscription - PDF] inscrire à votre agenda Cette année et dans le cadre de la Journée d'études fiscales, la Fondation canadienne de fiscalité a choisi de présenter des conférences ayant pour thème les Canadiens qui travaillent temporairement ou de façon permanente à l'étranger. Plusieurs aspects de la fiscalité seront abordés, tant du point de vue de l'employé que du point de vue de l'employeur, par des experts en la matière. Les faits saillants de la Journée d'études fiscales comprennent : (certaines présentations seront en anglais) • Les aspects fiscaux pour l'employé et pour la société (employeur)                  > impact sur les régimes de retraite et autres régimes de rémunération                  > frais de localisation du ou vers le Canada                  > planification du rapatriement                  > mécanisme de compensation salariale (tax equalization)                  > impôt au décès ou impôt sur les successions • Utilisation d'une société particulière pour « services d'employé »                  > exemple de mécanismes d'opération                  > bénéfices potentiels et éléments fiscaux à considérer • Éléments fiscaux à considérer lors d'un transfert dans un pays émergeant • Aspects administratifs à considérer                  > Retenues à la source                  > Mécanismes de recharge intragroupe • Visa et autres aspects légaux à considérer Pour consulter le programme ou pour vous inscrire s.v.p. cliquez ici. Pour toutes informations supplémentaires s.v.p. contactez le bureau de Montréal au 514 939 6323 ou par courriel à adminmtl@ctf.ca   Prochains événements : Le mardi 14 mai 2013: TAX STRATEGIES FOR EXECUTIVE COMPENSATION (en anglais) (Ottawa) (demi-journée) Le jeudi 16 mai 2013: FAIRE AFFAIRE AUX ÉTATS-UNIS : STRUCTURES DE FINANCEMENT AMÉRICAINES (Québec) (demi-journée) Pour les jeunes fiscalistes: Le vendredi 10 mai 2013: PERTES SUPENDUES (Midi-conférence) (Montréal) Le jeudi 30 mai 2013: ACTIONS ACCRÉDITIVES (Petit-déjeuner fiscal) (Québec) FONDATION CANADIENNE DE FISCALITÉ ***** Register before May 4th to benefit from the Early Bird rate  Journée d'études fiscales Employee Mobility - Assignments Abroad  Wednesday, May 29, 2013  8 :20 a.m.  –  4 : 45 p.m. Followed by a cocktail reception sponsored by Stikeman Elliott  McGill University, Faculty of Law 3644 Peel Street Montréal [Register online] [Registration form - PDF] (Take advantage of our early bird rate by registering before May 3rd, 2013) add to calendar This year, the theme for the Canadian Tax Foundation's annual Journée d'études fiscales, is employee foreign assignments. Speakers at this conference will be discussing the various taxation considerations which arise, both from the perspective of the employee and of the employer, when Canadians choose to temporarily or permanently move their place of work abroad. Various aspects of taxation will be analyzed during the course of the day by experts in the field. Topics covered at the Journée d'études fiscales will include: (certain presentations will be in English) • Tax considerations for the employee and employer corporation            > Impact on retirement savings vehicles            > Cost of relocation to or from Canada            > Planning the repatriation            > Tax equalization            > Death and inheritance taxes • Using a special purpose corporation for employee services           > Examples of methods of operation           > Potential benefits and taxation considerations • Taxation issues when considering a move to a developing country • Administrative issues to consider          > Source deductions          > Mechanisms for intra-group charge back • Visas and other legal considerations To consult the program or to register, please click here. For any additional information, please contact the Montréal office at 514 939 6323 or by email at adminmtlctf.ca

Who is to blame for Starbucks-style tax dodging?

The answer is "government" if you believe the Telegraph, from an opinion by "Richard Emerton, Head of Board Practice at Korn/Ferry Whitehead Mann" (an executive recruiting firm). He's enthusiastic about tax competition: the kind that will keep European companies "competitive" on a "level playing field" by lowering their taxes on purpose, and he's keen to blame government alone for any failure of tax policy to date, e.g. the kind of failure that led to the public shaming of Starbucks and friends.

I agree with Emerton when he says stop blaming the companies (alone) for failing to pay taxes when this is the system that has been deliberately set up to meet them. But let us not forget that the rules have long been written collaboratively amongst government and business interests with virtually no civil society oversight. Once again, multinationals have the best tax system money can buy. Emerton does forget to mention that part, and goes too far in shifting the blame to government alone. Excerpts:

...The UK Government has done a good job in creating a tax system that encourages businesses to set up in Britain and the Chancellor has made it clear he wants international businesses to operate here. It is therefore important he does all he can to prevent European politics from perverting his well-intentioned efforts to look at the problem from an international perspective.  

What strikes me as counter-productive about the debates that have taken place over the likes of Starbucks and Google is the anti-business rhetoric from many politicians in the search for public approval. A degree of anger from the public may be understandable, but is it directed at the right targets? Korn/Ferry’s latest “Boardroom Pulse” survey of FTSE 100 chairmen suggests that business leaders think not.

Not sure what that survey asked, but let's assume it was something on the order of, "do you enjoy being publicly pilloried for doing your best to exploit every means of tax reduction your government generously makes available to you?" And the follow up question ought to have been (but probably was not) "Do you enjoy public scrutiny of your constant attempts to influence tax policy at every level of governance in order to achieve that generosity of spirit on the part of lawmakers?" To which the answer would no doubt have likewise been a resounding "business leaders think not." Emerton goes on:

While agreeing that the public has a right to be angry, many respondents felt that dissatisfaction should be directed towards the tax legislation and those in charge of it, rather than the companies observing it.Indeed, it is governments that have failed to modernise international tax legislation in decades, despite the wholesale changes that have taken place in the way businesses operate across borders. 

Oh, but Mr. Emerton, you failed to define a key term here: "those in charge of it." I mean, it's not like the companies that help write the law are shy about it. That is, after all, what organizations like the BIAC and the ICC are for, and if you don't know what the BIAC or ICC are, well, you're not trying hard enough to understand international tax. Look also for example at any number of marketing brochures by the likes of the big four. They are not hiding their influence, they are selling it as a product. Here's one by KPMG that I just happened to come across yesterday:

Our professionals have been directly involved in writing and reviewing the applicable Treasury regulations ... which govern tax-free separations."

You will come across this kind of claim all the time if you do any work at all in tax, so it is disingenuous at best to fail to mention industry influence as a major aspect of tax lawmaking at the national and international levels. But Mr. Emerton moves along quickly to make hay of the old adage that every one has a right to minimize their taxes and for company directors this has become a duty:

The chairmen we surveyed pointed out that company directors have a fiduciary duty to minimise tax bills, providing they are acting in an ethical manner and are not inviting legal risks.

That's a pretty vague provided, and a big weight to carry for fiduciary law. Emerton hammers it home:

Which raises a fundamental question stemming from the tax issue – should the primary duty of a company’s board and senior management be to its shareholders, or to the wider moral and social concerns of the public?

Notice this is assumed to be an either/or and not a both, and it's also committing the false dilemma fallacy. But having committed, we must have follow-through:

The chairmen we talked to were divided. Yes, business leaders have a duty to drive value for their shareholders. And yes, businesses also have a duty to act responsibly as members of wider society. It is the responsibility of the leaders of these businesses to strike a balance and most of them make significant efforts to do so. Inevitably, sometimes they get this balance wrong, but attacking them for trying to drive shareholder value while playing by the rules of the game will solve little. A better focus of our energies is to ensure that international tax laws are strengthened by the regulatory framework governing businesses, allowing them to focus on achieving long-term sustainable value for shareholders and for society. However, policymakers must ensure that this isn’t achieved at the expense of a level playing field for businesses across the world, not just one part of it.

The author channels every "we paid all the tax that is legally due" defense ever given in the face of public pressure against tax dodging. He also invokes the "level playing field" metaphor, which is always invoked for every destructive tax policy that was ever invented in response to every other destructive tax policy that was ever invented. So three cheers for tax industry rhetoric, bandied about in any tax policy dialogue to make sure no one thinks too hard about the systemic choices at issue here.

Score ten points to Mr. Emerton in pointing out that blame for tax dodging rests in a legal system that has been specifically designed to encourage it. But take away nine points for failing to mention the big part business plays in constantly perpetuating that kind of design. Then take away two more points for failing to mention that some things only look like dutiful tax minimization until the tax authority figures out what you are doing, and then they are clearly tax evasion. Cf Dow, Ernst & Young, and Jenkins & Gilchrist tax partners, and that's all in just one week.

That puts the column in the negative territory, which is right about where the author appears to think that the tax liabilities of fiduciary-duty-abiding corporate managers ought to keep their companies' tax burdens.

Supreme Court does algebra; hilarity ensues

Over at SCOTUSblog I've got a recap of the arguments in yesterday's hearing on the PPL Corp foreign tax credit case.  The justices seem to have had some fun with the formula and its many algebraic reformulations, but at the end of the day the discussion was not terribly enlightening.

I will note that by the end of oral argument I started thinking that maybe the government conceded too much in the case by stipulating that the windfall tax is a "tax" in the first place.  The government's answers to Justice Breyer's questions suggest that they now look at the windfall tax as in effect a purchase price adjustment, nothing more than an attempt for the UK to go back and claim a higher sale price in the privatization. Maybe you can call that a tax on value, but it's odd to say the least. Nothing to do now but wait for a decision, in which it will also be interesting to see what question the Court decides to answer.

Giving credit where credit is due: argument preview for PPL Corp v Cmr

I've got a post up over at SCOTUSblog on the PPL Corp case, which involves the 1997 UK windfall tax imposed on energy companies that had been privatized under Thatcher--the US parent wanted to take a foreign tax credit for the tax but the IRS said it's not an income tax so no credit allowed. Yes, the year in question is 1997.  Fifteen years of litigation!  $$ at issue: $10M.  Who's got the better side of the argument: the Commissioner, in my view. The tax is a clawback to remedy a too-low flotation price, not a retroactive income tax. Oral arguments tomorrow, and I'll have a recap asap thereafter.

The Dubious Legal Pedigree of FATCA intergovernmental agreements (and why it matters)

My latest column in Tax Analysts' Tax Notes International is here.  I argue that the IGAs have a dubious legal pedigree because they are not treaties, not congressionally-authorized executive agreements, and not interpretations of existing agreements; therefore they are sole executive agreements--entered into by the executive branch with no authorization or oversight from Congress. This puts them on very shaky ground in terms of the constitutional process for binding the US internationally, and I argue that this is both unhelpful to other governments as a practical matter (IGAs override the statute, so if they fail, then what) and an unnecessary muddling of the rule of law, which should make other governments wary (if you have a process in place to bind the US under international law, why aren't you using it).

Starbucks' £20m pledge is not a tax, but likely is a tax benefit

I've mentioned here and there that Starbucks' decision to pledge £20m to the UK as penance to the public for its extremely effective tax planning over the past fifteen years is not a tax but might be and probably is a tax benefit, and I've been asked to explain why that is, and why it matters.

First, lets define what a tax is. A tax is a compulsory extraction of resources undertaken by a government, for which failure to comply results in threat of penalty.  A government can do this because it monopolizes the use of force. A tax can be fair or unfair, regressive, progressive, good, bad, or ugly. Not every forceful extraction of resources is a tax per se, but every tax is certainly a forceful extraction of resources. Governments can be (and are) lax, selective, even grossly unjust, in enforcing stated penalties, but so long as the threat exists, an extraction is a tax. No threat of penalty for nonpayment, no tax.

Now let's look at three reasons why Starbucks' £20m pledge cannot possibly be a tax.

1. It is not being imposed by a government.  Despite the BBC calling this an "agreement," Starbucks itself has characterized the 20m as the product of its own internal decision-making processes. Sure, it's responding to public pressure, but that's not government extraction.
2. It is not compulsory. After David Cameron piled on at Davos, Starbucks hinted that it might change its mind about its pledge, maybe not be quite so generous if the government won't even bother to be decently grateful about its magnanimity. Who's to stop that? Not HMRC.
3. There is no penalty if Starbucks doesn't actually hand over the money. At least, not by government; the court of public opinion might be a different story, depends on the news cycle I suppose. But having failed to levy taxes, HMRC can hardly argue if the 20m doesn't show up at some point.

One happy result is that at least Starbucks will not be able to immediately claim the 20m as a credit against taxes it owes at home in the USA (not a tax, let alone one on income, so no foreign tax credit). But what can we say then of the 20m? If it is not a tax, what is it?

The answer is, it is a charitable contribution to the UK government. Why, you may say, that would imply that it's deductible! Yes, depending on the UK's rules for deductibility of contributions to the government. I suspect it would be deductible (UK readers, correct me if I am wrong). Certainly in the US a similar pledge would be deductible under s170:

[T]he term "charitable contribution" means a contribution or gift to or for the use of— 

(1) A State, a possession of the United States, or any political subdivision of any of the foregoing, or the United States or the District of Columbia, but only if the contribution or gift is made for exclusively public purposes. 

Notice: no need for it to be out of generosity, just need a contribution for exclusively public purposes. Not, say, lobbying, outings for lawmakers, bribery, kickbacks, collusion, etc. But I digress.

Keep in mind that the whole point here is that Starbucks has no income in the UK against which to take any deduction, should it be available...at least, right now. But if the UK rules for NOLs are anything like those in the US, they can hold that £20m on the books for years, maybe even a couple of decades and deduct it later, if and when they ever do have positive income being booked in the UK (maybe subject to some limitations, as in the US).

 So, it's not a tax, but if Starbucks in fact turns it over it will be a tax benefit, tucked away somewhere in some regulatory filing in extreme fine print, to be used at some future date to--wait for it---reduce the company's tax bill.

Neat trick!

Corporate tax: why disclosure is the key to reform

Two columns of interest emerged today on the issue of corporate tax disclosure, plus another interesting public hearing in the UK, this time with the big four in the hot seat.  Put all of this together and we can see very clearly the intense connection between tax reform and public understanding of the status quo.  With the latter as to corporate tax being woefully inadequate and relevant information intentionally hidden from public view, the former can be neither informed nor meaningful.  The answer is corporate tax transparency, particularly for multinationals, i.e., on the order of country-by-country reporting for listed companies.  First, on the columns, both from the FT.

In this one, John Gapper says "Companies are complying with laws that governments could change if they wished," and then explains:

Starbucks’ supposed immoral act is not to pay UK corporation tax that it does not owe, and would not owe even if it did not license its brand from the Netherlands. It obeys both the letter and the spirit of global tax law, which governments could reform if they wished.

That's 100% correct. And if you think there is some "spirit" in the transfer pricing law that isn't being acknowledged, then you are forgetting that the transfer pricing rules were effectively written by the industry they are meant to police. So I think the spirit is pretty much being well given its due. Gapper also nicely illustrates what I call the mercenary tendency of the tax state in an economically integrated world: agree with whatever seems politically expedient in principle, defect in practice:

I look forward to Mr Cameron naming and shaming companies such as Google (also a target of British politicians) if they are drawn from Ireland to the UK by his tax arbitrage. 

...Governments must decide which regime is fair, and companies and individuals must comply. 

... most companies that place operations or intellectual property in low-tax countries – or even in tax havens such as Bermuda – are not breaching the spirit of global tax law. They comply with a structure established under the League of Nations in the 1920s. 

This allows – indeed, encourages – multinationals to split their operations among countries, paying taxes as if they were separate entities, in order to avoid double taxation. They have to make transactions at “arm’s length” – as they would deal with others. 

It worked for a long time but is under strain because of the growing value of brands, intellectual property and intangibles to global corporations. “Ideas are their biggest asset, and what generate profits, and it is far easier to shift intangibles than factories,” says Jeffrey Owens, of the Institute for Austrian and International Tax Law.

Well, this is mostly right, at least close enough for its purposes. However, I am just not sure what principles we should expect to emerge when reporters turn, as they too often do, to Mr. Owens, former director of the OECD's tax arm and the man who presided over the demise of the corporate tax on a global scale under the nurturing constancy of the OECD's business-driven tax policy making machine, a person moreover who has publicly called for governments to "avoid like hell" any taxes on corporations. He would seem to be the last person you would ask about how to make a corporate tax system function, again, unless we are talking about that movie.  Gapper concludes:

Politicians thus have the choice of indulging in easy rhetoric against companies that obey the laws they have passed or struggling to reform the tax regime for little reward, with lots of disruption. In their position, I might posture too.

If that's not an argument for greater public accountability of how transfer pricing works out in practice, I am not sure what is.

That brings me to the second column of the day from the FT which illustrates why the public ought to know more about how these regimes work in practice, this one by Bruce Bartlett in which he asks, can publicity curb corporate tax avoidance? He lays out the case nicely for the runaway corporate tax base and he concludes:

[L]ittle in the way of real economic activity, such as jobs or tangible investment, has shifted anywhere. All that has shifted is the tax base. 

...This makes the international tax regime a ripe target for reformers.

... With reports of low domestic taxes paid by large profitable corporations such as Starbucks in the UK, the time may also be ripe for an international agreement to curb tax shifting. The US has recently implemented a law called the Extractive Industries Transparency Initiative that requires companies to disclose their payments to governments from oil, gas and mining assets. Allison Christians of McGill University argues that the expansion of such information reporting to the transfer pricing of all multinationals is the first step towards capturing the revenue now lost to the shifting of business costs to high-tax jurisdictions and revenues to low-tax jurisdictions. 

There is growing evidence that corporations are sensitive to the public outcry when they are caught avoiding taxation excessively. Starbucks, for example, recently agreed to pay more taxes in the UK than legally required to quell the controversy over its virtually nonexistent tax bill. The same shaming technique may have broader application to multinationals generally. 

As Justice Louis Brandeis of the US Supreme Court once put it, “publicity is justly recommended as the remedy for social and industrial diseases”.

First, thank you for the shout out, Mr. Bartlett! Second, this column demonstrates clearly the strong connection between tax reform and public understanding of the status quo, as I suggested above.  Tax reform is not going to come from the only party that has all the info it needs right now, namely, the IRS. Tax reform comes from public expression.  Right now, observers of tax policy need more information in order to offer meaningful reform proposals, and that information is being hidden because governments do not require it to be disclosed, plain and simple.  That is a matter of regulatory choice, and these columns show the choice is bad for policy analysis.

That then brings us to the UK's hearings today in which the public accounts committee taking on the big four accounting firms, trying to suss out what the letter and the spirit of the law is with respect to corporate tax on multinationals.  What emerges is the "perfectly legal" nature of all of this tax avoidance, again confirming the editorials by Gapper and Bartlett.  Here is the BBC's take on the hearings, worth reading in full.  Richard Murphy declares it a win for the PAC but the question is whether that translates to a win for those who do in fact pay taxes in the UK and elsewhere.

That question will be answered affirmatively if instead of killing EITI, which is currently apparently a high priority for many, we expand it to cover all listed companies.

How a tax haven is born

Can $1.1 billion buy you a country?  Some investors want to try it, by buying Belle Island, currently a Detroit park, and turning it into a tax haven.  Here's the plan:

Looks like Manhattan. The idea:

The 982-acre island would then be developed into a U.S. commonwealth or city-state of 35,000 people with its own laws, customs and currency.

Come on now. There is a whole city there, it's called Detroit, it's full of buildings and infrastructure that are underused, just waiting for investment.  You don't want to invest in that, though, because that would entail accountability to others and-gasp--paying taxes (well, maybe--after incentives and subsidies, maybe not). It's so much easier to make profits if you don't have to pay taxes or observe other regulatory standards such as those protecting worker's rights, the environment, etc. What you want is a regulatory haven that is conveniently located to your clients, that isn't tainted with the tax haven moniker, and that won't be caught up in any global anti-tax evasion net.  Offshore, but in your own backyard, and not treated like the rest of offshore (otherwise what is the point).  A US commonwealth or city-state just about does the trick...ingenious!

Have any doubts that this is about building a tax haven?  Just read to the end of the article:

Here's the scenario for the Commonwealth of Belle Isle that Lockwood and others want to see: Private investors buy the island from a near-bankrupt Detroit for $1 billion. It then would secede from Michigan to become a semi-independent commonwealth like Puerto Rico and the Northern Mariana Islands. 

Under the plan, it would become an economic and social laboratory where government is limited in scope and taxation is far different than the current U.S. system. 

There is no personal or corporate income tax. Much of the tax base would be provided by a different property tax — one based on the value of the land and not the value of the property. 

It would take $300,000 to become a "Belle Islander," though 20 percent of citizenships would be open for striving immigrants, starving artists and up-and-coming entrepreneurs who don't meet the financial requirement. 

I called the Honduras charter city little more than a glorified gated community; this is clearly the same. An economic and social laboratory?  Hardly--add it to a long list of contenders.  The story says "City officials are likely to reject the plan." Too bad, because it would be fun to watch the US open its own tax haven even as it tries to shut down all the others.

Paper: Putting the Reign Back in Sovereign

I've just posted a draft of my paper, "Putting the Reign Back in Sovereign: Advice for the Second Obama Administration," which I presented at Pepperdine last week. Abstract:

In its first term, the Obama administration enacted two pieces of legislation, each designed to protect an increasingly vulnerable income tax base, and each of which had the potential to set a new and unprecedented course for no less than the regulation of the global economy by the nation-state. The first, the Foreign Account Tax Compliance Act (FATCA), sought to end global tax evasion through tax havens.  The second, a little-noticed two-page addendum to the Dodd-Frank Wall Street Reform and Consumer Protection Act (Dodd-Frank), sought to end the contribution of American multinationals to corruption in governance by codifying the transparency principles of the global Extractive Industries Transparency Initiative (EITI).  Both of these reforms reasserted a role for the nation state in regulating people and resources. But neither has yet to fulfil its potential. First, each has raised difficult questions about what the state can and cannot do to enforce disclosure and compliance on a global basis; failing to answer these questions is impeding implementation and aggravating an already-flagging taxpayer morale. Second, neither is broad enough: FATCA should be truly reciprocal and EITI should expand beyond the extractive industries. By acknowledging and responding in a principled way to the obstacles that limit their effectiveness, a second Obama administration could take significant steps to bring each piece of legislation to its potential, while ensuring that its scope focuses on its intended target in each case. This article outlines how these proposals could be accomplished and makes the case that they should be attempted.

I would be happy to have comments.  And in case it is of interest, here is a link to my powerpoint from the presentation as well (I don't know how to embed that here); you can actually watch the entire conference video here (my presentation was second to last).

Larded by Lobbyists: More from the Fiscal Cliff

From the NYT today, Fiscal Footnote: Big Senate Gift to Drug Maker:

A provision buried in the fiscal bill passed earlier this month gives Amgen, the world's largest biotechnology firm, more time to sell a lucrative kidney dialysis drug without price restraints.

No big surprise, we already knew the bill was larded with giveaways, but the NYT provides a nice look into the flawed process, which all starts with a small army of lobbyists. Read the whole thing.

Why FATCA is a Tax Treaty Override

I've been asked to explain comments I made in a recent talk about FATCA, when I said that this regime constitutes a tax treaty override, and that I don't think that IGAs are a valid fix as a matter of law. Here is my reasoning. I will use the US-Canada tax treaty as an example, but the override applies to all US tax treaties currently in force.

This is a lengthy post so let me preface with the executive summary, after which I will provide more detail:

• US and Canada have an existing tax treaty that imposes specific rates for investment income earned by Canadian residents from US sources.
• FATCA places a new condition on receiving those rates.
• This restricts the benefits of the treaty, which is treated as a treaty override by the terms of the treaty itself.
• The treaty provides that the remedy for such an override is a change to the terms of the treaty.
• the IGAs do not change the terms of the treaty but purport to interpret it to allow a different new condition (which condition is itself an override of the domestic FATCA statute) to take effect immediately. 

And now for the detail.

Canada and the US have a tax treaty in force in which each government agrees to impose specified tax rates on domestic-income received by investors in the other country. For example, a Canadian person (individual or entity) that invests in the stock of a US corporation and receives dividends on that stock would be subject to a maximum rate of 15% US withholding tax on that dividend under the treaty (see Art. 10); for royalties, the maximum rate would be 10%, and for interest and most capital gains, no tax would be withheld by the US (see Art. 11 and 13(4)).  In most cases, a tax treaty overrides domestic statutory law that would impose a higher source-based tax rate on payments made to foreign persons.  Accordingly, the statutory US rate on a Canadian resident receiving passive income from US sources would be 30% (with several exceptions, see s. 871). The agreement undertaken in tax treaties is that the US will not impose that statutory rate on payments to Canadian residents, but will restrict its tax to 15% (dividends), 10% (royalties), or even 0 (most interest and capital gains).

Every tax treaty also includes information exchange provisions under which each country agrees to "exchange such information as may be relevant for carrying out the provisions of this Convention or of the domestic laws of the Contracting States concerning taxes to which this Convention applies insofar as the taxation thereunder is not contrary to this Convention." In the Canada-US treaty that is Article 27.

Although this is not critical to the override argument, it is worth noting that the various provisions of the treaty are not conditional on each other; that is, Canadian residents are entitled to the specified tax rate even if, for example, the countries get into a tangle over their information exchange efforts.

FATCA's effect is to impose a new condition on the treaty-based withholding tax rate. That is, under FATCA, the only way for resident Canadian institutions to continue to get the treaty rate (of 0, 10, or 15%, depending on the type of income in question) is to fulfill FATCA information gathering and reporting requirements. If they do not fulfill these requirements, they will not be eligible for the treaty rate, but rather they will be subject to a 30% withholding rate on all "withholdable payments"--an expansive concept of US-source income items which you can read in the statute.

FATCA is thus a new condition on the treaty rate, a condition that is not by any stretch included or even contemplated in the treaty.  Indeed, how could FATCA be contemplated by any treaty that came into force prior to 2010, as FATCA did not exist as law before then.  This is not to say that no conditions can be placed on the access of Canadian residents to treaty rates. There are many existing conditions for treaty benefits--see particularly the limitation on benefits clause (Art 29A), which are quite expansive and form a major part of any treaty negotiation with the US.  But it is to say that FATCA's particular condition is not in the treaty.

Therefore FATCA overrides the existing treaty by unilaterally denying the treaty rate to Canadian residents who would otherwise qualify therefore under the existing, duly negotiated, treaty provisions currently in force.

Now let us look at Art 29(7), which tells us how the countries are supposed to deal with potential tax treaty overrides that arise when one country enacts a domestic law that conflicts with the treaty in effect:

"Where domestic legislation enacted by a Contracting State unilaterally removes or significantly limits any material benefit otherwise provided by the Convention, the appropriate authorities shall promptly consult for the purpose of considering an appropriate change to the Convention."

Thus the remedy to a law that would restrict or remove a material benefit--namely, a specified tax rate on a payment of US-source income to a Canadian investor--is a change to the convention.

A change to an existing convention is undertaken in a protocol. A protocol is in legal terms nothing less than a new treaty that overrides specific provisions of the existing treaty to reflect the parties' later agreement. That is, to change a treaty, each government must agree to the change via a new treaty, which each government must ratify under its internal treaty-making processes.

This therefore suggests that the proposed intergovernmental agreements (IGAs) are not a valid means to get FATCA to work as a matter of law. This is because the US is not treating IGAs as treaties at all; it is treating them as interpretations of the existing treaty, specifically, the information exchange provision.  You can read this setup in the preamble to these agreements. This position seems plainly incorrect, but the subject of the legal status of the IGAs is its own complicated analysis, and I will post more on that subject very soon.

I will note, however, that the IGAs further muddy the interpretive waters since what they do is in fact override the terms of the FATCA statute, by switching the reporting relationship from Canadian resident institutions to a government-to-government relationship. Some have argued that they do not override but merely use Treasury's mandate to define exemptions to FATCA. Perhaps, but Treasury was not given any mandate by Congress to encase those exemptions in international agreements. Moreover, it seems a real stretch to assert that the IGAs simply interpret existing information exchange provisions, especially when it is clear that many or most countries will have to enact domestic legislation to fulfill the new reporting requirements. The valid way forward for Treasury would have been to create straightforward conditional exemptions: exempt countries from FATCA provided those countries enacted laws according to Treasury specifications. That would still be an extra-territorial reach, perhaps, but there are precedents for the mechanism (such as what was done to shut down bearer bonds--thank you to Michael Schler for reminding me of that example, and I know that there are others as well). But, importantly, this established way forward would not solve the tax treaty override problem. Therein may lie a main reason for going the IGA route, even though it is not a clearly valid resolution.

What is clear at this stage is that FATCA overrides the existing tax treaty by significantly limiting a material benefit thereunder, and the only valid way to fix that override is to change the treaty itself, by entering into a new protocol. We can see that the US and Canada have a lot of experience with protocols: protocols to the current tax treaty were signed on June 14, 1983, March 28, 1984, March 17, 1995, July 29, 1997 and September 21, 2007. One of those was to fix another infamous US tax treaty override: the branch profits tax. In short, it doesn't seem to have been that big deal in the past to agree to changes to the treaty terms by the normal treaty-making process, even when the issue was unilateral override, which is typically seen as a bit of bad faith in international relations. That raises the question why this particular change is not being marshaled through the same process.  I will leave it to the reader to speculate for now, and will have more on this later as well.

US-Mexico IGA on FATCA: in force as of Jan 1 2013

Mexico is following the US lead in treating the IGA as a competent authority agreement that merely interprets and clarifies the existing tax treaty between the two countries and therefore does not need to be subjected to internal ratification or implementation processes. From a Baker & McKenzie client alert posted at Tax Analysts today:

Upon a number of consultations with the relevant tax authorities, we have concluded that no need exists for the United States and Mexico FATCA Intergovernmental Agreement to be published in the Mexican Federal Official Gazette in order for it to be effective. The Intergovernmental Agreement has become effective as of January 1st, 2013 as stated therein.  

The Intergovernmental Agreement merely constitutes an accord between the two countries as to the actual implementation of the exchange of information in connection with taxes already covered in other Conventions – i.e., the Convention on Mutual Administrative Assistance in Tax Matters the US-Mexico Double Tax Treaty, and the US-Mexico Tax Information Exchange Agreement, all of which are in effect and authorize the exchange of information for tax purposes on an automatic basis. This Intergovernmental Agreement sets the framework for the coordination of the Competent Authority of each country in their efforts to improve international tax compliance.

I confess, I still don't see it. How can an agreement to implement a law passed in the US in 2010 "interpret" an existing treaty that predates it, especially when the law in question would override the treaty? A possible explanation is that Mexico's internal financial reporting rules already require financial institutions with the specific information being asked by the US, and that this is just a matter of turning over an existing data stream on an automatic basis. But how can that be--is it likely that Mexican financial institutions already as all of their clients for indicia of US person status? And that it imposes withholding taxes on US-source payments in excess of treaty rates in cases of noncomplianee? Not likely, and obviously not, respectively.

I note that Mexico does seem to have much more info flow between its financial institutions and its tax authority--so much so that it wants to provide the US with monthly average balances of accounts held by US persons, because its banks have monthly info requirements to the Mexican tax authority, you can read about that here.

India revives tax on Vodafone

The headline reads "Government revives Rs 14,000 crore tax demand on Vodafone; company may go for arbitration." Crore = $10 million, so that's 140 billion rupees, which converts to about USD $2.6 billion, up a bit from the original $2.5 billion sought by India's tax authority last year, to account for "delayed payment".

The report says "The company could initiate arbitration before international tribunals under the India-Netherlands Bilateral Investment Protection Agreement"--but this was already done early last year, in anticipation of the reassertion of the tax.  In connection with its filing, Vodafone stated:

"The dispute arises from the retrospective tax legislation proposed by the Indian government which, if enacted, would have serious consequences for a wide range of Indian and international businesses, as well as direct and negative consequences for Vodafone."

I wondered at the time about the oddity that Vodafone could draw India into a dispute resolution with the Netherlands in respect of a law that is not yet passed, but noted that apparently once invoked, the BIT automatically provides for dispute resolution.

The latest is merely an assertion by the Indian tax authority, so it remains to be seen whether Vodafone will seek another victory from the Indian courts (challenging the reassessment) or from the BIT (challenging the retroactive law as a breach of fair & equitable treatment to foreign investors).

Current status of US tax treaties, with FATCA IGA update

Latest US tax treaty update is available here, with a new section covering the developments on FATCA IGAs. I'm still not convinced they should be included in such a list, since from the US perspective these appear to be nothing more than competent authority agreements, presumably entered into under the CA's authority "to clarify or interpret" existing treaty & TIEA provisions.  Certainly, it seems that no internal legislative procedure will be undertaken to get these in force in the US--they await only the internal ratification by FATCA partners.

I have seen absolutely nothing offered by the IRS or Treasury that explains the character of these agreements, so I am deducing that they are being considered CA agreements from what I've seen so far.  But I'll admit the evidence is conflicting and confusing: for example, the IGA with the UK was apparently signed by a non-Treasury embassy official, and not the CA, so how could it be a CA agreement?

Fortunately, at some point the mystery will be solvable: I'll be able to confirm the legal status of the IGAs as soon as the first one enters into force, by checking to see if it lands in the pages of the US treaties and international agreements series. If it does not (as I suspect), then the IGAs really belong only in a list of competent authority agreements, where they will be treated not as treaties or international agreements per se but merely as interpretations of existing treaties. That will be interesting because it really stretches the boundaries of how I think we've understood up until now the competent authority's ability to stray beyond the text of the treaty. Of course, even if they do not end up in the TIAS I can certainly understand why Connery et al included them in their regular tax treaty update, because they sure look like treaties, don't they.

If I am wrong, though, and the IGAs do land in the treaties and international agreements series, then things get even more interesting.  We will be witnessing an unprecedented first in the history of US treaty making: the introduction of sole executive agreements on tax, not pre-authorized by congress, not expressly authorized by any existing treaty, and serving to override existing statutory tax law without any congressional oversight at all. Intriguing to say the least.

Of course, none of this has any bearing on the legal force of the IGAs from an international perspective. In the eyes of the world, these are just like any other international agreement. But in terms of those who think about the treaty making power in the US, I would think this would be a very interesting and controversial development.

UK PAC vs Starbucks and HMRC: Driving recursive cycles of change in tax law?

An interesting real time example of the recursive cycle of lawmaking, as described e.g. here by Halliday and Carruthers, is unfolding in the ongoing drama of the UK Public Accounts Committee's hearings on tax avoidance by Google, Starbucks, and Amazon. Richard Murphy has posted a press release issued by the PAC today in which they hit a lot of core tax policy notes: what "fairness" requires in taxation, the duty of taxpayers to the state, the state's duty toward taxpayers as a group, the problem of taxpayer morale when perceptions of unfairness abound, the role of morality in taxation.

But it also draws a picture of contestation in both the domestic and the global lawmaking spheres, drawing in ideas about and challenges to the rule of law, standards, and norms, and involving legal and nonlegal actors. Halliday & Carruthers point to four mechanisms that drive the recursive cycle forward and lead to phases of legal change: the indeterminacy of law, contradictions, diagnostic struggles, and actor mismatch. The press release suggests we have all four of these drivers in play. Excerpts:

"Global companies with huge operations in the UK generating significant amounts of income are getting away with paying little or no corporation tax here. This is outrageous and an insult to British businesses and individuals who pay their fair share. 

...There is little credible information about what is going on. The evidence we took from large corporations was unconvincing and, in some cases, evasive. HMRC also lacked clarity when trying to explain its approach to enforcing the corporation tax regime. The inescapable conclusion is that multinationals are using structures and exploiting current tax legislation to move offshore profits that are clearly generated from economic activity in the UK. HMRC should be challenging this but its response so far to these big businesses and their aggressive tax planning has lacked determination and looks way too lenient. Policing the tax system must be at the heart of what HMRC does.

So we see the PAC taking on a role as a fiduciary for the people and claiming that the state revenue authority has failed in its own duty to act in that capacity: the result has been indeterminacy of law, contradictions and diagnostic struggles as per H&C.

The PAC calls for naming and shaming of "offenders" (difficult when all these companies claim full compliance with all applicable laws), and for transparency and fairness in the administration of the tax regime by HMRC, that "Government has a responsibility to assess and collect tax due from all taxpayers, without fear or favour," and that "[i]f companies do not pay their fair share of tax, other taxpayers have to pay more." As a result, the PAC says "[b]oth HMRC and corporate taxpayers are failing to meet the legitimate public expectations from the tax system."

This essentially frames multinationals as lawbreakers with HMRC in an accomplice role, whether intentionally or out of neglect. The PAC says "it will always be an unequal fight between HMRC and multinational companies," but calls on the revenue authority both to be more agressive in chasing MNCs and to do more to publicly explain why these companies pay so little. We can interpret this to mean that the PAC seeks to involve more public input into this cycle of legal change, i.e., introducing more actor mismatch.

 You can read the rest of the press release at the link above. Will be interesting to see what comes of it, whether the PAC succeeds in driving forward legal change and whether we will be able to identify a beginning and end of a particular recursive cycle of tax lawmaking (H&C say this is generally very difficult to do, since so many variables are involved in legal change). So far on the part of Starbucks, the result seems to be PR/damage control, in the form of public assertions of willingness to pay a bit more. That just underscores the effectively voluntary nature of international taxation when it comes to MNCs--Starbucks is negotiating with the state--and won't address any of the issues raised by the PAC, so the contestation should continue and may bring in more actors and more struggle.

Canada's decision on Glaxo coming soon!

Prepare yourselves--the Supreme Court will soon release its decision in the Glaxo SmithKline case.  The case record is here.  But as a quick reminder, here are the basics of the dispute:

• Glaxo Group and Glaxo Canada entered into a License Agreement giving Glaxo Canada the right to market Zantac, the active ingredient of which is ranitidine
• The agreement required Glaxo Canada to buy its ranitidine from a member of the Glaxo Group, Adechsa, a nonresident company. 
• Under that supply agreement, Glaxo Canada paid about five times as much per kilo for its ranitidine supply as its generic brand competitors paid for theirs (Glaxo Canada paid between $1,512 and $1,652 per kilo, while two generic brand competitors paid non arms' length suppliers between $194 and $304 per kilo).  
• Even at the inflated price, Glaxo Canada stood to earn a 40% profit margin on the sales of Zantac.
• The Minister deemed Glaxo Canada's purchase price to be greater than that which "would have been reasonable in the circumstances if ... [Adechsa] and ... [Glaxo Canada] had been dealing at arm's length," and therefore reallocated Glaxo Canada's profits under ITA s. 69(2) using $300 as the appropriate price for ranitidine.
• Glaxo Canada argued that any reasonable business person would enter into the supply agreement with Adechsa in order to obtain the benefit of the license agreement with the Glaxo Group.
• The trial judge assessed the license agreement and the supply agreement separately, and upheld the Minister's assessment but allowed an adjustment of $25 per kilogram to reflect the price of processing the ranitidine, therefore setting the arm's length price at $325 per kilo.
• The Federal Court of Appeal decided that the license and supply agreements should have been assessed together and determined that Glaxo Canada’s business circumstances were not comparable with the generic brand competitors because the question at issue was “whether that arm’s length purchaser would be able to sell his Ranitidine under the Zantac trademark." The FCA therefore found that the Tax Court erred in not considering the license agreement as a circumstance, and sent the matter back to trial court to decide whether the price was reasonable under the circumstances (following Gabco).
• On appeal, the SCC is to determine (1) whether the Federal Court of Appeal erred by applying the reasonable business person test to the interpretation of subsection 69(2) of the Income Tax Act; and (2) whether the Federal Court of Appeal erred in interpreting subsection 69(2) by failing to apply the arm’s-length principle on a transaction-by-transaction basis and on the basis that members of the multinational group are operating as separate entities.

My own view is the Gabco reasonable business person test was wrongly applied, and the license and supply agreement must be viewed separately under any coherent transfer pricing assessment, otherwise the taxpayer is free to create any pool of agreements they want to and tie them all together to justify any price--in other words, there would never be any comparables and you might as well not have a transfer pricing regime at all.      But the case deals with repealed s. 69(2) and not the current standard (ITA 247), so even if the SCC rules against the government here and delivers Glaxo a big win by letting it hide royalty payments in its supply agreement, there is likely still a chance that Canada could have a coherent arms' length rule under current law.

Keep in mind that Glaxo settled a similar transfer pricing dispute in the US for $3.4 billion back in 2006 pending a trial that was to begin in 2007; the bulk of the issues in that dispute involved Zantac, but the issue was the deductibility of royalties connected to marketing intangibles rather than the price paid for ranitidine.  The IRS said that GSK conceded over 60% of the total amount at issue in that case.