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S. HRG. 114–389 

INTERNATIONAL TAX: 

OECD BEPS AND EU STATE AID 

HEARING 

BEFORE THE

COMMITTEE ON FINANCE 

UNITED STATES SENATE 

ONE HUNDRED FOURTEENTH CONGRESS 

FIRST SESSION 

DECEMBER 1, 2015 

( 

Printed for the use of the Committee on Finance 

COMMITTEE ON FINANCE 

ORRIN G. HATCH, Utah, Chairman 

CHUCK GRASSLEY, Iowa 

MIKE CRAPO, Idaho 

PAT ROBERTS, Kansas 

MICHAEL B. ENZI, Wyoming 

JOHN CORNYN, Texas 

JOHN THUNE, South Dakota 

RICHARD BURR, North Carolina 

JOHNNY ISAKSON, Georgia 

ROB PORTMAN, Ohio 

PATRICK J. TOOMEY, Pennsylvania 

DANIEL COATS, Indiana 

DEAN HELLER, Nevada 

TIM SCOTT, South Carolina 

RON WYDEN, Oregon 

CHARLES E. SCHUMER, New York 

DEBBIE STABENOW, Michigan 

MARIA CANTWELL, Washington 

BILL NELSON, Florida 

ROBERT MENENDEZ, New Jersey 

THOMAS R. CARPER, Delaware 

BENJAMIN L. CARDIN, Maryland 

SHERROD BROWN, Ohio 

MICHAEL F. BENNET, Colorado 

ROBERT P. CASEY, Jr., Pennsylvania 

MARK R. WARNER, Virginia 

CHRIS CAMPBELL, Staff Director 

JOSHUA SHEINKMAN, Democratic Staff Director 

(II) 

C O N T E N T S 

OPENING STATEMENTS 

Page 

Hatch, Hon. Orrin G., a U.S. Senator from Utah, chairman, Committee on 

Finance .................................................................................................................. 1 

Wyden, Hon. Ron, a U.S. Senator from Oregon .................................................... 3 

WITNESSES 

Stack, Robert B., Deputy Assistant Secretary for International Tax Affairs, 

Department of the Treasury, Washington, DC .................................................. 6 

Coleman, Dorothy, vice president for tax and domestic economic policy, National Association of Manufacturers, Washington, DC ..................................... 8 

Danilack, Michael, principal, PricewaterhouseCoopers LLP, Washington, DC . 10 

ALPHABETICAL LISTING AND APPENDIX MATERIAL 

Coleman, Dorothy: 

Testimony .......................................................................................................... 8 

Prepared statement .......................................................................................... 33 

Responses to questions from committee members ......................................... 36 

Danilack, Michael: 

Testimony .......................................................................................................... 10 

Prepared statement .......................................................................................... 41 

Responses to questions from committee members ......................................... 43 

Hatch, Hon. Orrin G.: 

Opening statement ........................................................................................... 1 

Prepared statement .......................................................................................... 46 

Stack, Robert B.: 

Testimony .......................................................................................................... 6 

Prepared statement .......................................................................................... 48 

Responses to questions from committee members ......................................... 54 

Wyden, Hon. Ron: 

Opening statement ........................................................................................... 3 

COMMUNICATIONS

Business and Industry Advisory Committee to the OECD .................................. 63 

Center for Freedom and Prosperity ....................................................................... 70 

Motion Picture Association of America .................................................................. 75 

Tax Innovation Equality (TIE) Coalition ............................................................... 78 

(III) 

(1) 

INTERNATIONAL TAX: 

OECD BEPS AND EU STATE AID 

TUESDAY, DECEMBER 1, 2015 

U.S. SENATE, COMMITTEE ON FINANCE, Washington, DC. 

The hearing was convened, pursuant to notice, at 2:49 p.m., in 

room SD–215, Dirksen Senate Office Building, Hon. Orrin G. Hatch 

(chairman of the committee) presiding. 

Present: Senators Grassley, Crapo, Thune, Portman, Scott, 

Wyden, Stabenow, Carper, Cardin, Brown, Bennet, Casey, and 

Warner. 

Also present: Republican Staff: Chris Campbell, Staff Director; 

Tony Coughlan, Tax Counsel; Eric Oman, Senior Policy Advisor for 

Tax and Accounting; and Jeff Wrase, Chief Economist. Democratic 

Staff: Todd Metcalf, Chief Tax Counsel; and Tiffany Smith, Senior 

Tax Counsel. 

OPENING STATEMENT OF HON. ORRIN G. HATCH, A U.S. 

SENATOR FROM UTAH, CHAIRMAN, COMMITTEE ON FINANCE 

The CHAIRMAN. The committee will come to order. I want to welcome everyone here this afternoon and thank you all for attending 

this important hearing on international taxation, focusing particularly on the Organisation for Economic Co-operation and Development’s, or OECD’s, project on Base Erosion and Profit Shifting, or 

BEPS. 

The overall discussion about international tax is very timely. 

Just a couple of weeks ago, we were informed that a major American pharmaceutical company had decided to invert, meaning merging with another drug company with the headquarters in a newly 

formed corporation to be located in a foreign country. 

Of course, this is nothing new. We have been seeing these types 

of transactions take place for some time. Inversions like these are 

some of the clearest examples of base erosion, and are largely motivated by tax considerations as American companies determine that 

they can reduce their overall operating costs if they become foreign 

corporations. 

Given the burdensome and anti-competitive nature of the U.S. 

tax code, these companies are, unfortunately, not acting irrationally. The administration’s response to the wave of inversions has, 

in my opinion, been very shortsighted, focusing only on the symptoms rather than on the underlying illness. 

While the latest guidance from Treasury might very well stem 

the tide of inversions, it will leave other, potentially more harmful 

2 

avenues for tax avoidance—like foreign takeovers—wide open, and 

perhaps even make them more attractive than they are now. Long 

story short, any steps we take to address inversions should focus 

on fixing the shortcomings of the underlying system and make the 

U.S. a better place for companies to do business. 

The BEPS project is another effort aimed at addressing international tax problems and base erosion. But on a more global scale, 

the purpose of the project was to provide OECD member countries 

with recommendations for both domestic tax policy changes and 

amendments to existing tax treaties to address business practices 

that do result in base erosion. 

After several years of discussion, the OECD released its final reports earlier this year, and last month, leaders from the G20 countries endorsed the recommendations. Throughout this process, we 

have heard concerns from large sectors of the business community 

that the BEPS project could be used to further undermine our Nation’s competitiveness and unfairly subject U.S. companies to greater tax liabilities abroad. 

Companies have also been concerned about various reporting requirements that could impose significant compliance costs on 

American businesses and force them to share highly sensitive, proprietary information with foreign governments. I expect that we 

will hear about these concerns from the business community and 

others during today’s hearing. 

In addition, throughout the BEPS negotiations, I urged the 

Obama administration to both acknowledge the limits of their authority under the law and to cooperate with Congress on any and 

all efforts to implement the recommendations. And, while the U.S. 

was a party to the BEPS negotiations, Congress had neither a seat 

at the negotiating table nor a meaningful opportunity to weigh in 

with the administration on the substance of these proposals. 

However, it is Congress, and Congress alone, that has the ultimate authority to make changes to the U.S. tax code. And while 

the Treasury Department does have broad regulatory authority 

under the law, that power is not without limits. 

Even in those areas where authority clearly exists for the administration to promulgate regulations, it is virtually always better if 

Congress is viewed as a partner in this process, rather than an adversary. And in those instances where the regulatory authority is 

less clear, congressional involvement and approval is even more important to ensure that policy changes are viewed by the public as 

legitimate. 

Of course, most of this should go without saying. It is, after all, 

a basic lesson in government, and I do not think anyone here is in 

need of a civics refresher course from me. However, I think it also 

goes without saying that the current administration has not always 

viewed Congress as a necessary or even important part of its efforts to develop and implement policy changes. 

So I think it is, at the very least, helpful to offer a brief reminder 

to everyone that Congress has a role to play on these issues that 

cannot be overlooked. That is another set of concerns that I expect 

we will discuss during this hearing. 

We have a representative from Treasury here today, so I am 

looking forward to getting a better sense of what elements of the 

3 

* For more information, see also, ‘‘Background, Summary, and Implications of the OECD/G20 

Base Erosion and Profit Shifting Project,’’ Joint Committee on Taxaton staff report, November 

30, 2015 (JCX–139–15), https://www.jct.gov/publications.html?func=startdown&id=4853. 

BEPS recommendations the administration believes it can implement unilaterally and where they believe congressional action will 

be necessary. 

I also want to note that I have asked the Government Accountability Office to provide its own analysis on the BEPS recommendations, taking into account all of the complex elements, both domestic and global, that are implicated with these types of policy 

changes. And I expect their work will take some time, but gathering this type of information is, in my view, an essential part of 

our overall evaluation of the BEPS project. 

There are other topics that I expect will come up today, including 

a discussion of so-called ‘‘state aid’’ remedies and recent activities 

in the eurozone that to me look like attempts to impose retroactive 

taxation on multinational enterprises, including a number of U.S.- 

based companies. 

Speaking more broadly, I just want to say that when it comes to 

international tax issues, I hope we can all have the same goals in 

mind. I would hope that we all want to improve conditions for 

American businesses, and I would hope that we would all want to 

make our country more competitive on the world stage. 

And to that end, I would hope that we all want to improve the 

overall health of the U.S. economy. That is why all of us are here 

today—or at least it should be. Any regulations promulgated by 

this administration to prevent businesses from moving offshore 

should have these goals in mind. 

At the same time, while international efforts to align tax systems 

are worth exploring, we should not be negotiating agreements that 

undermine our own interests for the sake of some supposedly higher or nobler cause. The interests of the United States, our own 

economy, our own workers, and our own job creators, should be our 

sole focus. 

So, throughout the day’s discussion, whether we are talking 

about BEPS, inversions, or any other international tax issues, I am 

most interested in hearing views as to how various policies and 

proposals will or will not serve our Nation’s interests and advance 

these important goals. 

Long story short, we have quite a bit to talk about today, and 

we have a distinguished panel of witnesses who should be able to 

shed some light on these complicated issues. So I look forward to 

their testimony.* 

With that, I will turn to Senator Wyden for his opening remarks. 

[The prepared statement of Chairman Hatch appears in the appendix.] 

OPENING STATEMENT OF HON. RON WYDEN, 

A U.S. SENATOR FROM OREGON 

Senator WYDEN. Thank you very much, Mr. Chairman, and, Mr. 

Chairman, thank you for holding this hearing. I think you describe 

it very appropriately in saying that it is especially timely. 

And the reality, colleagues, is that the inversion virus is growing. 

The inversion virus is mutating, and nothing could prove that more 

4 

clearly than what we saw just a few days ago, with Pfizer merging 

with Allergan and moving its headquarters overseas in pursuit of 

a lower tax bill. 

Now, we are doing some checking, but I believe this is the biggest inversion to date. This is the biggest one on record—and we 

will have the recorder note that Mr. Stack nodded his head, quietly, yes. So I think that that gives me some added validation. 

But kidding aside, the point is, the Pfizer move is clear proof of 

what everybody in this room knows, and that is that the American 

tax code is a broken, dysfunctional mess, and it is a drag on the 

American economy. 

So we are now coming together for the third time in 18 months 

to examine the need for international tax reform. In that time, the 

Treasury Department has taken multiple steps to slow the spread 

of the inversion virus, but there is only so much that the Treasury 

Department can do to quarantine the problem. We are going to 

need comprehensive tax reform. 

And while the broken tax code sits in place, something of an antiquated monument to a different economic era, essentially the 

sand shifts around it, and more and more of the country’s tax base 

erodes into this kind of international sea of harmful tax practices 

and ruinous competition. 

And my guess is, until the Congress has the political will to do 

what has to be done, these inversions are going to continue. And 

my guess is the Pfizer inversion will not be the last, and it will not 

be the largest. And foreign governments are going to continue to 

use our obsolete tax code against our country by agreeing to give 

certain companies what amount to sweetheart deals to locate within their borders. 

Now, as matters have just continued to spin out of control, the 

largest economies in the world, through the G20 and the OECD, 

came together for a very significant tax policy project known as the 

Base Erosion and Profit Shifting discussion. And what they sought 

to do is come up with—and this is really their singular goal: to 

make it harder to game the system. 

Now, when it comes to these kinds of proposals, there are some 

big questions that you have to get into right at the outset. And certainly, they are going to take a lot of study by the Congress. 

I do want to commend our Treasury witness, Mr. Stack. He has 

tried very hard to advocate our interests, the American interests, 

in these discussions. And obviously, as Mr. Stack will tell you, he 

has had a very steep hill to climb in these discussions, and we appreciate his efforts. 

Now, Chairman Hatch mentioned this question of unlawful state 

aid. What we are really talking about is very aggressive actions 

taken by the European Commission. And they call it unlawful state 

aid, but what it really looks like to me is tax-planning strategies 

that our broken tax code is driving our companies to go out and 

pursue. 

So, from the standpoint of a bottom line, here is mine: if you 

shudder, colleagues, at these tax-avoidance schemes; if you really 

get angry about matters like the double Irish with a Dutch sandwich; if you want to crack down on it, you have to be for comprehensive tax reform. If you want to give companies a reason to 

5 

invest and grow and headquarter in the United States, the path to 

reach those goals is major tax reform. 

And I do not see our colleague, Senator Coats, with us, but he 

and I have worked together. I have worked with Senator Gregg. I 

have worked with Senator Hatch. I want it clear that I think Senators on both sides of the aisle want to move forward on this, and 

the sooner we get to it, the better. 

And, Mr. Chairman, also, an apology at this point. We are beginning the reconciliation on the floor, and I am going to have to be 

there for my portion of it here in a few minutes. But I just want 

it clear that I am looking forward to working with you in a bipartisan way and with our colleagues on both sides of the aisle. 

The CHAIRMAN. Well, thank you, Senator Wyden. We appreciate 

it. 

Now I would like to take a few minutes to introduce our distinguished panel of witnesses. 

First, we will hear from Assistant Secretary Robert Stack, who 

covers international tax affairs issues in the Office of Tax Policy at 

the Department of the Treasury. Mr. Stack serves as the U.S. Delegate to the Committee on Fiscal Affairs in the OECD. Mr. Stack 

has over 26 years of private-sector experience in international tax 

matters, representing both corporations and individuals. Mr. Stack 

is a graduate from Georgetown University Law Center, where he 

was editor-in-chief of the Georgetown Law Journal. 

Second, we will hear from Dorothy Coleman, vice president of tax 

and domestic economic policy at the National Association of Manufacturers, or NAM. Ms. Coleman has served in her current position 

for more than 15 years, bringing a wealth of knowledge and experience. She has also worked for a major accounting firm and in the 

tax press. Ms. Coleman received her law degree from Georgetown 

University Law Center and her bachelor of arts in economics from 

Manhattanville College in Purchase, NY. 

Finally, we will hear from Michael Danilack, a principal at 

PricewaterhouseCoopers, or PwC. Mr. Danilack currently works in 

PwC’s Washington national tax services practice and focuses specifically on international tax issues. Before joining PwC in 2014, 

Mr. Danilack served as the Deputy Commissioner in the IRS Large 

Business and International Division, where he was responsible for 

all international tax matters for the IRS, including serving as the 

U.S. competent authority. He also served for 6 years as an assistant to the IRS Commissioner and then as IRS Associate Chief 

Counsel for International Matters. Mr. Danilack earned a B.A. 

from the University of Pennsylvania and a J.D., as well as an 

LL.M., from New York University School of Law. 

I want to thank each of these distinguished witnesses for being 

here today, but more especially for their hard work and dedication, 

especially as they prepared for this hearing over the Thanksgiving 

holiday. 

Mr. Stack, we will start with you. If you will proceed with your 

opening statement, we would appreciate it. 

6 

OPENING STATEMENT OF ROBERT B. STACK, DEPUTY ASSISTANT SECRETARY FOR INTERNATIONAL TAX AFFAIRS, DEPARTMENT OF THE TREASURY, WASHINGTON, DC 

Mr. STACK. Thank you, Mr. Chairman. Chairman Hatch, Ranking Member Wyden, and distinguished members of the committee, 

I appreciate the opportunity to appear today to discuss some key 

international tax issues, including the recently completed G20 

OECD Base Erosion and Profit Shifting, or BEPS, program. 

In June 2012 at the G20 Summit in Los Cabos, Mexico, the leaders of the world’s largest economies identified the ability of multinational companies to reduce their tax bills by shifting income into 

low- and no-tax jurisdictions as a significant global concern. They 

instructed their governments to develop an action plan to address 

these issues, which was endorsed by the G20 leaders in St. Petersburg in 2013. The project came to fruition this fall with the presentation of the final reports to the G20. 

The BEPS project covers 15 separate topics. Some reports, such 

as those on the digital economy and controlled foreign corporations, 

are more or less descriptive of the underlying issues and discuss 

approaches or options that countries might take without demonstrating any agreement among participants on a particular path. 

Other reports, such as those on interest deductibility and hybrid 

mixed securities, describe the elements of a common approach that 

countries might take with respect to those issues. 

With respect to transfer pricing, the arm’s-length standard was 

further amplified in connection with issues around funding, risk, 

and hard-to-value intangibles. Finally, in the areas of preventing 

treaty shopping, requiring country-by-country reporting, fighting 

harmful tax practices—including through the exchange of crossborder tax rulings—and improving dispute resolution, countries 

agreed to a minimum standard. 

I believe that the transparency provided by country-by-country 

reporting that tightens the transfer pricing rules and the agreement to exchange cross-border tax rulings will go a long way to 

curtail the phenomenon of stateless income that pushed the BEPS 

program forward. Companies will very likely be reluctant to show 

on their country-by-country reports substantial amounts of income 

in low- or no-tax jurisdictions, and the transfer pricing work will 

better align profits with the functions, assets, and risks that create 

that profit. 

The exchange of rulings on cross-border matters will drive out 

bad practices and shine sunlight on the practices that remain. The 

improvement of dispute resolution and the inclusion, where possible, of arbitration will streamline dispute resolution and should 

thereby reduce instances of double taxation. 

So where do we go from here? Well, certain technical work remains for the OECD in 2016 and beyond, and the OECD will turn 

its attention to implementation and monitoring of the various 

BEPS deliverables on the action items. More importantly, however, 

we believe that the best way to foster the G20 goal of supporting 

global growth is to actively promote the connection between foreign 

direct investment, growth, and efficient and effective tax administration built on the rule of law. We are working hard to ensure 

7 

that issues around effective and fair tax administration around the 

world are made part of the post-BEPS agenda. 

The BEPS project was one manifestation of global concern about 

international tax issues, and the EU state aid investigations are 

another. In 2014, the European Commission opened four in-depth 

investigations to examine whether decisions by tax authorities in 

Ireland, the Netherlands, and Luxembourg with regard to corporate income tax paid by Apple, Starbucks, Fiat Finance and 

Trade, and Amazon complied with EU rules on state aid. 

On October 21, 2015, the EU Commission announced its conclusions that Luxembourg has granted selective tax advantages to 

Fiat’s financing company, and the Netherlands has granted selective tax advantages to Starbucks Coffee Roasting Company in the 

Netherlands. U.S. companies are reported to be the subject of still 

more investigations. 

Treasury has followed the state aid cases closely for a number of 

reasons. First, we are concerned that the EU Commission appears 

to be disproportionately targeting U.S. companies. 

Second, these actions potentially undermine our rights under our 

tax treaties with European member states. The United States has 

a network of income tax treaties with the member states and has 

no income tax treaty with the EU, because income tax is a matter 

of member-state competence, under EU law. 

While these cases are being billed as cases of illegal state subsidies under EU law, or state aid, we are concerned that the EU 

Commission is, in effect, telling member states how they should 

have applied their own tax laws over a 10-year period. Plainly, the 

assertion of such broad power with respect to an income tax matter 

calls into question the finality of U.S. taxpayers’ dealing with member states, as well as the U.S. Government’s treaties with member 

states in the area of income taxation. 

Third, the EU Commission is, by all accounts, taking a novel approach to the state aid issue, yet they have chosen to apply this 

new approach retroactively rather than only prospectively. 

While in the Starbucks case, the sums were relatively modest— 

20 to 30 million euros—they may be substantially larger, perhaps 

in the billions, in other cases. The retroactive application of a novel 

interpretation of EU law calls into question the basic fairness of 

the proceedings. 

Fourth, while the IRS and Treasury have not yet analyzed the 

equally novel foreign tax credit issues raised by the payments that 

may be required under these cases, it is possible that the settlement payments ultimately could be determined to give rise to creditable foreign taxes. If so, U.S. taxpayers would wind up footing the 

bill for these state aid settlements when the affected U.S. taxpayers’ companies either repatriate amounts voluntarily, or Congress requires a deemed repatriation as a part of tax reform, unless 

U.S. taxes are paid on the repatriated amounts on account of the 

higher creditable taxes. 

Finally—and this relates to the EU’s apparent substantive position in these cases—we are greatly concerned that the EU Commission is reaching out to tax income that no member state had the 

right to tax under internationally accepted standards. 

8 

Let me close with a quick reference to the topic of inversions. As 

you are aware, the IRS and Treasury last week issued Notice 2015- 

79 to deter and reduce further the economic benefits of corporate 

inversions. 

Treasury will continue to examine additional ways to reduce the 

tax benefits of inversions, including through limiting the ability of 

inverted companies to strip earnings with inter-company debt. 

However, only legislation can effectively address these issues. To 

this point, we look forward to working with Congress in a bipartisan manner to protect the U.S. tax base, to address the issue of 

corporate inversions, and to reform our business tax system. 

Let me repeat our appreciation for the committee’s interest in 

these important issues. I would be happy to answer any questions 

that you may have. 

Thank you. 

The CHAIRMAN. Thank you, Mr. Stack. 

[The prepared statement of Mr. Stack appears in the appendix.] 

The CHAIRMAN. We will turn to you now, Ms. Coleman. 

OPENING STATEMENT OF DOROTHY COLEMAN, VICE PRESIDENT FOR TAX AND DOMESTIC ECONOMIC POLICY, NATIONAL ASSOCIATION OF MANUFACTURERS, WASHINGTON, 

DC 

Ms. COLEMAN. Chairman Hatch, Ranking Member Wyden, and 

members of the committee, thank you for the opportunity to testify 

today about the BEPS project spearheaded by the G20 and the 

OECD. I appreciate the chance to highlight the NAM’s concerns 

about some of the recommendations in the BEPS project that 

would impose unnecessary compliance costs on companies, and in 

some cases force disclosure of sensitive, confidential taxpayer information. 

The NAM is the Nation’s largest industrial association and voice 

for more than 12 million women and men who make things in 

America. Manufacturers know how critically important it is for 

U.S. companies to be able to invest and compete effectively in a 

global economy where 95 percent of the world’s customers are outside the United States. 

The BEPS project included 15 action items, and I would like to 

focus my comments on Action 13, ‘‘Re-examine Transfer Pricing 

Documentation.’’ 

Action 13 adopts a three-tiered approach: a master file to provide 

a complete picture of a multinational company’s global operations, 

a local file of more detailed information relating to specific intercompany transactions impacting a tax jurisdiction, and a countryby-country report with aggregated financial and tax data. 

The country-by-country reports that companies would file with 

their own country would impose an additional administrative burden on companies. These reports, however, would be submitted to 

foreign countries under bilateral treaties and information exchange 

agreements with protections to ensure confidentiality, consistency, 

and appropriate use of the information by foreign countries. If a 

country fails to abide by these conditions, the U.S. Treasury has 

stated its intent to suspend the information exchange. This would 

9 

not be the case with the master file, which could be required directly by any country where a company does business. 

While both the country-by-country reports and the master file include extremely sensitive information unrelated to actual taxpayer 

activities in the country requesting the information, the master file 

does not have the protections of the information exchange process, 

and thus is not subject to any confidentiality, consistency, or 

appropriate-use conditions beyond those that may apply locally. 

Manufacturers also are concerned that the master file requirement 

would force them to disclose an unprecedented amount of proprietary information about their global operations to foreign governments. 

The master file would include organizational charts, consolidated 

financial statements, and analyses of profit drivers, supply chains, 

intangibles, and financing—in short, a comprehensive plan that includes every aspect of a company’s worldwide business. For privately held companies, the requirements to include a global organizational chart and consolidated financial statements would constitute an unprecedented level of disclosure to foreign governments. 

The fact that taxpayers have some level of control over what information is included in the master file does little to address confidentiality concerns, since it is unclear how much flexibility taxpayers actually have to exclude sensitive information. The OECD 

recommends taxpayers use a prudent business judgment standard 

to determine the appropriate level of detail to be included in the 

master file. This standard provides little comfort for taxpayers who 

want to omit sensitive information and avoid penalties for failing 

to comply with the filing requirements. 

Even though the BEPS recommendations were finalized this fall, 

confidentiality concerns can and should be addressed during the 

BEPS implementation phase. Specifically, the NAM believes that 

Treasury should link master file information to its agreements to 

provide the country-by-country report to other countries through 

information exchange. 

Thus, we urge Congress to ensure that Treasury enters into 

agreements with foreign countries specifying that Treasury agrees 

to provide country-by-country reports for U.S. multinationals only 

if U.S. multinationals or their subsidiaries are not required to provide master file information to the foreign country, that the foreign 

country agrees that it will not collect country-by-country reports 

from U.S. multinationals or their subsidiaries, and that Treasury 

agrees to provide to the foreign country only the master file information that a U.S. multinational chooses to file with its countryby-country report in order to provide context for its country-bycountry data. 

Manufacturers believe a fair and transparent tax climate in the 

United States, including competitive business tax rates and modern international tax rules, will boost standards of living and economic growth worldwide. At the same time, an appropriate balance 

needs to be struck between transparency and confidentiality of the 

proprietary information that enables companies to compete and 

prosper in a global economy. 

Thank you for the opportunity to appear before the committee to 

discuss the NAM’s concerns with the master file requirement. This 

10 

concludes my testimony, and I would be happy to answer any of 

your questions. 

Thank you. 

The CHAIRMAN. Well, thank you so much. 

[The prepared statement of Ms. Coleman appears in the appendix.] 

The CHAIRMAN. Mr. Danilack, we will take your testimony now. 

OPENING STATEMENT OF MICHAEL DANILACK, PRINCIPAL, 

PRICEWATERHOUSECOOPERS LLP, WASHINGTON, DC 

Mr. DANILACK. Chairman Hatch, Ranking Member Wyden, and 

distinguished members of the committee, I appreciate the opportunity to appear this afternoon as the committee considers BEPS 

and state aid. 

I would like to compliment the committee for holding today’s 

hearing. The subject is of considerable importance to the U.S. tax 

base and to U.S. tax administration. 

As Chairman Hatch mentioned at the outset, currently I am a 

tax principal at PricewaterhouseCoopers in the Washington national tax services practice, but previously I held a number of 

international-focused leadership positions at the IRS. 

I appear here today, however, on my own behalf and not on behalf of PwC or any client of the firm or certainly not on behalf of 

the U.S. Government. And therefore, the views I express today are 

entirely my own. 

Before I begin, I would like to offer my compliments to Mr. Stack 

personally and to his team at the Treasury Department. The BEPS 

project seemed threatening to U.S. interests right from the start, 

and Mr. Stack’s diligent efforts to bring balance and wisdom to the 

project are greatly appreciated. 

The subject of today’s hearing raises numerous legal and policy 

considerations. In my view, however, the most important effect of 

the BEPS project in the near term is likely to be on international 

tax enforcement activities around the world, and this I believe will 

create a serious challenge both for U.S.-based multinational businesses and for the U.S. Government. 

The scope of the BEPS project and the timetable set for completing the work were extraordinarily ambitious. In addition, the 

OECD invited participation by non-OECD-member countries that 

brought new points of view to the table. 

As a consequence, it is not surprising that the papers issued on 

October 5th of this year do not reflect a clear global consensus on 

many of the difficult issues that were evaluated. In some respects, 

the papers merely provide governments with options. In other respects, they draw conclusions based on new concepts that are somewhat ambiguous. In still other respects, the work is unfinished. 

So, despite the OECD’s accomplishments, so far the BEPS project 

has created significant ambiguities and considerable uncertainties. 

Notwithstanding the ambiguities, however, in my estimation it is 

inevitable that countries will begin to assert the new concepts 

through enforcement actions guided by their own interpretations 

and with their own revenue collection goals in mind. 

Indeed, this is already happening around the world. I hear stories about it from clients nearly every day. 

11 

Because the BEPS project provides concepts that can be used to 

expand the revenue base of almost any country, the resulting 

threat is widespread double taxation, or even multiple taxation. 

The U.S. network of tax treaties, of course, is designed to eliminate double taxation, and all countries agree that double taxation 

is wrong as a matter of policy. But when double taxation is created 

by one country’s enforcement action, it is not automatically eliminated by a rule in the treaty. Rather, the case is presented by the 

taxpayer to the designated competent authorities of the two jurisdictions involved, and those competent authorities seek to arrive at 

a principle-based settlement to ensure that the profits of the business are taxed only once. 

But this so-called mutual agreement procedure is far from easy 

to conduct. At the competent authority table, the country that 

makes the adjustment has the greater leverage. Essentially, that 

country is in a position to enforce its determination at will. 

The other country, the one where the profits were originally reported, can only attempt to convince the adjusting country to withdraw or reduce the adjustment by pointing to well-established 

international principles. This can be difficult under normal circumstances, but where the underlying principles are unclear, the 

effort may well be a losing one. 

A number of things might be done about the problem. One is to 

ensure that the IRS competent authority is equipped to handle the 

challenges that lie ahead. A second is to reform the U.S. international tax system. 

Lowering the U.S. corporate rate and reforming our international 

rules are critical, but I note that even if such changes are made, 

other taxing authorities will be looking to tax a bigger share of a 

bigger pie. 

I also note, in closing, that there seems to be a target unfairly 

painted on the backs of U.S. companies. Nevertheless, it is likely 

that taxing authorities will seek to tax a larger share of global 

profits of all multinational businesses. There is, however, an important difference between U.S. companies and foreign companies in 

this respect. 

As we all know, the United States has a worldwide system with 

credits provided for foreign taxes paid, which may include those 

imposed through foreign audits. So, if the U.S. competent authority 

does not have the resources to handle the tsunami of new doubletax cases predicted by many, or if the IRS cannot successfully convince foreign governments that their adjustments are wrong by 

pointing to established principles, the U.S. companies generally 

will not bear the resulting double taxation. Instead, they will be 

entitled to take a credit for the adjusted foreign taxes in the United 

States, and the U.S. tax base will be eroded as a result. 

Chairman Hatch, Ranking Member Wyden, and other distinguished members of the committee, I thank you again for the opportunity to be heard today, and I would be happy to answer any 

questions you may have. 

The CHAIRMAN. Well, thank you so much. 

[The prepared statement of Mr. Danilack appears in the appendix.] 

The CHAIRMAN. We will turn to Senator Grassley first. 

12 

Senator GRASSLEY. Thank you very much for that courtesy, Mr. 

Chairman. 

I have three questions, if I have time, to ask Mr. Stack, but if 

the other two of you would like to join in, that is all right as well. 

Mr. Stack, in a talk that you gave in June on the progress of 

BEPS, you stated that you had, quote, ‘‘been personally shocked 

and appalled at the lack of attention that clarity and the ability to 

administer get at the OECD.’’ You further stated, quote, ‘‘This was 

motivated by the fact that tax administrators like having whatever 

tools they can to go after taxpayers.’’ 

So, a question: do you continue to have concerns about the lack 

of clarity and the ability to administer rules contained in the final 

BEPS report? If so, should American companies be worried that 

they will be unfairly targeted by foreign tax administrators taking 

an I-know-it-when-I-see-it approach to their implementation and 

enforcement of the recommendations? 

Those two questions. 

Mr. STACK. Yes, Senator, I stand by those remarks, and I work 

very closely with the business community and lots of stakeholders 

in the BEPS work. 

I think that the areas that concerned us the most in these negotiations were questions like a looser standard on permanent establishments, and questions like how other countries were going to determine treaty abuse by putting in place what we consider a vague 

principal purpose test for treaty abuse. And I stand by the remark 

that I did not find the questions of the importance and clarity and 

administrability of rules to be a central concern of the negotiators 

at the OECD. 

I would say two things on those particular issues. Because of our 

reservations on both the PE and the treaty abuse issues, the 

United States has made it clear that we will not be adopting the 

permanent establishment rules that were agreed to, unless we get 

further guarantees on how profits will be attributed once they are 

put in place. And second, the U.S. has made clear that we will not 

be putting a principal purpose test in our treaties. 

Now, granted, U.S. multinationals operate all around the world, 

so they are still going to run into these rules, but that was a position that we were able to take on that. 

Having said that, there were many areas where I think we were 

able to push back and get better rules and more clarity because we 

were insistent. The transfer pricing reports at the end were a lot 

better than they were in the middle drafts, and so we stayed focused on that. 

And the last point I want to make is, we are trying to turn the 

attention of the OECD next to this very issue, which is, we have 

written a thousand pages of reports, but what are the guarantees 

that your auditor in X country is going to understand them and 

apply them fairly and that people will get a fair shake? 

So we think we can pivot now from having written some new 

rules to try to turn the world’s attention to what is fair and efficient tax administration. And that is a heavy lift, but we think it 

is a very important thing to do for global growth and foreign direct 

investment. 

13 

Senator GRASSLEY. All right. My next question to you is, this 

project was sold as a means to stave off uncoordinated unilateral 

action by some countries that would erode international tax certainty and predictability, yet it is unclear that this has been the 

case. 

For instance, the U.K. and Australia have gone forward with socalled diverted profits taxes, and now we have the EU state aid 

cases, which could be seen as linked to BEPS concerns. 

So, Mr. Stack, in your view, will the finalizing of the BEPS project help put an end to unilateral action, or should we be concerned 

that it has only emboldened countries to take even more aggressive 

action towards American companies? 

Mr. STACK. Thank you, Senator. 

Look, I think the unilateral action point is, we will never know, 

as we sit here, what more unilateral action there would have been 

if we had not fully engaged in the BEPS project, number one. And 

I think one of the things I have learned by talking to other governments is that foreign, multinational tax avoidance, often with a 

focus on U.S. companies, is headline news around the world that 

very much creates a great deal of political pressure. 

So what might have happened if we had not engaged in BEPS 

is a story we do not know the answer to. Has there been unilateral 

action? Yes, there has. Are we upset about it in the case of the 

U.K. tax and the Australian tax and the state aid? Yes we are, and 

what can we do to manage it is an open question. 

We are hopeful that we can use the BEPS reports and monitor 

the ongoing output to invite countries to pull back from places 

where they have strayed from what is in the BEPS reports, to come 

back to the rules that we have now all agreed to. 

But I would say, that is very much a work in progress, as working with these countries and their sovereignty in writing their 

rules is not something we control all that easily. 

Senator GRASSLEY. Thank you. 

Thank you, Mr. Chairman. 

The CHAIRMAN. Well, thank you. 

Senator Wyden? 

Senator WYDEN. Thank you, Mr. Chairman. 

So we have obviously had, as the kind of cloud over all this, the 

question of companies inverting because they say they have to 

lower their tax bills. That is what Pfizer said. The Wall Street 

Journal recently reported that Aon is using earnings stripping to 

lower its tax bill, and certainly evidence suggests it is not alone. 

So, Mr. Stack, on this point, does the Treasury Department have 

sufficient authority to, in effect, nullify efforts to strip earnings out 

of the United States? 

Mr. STACK. Senator, we continue to look at the earnings stripping questions very closely. We are mindful of the point the chairman made, that there are lines between what can be done administratively and where the Congress needs to act. And it is difficult 

for me to say point blank, because this work is ongoing at the 

Treasury, where that line is between what we can do regulatorily 

and what would require congressional action. 

I can say that in the inversion space and the earnings stripping 

space, Congress could tomorrow limit earnings stripping below 

14 

what it is currently in 163(j), but we are still looking at the contours of our authority relative to your authority. And we, as the 

Secretary said recently, continue to examine these issues. 

Senator WYDEN. All right. Let us turn to the question of state 

aid—and maybe for you, Mr. Stack, and I think probably Mr. 

Danilack, but any of you who would like to participate. 

The EU state aid cases look like, to me, another example of foreign governments targeting American firms. And they are targeting 

American firms because they would like to expand their tax base. 

So I think, based at least on comments I have read in the press, 

that you all largely share my concerns that these cases could lead 

to retroactive tax increases. Is that right, Mr. Stack? That is just 

a ‘‘yes’’ or ‘‘no.’’ 

Mr. STACK. Yes, sir. 

Senator WYDEN. All right. And so we would be talking about retroactive tax increases on American companies that could result in 

American taxpayers footing the bill through foreign tax credits, 

which is something we have had for quite some time. 

So my concern here is—and the point of the question is—the effects could go far beyond what are just these initial state aid cases. 

So, let us see if we can get a reaction. One, are these cases, in 

your view, Mr. Stack, paving the way for the EU to go after the 

historical earnings of many more U.S. multinationals? 

Mr. STACK. Senator, I only know that there have been reported 

instances of more U.S. companies being examined. So that would 

take you in the direction of saying yes, they might go further than 

the cases we have been looking at. And yes, I do believe that the 

target is the unrepatriated earnings of our companies that have 

been deferred from U.S. taxes. 

Senator WYDEN. So these cases, then, could have a substantial 

and direct impact on the U.S. fisc, and consequently American taxpayers? 

Mr. STACK. Yes, Senator. 

Senator WYDEN. All right. So on this point, what is the Treasury 

Department’s strategy on these issues, and what can the Congress 

do in that effort? 

Mr. STACK. Senator, we have taken measures to be sure that the 

Commission understands the direct U.S. concerns around our tax 

treaty network and the potential for these taxes to be borne by 

American taxpayers. So the first thing we could do, and we have 

done, is to let the Commission know that we have a stake in these 

cases. We are not just bystanders. 

I think a broader point is, we have also made it clear that the 

retroactive element of these cases—because it seems clear to me as 

an observer that the theories being put forth here surprised countries, companies, advisers, auditors. And when you have a new type 

of ruling that is not foreseen by the community that effectively had 

no notice, for it to be retroactive strikes me as particularly unfair. 

Now, beyond the Treasury Department making clear our view 

with respect to these issues, since this is a proceeding in another 

jurisdiction, I do not have some magic bullet for the next things 

that the Treasury can do, except I will say we did not want to wait 

for these rulings to be in the books and the money to be paid before 

we looked up and realized that these issues had arisen. 

15 

So I believe we have been very aggressive and forward-leaning 

in making sure that we are getting ahead of and not being surprised about the direction this is heading. 

Senator WYDEN. Let me ask you about this in the context of tax 

reform, and I think you and I have talked about it down there in 

the office a few doors down. I really spent years, particularly with 

Senator Gregg and Senator Coats, putting together bipartisan bills 

and working with various colleagues on the committee. And Chairman Hatch and I have discussed this at some length. 

And we never really had to deal with things like what we are 

talking about now, the question of EU state aid cases and what the 

implications are. Now, it looks to me that, given the debate now, 

most international tax reform plans are going to include revenue 

from some sort of deemed repatriation of historical foreign earnings 

as a transition to a new system—really, an exemption-based system. 

How is the EU state aid situation going to impact something like 

a deemed repatriation transition tax? The reason I am asking is, 

I am telling you as somebody who has spent a lot of time looking 

at this and working with the bipartisan groups that Chairman 

Hatch set up as part of tax reform, I think this is really new stuff 

and pretty ominous. 

So what is your thought on that? 

Mr. STACK. Thank you, Senator. First I want to lead by being 

very clear that the Treasury Department, because we are out in 

front of these cases, we have not done the analysis, the technical 

analysis that, in fact, these payments constitute taxes and that, in 

fact, they will be creditable. 

Having said that, I think many people in the tax practitioner 

community and many people who have thought about these issues 

think that there is a substantial likelihood that they may be creditable. 

In that case, if they were to turn out to be creditable taxes, when 

we do those deemed repatriations, those same companies that are 

having deemed repatriations will claim a tax credit for the amounts 

that the Commission has ordered the local governments to impose 

on them, if one were to conclude that they are taxes and that, in 

fact, they are creditable taxes. 

So that gives us a direct fiscal stake, and I did not think we 

should wait until that horse is completely out of the barn before 

letting our interests be known. 

Senator WYDEN. Let us do this. I am way over my time. I would 

like to give you a couple more questions on this general point. Can 

you get back to us, say, within a couple of weeks on it? 

Mr. STACK. Absolutely, Senator. 

Senator WYDEN. The question will be, I would like to know what 

they mean, the EU state aid cases, for our tax treaties. And also, 

what about the prospect that Europe tries to retroactively impose 

some sort of back-door tax on what they think are unfair earnings? 

So you have a general sense of what I am interested in. We will 

get that to you. If you can get back to me with your take on that 

within a couple of weeks, that would be very helpful. 

16 

And again, I want to commend you because I know in a very, 

very difficult forum you have been trying to represent American interests, and I appreciate it. 

Thank you, Mr. Chairman. 

The CHAIRMAN. Well, thank you, Senator. 

Senator Warner? 

Senator WARNER. Thank you, Mr. Chairman. And let me first of 

all say I agree with you and the ranking member that we desperately need to do international tax reform. We need to have an 

international tax system that allows us to be competitive, with 

lower rates. 

I would point out, though, that one of the challenges we have, 

and correct me if I am wrong, Mr. Stack, out of the 34 OECD nations, America, which has the most—I will take a combination of 

both your comments—the most mixed-up, screwed-up tax system of 

all with, technically on the business side, some of the highest rates 

in the world, yet you look at what we collect, state, local, and Federal combined, business and personal combined, and we are 32nd 

out of 34 in terms of percent of GDP. Is that correct, Mr. Stack? 

Yes. I will get you the written validations. 

So we have both the nemesis of the most complicated system 

around, yet we collect, on a comparative basis, the least revenue. 

One of the reasons—and again, I appreciate both of you mentioning 

the challenges around inversions. 

As somebody who has been a strong supporter of the benefits of 

PhRMA for a long time, I am very disappointed by those actions, 

and particularly disappointed by some of the comments of the CEO 

there in terms of whatever obligation he feels he has to this country, which has in many ways subsidized the R&D for PhRMA for 

the whole world, since we pay higher drug prices than the rest of 

the world, and things like NIH and others that do not seem to go 

into his calculation. 

I guess, Mr. Stack, what I am wondering is—and this kind of 

goes with what the chairman and the ranking member have said— 

this may be too early to have some data. But when we are talking 

about inversions, when we are talking about the BEPS process, 

which is now driving some of these state aid and other potential 

actions, when we are seeing the growth in, particularly, Europe, on 

patent boxes, has anyone calculated at least a ballpark number in 

terms of amount of lost revenue to our country, in the current year, 

future years? 

How do we factor this in, if we need even more impetus to try 

to get our tax codes fixed in terms of estimating what is going to 

happen in terms of both erosion of our base, and even companies 

that stay within our base, the tax actions that may be taken 

against them in the OECD? 

Mr. STACK. I am not aware, Senator, of the precise figures on 

where we are headed. I would make a few observations. 

In the inverted company cases, I think we know, once the companies are gone, they are not coming back. So that is kind of like a 

permanent loss. 

And second, once—— 

17 

Senator WARNER. And yet there is—has there been any estimate 

done by Treasury of over, say, the last 3 to 5 years, of inverted 

companies, total amounts of revenue lost on a projected basis? 

Mr. STACK. Not that I am aware of, Senator, but I will doublecheck, and if so, I will get back to you. 

The second thing that happens is, once the company inverts, it 

is able to strip revenue out of the United States through interest 

in a far more generous way than it could have done while it was 

still domestic. 

And again, I will check to see if we have data on what that has 

been, but I am not aware, off the top of my head. But those are 

two very palpable issues with respect to inversions, and where we 

lose our base. 

I could speak to other issues in our tax reform, where we want 

to shore up some of the rules about moving intangible property offshore by U.S. companies, which is another way that we have our 

base eroded. 

In the President’s tax reform proposal, we have a series of ways 

to protect the U.S. base as we lower the tax rate and broaden the 

base for corporate tax. 

Senator WARNER. Mr. Chairman, one thing I would hope, as we 

look at whatever package that may come around on tax extenders, 

is that some of the provisions that might be part of an international tax reform package, that we do not make those provisions 

permanent in the short term now, which frankly would incent companies to keep more earnings offshore. 

Some of the proposals being talked about I think will, again, 

make it even harder for us to get to our ultimate goal, which is an 

international tax reform system that makes America competitive 

with lower rates, with less exemptions. I know there is discussion 

about making some provisions permanent now that I think would 

dramatically benefit American companies, but would benefit them 

in the way of keeping those revenues and profits offshore. 

My last question—I guess this will be for the whole panel. One 

of the areas I think the BEPS process resolved or came to some 

conclusion on—and I love your general comments on this. I have 

been very concerned about the movement towards the patent boxes, 

what that regime may do in terms of dramatically lowering corporate tax rates, particularly around high-value intellectual property, with our competitive nations. 

Now I understand BEPS has ended up saying there has to be a 

linkage, a nexus in terms of R&D and patent boxes. How worried 

should we be about the patent box regimes in the OECD nations? 

Very briefly, because my time is out. If each of you would take 

a crack. 

Ms. COLEMAN. Manufacturers have looked at patent box proposals in the United States. In reality, they do not provide that 

much benefit to the industry across the board. We found the benefits tend to be concentrated in different sectors of the manufacturing industry. So I think patent boxes would probably have a 

mixed impact on my industry. 

Mr. DANILACK. Senator, I would say generally speaking, we 

should be worried about the nexus requirements, if we are concerned about where the R&D jobs are, at the end of the day. 

18 

Because the nexus requirements call for those jobs to be in those 

jurisdictions where the rates are beneficial. And companies respond 

to incentives like this and will move jobs in order to obtain the benefits of the tax regimes that are put in place. 

Mr. STACK. I will only say briefly, Senator, that I think there has 

been some broad bipartisan notion that we should do a revenueneutral, broaden-the-base, and lower-the-rates tax reform. And 

when you go in the direction of a patent box, you have kind of broken away from that and are creating new special treatment for a 

particular industry and a particular kind of income that may make 

it harder to do international tax reform rather than easier. 

Senator WARNER. Thank you, Mr. Chairman. 

The CHAIRMAN. Senator Casey, you are next. 

Senator CASEY. Thank you, Mr. Chairman. And I appreciate the 

testimony of the panel. 

Mr. Stack, I want to start with you in terms of some fundamentals that we try to keep an eye on here, such as wage growth, 

which is, in my judgment, a several decades long challenge for the 

country. 

We really haven’t turned wages in the right direction in several 

decades—by one estimate this past January, 40 years of wage 

growth amounting to just 9 percent. In the prior 25 years, 90 percent or 91 percent. So wage growth, economic growth, and just job 

creation. 

When we are looking at those issues and looking at tax issues 

through that lens, one of the areas of concern would be, in addition 

to what Congress can do and must do, in your work at Treasury, 

what can you say that you are doing or the Treasury Department 

overall is doing to protect those basic U.S. interests when it comes 

to tax policy, to the tax strategy, and how it ensures that we have 

the kind of wage and job growth that we want? 

Mr. STACK. Thank you, Senator. In the Office of Tax Policy, I 

think the driver is, we want companies to be able to make decisions 

for their economic benefits and not decisions necessarily driven by 

tax incentives or tax regimes. 

So to the extent one can remove the tax gimmicks out of economic decision-making and investment, then you do wind up with 

the jobs in the right places and the factories in the right places. 

One way the President has talked about doing that is by lowering the rate so we are more competitive around the world, and 

to do that, we need to broaden the base. And the minimum tax proposal the President has put forward basically says to companies, if 

you are operating abroad in a jurisdiction where the tax rate is 

higher than the minimum, you are going to have the same rate as 

your competitor. So you can make your investment decisions in 

that jurisdiction based on that market and the cost of operating 

and where to put the factory and who to hire, and you are not so 

worried about having some additional tax when that money comes 

back home, in which case you wind up with skewed incentives. 

So I think our goal is, take the tax out of the equation; let companies make good investment decisions. That should put the factories and the jobs in the places where they are economically needed. And hopefully, at the end of the day, that fuels the kind of 

growth that you are talking about. 

19 

Senator CASEY. Mr. Danilack, or Ms. Coleman, do have any opinions on this question? 

Mr. DANILACK. No, sir, I do not have a particular opinion on the 

question you asked of the Treasury Department. 

Senator CASEY. I want to ask as well—I know that Senator 

Wyden raised the question of the European Union state aid cases 

and the overall impact because of potential targeting of U.S. companies and what that impact is for American taxpayers. 

Mr. Stack, could you kind of walk through that, just in terms of, 

if a taxpayer were sitting in front of you asking how does this affect me ultimately, or how could it potentially affect that taxpayer? 

Mr. STACK. Sure, Senator. When a U.S. company pays a tax in 

a foreign jurisdiction and then they bring money home, they get a 

credit for that tax paid in the foreign jurisdiction, up to a certain 

limit. Now, in the normal case, that means you are actually doing 

some business in Germany, let us say, and you had some tax, and 

you brought it home and you got your credit. 

In this fact pattern, the EU is coming along and they are saying, 

oh, we think when you cut your deal with Ireland or Luxembourg 

or the Netherlands that, in fact, you, company, should have been 

paying more tax to those jurisdictions. 

Now, if we were to determine that those payments are in fact 

taxes, and were to determine that they are creditable under our 

rules, now when that money comes home from those countries, in 

addition to the credit the company got for the tax they originally 

paid in those jurisdictions, they get an extra credit. 

And that credit, to this taxpayer you asked me about, means in 

effect the U.S. Treasury got less money and in effect made a direct 

transfer to the European jurisdiction that is getting the ruling from 

the Commission. So if these turn out to be creditable taxes, it is 

the U.S. taxpayer who is footing the bill for these EU investigations. 

Senator CASEY. So now, you referred to it in your testimony as 

well. Is there anything you want to add? 

Mr. DANILACK. Yes, and I would like to broaden out the particular problem you are asking about, beyond state aid, because the 

very same profits that the European Commission is having a look 

at are also being looked at by other jurisdictions around the world. 

You will have another country that will see the low tax profits 

in a jurisdiction like the ones Mr. Stack mentioned, and they are 

currently already—this is what I am trying to get across—in the 

enforcement mode, attempting to tax those profits for themselves. 

Now, if that happens, and it is happening, those taxes are also 

going to be creditable taxes in the U.S. So that same pot of profits 

is going to be subject to taxation, perhaps by multiple countries, 

and those credits will all come back. 

And you will not have the state aid tax credit question if it is 

another jurisdiction. That is just applying their normal income 

taxes, attempting to drag those profits into their jurisdictions. And 

this is happening already with a number of the clients of the firm. 

Senator CASEY. I appreciate that. And I know my time is up and 

over. I do want to say for the record, Mr. Chairman, my father-inlaw, John Foppiano, spent a lot of his years as a tax partner at 

Pricewaterhouse. So that is on the record now. Mr. Danilack, you 

20 

do not have to comment, but I wanted to make sure that was part 

of the record. 

Thank you, Mr. Chairman. 

The CHAIRMAN. Well, I think every member of this committee 

ought to be able to brag about his father-in-law once in a while. 

Senator Portman? 

Senator PORTMAN. Having a father-in-law who can do your taxes 

is quite an advantage. [Laughter.] 

Mr. DANILACK. That is right. That is right. 

Senator PORTMAN. So I think Senator Casey asked a really good 

question about jobs and wages, and how do we get past the point 

in this country where we see not just flat but actually declining 

wages, higher expenses, the middle-class squeeze. It is very real. 

And I think the testimony today has also been very helpful and 

raised a lot of issues, and I think the answer to it all is pretty obvious, which is tax reform. 

I mean, we could do a number of things to get wages up. But 

every economic study I have seen says the same thing, which is, 

if you do in fact go with a pro-growth tax reform on the business 

side, you are going to see the benefit go to the workers. The CBO 

study that many of you have seen shows 70 percent of the benefit 

is going to go to higher wages and better benefits. And it is because 

American firms will be more competitive and they can pay more. 

And I just think we are missing the boat. And I hope this has 

been a wake-up call today for everybody to hear you all talk about 

the fact that, even if we were not already convinced that we are 

missing this opportunity to help the people we represent—those 

workers should be able to have more opportunity for themselves 

and their families—but now it is getting even worse. 

Because everything you have said—and I have looked at your 

testimony. And also we have had a chance, some of us, to talk 

about these issues, and if we do not move to do it—we should do 

it anyway, reform our code to make it more competitive—in effect 

what will happen is, this is not just in Europe, as you know very 

well, Mr. Stack, because you have had to sit through probably dozens of meetings on this, this is not just OECD; this is the G20. As 

Mr. Danilack has said, this is other countries as well. It is global 

now. They are going to go after these profits. 

So, in effect, we are having the worst of all worlds. We have a 

non-competitive tax code that makes our workers have to compete 

with one hand tied behind their back, that keeps their wages depressed, and yet we are also seeing now that, because we have not 

acted, other countries are moving in to try to grab those earnings 

themselves. 

And I just hope that we can figure out a way, on a bipartisan 

basis, to fix this. And this committee has done a good job, I think, 

on the hearings. And I think the working group that Chairman 

Hatch asked us to convene was effective. 

Senator Schumer and I do not agree on everything, to say the 

least, but we did come up with an agreement on this issue, which 

is a framework to deal with tax reform. And I know there are some 

controversial parts of it, but I see a lot of consensus as to what we 

ought to do. 

21 

And it does involve, as Mr. Stack has said, lowering the rate, 

broadening the base, but also, on the international side, moving to 

this territorial-type system before it is too late. 

I just have a couple quick questions, if I might. This nexus requirement that the BEPS project has now blessed, which is to say, 

if you do have an innovation box or a patent box in your country, 

you have to actually have the work connected with it. 

I assume you believe that is also going to draw additional jobs 

overseas, because companies that are now taking advantage of 

moving that intangible income overseas to lower-tax jurisdictions 

are going to find, gosh, they have to actually send the researchers, 

the scientists, the infrastructure over there. Is that not true? 

Mr. STACK. Not necessarily, Senator. I think—I want to make 

two points about the work we did at BEPS on the patent box. 

First of all, I think we all have to appreciate where we began. 

We began with countries like the U.K. that said, if you just drop 

your paper patents into London, you can get a 10-percent rate and 

you can strip out of all our neighbors at a 25- or 35-percent rate. 

And the OECD said, wait a second. That is not having any domestic tax policy other than trying to strip income out of your neighbors. 

So the work at the OECD—and one premise we have at OECD 

is, countries can have their own rates and countries can favor some 

income over others. But what we said was, if you are going to have 

a separate rate for patent box-type income, it has to be promoting 

a domestic policy of encouraging research and development. So do 

some research and development in country. 

Now, once you go there, you have to—there are two things. I do 

not think it is a given in the economic literature that the tax rate 

of where the research is done is the determining factor of where 

the research is done. People like to conduct research in the United 

States because we have universities and communities and synergies of all these great dynamic people we have here, number one. 

And number two, remember, if you are going to take your winners at 6.5 percent in Ireland, your income, you are going to have 

to take your deductions at 6.5 percent on your losers. So it is not 

a no-brainer for a company to say, I am going where there is a 6.5- 

percent rate, because they have to make a judgment to give up the 

28- or the 35-percent deduction in the U.S. as they do it. 

And finally, I do not also think it is a no-brainer that U.S. tax 

policy should race to the lowest tax rates of any neighbor we have, 

because that is a very expensive way to proceed, given all of our 

competing fiscal demands. 

So I think the work we did on patent boxes was good, from where 

we started and got to a better place. And I do not think it is necessarily going to drive U.S. researchers, and the ownership of IP, 

out of the U.S. overnight. 

And I have had an opportunity to discuss some of this with my 

European counterparts, and a lot of them view their patent boxes 

as probably more beneficial to some of their small and medium enterprises that can benefit, because they are doing the research 

there locally. Obviously, that is something we should study and 

look at as we go forward, but I still think we did good work in that 

space. 

22 

Senator PORTMAN. I am not challenging your work, but I am perplexed by your answer. I do not see how you can say this is good 

for the United States to have a BEPS project that ends up saying, 

for those American companies that do research overseas because 

they can take advantage of a patent box or an innovation box, now 

there is a nexus that they have to actually not just move, as you 

say, the paper patents overseas, they have to move the people overseas. How is that good for the United States of America? 

Mr. STACK. Well, Congressman, we do not get to tell countries 

what rates they should have. 

Senator PORTMAN. No, I understand that. But I do not see how 

you can say that is good. I mean, that should make you want to 

look at our tax code and figure out a way to make our code more 

competitive. 

Mr. STACK. Absolutely. 

Senator PORTMAN. Which is the point that Senator Schumer and 

I made in our report, having talked to a lot of experts, including 

at least one member of your panel. This is the reality. This is what 

is happening. 

Now, we may not like it, and you are right, other countries have 

the right to do it, I suppose. But that does not mean that we should 

sit back and simply not react, because I do think you are going to 

see an erosion, not just of inversions and foreign takeovers—which, 

by the way, doubled last year in value as compared to the year before, and this year is on track probably to go up another 70, 80 percent. But I think you are going to see not just the paper patents, 

but the researchers move overseas. That just seems to me logical. 

Mr. STACK. Well, Senator, that is why the President has proposed lowering the rate, broadening the base, and doing a whole 

host of other things to make us more competitive and pro-growth 

in the world. And so I was answering, in isolation, the patent box 

question. 

But I fully agree with you: we need to do better at international 

tax reform to make ourselves more competitive. And on that, there 

is bipartisan agreement. So I fully agree with you. 

Senator PORTMAN. On the—well, my time has expired. I apologize. I see one of my colleagues has now arrived. But I would like 

to talk to you more at some point about this notion of these retroactive tax increases you talked about, and all three of you talked 

about, being creditable, and what that means for tax reform. 

Because one of the very specific concerns we have obviously is 

that in our proposal, there is a deemed repatriation. And Treasury 

agrees with us on that, and obviously that deemed repatriation will 

be a lot less to be able to pay for moving to a territorial system 

if there are creditable tax credits against it. And so that is my biggest concern: the impact of this specifically on tax reform. 

And just a quick—do you all agree with that as a concern, and 

is that one reason for us to move quickly? 

Mr. STACK. Yes, Senator. 

Mr. DANILACK. Yes, Senator, I believe it is something to consider, 

yes. 

Senator PORTMAN. Thank you, Mr. Chairman. 

The CHAIRMAN. All right, thank you. 

23 

I have deferred my questions, so I think I will ask a couple right 

now. 

Mr. Stack, I appreciate that you discuss the problem of inversions in your testimony. It seems that the decision to invert is driven, for the most part, by the fact that the tax consequences for 

being a foreign company are much better than being a U.S. company. I think that is coming out here today. 

Some of the proposals from the administration, in an effort to 

combat the problem of intangibles migrating from the U.S., call for 

a minimum tax on income of foreign subsidiaries of U.S. companies. But I wonder if taxing U.S. companies more heavily on the 

income of their foreign subsidiaries would create yet more pressure 

to invert. So combating one type of base erosion and profit shifting—that is, intangible property migration—perhaps would create 

more pressure for another type of base erosion and profit shifting, 

and that is inversion. 

What are your thoughts on that? And, if Mr. Danilack would like 

to weigh in as well, I would welcome his thoughts as well. 

Mr. STACK. Thank you, Senator. I think that you mentioned our 

minimum tax, and we think that the President’s proposal needs to 

be looked at in its entirety. 

Ways to take pressure off inversions are, number one, to lower 

our rate, broaden the base, and enact other elements of our proposal like limiting the ability of inverted companies, or all foreign 

multinationals, to strip interest out of the United States once they 

invert. 

The minimum tax proposal—it surprises me; we get so much 

focus on the min tax piece. Because in my experience, companies 

actually do business in jurisdictions with tax rates higher than the 

minimum tax rate. 

And what our proposal says is, if you are in a jurisdiction with 

a tax rate higher than the minimum tax rate, you get to go there 

and compete with all the competitors in that jurisdiction and pay 

the same tax in, let us say Germany, as your competitors in Germany get to pay. And when you repatriate that money, you do not 

pay any additional tax. 

What the minimum tax part of it does is to say, if you are shifting income into very low-tax jurisdictions—and one can always 

quibble on where the line is. We put it at 19 percent in the budget, 

but my boss has said that is not divinely inspired. We could pick 

other numbers. When that happens, it is probably true that there 

is some shifting going on that is dangerous to the U.S. base, because it is attracting people to put the income offshore. 

So one way to think about tax reform and inversions is, lower the 

rates, broaden the base, put in an entire package of sensible tax 

rules to take the pressure off inversions, and for that, highlighting 

the need to get at interest-stripping, I think is critical. 

And then, if people are still putting high-value items in low-tax 

jurisdictions and tax havens, we protect our base by saying we will 

pick up the tax on that at the minimum rate. 

The CHAIRMAN. Well, you also talk about earnings stripping in 

your testimony. Apparently the ability to engage in earnings stripping creates pressure to invert as well. 

24 

And if you agree that U.S. companies invert or become foreign 

companies because the tax consequences to being foreign are better 

than the tax consequences of being a U.S. company, then perhaps 

limitations on earnings stripping reduce the attractiveness to being 

foreign—that is, reduce the attractiveness of inverting. 

Earnings stripping is one factor in the decision to invert. Do you 

agree with that? 

Mr. STACK. Yes, Senator, I do very much. 

The CHAIRMAN. And do you think that the OECD BEPS project 

recommends a more aggressive posture against earnings stripping? 

Mr. STACK. Yes it does, Senator. 

The CHAIRMAN. All right. Well, Mr. Danilack, I welcome your 

comments on these two questions that I have asked, if you care to 

make any. 

Mr. DANILACK. I think that each of these questions is interrelated with each of the others. And what you are really looking 

for is a formula to balance out your tax environment for your U.S. 

companies with the environment for foreign companies. And ultimately, you want to ensure that a U.S. company is happy to be 

here and is not interested in being somewhere else because the tax 

environment for a company abroad is beneficial. 

And this involves the U.S. rate. If the rate is lower, there is less 

incentive to strip. If the rate is high, there is clearly a lot of pressure to strip as much as possible. 

So you are essentially asking, what is the right formula for tax 

reform to ensure that businesses, as Mr. Stack said, make decisions 

based on economics and not based on taxation? So there is not a 

real magic answer; it takes a lot of hard work to figure out exactly 

how to get it right. 

The CHAIRMAN. All right. 

Well, Senator Carper is next and then Senator Thune. 

Senator CARPER. When I walked for the second time into the 

hearing, I think Senator Portman was asking a question relating 

to BEPS, U.S. competitiveness, and the tax base, I think, of Mr. 

Stack. And I do not know that we really heard from the other witnesses on that question. I will just frame it briefly. 

While we have been talking a lot about tax reform in this country, other places have actually been doing it, and we have been an 

observer in that process. But a lot of countries are putting in place 

patent box regimes in order to offer some lower rates on profits 

that are derived from intellectual property. 

In the context of these patent boxes, the BEPS project is proposing what is called a nexus approach. And I think you were having some discussion with Senator Portman about that. 

I would just like to hear from our other two witnesses, just your 

comments and thoughts in this regard, particularly about the impact you believe a nexus requirement, if it is adopted on a widespread basis, might have both on the U.S. tax base and also the 

impact it might have on our ability to keep intellectual property 

and R&D jobs here in the U.S. 

Yes, ma’am? 

Ms. COLEMAN. I think one way to keep R&D jobs in the United 

States is to have a permanent R&D credit. And as I mentioned beVerDate Mar 15 2010 17:20 Oct 17, 2016 Jkt 000000 PO 00000 Frm 00028 Fmt 6633 Sfmt 6633 R:\DOCS\22145.000 TIMD
25 

fore, the NAM took a look at the innovation box, and we had a 

mixed reaction from our members. 

In contrast, the NAM has been a strong proponent of a permanent R&D credit. In fact, we are very optimistic about the discussions going on right now. We feel that a permanent R&D credit 

would keep R&D in the United States. 

And when you look across our competitors in the OECD, all of 

them have much stronger and, in most cases, permanent incentives. As you know, we have an on-again-off-again incentive, which 

currently is off. So the U.S. credit is not as attractive as incentives 

in our competitor nations. 

So I think a simple solution and something that we could do 

right away is to make the credit permanent. 

Senator CARPER. All right. Thank you. 

Mr. DANILACK. I answered the question earlier, before you came 

in, Senator. 

Senator CARPER. What did you say? 

Mr. DANILACK. I said generally speaking, I would be concerned 

about patent box regimes cropping up around the world, especially 

if they are widespread and especially if the value of those regimes 

from a tax savings perspective is very high. 

I also agree with Mr. Stack’s comments earlier that it is not 

automatically going to be the case that jobs will migrate to these 

jurisdictions, because it is a complex calculus that a business needs 

to make. 

There are businesses where there is a great deal of risk in R&D, 

and there are losers. And the deductibility of the expenses—you 

will have to also take into account the respective tax rates. 

So it is like anything else. This is not a one-issue question. You 

necessarily have to bring in the other issues that are on the table, 

like what the respective rates are in the jurisdictions in question. 

If a baseline rate in the U.S. is relatively low, you are obviously 

going to have less incentives for jobs to migrate to a lower-tax jurisdiction than if the baseline rate is very high. 

So I do not have a strong sort of on-off type of view on the threat 

posed by the nexus requirements. I think generally it is something 

to really take into account, especially if patent boxes become widespread and very beneficial and nothing is done here in the U.S. 

Senator CARPER. All right. Thanks. 

If we could talk a minute or so about the time frame for BEPS 

implementation, and to Mr. Stack, could you give us some reasonable estimate, if you will, as to when other countries will ratify, 

might ratify, the BEPS multilateral instrument, and will taxpayers 

be given a reasonable amount of time to create systems to comply? 

Mr. STACK. Thank you, Senator. 

Because there are 15 different action items, each one relates differently to the question of implementation. With some, for example 

in digital economy and Controlled Foreign Company rules, there is 

nothing to do or implement. 

If you look at the interest deductibility in hybrids, since they are 

effectively setting out common approaches for countries, there is no 

particular expectation of when things might be implemented. So it 

kind of runs the gamut. 

26 

The transfer pricing work in many countries, because it amplifies 

the arm’s-length standard, is kind of automatically absorbed into 

law. 

The two things on the multilateral instrument, that work will be 

going on this year. They are hoping to have a draft out by the end 

of the year. It is going to try to embody the different treaty things 

we have agreed to. 

Frankly, I think that is an ambitious schedule. Obviously, we 

would have to work with the Senate Foreign Relations Committee 

if we are going to move forward on elements of that. So I think 

that is still a ways down the road, and we will have plenty of time 

to work with Congress in terms of implementing that, I would say. 

Senator CARPER. Good. Thanks. Thanks to all of you. Much 

obliged. 

Senator THUNE [presiding]. Senator Cardin? 

Senator CARDIN. Chairman Thune, it is nice to be with you here. 

Let me sort of preface this question. Clearly we are interested in 

collecting our taxes. To the extent that we do not collect the taxes 

that are due from a particular entity, everyone else pays a little bit 

more in taxes. So being able to collect our fair share of taxes allows 

us to have lower tax rates. That is one reason that we want to 

make sure that we have a fair tax structure. 

There is also the reason of fairness. Everybody should pay their 

fair amount. 

We are clearly concerned about these flagship tax investigations 

that are taking place that we see targeting American companies. 

And therefore we obviously want to support the tax treaties that 

can help us deal with some of these issues to make sure our companies are treated fairly and we do collect our taxes. 

And hopefully, we are going to move these tax treaties in a more 

expedited way than we have over the last 4 or 5 years. All that is 

very, very important, and we want to gauge our OECD partners to 

make sure that we have more uniform rules in determining allocations of costs and revenues. 

But I want to get to the fundamental issue here and ask you this 

question: if the business tax rates in the United States were lower 

than the OECD countries, would we be having these problems? If 

we, after all, were the low-tax jurisdiction rather than the high-tax 

jurisdiction, it seems to me the dynamics here would be dramatically different. 

And I will give you a chance to answer that question. Senator 

Thune and I worked on the business reform issues, and I thought 

we made a lot of progress. 

Senator Thune raised a very good issue about the corporate entity, or the business entity you pick, and why that should be neutral 

rather than what it is today. I agree that is certainly an inequity 

in our tax code, depending on double taxation issues. 

And I raised the fact that the United States, among the OECD 

countries, has by and large a lower reliance on the governmental 

sector than they do, so therefore, since our reliance on government 

revenues is less, we should have lower marginal rates, not higher 

marginal rates. 

Of course the reason is that the United States is stubborn. We 

have always been. We do things right; the rest of the world does 

27 

not. And therefore, for Federal purposes we rely almost solely on 

income taxes, where they use consumption taxes as well as income 

taxes. 

So my question to you is, if we could reform our tax code—I 

know a lot of my colleagues have talked about that—to be more in 

harmony regarding how we collect taxes, as the OECD countries 

are, so that we would end up with the lowest marginal tax rates 

among the OECD countries, would it not make some of these discussions a little bit more different and dynamic? It might be just 

the reverse of the arguments that we are having today on targeting. 

Whoever wants—Mr. Stack, you look anxious, and I think you 

might agree with me, so—— 

Mr. STACK. Yes, certainly, Senator, if we had lower rates, there 

is less pressure on stripping out of our jurisdiction. 

Now, I would just add that in the case of multinationals, you 

sometimes get these jurisdictions that sit in the middle where you 

may not pay tax at all, and so you bring the money home, and that 

is just something I think there is bipartisan consensus we should 

be fixing as well. 

Senator CARDIN. I would point out that this is not theoretical. I 

filed the Progressive Consumption Tax Act that incorporates two 

major provisions that seem to be reasons why we have not been 

able to advance this in the past. 

One is, it is progressive. We do incorporate the current benefits 

in the income tax code for the Earned Income Tax Credit and the 

Child Tax Credit, and we do provide rebate payments for recipients 

so that we are dealing with a more progressive way to collect taxes. 

And then second, we put a circuit breaker in the bill to make 

sure that the revenue growth is not more than we say it is going 

to be, so we do not grow government, which is another complaint 

that has been made about consumption taxes, which I think is a 

legitimate concern, because I expect that the Joint Tax Committee 

will not score this for the true revenue potential that it will unleash by having more competitive rates. 

So I do think this is doable, and I know we spend a lot of time 

in this committee, and you all spend a lot of time talking about 

ways that we can protect American companies from discriminatory 

actions and how we can keep jobs in America and how we can be 

competitive and how we deal with inversions or deal with how we 

get the monies that are parked overseas back to the United States. 

It seems to me that if we dealt with the fundamental problem we 

have—and that is, America is out of step with our competing countries in how we collect our revenues and the sources of our revenues—that would go a long way to resolving a lot of these issues, 

and we probably would not have had to have this hearing. 

So let us have a hearing on the progressive consumption tax. 

Thank you, Mr. Chairman. 

Senator THUNE. The Senator from Maryland has done a lot of 

work and put a lot of effort into examining these issues and coming 

up with solutions. And he is out there at least advocating reforms 

to the tax code that would get us away from many of the embedded 

problems that we have and that have led us to where we are having hearings like this one today to talk about issues that, unfortuVerDate Mar 15 2010 17:20 Oct 17, 2016 Jkt 000000 PO 00000 Frm 00031 Fmt 6633 Sfmt 6633 R:\DOCS\22145.000 TIMD
28 

nately, I think could be solved if we had a more competitive tax 

code in this country. 

So I appreciate his efforts and enjoyed working with him on our 

working group, and, as he said, we made a lot of good progress. We 

will see how much of that can be incorporated. And I know in the 

end he wants to see his concept, his idea, become the law of the 

land. So we will see if that emerges as one of the top ideas. 

But I want to—first off, I think this is an important hearing, because it does have important implications for how American companies do business in Europe and around the globe. And efforts to 

combat inappropriate tax base erosion, if done incorrectly, could 

further damage the ability of American companies to compete in 

the global economy. 

And I think, to put it more simply, American businesses deserve 

fair treatment and due process when it comes to their tax obligations in foreign nations, including from European nations as well 

as the European Commission. 

And I hope today’s hearing will send a signal that Congress is 

paying attention to the actions taken at the OECD in Brussels, and 

that Congress is not going to stand idly by if these actions are conducted in a way that negatively impacts innovative American companies from doing business abroad. 

But I do want to just follow up on one point that the Senator 

from Maryland was sort of getting at, and that is to say that with 

the state aid cases, it would appear at least that the EU is taking 

advantage of America’s lack of a competitive international tax system to pursue American companies, to accumulate overseas earnings as a revenue source. Those earnings are only overseas because 

Congress has failed to reform the U.S. international tax system. 

So the question is—this is just a general question—are these 

cases, at least in large part, really just a symptom of the larger 

problem of a non-competitive U.S. tax system? 

Mr. STACK. Senator, I want to answer with kind of two notes of 

humility. First, I am not an EU competition lawyer, and second, 

these cases have not run the gamut over there so that one can read 

and analyze final cases. 

Having said that, we were faced with a choice as to whether to 

speak up now, before multi-billion-dollar judgments are rendered 

against our companies, or wait until the decisions were handed 

down. So we have been raising this issue today. 

From my personal observation and study of these cases, it appears to me that the Commission here is attempting to tax income 

that really, under international standards, does not belong to any 

member. 

My perception is that they are trying to tax the income that they 

perceive is untaxed because it has been deferred for U.S. tax, and 

they see it as something that is there for the taking, because our 

system has let it sit offshore without being taxed. 

So that is my perception of the substantive state of those cases. 

They have a ways to go. I could be wrong, but that is the way I 

see them today. 

Senator THUNE. And, Mr. Stack, do you believe that the Treasury 

Department—let me ask it this way. Does the Treasury Department believe that the sovereign right of taxation resides with the 

29 

individual nations of Europe and their tax departments, or does it 

reside in Brussels? 

Mr. STACK. So my understanding under EU law is that income 

tax is the right of the member states. Now, having said that, there 

are a lot of complicated rules in the EU. 

For example, you are not allowed to use your income tax to benefit one company over another, or one industry over another, and 

that is state aid in a very classic case. So there is some complexity 

of when an income tax could turn into a state subsidy that the EU 

Commission has every right to rule against. 

In these particular cases where they are looking at particular 

rulings and telling countries that their transfer pricing rules 

should have been applied this way or that way, from our perspective, that crosses the line from the traditional state aid analysis, 

as I understand it. 

That is novel, as I understand it, and that is why we have been 

asking for this to be done prospectively and not retroactively. And 

therefore these issues, the way I understand it, should have been 

within the purview of the member states and not the Commission. 

But again, I am not an EU lawyer and certainly not a competition 

lawyer in the EU. 

Senator THUNE. So what recourse does the administration and 

Congress have to ensure that these state aid investigations are conducted fairly and not just simply another effort to tax or target 

American high-tech companies? 

Mr. STACK. Senator, beyond what we have been doing, which is 

talking to the Commission, and what you are doing, which is shining a light on them, I do not have a magic bullet for what role we 

play in another sovereign’s internal investigations. 

But I do think it is a service to shine a light, talk about these 

issues openly, and hope that the Commission will see that being 

fair is better in the long run than perhaps what is about to occur. 

Senator THUNE. I want to ask, just for a minute, a question 

about base erosion and profit-shifting efforts at the OECD. You 

were recently quoted in the Financial Times as saying—and this is 

a quote: ‘‘It is to the great credit of the U.K. that they were able 

to step back from a patent box widely seen as harmful.’’ 

As you may know, there has been much discussion in Congress 

about the possibility of a patent box, often called an innovation box, 

as part of tax reform. In fact, it is something that Senator Cardin 

and I examined in our tax reform working group, as did Senators 

Portman and Schumer. 

Could you elaborate on why you view the U.K. patent box as 

harmful, and to whom do you view it as harmful? And perhaps 

maybe follow up with, are there existing patent boxes or patent box 

proposals that you would find to be beneficial? 

Mr. STACK. Sure. Look, the U.K. started out and went around the 

world and said to companies, come and take your patents and just 

bring them on to our shores. You did not do any research here. You 

did not do anything. And when those patents are earning income, 

we are going to tax that at—I think 10 percent was the rate. And 

that meant that companies were being invited to strip out of the 

Germanies, the Frances, the U.S.es, at 25- and 35-percent rates. 

Watch the income flow into the U.K. 

30 

The reason that was harmful is, it appeared to have no other domestic policy purpose than attracting income from other jurisdictions. And really, all of Europe got very, very upset about it. 

I gave them credit in that article—because they walked back 

from it in an agreement with Germany—to realize it was harmful 

and walk away from it, put that aside. 

Now, the U.S. is unique with respect to intellectual property, because I am told that 85 percent of our R&D is already done in this 

country. We tend to agree that the R&D credit is a superior way 

to incentivize research. 

But in terms of the work we have done at the OECD, programs 

built around the fact that we might want to reward research done 

in this country are not something that will probably violate what 

we have done at the OECD. 

So I think the critical thing is, there are many shapes and sizes 

of what one might think of as a patent box, and so it is hard to 

speak about them generally. But none of the proposals I have seen 

for the U.S. involves the same kind of naked tax competition that 

the original U.K. proposal did, because we are an engine of global 

research and development, and rewarding our companies for the 

output of that in whatever way people think best is a fair debate 

to have, even if the administration, for example, would prefer the 

credit over an innovation box. 

But nothing being proposed here is like what the U.K. had been 

doing and that they walked back from. 

Senator THUNE. This question anybody may respond to. Europe 

obviously is an important market for American companies, both as 

a large consumer of American products and a location for U.S. foreign direct investment. 

From the perspective of American enterprises looking to do business in Europe, what is likely to be the impact of these state aid 

investigations if, as expected, they result in prior tax rulings by 

certain EU member states being overruled by Brussels? Again, 

there are assumptions we are making here. 

And the broader question has to do with what does this do to 

U.S. companies? Would it make them less likely to invest in Europe if they know that the European Commission is exerting this 

kind of authority, and are there likely to be more or fewer jobs created in Europe by American businesses as a result of these investigations? 

I know these are kind of hypotheticals, but if you could just perhaps elaborate on what the likely outcome is with respect to jobs 

in that country and to investment by U.S. companies. 

Mr. STACK. I will take the first stab. First, I think companies realize that there is this kind of instability, that when all of a sudden 

there is a new game in town where somebody can look back 10 

years over rulings I got from members, I think it creates issues 

with respect to that kind of investment. 

I will point out—and this is one of the unfortunate aspects of 

state aid, of these investigations—the landscape in Europe is 

changing. I think it is going to be more difficult to get Luxembourg 

rulings as we go forward, because of the BEPS work. 

I think that there is going to be more attention paid to putting 

the actual profit where the activities occur. The Irish have already 

31 

taken steps to do away with some of the elements that are under 

investigation with state aid. 

So I think a prospective remedy, actually, would work for the EU 

Commission, work for the companies, and also take the moving 

landscape in a positive direction in Europe. And so I am not sure 

that we would see that much more harm down the road in practice 

from these things, because the landscape is changing there. 

Senator THUNE. All right. If anybody else cares to comment, feel 

free to. 

Mr. DANILACK. I would say generally what I would be worried 

about if I were a company is not so much the specific results and 

how they might change and what Ireland may do in response and 

what Luxembourg may do in response, but more generally that 

what the European Commission actions represent is an erosion of 

a process by which to achieve tax certainty. 

Not all companies are looking to achieve the lowest rate possible. 

They are looking to achieve a certain degree of certainty. The way 

companies generally think they should achieve certainty is by 

working directly with the government and entering into a ruling 

where that certainty is established. 

And I think what the inquiries under state aid have done is 

called into question whether rulings are good, whether you can go 

into a country and get a ruling on transfer pricing principles that 

is widely accepted by the OECD and not have it subsequently challenged retroactively. 

So there is a retroactive element. There is the fact that it is a 

ruling. You are looking for prospective certainty, and that is taken 

away. And the principles themselves that you thought were the 

right principles, and governments agreed to, suddenly now are 

being called into question. 

And that type of a dynamic, where you cannot rely on a ruling 

anymore, is very, very dangerous, not only in Europe, but elsewhere. So, if other governments begin to think that you can tear 

up a ruling and go back and start all over and come up with a different tax answer, this is just very bad tax administration. 

Senator THUNE. Good. All right. Does anybody have anything 

else for the good of the order? Closing thoughts? 

All right. Well, I want to thank our colleagues who have been 

here, the distinguished panel of witnesses, and all the staff who 

have worked so hard over the Thanksgiving holiday to prepare for 

this hearing. 

And I would say for the record that any member who wishes to 

submit statements, they should be submitted by the close of business on Monday, December the 7th. 

And I certainly hope that this is something that we will continue 

to discuss, going forward, on both sides of the aisle as we work on 

topics related to tax policy in the future. 

So thank you very much for being here, and with that, I guess 

I will adjourn this hearing, even though I do not have a gavel. This 

hearing is adjourned. Thank you. 

[Whereupon, at 4:27 p.m., the hearing was adjourned.] 

(33) 

1 Bureau of Economic Analysis, August 2014. 

A P P E N D I X 

ADDITIONAL MATERIAL SUBMITTED FOR THE RECORD

PREPARED STATEMENT OF DOROTHY COLEMAN, VICE PRESIDENT FOR TAX AND

DOMESTIC ECONOMIC POLICY, NATIONAL ASSOCIATION OF MANUFACTURERS

Chairman Hatch, Ranking Member Wyden, and members of the committee, thank 

you for the opportunity to testify today about the Base Erosion and Profit Shifting 

(BEPS) project spearheaded by the G20 and the Organisation for Economic Cooperation and Development (OECD). I appreciate the chance to highlight on behalf 

of the National Association of Manufacturers (NAM) our concerns about some of the 

recommendations in the BEPS project that would impose substantial and unnecessary compliance costs on companies and, in some cases, force disclosure of sensitive, 

confidential U.S. taxpayer information. These recommendations would create a new 

set of challenges for manufacturers and stand to harm our competitiveness in an 

already difficult global economic environment. 

The NAM is the nation’s largest industrial association and voice for more than 

12 million women and men who make things in America. Manufacturing in the 

United States supports more than 17 million jobs, and in 2014, U.S. manufacturing 

output reached a record of nearly $2.1 trillion. It is the engine that drives the U.S. 

economy by creating jobs, opportunity and prosperity. The NAM is committed to 

achieving a policy agenda that helps manufacturers grow and create jobs. Manufacturing has the biggest multiplier effect of any industry and manufacturers in the 

United States perform more than three-quarters of all private-sector R&D in the 

Nation—driving more innovation than any other sector. 

Manufacturers know full well how critically important it is for U.S. companies to 

be able to invest and compete effectively in the global marketplace. Indeed, 95 percent of the world’s customers are outside the United States. Investment by U.S. 

global companies has paid off for the U.S. economy: U.S. global companies employ 

35.2 million workers and are responsible for 20 percent of total U.S. private industry employment.1 Moreover, U.S. companies that invest abroad export more, spend 

more on U.S. research and development performed by U.S. workers and pay their 

workers more on average than other companies. 

BACKGROUND

In 2012, representatives from the G20 asked the OECD to develop a comprehensive approach to address aggressive global tax planning that resulted in inappropriate corporate tax avoidance. The OECD released its final recommendations in October 2015 and the recommendations were approved by the G20 Finance Ministers 

on October 9, 2015, and by the G20 Leaders on November 16, 2015. 

In July 2013, the OECD released the G20/OECD Base Erosion and Profit Shifting 

(‘‘BEPS’’) Action Plan, which provided for 15 actions designed to reach consensus 

among members for recommended changes in tax policy. The BEPS Action Plan included Action 13, ‘‘Re-examine Transfer Pricing Documentation,’’ to develop rules to 

require multinational companies (MNEs) ‘‘to provide all relevant governments with 

needed information on their global allocation of the income, economic activity and 

taxes paid among countries according to a common template.’’ 

On October 5, 2015, the OECD released its final report on Action 13 (along with 

reports on all 15 BEPS Actions). The OECD identified Action 13 as one of the areas 

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where all countries agreed to consistent implementation. The Action 13 report was 

virtually identical to an earlier draft (released in September 2015) and previously 

released implementation guidance (released in February and June 2015). Action 13 

adopts a three-tiered approach to achieve transfer pricing documentation: a master 

file containing information to provide a complete picture of the MNE’s global operations, including an organizational chart, consolidated financial statements, and 

analyses of profit drivers, supply chains, intangibles, and financing; a local file providing more detailed information relating to specific intercompany transactions of 

the MNE group impacting the specific tax jurisdiction; and a country-by-country report (CbCR) containing aggregated financial and tax data by tax jurisdiction. According to the OECD, the two documents that provide group-wide information— 

master file and CbCR—are intended to provide governments with information necessary to conduct high-level transfer pricing risk assessment. 

The CbCR will only be required of multinational groups with annual consolidated 

group revenue of at least 750 million Euro in the immediately preceding year. The 

first CbCRs would be filed for tax years beginning in 2016 with the tax residence 

country of the parent of the MNE group (e.g., the United States for U.S. MNEs). 

Other countries could obtain CbCRs through exchange of information processes 

under bilateral treaties and tax information exchange agreements. 

In order to obtain CbCRs, countries must agree to certain conditions related to 

confidentiality, consistency and appropriate use of the information. In this document, appropriate use is defined as ‘‘assessing high level transfer pricing risk’’ and 

‘‘other BEPS-related risks.’’ If the tax residence country of the parent company does 

not collect CbCRs, or has not agreed to provide CbCRs via information exchange, 

then other countries would be authorized to collect CbCRs directly from subsidiaries 

in their jurisdictions. 

Action 13 includes model legislative language for adopting CbCR requirements 

and model competent authority agreements for use by governments to implement 

CbCR exchange. It also provides a detailed framework for confidentiality and data 

safeguards that need to be in place for countries to receive the CbCR through information exchange. 

Under Action 13, the master file and the local file would be collected directly by 

each local jurisdiction in which the MNE conducts business. Confidentiality, consistency, and appropriate use standards that apply to the CbCR do not explicitly apply 

to the master file or local file, although participating countries have agreed that the 

confidentiality and consistent use standards associated with transfer pricing documentation generally ‘‘should be taken into account.’’ 

POTENTIAL IMPACT OF THE CBCR AND MASTER FILE REQUIREMENTS

The CbCRs on a company’s financial and tax data that companies file with their 

own country could impose a significant, additional administrative burden on companies. These reports however, would be submitted to foreign countries under bilateral 

treaties and information exchange agreements and thus have protections to ensure 

confidentiality, consistency and appropriate use of the information by foreign countries. 

Unfortunately, this would not be the case with the master file, which could be required directly by any country where a company does business. The master file asks 

for extremely sensitive information unrelated to actual taxpayer activities in the 

country requesting the information. In this way, the master file is similar to the 

CbCR. However, unlike the CbCR, the master file information does not have the 

confidentiality protections of the information exchange process and is not subject to 

any confidentiality, consistency, or appropriate use conditions beyond those that 

may apply locally. 

If a country fails to abide by these conditions with respect to the CbCR, Treasury 

has stated its intent to suspend CbCR information exchange. To the extent this 

threat is effective in ensuring that other countries maintain confidentiality of 

CbCRs of U.S. MNEs, it is irrelevant to the master file, which is arguably more intrusive. With respect to maintaining confidentiality of the master file, U.S. MNEs 

are at the mercy of foreign governments. 

Manufacturers are concerned that the master file requirement would force them 

to disclose an unprecedented amount of proprietary information about their global 

operations to foreign governments. The master file would include organizational 

charts, consolidated financial statements and analyses of profit drivers, supply 

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chains, intangibles, and financing. In short, it would provide a comprehensive plan 

that includes every aspect of a company’s worldwide business. 

While a small amount of the required information in the master file may be contained in public filings with the Securities and Exchange Commission (SEC), most 

of the required information is descriptive in nature and even publicly traded companies will need substantial input from across the business enterprise to recompose 

the data. Information about global supply chains, for example, can be considered 

sensitive commercial information that, if disclosed, would be of high value to the 

MNE’s market competitors. For privately held companies, the requirements to include a global organizational chart and consolidated financial statements would constitute an unprecedented level of disclosure to foreign governments. Disclosure, misappropriation, or inappropriate use of this information could be extremely detrimental to the ability of U.S. manufacturers to create value in the United States and 

global marketplaces. 

The fact that taxpayers may have some level of control over what information is 

included in the master file does little to address confidentiality concerns since it is 

unclear how much flexibility taxpayers have to exclude sensitive information. 

In the Action 13 report, the OECD recommends taxpayers use a ‘‘prudent business judgment’’ standard to determine the ‘‘appropriate level of detail’’ to be included in the master file. Information that is ‘‘important,’’ however, cannot be omitted. The OECD considers information to be important ‘‘if its omission would affect 

the reliability of the transfer pricing outcomes.’’ 

Manufacturers believe that this standard provides little comfort for taxpayers that 

want to omit sensitive information and avoid penalties for failing to comply with 

the filing requirements. There is, at best, a questionable nexus between the master 

file information and transfer pricing outcomes within a particular country under the 

arm’s length standard, since that is the purpose of the local file. For example, a taxpayer could reasonably take the position that omitting a global organizational chart 

or consolidated financial statements would not ‘‘affect the reliability of the transfer 

pricing outcomes’’ within any particular jurisdiction, yet be concerned that such 

omissions would constitute non-compliance. 

ADDRESSING CONFIDENTIALITY CONCERNS

Even though the BEPS recommendations were finalized this fall, the NAM strongly believes that taxpayer confidentiality concerns can and should be addressed during the BEPS implementation phase. Specifically, we believe that Treasury should 

link master file information to its agreements to provide the CbCR to other countries through information exchange. Thus, we urge Congress to ensure that Treasury enters into agreements with foreign countries specifying that: 

• Treasury agrees to provide CbCRs for U.S. MNEs only if U.S. MNEs or their 

subsidiaries are not required to provide master file information to the foreign 

country; 

• The foreign country agrees that it will not collect CbCRs from U.S. MNEs or 

their subsidiaries; and 

• Treasury agrees to provide to the foreign country only the master file information that a U.S. MNE chooses to file with its CbCR in order to provide context for its CbCR data. 

CONCLUSION

NAM members recognize the crucial role tax policy plays in the ability of businesses around the world to compete and grow, and we support tax rules that are 

pro-growth, pro-competitiveness, fair, clear, and predictable. In contrast, the proposed information sharing and disclosure rules included in the BEPS recommendations described above would impose new and unnecessary compliance costs on companies and, in some cases, force disclosure of proprietary business information, creating a new set of challenges for global companies. 

In particular, the master file requirement would provide foreign governments with 

a comprehensive roadmap detailing every aspect of a company’s worldwide business. 

Many manufacturers in the United States with operations overseas would have to 

comply with this provision, which represents an unacceptable and unprecedented 

expansion of required proprietary data sharing and a very real competitive threat 

for some of America’s most innovative firms. 

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Manufacturers are particularly concerned about the lack of safeguards to protect 

the confidentiality of this very sensitive information in the master file. Unlike the 

CbCR, the master file is not provided through information exchange and is not subject to any confidentiality, consistency, or appropriate use conditions beyond those 

that may apply in a local jurisdiction. If a country fails to meet these conditions on 

CbCRs, Treasury can suspend the information exchange. Unfortunately, this option 

does not apply to the master file information, which is even more intrusive. 

On a positive note, the United States has not announced plans to collect the master file. We urge Treasury officials to go one step further and only provide CbCRs 

to foreign countries that do not require a master file. At a company’s option, Treasury can provide any master file information the company chooses to provide as context for its CbCR data that is provided through information exchange. 

When it comes to tax policy, manufacturers believe a fair and transparent tax climate in the United States—including competitive business tax rates and modern 

international tax rules—will boost standards of living and economic growth worldwide. At the same time, an appropriate balance needs to be struck between transparency and confidentiality of the proprietary information that enables companies 

to compete and prosper in a global economy. 

QUESTIONS SUBMITTED FOR THE RECORD TO DOROTHY COLEMAN

QUESTIONS SUBMITTED BY HON. ORRIN G. HATCH

MASTER FILE REPORTING AND CONFIDENTIALITY

Question. There are concerns about taxpayer confidentiality in the Master File reports. Treasury officials have suggested that those concerns have been addressed because taxpayers have discretion over what they put in the Master File. 

But there must be some limits to that discretion, right? To what extent will companies have discretion over what goes into the master file? Foreign countries may 

very well ask for items that taxpayers will wish to keep secret, right? 

And what are other OECD countries thinking as to the amount of discretion to 

be allowed here? What recourse does a company have if the foreign tax authority 

disagrees with the company’s judgment and demands sensitive information on audit 

or imposes a fine for non-compliance? 

Could a non-public company exclude from the master file consolidated financial 

statements or a global organizational chart if in its ‘‘prudent business judgment’’ 

that information goes beyond the ‘‘appropriate level of detail’’ and does not ‘‘affect 

the reliability of transfer pricing outcomes’’? 

The Treasury Department has indicated that other countries can collect the Master File directly from multinational corporations, rather than going through the 

more typical information exchange process whereby foreign governments would ask 

the U.S. Government for such Master Files on a given taxpayer. 

What should the U.S. Government do if a foreign government fails to keep a U.S. 

multinational corporation’s master file confidential? Does that heighten confidentiality concerns? Would there be greater protection of U.S. taxpayer confidentiality 

if the U.S. Government were the gatekeeper to this information? 

Answer. Action 13 of the BEPS Final Report specifically requires countries to adhere to certain confidentiality, consistency, and appropriate use standards in order 

to obtain country-by-country reports (CbCRs). In the case of the United States, the 

Treasury Department plans to collect CbCRs from U.S. multinationals and transfer 

them to other countries through treaty information exchange. Treasury officials 

have stated that if a foreign tax authority does not comply with these standards, 

they would suspend transmitting CbCRs to that tax authority. Unfortunately, the 

master file, which individual countries will require to be provided directly by companies, and would not be covered by the confidentiality, consistency, and appropriate 

use standards that apply to CbCRs. While countries have agreed that confidentiality 

‘‘should be taken into account’’ when it comes to the master file, there are insufficient safeguards to protect against misuse of the information. 

We believe that putting this information into the hands of foreign tax authorities, 

without any clear safeguards to protect confidentiality, could put critical commercial 

information at substantial risk of public disclosure. At a time of widely reported corVerDate Mar 15 2010 17:20 Oct 17, 2016 Jkt 000000 PO 00000 Frm 00040 Fmt 6601 Sfmt 6621 R:\DOCS\22145.000 TIMD
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porate espionage and high profile data hacks, there is no guarantee that other countries would not inadvertently compromise companies’ information, a risk that U.S. 

businesses should not have to face. Moreover, the EU has stated its ambitions to 

make CbCRs public. While the information exchange process gives Treasury some 

leverage to prevent that for U.S. multinationals, no such leverage exists under current law with respect to master file information. 

In addition, we disagree with any assertions that companies already include the 

master file information in filings with the U.S. Securities and Exchange Commission 

(SEC). Obviously, private companies do not file with the SEC. Thus, requirements 

to provide foreign tax authorities with a global organizational chart and consolidated financial statements constitute an unprecedented level of disclosure to foreign 

governments. 

The master file also presents problems for publicly traded companies. Since most 

of the required information is descriptive in nature, it will have to be compiled with 

substantial input from across the multinational enterprise (MNE) group and some 

of the information could be considered confidential or proprietary. For example, information about global supply chains could well be considered sensitive commercial 

information that, if disclosed, would be of high value to the MNE’s market competitors, which could include state-owned enterprises. 

Moreover, even if there are individual pieces of information that, taken alone, 

may not be sensitive, the master file requires companies to pull it all together as 

a ‘‘blueprint of the MNE group.’’ Such a ‘‘blueprint’’ could reveal competitively important strategic information that would be valuable to competitors. We also believe 

that, like the CbCR, the global nature of information required in the master file will 

lead to more aggressive foreign audits and tax assessments that are inconsistent 

with international tax norms, and U.S. MNEs are likely to be the primary targets. 

Before the BEPS recommendations were approved, companies had the ability to 

push back on specific information requested by a foreign tax authority during an 

audit. This is particularly true with respect to global information that has little or 

no connection with a MNE’s operations within a particular country. Before Action 

13, this type of global information was generally available only through treaty-based 

information exchange, and the U.S. competent authority would require the foreign 

tax authority to demonstrate a clear linkage to a tax determination. Action 13, however makes local filing of master file information part of the international standard, 

making it much more difficult for U.S. companies to push back on specific information requests. 

On numerous occasions, Treasury officials have taken the position that since taxpayers have control over what they include in the master file, confidentiality concerns are manageable. In reality however, the fact that taxpayers have some level 

of control over what information is included in the master file does little to address 

confidentiality concerns because, as noted above, it is not clear how much flexibility 

taxpayers have to exclude sensitive information. 

The ‘‘prudent business judgment’’ standard that the Action 13 report recommends 

taxpayers use to determine the level of information to include in the master file is 

vague and subjective, and provides little comfort for taxpayers that wish to omit 

sensitive information and avoid penalties. For example, a taxpayer could reasonably 

take the position that omitting a global organizational chart or consolidated financial statements would not ‘‘affect the reliability of the transfer pricing outcomes’’ 

within any particular jurisdiction, yet be concerned that such omissions would constitute non-compliance. 

Some Treasury officials and commentators also have suggested that the master 

file requirement benefits taxpayers because it allows them to put their CbCR data 

into a narrative context. If this is the case, the master file itself, and the information included, should be optional and part of the CbCR filing to allow companies 

that want to provide more context for the financial information in the CbCR can 

do so with the confidentiality protections that come with treaty-based information 

exchange provided for the CbCR. 

The NAM supports legislation—the Bad Exchange Prevention (BEPS) Act (H.R. 

4297)—introduced late last year by Rep. Charles Boustany (R–LA) that addresses 

many of NAM’s concerns outlined above. Specifically, H.R. 4297 clearly describes potential abuses of the master file requirements and requires the Federal Government 

to withhold CbCRs from countries abusing master file documentation requirements 

or failing to keep master file information confidential. Abuses of the master file requirement include requesting trade secrets, group consolidated financial statements 

38 

not filed with the SEC, certain attorney-client privileged information, and other information that Treasury determines to be inappropriate. Thus, H.R. 4297 provides 

Treasury and taxpayers with the same leverage for master file information that now 

exists for CbCRs—suspension of CbCR exchange. This helps ensure that the Federal 

Government will protect U.S. businesses from being forced to disclose sensitive and 

confidential taxpayer information to foreign tax authorities as part of their implementation of Action 13. 

COUNTRY-BY-COUNTRY REPORTS

Question. Does the Treasury Department have the authority to issue regulations 

as called for by the BEPS reports as to country-by-country reporting? If so, how will 

the country-by-country reports assist the U.S. Government in the collection of U.S. 

income taxes? 

Answer. While manufacturers recognize that there is a compliance burden associated with the CbCRs, we support efforts by the Internal Revenue Service (IRS) and 

Treasury to issue CbCR guidance so U.S. MNEs can file once with the IRS and have 

their information confidentially exchanged via tax treaty or tax information exchange agreements with countries that agree with these confidentiality protections. 

Other countries already have announced that they will require CbCRs and our 

members have some level of comfort in exchanging information under a standard 

process that offers data protection. Moreover, if the United States does not collect 

and remit CbCRs, other countries may require local subsidiaries of U.S. MNEs to 

file a CbCR in a much less controlled and confidential manner under the ‘‘secondary 

mechanism’’ laid out in the BEPS report. This approach would be more costly for 

U.S. MNEs and provide less protection for confidential taxpayer information than 

if the IRS requires CbC reporting. 

QUESTIONS SUBMITTED BY HON. DEAN HELLER

Question. I strongly believe that tax reform, done the right way, can improve our 

fiscal picture. That said, without comprehensive tax reform, we are left with a crumbling tax code that negatively impacts our American and Nevadan businesses, while 

our other OECD partners are lowering their corporate tax rates and expanding their 

tax base. I am deeply concerned that U.S. multinational companies are being targeted and that the administration is not taking steps to defend our U.S. businesses. 

Answer. The NAM strongly agrees with you on the need for comprehensive tax 

reform. NAM members know firsthand that our current tax system is fundamentally 

flawed and discourages economic growth and U.S. competitiveness. Indeed, a key objective for the association is to create a national tax climate that promotes manufacturing in America and enhances the global competitiveness of manufacturers in the 

United States. To achieve these goals, we need a comprehensive tax reform plan 

that both reduces the corporate tax rate to 25 percent or lower and includes lower 

rates for the nearly two-thirds of manufacturers organized as flow-through entities. 

We also believe that comprehensive tax reform must include a shift from the current 

worldwide system of taxation to a modern and competitive international tax system, 

a permanent and strengthened research and experimentation (R&E) incentive and 

a strong capital cost-recovery system. 

We also feel that while enactment of a pro-growth tax reform plan will strengthen 

our economy and ensure vibrant economic growth in the future, our economy is suffering because of inaction on tax reform. A Missed Opportunity: the Economic Cost 

of Delaying Pro-Business Tax Reform, a study released by the NAM in January 

2015, takes a close look at the economic impact of enacting a five-prong pro-business 

tax package similar to NAM’s priorities and concludes that lack of action on probusiness tax reform is costing the U.S. economy in terms of slower growth in Gross 

Domestic Product (GDP), investment and employment. In contrast, the report finds 

that over a 10-year period, a pro-business tax plan would increase GDP over $12 

trillion relative to CBO projections, increase investment by over $3.3 trillion and 

add over 6.5 million jobs to the U.S. economy. 

Question. As you know, the OECD BEPS plan generally can’t force member governments to do anything they don’t want to do. Does BEPS strengthen the EU Commission’s hand by providing political cover? 

Answer. Yes. From our perspective, the European Commission (EC) appears very 

committed to the BEPS recommendations. Based on recent news reports, the EC 

later this month is expected to issue a proposal that will require countries in the 

39 

European Union (EU) to adopt the BEPS proposals as legislation. According to a 

top EC official, the EU could adopt the BEPS recommendations by June 2016. The 

NAM is extremely concerned that adoption of these recommendations by the EU will 

force U.S. companies to hand over a significant amount of detailed and, in some 

cases, confidential business information to foreign tax authorities without safeguards to protect confidentiality or misuse of the information. We also believe that 

the type of amount of information required under the BEPS recommendations will 

lead to more aggressive foreign audits and tax assessments, particularly of U.S. 

multinational companies. 

Question. I am deeply concerned with recent reports, as I am sure you are, that 

these EU state aid cases will lead to retroactive foreign tax increases on U.S. companies. Does it make sense that if the Commission finds that a country has violated 

its obligations to the EU that the company should be held liable retroactively? 

Answer. The NAM shares your concerns and those expressed by Treasury at the 

hearing about the continuing EU ‘‘state aid’’ cases involving the ex post facto and 

novel application of non-tax European law to effectuate tax policy changes that lead 

to retroactive taxation. It is a long-standing position of the NAM that the retroactive 

imposition or increase of taxes is fundamentally unsound, unfair and punitive. 

Question. As you may know, this committee is dedicated to overhauling the tax 

code. Earlier this year the committee held tax reform hearings analyzing simplicity, 

fairness, growth and international competitiveness. As this committee discusses 

overhauling the tax code, including international tax reform, what is the single biggest element that lawmakers can implement to promote pro-growth international 

competiveness? 

Answer. Manufacturers believe that the OECD’s focus on global profit shifting 

highlights the critical need for a comprehensive overhaul of the U.S. tax system to 

reflect the global marketplace of the 21st century. Indeed, policy makers in the 

United States should focus on the underlying problems of the U.S. business tax system—the high business tax rates and the double tax burden faced by U.S. global 

manufacturers and other U.S. multinationals because of our outdated worldwide tax 

system. Most of our competitor nations—including most of the countries that participated in the BEPS project—have much lower rates and territorial tax systems that 

only tax income earned within their borders. Consequently, in order to spur economic growth—and additional revenues for Treasury—the focus should be on reforming our outdated tax code by lowering business tax rates and adopting competitive international tax rules. In sum, we need a competitive tax system that makes 

the U.S. the best place in the world to manufacture and attract foreign direct investment. 

Question. I am here to help. How can Congress protect U.S. businesses from being 

targeted by foreign governments? 

Answer. In addition to advancing pro-growth tax-reform as described above, Senate action on pending tax treaties could be very helpful in protecting U.S. businesses from being targeted by foreign governments. Income tax treaties play a critical role in promoting U.S. bilateral trade and investment. In particular, globally 

competitive tax treaties protect U.S. businesses from double taxation of income 

earned overseas and reduce U.S. withholding taxes thus encouraging foreign companies to invest in the United States. The NAM supports inclusion in tax treaties dispute resolution procedures for U.S. taxpayers, treaty-partner taxpayers, and the 

U.S. and foreign taxing authorities to resolve disagreements and to assist in the enforcement of individual countries’ tax laws. Unfortunately, no treaties or protocols 

have been approved since 2010. Currently, treaties with Chile, Switzerland, Hungary, Poland, Luxembourg, and Spain and a protocol to amend a multilateral convention, all are pending in the Senate. 

QUESTIONS SUBMITTED BY HON. MICHAEL B. ENZI

Question. The EU state aid cases are targeting multinationals—predominantly 

U.S. multinationals. Based on its announcement of the first two decisions last 

month, the Commission believes the investigated countries are providing multinationals unfair competitive advantages over smaller domestic competitors through 

tax rulings that ‘‘do not reflect economic reality.’’ We haven’t seen the legal analysis 

of these cases yet, but if these are the standards that are being applied, do you 

agree that the decisions should not produce results that actually disadvantage integrated multinationals and that do reflect economic reality? 

40 

Answer. While the NAM has not been involved in any specific case, we share 

Treasury’s concerns expressed at the hearing about the continuing EU ‘‘state aid’’ 

cases involving ex post facto and novel application of non-tax European law to effectuate tax policy changes that lead to retroactive taxation. It is a long-standing position of the NAM that the retroactive imposition or increase of taxes is fundamentally unsound, unfair and punitive. 

Question. Isn’t the arm’s length principle the internationally accepted mechanism 

that strikes that balance? 

Answer. Manufacturers strongly believe that the current arm’s length standard— 

embodied in U.S. tax law and tax treaties—is the appropriate standard for transfer 

pricing that is designed to, as you put it in your question, ‘‘reflect economic reality’’ 

of intercompany transactions. Basing intercompany pricing on what unrelated third 

parties would do under the same or similar circumstances is a fundamental principle of tax policy. The arm’s length standard has been, and remains, conceptually 

sound, relevant and reliable in addressing related party transactions. 

Transfer pricing transactions involve at least two jurisdictions and the arm’s 

length standard recognizes the natural ‘‘tension’’ when each jurisdiction is interested in maximizing revenue and discouraging ‘‘leakage’’ from its tax base. In addition, a system of ‘‘advance pricing agreements,’’ a mechanism whereby governments 

agree to pricing arrangements in advance, provides certainty both to the governments and taxpayers. The arm’s length standard has been adopted by the Organisation for Economic Co-operation and Development (OECD) and is used by every 

major industrial nation. We would note that in announcing its appeal of the European Commission’s state aid decision in the Netherlands/Starbucks case, the Dutch 

Minister of Finance said, ‘‘the Commission applies its own new criterion for profit 

calculation, which is incompatible with domestic regulations and the OECD framework.’’ 

Moreover, there is a well-developed body of law and regulatory guidance on the 

standard in the United States. For example, over the years, Treasury has issued numerous regulations and other guidance on issues involving transfers of intangible 

assets, including inventions, scientific discoveries, patents, designs, trademarks, 

brand names, and copyrights. In addition, the Internal Revenue Service (IRS) has 

broad authority to audit intercompany transactions and change the results reported 

on tax returns, even absent intent to evade or avoid taxes. 

Question. Regarding the EU state aid cases: What do these cases mean for our 

ability to rely on bilateral tax treaties negotiated with European countries if the European Commission can unilaterally change a treaty partner’s tax positions through 

enforcement of EU competition policy? 

Answer. The NAM shares Treasury’s concerns expressed at the hearing that the 

state aid cases potentially undermine U.S. rights under our bilateral tax treaties 

with EU member states. 

Question. Does the U.S. have any rights under the treaty to protect U.S. tax interests while ensuring U.S. multinationals are not subject to double taxation because 

of the EU state aid decisions? 

Answer. See answer above. 

Question. We’ve all heard how BEPS threatens the U.S. tax base because its general policy objective is to align taxing rights with value creating activities. While 

BEPS represents prospective tax policy changes, and the U.S. at least had a seat 

at the table, the EU state aid cases represent EU assertion of retroactive taxing 

rights over the historical foreign earnings of U.S. multinationals, with the U.S. Government unable to participate. 

Do you view the EU state aid cases as an attempt by the EU to unilaterally and 

retrospectively attack the ‘‘stateless income’’ issue that the BEPS project was designed to address on a multilateral and prospective basis? 

Answer. The NAM shares Treasury’s concerns expressed at the hearing that, in 

substance, the state aid cases appear to reach results that are inconsistent with the 

internationally accepted standards in place at the time the income was earned. 

Question. If the cases result in a single member state collecting tax on virtually 

all of the income, without regard to the level of economic activity within that state— 

wouldn’t that actually contradict the underlying premise of the BEPS project—to 

align taxing rights with underlying value creating activity? 

41 

Answer.Yes, disregarding the level of economic activity within the EU member 

state under investigation would seem to contradict the underlying premise of BEPS 

to align taxing rights with underlying value creating activity. 

Question. With respect to income from intangible property, isn’t it true that a significant portion of this value-creating activity is likely to have taken place in the 

U.S., giving the U.S. primary taxing rights, on a deferred basis or otherwise? 

Answer. We are not familiar enough with the cases to answer this question. 

PREPARED STATEMENT OF MICHAEL DANILACK, PRINCIPAL, 

PRICEWATERHOUSECOOPERS LLP 

Chairman Hatch, Ranking Member Wyden, and distinguished members of the 

committee, I appreciate the opportunity to appear this afternoon as the committee 

considers the OECD’s project on ‘‘base erosion and profit shifting’’ and the European 

Commission’s inquiries into ‘‘State Aid.’’ I’d like to compliment the Committee for 

holding today’s hearing. The subject is of considerable import to the U.S. tax base 

and tax administration. In addition to having 20 years of experience with various 

accounting and law firms advising businesses on tax matters, from January 2010 

until July of 2014, I had the honor of serving as the Deputy Commissioner (International) in the Large Business and International division at the Internal Revenue 

Service. In that position, I was responsible for the IRS’s international enforcement 

programs and served as the U.S. competent authority under our bilateral tax conventions. As competent authority, my team and I represented the United States on 

all cross-border matters pertaining to dispute resolution, treaty interpretation, and 

information exchange. From 1995 to 2000, I also had the honor of serving as the 

Associate Chief Counsel (International) at the IRS, where my team and I were responsible for all legal matters pertaining to U.S. international tax laws and tax 

treaties. The effect of the BEPS project on tax administration will be the focus of 

my testimony. 

Currently, I am a tax Principal at PricewaterhouseCoopers LLP in the firm’s 

Washington National Tax Services practice. I appear here today, however, on my 

own behalf and not on behalf of PwC or any client of the firm. Therefore, the views 

that I express are entirely my own. 

The subject of today’s hearing—BEPS and State Aid—is both broad and complex. 

The OECD BEPS project has called for numerous changes to the laws and policies 

guiding the taxation of multinational businesses. In my view, however, the most important effect of the BEPS project in the near term is likely to be on international 

tax enforcement activities around the world, and this, in turn, will create a serious 

challenge for both U.S.-based multinational businesses and the U.S. Government. 

Further, I believe this more practical impact on international enforcement may well 

cause an erosion of the U.S. tax base. I will focus my testimony on the reasons for 

this view. 

Before I begin, I’d like to offer my compliments to Mr. Stack and his team at the 

Treasury Department. The BEPS project seemed threatening of U.S. interests from 

the start, and Mr. Stack’s diligent efforts to bring balance and wisdom to the project 

are greatly appreciated. 

I’ll begin by observing that the scope of the BEPS project and the timetable set 

for completing the work were extraordinarily ambitious. In addition, the OECD invited participation by non-OECD member countries that brought new points of view 

to the table. As a consequence, it isn’t surprising that the papers issued on October 

5th of this year do not reflect a true global consensus on many of the difficult issues 

that were evaluated. The papers achieve consensus in some respects by merely providing governments with options to address the issues in question. In other respects, 

they draw conclusions based on new concepts that are ambiguous and that could 

be read to mean any number of things to countries seeking to enlarge their tax 

bases. In still other respects, the work is unfinished. In addition, many of the recommendations coming out of the project will need to be implemented by each country through changes in law, regulations, or treaties, and these haven’t happened yet. 

So in important ways, we just don’t know what the new policies will be in each 

country. Despite its accomplishments, the BEPS project has created significant ambiguities and considerable uncertainty. 

Creating uncertainty regarding how tax compliance will be measured in a particular area is not necessarily a poor way for governments to proceed if the effort 

42 

is targeted at specific practices that clearly should be ended. In other words, governments can and often do create ambiguity about how a particular law will work going 

forward as a means of addressing specific situations where the intent of current law 

is clearly being circumvented. If BEPS were focused on ending a specific kind of 

abusive tax planning, then perhaps the uncertainty the project has created would 

be less objectionable, and companies would be advised to react by moving out of the 

identified structures before the new standards crystallize. 

The problem, though, is that the October 5th papers are not aimed at what might 

be fairly referred to as abusive. Rather, the papers will have the effect of broadening 

the collective corporate tax base and providing countries with new ways to claim a 

bigger share of that corporate base. The papers also break down the previously accepted view that each corporate entity in an affiliated multinational group should 

be regarded as a separate taxpayer that is taxed based on the risks it takes, the 

assets it owns, and the functions it performs. In this regard, the papers edge toward 

the concept that a multinational group should be viewed as an integrated whole. 

The risk is that the multinational group’s profits will be divided among the countries in which it conducts business not based on the arm’s-length principle that has 

guided international taxation for decades, but based on what each government perceives to be the value contributed by the part of the enterprise operating within its 

borders. 

I don’t intend to explore these policy changes today. Rather, I want to focus on 

the implications of setting forth broad and ambiguous concepts without taking the 

time to work through the ambiguities, which is essential to proper implementation 

and administration of the concepts. In my estimation, it is inevitable that countries 

will begin to assert these new concepts through enforcement actions, guided by their 

own interpretations and with their own revenue collection interests in mind. Indeed, 

this is already happening around the world. I hear stories from clients about it 

nearly every day. Unlike IRS agents, examining agents in other countries often are 

driven by particular revenue collection metrics, and the BEPS project has for them 

has established new goals. In the best of circumstances, it is a challenge for taxing 

authorities to administer policy nuances and act with caution when rules are unclear; and if examining agents are told they’re not collecting enough revenue, we 

should expect that they will construe ambiguity in their own favor. 

As a result, many are predicting that the BEPS project will lead to far more aggressive tax enforcement efforts targeted at multinational companies, many of which 

are headquartered in the United States. Further, because the BEPS project provides 

concepts that can be used to expand the revenue base of almost any country, the 

resulting threat is widespread double taxation. Allow me to explain the double taxation threat because it’s critical. When an examining agent adjusts the profits of a 

multinational business, the adjustment can, and often does, mean the adjusted profits could be taxed twice—once by the country making the adjustment and once by 

the country in which the profits were originally reported. In my view, increased instances of double, or even multiple, taxation is an unintended but very real threat 

flowing from the BEPS reports. 

The U.S. network of tax treaties is, of course, designed to eliminate double taxation so as not to impede cross-border business, and all countries agree that double 

taxation is wrong as matter of policy. But when double taxation is created by one 

country’s enforcement action, it isn’t automatically eliminated by a rule in a treaty. 

Rather, the case is presented by the taxpayer to the designated competent authorities of the two jurisdictions involved, and those competent authorities seek to arrive 

at a principle-based settlement to ensure that the profits of the business are taxed 

only once. But this so-called mutual agreement procedure is far from easy to conduct. As I mentioned at the outset, I had the honor to serve as the U.S. competent 

authority for a number of years and feel the need to convey to this body why I am 

so worried about the BEPS project from that perspective. 

At the competent authority negotiating table, the country that makes the adjustment has the greater leverage. That country is in a position to enforce its determination at will, and in some cases the tax has already been collected and the country can be quite reluctant to negotiate in good faith. The other country—the one 

where the profits were originally reported—can only attempt to convince the adjusting country to withdraw or reduce the adjustment by pointing to well-established 

international principles. This can be a difficult under normal circumstances, but 

where the underlying principles are unclear, the effort may well be a losing one. 

If we were to roll back the clock to the 1990s, we would find that the United 

States was the first, and for a while the only, country in the world attempting to 

43 

police income shifting through transfer pricing audits. As a result, the cases in front 

of competent authorities at the time were largely the result of IRS-proposed adjustments to increase profits reported in the United States. Since then, the situation 

has changed dramatically. When I left my position, in July of 2014, well over 80 

percent of the mutual agreement cases in inventory were the result of foreigninitiated adjustments on U.S.-based companies; and this, even though U.S. companies typically do not attempt to shift profits to the United States from foreign countries where tax rates generally are lower. Regardless, foreign tax authorities increasingly have been seeking to tax profits reported and taxed in the United States 

and it can be difficult for the U.S. competent authority to convince the other government to accede to the taxpayer’s reported position—even by pointing to principles 

that are well-established. In my estimation, in the post-BEPS world, this challenge 

will grow exponentially. The risk is that, with ambiguous new principles, governments will be even less willing to concede their adjustments despite another government’s objection. 

In the near term, there is little that can be done to ameliorate the enforcement 

problem I describe. Eliminating the ambiguities in the BEPS papers will take a long 

period of time, and in the meantime, the rhetoric that has driven the BEPS project 

will continue to affect how taxing authorities administer the law. While there was 

a need to examine the international rules to ensure consensus, I believe rhetoric to 

the effect that governments must do something about BEPS quickly negatively impacted the goal of achieving the consensus that is needed. In the near term, experience suggests that what governments will do quickly is seek to collect more revenue 

through enforcement actions against foreign-based businesses. Without clear principles to guide these enforcement actions, the result will be more disputes that will 

be more difficult to resolve. 

In the meantime, two things can be done. One is to ensure the IRS competent 

authority is equipped to handle the increased challenges that lie ahead. The second 

is to reform the U.S. international tax rules. Making rapid changes in U.S. policy, 

however, will not, in my view, reverse the enforcement problem. Lowering the U.S. 

corporate tax rate and reforming our international system is critical. But even if 

such changes are made, other taxing authorities will be looking to tax a bigger 

share of a bigger pie, and that will not be stopped through U.S. legislative change. 

In summary, major multinational companies all around the world likely will face 

the problems I am describing. While there seems to be a target unfairly painted on 

the backs of U.S. companies, taxing authorities will seek to tax a larger share of 

global profits by pursuing what Senator Russell Long referred to as ‘‘that fellow behind the tree.’’ That fellow will include foreign-based multinational companies as 

well as those based here in the United States. There is, however, an important difference between U.S. companies and foreign companies in this respect. As we all 

know, the United States has a worldwide system with credits provided for foreign 

taxes paid, not a so-called ‘‘exemption’’ or ‘‘territorial system.’’ This means that we 

allow a tax credit against U.S. taxes on income for foreign taxes imposed on that 

same income, including those imposed through foreign audits without a principled 

basis. So if the U.S. competent authority does not have the resources to handle the 

tsunami of new double tax cases predicted by many, or if the IRS cannot successfully convince foreign governments that their adjustments are wrong by pointing to 

well-established principles, U.S. companies generally won’t bear the resulting double 

taxation. Instead, companies will be entitled to take a credit for the adjusted foreign 

taxes in the United States and the U.S. tax base will be eroded as a result. 

Chairman Hatch, Ranking Member Wyden, and other distinguished members of 

the committee, I thank you again for the opportunity to be here today, and I would 

be happy to answer any questions you may have. 

QUESTIONS SUBMITTED FOR THE RECORD TO MICHAEL DANILACK

QUESTIONS SUBMITTED BY HON. ORRIN G. HATCH

MASTER FILE REPORTING AND CONFIDENTIALITY

Question. There are concerns about taxpayer confidentiality in the Master File reports. Treasury officials have suggested that those concerns have been addressed because taxpayers have discretion over what they put in the Master File. 

44 

But there must be some limits to that discretion, right? To what extent will companies have discretion over what goes into the master file? Foreign countries may 

very well ask for items that taxpayers will wish to keep secret, right? 

And what are other OECD countries thinking as to the amount of discretion to 

be allowed here? What recourse does a company have if the foreign tax authority 

disagrees with the company’s judgment and demands sensitive information on audit 

or imposes a fine for non-compliance? Could a non-public company exclude from the 

master file consolidated financial statements or a global organizational chart if in 

its ‘‘prudent business judgment’’ that information goes beyond the ‘‘appropriate level 

of detail’’ and does not ‘‘affect the reliability of transfer pricing outcomes’’? The 

Treasury Department has indicated that other countries can collect the Master File 

directly from multinational corporations, rather than going through the more typical 

information exchange process whereby foreign governments would ask the U.S. Government for such Master Files on a given taxpayer. 

Answer. What is to be included in a master file report and what discretion a company will have in completing the report will be based entirely on the laws and administrative practices adopted by each country choosing to implement the requirement. In other words, the requirements and how they are enforced will vary from 

country to country, and possibly from situation to situation. Likely, some tax authorities will be sensitive to the concerns of business and circumspect about the information required, while others may make more expansive requests. 

Question. What should the U.S. Government do if a foreign government fails to 

keep a U.S. multinational corporation’s master file confidential? Does that heighten 

confidentiality concerns? Would there be greater protection of U.S. taxpayer confidentiality if the U.S. Government were the gatekeeper to this information? 

Answer. In general, if a foreign tax authority discloses a U.S. company’s tax information (whether master file information or other information) in violation of its own 

confidentiality laws, the foreign tax authority would not be accountable to the U.S. 

Government. If the disclosure is by a U.S. treaty partner, however, the IRS would 

likely take note of the violation, particularly if it reflects a systemic problem, because its agreement to exchange tax information with any foreign tax authority is 

premised on the country’s laws and administrative practices being adequate to safeguard all tax information. Thus, any violation of a treaty partner’s tax confidentiality laws (whether with respect to master file reports or otherwise) could cause 

the IRS to question the propriety of exchanging tax information with the tax authority of that country. 

If the disclosed information had been collected by the IRS and then provided to 

the foreign tax authority under an exchange of information provision (that is, if the 

IRS were a ‘‘gatekeeper’’ of the information), the information would not be subject 

to any ‘‘greater protection’’ legally speaking. The provisions of tax treaties and tax 

information exchange agreements generally provide that information exchanged is 

to be protected by the receiving tax administration in the same manner as information collected directly by that tax administration under its own laws. Thus, treaty 

exchange provisions do not generally provide greater confidentiality protection to exchanged information. Some heightened ‘‘comfort’’ may be achieved, however, because 

a foreign tax authority may take more care with information it receives from the 

IRS, either out of a general sense of duty or in supposing the IRS will more likely 

call treaty exchange into question if it provides the information that is inappropriately disclosed. Further, the IRS may in fact be more watchful for, and sensitive 

about, inappropriate disclosures of information it provides a foreign tax authority 

than it may be about disclosures of confidential information its treaty partner acquires elsewhere. In theory, however, the IRS should be equally concerned about 

any violation of tax confidentiality by its treaty partners. 

COUNTRY-BY-COUNTRY REPORTING

Question. Does the Treasury Department have the authority to issue regulations 

as called for by the BEPS reports as to country-by-country reporting? If so, how will 

the country-by-country reports assist the U.S. Government in the collection of U.S. 

income taxes? 

Answer. Statutory authority granted to the IRS to collect information (whether 

under 6001, 6011, 6038, or 7602) is limited to collections of information relevant to 

the determination of a U.S. tax liability. Importantly, according to the preamble to 

the proposed Treasury regulations requiring country-by-country reporting, the IRS 

has concluded that the country-by-country reports it will collect from U.S.-based 

45 

multinational companies, as well as the country-by-country reports it will receive 

from other governments in the exchange process, ‘‘will assist in better enforcement 

of the Federal income tax laws by providing the IRS with greater transparency regarding the operations and tax positions taken by U.S. MNE groups.’’ 

QUESTIONS SUBMITTED BY HON. DEAN HELLER

Question. I strongly believe that tax reform, done the right way, can improve our 

fiscal picture. That said, without comprehensive tax reform, we are left with a crumbling tax code that negatively impacts our American and Nevadan businesses, while 

our other OECD partners are lowering their corporate tax rates and expanding their 

tax base. I am deeply concerned that U.S. multinational companies are being targeted and that the administration is not taking steps to defend our U.S. businesses. 

As you know, the OECD BEPS plan generally can’t force member governments 

to do anything they don’t want to do. Does BEPS strengthen the EU Commission’s 

hand by providing political cover? 

I am deeply concerned with recent reports, as I am sure you are, that these EU 

state aid cases will lead to retroactive foreign tax increases on U.S. companies. Does 

it make sense that if the Commission finds that a country has violated its obligations to the EU that the company should be held liable retroactively? 

Answer. I have no views either on whether BEPS provides political cover to the 

European Commission or on whether retroactive recoveries following EU state aid 

determinations make sense. I will point out, however, that if Congress is worried 

about retroactive taxation of U.S. companies’ offshore profits, EU state aid recoveries should not be the only concern. The BEPS project outputs include vague new 

concepts that provide tax administrations with discretion to ignore entities and contracts in determining tax liabilities. Many U.S. companies are experiencing audits 

by foreign tax authorities in which these vague concepts are being applied for years 

past. The anti-BEPS rhetoric (that tax planning is abusive and that multinational 

companies have not paid a fair share) seemingly has encouraged tax authorities to 

apply these vague new concepts retroactively. Thus, it is increasingly likely that offshore profits will have already been taxed by foreign governments, perhaps more 

than once, when repatriated to the United States. 

Question. As you may know, this committee is dedicated to overhauling the tax 

code. Earlier this year the committee held tax reform hearings analyzing simplicity, 

fairness, growth and international competitiveness. As this committee discusses 

overhauling the tax code, including international tax reform, what is the single biggest element that lawmakers can implement to promote pro-growth international 

competiveness? 

Answer. International tax reform will require that several complex concepts be 

addressed carefully, but the ‘‘single biggest element’’ of such reform, which is essential to promoting growth and international competitiveness, is a substantially lower 

corporate tax rate. 

Question. I am here to help. How can Congress protect U.S. businesses from being 

targeted by foreign governments? 

Answer. Establishing U.S. tax relevance of information to be collected by the IRS 

is particularly important when the information is located offshore. The courts have 

established that, under principles of international law, the IRS has the authority 

to collect information located offshore, but only if it clearly identifies its tax purpose 

and the information is clearly relevant to that purpose. Presumably due to this sensitivity about offshore information, Congress granted special authority to the IRS, 

in section 6038 of the Internal Revenue Code, to collect particular offshore information needed to determine a U.S. person’s liability under subpart F of the Code. 

Country-by-country information is not expressly covered by section 6038 itself. 

Treasury, however, was granted authority in section 6038(a)(1) to require other information that is ‘‘similar or related in nature’’ to the information listed in section 

6038 or which the Secretary determines to be appropriate to carry out the provisions 

of the Internal Revenue Code. 

46 

QUESTIONS SUBMITTED BY HON. MICHAEL B. ENZI

Question. The EU state aid cases are targeting multinationals—predominantly 

U.S. multinationals. Based on its announcement of the first two decisions last 

month, the Commission believes the investigated countries as providing multinationals unfair competitive advantages over smaller domestic competitors through 

tax rulings that ‘‘do not reflect economic reality.’’ We haven’t seen the legal analysis 

of these cases yet, but if these are the standards that are being applied, do you 

agree that the decisions should not produce results that actually disadvantage integrated multinationals and that do reflect economic reality? 

Isn’t the arm’s length principle the internationally accepted mechanism that 

strikes thatbalance? 

Question. Regarding the EU state aid cases: What do these cases mean for our 

ability to rely on bilateral tax treaties negotiated with European countries if the European Commission can unilaterally change a treaty partner’s tax positions through 

enforcement of EU competition policy? 

Does the U.S. have any rights under the treaty to protect U.S. tax interests while 

ensuring U.S. multinationals are not subject to double taxation because of the EU 

state aid decisions? 

Question. We’ve all heard how BEPS threatens the U.S. tax base because its general policy objective is to align taxing rights with value-creating activities. While 

BEPS represents prospective tax policy changes, and the U.S. at least had a seat 

at the table, the EU state aid cases represent EU assertion of retroactive taxing 

rights over the historical foreign earnings of U.S. multinationals, with the U.S. government unable to participate. 

Do you view the EU state aid cases as an attempt by the EU to unilaterally and 

retrospectively attack the ‘‘stateless income’’ issue that the BEPS project was designed to address on a multilateral and prospective basis? 

If the cases result in a single member state collecting tax on virtually all of the 

income, without regard to the level of economic activity within that state, wouldn’t 

that actually contradict the underlying premise of the BEPS project—to align taxing 

rights with underlying value-creating activity? 

With respect to income from intangible property, isn’t it true that a significant 

portion of this value-creating activity is likely to have taken place in the U.S., giving 

the U.S. primary taxing rights, on a deferred basis or otherwise? 

Answer. I am neither expert in EU competition law nor knowledgeable about the 

particular state aid cases pending at this time. Therefore, I have no responses to 

offer to Senator Enzi’s questions above. 

PREPARED STATEMENT OF HON. ORRIN G. HATCH, 

A U.S. SENATOR FROM UTAH

WASHINGTON—Senate Finance Committee Chairman Orrin Hatch (R–Utah) today 

delivered the following opening statement at a committee hearing examining the 

Organisation for Economic Co-operation and Development’s (OECD) Base Erosion 

and Profit Shifting (BEPS) reports, and the European Union’s (EU) State Aid investigations regarding member-countries’ tax rulings: 

I want to welcome everyone here this morning and thank you all for attending 

this important hearing on international taxation, focusing particularly on the Organisation for Economic Co-operation and Development, or OECD’s, project on base 

erosion and profit shifting, or BEPS. 

The overall discussion about international tax is very timely. 

Just a couple of weeks ago, we were informed that a major American pharmaceutical company had decided to invert—merging with another drug company, with 

the headquarters of the newly-formed corporation to be located in a foreign country. 

Of course, this is nothing new. We’ve been seeing these types of transactions take 

place for some time. 

Inversions like these are some of the clearest examples of base erosion and are 

largely motivated by tax considerations, as American companies determine that they 

can reduce their overall operating costs if they become foreign corporations. Given 

47 

the burdensome and anti-competitive nature of the U.S. tax code, these companies 

are, unfortunately, not acting irrationally. 

The administration’s response to the wave of inversions has, in my opinion, been 

short-sighted, focusing only on the symptoms rather than the underlying illness. 

While the latest proposed guidance from Treasury might very well stem the tide of 

inversions, it will leave other, potentially more harmful avenues for tax avoidance— 

like foreign takeovers—wide open, and perhaps even make them more attractive. 

Long story short, any steps we take to address inversions should focus on fixing 

the shortcomings of the underlying system and make the U.S. a better place for 

companies to do business. 

The BEPS project is another effort aimed at addressing international tax problems and base erosion, but on a more global scale. The purpose of the project was 

to provide OECD member countries with recommendations for both domestic tax 

policy changes and amendments to existing tax treaties to address business practices that result in base erosion. After several years of discussion, the OECD released its final reports earlier this year and, last month, leaders from the G20 countries endorsed the recommendations. 

Throughout this process, we have heard concerns from large sectors of the business community that the BEPS project could be used to further undermine our nation’s competitiveness and to unfairly subject U.S. companies to greater tax liabilities abroad. Companies have also been concerned about various reporting requirements that could impose significant compliance costs on American businesses and 

force them to share highly sensitive proprietary information with foreign governments. 

I expect that we’ll hear about these concerns from the business community and 

others during today’s hearing. 

In addition, throughout the BEPS negotiations, I urged the Obama administration 

to both acknowledge the limits of their authority under the law and to cooperate 

with Congress on any and all efforts to implement the recommendations. While the 

U.S. was a party to the BEPS negotiations, Congress had neither a seat at the negotiating table nor a meaningful opportunity to weigh in with the administration on 

the substance of the proposals. 

However, it is Congress—and Congress alone—that has the ultimate authority to 

make changes to the U.S. tax code. While the Treasury Department does have broad 

regulatory authority under the law, that power is not without limits. Even in those 

areas where authority clearly exists for the administration to promulgate regulations, it is virtually always better if Congress is viewed as a partner in this process 

rather than an adversary. And, in those instances where the regulatory authority 

is less clear, congressional involvement and approval is even more important to ensure that policy changes are viewed by the public as legitimate. 

Of course, most of this should go without saying. It is, after all, a basic lesson 

in government, and I don’t think anyone here is in need of a civics refresher from 

me. 

However, I think it also goes without saying that the current administration 

hasn’t always viewed Congress as a necessary or even important part of its efforts 

to develop and implement policy changes. So, I think it is, at the very least, helpful 

to offer a brief reminder to everyone that Congress has a role to play on these issues 

that cannot be overlooked. 

That’s another set of concerns that I expect we’ll discuss during this hearing. We 

have a representative from Treasury here today—so, I’m looking forward to getting 

a better sense of what elements of the BEPS recommendations the administration 

believes it can implement unilaterally and where they believe congressional action 

will be necessary. 

I also want to note that I have asked the Government Accountability Office to provide its own analysis on the BEPS recommendations, taking into account all of the 

complex elements—both domestic and global—that are implicated with these types 

of policy changes. I expect their work will take some time, but gathering this type 

of information is, in my view, an essential part of our overall evaluation of the 

BEPS project. 

There are other topics that I expect will come up today, including a discussion 

of so-called ‘‘state aid’’ remedies and recent activities in the eurozone that, to me, 

48 

look like attempts to impose retroactive taxation on multinational enterprises, including a number of U.S.-based companies. 

Speaking more broadly, I just want to say that, when it comes to international 

tax issues, I hope we all have the same goals in mind. 

I would hope that we all want to improve conditions for American businesses. 

I would hope that we all want to make our country more competitive on the world 

stage. 

And, to that end, I would hope that we all want to improve the overall health 

of the U.S. economy. That’s why all of us are here today, or at least it should be. 

Any regulations promulgated by the administration to prevent businesses from 

moving offshore should have these goals in mind. 

At the same time, while international efforts to align tax systems are worth exploring, we shouldn’t be negotiating agreements that undermine our own interests 

for the sake of some supposedly higher or nobler cause. The interests of the United 

States—our own economy, our own workers, and our own job creators—should be 

our sole focus. 

So, throughout today’s discussion—whether we’re talking about BEPS, inversions, 

or any other international tax issues—I am most interested in hearing views as to 

how various policies and proposals will or will not serve our Nation’s interests and 

advance these important goals. 

Long story short, we have quite a bit to talk about today. And, we have a distinguished panel of witnesses who should be able to shed some light on these complicated issues. I look forward to their testimony. 

PREPARED STATEMENT OF ROBERT B. STACK, DEPUTY ASSISTANT SECRETARY FOR

INTERNATIONAL TAX AFFAIRS, DEPARTMENT OF THE TREASURY

Chairman Hatch, Ranking Member Wyden, and distinguished members of the 

committee, I appreciate the opportunity to appear today to discuss some key international tax issues, including the recently completed G20/Organisation for Economic 

Co-operation and Development (OECD) Base Erosion and Profit Shifting (BEPS) 

project. We appreciate the committee’s interest in these important issues. 

I would like to begin by describing the outcome of the G20/OECD BEPS project, 

and then describe the expected BEPS follow-on work. I will then link that discussion 

to a consideration of the need for general corporate and international tax reform, 

as well as the related need to address U.S.-base stripping and inversion transactions. I will close with a discussion of the European Commission’s current state 

aid investigation of multinational firms, including U.S. multinationals. 

G20/OECD BASE EROSION AND PROFIT SHIFTING (BEPS) PROJECT

In June 2012, at the G20 Summit in Los Cabos, Mexico, the leaders of the world’s 

largest economies identified the ability of multinational companies to reduce their 

tax bills by shifting income into low- and no-tax jurisdictions as a significant global 

concern. They instructed their governments to develop an action plan to address 

these issues, which was endorsed by G20 leaders in September 2013 in St. Petersburg. The OECD has hosted this process, but all G20 governments, some of which 

are not members of the OECD, had a role. The G20/OECD BEPS Action Plan outlined 15 specific areas for further examination. The results were delivered to Finance Ministers this October in Lima, Peru, and to President Obama and other 

world leaders at last month’s G20 summit in Antalya, Turkey. 

The United States has a great deal at stake in the BEPS project and a strong 

interest in its success. Our active participation is crucial to protecting our own tax 

base from erosion by multinational companies, much of which occurs as a result of 

exploiting tax regime differences. A key goal of BEPS is to identify those differences 

and write rules that close loopholes. In addition, as the home of some of the world’s 

most successful and vibrant multinational firms, we have a stake in ensuring that 

companies and countries face tax rules that are clear and administrable and that 

companies can avoid unrelieved double taxation, as well as expensive tax disputes. 

Both the United States and our companies have a strong interest in access to robust 

dispute resolution mechanisms around the world. In contrast, failure in the BEPS 

project could well result in countries taking unilateral, inconsistent actions, thereby 

49 

increasing double taxation, the cost to the U.S. Treasury of granting foreign tax 

credits, and the number and scale of tax disputes. Indeed, notwithstanding the 

BEPS project, some countries have taken unilateral action, and it is our hope that 

they will reconsider those actions in the post-BEPS environment. 

The principal target of the BEPS project was so-called ‘‘stateless income,’’ basically very low- or non-taxed income within a multinational group. The existence of 

large amounts of stateless income in a time of global austerity has called into question the efficacy of longstanding international tax rules. This issue is prominent in 

a global economic environment in which superior returns can accrue to intangibles 

that are easily located anywhere in the world and that often result from intensive 

research and development activities that a single multinational may conduct in 

many countries, or that result from marketing intangibles that can be exploited in 

one country but owned and financed from another country. Some countries with 

large markets believe that some of these premium profits should be taxed in the 

market country, whereas current international norms attribute those profits to the 

places where the functions, assets, and risks of the multinational firm are located— 

which are often not the market countries. Finally, I would be remiss to not note that 

the ability of U.S. multinationals to defer tax on large amounts of income in lowand no-tax jurisdictions has fed the perception of tax avoidance by these multinationals. This perception exists even though the U.S. would tax that income upon 

repatriation to the U.S. parent firm—whether voluntarily by the taxpayer, or 

through a deemed repatriation that might occur as a part of tax reform. 

The G20/OECD project produced a broad array of reports outlining measures addressing stateless income ranging from revision of existing standards to new minimum standards, as well as describing common approaches, all of which are expected to facilitate the convergence of national practices. All OECD and G20 countries have committed to minimum standards in the areas of preventing treaty shopping, requiring country-by-country reporting, fighting harmful tax practices, and improving dispute resolution. In transfer pricing, existing standards have been updated. With respect to recommendations on hybrid mismatch arrangements and best 

practices on interest deductibility, countries have agreed on a general tax policy direction. In these areas, we expect that practices will converge over time through the 

implementation of the agreed common approaches. In the United States, most of the 

rules restricting the use of hybrid entities and hybrid securities and the rules limiting excessive interest deductibility would require congressional action, and the administration proposed new policies along these lines in the FY 2016 Budget. Guidance based on best practices will also support countries in the areas of disclosure 

initiatives and controlled foreign company (CFC) legislation. Finally, participants 

agreed to draft a multilateral instrument that countries may use to implement the 

BEPS work on tax treaty issues. 

I would like to highlight some of the more important outputs from the BEPS 

project. Interest expense deductions are a major contributor to the BEPS problem. 

The ability to achieve excessive interest deductions, including those that finance the 

production of exempt or deferred income, is best addressed in a coordinated manner. 

The BEPS project has agreed on a best practice approach, which recommends that 

countries provide two alternative caps on interest deductions from which companies 

can choose. The first cap is a fixed ratio, which is similar to the rules under current 

U.S. law and looks at the ratio of interest expense to earnings before interest, taxes, 

depreciation and amortization, also known as EBITDA. The BEPS 2015 Final Report recommends that countries adopt a fixed ratio for allowable interest deductions 

within a range of 10 percent to 30 percent of EBITDA (current U.S. law allows up 

to 50 percent). The report also recommends that countries adopt as an alternative 

cap a group ratio based on earnings. Under this cap, each entity in a multinational 

group could deduct interest up to its allocable portion of the group’s third party interest expense, which would be determined based on the entity’s proportionate share 

of the group’s worldwide earnings. This rule is based on the premise that multinational groups should be able to deduct interest up to their group-wide third party 

interest expense. The combination of this rule with a low fixed ratio also would ensure that groups would not be able to use related party loans to deduct interest expenses well in excess of the group’s third party interest expense. As discussed below, 

the President’s FY 2015 and FY 2016 Budget have included a proposal that is in 

line with this recommendation. 

The OECD has agreed on hybrid entity and hybrid security best practices that 

target a ‘‘deduction/no inclusion’’ situation (i.e., a tax deduction in one country without an income inclusion in the other country) and a double deduction situation (i.e., 

tax deductions taken in more than one jurisdiction for the same item). In the case 

50 

of the ‘‘deduction/no inclusion’’ scenarios, these recommendations would require 

Congressional action, and are broadly consistent with rules proposed in the President’s FY 2015 and FY 2016 Budget The recommendations addressing double deductions are modeled after existing U.S. rules. Importantly, the OECD approach to this 

action item is to neutralize the mismatch in tax outcomes, but not otherwise interfere with the use of such arrangements so as to not adversely affect cross-border 

trade and investment. 

An agreement on a minimum standard to secure progress on dispute resolution 

was reached to help ensure that cross-border tax disputes between countries over 

the application of tax treaties are resolved in a more effective and timely manner. 

The Forum on Tax Administration (FTA), including all OECD and G20 countries 

along with other interested countries and jurisdictions, will continue its efforts to 

improve mutual agreement procedures (MAP) through its recently established MAP 

Forum. This will require an assessment methodology to ensure the new standard 

for timely resolution of disputes is met. In parallel, a large group of countries is 

committed to move quickly towards mandatory binding arbitration. It is expected 

that rapid implementation of this commitment will be achieved through the inclusion of arbitration as an optional provision in the multilateral instrument that 

would implement the BEPS treaty-related measures. 

Standardized country-by-country reporting and other documentation requirements 

will give tax administrations a global picture of where profits, tax, and economic activities of multinational enterprises are reported, and the ability to use this information to assess various tax compliance risks, so they can focus audit resources where 

they will be most effective. Multinational Enterprises (MNEs) will report their revenues, pre-tax profits, income tax paid and accrued, number of employees, stated capital, retained earnings, and tangible assets in each jurisdiction where they operate. 

The implementation package provides guidance to ensure that information is provided to the tax administration in a timely manner, that confidentiality is preserved, and that the information is used appropriately. The filing requirement will 

be on multinationals with annual consolidated group revenue equal to or exceeding 

EUR 750 million, meaning this regime applies only to the largest and most sophisticated entities. 

The existing standards in the area of transfer pricing have been clarified and 

strengthened as part of the BEPS project. Because the transfer pricing work is 

based on the arm’s length principle, it is consistent with U.S. transfer pricing regulations under section 482. A key element of the work relates to the arm’s length 

return to so-called ‘‘cash boxes,’’ which would be entitled to no more than a riskfree return if they are mere funders of activities performed by other group members. 

The work on cash boxes is one aspect of new approaches to risk, which generally 

provide that contractual allocations of risk are respected only when the party contractually allocated risk has the capacity to control the risk and the financial capacity to bear it. The transfer pricing work also addresses specific issues relating to 

controlled transactions involving intangibles, including providing a special rule for 

hard-to-value intangibles akin to the U.S. ‘‘commensurate with income’’ standard. 

Where do we go from here? Certain technical work remains for the OECD in 2016 

and beyond. More importantly, however, we believe the best way to foster the 

G20 goal of supporting global growth is to actively promote the connection between 

foreign direct investment, growth, and efficient and effective tax administrations. 

Too often countries fail to recognize that strong civil institutions promote growth 

and investment. The OECD is expected to present to the G20 a framework for moving forward at the Finance Minister’s meeting to be held in China in February 2016. 

We are working hard to ensure that issues around effective and fair tax administration are made part of the post-BEPS agenda. 

INTERNATIONAL TAX REFORM

The G20/OECD BEPS project shined a spotlight on so-called stateless income, a 

phenomenon that is a byproduct of outdated tax rules. I would like to outline the 

steps the United States could take today to reform our own tax system to improve 

competitiveness, secure our tax base, and reduce incentives for profit shifting by 

U.S. firms. 

As the President has proposed, we should reform our business tax system by reducing the corporate income tax rate and broadening the base. It is frequently noted 

that the United States has a high statutory corporate rate, but much lower effective 

tax rates. High statutory rates encourage multinational firms to find ways to shift 

51 

profits, especially on intangible income, to other jurisdictions. So lowering our statutory rate while broadening the base could help reduce erosion of the U.S. base. 

But it would only be a start, because even with lower rates U.S. multinationals 

would continue to aggressively seek ways to lower their tax bills by shifting income 

out of the United States since there will always be jurisdictions with lower tax 

rates. We can, however, take other steps. 

First, the President’s framework for business tax reform proposes a minimum tax 

on foreign earnings that represent excess returns, which typically arise from intangible assets. This would reduce the benefit of income shifting and impose a brake 

on the international ‘‘race to the bottom’’ in corporate tax rates. Other recent tax 

reform plans have included similar proposals, which would improve on the current 

complex international tax rules by requiring that companies pay a minimum rate 

of tax (either to the United States or to a foreign jurisdiction) on all foreign excess 

returns. 

Second, as part of tax reform, we should also take a close look at interest deductibility, noting that our thin capitalization rules are inadequate and that our system 

actually gives an advantage to foreign-owned multinationals. These foreign-owned 

multinationals can lend funds to their U.S. subsidiary to benefit from interest deductions against a 35 percent tax rate, while the related interest income is subject 

to significantly lower tax rates, or no tax at all, in the lending jurisdiction. It is especially disconcerting to observe that among the foreign multinationals that most 

aggressively take advantage of this strategy are so-called ‘‘inverted’’ companies— 

that is, foreign-parented companies that were previously U.S.-parented. The administration’s FY 2016 Budget proposes to level the playing field by limiting the ability 

of U.S. subsidiaries of a foreign multinational to claim interest deductions in the 

United States that greatly exceed their proportionate share of the group’s global interest expense. Specifically, this proposal would limit a U.S. subsidiary’s interest expense deductions to the greater of 10 percent of the subsidiary’s EBITDA or the subsidiary’s proportionate share of worldwide third-party interest expense, determined 

based on the subsidiaries’ share of the multinational’s worldwide earnings. 

A related administration FY 2016 Budget proposal would limit a U.S. multinational’s ability to claim a U.S. deduction for interest expense that is related to 

foreign subsidiary income. U.S. multinationals typically borrow in the United States 

to benefit from interest deductions against a 35 percent tax rate, but they then use 

the borrowed cash throughout the multinational group, financing operations that 

may not be subject to current U.S. tax. Indeed, we have recently seen examples of 

U.S. multinationals borrowing in the United States—rather than bringing back cash 

from offshore operations—to pay dividends to their shareholders. The proposal 

would align the treatment of interest expense deductions with the treatment of the 

income supported by the proceeds of the borrowing. 

In addressing stripping of the U.S. base, it is also important to consider so-called 

‘‘hybrid arrangements,’’ which allow U.S. subsidiaries of foreign multinationals to 

claim U.S. deductions with respect to payments to related foreign entities that do 

not result in a corresponding income item in the foreign jurisdiction. These arrangements produce stateless income and should be remedied. To neutralize these arrangements, the administration’s FY 2016 Budget proposes to deny deductions for 

interest and royalty payments made to related parties under certain circumstances 

involving hybrid arrangements. For example, the proposal would deny a U.S. deduction where a taxpayer makes an interest or royalty payment to a related person and 

there is no corresponding inclusion in the payee’s jurisdiction. 

Additionally, shifting intangibles outside the United States is a key avenue 

through which U.S. base erosion occurs. The principal means of shifting intangible 

income is to undervalue intangible property transferred offshore or to take advantage of the uncertainty in the scope of our definition of intangibles. Once this intellectual property is located offshore, the income that it produces can accrue in lowor no-tax jurisdictions. The administration’s FY 2016 Budget contains a number of 

proposals that would discourage the corporate tax base erosion that occurs via intangibles transfers. In addition to our proposal to impose a minimum tax on excess 

returns, the FY 2016 Budget would explicitly provide that the definition of intangible property includes items such as goodwill and going concern value and would 

also clarify the valuation rules to address taxpayer arguments that certain value 

may be transferred offshore without any U.S. tax charge. Another proposal would 

update subpart F to currently tax certain highly mobile income from digital goods 

and services. 

52 

CORPORATE INVERSIONS

By lowering rates and reducing the ability of multinationals to severely reduce 

their U.S. taxable income through outsized interest deductions, the United States 

could go a long way towards reducing the incentives that U.S. multinationals have 

to invert. Doing nothing and letting our corporate tax base erode through inversions 

will worsen our fiscal challenges over the coming years. Once companies undertake 

an inversion transaction, there is a permanent loss to the U.S. income tax base because it is unlikely that these companies will return their tax residence to the 

United States. 

An anti-inversion provision has been part of the Internal Revenue Code since 

2004, but experience has shown that this provision insufficiently deters inversions. 

According to a 2014 Congressional Research Service report, 47 U.S. corporations reincorporated overseas through corporate inversions in the 10-year period ending 

July 2014. This marked an increase from only 29 inversions in the prior 20 years. 

More inversions have occurred since the CRS report and proposed inversions are 

being reported in the media on a fairly regular basis. 

Only legislation can decisively stop inversions. The administration has been working with Congress for several years in an effort to reform our business tax system, 

make it simpler and more pro-growth, and remove the incentives that encourage 

companies to engage in inversions. To reinforce the existing anti-inversion statute, 

the administration has proposed in recent Budgets to broaden the scope of the statute to prevent more inversion transactions. As amended by the proposal, the statute 

would provide that, unless the inverted company has substantial business activities 

in the country where it purports to have moved its tax residence, the inverted company would continue to be treated as a domestic corporation for U.S. Federal income 

tax purposes if either (i) shareholder continuity in the inverted company after the 

transaction is more than 50 percent, or (ii) the transaction involved the combination 

of a larger U.S. entity with a smaller foreign entity and the group maintains its corporate headquarters in the United States. This strengthened anti-inversion statute 

is necessary to prevent a permanent reduction in Federal corporate income tax revenues. 

In the interim, it is Treasury’s obligation to protect the tax base, and we have 

repeatedly stated that we will use all of our existing administrative tools to address 

this problem. In Notice 2014–52, which was issued in September 2014, Treasury 

and the IRS took several steps to address inversions. First, the notice announced 

rules that would prevent inverted companies from accessing a foreign subsidiary’s 

earnings while deferring U.S. tax through the use of so-called hopscotch loans 

(which are loans from a foreign subsidiary of the former U.S. parent either to the 

new foreign parent or one of its foreign affiliates). Second, the notice closed a loophole pursuant to which an inverted company could restructure the group’s ownership in the foreign subsidiaries of the former U.S. parent and thereby access earnings in those entities without incurring the U.S. tax that would otherwise have been 

due. Third, the notice made it more difficult for U.S. companies to invert by 

strengthening the requirement that the former owners of a U.S. company own less 

than 80 percent of the new combined entity. 

A few weeks ago, Treasury and the IRS issued Notice 2015–79 to further limit 

the ability of U.S. companies to invert and to reduce the tax benefits of inversions. 

This most recent notice makes it more difficult for U.S. companies to undertake a 

corporate inversion by (1) limiting the ability of U.S. companies to combine with foreign entities using a new foreign parent located in a ‘‘third country;’’ (2) limiting 

the ability of U.S. companies to inflate the new foreign parent corporation’s size and 

therefore avoid the rule requiring minimum ownership of the combined firm by the 

shareholders of the foreign target entity; and (3) requiring the new foreign parent 

to be a tax resident of the country where the foreign parent is created or organized 

in order to take advantage of the substantial activity exception that permits an inversion into a country in which the inverted group has at least 25 percent of its 

worldwide business activities. Additionally, the notice reduces the tax benefits of inversions by limiting the ability of an inverted company to transfer its foreign operations to the new foreign parent after an inversion transaction. 

Treasury will continue to examine additional ways to reduce the tax benefits of 

inversions, including through limiting the ability of inverted companies to strip 

earnings with intercompany debt. However, only legislation can effectively address 

these issues. To this point, we look forward to working with Congress in a bipartisan manner to protect the U.S. tax base, to address the issue of corporate inversions, and to reform our business tax system. 

53 

STATE AID INVESTIGATION

In June 2014, the European Commission opened three in-depth investigations to 

examine whether decisions by tax authorities in Ireland, the Netherlands, and Luxembourg with regard to the corporate income tax paid by Apple, Starbucks, and Fiat 

Finance and Trade, respectively, complied with the EU rules on state aid. In October 2014, the EU announced that it had also opened an in-depth investigation into 

whether the decision by Luxembourg’s tax authorities with regard to the corporate 

income tax to be paid by Amazon complied with EU rules on state aid. On October 

21, 2015, the EU Commission announced its conclusions that Luxembourg has 

granted selective tax advantages to Fiat’s financing company and the Netherlands 

has granted selective tax advantages to Starbucks’s coffee roasting company. Finally, press reports have explained that tax rulings given to several other U.S. companies are also being examined by the EU Commission. In the area of state aid, 

as I understand it, the remedy is for the Commission to require the member state 

to collect the amount of income tax that, in the Commission’s view, should have 

been imposed in the first place. State aid rulings can go back and reexamine up to 

10 years of prior conduct. 

Treasury has followed the state aid cases closely for a number of reasons. First, 

we are concerned that the EU Commission appears to be disproportionately targeting U.S. companies. Second, these actions potentially undermine our rights under 

our tax treaties. The United States has a network of income tax treaties with the 

member states and has no income tax treaty with the EU because income tax is 

a matter of member state competence under EU law. While these cases are being 

billed as cases of illegal state subsidies under EU law (state aid), we are concerned 

that the EU Commission is in effect telling member states how they should have 

applied their own tax laws over a 10-year period. Plainly, the assertion of such 

broad power with respect to an income tax matter calls into question the finality 

of U.S. taxpayers’ dealings with member states, as well as the U.S. Government’s 

treaties with member states in the area of income taxation. Third, the EU Commission is taking a novel approach to the state aid issue; yet, they have chosen to apply 

this new approach retroactively rather than only prospectively. While in the 

Starbucks case, the sums were relatively modest (20 to 30 million Euros), they may 

be substantially larger—perhaps in the billions—in other cases. The retroactive application of a novel interpretation of EU law calls into question the basic fairness 

of the proceedings. Fourth, while the IRS and Treasury have not yet analyzed the 

equally novel foreign tax credit issues raised by these cases, it is possible that the 

settlement payments ultimately could be determined to give rise to creditable foreign taxes. If so, U.S. taxpayers would wind up footing the bill for these state aid 

settlements when the affected U.S. taxpayers either repatriate amounts voluntarily 

or Congress requires a deemed repatriation as part of tax reform (and less U.S. 

taxes are paid on the repatriated amounts as a result of the higher creditable foreign income taxes). 

Finally, and this relates to the EU’s apparent substantive position in these cases, 

we are greatly concerned that the EU Commission is reaching out to tax income 

that no member state had the right to tax under internationally accepted standards. 

Rather, from all appearances they are seeking to tax the income of U.S. multinational enterprises that, under current U.S. tax rules, is deferred until such time 

as the amounts are repatriated to the United States. The mere fact that the U.S. 

system has left these amounts untaxed until repatriated does not provide under 

international tax standards a right for another jurisdiction to tax those amounts. 

We will continue to monitor these cases closely. 

CONCLUSION

Chairman Hatch, Ranking Member Wyden, and distinguished members of the 

committee, let me conclude by thanking you for the opportunity to appear before the 

committee to discuss the administration’s work on various international tax matters. We appreciate the committee’s continuing interest in the BEPS Project, international tax reform, inversions, State Aid, and other matters. On behalf of the administration, that concludes my testimony, and I would be happy to answer any 

questions. 

54 

QUESTIONS SUBMITTED FOR THE RECORD TO ROBERT B. STACK

QUESTIONS SUBMITTED BY HON. ORRIN G. HATCH

MASTER FILE REPORTING AND CONFIDENTIALITY

Question. There are concerns about taxpayer confidentiality in the Master File reports. Treasury officials have suggested that those concerns have been addressed because taxpayers have discretion over what they put in the Master File. 

But there must be some limits to that discretion, right? To what extent will companies have discretion over what goes into the master file? Foreign countries may 

very well ask for items that taxpayers will wish to keep secret, right? 

And what are other OECD countries thinking as to the amount of discretion to 

be allowed here? What recourse does a company have if the foreign tax authority 

disagrees with the company’s judgment and demands sensitive information on audit 

or imposes a fine for non-compliance? 

Could a non-public company exclude from the master file consolidated financial 

statements or a global organizational chart if in its ‘‘prudent business judgment’’ 

that information goes beyond the ‘‘appropriate level of detail’’ and does not ‘‘affect 

the reliability of transfer pricing outcomes’’? 

The Treasury Department has indicated that other countries can collect the Master File directly from multinational corporations, rather than going through the 

more typical information exchange process whereby foreign governments would ask 

the U.S. government for such Master Files on a given taxpayer. 

Answer. The purpose of the so-called ‘‘master file’’ is to provide context to the 

more detailed information on the taxpayer, including financial information, provided 

in the country-by-country (CbC) report and the local file. Apart from specific documents requested as part of the master file, such as consolidated financial statements 

and a global organizational chart, taxpayers have complete discretion to provide this 

important contextual information in the way that they think best. We think that 

taxpayers are in the best position to balance the desire to protect sensitive information with the need to provide relevant information to tax authorities, and this concept lies at the heart of the work. The BEPS report on transfer pricing documentation specifically explains that ‘‘taxpayers should use prudent business judgment in 

determining the appropriate level of detail for the information supplied, keeping in 

mind the objective of the master file to provide tax administrations a high-level 

overview of the MNE’s (multinational enterprise’s) global operations and policies.’’ 

The reference to ‘‘prudent business judgment’’ is intended to highlight to taxpayers 

and to revenue authorities that this is inherently a cost/benefit exercise: maintaining the balance between taxpayer compliance burden and confidentiality concerns 

and the provision of truly useful information. During the course of the work, Treasury representatives focused on maintaining such a balance. 

It should be noted that foreign countries have always had and continue to have 

under their own domestic laws the ability to ask for information from entities doing 

business in their country in order to enforce their tax laws. Those countries also 

have had and will continue to have the ability to impose fines on taxpayers who 

do not supply requested information (presumably after the exhaustion of local administrative and judicial processes). The master file component of the new guidelines on transfer pricing documentation does not alter those domestic laws, nor 

could it be expected to do so. The transfer pricing documentation work, taken as 

a whole, had the goal of bringing increased harmonization to transfer pricing documentation requirements in order to improve the information collected and to minimize the burden on business that would result if each country set its own documentation requirements. 

Question. What should the U.S. Government do if a foreign government fails to 

keep a U.S. multinational corporation’s master file confidential? 

Please explain the reason for that. Does that heighten confidentiality concerns? 

Would there be greater protection of U.S. taxpayer confidentiality if the U.S. Government were the gatekeeper to this information? 

Does the U.S. Government anticipate requiring foreign-based multinational corporations to file a master-file report with the IRS? 

Answer. The United States cannot prevent foreign governments from requesting 

the master file information directly from subsidiaries of U.S. multinational groups, 

55 

a capability these governments have always had. The work at the OECD was aimed 

at helping minimize burden on taxpayers by achieving international agreement on 

a single uniform document that would be acceptable to all participating G20/OECD 

jurisdictions. If the U.S. had insisted that this information be presented by U.S.- 

based firms first to the IRS and then shared via treaties and tax information exchange agreements, it is not clear that we would have achieved the goal of standardization and burden reduction desired by U.S. taxpayers. 

If a foreign government fails to protect the confidentiality of a U.S. multinational 

group’s master file, the U.S. Government may raise that issue directly with the foreign government and take the issue into account in its assessment of the suitability 

of the foreign country’s data-protection safeguards for country-by-country reporting 

and other exchange-of-information programs. 

At this time, the Treasury Department does not have plans to modify existing 

U.S. transfer pricing documentation regulations applicable to foreign-based multinational corporations, which request much of the same information as the master 

file requests, but will consider doing so in the course of our continuing evaluation 

of our regulations and reporting requirements. 

COUNTRY-BY-COUNTRY REPORTING

Question. Does the Treasury Department have the authority to issue regulations 

as called for by the BEPS reports as to country-by-country reporting? If so, how will 

the country-by-country reports assist the U.S. Government in the collection of U.S. 

income taxes? 

Answer. The Treasury Department has authority under sections 6001, 6011, 6012, 

6031, 6038, and 7805 of the Tax Code to issue final regulations consistent with the 

proposed regulations published on December 23, 2015. The information that would 

be provided under the proposed regulations will assist in better enforcement of the 

Federal income tax laws by providing the IRS with greater insight into the operations and tax positions taken by U.S. multinational groups. In particular, it is expected that the information will improve transparency and help the IRS perform 

high-level transfer pricing risk identification and assessment. 

Question. Could you please tell us more about how the IRS will use the information from the country-by-country reports? Specifically, does Treasury plan on following the BEPS Action 13 report in terms of who must file (i.e., those multinationals with group revenue in excess of 750 million euros) and the information 

that is to be included in the report (i.e., income, taxes paid, etc.)? If not, what additions or changes should taxpayers expect in terms of the reporting requirements? 

Is Treasury considering making the reporting requirement effective for taxable 

years beginning in 2016? If so, when would the reporting be provided to the IRS 

and Treasury? By the extended due for the tax return for the applicable tax year? 

When would the first CbC reports be shared with foreign governments? 

Do Treasury and the IRS currently plan on requesting CbC reports from foreign 

governments? What is the criteria that Treasury and the IRS plan on utilizing in 

making the determination of what CbC reports they want to obtain? Do Treasury 

and the IRS currently have a plan of action for analyzing and utilizing the data they 

may obtain from CbC reports? 

It appears that Treasury agreed to provide foreign governments with a significant 

amount of information on U.S. multinationals via the CbC report, as well as agreeing to allow foreign governments to directly obtain master file and local file information from local subsidiaries of U.S. multinationals. What is Treasury getting in return, particularly if it may not obtain master file or local file information from local 

subsidiaries of foreign multinationals and if CbC reports provided by foreign governments are not effectively utilized? 

Answer. The Treasury Department issued proposed regulations to implement 

country-by-country (CbC) reporting on December 23, 2015. Those regulations do, in 

general, follow the BEPS Action 13 report in terms of filing threshold and information included in the report. Specifically, a U.S. MNE group does not have to file a 

CbC report if the group has revenues of less than $850 million. The information to 

be reported includes: (i) revenues generated from transactions with other constituent entities of the U.S. MNE group; (ii) revenues not generated from transactions with other constituent entities of the U.S. MNE group; (iii) profit or loss before income tax; (iv) income tax paid on a cash basis to all tax jurisdictions, including any taxes withheld on payment received; (v) accrued tax expense recorded on 

56 

taxable profits or losses, reflecting only the operations in the relevant annual accounting period and excluding deferred taxes or provisions for uncertain tax positions; (vi) stated capital; (vii) accumulated earnings; (viii) number of employees on 

a full-time equivalent basis; and (ix) net book value of tangible assets other than 

cash or cash equivalents. 

The regulations incorporating the CbC reporting requirement are proposed to be 

applicable to taxable years of ultimate parent entities of U.S. MNE groups that 

begin on or after the date of publication of the final regulations. As a practical matter, this will mean that for most U.S. taxpayers the CbC reporting requirement will 

be effective for taxable years beginning in 2017. The regulations require the CbC 

report to be filed with the U.S. MNE group’s tax return, on or before the extended 

due date of that return. 

CbC reports generally will be provided to foreign countries with which the United 

States has a treaty or tax information exchange agreement within 15 months of the 

end of the fiscal year to which the CbC report relates. For example, a CbC report 

for the year ending on December 31, 2017, will be filed with the U.S. corporate parent’s tax return on or before September 15, 2018 (the due date for returns with extensions to file), and will be provided to foreign countries before March 31, 2019. 

Likewise, foreign countries generally will provide foreign CbC reports to the IRS 

within 15 months of the end of the fiscal year to which the CbC report relates. Importantly, CbC reports will only be provided to foreign countries in which one or 

more members of the U.S. MNE group carry on a business that is subject to tax 

and only if the foreign country has agreed to provide the United States with CbC 

reports filed in that foreign country by foreign MNE groups that have operations 

in the United States. Treasury plans to enter into Competent Authority Arrangements that will require foreign countries with which the United States has an exchange of information agreement to automatically provide the IRS with CbC reports 

that are filed by all foreign MNE groups that carry on a business in the United 

States. 

The IRS plans to use the data provided by CbC reports in high-level transfer pricing risk assessment. The CbC reports will provide the IRS with information related 

to the MNE group’s income and taxes paid, together with indicators of the location 

of economic activity within the MNE group on a country-by-country basis. This information, along with other transfer pricing documentation provided by the MNE 

group, will aid in the identification of transfer pricing practices that may warrant 

further inquiry, resulting in more efficient use of IRS examination resources. 

By agreeing to provide CbC reports to foreign countries pursuant to exchange of 

information agreements, Treasury secured several benefits for U.S. MNE groups 

and tax administration in the United States. It is important to note that foreign 

countries already have the right to ask U.S. MNE groups to provide, at a minimum, 

the CbC information, master file information, and local file information. In agreeing 

to the Action 13 standards, particularly with respect to CbC reporting, these countries have effectively agreed not to exercise their right to require additional information, such as transactional data on intercompany royalties and intercompany service 

fees, as part of the standard reporting package. The model CbC reporting template 

reflects an agreed international standard for reporting that will promote consistency 

of reporting obligations across tax jurisdictions and reduce the risk that countries 

will depart from the agreed standard by imposing inconsistent and overlapping reporting obligations. This will reduce compliance costs of U.S. MNE groups. In addition, the IRS will receive CbC reports that will be useful in evaluating the compliance risk associated with transfer pricing practices of both U.S. MNE groups and 

foreign MNE groups conducting business in the United States, thereby enhancing 

the efficient use of IRS examination resources. In sum, Treasury limited the reporting burdens of U.S. MNE groups and provided the IRS with a useful tool for the 

efficient risk assessment of transfer pricing practices of U.S. and foreign MNE 

groups. 

SENATE ADVICE AND CONSENT TO MULTILATERAL INSTRUMENT

Question. BEPS Action 15 envisions a multilateral process to come up with a multilateral instrument to allow for numerous tax treaties to be amended in one fell 

swoop, rather than having the world’s network of tax treaties be renegotiated in 

thousands of bilateral tax treaty negotiations. I understand the U.S. Treasury is 

participating in this process. 

Please tell us what you envision the U.S. Treasury’s negotiating posture to be as 

to this multilateral instrument? Please confirm that any multilateral instrument 

57 

that the U.S. signs on to would need the Senate’s Advice and Consent in order to 

become ratified and effective. 

Answer. The multilateral instrument discussions will generally be limited to negotiations on the different treaty provisions recommended as a part of the BEPS 

project. Given that most U.S. tax treaties already contain most of the treaty provisions that are part of the BEPS minimum standard, theTreasury Department will 

have to determine if signing the multilateral instrument, or agreeing to particular 

provisions in it, will on balance be beneficial to the United States. 

The multilateral instrument is a treaty instrument and as such, if the United 

States becomes a signatory, the instrument would require the advice and consent 

of the Senate. 

QUESTIONS SUBMITTED BY HON. DEAN HELLER

Question. I strongly believe that tax reform, done the right way, can improve our 

fiscal picture. That said, without comprehensive tax reform, we are left with a crumbling tax code that negatively impacts our American and Nevadan businesses, while 

our other OECD partners are lowering their corporate tax rates and expanding their 

tax base. I am deeply concerned that U.S. multinational companies are being targeted and that the administration is not taking steps to defend our U.S. businesses. 

Will you fight to protect U.S. businesses from targeting? ‘‘Yes’’ or ‘‘No.’’ 

Answer. Yes. 

Question. Does the U.S. have any legal authority to fight these rulings on behalf 

of U.S. multinationals? 

Answer. The U.S. Government may have a sufficient stake in the outcome of these 

cases such that it can intervene in any or all of these cases when and if they are 

appealed, either to the European General Court, or subsequently to the European 

Court of Justice. 

Question. As you know, the OECD BEPS plan generally can’t force member governments to do anything they don’t want to do. Does BEPS strengthen the EU Commission’s hand by providing political cover? 

Answer. The G20/OECD BEPS project has heightened awareness of techniques 

used by multinationals to minimize their tax bills. It is my view that this general 

awareness has influenced efforts in Europe and elsewhere to constrain the use of 

these practices. 

Question. Can you explain the process for how the EU Commission determines if 

a case is deemed state aid? 

Answer. The Commission’s antitrust (competition) authorities are investigating 

tax arrangements between EU member states and multinational firms. These investigations are meant to examine whether the tax authorities of specific countries 

have entered into special arrangements with individualfirms to provide tax benefits 

that are unavailable to competitor firms and thus constitute impermissible state aid 

under EU competition rules. 

It is my understanding that the EU’s state aid rules are aimed at member state 

policies that favor one business or sector over another, and typically come into play 

when states give subsidies to businesses or sectors to the detriment of other businesses or sectors. Demonstrating ‘‘selectivity’’ is the key to a showing of improper 

state aid. In tax cases, the Commission typically establishes, first, the general rules 

and practices that apply to similarly situated taxpayers in a country and, second, 

that the practice or law in question deviates from that framework in a material way 

(commonly referred to as ‘‘selectivity’’ or ‘‘selective benefit’’). This might occur, for 

example, if one company obtained a ruling that a similarly situated company was 

unable to obtain, or, more broadly, where a specific industry obtained rulings that 

other industries could not obtain. 

Question. I am deeply concerned with recent reports, as I am sure you are, that 

these EU state aid cases will lead to retroactive foreign tax increases on U.S. companies. Does it make sense that if the Commission finds that a country has violated 

its obligations to the EU that the company should be held liable retroactively? 

Answer. As I understand it there are well-grounded ways in which state aid law 

could be, and has been, applied to tax rules. However, to our knowledge, the Commission has never before examined determinations by member state tax authorities 

58 

regarding the application of their tax laws (as opposed to examining the laws/rules 

themselves) in particular cases without finding that a specific benefit was given to 

specific taxpayers that was not available to similarly situated taxpayers. In the current cases, our understanding is that there is no allegation that the countries involved gave special deals to these companies that were not available to similarly situated companies that engaged in cross border transactions. Rather, the theory of 

selectivity appears to be that the rulings would be available only to companies with 

affiliate dealings (for which transfer pricing is set by tax rules), but would not be 

available to firms without affiliates (for which the market sets prices). It is this latter theory of selectivity that is novel. Given that the theory is novel and could not 

have been anticipated by the firms and Member states involved in the ruling process, it seems unfair to apply it on a retroactive basis. 

Question. These back-door tax increases on American companies could also result 

in American taxpayers footing the bill through foreign tax credits. Does the Treasury have any plans to address this? 

Answer. We have not yet analyzed whether the resulting payments to be made 

by companies as a result of the state aid investigations are creditable foreign taxes 

and whether they would generate foreign tax credits that could be used by the affected firms. 

Question. As you may know, this committee is dedicated to overhauling the tax 

code. Earlier this year the committee held tax reform hearings analyzing simplicity, 

fairness, growth and international competitiveness. As this committee discusses 

overhauling the tax code, including international tax reform, what is the single biggest element that lawmakers can implement to promote pro-growth international 

competiveness? 

Answer. Reducing the Federal corporate income tax rate by broadening the tax 

base, as outlined in the President’s Framework for Business Tax Reform (an updated version of which the administration released in April) and implementing the 

international tax reform proposals outlined in the administration’s FY 2017 budget, 

would promote growth and the competitiveness of U.S. businesses, including U.S.- 

based multinational corporations as well as domestic and small businesses. 

Question. I am here to help. How can Congress protect U.S. businesses from being 

targeted by foreign governments? 

Answer. Enacting comprehensive business tax reform that includes measures such 

as a minimum tax on low-taxed excess returns earned abroad would help by eliminating the income that other countries regard as ‘‘stateless income’’ and try to tax. 

The President’s Framework for Business Tax Reform and the FY 2017 Budget submission provide more detail on desirable tax policies in this area. 

Question. I am deeply concerned with the EU Commission’s determination of 

whether a measure constitutes state aid. Specifically, that state aid is determined 

based on its effects, not its objectives. Would that mean that all tax rulings that 

include an element of negotiation be deemed state aid in the future? 

Answer. The Commission’s position as to when interactions between a company 

and a member state concerning tax issues might or might not constitute state aid 

is unclear, so it is difficult to draw a conclusion as to their view of the scope of their 

authority. 

Question. In what ways did the Treasury consult Congress as the BEPS plan was 

taking shape? 

Answer. I briefed interested staff members at various times, answered questions, 

and welcomed comments. 

Question. If nothing is legally binding in the BEPS process, why has the Treasury 

decided to implement country-by-country reporting? 

Answer. The Treasury Department has determined that the information that 

would be required under the proposed regulations published on December 23, 2015, 

will assist in better enforcement of the Federal income tax laws by providing the 

IRS with greater insight into the operations and tax positions taken by U.S. multinational groups. Country-by-country reporting also assists U.S. businesses by harmonizing transfer pricing documentation across jurisdictions around the world, 

thereby reducing compliance costs. 

59 

QUESTION SUBMITTED BY HON. PAT ROBERTS

Question. Mr. Stack, Interest-Charge Domestic International Sales Corporations 

(‘‘IC–DISCs’’) are important vehicles that enable small businesses to reach foreign 

markets. I understand that farmers and farmer cooperatives are eligible to use IC– 

DISCs to facilitate the export sale of agricultural product grown by farmers and cooperative members. However, guidance is needed to clarify how the accounting rules 

applicable to farmer cooperatives under subchapter T of the Internal Revenue Code 

interact with the IC–DISC rules. Without such clarity, cooperatives may not go forward with IC–DISCs, hindering the ability for farmers to efficiently reach export 

markets. I understand that the IRS may not have the resources to issue private letter rulings to all cooperatives seeking to form IC–DISCs. I believe that Treasury 

could and should issue formal guidance clarifying these issues. Properly drafted 

guidance would remove uncertainty in this area, provide uniform treatment among 

similarly situated taxpayers, and ensure that farmers can avail themselves of the 

benefits Congress intended in enacting the IC–DISC rules. 

Thank you for your attention to this matter. I respectfully request that Treasury 

and the IRS add a guidance project on the next quarterly revision of your Priority 

Guidance Plan to address these issues, and would appreciate a response to this request beforehand. 

Answer. Thank you for highlighting this issue encountered by farmers and farmer 

cooperatives. We have in fact met with representatives of these taxpayers to discuss 

the questions that you describe regarding how the accounting rules applicable to 

farmer cooperatives under subchapter T of the Internal Revenue Code interact with 

the IC–DISC rules, and we can appreciate the need for guidance in this area. As 

you noted, the IRS has limited resources. In this regard, Treasury and IRS have 

to make difficult decisions regarding which formal guidance is needed most within 

the next plan year. We will take your views into account when making these determinations. 

QUESTIONS SUBMITTED BY HON. MICHAEL B. ENZI

Question. The EU state aid cases are targeting multinationals—predominantly 

U.S. multinationals. Based on its announcement of the first two decisions last 

month, the Commission believes the investigated countries as providing multinationals unfair competitive advantages over smaller domestic competitors through 

tax rulings that ‘‘do not reflect economic reality.’’ We haven’t seen the legal analysis 

of these cases yet, but if these are the standards that are being applied, do you 

agree that the decisions should not produce results that actually disadvantage integrated multinationals and that do reflect economic reality? 

Isn’t the arm’s length principle the internationally accepted mechanism that 

strikes that balance? 

Answer. Yes. The arm’s length principle is the internationally accepted mechanism for cross-border transactions that strikes the balance. The concern is whether 

the EU Commission will reach the same interpretation of the arm’s length standard 

that the member state did when it initially granted the multinational the ruling in 

question, and whether taxpayers were on notice that the Commission might be reviewing member country transfer pricing rulings well after they were issued. If taxpayers were not aware that the Commission would be reviewing transfer pricing rulings for their adherence to the arm’s length standard then it seems unfair to impose 

substantial retroactive payments on them. 

Question. Regarding the EU state aid cases, what do these cases mean for our 

ability to rely on bilateral tax treaties negotiated with European countries if the European Commission can unilaterally change a treaty partner’s tax positions through 

enforcement of EU competition policy? 

Answer. We are concerned that the European Commission’s broad new assertion 

of authority in tax matters if applied to cases directly between a U.S. entity and 

an EU entity would undermine our ability to rely on our treaties with member 

states, in particular our ability to utilize the mutual agreement procedures. 

Question. Does the U.S. have any rights under the treaty to protect U.S. tax interests while ensuring U.S. multinationals are not subject to double taxation because 

of the EU state aid decisions? 

60 

Answer. None of the current cases we are aware of have yet to implicate a treaty 

issue between the U.S. and a member state. 

Question. We’ve all heard how BEPS threatens the U.S. tax base because its general policy objective is to align taxing rights with value creating activities. While 

BEPS represents prospective tax policy changes, and the U.S. at least had a seat 

at the table, the EU state aid cases represent EU assertion of retroactive taxing 

rights over the historical foreign earnings of U.S. multinationals, with the U.S. Government unable to participate. 

Do you view the EU state aid cases as an attempt by the EU to unilaterally and 

retrospectively attack the ‘‘stateless income’’ issue that the BEPS project was designed to address on a multilateral and prospective basis? 

Answer. Yes, and done on a retroactive basis. 

Question. If the cases result in a single member state collecting tax on virtually 

all of the income, without regard to the level of economic activity within that state, 

wouldn’t that actually contradict the underlying premise of the BEPS project—to 

align taxing rights with underlying value-creating activity? 

With respect to income from intangible property, isn’t it true that a significant 

portion of this value-creating activity is likely to have taken place in the U.S., giving 

the U.S. primary taxing rights, on a deferred basis or otherwise? 

Answer. To us, ‘‘aligning taxing rights with underlying value-creating activity’’ is 

another term for ‘‘appropriately remunerating functions, assets, and risks under the 

arm’s length principle.’’ Under our domestic law and the OECD transfer pricing 

guidelines (which all EU countries embrace), all contributions of value must be appropriately remunerated. Accordingly, if a single member state collects tax on virtually all of the firm’s income regardless of the amount of economic activity that occurs in the state that may imply that important contributions to value are not being 

considered, which would reflect a contradiction of the underlying premise of the 

BEPS project. 

While it is difficult to comment in the absence of specific facts, we agree that quite 

often a critically important value-creating activity with respect to intangible assets 

or intellectual property is R&D activities, and that these activities often take place 

in the U.S. 

QUESTIONS SUBMITTED BY HON. RON WYDEN

Question. Regarding the EU state aid cases, I am concerned about the implications for our tax treaty policy when it comes to members of the EU. 

What do these cases mean for our ability to rely on bilateral tax treaties negotiated with European countries if the European Commission can unilaterally change 

a treaty partner’s tax positions through enforcement of EU competition policy? 

Answer. We are concerned that the European Commission’s broad new assertion 

of authority in tax matters if applied to cases directly between a U.S. entity and 

an EU entity would undermine our ability to rely on our treaties with member 

states, in particular our ability to utilize the mutual agreement procedures. 

Question. Does the U.S. have any rights under the treaty to protect U.S. tax interests while ensuring U.S. multinationals are not subject to double taxation because 

of the EU state aid decisions? 

Answer. None of the current cases we are aware of have yet to implicate a treaty 

issue between the U.S. and a member state. 

Question. How can Congress protect U.S. taxpayers and help ensure that Europe 

does not retroactively impose a back-door tax on these earnings? 

Answer. If Congress were to deny a foreign tax credit for amounts recovered 

under the State Aid rules, U.S. taxpayers as a whole would not be at risk of footing 

the bill for amounts imposed by the EU Commission in these cases. However, the 

U.S. MNE would be required to make the payment, disadvantaging this U.S.-based 

firm. 

61 

QUESTIONS SUBMITTED BY HON. THOMAS R. CARPER

Question. Following up on a question during the hearing, I’d like to ask about the 

timeline for ratification of the BEPS Action on permanent establishment (PE). It’s 

admirable how quickly the BEPS process has moved forward; it’s rare for a multilateral negotiation to successfully develop and come to (general) agreement around a 

comprehensive set of recommendations—or at the very least, options—within just a 

couple years. 

However, I have concerns that the speed of the BEPS process may not leave sufficient time for even the most diligent and prescient taxpayers to adjust and build 

the accounting systems needed to comply with new PE proposal. 

Mr. Stack, can you give us a reasonable estimate as to when other countries will 

ratify the BEPS multilateral instrument regarding permanent establishment? What 

do you think is a reasonable effective date? 

Answer. The work on the multilateral instrument is supposed to be complete at 

the end of 2016, and assuming that the timeline is met, we may expect that some 

countries would be in a position to sign and ratify the instrument in 2017. It is common practice among countries to make the text of a tax treaty available when the 

agreement is signed. This public release of a signed tax treaty before it enters into 

force can serve as a helpful advance notice to taxpayers of the terms of the treaty 

before it enters into force. Further, it is common for treaty provisions to take effect 

for the taxable periods beginning on or after the first day of the year following the 

date on which the convention enters into force. 

Question. Will taxpayers given a reasonable amount of time to create the necessary accounting systems (and possibly inventory systems) to comply? 

Answer. At this time the Treasury Department has not decided whether to include most of the new permanent establishment provisions into U.S. tax treaties, 

or to agree to the multilateral convention provisions relating to permanent establishment. Unfortunately, we cannot speak to how or if other countries that seek to 

adopt the new permanent establishment rules will permit transition periods to allow 

taxpayer to create any necessary accounting or inventory systems. 

Question. The BEPS changes regarding permanent establishments will trigger a 

permanent establishment based on a person ‘‘habitually playing the principal role 

leading to conclusion of contracts that are routinely concluded without material 

modification by the enterprise.’’ The commentary further indicates that this principal role will ‘‘typically be associated with the actions of the person who convinced 

the party to enter into a contract.’’ 

Mr. Stack, does this trigger a permanent establishment even if the sales person 

has no authority to modify a contract and does not even participate in conclusion 

of a contract that is done online? 

Answer. Permanent establishment determinations are fact intensive. We would 

need to determine what type of activities are performed by the sales person in your 

example and whether such sales solicitation activities play the principal role leading 

to the conclusion of contracts that are routinely concluded without material modification by the enterprise. If, for example, the sales activities are merely providing 

marketing and promotional services, such activities would not directly result in the 

conclusion of contracts on behalf of the enterprise. See also bottom of paragraph 

32.5 of the Commentary to Article 5(5) of the OECD Model Tax Convention. 

Question. I have concerns about how clear a standard we are talking about when 

discussing who may or may not have ‘‘convinced the party to enter into a contract.’’ 

What about a case in which a seller of a good or service is already well known prior 

to any customer contact? Or alternatively, what about a situation in which the principal contributing factor was a positive recommendation by an unrelated third 

party? Can you outline for us your concerns you have that this standard might leave 

taxpayers unclear on whether they have any genuine taxable presence or permanent 

establishment? If so, what actions should be taken, going forward, to provide more 

clarity and certainty? 

Answer. Throughout the development of the new tax treaty provisions, in particular the development of the so-called ‘‘principal purpose test’’ to combat treaty 

shopping and the new permanent establishment provisions, the Treasury Department has stressed our concern that any new treaty provisions be as clear as possible, because ambiguous or unclear rules are likely to lead to disputes between taxpayers and the revenue authorities. The lack of certainty in the application of the 

62 

principal purpose test is a primary reason why the Treasury Department (in concurrence with the views of the Senate) rejects the inclusion of such a rule in U.S. tax 

treaties. The Treasury Department is interested in developing ways to mitigate the 

compliance burdens that the new permanent establishment rules could create, and 

to facilitate the resolution of any disputes of interpretation, perhaps by coupling 

such rules with mandatory binding arbitration. 

(63) 

COMMUNICATIONS

BUSINESS AND INDUSTRY ADVISORY COMMITTEE TO THE OECD 

13–15 Chausse ́e De La Muette, 75016, Paris, France 

Tel: + 33 (0) 1 42 30 09 85 

Fax: + 33 (0) 1 42 88 78 38 

Position Paper on the Organisation for Economic Co-Operation and Development’s Project on Base Erosion and Profit Shifting 

Submitted to The United States Senate Committee on Finance 

In relation to Full Committee Hearing: International Tax: OECD BEPS and EU 

State Aid 

Date 3 December 2015 

BIAC has been supportive of the OECD’s Base Erosion and Profit Shifting 

(‘‘BEPS’’) project since its inception and has provided constructive and detailed input from the international business community in response to all 

discussion drafts. Although we value the openness of the consultation processes and acknowledge the efforts of OECD and G20 member governments 

and the OECD Secretariat, we are anxious that some serious business concerns have not been sufficiently considered or addressed. 

At the March 2015 meeting of the BIAC Tax Committee, a substantial number of 

member organizations expressed concerns over the direction of certain aspects of the 

BEPS project, and the potential significant negative economic consequences of several Action Items, and it was agreed to set those out in a short document. This document has been updated following the release of the OECD’s final reports in October 

2015. We would reiterate, despite the concerns noted below, that we want the BEPS 

project to succeed. We will continue to approach this project—both before and after 

the adoption of the recommendations by the G20—in a constructive, flexible and incremental way as we believe this is the best way of achieving that success. We call 

on the OECD to continue to include us in the completion of outstanding work, and 

the development and implementation of the G20 proposed framework for implementation. 

General Comments 

Many of the concerns identified in this Position Paper are common across the range 

of Action Items. We feel they are worth repeating up front as their importance continues to grow as the follow-up and implementation work commences. 

Economic Impact: There is great concern that the economic consequences of the 

recommendations have not yet been fully considered. Countries should be undertaking realistic assessments of the tax revenues they may be due under the consensus reached, rather than assuming that implementation will bring additional tax 

revenues. The possibility should be understood that overly strict regulation could 

force economic activity out of countries. Countries should not rush to implement proposals with such aims in mind when the actual impact on their tax revenues has 

not been determined—this could undermine the BEPS process and bring about unintended economic implications. Although uncertainty, double taxation, disputes and 

compliance burdens are a focus of business, we are also concerned about the broader 

economic impact, which may include, for example, the impact on the efficiency of 

markets, or the sustainability of certain legitimate non-tax driven commercial transactions and structures (for example, cross-border infrastructure projects or 

regionalisation of certain functions to improve quality and efficiency). We believe 

that the justified targeting of BEPS activities must be integrated with larger ecoVerDate Mar 15 2010 17:20 Oct 17, 2016 Jkt 000000 PO 00000 Frm 00067 Fmt 6601 Sfmt 6621 R:\DOCS\22145.000 TIMD
64 

nomic concerns related to creating jobs and growth through cross-border trade and 

investment. 

Complexity and Compliance: In a number of areas, the BEPS Action Plan proposes substantially new and complex rules to tackle avoidance. Given the pressures 

of the ambitious timeframe, there have been very few opportunities to explore how 

these complex proposals can be adopted and implemented on an international basis. 

Both tax authorities and businesses will need detailed implementing guidance to ensure that the intention of each recommendation is clear. This will be critically important in ensuring that the recommendations are uniformly adopted, whilst avoiding overlaps. The challenges that will be brought about through the interaction of 

different timelines and domestic implementations should not be underestimated. 

They could lead to double taxation and a significant compliance burden on both 

businesses and tax authorities and create uncertainty that will delay necessary investments. We look forward to the OECD’s development of an inclusive framework 

to support and monitor the implementation (as proposed by the G20 Finance Ministers) to assist in maintaining international co-operation and as much consistency 

in timing and application as is possible. We would encourage the OECD to seek 

agreement from involved countries on effective dates after which new rules and 

guidelines will apply; even with the OECD’s work on Action 14, it will be very difficult to eliminate double taxation and would be inequitable if some tax authorities 

seek to revisit past years with new concepts and methodologies. 

Scoping: As part of the implementation framework, we believe it would be helpful 

to target the scope of each recommendation more narrowly to increase the chance 

of developing the necessary inter-governmental co-operation. At present, many proposals appear to go beyond the scope required to effectively target BEPS related activities. We strongly believe that ‘‘success’’ in the BEPS project would be achieved 

with a set of detailed, well-defined proposals that can be (and are) implemented consistently. Countries should be encouraged to avoid overly-broad implementation that 

could lead to a less uniform international tax regime. 

Timing: As well as the timing concerns raised above in relation to the potential economic impact and the potentially disjointed international adoption of the recommendations, we also have a more general timing concern that impatient countries 

and tax authorities may seek to commence full implementation of recommendations 

where it has been agreed that further work is required. For example, critically important work remains in relation to profit attribution to permanent establishments 

and specific rules in relation to financial services and insurance businesses. 

Reaching Consensus 

BIAC has strongly supported the OECD as the best organisation to deliver a successful consensus outcome under the BEPS mandate and recognises the phenomenal 

work that the OECD has done in brokering compromises and consensus wherever 

it has been possible. However, despite the OECD’s claims, we are concerned that 

in many instances it has proved difficult (and occasionally impossible) for member 

governments to reach consensus. This has resulted in a lack of clarity and a degree 

of ambiguity. For example, whilst the OECD has not recommended solutions regarding the ‘‘digital economy,’’ the door has been left open for countries to implement 

solutions unilaterally which, if implemented, could lead to double taxation. 

Understanding the Economic Impact 

It remains a matter of some regret that, owing to the political nature of the timetable, the BEPS project could not begin with a detailed economic analysis of the 

abuses identified in the Action Plan, including the scale and importance of ‘‘double 

non-taxation’’ and ‘‘tax competition.’’ We are concerned that the public announcements and discourse have been optimistic in terms of the amounts of additional tax 

that will be collected as a result of the BEPS recommendations, due in part to the 

conclusions reached in Action 11, and strengthened by the impression that the expectation of additional tax receipts was in some way a pre-requisite of reaching a 

broad consensus. Whilst we understand the public and political pressure surrounding the project elevated a need for consensus in agreeing that businesses 

should be taxed on all profits, most countries who have offered a public opinion on 

the matter seem to have assumed that the implementation of the proposals will increase their tax revenues substantially. 

In reality, depending on which of the proposals are introduced by themselves and/ 

or other countries, there could be many countries that do not receive additional tax 

revenues. There may be cases where overly strict regulation pushes economic activity out of some countries. If not dealt with by rigorous impact assessments both at 

65 

international and domestic levels, we are concerned that this expectations gap could 

lead to countries budgeting for higher tax revenues than they will receive. The resulting pressure could end in countries opting not to implement all of the proposals 

uniformly, an outcome that would result in double taxation and more pressure on 

individual tax authorities to aggressively audit taxpayers in an attempt to collect 

more tax rather than the right amount of tax based on the consensus agreed. A failure of the BEPS project in such a manner is not in the interests of business, governments or the public and will significantly increase the costs of tax administration 

and tax compliance. 

Complexity and Compliance Burden 

The BEPS recommendations are likely to create significant implementation difficulties and greater compliance burdens, not only for Multinational Enterprises (MNEs), 

but also governments—this is in part due to the substantial number of recommendations, but also their complexity and the different timelines that will need to be followed to implement them (for example, the adoption of revised OECD Guidelines 

into domestic law, or different processes for implementing domestic recommendations). Public and considered consultation and strong commitment by countries to 

work together (supported by the OECD’s implementation framework to be developed 

in 2016) are essential to avoid fragmentation. 

We would encourage the OECD to seek agreement from involved countries on effective dates after which new rules and guidelines will apply; even if the OECD’s work 

on Action 14 is successful in improving dispute resolution, it will be very difficult 

to eliminate double taxation and would be inequitable if some tax authorities seek 

to revisit past years with new concepts and methodologies. 

We support the OECD’s statement that VAT registrations should not create PEs, 

and we would encourage tax administrations to heed this and not assume that PEs 

exist where a company is registered for VAT (or vice versa), which would result in 

significant compliance burden. Other Action Items (for example, Actions 2, 3, 4, 7 

and 12) are also likely to require significant additional resource to ensure compliance with new, complex and sometimes contradictory rules. 

Discouragement of Related Party Trade 

Many of the BEPS Action Items apply only in an intra-group context and could significantly increase the cost of performing various functions or undertaking certain 

transactions inside a group of related companies. For example, the recommendations 

to lower the PE threshold and the complex new transfer pricing analyses that only 

apply to transactions between affiliates could greatly increase the compliance cost 

and tax liabilities associated with various intra-group activities. In some cases, taxpayers may, effectively, be forced to conduct business with third parties to mitigate 

excessive tax cost or uncertainty. This would reduce commercial and economic efficiencies and hamper international trade (as well as, quite possibly, lowering the 

wages and benefits in outsourced functions—especially in developing countries). We 

believe that these effects should be considered in greater detail and encourage additional guidance to be developed to provide greater certainty. 

Appropriate Resources for Tax Administrations 

Tax administrations already receive significant amounts of information that they 

often struggle to process. We are concerned that without additional resources, tax 

administrations will face difficulties in effectively using additional information and 

in dealing with the expected increase in requests for exchange of tax information 

between countries. It may actually become more difficult to identify risks, or to target abuse, to the advantage only of the most aggressive taxpayers. 

We believe a greater focus on tax administration would be beneficial—for example, 

through fully integrating the work of the Forum on Tax Administration—and the 

use of targeted risk-based measures. This could include materiality thresholds and 

other risk-identification tools to target higher risk taxpayers/issues that represent 

the most substantial sums of lost tax revenues. Such approaches reduce the burden 

on the vast majority of compliant taxpayers, freeing up resources for more productive, value-creating activities. Cooperative compliance also has an important role to 

play in this area. 

Multilateral Implementation 

The ultimate success of the BEPS project will be the multilateral implementation 

of specific, measurable, achievable and realistic recommendations on a timely basis. 

Whilst much work on implementation mechanisms is still to come throughout 2016; 

66 

we encourage early discussions on approaches to enhance credibility and likely success of the project. We make the following recommendations in this regard: 

• The G20 proposed engagement framework should be prepared and managed by 

the OECD Secretariat; • As a first step, all countries should agree to key principles to be followed in any 

domestic legislation used to enact BEPS proposals. Such principles could include that: 

Æ the policy objective should be clearly stated; Æ the policy objective should be consistent with the BEPS recommendation, 

and in particular, should be limited to addressing specific abuses; Æ draft legislation should be prospective in application and be published with 

a minimum period for detailed stakeholder consultation; and Æ an impact assessment should be prepared to evaluate any compliance burdens created. • We encourage the OECD to coordinate the implementation so that national 

measures have a reasonable degree of consistency. 

BEPS Action Item-Specific Comments 

Address the Tax Challenges of the Digital Economy (Action 1) 

We greatly welcomed the original 2014 report (Addressing the Tax Challenges of the 

Digital Economy), but we consider that the final 2015 report does not go far enough 

by recommending only that such countries are mindful of their treaty obligations 

until further review in 2020. There is concern amongst BIAC members that some 

countries are considering withholding taxes on digital transactions, and whilst the 

final report recognises that this is not recommended, it neither discourages such action nor identifies the treaty obligations and implications that such taxes could 

breach. Such unilateral action will certainly result in double or even multipletaxation unless there is a very clear and strong consensus as to how the profits of 

digital business transactions should be taxed. BIAC looks forward to participating 

in ongoing monitoring and evaluation characteristics of digital trade that may cause 

BEPS concerns. 

Neutralizing the Effects of Hybrid Mismatch Arrangements (Action 2) 

While we do not defend hybrid mismatches as a general policy matter, we do want 

to make three important points on the final report: 

• It is not clear which countries intend to implement any or all of the recommendations, when they plan to do so, or how the interaction with the local 

legislative processes will result in differences between countries in terms of application or timing. Implementation through a combination of complex changes 

to domestic laws, bilateral treaty provisions and potentially a multilateral instrument increases the uncertainty on timing further. We welcome the development of an inclusive monitoring framework in early 2016 to assist international 

cooperation but retain concerns in particular regarding the risk of double taxation, increased compliance burden, and uncertainty that will arise from countries implementing at different times. 

• Even if implemented in a coordinated manner, the complexity of the proposed 

rules will create substantial compliance difficulties, and will complicate the allocation of taxing rights between jurisdictions, increasing the risk of double taxation (e.g., the rules on ‘‘imported mismatches’’). The accompanying expanded 

examples may provide clarity on some issues, but at the price of still further 

complexity. 

• The financial services industry continues to be concerned that insufficient attention has been given to how the proposals will impact instruments deemed important by banking regulatory authorities for systemic liquidity. By relying on 

countries to opt not to tax such transactions at their discretion increases uncertainty and the risk of double taxation. 

Strengthen CFC Rules (Action 3) 

The broad nature of the OECD’s final CFC proposals illustrate the difficulty in 

reaching a consensus position on even the basic purpose of rules, with clear disagreements between governments over whether such rules should tackle profit shifting from the parent entity or foreign-to-foreign abuse. Without clear agreement over 

the underlying principles, the chances of delivering clear, proportionate and practical solutions were almost impossible. This was an opportunity missed to refine a 

useful tool, based on well-understood concepts of ‘‘active’’ and ‘‘passive’’ income in 

ways that could reduce dependence on subjective, fact-intensive enquiries while at 

the same time limiting the compliance burden and risk of double taxation. We urge 

67 

the OECD to consider CFC rules further when addressing any future BEPS concerns that the monitoring and analysis highlight. 

Limiting Base Erosion Via Interest Deductions and Other Financial Payments (Action 4) 

The final report on Action Item 4 will have serious implications for groups’ economic 

activity and their ability to obtain tax deductions for funding costs. The proposals 

have been made without a clear articulation of how they specifically target BEPS 

activities. The OECD’s proposals are likely to restrict interest deductions for a significant number of non-aggressive taxpayers, particularly those investing in infrastructure or long term projects where it remains unclear whether they would qualify 

for the proposed exemptions. The lack of support for the arm’s length principle in 

Action Item 4 also undermines legitimate commercial reasons for having intercompany debt. A group’s cash position and decisions on how to deploy cash should not 

be limited by rules that are not based on the arm’s length principle. 

However, given the options previously put forward in discussion drafts, we do welcome the broadening of the corridor approach to a range between 10 percent and 

30 percent of EBITDA and the relative simplicity it brings. However, this approach 

could have serious consequences if detailed work is not undertaken to determine appropriate ratios, taking into account the funding requirements of different industries. Where ratios are set too low, this could substantially raise the cost of capital 

for low-risk taxpayers undertaking commercial transactions. We are disappointed 

that the proposals do not recommend more strongly the elements of the proposals 

that would seek to limit double taxation, such as the ability to carry forward 

unutilised interest capacity (especially for start-ups and companies in loss-making 

positions) or give credit for all withholding taxes suffered. 

Additionally, we note that interest is the ‘‘raw material’’ for financial services businesses. Although a ‘‘net interest’’ approach is endorsed, it is important that the outstanding questions facing the financial services industry be resolved, particularly so 

that proposals do not contradict the regulatory agenda. 

Whilst we welcome the attention that the OECD plans to give to the group wide 

ratio rules, financial services and insurance industries 2016, we have serious concerns that so much work remains outstanding in this area at a time when countries 

are otherwise being encouraged to start implementing the rules. 

Prevent Treaty Abuse (Action 6) 

We are concerned that significant uncertainty remains as to whether treaty relief 

is available in ordinary commercial circumstances. This uncertainty risks undermining the usefulness of treaty networks in facilitating trade and promoting economic growth. Whilst we recognise that tax administrations require assurance that 

treaty benefits are only being granted in appropriate circumstances, anti-abuse 

rules should be applied in a proportionate and targeted manner. The existing provisions and Guidance could provide more clarity (e.g., low taxed branches with substance, calculation of head office tax rate). Broad disapplication of treaty benefits 

could create substantial withholding tax burdens and negatively impact cross-border 

trade. 

The final proposed minimum treaty standards are at the very least expected to create a significant compliance burden for taxpayers (especially where both a simplified 

LOB and a PPT rule are adopted in certain treaties), and will potentially bring into 

scope legitimate structures that ought to be entitled to treaty benefits. We remain 

concerned that: 

• Structures not involving treaty shopping may be unintentionally caught by 

broad rules. 

• There will be increased cross-border investor uncertainty, especially for pension 

fund investors and sovereign wealth funds, where the potential for tax treaty 

abuse is low. 

• Uncertainty for Collective Investment Vehicles (CIVs) will be unavoidable, and 

the time taken to receive repayments of tax deducted at source will impact the 

Net Asset Values of funds. 

• Source country tax authorities may experience additional demands to process 

an increased volume of reclaims, placing further pressure on already resource 

constrained administrations. 

Whilst we recognise that the OECD has further work to do regarding the commentary on LOB rules and the impact on non-CIVs and pension funds and welcome 

the OECD’s commitment to consult on such matters, we remain concerned that in 

68 

order for this to be taken into account as a meaningful component of the multilateral instrument negotiations, this work must be completed swiftly. 

Preventing the Artificial Avoidance of PE Status (Action 7) 

Whilst many of our members welcome the move away from the ambiguous language 

of the discussion draft that sought to establish a PE where persons ‘‘negotiated the 

material elements of contracts,’’ we are concerned that the final deliverables introduce new concepts that were not open to consultation and so retain ambiguity. 

Whilst we welcome the move to recommendations that a dependent agent PE is only 

established where a person ‘‘plays the principal role’’ in negotiating contracts, we 

urge the OECD to undertake additional consultation and provide tax authorities 

with additional guidance to clarify the meaning further. Similarly, the meanings of 

‘‘complementary functions that are part of a cohesive business operation’’ in relation 

to fragmentation and ‘‘at the disposal of’’ regarding fixed places of business should 

be more tightly defined to ensure consistency in implementation. 

It is disappointing that recommendations regarding PE thresholds have been released before the guidance that will follow on profit attribution. We are concerned 

that tax authorities will seek to establish the existence of PEs based on new concepts before providing business with any certainty regarding the attribution of profits to these newly defined PEs. For instance, the example of a PE being triggered 

by an agent who convinces customers to accept standard contracts without any authority to make deviations is very different to the previous definitions. Additionally, 

we would welcome the confirmation that PEs can be loss making. 

It is more disappointing still that the changes required to the OECD Model Treaty, 

OECD Guidance and domestic/multilateral implementation thereof will undoubtedly 

be disjointed, and we fear that some tax authorities may seek to apply the new concepts to open periods, which will cause considerable uncertainty and double taxation 

to arise. We urge the OECD to consider the impact of this as part of the implementation framework being developed and wait until there is a consistent understanding of the concepts before updating the Model Treaty and Guidance. 

Transfer Pricing (Actions 8–10) 

We have consistently acknowledged the need to update international tax rules on 

Transfer Pricing (TP), especially in relation to intangibles. However, aspects of 

BEPS project illustrate fundamental differences in opinions between countries over 

the Arm’s Length Principle (ALP) in TP and its continued viability. We are hesitant 

in agreeing with the OECD that the final report’s recommendations have been 

finalised without a departure from the ALP. 

We welcome the confirmation that where clear contractual arrangements exist that 

are supported by economic reality, then recharacterisation is not generally required. 

However, we are concerned about the complexity of the process, the level of detail 

required, and the consequences it will entail in the practical application. For example, the modifications do not clearly address the relevance of or extent to which (control and) performance of DEMPE functions and risk should contribute to calculating 

price under the ALP. These are not generally factors that are taken into account 

by unrelated parties. We welcome the reiteration that the most appropriate TP 

methodology should be used, and the OECD’s commitment to developing guidance 

on profit split methodologies. However, we note that with this work expected to remain incomplete until 2017, a significant period of uncertainty remains, which will 

cause considerable uncertainty and double taxation to arise. We urge the OECD to 

consider the impact of this as part of the implementation framework being developed and prioritise these areas accordingly. 

We welcome the confirmation that tax authorities should only be permitted to consider ex post outcomes as presumptive evidence about the appropriateness of the ex 

ante pricing arrangements where taxpayers cannot demonstrate that the uncertainty was appropriately measured in the pricing methodology adopted. However, 

the distinction between foreseen and unforeseen is subjective and very difficult to 

make. Additionally, there are many areas of the report that appear ambiguous 

which will allow countries to take divergent positions. We believe that there remains a significant risk of divergence in interpretation and extent of these approaches, and ultimately of tax authorities using hindsight to recharacterise nonabusive transactions. 

Whilst we would welcome the simplicity that the elective regime for Cost Contribution Arrangements (CCAs) could provide, without a commitment from a significant 

number of countries to implement such a regime it remains the case that businesses 

will still face a significant compliance burden in satisfying the countries that do not 

69 

implement it. If a significant number of countries could be encouraged to implement 

the elective regime at least in part (e.g., service CCAs) this would address these concerns in some cases. 

Financial services institutions face regulatory pressures that differentiate them 

from groups operating in other sectors. The OECD’s 2010 report on the attribution 

of profits to PEs remains relevant for the taxation of this sector. BIAC cautions 

against special measures or general principles that move away from this wellestablished approach. 

BEPS Data (Action 11) 

Whilst the business community generally agrees that insufficient data is available 

and that such data would be useful (and are thus supportive of the initiative), there 

has not been significant engagement with business in this area. We would welcome 

the opportunity to assist the OECD in its further work on identifying and analysing 

data on BEPS. 

Re-examine Transfer Pricing Documentation (Action 13) 

BIAC fully supports the recognition under Action 13 of the importance of protecting 

the confidentiality of commercially sensitive information. This protection should 

apply across all three pillars of TP documentation. We consider it would be a useful 

addition (perhaps under the framework to be developed in 2016) if peer review 

mechanisms could be developed to monitor jurisdictions’ adherence to appropriate 

confidentiality standards, and to ensure that the OECD’s proposals are uniformly 

adopted. 

The Action 13 recommendations will create substantial burdens for business, and 

effective compliance will require much preparation. For example, there remains ambiguity around areas such as the practicalities of reporting Master Files on a business line basis whilst maintaining a global overview, and many countries are already seeking to implement the country-by-country reporting elements recommendations before the guidance and XML schema are even released. Without further guidance, much of the necessary preparation is impossible. Such implementing guidance 

should, where possible, leverage data reported under similar regimes (for example 

the EU’s CRD IV for banking organisations) to streamline the compliance burden 

for as many taxpayers as possible. Only uniform TP documentation rules across 

countries will limit the resulting increase in compliance costs for companies, and we 

urge the OECD to encourage consistency in this area. 

Make Dispute Resolution Mechanisms More Effective (Action 14) 

We congratulate the OECD on the significant steps forward that have been taken 

in its work on Mutual Agreement Procedure (MAP). The recommended minimum 

standards on MAP and peer reviews is a welcomed development in the final report. 

We welcome the OECD FTA’s MAP Forum as the best place for peer reviews to be 

undertaken, and encourage the OECD and governments to commit appropriate resource to ensure that the minimum standards can be upheld. The full picture of the 

success of the minimum standards on MAP (and the success of the BEPS Project 

as a whole) cannot be judged with reference only to tax authorities’ data; we would 

welcome the opportunity to also be consulted as part of the OECD’s monitoring 

framework. 

We also congratulate the OECD on securing the commitment of 20 countries to 

binding arbitration and we urge the OECD to allocate necessary resource to ensuring this area is successful. We hope that this will demonstrate to non-participating 

countries the benefits of such a process to its participants and hope that this will 

become an international standard that other countries are compelled to join. 

Multilateral Instrument (Action 15) 

We congratulate the OECD on securing the commitment of c.90 countries to participate in the development of this ambitious project in 2016. We recognise the benefits 

that could arise from a significant number of countries signing up to the instrument 

in order to swiftly and uniformly implement the OECD’s proposals. 

Whilst the detailed timeline and consultation requirements have not been made 

public; we hope that the OECD will seek to consult widely and take up BIAC’s offer 

of support in its work on development of the Multilateral Instrument. 

70 

CENTER FOR FREEDOM AND PROSPERITY

Statement of 

Andrew F. Quinlan 

President 

Senate Committee on Finance 

Hearing on International Tax: OECD BEPS and EU State Aid 

December 1, 2015 

Chairman Hatch, Ranking Member Wyden, and Members of the Committee on Finance, thank you for the opportunity to submit written testimony on the OECD’s 

project on Base Erosion and Profit Shifting (BEPS). 

My name is Andrew Quinlan. I am the president of the Center for Freedom and 

Prosperity (CF&P). The primary mission of the Center for Freedom and Prosperity 

is to defend tax competition as an important principle that helps ensure a prosperous global economy. 

The BEPS project poses a direct threat to tax competition and American business. 

First and foremost, it is necessary to understand that the OECD does not have 

American interests at heart, nor even the welfare of the global economy. Rather, it 

is an unaccountable bureaucracy that serves the narrow interests of finance ministers and tax collectors from its rich-nation members. 

The OECD has a long documented history of advocating policies against the interests of American taxpayers and businesses, and of abusing its reputation to strongarm jurisdictions into adopting self-destructive tax policies. 

The United States must not buckle under pressure to do so in the case of BEPS. 

The project on Base Erosion and Profit Shifting has been pushed under a dishonest 

premise. Despite a relatively small and temporary dip in recent years thanks to the 

recession, corporate tax revenues as a share of global GDP have trended steadily 

and decisively upward over the last few decades. The contrary but popular idea of 

a corporate tax dodging problem is a myth designed to draw attention away from 

irresponsible budgets and profligate government spending. 

In order to avoid scrutiny of the project, BEPS preceded rapidly from conception to 

completion. The OECD is now hoping that the world similarly implement its dictates without the careful consideration the subject demands. 

It is paramount that Congress prevent the U.S. Treasury from unilaterally fulfilling 

the OECD’s wish to rewrite global tax rules without democratic oversight. In particular, rules designed to enable global fishing expeditions on American businesses 

through demands for inordinate and unnecessary amounts of private and proprietary data should be rejected. 

Far from acquiescing to the OECD’s scheme, the U.S. should take a leading role in 

defending the principles of free and open markets, and call on other nations to similarly reject their demands. 

For further substantiation of the OECD’s motives and more in-depth explanation of 

the true costs of allowing BEPS to proceed, please consider the additional materials 

appended to this statement. 

Coalition for Tax Competition 

July 14, 2015 

Dear Senators and Representatives: 

The Organisation for Economic Co-operation and Development (OECD) is rapidly 

working to rewrite global tax rules in the name of combating base erosion and profit 

shifting (BEPS). We the undersigned organizations are deeply concerned that this 

process lacks oversight and will result in onerous new reporting requirements and 

higher taxes on American businesses, and are urging Congress to speak up for U.S. 

interests by adding its voice to the process. 

71 

The OECD has a history of supporting higher tax burdens and larger government, 

and the BEPS project represents just the latest salvo in a long-running campaign 

by global bureaucrats to undermine tax competition and its restraining force on political greed. 

Because the OECD is populated by tax collectors and finance ministers, new rules 

being drafted through the BEPS initiative are necessarily going to be skewed in 

their favor. Businesses are given only a token voice, while other interests are not 

considered at all. Consumers, employees, and everyone that benefits from global economic growth are not able to make their preferences known. 

The inevitable prioritizing of tax collection over every other political or economic interest ensures that the result of the BEPS project will be economic pain. And based 

on the OECD’s own acknowledgement that corporate tax revenues have not declined 

in recent years, that pain will provide little to no real gain to national treasuries. 

BEPS recommendations already released further show a troubling trend toward excessive and unnecessary demands on taxpayers to supply data not typically relevant 

to the collection of taxes. This includes proprietary information that is not the business of any government, and for which adequate privacy safeguards are not and 

likely cannot be provided. 

The Treasury Department should not be the only voice representing U.S. interests 

during this critical process. We urge members of Congress to get involved before it 

is too late, and to protect American interests by ensuring that the voices of tax collectors are not allowed to speak for everyone. 

Sincerely, 

Andrew F. Quinlan, President Grover Norquist, President 

Center for Freedom and Prosperity Americans for Tax Reform 

Pete Sepp, President Michael A. Needham, CEO 

National Taxpayers Union Heritage Action for America 

Tom Schatz, President Seton Motley, President 

Council for Citizens Against Government 

Waste 

Less Government 

Wayne Brough, Chief Economist and J. Bradley Jansen, Director 

Vice President of Research Center for Financial Privacy and Human 

Freedom Works Rights 

Phil Kerpen, President David Williams, President 

American Commitment Taxpayers Protection Alliance 

Bob Bauman, Chairman Karen Kerrigan, President 

Sovereign Society Freedom Alliance Small Business and Entrepreneurship 

Council 

Sabrina Schaeffer, Executive Director James L. Martin, Chairman 

Independent Women’s Forum 60 Plus Association 

Heather Higgins, President George Landrith, President 

Independent Women’s Voice Frontiers of Freedom 

Lew Uhler, President Terrence Scanlon, President 

National Tax Limitation Committee Capital Research Center 

Tom Giovanetti, President Andrew Langer, President 

Institute for Policy Innovation Institute for Liberty 

Eli Lehrer, President Chuck Muth, President 

R Street Institute Citizen Outreach 

BEPS Has Tax Competition in the Crosshairs 

Brian Garst, Center for Freedom and Prosperity 

Originally published October 2015 by Offshore Investment 

The OECD’s work on Base Erosion and Profit shifting is completing after what can 

only be described as an extremely rushed process by global policy standards. In an 

effort to understand the broader implications of the project and what it means for 

the future of international taxation, I authored a study published June 2015 by the 

72 

1The full version is available at www.freedomandprosperity.org/2015/publications/makingsense-of-beps. 

Center for Freedom and Prosperity titled, ‘‘Making Sense of BEPS: The Latest 

OECD Assault on Tax Competition.’’ 1 The following is an abridged version of the 

paper. 

Introduction 

Under direction of the G20, the Organisation for Economic Co-operation and Development (OECD) began 2 years ago a major initiative on ‘‘base erosion and profit 

shifting’’ (BEPS). The project has garnered little interest from U.S. policymakers to 

date, yet its ever expanding scope and profound implications for the global economy 

should demand their attention. 

In February 2013 the OECD released a report titled, ‘‘Addressing Base Erosion and 

Profit Shifting’’ (BEPS Report), declaring that, ‘‘Base erosion constitutes a serious 

risk to tax revenues, tax sovereignty, and tax fairness for OECD member countries 

and non-members alike.’’ The OECD followed up with a plan in July 2013, ‘‘Action 

Plan on Base Erosion and Profit Shifting’’ (Action Plan), that identified 15 specific 

areas to address. 

Through the BEPS project, the OECD is continuing its war against tax competition. 

Its proposals would enable endless global fishing expeditions and provide cover for 

governments to choke the economy with new taxes. 

The Threat to the Economy 

The OECD and other supporters of the BEPS initiative argue that there are economic benefits to preventing legal tax avoidance techniques. Namely, they contend 

that activity undertaken in response to tax policy represents a market distortion. 

In the narrow sense this is accurate, but as a justification for the OECD’s current 

activities, it falls short. 

Typically ignored in the BEPS discussion are the broader implications of proposed 

reforms on the political economy. If all differences in tax policy were successfully 

minimized, to some extent it would indeed reduce profit-shifting aimed at suppressing tax burdens. So too would reducing taxes to zero, but policymakers have 

a variety of objectives to weigh and ought not elevate ending profit-shifting above 

all other national interests. 

BEPS would lead to an overall higher tax environment as politicians freed from the 

pressures of global tax competition inevitably raise rates to levels last seen in the 

early 1980s, when reforms by Reagan and Thatcher sparked a global reduction in 

corporate tax rates that has continued to this day. Through tax competition, the average corporate tax rate of OECD nations declined from almost 50 percent in 1981 

to 25 percent in 2015. 

Taxes themselves distort the market by shifting resources away from market driven 

activities and toward politically driven activities, and higher rates, all else being 

equal, increase the effect of the distortion. Poorly designed tax systems—the global 

norm—introduce yet more distortions through the common practice of double taxing 

capital, which is of particular importance when discussing BEPS given that corporate taxes are often identified as the most destructive form of capital taxation, 

as even OECD affiliated economists have acknowledged. 

Governments necessarily need taxes to fund essential functions, but ideally should 

seek to minimize the economic footprint of taxation as much as possible. Political 

incentives, however, often work in opposition of this goal. Politicians face pressure 

to demonstrate to constituents that they are performing and to please the interests 

that support their campaigns, and that in turn encourages taxes to rise above and 

beyond the level of optimum growth, or where new spending no longer provides net 

economic benefits. 

Tax competition thus provides one of the main sources of push-back against the 

drive to spend and tax. 

Tax collectors and finance ministers have inordinate say in the activities of the 

OECD, so it’s expected that the BEPS initiative would represent their views above 

all else. The Action Plan thus considers the benefits of tax competition to be the 

real problem, explaining that ‘‘there is a reduction of the overall tax paid by all parties involved as a whole.’’ The prospect of there being less money to be spent by politicians is perceived as a problem to be solved, rather than as a positive for the global economy. 

73 

The Threat to Privacy 

Several BEPS action items raise serious privacy concerns. Proposed recommendations for transfer-pricing documentation and country-by-country reporting, for instance, feature broad reporting requirements that go far beyond what is required 

for purposes of immediate tax assessment. 

Guidance for Action 13 recommends a three-tiered approach to transfer-pricing documents consisting of a master file, a local file, and a country-by-country (CbC) reports. Information contained in the local and master files are particularly vulnerable, since it would take a breach in only a single jurisdiction for it to be exposed. 

The OECD makes assurances for the confidentiality of these reports, but they are 

empty promises. Such government assurances of privacy protection are contradicted 

by experience and the long history of leaks of taxpayer information. In the United 

States alone tax data has frequently been exposed thanks to inadequate safeguards, 

or even released by officials to attack political opponents. 

Even without malicious intent, governments are ill equipped to protect sensitive information from outside access. According to the U.S. Treasury Inspector General for 

Tax Administration, 1.6 million American taxpayers were victimized by identity 

theft in the first half of 2014, up from just 271,000 in 2010. Chinese hackers were 

blamed for a breach that exposed the data of 4 million current and former federal 

employees, and the massive new collection effort and reporting system being established to enforce the Foreign Account Tax Compliance Act has also been faulted for 

its insufficient privacy safeguards. 

As poor as the United States has proven at protecting privacy, there are likely to 

be nations even more vulnerable. Through the master file and other reporting mechanisms, BEPS will demand of corporations propriety information and other sensitive 

data that they have every right to keep private and out of the hands of competitors. 

When it takes a breach of only a single national government to expose this information, there will no longer be such expectation of privacy. 

Is BEPS a Serious Problem? 

The OECD’s website describes BEPS as ‘‘tax planning strategies that exploit gaps 

and mismatches in tax rules to artificially shift profits to low or no-tax locations 

where there is little or no economic activity, resulting in little or no overall corporate tax being paid.’’ The BEPS Report further claims that, ‘‘it may be difficult 

for any single country, acting alone, to fully address the issue.’’ Or as the website 

more succinctly describes, BEPS ‘‘is a global problem which requires global solutions.’’ 

No significant evidence for these assertions is provided, however. The OECD’s BEPS 

Report itself undercuts the argument that there is a pressing need for a global response when it acknowledges that ‘‘revenues from corporate income taxes as a share 

of GDP have increased over time.’’ 

Academic research on the impact of BEPS is far less certain than the rhetoric of 

the G20 and the OECD. The strongest analysis yet to date comes from Dhammika 

Dharmapala, whose survey of the literature reports that recent studies tend to find 

lower levels of shifting than earlier works. It also challenged arguments that ‘‘point 

to the fraction of the income of MNCs that is reported in tax havens or to various 

similar measures as self-evidently demonstrating ipso facto the existence and large 

magnitude of BEPS.’’ Simply identifying money in other jurisdictions, even those 

with low tax rates, is not evidence of a BEPS problem. It should be expected to see 

more money being earned where tax policy is less hostile. 

Part of the reason there exists little evidence of a significant global BEPS problem 

is that domestic policy solutions are already available to address legitimate areas 

of concern when they arise. More importantly, the best solution available for preventing base erosion is the adoption of a competitive tax code. Pro-growth tax policy 

that eschews double and worldwide taxation not only won’t cause capital flight, but 

will attract investment instead. 

Broader Aims of the OECD 

To fully understand the significance of the BEPS effort, it’s necessary to place the 

current agenda within the broader context of the OECD’s work in recent decades. 

In 1998 the OECD declared war on tax competition with a report entitled, ‘‘Harmful 

Tax Competition: An Emerging Global Issue.’’ Its authors worried that, among other 

things, tax competition ‘‘may hamper the application of progressive tax rates and 

the achievement of redistributive goals.’’ 

74 

The organization was eventually forced by political opposition to back away from explicit condemnations of all tax competition, but has not abandoned its views. Rather, 

it has adopted new tactics toward the same end. To make this point clear, the Action Plan favorably references Harmful Tax Competition as justification for its recommendations. It also repeats a popular but baseless theory among left-wing academics and politicians about tax competition—that it promotes a ‘‘race to the bottom.’’ 

The ‘‘race to the bottom’’ theory has claimed for decades that tax competition would 

force zero rates on mobile capital. It hasn’t happened. One review of common such 

claims finds: ‘‘there can be little doubt that history has proven wrong the prediction 

of a complete erosion of capital tax revenue. Comparative data on corporate and capital tax rates demonstrate that governments in all economies continue to tax mobile 

sources of capital, effective capital tax rates have not changed much compared with 

the mid-1980s, when tax competition was triggered by the 1986 U.S. tax act, and 

tax systems are as varied as countries and political systems themselves, with no 

visible sign of converging.’’ 

Nevertheless, the BEPS report notes: ‘‘In 1998, the OECD issued a report on harmful tax practices in part based on the recognition that a ‘race to the bottom’ would 

ultimately drive applicable tax rates on certain mobile sources of income to zero for 

all countries, whether or not this was the tax policy a country wished to pursue.’’ 

Reality, essentially, is an unwarranted intrusion on the desire of policymakers to 

act without consequence. The BEPS report goes on: ‘‘It was felt that collectively 

agreeing on a set of common rules may in fact help countries to make their sovereign tax policy choices.’’ Unless, that is, their sovereign choice involves something 

other than raising taxes. 

Nations that opt for little to no taxes on capital are a problem for this quixotic theory of sovereignty—where the rest of the world must be brought to heel in order 

to ensure that politicians ought not have to consider the economic consequences of 

their policies—hence why the primary indicator for determining whether a nation 

is to be identified as ‘‘potentially harmful’’ is that it has ‘‘no or low effective tax 

rates.’’ 

Other factors are said to be considered, but without clear indication of how they are 

to be weighted any calculation will be arbitrary and open to excessive emphasis on 

the ‘‘gateway criterion’’ that is a low tax rate. When a low-tax scourge is identified, 

the OECD benevolently provides that, ‘‘the relevant country will be given the opportunity to abolish the regime or remove the features that create the harmful effect.’’ 

To make perfectly clear that this is the sort of offer a nation cannot refuse, they 

warn: ‘‘Where this is not done, other countries may then decide to implement defensive measures to counter the effects of the harmful regime, while at the same time 

continuing to encourage the country applying the regime to modify or remove it.’’ 

The OECD’s previous aggressions against low-tax jurisdictions in pursuit of its 

quest to abolish tax competition make clear just what ‘‘defensive measures’’ it has 

in mind, and how its members will go about trying to ‘‘encourage’’ compliance. In 

the years that followed release of Harmful Tax Competition, the OECD used threats 

of blacklists, peer pressure, and intimidation to cajole low-tax jurisdictions into 

adopting various policies presented under the auspices of increasing tax transparency and combating evasion. In practice the changes were intended to undermine 

the attractiveness of low-tax jurisdictions and protect high-tax nations from base 

erosion due to capital flight. 

Of particular relevance for understanding the BEPS initiative is the pattern demonstrated by the OECD during the course of this campaign. After each recommendation was widely adopted—typically under duress in the case of low-tax jurisdictions—the OECD immediately pushed a new requirement that was more radical and 

invasive than the last. 

The fact that the OECD is always ready with a new policy after one is implemented 

suggests either that the organization’s goal is not merely what is stated, or that it 

is horribly ineffective. In either case it should serve as a blow to its credibility and 

a reason to question its work on BEPS. 

Conclusion 

Were the OECD merely a research institution, its work could be dismissed simply 

as a bad idea that no nation need adopt. Unfortunately, Europe’s dominant welfare 

states use the OECD’s work as a benchmark when coercing other nations through 

use of political and economic leverage. For the low-tax jurisdictions, and now multinational businesses, caught in the OECD’s crosshairs, the ride truly never ends. The 

75 

1Senate Committee on Finance, Report of the International Tax Bipartisan Tax Working 

Group (July 2015), p. 76. 

BEPS project is a continuation of the OECD’s well-documented effort to eliminate 

tax competition, and will likely follow the same pattern of consistently moving goalposts. 

The BEPS project began at the behest of a tiny few, without open and public debate 

regarding the assumptions motivating the effort, its goals, or the most appropriate 

methods to achieve them. There is a lack of accountability, reflected in the activities 

of the BEPS initiative, that can only be rectified through real public debate and 

more direct political oversight. 

MOTION PICTURE ASSOCIATION OF AMERICA

December 15, 2015 

The Honorable Orrin Hatch The Honorable Ron Wyden 

Chairman Ranking Member 

Senate Finance Committee Senate Finance Committee 

Re: December 1st Hearing: ‘‘International Tax: OECD BEPS and EU State Aid’’ 

Dear Chairman Hatch and Ranking Member Wyden: 

The MPAA and its member companies are grateful to you and your staffs for your 

efforts to reform the U.S. tax system. We very much appreciate the Committee’s recent hearing entitled ‘‘International Tax: OECD BEPS and EU State Aid’’ and the 

examination of the potential effects of BEPS Actions on U.S. companies. We also are 

grateful for the efforts of the various working groups, which helped to advance the 

tax reform process. 

In particular, we are hopeful that the bipartisan findings of the International Tax 

Bipartisan Tax Working Group will provide an impetus and structure for international tax reform. We believe one of the most important elements of tax reform 

will be to modernize our international tax system in order to put American companies on a level playing field when competing in the global market place. The current 

U.S. worldwide system is an outlier among major developed countries with its high 

statutory rates and the imposition of a residual U.S. tax on foreign earnings. This 

has a number of adverse economic consequences, causing our companies to be less 

competitive overseas, encouraging foreign ownership of IP, and locking out cash that 

could be used for domestic investment. We also agree with the co-chairs’ conclusion 

‘‘that we must take legislative action soon to combat the efforts of other countries 

to attract highly mobile U.S. corporate income through the implementation of our 

own innovation box regime that encourages the development and ownership of IP 

in the United States, along with associated domestic manufacturing.’’ 1

In that regard, we would like to submit the following comments for the record focused on BEPS Action 5 and the need for the U.S. to adopt an innovation box to 

respond to actions being taken overseas. This is essential to encourage domestic innovation and development, to preserve and create well-paying U.S. jobs, and to generate economic growth in an increasingly competitive global marketplace. 

Introduction 

The MPAA’s six members—Walt Disney Studios Motion Pictures, Paramount Pictures Corporation, Sony Pictures Entertainment, Inc., Twentieth Century Fox Film 

Corporation, Universal City Studios LLC, and Warner Bros. Entertainment Inc.— 

produce, distribute and export theatrical motion pictures, television programming, 

and home video entertainment. The studios typically license their IP directly, or indirectly through subsidiaries, to unrelated parties for distribution in U.S. and foreign markets. In exchange, they receive royalties that historically have been subject 

to tax in the United States. 

The motion picture and television industry is an important productive component 

of the U.S. economy. The industry employed directly or indirectly nearly 2 million 

people in the United States in 2013 and generated $113 billion in wages. Core production, marketing, manufacturing, and distribution jobs paid an average of 

$84,000, which is nearly 70 percent higher than the national average. The industry 

is comprised of a nationwide network of tens of thousands small businesses across 

76 

2See id, p. 73. 

3Specifically, with respect to films, many of our major trading partners (e.g., Australia, Canada, France and the United Kingdom) offer significant wage credits and other above-the-line incentives to attract film productions and jobs abroad, in addition to their lower statutory rates. 

In fact, recognizing the benefits of film production to its economy, the United Kingdom this year 

sweetened its film and television production incentives by increasing its refundable tax credit 

from 20 percent to 25 percent for all qualifying UK film expenditure. 

all 50 states, with 85 percent of these businesses employing fewer than 10 people. 

The industry also supports good jobs and wages in thousands of companies with 

which it does business, such as caterers, hotels, equipment rental facilities, lumber 

and hardware suppliers, transportation vendors, and many others. Finally, the industry creates one of our country’s most successful products, garnering a positive 

balance of trade with virtually every country to which we export and generating an 

overall $13.4 billion trade surplus in 2013. 

Background—BEPS Action 5 

Several countries have introduced favorable tax regimes for income that is derived 

from ownership of intellectual property. These ‘‘IP Box’’ regimes were enacted with 

the aim of attracting foreign investment and ownership of IP in the applicable country. Prior to BEPS and Action 5, such regimes generally have not required work related to the IP be carried out within the country in order to be eligible for IP box 

benefits. Thus, the tax benefit is currently not dependent on economic activity and 

innovation taking place in the jurisdiction. 

Several OECD countries had raised concerns that these types of regimes are 

‘‘harmful’’ and artificially shift IP ownership and taxable profits away from the 

country or countries where the value of the IP is created. In part to address whether 

these regimes are harmful, the OECD released its final report on Action 5 ‘‘Countering Harmful Tax Practices More Effectively, Taking into Account Transparency 

and Substance’’ in early October. Under the final report, to avoid being labeled as 

harmful, a preferential regime generally must require substantial economic activity 

occur within the country for a taxpayer to be eligible for benefits. Specifically, Action 5 proposes that there must be a nexus between the income receiving the benefits and the expenses contributing to that income. Put another way, IP income will 

only qualify under this ‘‘nexus approach’’ for the preferential rates under an innovation box regime to the extent that the IP development expenses are incurred in the 

relevant country. Consequently, companies wishing to take advantage of the preferential regimes will need to shift at least a portion of their IP development jobs 

overseas. 

International Tax Reform: The Need for a U.S. Innovation Box 

In addition to adopting lower statutory rates and a dividend exemption system, 

the U.S. needs to take specific steps to respond to BEPS and other developments 

overseas that, if left unanswered, will result in significant U.S. job and revenue loss. 

We agree with the co-chairs of the International Tax Bipartisan Tax Working Group 

that ‘‘the anticipated impact of the new nexus requirements on innovation box regimes will have a significant detrimental impact on the creation and maintenance 

of intellectual property in the United States, as well as on the associated domestic 

manufacturing sector, jobs, and revenue base.’’ 2

As noted above, other countries are aggressively seeking to attract IP creation and 

commercialization through the introduction of broad IP regimes and other incentives.3 The nexus requirement under BEPS Action 5 will likely require companies 

to shift IP development and jobs overseas in order to take advantage of innovation 

box incentives. Because companies like ours are facing increased pressure from 

stakeholders to take advantage of these incentives, many will decide to locate IP 

ownership and a higher proportion of IP development functions overseas to establish 

the requisite ‘‘nexus’’ to claim such benefits or to justify a higher allocation of income attributable to that IP. This will cause U.S. tax revenues to shrink as the U.S. 

tax base attributable to IP decreases and credits for foreign taxes paid on IP developed and owned overseas increase. 

To prevent greater migration of IP ownership and quality jobs to other developed 

countries, and loss of the associated tax revenue, we believe the U.S. needs to respond quickly by adopting an IP box that encourages the development, ownership 

and commercialization of film and other IP in the United States. This is essential 

to counteract BEPS and other actions overseas, and help ensure that IP development and the associated well-paying jobs remain in the United States. 

77 

4The effective tax rate would be achieved through a 71-percent corporate tax deduction on 

‘‘innovation box profits.’’ 5See H.R. 1 , ‘‘The Tax Reform Act of 2014,’’ sec. 4211. 

To date, there are two principal alternative approaches to designing an innovation 

box regime. First Congressmen Boustany and Neal released an innovation box proposal in late July that proposes a 10.15-percent effective rate of corporate tax on 

certain ‘‘innovation box profits’’ derived from qualifying IP, including films.4 We believe the inclusion of films in the types of ‘‘qualified property’’ eligible for the innovation box deduction properly reflects the fact that production of films, like other 

forms of IP, is highly mobile and susceptible to other developed countries’ incentives. The determination of innovation box profits would be dependent on a nexus 

ratio based on the taxpayer’s research and development expenditures in the United 

States. 

To ensure the purposes of adopting an IP box are fully met with respect to films, 

we believe that certain modifications should be made to the Boustany-Neal bill that 

properly account for differences between the development of films and other forms 

of IP. Most notably, the ratio in the discussion draft is based on incurring R&D expenses, rather than IP production expenditures generally. The production of films, 

in contrast to most other forms of IP, requires only limited R&D expenses. The numerator and denominator of the nexus ratio should be modified appropriately to reflect all IP development costs (incurred domestically compared to worldwide), not 

just R&D expenses. Also, the inclusion in the numerator and denominator of costs 

of an expanded affiliated group will often lead to anomalous results. For example, 

a corporation with significant business activities unrelated to development of IP, 

such as cruise ships, will be disadvantaged for no apparent reason relative to competitors without such activities. Conversely, a corporation that has an affiliate with 

significant unrelated IP development activities could be advantaged relative to its 

competitors. 

Also, similar to section 199, income derived from film-related copyrights and 

trademarks should be eligible for the deduction under the discussion draft, because 

such income is a significant portion of the film’s revenue stream and is essential 

to the decision whether to produce a film or not. 

In addition, on-line viewing is a rapidly evolving portion of the film and television 

market that should be encouraged. Congress recognized this when it specifically provided that the methods and means of distributing a film should not affect eligibility 

under section 199. Failure to extend eligibility for innovation box benefits to income 

derived from digital broadcasts could mean that, as the demand for digital programming grows, the intended tax incentive for domestic film production could shrink 

substantially over time. 

Finally, we believe it is important that the benefits of an innovation box be available to partnerships, as well as corporations. A substantial number of film projects 

every year are produced through partnerships, co-productions and joint ventures. 

Film production by partnerships is also susceptible to foreign incentives and the effects of nexus requirements under BEPS. Thus, to counteract those incentives and 

preserve the U.S. revenue base and jobs, partnerships should also be eligible for innovation box benefits. 

The other alternative approach to implementing an innovation box in the U.S. 

would be to adopt an approach similar to the one taken by former Ways and Means 

Committee Chairman Camp in his tax reform bill (H.R. 1) to address base erosion.5

By establishing a competitive tax rate on IP income and a balance between the 

treatment of exported IP and IP owned overseas, the ‘‘carrot and stick’’ approach 

of H.R. 1 will promote the creation, ownership and commercialization of IP in the 

United States. 

The incentive effect of the ‘‘carrot’’ in H.R. 1 could be enhanced in several sensible 

ways. For example, the carrot will be heavily dependent on how intangible property 

development expenses are allocated for purposes of determining foreign intangible 

income. Specific rules are provided in the regulations under section 861 to allocate 

and apportion R&D expenses (Treas. Reg. sec. 1.861–17). These rules were adopted 

in part to encourage domestic research and development. Applying similar allocation 

and apportionment rules to film industry content and other intangible property for 

purposes of determining net foreign intangible income would provide similar incentives and help to ensure the carrot properly encourages domestic production of intangible property. 

78 

1The TIE Coalition is comprised of leading American companies and trade associations that 

drive economic growth here at home and globally through innovative technology and biopharmaceutical products. For more information, please visit www.tiecoalition.com. 

It would also enhance the ‘‘carrot’’ to specify that indirect expenses are not taken 

into account in computing net foreign intangible income. This would exclude expenses not directly allocable to IP development, including SG&A, stewardship and 

interest costs. A similar approach is used in Chairman Camp’s discussion draft to 

define foreign source taxable income for purposes of the foreign tax credit limitation. 

This would provide a consistent approach for both purposes. 

Finally, similar to the computation of the ‘‘stick’’ (which is done on a CFC-by-CFC 

basis), net losses from one transaction should not offset net intangible income from 

other transactions in determining the carrot under the bill. 

Conclusion 

We are very appreciative of the work by the Finance Committee to improve our 

tax system in order to promote domestic job growth and enhance the global competitiveness of U.S. businesses. 

As we have written to the Committee before, our industry is highly sensitive and 

responsive to global competition. Recent technological developments have created an 

environment where jobs related to the production of underlying works, and the creation and commercialization of valuable intellectual property, are more highly mobile than ever before. At the same time, other countries are becoming more aggressive in using lower statutory tax rates, targeted tax incentives, broad innovation box 

regimes, and other subsidies to attract IP production and ownership overseas. The 

nexus requirements under the BEPS project will create pressures for companies like 

ours to move film and other IP development (and the associated jobs) overseas to 

take advantage of these incentives. We believe the U.S. must act quickly to respond 

to these challenges to avoid migration of IP development to foreign countries. 

We are grateful for your efforts to address these challenges so U.S. companies remain highly competitive, and IP development (and the resultant revenue base) remains at home. We believe that a significant reduction in the U.S. corporate tax 

rate and adoption of a dividend exemption system with an appropriate IP box will 

successfully achieve these goals. 

Please contact Patrick Kilcur (202) 378–9175 if you have any questions or need 

anything else from us. We look forward to working with the Committee members 

and the staff on these important issues. 

Sincerely, 

Joanna McIntosh 

Executive Vice President, Global Policy and External Affairs 

cc: 

Members of the Senate Finance Committee 

TAX INNOVATION EQUALITY (TIE) COALITION

Working Together for Tax Innovation Equality 

Washington, DC 20005 

info@tiecoalition.com 

202–525–4872 ext. 110 

Senate Finance Committee 

Hearing on OECD BEPS Reports 

December 1, 2015 

The Tax Innovation Equality (TIE) Coalition is pleased to provide this statement 

for the record of the Finance Committee’s hearing on the OECD BEPS Reports.1 As 

the testimony at the hearing made clear, many of the concerns of the U.S. government and U.S. businesses with the BEPS Reports would be alleviated by reforming 

the U.S. tax code. Therefore, as the Committee considers what actions to take in 

view of the OECD BEPS Reports, we urge you to move forward with tax reform that 

will modernize the U.S. tax system and help American businesses compete in a global market. The TIE Coalition believes that the U.S. must: (i) implement a competitive territorial tax system; (ii) lower the U.S. corporate tax rate to a globally comVerDate Mar 15 2010 17:20 Oct 17, 2016 Jkt 000000 PO 00000 Frm 00082 Fmt 6601 Sfmt 6621 R:\DOCS\22145.000 TIMD
79 

2Please note that the TIE Coalition is opposed to both versions of ‘‘Option C’’ (version one 

of ‘‘Option C’’ in the Camp Draft and version two of ‘‘Option C’’ in H.R. 1 as introduced). 

petitive level; and (iii) not pick winners and losers in the tax code by discriminating 

against any particular industry or type of income—including income from intangible 

property (IP). 

Recognizing the importance of IP to the U.S. economy, many of the members and 

witnesses at the hearing expressed concern about the adoption of so-called ‘‘innovation boxes’’ by OECD countries, raising questions about whether these measures 

will result in the movement of IP jobs from the U.S. to other countries and asking 

whether the U.S. should adopt similar measures. The TIE Coalition does not have 

a position on the adoption of a U.S. ‘‘innovation box’’ but we are very concerned that 

in prior international tax reform proposals income from intangible property (IP) 

would be singled out for harsher tax treatment than income from other assets. By 

discriminating against IP income as compared to income from other types of assets, 

these prior proposals would create an unfair advantage for companies who don’t derive their income from IP and significantly disadvantage the most innovative U.S. 

companies, especially compared to their foreign competition. 

For example, the ‘‘Tax Reform Act of 2014’’ (H.R. 1), as introduced by former House 

Ways and Means Chairman Camp, would seriously disadvantage innovative American companies. Under that proposal, Chairman Camp chose to use what is now 

widely known as ‘‘Option C.’’ 2

The problem with ‘‘Option C,’’ is if it became the law of the land, its adverse tax 

treatment of IP income would significantly hinder U.S. companies who compete 

globally, and it would result in more inversions of U.S. companies. The TIE Coalition is opposed to ‘‘Option C’’ because it would have a devastating impact on both 

innovative technology and biopharmaceutical companies. 

In an effort to really understand the full scope of ‘‘Option C,’’ the TIE Coalition earlier this year commissioned a study by Matthew Slaughter, the Dean of the Tuck 

School of Business at Dartmouth University. We have attached a copy of the January 2015 study, entitled, ‘‘Why Tax Reform Should Support Intangible Property in 

the U.S. Economy,’’ and urge the Finance Committee to consider its findings when 

examining options for international tax reform. A copy of the study can also be 

found at: http://www.tiecoalition.com/why-tax-reform-should-support-intangibleproperty-in-the-u-s-economy. 

As Dean Slaughter emphasizes, ‘‘Policymakers should understand the long-standing 

and increasingly important contributions that IP makes to American jobs and American standards of living—and should understand the value of a tax system that encourages the development of IP by American companies.’’ The study finds that ‘‘Option C’’ in the Camp legislation would fundamentally change the measurement and 

tax treatment of IP income earned by American companies abroad. The study finds 

that ‘‘Option C’’ of the proposal would disadvantage IP income earned abroad by 

U.S. companies in three ways. First, it would tax IP income at a higher rate than 

under current law. Second, it would tax IP income more than other types of business income. Third, it would impose a higher tax burden on the IP income of U.S. 

companies compared to their foreign competitors. The likely outcome of using ‘‘Option C’’ as proposed in the Camp legislation would be to increase corporate inversions and incentives for foreign acquisitions of U.S. based IP intensive companies. 

The Slaughter study finds that the ‘‘United States, not abroad, is where U.S. multinationals perform the large majority of their operations. Indeed, this U.S. concentration is especially pronounced for R&D, which reflects America’s underlying 

strengths of skilled workers and legal protections such as IP rights that together 

are the foundation of America’s IP strengths, as discussed earlier.’’ The Slaughter 

study concludes that the overseas operations of these companies complement their 

U.S. activities and support, not reduce, the inventive efforts and related jobs of their 

U.S. parents. So it is increasingly important to America’s IP success that these companies continue to operate profitably overseas and any tax reform proposals do not 

impose discriminatory taxes on income from intangible assets located there. 

IP jobs are very important to the U.S. economy and make up a large portion of the 

workforce. That is why it is important to have a tax code that supports the IP economy here in the U.S. To that point, the U.S. Chamber’s Global Intellectual Property 

Center commissioned a study on the benefits of IP jobs to economic growth in the 

U.S. The study found that in 2008–09 that there were 16 percent or 19.1 million 

direct IP jobs and 30 percent or 36.6 million indirect IP jobs in the U.S. IP or IP 

80 

3See, http://image.uschamber.com/lib/fee913797d6303/m/1/IP+Creates+Jobs+-+Executive+ 

Summary+Web+-+2013.pdf. 4The U.S. Chamber study found that ‘‘IP-intensive companies added more than $2.8 trillion 

direct output, accounting for more than 23 percent of total output in the private sector in 2008– 

09’’ and that the ‘‘Output per worker in IP-intensive companies averages $136,556 per worker, 

nearly 72.5 percent higher than the $79,163 national average. Id. 

related jobs account for 46 percent of the U.S. economy or 55.7 million jobs. With 

our modernizing economy it is likely that this number has grown.3

To be constructive and help the Committee find solutions that will allow American 

companies to succeed in a very competitive global market, the TIE Coalition has developed anti-base erosion solutions that do not target IP income. We would like to 

work with the Committee to develop alternative options that would apply to situations in which companies are simply trying to shift income to low tax jurisdictions 

with no substance or real business presence, but would not discriminate against income from intangible assets. Such options would apply to income from all goods and 

services, not just income from intangible assets. 

In conclusion, the TIE Coalition supports tax reform that modernizes the U.S. tax 

system, allowing American businesses to compete in global markets in a manner 

that does not discriminate against any particular industry or type of income, including income from intangible property. As the witnesses at this hearing indicated, 

many other countries are lowering their corporate tax rates and adopting tax rules 

to attract IP companies to their shores. So, it would be especially harmful to the 

U.S. economy to adopt a tax policy that will hurt, not help, American companies 

who compete globally. Now is not the time to drive high paying American jobs overseas.4

Why Tax Reform Should Support Intangible Property 

in the U.S. Economy 

Matthew J. Slaughter 

January 2015 

About the Author 

Matthew J. Slaughter is Associate Dean for Faculty and Signal Companies’ Professor of Management at the Tuck School of Business at Dartmouth. He is also a 

Research Associate at the National Bureau of Economic Research, an adjunct Senior 

Fellow at the Council on Foreign Relations, and an academic advisor to the 

McKinsey Global Institute. From 2005 to 2007, he served as a Member of the President’s Council of Economic Advisers. 

This report was sponsored by the Tax Innovation Equality Coalition. The views expressed in this report are those of the author. 

© 2015 Matthew J. Slaughter 

Executive Summary 

America today continues to confront a competitiveness challenge of too little economic growth and too few good jobs. In the future America has the potential to create millions of good, knowledge-intensive jobs connected to the world via international trade and investment. Doing so will require sound U.S. policies that are 

based on a comprehensive understanding of how innovative American companies 

succeed in today’s dynamic global economy. 

In particular, policymakers should understand the long-standing and increasingly 

important contributions that intangible property (IP) makes to American jobs and 

American standards of living—and should understand the value of a tax system that 

encourages the development of IP by American companies. Unfortunately, the taxreform proposals in former House Committee on Ways and Means Chairman Camp’s 

Discussion Draft, the Tax Reform Act of 2014, would undermine these contributions. 

This white paper develops three central messages. 

81 

1 At the end of the 113th Congress, the Discussion Draft of Chairman Camp was formally introduced as H.R. 1, The Tax Reform Act of 2014. At the time of writing in early 2015, the 114th 

Congress showed no indications of reviving this bill. 

1. The Discussion Draft proposes sweeping changes to the U.S. tax treatment of 

IP. It would fundamentally alter the measurement and tax treatment of IP income earned by the foreign affiliates of U.S.-based multinational companies— 

and in so doing would discriminate against these affiliates’ IP income relative 

to their non-IP income. Moreover, it would imperfectly measure this IP income—in many cases far too broadly. The bottom line is that the Discussion 

Draft would raise the current U.S. tax liability on IP income earned by the foreign affiliates of U.S.-based multinational companies—and thus would discourage these companies’ investment in IP. 

2. In three important ways, the Discussion Draft would disadvantage IP income 

earned abroad by U.S.-based multinationals. First, the U.S. tax burden on IP 

income would be higher than the tax burden on IP income under current law. 

Second, the U.S. tax burden on IP income would be higher than the tax treatment of many other forms of business income under the Discussion Draft. 

Third, the U.S. tax burden on IP income of U.S.-headquartered multinational 

companies would be higher relative to the tax burden on IP income of their 

foreign competitors as compared to current law. This would aggravate the nettlesome issue of corporate inversions and would create additional incentives for 

foreign acquisitions of U.S.-based IP-intensive companies. 

3. Globally engaged U.S.-headquartered multinational companies, which create 

the large majority of America’s IP, rely on their worldwide operations to maximize the creativity and benefits of their U.S. inventions. These globally engaged U.S. companies have long performed the large majority of America’s IP 

discovery and development. Increasingly central to America’s IP success is the 

ability of U.S. companies to operate profitably around the world. The latest research continues to show that the foreign-affiliate operations of U.S.-based 

multinationals complement their U.S. activities. Foreign affiliates support, not 

reduce, the inventive efforts and related jobs of their U.S. parents. 

America’s economic recovery remains too tentative and productivity growth has 

slowed dramatically in recent years. America stands to gain much from broad and 

fundamental policy reform that creates an internationally competitive tax system. 

But that reform should not discriminate against IP and its increasingly important 

contributions to the American economy. 

Section One: 

Overview of the Discussion Draft’s Proposals 

for Reform of U.S. Tax Treatment of IP Income 

The Discussion Draft would enact sweeping changes to U.S. tax treatment of IP. It 

would fundamentally alter the measurement and tax treatment of IP income 

earned by the foreign affiliates of U.S.-based multinational companies—and is so 

doing would discriminate against these affiliates’ IP income relative to their nonIP income. Moreover, it would imperfectly measure this IP income—in many cases 

far too broadly. The bottom line is that the Draft would raise the current U.S. tax 

liability on IP income earned by the foreign affiliates of U.S.-based multinational 

Companies—and thus would discourage these companies’ investment in IP. 

The Treatment of Intangible Income Under the Discussion Draft: Description of 

FBCII 

In February 2014, Chairman of the House Committee on Ways and Means, Dave 

Camp (R–MI), introduced a Discussion Draft on comprehensive tax reform, the Tax 

Reform Act of 2014. This Discussion Draft proposed sweeping changes to America’s 

taxation of both individuals and corporations overall—including current taxation of 

intangible income of U.S.-headquartered multinational companies.1

Under current law, when a foreign subsidiary of a U.S.-headquartered multinational 

earns income in a foreign jurisdiction, that income—regardless of whether related 

to tangible property or to intangible property (IP)—generally can be deferred and 

does not bear U.S. tax until the income is distributed to the U.S. parent. Thus, like 

other income, a foreign subsidiary’s intangible income generally is not taxable in the 

82 

2The Internal Revenue Service defines intangible property to include the following six broad 

sets of ideas and related economic manifestation thereof: ‘‘computer software; patents, inventions, formulae, processes, designs, patterns, trade secrets, or know-how; copyrights and literary, 

musical, or artistic compositions; trademarks, trade names, or brand names; franchises, licenses, 

or contracts; methods, programs, systems, procedures, campaigns, surveys, studies, forecasts, estimates, customer lists, or technical data.’’ See this definition and related discussion at http:// 

www.irs.gov/irm/part4/irm_04-048-005.html. This paper follows this definition of intangible 

property. 3The tax rate of 25 percent applied to the non-deductible 5 percent of foreign-affiliate nonIP related earnings results in an effective tax rate on those earnings of just 1.25 percent (5 percent multiplied by 25 percent). 4Tax Reform Act of 2014 Discussion Draft, Committee on Ways and Means Majority Tax Staff, 

pp. 149–150. House Ways and Means Committee Majority Counsel and Special Advisor for Tax 

Reform Ray Beeman later clarified that FBCII would likely include royalties, after initial uncertainty arose on this. ‘‘I don’t believe we meant to exclude royalties because that is where we 

started in the process. . . . That’s definitely something we will want to go back and evaluate.’’ 5Tax Reform Act of 2014 Discussion Draft, Committee on Ways and Means Majority Tax Staff, 

p. 150. 

United States so long as it is not repatriated back to the U.S. parent. Stated differently, a foreign subsidiary’s intangible income is not currently subject to immediate taxation under Subpart F.2

When fully phased in over 5 years in 2019, the Discussion Draft would implement 

a statutory corporate tax rate of 25 percent, 10 percentage points below today’s rate 

of 35 percent. In addition, it would effectively replace today’s worldwide taxation of 

U.S.-based multinationals with a hybrid territorial system. The non-IP related foreign earnings of U.S.-based multinationals would enjoy a dividends-received deduction of 95 percent. This would result in an effective U.S. tax rate of just 1.25 percent 

on the non-IP related foreign-affiliate earnings repatriated back to U.S. parents 

through dividends.3 Thus, the Discussion Draft would establish a baseline of largely 

exempting from U.S. taxation the non-IP related income of the foreign subsidiaries 

of U.S. multinationals. 

The IP-related income of these foreign subsidiaries would be treated quite differently, however. Section 4211 of the Discussion Draft would create a new category 

of immediately taxable income, ‘‘foreign base company intangible income’’ (FBCII), 

and thus would replace today’s deferral-based worldwide system with a pure worldwide system for IP-related income. Here is the definition: 4

FBCII would equal the excess of the foreign subsidiary’s gross income over 

10 percent of the foreign subsidiary’s adjusted basis in depreciable tangible 

property (excluding income and property that are related to commodities). 

In addition, the calculation of FBCII would also subtract from gross income an ‘‘applicable percentage’’ of the foreign affiliate’s other ‘‘foreign base company income,’’ 

or FBCI. Depreciable tangible property consists of physical assets used by the affiliate in the course of its production, such as office buildings and equipment. The adjusted basis on this tangible property would be determined each tax year in accordance with rules specified elsewhere in the tax code. The 10 percent applied to the 

adjusted basis in depreciable tangible property receives little explanation in the Discussion Draft or its technical explanation, beyond being described as ‘‘in effect exempting normal returns on investments in tangible property.’’ 

Consistent with current U.S. tax treatment of Subpart F income, this newly created 

FBCII would cause an immediate tax liability for a U.S. multinational. The effective 

tax rate applied to FBCII would vary depending on whether the goods and services 

linked to that FBCII were for use inside or outside of the United States. 

For goods and services for use in the United States—e.g., for FBCII realized by a 

foreign affiliate exporting products back to customers in the United States—the effective tax rate on FBCII would ultimately be the Discussion Draft’s statutory rate 

of 25 percent. This 25 percent tax rate on U.S.-connected foreign-affiliate IP earnings would be 20 times the effective tax rate of 1.25 percent that the Discussion 

Draft would levy on non-IP related earnings of foreign affiliates. 

For ‘‘foreign derived’’ FBCII related to goods and services intended for use outside 

the United States, the Discussion Draft would allow a deduction that, if enacted, 

would result in a lower effective tax rate. ‘‘The U.S. parent could claim a deduction 

equal to a percentage of the foreign subsidiary’s FBCII that relates to property that 

is sold for use, consumption, or disposition outside the United States or to services 

that are provided outside the United States.’’ 5 During the phase-in years, the 

amount of this deduction from FBCII would phase down in conjunction with the 

83 

6Suppose a foreign affiliate earns FBCII of 100 through sales to host-country customers. Then 

against its FBCII it can claim a deduction of 40 (i.e., of 40 percent of 100) and thus face a 

deduction-included FBCII of just 60. A statutory 25-percent tax on this 60 yields 15; thus would 

the effective tax rate on FBCII linked to foreign sales be just 15 percent. 7The Tax Reform Act of 2014: Fixing Our Broken Tax Code So That It Works for American 

Families and Job Creators, House Ways and Means Committee, p. 20. These revenue estimates 

should most accurately be thought of as 9-year estimates (rather than the more-common 10-year 

estimates) because its effective date is generally the tax years beginning after 12/31/14. 8Technical Explanation of the Tax Reform Act of 2014: Title III—Business Tax Reform, Joint 

Committee on Taxation, JCX–14–14, February 26, 2014. 

phase-in of the new lower statutory corporate tax rate, ultimately reaching 40 percent starting in 2019. This 40 percent deduction, if enacted, would imply a 15 percent effective tax rate on FBCII linked to foreign sales. A 15 percent tax rate on 

foreign-derived foreign-affiliate IP earnings would be 12 times the effective tax rate 

of 1.25 percent that the Discussion Draft would levy on non-IP related earnings of 

foreign affiliates.6

This deduction would also be available to any U.S. corporation that earns foreign 

intangible income directly—e.g., through exports from the United States to a foreign 

customer—rather than through a foreign affiliate. Thus, a U.S. company—a purely 

domestic company or a U.S. parent of a U.S. multinational—would also face an effective tax rate of 15 percent (assuming the 40 percent deduction applies), rather 

than the baseline statutory rate of 25 percent, on intangible income linked to sales 

or services abroad. 

This particular deduction, if enacted, results in an effective rate of 15 percent on 

intangible income from serving foreign markets regardless of the location of intangible property or whether it is earned by the foreign affiliate or by the U.S. parent. 

Chairman Camp therefore claimed that the Discussion Draft ‘‘removes incentives 

companies currently have to move their innovation offshore, by providing a neutral 

15-percent tax rate on profits from innovations regardless of whether the manufacturing takes place in the United States or overseas.’’ 7

To avoid foreign affiliates facing double taxation of FBCII, their effective U.S. tax 

would be reduced for any affiliate whose FBCII first faced a tax liability to the hostcountry tax authorities: all foreign taxes on FBCII would be eligible for credit 

against the U.S. tax. FBCII would be taxable immediately in the U.S. only when 

that foreign effective tax rate was lower than the effective U.S. tax rate. 

Relative to current law, which leaves untaxed by the U.S. any un-repatriated foreign-affiliate intangible income, the Discussion Draft would raise substantial 

amounts of U.S. tax revenues. This is mainly because it would treat all such FBCII 

as immediately taxable (subject to any foreign tax credits). The Joint Committee on 

Taxation estimated that this new FBCII, along with some related changes, would 

raise net U.S. tax revenues by $115.6 billion over the years of 2014 through 2023.8

The Discussion Draft Would Disadvantage the IP Income of Foreign Affiliates of 

Multinationals 

Under Discussion Draft the IP income of foreign affiliates of U.S. multinationals (as 

calculated under the FBCII formula) would become immediately taxable income. 

This would mean foreign affiliates would face a higher rate of U.S. taxation on their 

IP income than they do today under current law. These affiliates may face some foreign tax liability on this IP income (a foreign tax liability that would tend to offset 

any U.S. tax liability). But today there is no U.S. tax liability until and unless that 

IP income is repatriated. Under the Discussion Draft, that IP income would face an 

immediate additional U.S. tax liability of up to 25 percent. 

As described above, the effective tax rate on this FBCII is intended to be the statutory 25 percent for income linked to serving U.S. customers and 15 percent for income linked to serving foreign customers—the lower effective rate attainable only 

if the intended 40 percent deemed deduction of the calculated FBCII ends up enacted into law. So, under the Discussion Draft, a foreign affiliate of a U.S.- 

headquartered multinational would face a U.S. tax rate on IP income somewhere between 12 and 20 times the effective tax rate of 1.25 percent that the Draft would levy 

on non-IP related earnings of that foreign affiliate. 

A fundamental problem with the overall structure of Discussion Draft is it would disadvantage IP income earned abroad by U.S.-based multinationals. The U.S. tax burden on IP income under the Draft would be higher compared with the tax burden 

on IP income under current law. And the U.S. tax burden on IP income under the 

Draft would be higher compared with the U.S. tax burden on many other forms of 

84 

9 Comments delivered on a March 7, 2014 webcast sponsored by KPMG, LLP. 

business income under the Draft. As Section Two of this paper will discuss, there is 

no economic rationale for discriminating against IP income. Indeed, as Section Three 

of this paper will discuss, IP has long driven the large majority of the productivity 

growth and job creation at the foundation of generations of American economic success—investment in which is complemented by the foreign affiliates of U.S. multinationals. 

The Discussion Draft’s policy preference for foreign affiliates intensive in the ownership and use of tangible property is underscored by the FBCII formula itself. The 

larger the adjusted basis in depreciable tangible property that a foreign affiliate 

owns, the smaller the affiliate’s FBCII would be and thus its current U.S. tax liability (thanks to being able to subtract off 10 percent of the adjusted basis). As Section 

2 discusses, this preference would tend to dampen investment in tangible property 

in the United States by U.S.-based multinational companies. 

Beyond this fundamental economic problem with the Discussion Draft’s increased 

and uneven taxation of foreign-affiliate IP income, two other concerns with the design of FBCII merit mentioning: its formulary approach and its possible violation 

of World Trade Organization (WTO) obligations. Consider each of these in turn. 

Using the formula of FBCII to measure IP-related income of foreign affiliates would 

constitute a radical departure from the current practice of defining and taxing income based on legal and market-based definitions that distinguish different sources 

and kinds of income based on the assets and/or the operations generating the income. This deviation has little precedent, either within the history of U.S. tax code 

or in terms of other countries’ treatment of IP income. 

This formulary approach to measuring IP income does promote administrative simplicity because it would not require companies to identify specific intangible assets 

or income flowing from those intangible assets. On this point, here are the words 

of House Ways and Means Committee Majority Counsel and Special Advisor for Tax 

Reform Ray Beeman.9

We developed a formula that would apply to everybody. We could have gone 

in a direction where you created exact ways to measure embedded intangible income. . . . The formula should be a lot simpler to apply. . . . We 

are aware of and appreciate the fact that in service industries, there may 

be more of an effect. . . . Now I think we have something that is probably 

not always going to perfectly measure intangible income, but it’s far easier 

to use. It’s a formula that basically measures the return on invested capital 

. . . an example where you see precision in measuring income at war with 

simplicity. 

Simple though the administration of FBCII might be, as will be discussed below, 

conceptually it is only vaguely linked to IP and thus cannot capture and adjust for 

the complex variety of business models both within and across industries. This 

vague link is especially worrisome given today’s reality of U.S.-based companies increasingly producing their goods and services in elaborate global supply networks 

dictated by their evolving business needs. And, it is essential to stress again, these 

measurement problems of FBCII sit in the broader context of the more-fundamental 

problem with FBCII discussed above; namely, that it discriminates against the IP 

that has long driven the large majority of the productivity growth and job creation 

at the foundation of generations of American economic success. 

On measurement, it is also important to note there is no obvious economic rationale 

for setting this percentage at 10 percent, rather than at some other share. This chosen percentage is intended to be a ‘‘normal’’ return to tangible investments. But 

there is nothing inexorable about this 10 percent. In particular, there is no established research literature supporting its chosen constancy. Rather, it is well documented that different countries often have persistently different real interest rates 

because of different underlying fundamentals. Simple though a fixed rate of return 

of 10 percent might be, no standard economic theory or evidence supports its blanket application in FBCII. 

The other design feature of the Discussion Draft’s treatment of IP income that 

raises concerns is the possibility that it may not comply with the rules of the World 

Trade Organization (WTO). Recall the tax rate of 15 percent that the Draft aims 

to impose on IP income linked to foreign customers regardless of whether that foreign customer is served by a U.S. multinational’s U.S. parent or foreign affiliate 

85 

10 ‘‘The Devil Is in the Details: Reflections on the Camp Draft,’’ by Reuven S. Avi-Yonah, in 

Tax Notes International, March 24, 2014, p. 1056. 11 ‘‘Royalties Included in Reduced Intangibles Rate in Camp Draft, Ways and Means Says,’’ 

by Andrew Velarde, Tax Notes, March 11, 2014. 

(again, assuming that the 40 percent deduction is applied to foreign-linked IP income). This means a U.S. company earning IP income from exports would pay a 15- 

percent tax rate. But IP income stemming from the imports by a U.S. customer from 

a foreign affiliate of a U.S. multinational would be subject to a 25 percent tax rate. 

Many WTO rules prohibit countries from subsidizing exports relative to imports. 

Thus have a number of analysts voiced concern about taxing income from imports 

at a higher rate than income from exports. 

For example, scholar Reuven S. Avi-Yonah has commented that Section 4211 ‘‘translates into a 15 percent tax rate applied to rents from exports but a 25 percent rate 

on rents from imports, which raises serious WTO compatibility issues.’’ 10 Similarly, 

‘‘former Ways and Means staffer John Buckley previously argued that [a similar 

provision, Option C in the 2011 Camp international tax reform draft, which largely 

resembles the Discussion Draft’s treatment of FBCII,] violated WTO agreements as 

a prohibited export-contingent subsidy.’’ 11

For over a decade the WTO has been struggling to close a successful Doha Development Round and to make progress on other important initiatives such as updating 

the original Information Technology Agreement. In this fragile trade-policy environment, a new U.S. violation of WTO rules would not help. And history clearly demonstrates that U.S. tax-related WTO violations can carry serious consequences—for 

example, when U.S. law regarding Foreign Sales Corporations was forced to be altered because of such violations. 

Regardless of whether the higher tax rate on affiliates’ exports to America would 

be WTO compliant, it clearly would impair the global competitiveness of these affiliates relative to foreign-headquartered companies exporting to America because 

under the Discussion Draft, foreign companies would face no FBCII tax. This anticompetitive implication of the Draft Section Two explores. For now, it also underscores a substantial concern about the Draft’s practical implementation, to which 

this paper now turns: the challenges of measuring FBCII in today’s complex reality 

of global supply networks. 

Measuring FBCII Would Not Be Simple in Today’s Complex Reality of Global Supply 

Networks 

In today’s era of rapidly expanding global supply networks, measuring FBCII by a 

simple formula would be only vaguely linked to IP conceptually and would not be 

adjustable for a complex variety of business models within and across industries. 

For example, in these networks global companies often choose not to own the physical assets involved in the production of their goods and services. It is critical to 

stress that favoring owned tangible assets in today’s era of globalized production is 

a major conceptual mismatch of FBCII. 

A distinguishing feature of the world economy over the past generation has been 

the fragmentation of production. Companies increasingly produce within elaborate 

global supply networks in which parts of final products are made by companies of 

all sizes, in many stages, spanning many countries, and linked together by knowledge, trade, and investment. How companies produce their goods and services today 

differs dramatically from earlier generations, when companies made in-house most 

of the components and value of their products. 

This proliferation of global supply networks is a striking and (barring catastrophe) 

irreversible feature of the world economy in which companies must operate to succeed. Three main forces account for their rise. 

One has been widespread reductions in political barriers to trade, investment, and 

immigration. At the multilateral level, the Uruguay Round, in many ways the most 

comprehensive trade agreement ever, was implemented in the years after its 1994 

closing. At the national level, a number of far-reaching unilateral, bilateral, and regional liberalizations have been implemented in the past generation, including the 

North American Free Trade Agreement in 1994 and China’s accession to the World 

Trade Organization (WTO) in December 2001. At the industry level, the WTO Information Technology Agreement was signed in 1996, whereby 70 countries representing about 97 percent of world trade in IT products agreed to eliminate duties 

on hundreds of intermediates, capital goods and final products in the IT industry. 

86 

12 Every year since 1977, the U.S. Bureau of Economic Analysis has multinational companies 

in America through legally mandated surveys (with penalties for noncompliance) that collect 

and publicly disseminate operational and financial data. By design, BEA statistics track all multinational companies in the United States: both the U.S. parents of U.S.-headquartered multinationals (as well as their foreign affiliates) and the U.S. affiliates of foreign-headquartered 

multinationals (but not their foreign parents). In accord with the practice of many countries, 

the BEA defines a U.S.-headquartered multinational company as any U.S. enterprise (the ‘‘parent’’) that holds at least a 10 percent direct ownership stake in at least one foreign business 

enterprise (the ‘‘affiliate’’). The BEA analogously defines a U.S. affiliate of a foreignheadquartered multinational company as any U.S. enterprise in which at least a 10 percent direct ownership stake is held by at least one foreign business enterprise. In Figure 1A, shares 

data were obtained from the BEA data online at www.bea.gov. 

Government restrictions on inward and outward foreign direct investment (FDI) 

have also fallen. 

A second important force driving global supply networks has been the choice of 

many mainly labor-abundant countries to allow their billions of citizens to integrate 

into the global economy by lowering trade and investment barriers—rather than 

choosing to prevent globally engaged companies from competing in their markets, 

as so many countries did over much of the 20th century. Prominent here are the 

BRIC countries of Brazil, Russia, India, and China. 

The third and perhaps most dramatic force driving global supply networks has been 

IT innovations that have driven to near zero the cost of global communication and 

information transmission. In the past generation, connectivity and communication 

facilitated by IT and the Internet have dramatically reduced the costs of trading 

many goods and, for services as discussed above, vastly expanding the scope of what 

activities are tradable. 

This IT revolution has interacted with the first two forces. The conscious choice of 

so many countries to connect to the global economy, plus falling policy barriers to 

the international flow of ideas, people, capital and products, have opened to global 

companies dramatically more options for how to configure what they produce where. 

But in many ways it has been IT that has made these options both low-enough cost 

to do and also manageable despite this complexity. 

The net result of these three forces has been a proliferation of global supply networks: elaborate and fluid structures in which companies locate different production 

tasks in different countries, some performed in-house and others with external partners. The productivity gains have been enormous: more innovation, lower costs, faster customer responsiveness and lower risks. The result for America (and others) is 

deeply globally engaged companies, each determining and building its strengths connected to the world to ensure continued success in keenly competitive world markets. 

Publicly available data on U.S.-headquartered multinational companies shed clear 

light on how important global production networks are to them. Figure 1A provides 

one indicator of this. For each of three years 1989, 1999 and 2009, it reports the 

share of total sales of U.S. parents and foreign affiliates of U.S.-headquartered multinational companies.12

87 

13 Barefoot, Kevin B., and Raymond J. Mataloni, Jr. 2011. ‘‘Operations of U.S. Multinational 

Companies in the United States and Abroad: Preliminary Results from the 2009 Benchmark 

Survey.’’ Survey of Current Business, November, pp. 29–55. 14 Barefoot, Kevin B., and Jennifer Koncz-Bruner. 2012. ‘‘A Profile of U.S. Exporters and Importers of Services.’’ Survey of Current Business, June, pp. 66–87. 

The key message of Figure 1A is that the share of intermediate inputs (i.e., of goods 

and services that companies purchase from other companies to help produce their 

own goods and services) in total sales has been high and rising for both the U.S. 

and foreign operations of U.S.-based multinationals: from 66.6 percent in 1989 to 

68.0 percent in 1999 and 73.3 percent in 2009 for U.S. parents and from 71.7 percent in 1989 to 74.5 percent in 1999 and 76.5 percent in 2009 for foreign affiliates. 

These high and rising shares reflect the deepening engagement of these companies 

in global supply networks. 

Looking at different industries offers additional insight into the dynamic evolution 

of how these companies produce. Companies changing their positions in global supply networks sometimes switch primary industry—and this trend has increased over 

time as companies switch focus from goods to services. In the words of the U.S. Department of Commerce: 

The tendency for U.S. sellers of goods to shift their activities from manufacturing toward wholesale trade predates 1999, but it has been growing in 

importance. For example, the number of parent companies whose primary 

industry classification changed from manufacturing to wholesale trade in 

1999–2009 more than doubled from the preceding 10-year period. The acceleration in this trend may be partly related to the rise of global value chains 

in firms’ business strategies.13

This blurring of traditional distinctions between goods and services, not just across 

but even within companies, is a hallmark of global supply networks. These networks 

allow the production of goods to be unbundled into a collection of inputs that are 

not just goods but services as well—and conversely the production of services such 

as wholesale trade, may require supply chains of goods. Successful globally engaged 

companies must continually shift the blend of goods and services they produce and 

sell. Indeed, many of America’s leading manufacturing companies make and sell 

services as an essential part of their overall operations. One recent study found that 

companies whose main business was manufacturing are among America’s largest exporters and importers of services spanning R&D, business processing, and management consulting.14

The clear implication of the rise of complex global supply networks is that FBCII 

would be only vaguely linked to IP conceptually and would not be adjustable for the 

complex variety of business models within and across industries. This combination 


120115.001
88 

15 ‘‘The Camp Proposal: Patent Boxes in the Age of BEPS,’’ by Marie Sapirie, Tax Notes International, March 24, 2014, p. 1065. 16 Note that these BEA calculations assume that implementation of FBCII would not measure 

gross income as something like total revenues—i.e., would not encompass basic costs of goods 

sold such as materials purchased and payroll. If FBCII approximated gross income with something broader like total revenues, then the mismeasurement of FBCII discussed in the text 

would be all the more egregious because it would capture business expenses wholly unrelated 

to IP such as purchases of electricity, heating fuel, water, and sewer connectivity. 

of features means FBCII likely would carry two unattractive features: (1) it would 

capture an unreasonably large fraction of current affiliate income, sharply reducing 

the Discussion Draft’s stated goal of largely exempting from U.S. taxation foreignaffiliate income; and (2) it would measure cross-industry variation that is only somewhat linked to common measures of industry IP intensity because of variation driven 

by different global-supply-network strategies of different companies. 

Consider, for example, a labor-intensive foreign affiliate whose many employees 

work with capital goods that are leased from its main customer in making its products. Under the FBCII formula, because this affiliate owns little tangible capital it 

would have very little to subtract from its gross income—and thus would be measured as having high IP-related income regardless of the actual IP intensity (or lack 

thereof) of the underlying production activities. 

More generally, companies that are more adept in situating themselves into the 

high-value-added positions of global supply networks will be companies that earn 

high profits whether or not those positions are in any way linked to IP assets. In 

some cases IP would be involved in a successful global production strategy, but surely not in all cases as there are a number of non-IP-related strategies that can yield 

profitability. High-quality customer service, for example—perhaps linked to products 

wisely tailored to local tastes—can generate high foreign-affiliate income regardless 

of any particular role for IP. 

This problematic tendency of FBCII to measure income as IP-related when it actually is not has been identified by a number of analysts. Here, for example, is an 

excerpt from a Tax Notes International article that includes the thoughts of Peter 

Merrill of PWC.15

Taxpayers in the services industry may not like the proposal much, particularly if they do not have significant amounts of depreciable property. Merrill pointed out that under the draft [Camp bill], a services firm could face 

a situation in which nearly all of its foreign income becomes FBCII. That 

result is contrary to the residual profit-split method used in transfer pricing, which gives a routine return for things like payroll and other factors 

of production before allocating residual profits. Merrill said the focus on depreciable property has implications for other types of industries, too. Banks, 

for example, have mostly non-depreciable assets would get no return on 

those assets under the formula, he said. Taxpayers who rent buildings and 

equipment abroad would have a huge incentive to buy them. . . . Another 

complication would arise when a company has acquired another company 

that has already depreciated its assets and would therefore have no tangible returns to reduce the amount . . . attributed to intangible income. 

In general, foreign affiliates with low profits—for whatever long-terms structural or 

short-term cyclical reasons—will have little or no FBCII. In contrast, foreign affiliates with large profits and/or little tangible property will have FBCII calculated to 

be very close to their total profits. In a world of constantly evolving global supply 

networks, only some of this variation in calculated FBCII will be driven by variation 

in IP-intensity. This less-than-tight correlation between calculated FBCII and 

IP-intensity is far from ideal. 

These measurement concerns can be demonstrated using publicly available Bureau 

of Economic Analysis (BEA) data on the operations of majority-owned foreign affiliates of U.S.-headquartered multinational companies (see note 12). Figure 1B below 

uses these BEA data for the most recent year available, 2012, to approximate the 

formulaic calculation of FBCII of these foreign affiliates, both for all industries together and for a number of particular industries. 

To estimate FBCII, the formula’s ‘‘gross income’’ is approximated using the BEA’s 

measure of net income.16 The formula’s ‘‘depreciable tangible property’’ is approximated using the BEA’s measure of net property, plant, and equipment (PPE) assets—i.e., the book value of these PPE assets net of accumulated depreciation 

charges. The Discussion Draft may intend to include other types of tangible propVerDate Mar 15 2010 17:20 Oct 17, 2016 Jkt 000000 PO 00000 Frm 00092 Fmt 6601 Sfmt 6621 R:\DOCS\22145.000 TIMD
89 

17 ‘‘Camp’s Approach Treats Most CFC Income as Intangible,’’ by Martin A. Sullivan, in Tax 

Notes International, March 24, 2014. 

erty, but PPE are clearly an important part of this concept. Finally, the publicly 

available BEA data do not contain sufficient detail to adjust FBCII for the other 

‘‘foreign base company income;’’ this may result in a slight over-estimate of FBCII. 

The six industries in Figure 1B highlighted with an asterisk are, as Section 3 will 

discuss, on many measures among America’s most IP-intensive. One is software; the 

other five are part of manufacturing: pharmaceuticals, machinery, computers, electrical equipment, and transportation. 

Figure 1B: Estimated FBCII for U.S.-Multinational Affiliates, 2012 

Industry Group Net Income ($M) Net PPE Assets ($M) Calculated FBCII FBCII Share of NI 

All Industries 1,062,817 1,283,875 934,430 87.9% 

Manufacturing 176,714 399,922 136,722 77.4% 

Pharmaceuticals * 42,376 28,089 39,567 93.4% 

Machinery * 13,252 22,417 11,010 83.1% 

Computers * 36,428 46,456 31,782 87.2% 

Electrical Equipment * 5,366 8,043 4,562 85.0% 

Transportation Equipment * 1,915 50,028 ¥3,088 ¥161.2% 

Software* 14,633 3,128 14,320 97.9% 

Retail Trade 8,991 63,392 2,652 29.5% 

Wholesale Trade 69,593 45,727 65,020 93.4% 

Finance and Insurance 93,665 37,127 89,952 96.0% 

There are two important points from the analysis in Figure 1B. First, FBCII would 

seem to encompass the very large share of total foreign-affiliate net income of not 

just IP-intensive industries but of many other industries as well. For all industries 

this share is estimated to be 87.9 percent. For five of the six IP-intensive industries 

in Figure 1B this share exceeds 80 percent—and for two, pharmaceuticals and software, it exceeds 90 percent. The only other such estimate of FBCII to date, by Martin Sullivan, uses IRS data but reaches a very similar conclusion: his estimates from 

2008 IRS data conclude that for all industries 79 percent of total earnings and profits of foreign subsidiaries would be considered FBCII.17

Whether such breadth of scope was intended when creating FBCII, in light of the 

above discussion of global supply networks this share seems implausibly high. To 

attribute to IP assets about or over 80 percent of all foreign-affiliate earnings misses 

the many other reasons for success such as high-quality products, responsive customer service, and efficient links to input suppliers. It seems to border on tautological to consider advantages of IP as encompassing all the many competitive advantages firms develop and deploy. Indeed, these FBCII calculations might more 

broadly call into question the notion that the Discussion Draft creates a nearterritorial tax system for the United States. If upwards of 87.9 percent of all foreignaffiliate income is immediately taxable as Subpart F FBCII at rates of at least 15 

percent, then only 12.1 percent of foreign-affiliate income would be left eligible for 

territorial treatment. It is doubtful such a regime would be more territorial than 

today’s worldwide-plus-deferral regime. 

The second important message of Figure 1B is the insensitivity of FBCII calculations to legitimate variation in business strategies and environments unrelated to 

IP—even among those industries that scholarship shows are IP-intensive. 

To see this, compare transportation equipment to pharmaceuticals and software. 

Transportation equipment has nearly twice the PPE assets of pharmaceuticals and 

over 10 times that of software, which at least partly reflects the obvious difference 

90 

18For an overview and many references to research studies on global supply networks, see 

American Companies and Global Supply Networks: Driving U.S. Economic Growth and Jobs by 

Connecting with the World, white paper for Business Roundtable and United States Council for 

International Business, Matthew J. Slaughter, 2013. 

in production technologies among the sectors. Building planes, trains, and automobiles requires massive amounts of sophisticated equipment and buildings. And 

the underlying demand dynamics often differ among these sectors. Much of the personal and business demand for transportation equipment is very sensitive to business-cycle conditions such as overall GDP growth, employment, and consumer confidence—conditions that in 2012 remained sluggish and fragile in regions such as 

the Europe. Demand for pharmaceuticals and software, in contrast, is often much 

less cyclically sensitive. 

For these economic reasons, it is not surprising that 2012 net income in transportation equipment was so much lower than in pharmaceuticals and software. But the 

FBCII formula does not account for these economic differences in any way—and 

thus implies a vastly different tax liability for the two sectors. Pharmaceuticals and 

software face an FBCII estimated to be 93.4 percent and 97.9 percent of each’s overall net income, respectively. But transportation equipment, because it earned so little net income and owned so many tangible assets, has negative FBCII. 

Other IP-intensive businesses in Figure 1B resemble pharmaceuticals and software. 

Electrical equipment, for example, has been widely studied as having some of the 

world’s most elaborate global supply networks in which participating companies 

tend to occupy relatively narrow spaces within the networks and contract heavily 

with partners for key intermediate inputs and even for renting shared production 

capacity. Thus it is not surprising how it, too, looks asset-light and has FBCII at 

a high 85 percent share of net income. 

Surely some of the estimated FBCII for affiliates in pharmaceuticals, software, and 

electrical equipment is surely connected to their IP. But some of it is not, and the 

FBCII methodology would allow no way to distinguish these underlying causes. Regardless, of all this calculated FBCII would face an immediate U.S. tax liability of 

between 15 percent and 25 percent—i.e., between 12 and 20 times the effective tax 

rate of 1.25 percent that the Discussion Draft would levy on non-IP related earnings 

of foreign affiliates. 

It is important to stress that, with the continued expansion of global supply networks, foreign affiliates increasingly operate for global distribution, which includes 

exporting goods and services to the United States—either to U.S. parents or to purely domestic unrelated U.S. companies. This increasingly important dimension of 

global supply networks means that over time, a rising fraction of the FBCII calculated in Figure 1B would, under the Discussion Draft, face an immediate tax liability of 25 percent rather than just 15 percent (as discussed earlier in this section). 

Figure 1C demonstrates this point. For the four most recent years of BEA data, the 

figure reports for majority-owned foreign affiliates their exports to the United States 

of goods (exports of services are tracked by BEA only infrequently); their total manufacturing sales, as a proxy for goods sales; and the share of these U.S. exports in 

affiliates’ total manufacturing sales. 

Figure 1C: Rising U.S.-Export Intensity of Foreign Affiliates 

Year Goods Exports to U.S. 

($ Billion) 

Manufacturing Sales 

($ Billion) 

Export 

Share 

2009 258.1 2,029.4 12.7% 

2010 292.6 2,228.6 13.1% 

2011 345.3 2,570.2 13.4% 

2012 346.4 2,525.2 13.7% 

The key message of Figure 1C is the steadily rising share of foreign affiliates’ goods 

production that is exported to the United States: from 12.7 percent in 2009 to 13.7 

percent in 2012. This rising share accords with the substantial body of research that 

has documented the spread of global supply networks.18 Indeed, much of what affiliVerDate Mar 15 2010 17:20 Oct 17, 2016 Jkt 000000 PO 00000 Frm 00094 Fmt 6601 Sfmt 6621 R:\DOCS\22145.000 TIMD
91 

19The trade data cited in this sentence come from the U.S. Census Bureau and the BEA. 20Technical Explanation of the Tax Reform Act of 2014: Title IV—Participation Exemption 

System for the Taxation of Foreign Income, Joint Committee on Taxation, JCX–15–14, February 

26, 2014, p. 40. 

ates are exporting to America are today intermediate inputs essential in the production of goods and services made in America. In recent years, over 60 percent of 

America’s goods imports were intermediate inputs that were used in America with 

American workers, capital and know-how.19 To succeed in global supply networks 

increasingly requires U.S. companies to import as well as export. ‘‘Made in America’’ 

increasingly hinges on creative new ways to make goods and services in conjunction 

with the world—including in conjunction with the foreign affiliates of U.S.-based 

multinationals. Yet under the Discussion Draft, the FBCII of these foreign affiliates 

connected to exports back to America and other ways of serving U.S. customers will 

face an immediate tax liability of 25 percent—versus just the effective tax rate of 

1.25 percent that the Draft would levy on non-IP related earnings of foreign affiliates. 

Whether taxed at a rate of 15 percent or 25 percent, Figures 1B and 1C together 

make clear that the tax base of foreign-affiliate FBCII income would be very large: 

hundreds of billions of dollars in 2012 alone. Again, the U.S. parents of these foreign 

affiliates would pay a U.S. tax only above and beyond whatever foreign taxes these 

affiliates would first pay. But the result would be a minimum effective tax on all 

foreign-affiliate income treated as FBCII, with any foreign tax rate below 15 percent 

(or 25 percent) on FBCII topped up to at least 15 percent (or 25 percent) for the 

U.S. owners. 

For these reasons the Joint Tax Committee forecasts that the Draft ‘‘increases the 

U.S. taxation of income derived from intangibles owned or licensed by a CFC.’’ 20

This tax increase would be large. JCT has estimated that this new Subpart F 

FBCII, along with some related changes to Subpart F income, would raise U.S. tax 

revenues by $115.6 billion over the years of 2014 through 2023. 

The Discussion Draft’s tax treatment of IP-intensive activities of multinational 

companies would be very discriminatory relative to all other activities. The IPrelated income of foreign-affiliates would lose current-law deferral without any offsetting territoriality and thus would be subject to a minimum tax rate of between 

15 percent and 25 percent—between 12 and 20 times the effective tax rate of 1.25 

percent that the Discussion Draft would levy on non-IP related income of foreign 

subsidiaries. 

Section Two: 

Three Ways In Which the Discussion Draft Would 

Disadvantage the Foreign-Affiliate IP Income of American Companies 

In three important ways, the Discussion Draft would disadvantage IP income 

earned abroad by U.S.-based multinationals. First, the U.S. tax burden on IP income under the Draft would be higher compared with the tax burden on IP income 

under current law. Second, the U.S. tax burden on IP income under the Draft 

would be higher compared with the U.S. tax burden on many other forms of business income under the Draft. Third, the U.S. tax burden on IP income of U.S.- 

headquartered multinational companies would be higher relative to the IP income 

of their foreign competitors under the Draft compared with under current law. 

This third aspect, in particular, would aggravate the already nettlesome issue of 

corporate inversions dominating much recent U.S. tax discussion and would further encourage the foreign acquisition of U.S.-headquartered IP-intensive firms. 

Section 1 focused on the mechanics of Foreign Base Company Intangible Income 

(FBCII) under the Discussion Draft. The analysis highlighted important problems, 

taking as a given the current structure of operations of U.S.-headquartered multinational companies. Section 2 broadens the focus to analyze the strategic choices 

that multinational companies intensive in intangible property (IP) would face under 

92 

21Macroeconomic Analysis of the ‘‘Tax Reform Act of 2014,’’ Joint Committee on Taxation, 

JCX–22–14, February 26, 2014, pp. 15–16. 

the Discussion Draft. For these IP-intensive multinational companies, three different strategic trade-offs are important to consider: 

1. The U.S. tax burden on foreign-affiliate IP income under the Draft compared 

with the tax burden on foreign-affiliate IP income under current law. 

2. The U.S. tax burden on foreign-affiliate IP income under the Draft compared 

with the U.S. tax burden on other forms of foreign-affiliate business income 

under the Draft. 

3. The U.S. tax burden on foreign-affiliate IP income of U.S.-headquartered multinational companies relative to the IP income of their foreign competitors under 

the Draft compared with under current law. 

The central message of this section is that the U.S. tax burden on foreign-affiliate 

IP income under the Discussion Draft is higher in all three comparisons: relative to 

current law, relative to other business activities under the Draft, and relative to foreign competitors under the Draft. From all three of these perspectives, U.S.- 

headquartered multinational companies will be disadvantaged by the treatment of 

foreign-affiliate IP income under the Discussion Draft. 

Comparing Foreign-Affiliate IP Income Under the Discussion Draft Versus Under 

Current Law 

Under current law, income related to IP that is earned by a foreign subsidiary of 

a U.S.-headquartered multinational can be deferred and is not a taxable event until 

distributed to the U.S. parent. Thus, a foreign subsidiary’s intangible income is not 

taxable in the United States so long as it is not repatriated back to the U.S. parent. 

Stated differently, that foreign subsidiary’s IP income is not considered part of immediately taxable income. 

The Discussion Draft would exempt from U.S. taxation most of the non-IP income 

of the foreign subsidiaries of U.S. multinationals, by establishing a dividendsreceived deduction of 95 percent on the foreign earnings of U.S.-based multinationals. This would result in an effective U.S. tax rate of just 1.25 percent on the 

non-IP related foreign-affiliate earnings repatriated back to U.S. parents through 

dividends. The intangible income of these foreign subsidiaries would be treated 

quite differently, however. Section 4211 of the Discussion Draft would create a new 

category of immediately taxable income, FBCII, creating a worldwide tax base (without deferral) for IP-related income at an effective rate of either 15 percent or 25 percent—12 to 20 times more than the 1.25 percent effective tax rate on non-IP income 

of these subsidiaries. 

In a Discussion Draft world, U.S.-based multinational companies would thus realize 

a smaller after-tax rate of return on IP investments relative to today’s world because the incremental U.S. tax liability on that income would be realized much earlier in time. This higher taxation on IP income would, all else being equal, reduce 

the incentives of U.S.-based multinationals to invest in IP assets because of this 

lower after-tax rate of return. Indeed, JCT analysis of the economic impacts of the 

Discussion Draft finds that lower investment rates in IP—presumably through 

channels such as lower R&D spending—would, along with the loss of accelerated depreciation, contribute to a slightly smaller U.S. capital stock under the Draft than 

under current law. ‘‘Overall, the proposal is expected to increase the cost of capital 

for domestic firms, thus reducing the incentive for investment in domestic capital 

stock.’’ 21

The bottom line here is that the higher U.S. tax liability on foreign-affiliate IP income under the Discussion Draft would induce U.S.-headquartered multinational 

companies to undertake less IP investment than they would under current law—e.g., 

less R&D spending and less other forms of knowledge discovery. As Section Three 

of this paper will discuss, IP has long driven the large majority of the productivity 

growth at the foundation of generations of American economic success—investment 

in which is complemented by the foreign affiliates of U.S. multinationals. 

Comparing Foreign-Affiliate IP Income Under the Discussion Draft Versus Other 

Business Activities Under the Discussion Draft 

A second important perspective to consider is the U.S. tax burden on foreignaffiliate IP income compared with the U.S. tax burden on all other forms of business 

income, both under the Discussion Draft. Here, three important points merit stressing. 

93 

22The underlying data in Figure 2A come from Table 1.1.5 of the National Income and Product Accounts of the Bureau of Economic Analysis, accessed on-line at www.bea.gov. The underlying dollar figures in Figure 2A are annual nominal totals. These two components of total U.S. 

capital investment together are the closest NIPA measure of the tangible assets specified in the 

Discussion Draft. 

First, economic theory clearly implies that pre-tax rates of return on IP investments 

should be higher than rates of return on investments in most tangible properties. 

This is because of the inherent riskiness of new-knowledge discovery: the uncertain 

prospects of cutting-edge innovations means the returns to successful discoveries 

should be and are high to compensate for their increased riskiness. Yet, because the 

intent of FBCII is to implement an immediate U.S. tax liability on foreign-affiliate 

IP income but not on income from other less-risky assets and activities, in practice 

the Discussion Draft would dull the economic incentive that induces companies to 

undertake risky investments in knowledge discovery. 

Second, some companies in IP-intensive industries may be less intensive in physical 

capital—e.g., property and equipment—than will other, more-traditional industries. 

Of course the optimal blend of knowledge and human capital in operations varies 

widely across companies—as was discussed in Section 1 in the context of measuring 

FBCII in an era of global supply networks—but some highly innovative firms do not 

use much tangible capital. 

Third, evolving global supply networks mean that many globally engaged companies 

connect with foreign partners to help them produce and distribute their knowledgeintensive products in ways that do not require ownership abroad of a great deal of 

depreciable tangible assets. Section 1 discussed this important consideration in 

greater detail. 

The net implication of these three business-strategy and economic considerations is 

that the calculation of FBCII will likely mean a greater share of foreign-affiliate income will be subject to immediate incremental U.S. tax for IP-intensive multinationals than will be the case for multinationals concentrated on other, moretraditional business activities. And, this calculated IP income of foreign affiliates will 

be taxed at much higher rates than the non-IP income of these foreign affiliates: at 

rates of 15 percent up to 25 percent, in contrast to just 1.25 percent. Incentives matter, and all of these considerations will tend to reduce the after-tax rate of return 

on U.S. multinationals’ investments in IP assets—and thus will induce these multinationals to invest less in IP assets and more in non-IP assets. 

For foreign affiliates, this skewing of business decisions away from IP might take 

a number of forms. The tax-induced value of owning tangible assets by foreign affiliates might compel multinationals to buy rather than lease tangible assets—e.g., to 

purchase an office building where employees work rather than simply leasing space 

in that building—purely for tax reasons rather than for more-fundamental businesscompetitiveness reasons. 

This skewing of business decisions away from IP might also compel U.S.-based multinationals to invest in tangible assets in their foreign affiliates rather than in their 

U.S. parent operations. Creating incentives to invest in physical capital abroad, not 

in America, would never make wise economic policy. But it would be especially unwelcome today given Figure 2A. For each year since 1980, Figure 2A reports America’s total investment in non-residential structures and equipment as a share of U.S. 

GDP (gross domestic product, the value of all newly produced goods and services).22

94 

The key message of Figure 2A is that investment in the United States in business 

equipment and structures as a share of GDP has been falling for decades. Except 

for the increase in this share over much of the 1990s driven by the IT revolution 

and the resulting accelerated investment in IT capital goods, the share has fallen 

from a bit above 12 percent around 1980 to only about 8 percent in recent years. 

Indeed, slow growth in capital investment is one reason for the sluggish U.S. economic recovery from the Great Recession. Tax policies that incentivize U.S.- 

headquartered multinationals to invest in physical capital outside America without 

any underlying economic or strategic rationale to do so—multinationals that, as Section 3 will document, in 2012 accounted for 43.3 percent of all the U.S. investment 

in Figure 2A—would be especially unwelcome today, for reasons including the fact 

that such investment tends to spur job creation. 

Tax distortions that disfavor one line of business relative to others are precisely what 

tax reform should avoid. The U.S. tax code should not induce U.S.-headquartered 

companies to migrate away from IP investments because, as Section 3 will discuss, 

IP has long been central to U.S. economic strength. Tax reform should not discriminate against any particular business activity—especially not IP creation and development. Yet the Discussion Draft would do just that: by raising the U.S. tax burden 

on foreign-affiliate IP income compared with the U.S. tax burden on many other 

forms of foreign-affiliate business income. 

The Discussion Draft Would Undermine the International Competitiveness of IPIntensive U.S. Multinationals 

A third important perspective to consider is the U.S. tax burden on IP income of 

U.S.-headquartered multinational companies relative to the IP income of their foreign competitors. Suppose an IP-intensive U.S.-headquartered multinational competes in world markets against another IP-intensive multinational headquartered in 

a territorial country. Suppose further that in some third market these two companies earn the same pre-tax income and thus face the same (if any) third-market tax 

liability. Under current law, the U.S. company faces an incremental U.S. tax liability that its foreign competitor does not—but this U.S. tax liability can be deferred 

by not repatriating these foreign earnings. So, under current U.S. law of worldwide 

taxation plus the possibility of deferral, the U.S. company can structure its operations to compete evenly in terms of not facing any immediate U.S. tax liability. 

Under the Discussion Draft, the situation would be markedly different. The U.S. 

multinational would face an immediate tax liability—at least 15 percent and as high 

as 25 percent—on the FBCII calculated for its foreign affiliate. As shown in Section 

1, for most affiliates their taxable FBCII will likely constitute the large majority of 

their net income. Because FBCII would apply only to U.S.-based companies, the territorial-based foreign competitor would face no such new tax liability. Thus the Discussion Draft would disadvantage U.S. IP-intensive companies against the rest of the 


120115.002
95 

23See surveys in, e.g., Cohen, Wesley, and Steven Klepper, 1996, ‘‘A Reprise of Size and 

R&D.’’ Economic Journal, 106(437). Another useful survey is Acemoglu, Daron, Ufuk Akcigit, 

Nicholas Bloom, and William Kerr, 2012, ‘‘Innovation, Reallocation, and Growth,’’ manuscript. 24 In Figure 2B, data were obtained from the BEA multinationals data online at www.bea.gov. 

world’s IP-intensive companies. The short-term and long-term distortions of this tax 

disadvantage created by FBCII are many. 

Start with the simple math of cash flows. All else being equal, U.S.-headquartered 

multinationals would have smaller after-tax cash flows from which to fund their 

R&D efforts to discover and develop new IP. This plus the reduced after-tax return 

on any IP investments would, as discussed earlier in this section, reduce the total 

amount of U.S. IP investment. Seen relative to other countries, this would also tend 

to mean more IP innovation being done abroad in foreign-headquartered global companies that would not face this FBCII tax burden—all at a time where, as Section 

3 discusses, it is well documented that America’s predominance in the world’s IP 

production has long ago passed. 

The differential after-tax cash flows would also mean that foreign-based companies 

would tend to outbid U.S.-based companies for other IP assets around the world, 

such as inventive new companies. This foreign-company bidding advantage may be 

especially salient in many IP-intensive industries in America in which start-ups 

play a central creative role. Under the Discussion Draft, these American start-up 

companies and/or their IP assets would be more likely to be purchased by foreign 

companies. 

Over time, the FBCII disadvantage facing U.S.-based IP-intensive companies would 

make them more vulnerable to acquisition by their foreign-based competitors: at 

least to acquisition of their foreign affiliates, and in many cases to acquisition of 

their U.S. operations as well. Indeed, the already nettlesome issue of corporate inversions—in which the merger of a U.S. and foreign company results in a company 

domiciled outside America—would be aggravated for U.S.-headquartered IPintensive firms. Under current law, today many of these U.S. companies already can 

realize tax savings on future foreign-affiliate earnings if incorporated outside of 

America. For many IP-intensive companies that would face certain U.S. taxation on 

their FBCII under the Discussion Draft, the tax advantages would be even stronger 

either of being acquired by a larger foreign company or of acquiring a smaller foreign company and inverting. 

There is one other important dimension on which the Discussion Draft would disadvantage U.S.-based IP-intensive companies: it would undermine the likelihood of 

new IP-intensive companies being founded in America. The same logic by which the 

Discussion Draft would disadvantage existing U.S.-based IP-intensive multinationals against their foreign counterparts would be a force compelling new IPintensive companies to be established abroad rather than in the U.S. This new tax 

burden on U.S. start-ups would come at a time when U.S. start-up rates have already been falling. 

Research has long documented that young startup companies are a key source of 

U.S. innovation dynamism. Younger, smaller firms tend to produce more innovations per dollar of innovation effort than do many older, larger companies. This innovation edge stems from a number of impediments facing many older and larger 

companies: worries about innovation disrupting existing lines of business; more-rigid 

bureaucracies that inhibit new ideas; and weaker individual incentives connected to 

innovation success.23 (Of course, U.S.-based multinational companies tend to contradict this overall pattern; as documented in Section 3, they are among America’s 

most dynamic and innovative companies—thus their ability to succeed globally, an 

ability that would be impaired by tax reform as envisioned by the Discussion Draft.) 

Tax policy that disadvantages the returns to IP income will be tax policy that inhibits the start-up of new IP-intensive companies in America. Lest one think from the 

above discussion that all globally competitive U.S. companies are monolithically 

large and old, that is not the case. By virtue of having operations outside America, 

in scope and in aspiration all U.S.-based multinationals are expansive. Yet, there 

are striking differences in their size in terms of common metrics such as employment and sales. Figure 2B documents this wide range: For the most recent year of 

data available, 2009, it splits the 2,347 U.S.-based multinational companies into 

four groups categorized by the number of U.S.-parent employees.24

96 

25This figure is reproduced from ‘‘The Role of Entrepreneurship in U.S. Job Creation and Economic Dynamism,’’ Journal of Economic Perspectives, Summer 2014, pp. 3–14, by Ryan Decker, 

John Haltiwanger, Ron Jarmin, and Javier Miranda. 

At one end of the spectrum, 415 companies each employ more than 10,000 people 

in America—indeed, an average of 43,630 workers each. At the other end of the 

spectrum, nearly 50 percent more multinationals, 613, each employ fewer than 500 

people in America—and thus, as this report later discusses, fit the U.S. government 

definition of being a small or medium-sized enterprise (SME). Many of these SME 

multinationals are likely dynamic, fast-growth companies that were recently ‘‘born’’ 

into the group of U.S.-based multinationals by establishing their first foreign affiliate. Many of America’s largest and most successful companies today once started 

small, with the quintessential person pursuing a dream from a garage or dorm 

room. 

The fact that today 26.1 percent of U.S. multinationals are SMEs speaks to how diverse these important companies truly are. Many small multinationals dream of 

growing much bigger tomorrow. For those that are IP-intensive, tax disadvantaging 

IP income through the Discussion Draft would make achieving these dreams harder. 

There is clear international evidence that tax burdens inhibit entrepreneurship. A 

recent study spanning 85 countries over decades estimated the drag of corporate 

taxes on entrepreneurship (measured either as new business establishments and 

also the rate of new-business registration). It found that a 10-percentage point increase in corporate tax rates reduces the rate of new-business startups by an average of 1.4 percentage points, which is 17.5 percent below the average startup rate 

of about 8 percent. This study also found that a similar increase in corporate taxes 

reduces a country’s ratio of capital investment to GDP by a sizable 2–2.5 percentage 

points. 

And it is important to recognize that America today is already facing an ongoing, 

worrisome decline in the rate of new-business start-ups. In the early-to-mid 1980s, 

each year about 12 percent to 13 percent of all U.S. firms were newly started that 

year. Starting in the late 1980s, however, this startup rate began to decline. This 

decline long pre-dates the World Financial Crisis, but its pace has quickened recently such that today only about 7 percent to 8 percent of all U.S. companies are 

startups. 

A consequence of this drop in the rate of new-business startups is that the share 

of the overall U.S. economy—in terms of the number of companies or where people 

work—accounted for by young firms has been steadily declining. Figure 2C, reproduced from a recent publication on waning U.S. economic dynamism, shows this.25


120115.003
97 

26Startup statistics in this and the previous paragraph come from the study in note 24 and 

also from Haltiwanger, John, Ron Jarmin, and Javier Miranda. 2012. Where Have All the Young 

Firms Gone? Kansas City: Kauffman Foundation. 

Defining young firms as those aged five or less, in the early 1980s nearly 50 percent 

of all U.S. companies were young. Today that share is down to only about 39 percent—the lowest on record— with falls across all states. Similarly, the share of U.S. 

employment at these young firms has fallen from about 19 percent in the early 

1980s to barely 10 percent today. And the share of job creation each year accounted 

for by these young firms has also been sliding: from over 40 percent in the early 

1980s to only about 30 percent today.26

Taken together, ebbing startup trends indicate the United States is becoming less 

entrepreneurial. It has a much lower rate of new-business startups and thus a much 

smaller share of new firms in the overall private sector. The underlying causes at 

play are not fully known. That said, this development should worry policymakers. 

Given the historical importance of startups in many IP-intensive industries, tax 

disadvantaging IP income through tax reform as envisioned by the Discussion Draft 

would dampen innovation in IP-startups and reduce the number of such start-ups 

arising in the United States. And compounding this dampening, high-talent individuals might accordingly be more inclined to seek employment with foreign-based 

rather than U.S.-based companies. 

The U.S. tax burden on foreign-affiliate IP income under the Discussion Draft 

would be higher in three important comparisons: relative to current law, relative 

to other business activities under the Draft, and relative to foreign competitors 

under the Draft. From all three of these perspectives, U.S.-headquartered multinational companies would be disadvantaged by the treatment of foreign-affiliate 

IP income under the Discussion Draft. This legislation would thus induce U.S.- 

headquartered multinationals to invest less in new ideas and innovation, to invest 

more in non-IP assets, to make those non-IP investments outside America rather 

than inside, and to be acquired by a larger foreign company or to acquire a smaller foreign company and invert. It would advantage foreign-headquartered multinationals not subject to its worldwide taxation in bidding for IP assets around the 

world, and it would discourage the start-up of new IP-intensive companies in 

America. 


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27See page 7 of The White House. 2011. A Strategy for American Innovation: Securing Our 

Economic Growth and Prosperity. February: National Economic Council, Council of Economic 

Advisers, and Office of Science and Technology Policy. 28See page 1 of United States Department of Commerce. 2012. Intellectual Property and the 

U.S. Economy: Industries in Focus. Washington, DC: Economics and Statistics Administration 

and the United States Patent and Trademark Office. 

Section Three: 

How IP Innovation Strengthens the U.S. Economy 

Globally engaged U.S. companies, which create the large majority of America’s IP, 

increasingly rely on their worldwide operations to maximize the creativity and 

benefits of their U.S. inventions. Globally engaged U.S. companies have long performed the large majority of America’s IP discovery and development. Increasingly 

central to America’s IP success is the ability of U.S. companies to deploy their IP 

abroad-especially in light of the worrisome recent slowdown in U.S. productivity 

growth. 

Intangible property (IP) has long played a central role in driving growth in U.S. output, jobs, and income—and this role will be even more important in the years 

ahead. 

The Past: The Massive Contribution of Innovation and IP to America’s Economy 

Since the founding of the American republic, IP has played a central role in driving 

growth in U.S. output, jobs, and income. This central economic fact of knowledge discovery and development via innovation has been widely established by academic and 

policy research in recent decades, and it is widely recognized by leaders in business, 

in government, and beyond. For example, here is an opening of a recent White 

House report on innovation in America. 

The history of the American economy is one of enormous progress associated with remarkable innovation. . . . Innovation—the process by which individuals and organizations generate new ideas and put them into practice—is the foundation of American economic growth and national competitiveness. Economic growth in advanced countries like the United States is 

driven by the creation of new and better ways of producing goods and services, a process that triggers new and productive investments.27

Here is a similar statement on the centrality of IP to America’s economic growth 

and overall success from a recent landmark study by the U.S. government of IP and 

the U.S. economy that focused on a subset of IP: patents, copyrights, and trademarks, or ‘‘intellectual property.’’ 

Innovation, the process through which new ideas are generated and put 

into commercial practice, is a key force behind U.S. economic growth and 

national competitiveness. . . . Innovation protected by intellectual property 

rights is key to creating new jobs and new exports. Innovation has a positive pervasive effect on the entire economy, and its benefits flow both upstream and downstream to every sector of the U.S. economy. Intellectual 

property is not just the final product of workers and companies—every job 

in some way, produces, supplies, consumes, or relies on innovation, creativity, and commercial distinctiveness.28

IP created through innovation has been the foundation of America’s economic 

strength. Over the arc of American economic history, many innovations have been 

incremental—slight refinements of products and processes that better served companies’ customers. Other innovations have been truly disruptive and transformational, 

creating entire new industries and jobs—often while simultaneously displacing existing companies, jobs, and technologies. 

The cumulative economic benefit of IP developed via innovation—indeed, the cumulative impact on the average standard of living of a country’s citizens is best expressed in terms of productivity: the average value of output of goods and services 

a country produces per worker. The following quotation from Nobel laureate Paul 

Krugman concisely makes this point that is widely acknowledged by leading economists of all political persuasions. 

99 

29Pages 9 and 13 of Krugman, Paul R. 1990. The Age of Diminished Expectations. Cambridge: 

MIT Press. 30Page 316 of Solow, Robert M. 1957. ‘‘Technical Change and the Aggregate Production Function,’’ The Review of Economics and Statistics, 39(3). See also his closely related work: ‘‘A Contribution to the Theory of Economic Growth,’’ Quarterly Journal of Economics, 70(1), 1956. 31 Jones, Charles I. 2002. ‘‘Sources of U.S. Economic Growth in a World of Ideas.’’ American 

Economic Review, 92(1). 32For example: Feenstra, Robert C., Benjamin R. Mandel, Marshall B. Reinsdorf, and Matthew J. Slaughter, 2013, ‘‘Effects of Terms of Trade Gains and Tariff Changes on the Measurement of U.S. Productivity Growth,’’ American Economic Journal: Economic Policy, 5(1). 33 Jones and Williams (1998), p. 1121, estimate ‘‘the social return [to R&D] of 30 percent and 

a private rate of return of 7 to 14 percent: optimal R&D spending as a share of GDP is more 

than two to four times larger than actual spending.’’ Bloom, et al (2012), p. 3, report, ‘‘We find 

that technology spillovers dominate, so that the gross social returns to R&D are at least twice 

as high as the private returns. . . . We estimate that the (gross) social return to R&D exceeds 

the private return, which in our baseline specification are calculated at 55 percent and 21 percent, respectively. At the aggregate level, this implies under-investment in R&D, with the soContinued 

Productivity isn’t everything, but in the long run it is almost everything. 

A country’s ability to improve its standard of living over time depends almost entirely on its ability to raise its output per worker . . . the essential 

arithmetic says that long-term growth in living standards . . . depends almost entirely on productivity growth.29

The economics of this ‘‘essential arithmetic’’ for why productivity matters is very 

simple. The more and better quality goods and services people produce—that is, the 

more productive they are—the more income they receive and the more they can consume. Higher productivity means a higher standard of living. 

How can a country raise its productivity? There are two basic means. One is to save 

and invest to accumulate the other inputs people work with to produce things. The 

most important other input needed is the tangible capital discussed earlier in this 

report, broadly defined as goods and services that help people make other goods and 

services—e.g., buildings, machinery, and software. 

The second way to raise productivity is to improve the technological know-how for 

transforming inputs into outputs thanks to innovation. New products and processes 

allow workers to make new and/or more goods and services. What makes innovation 

so potentially powerful for productivity is that many ideas don’t depreciate with extensive use (unlike, e.g., capital goods). Thus, the more ideas a country has today, 

the easier it is to produce additional ideas tomorrow. 

So, what do the data say has driven America’s rising productivity—and thus average 

standards of living—over the generations? A large body of academic and policy research has found that the overwhelming majority of America’s growth in productivity 

and living standards over the 20th century was driven by new IP and the resulting 

technological advances of new products and processes, not by tangible capital. 

Robert Solow, in seminal work that ended up being a major reason for being awarded the Nobel Prize in economics, calculated that the very large majority of U.S. 

growth during the first half of the 20th century was driven by innovation and technological progress. Of the rise in real GDP per person-hour in the United States 

from 1909 to 1949, he concluded that ‘‘It is possible to argue that about one-eighth 

of the total increase is traceable to increased capital per man hour, and the remaining seven-eighths to technical change.’’ 30 Looking at the second half of the 20th century, an authoritative study found that for growth in U.S. per capita GDP from 1950 

to 1993, 80 percent was accounted for by greater discovery and development of innovative ideas fostered by the combination of rising educational attainment and rising 

R&D effort.31

And looking at the most recent period of strong U.S. productivity growth that ran 

for a decade several years starting around 1995, the majority of that growth was 

driven by faster technological innovation in information-technology (IT)—one of the 

most IP-intensive industries. Post-1995, technical change has accounted for well 

over half of U.S. per capita GDP growth.32

Substantial research has found that IP and innovation matter because the social 

benefits of knowledge often exceed its private benefits—in the jargon of economics, 

discovery of ideas generates ‘‘positive externalities’’ through several channels (such 

as worker mobility, and the more-general property that ideas, different from nearly 

all goods and services, are easily shared). Studies have found that the social return 

to R&D tends to be at least double the private return.33

100 

cially optimal level being over twice as high as the level of observed R&D.’’ Jones, Charles I., 

and John C. Williams, 1998, ‘‘Measuring the Social Returns to R&D,’’ Quarterly Journal of Economics, 113(4). Bloom, Nicholas, Marck Schankerman, and John Van Reenen, 2012, ‘‘Identifying 

Technology Spillovers and Product-Market Rivalry,’’ Manuscript. 34 Both quotations in this paragraph come from p. 65 and p. 43, respectively, of National Research Council of the National Academies, 2012, Rising to the Challenge: U.S. Innovation Policy 

for the Global Economy, Washington, DC, The National Academies Press. 35Page 173 of: Hall, Robert E., and Charles I. Jones, 1997, ‘‘Levels of Economic Activity 

Across Countries,’’ American Economic Review, 87(2). 36See, for example, Bloom and Van Reenen (2002) cited in note 33. 37This U.S. Department of Commerce study (cited in note 28) focused on utility patents, 

which it defines (p. 5) as ‘‘patents which assist owners in protecting the rights of inventions and 

innovative processes.’’ Utility patents can be applied to processes, machines, articles of manufacture, and compositions of matter. The other two categories of U.S. patents are design patents, 

which cover the design of items (rather than the items themselves), and plant patents, which 

cover innovations of living plants. Patents enable the owner to pursue legal action to exclude, 

for a finite amount of time, others from making, using, or selling that invention in America. 

Patents are issued to individual inventors, who as they like can assign ownership rights to other 

individuals, corporations, universities, other organizations. 38 As described by U.S. Department of Commerce (2012), p. 29, copyrights protect ‘‘original 

works of authorship. These works must be fixed in a tangible form of expression, meaning that 

concepts that never leave the confines of our minds cannot be copyrighted. Protection under 

copyright, which lasts for the life of the author plus an additional 70 years, is secured automatically when a work is created. Neither publication nor registration with the U.S. Copyright Office 

is required to secure copyright protection. But registering a copyright does establish a public 

record of the copyright, and it can be beneficial because of incentives provided to encourage registration.’’ Works eligible for copyright protection include literary works, computer programs, 

musical works, dramatic works, pictorial and graphic works, motion pictures, and sound recordings. More than 33.7 million copyrights have been registered in America since Congress enacted 

the first copyright law in 1790. In 2009, more than 382,000 new basic copyrights were registered. 

Public policies that help foster and protect IP and innovation have long been an essential ingredient to America’s overall economic success. ‘‘Strong protection of intellectual property rights, business-friendly bankruptcy laws, a flexible labor force, and 

an entrepreneurial culture and legal system that favor risk taking and tolerate failure are among the framework conditions that have kept the U.S. at the forefront 

of innovation. Another crucial American advantage has been its openness to foreigners’’—especially because of immigration’s contribution to the talent, such as engineers and scientists, that discover, develop, and implement IP.34

Substantial academic and policy research has demonstrated how appropriate public 

policies have fostered America’s innovation strength—especially when compared to 

other countries that are far less innovative. ‘‘Differences in levels of economic success across countries are driven primarily by the institutions and government policies (or infrastructure) that frame the economic environment in which people 

produce and transact. Societies with secure physical and intellectual property rights 

that encourage production [capital accumulation, skill acquisition, invention, and 

technology transfer] are successful.’’ 35 And one important policy that shapes America’s overall innovation environment is its tax treatment of IP. 

The Present: The Strength of IP-Intensive Industries in America’s Economy Today 

IP’s central role in driving growth in output, jobs, and income for the overall U.S. 

economy can perhaps best be seen at the level of individual companies and industries. Examples of innovative companies achieving great success thanks to their IP 

abound in the public lore: e.g., companies born in the garages of Silicon Valley 

(sometimes literally, other times proverbially) that grow into global leaders in technology and many other IP-intensive industries. These examples are clearly borne 

out in more-systematic research. Companies that produce more IP tend to be more 

successful on several dimensions including profitability, revenues, and employment.36 Looking more broadly, entire new industries such as biotechnology and software have been created by new IP—new industries that, as explained above, have 

boosted national output, created jobs, and raised standards of living. 

The U.S. Department of Commerce recently undertook a landmark study aiming 

both to identify IP-intensive industries and to document their productivity-leading 

characteristics and the overall economy. Drawing on records and resources such as 

the USPTO, this study identified 75 industries (out of 313 total) that produce large 

amounts of IP measured by the three forms of IP-protection that entail governmentgranted or government-recognized legal rights: patents,37 copyrights,38 and tradeVerDate Mar 15 2010 17:20 Oct 17, 2016 Jkt 000000 PO 00000 Frm 00104 Fmt 6601 Sfmt 6621 R:\DOCS\22145.000 TIMD
101 

39Trademarks protect the brands of goods and services. As defined by the U.S. Department 

of Commerce (2012), p. 11, a trademark is ‘‘a word, phrase, symbol, design, or combination 

thereof that identifies and distinguishes the source of the goods of one party from those of others. . . . Unlike a patent, which protects an invention, or a copyright, which protects a work 

of original authorship, a trademark does not protect a new product or service per se. A trademark instead confers protection upon the brand or identity of a good, thus preventing competitors from leveraging another firm’s reputation and confusing consumers as to the source of the 

goods. Service marks are similar in nature to trademarks, but distinguish the source of a service 

rather than a good.’’ With payment of a nominal fee, any company or individual, American or 

foreign, can apply to register a trademark with the United States Patent and Trademark Office. 

Once granted, trademark registrations can remain in force indefinitely as long as the trademark 

remains in active use and maintenance payments are made. 40What is tracked here is average weekly earnings of private wage and salary workers. Included in wages are pay for vacation and other paid leave, bonuses, stock options, tips, cash 

value of meals and lodging, contributions to deferred compensation plans such as 401(k) plans. 

All data in this paragraph, in the following paragraph, and in the related figure and related 

discussion come from U.S. Department of Commerce (2012). 

marks.39 These industries were collectively defined to be ‘‘IP-intensive.’’ Figure 3A 

reports their share of several key dimensions of U.S. economic activity in 2010. 

The key message of Figure 3A is that America’s IP-intensive industries perform large 

shares of America’s economic activities that together support high and rising standards of living. 

• Employment: IP-intensive industries directly employed 27.1 million jobs, 18.8 

percent of total U.S. jobs (counting payroll jobs plus the self-employed and also 

unpaid family workers). IP-intensive industries supported an additional 12.9 

million jobs indirectly through their supply-chain intermediate-input purchases 

of goods and services needed to make IP-intensive products. So, IP-intensive industries supported a total of 40.0 million U.S. jobs, 27.7 percent of the national 

total. If anything, this jobs tally is conservative because it does not examine indirect jobs downstream, e.g., in distribution and trade of IP-intensive products. 

• Output: IP-intensive industries produced 34.8 percent of all U.S. output (measured in terms of GDP)—nearly $5.1 trillion. 

• Exports: IP-intensive industries exported $775 billion of merchandise to the rest 

of the world. This constituted 60.7 percent of total U.S. goods exports. From 

2000 to 2010, IP-intensive exports expanded by 52.6 percent. 

For workers in IP-intensive industries, the bottom line of all these productivityenhancing activities has been high and rising earnings. In 2010, average weekly 

wages in IP-intensive industries were 42 percent above that of other industries 

($1,156 versus $815). This IP compensation premium has been growing over time: 

from 22 percent in 1990 and 38 percent in 2000 to 42 percent in 2010.40


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41Figures O–27 and O–28 of: National Science Board, 2012, Science and Engineering Indicators 2012, Arlington, VA: National Science Foundation (NSB 12–01). 42Pages 1–5 of: National Academy of Sciences, National Academy of Engineering, and Institute of Medicine, 2010, Rising Above the Gathering Storm, Revisited: Rapidly Approaching Category 5, Washington, DC: The National Academies Press. 43The White House (2011), p. 8 as cited in note 27. 44For the three studies listed, see World Economic Forum (2014), World Intellectual Property 

Organization and INSEAD (2012), and Atkinson and Ezell (2012). World Economic Forum, Center for Global Competitiveness and Performance, 2014, The Global Competitiveness Report: 

2014–2015. World Intellectual Property Organization and INSEAD, 2012, The Global Innovation 

Index 2012: Stronger Innovation Linkages for Global Growth, Fontainebleau: INSEAD Press. Atkinson, Robert D. and Stephen J. Ezell, 2012, Innovation Economics: The Race for Global Advantage, Yale University Press: New Haven and London. 

Part of this compensation premium is explained by the higher average talent of 

workers in IP-intensive industries. 42.4 percent of workers aged 25 and older in IPintensive industries had a bachelor’s degree or higher—versus just 33.2 percent in 

the private sector. IP-intensive demand is commensurately lower for those with 

some college or an associate degree (27.4 percent vs. 27.7 percent), for high-school 

graduates (25.2 percent vs. 28.9 percent), and for high-school dropouts (5.0 percent 

vs. 9.2 percent). 

The contributions to the U.S. economy of IP-intensive industries looks strong not 

only in and of itself, as indicated above, but also in relation to other countries as 

well. In recent years the United States remains the world’s largest producer of 

many IP-intensive goods and services: in 2010, $3.6 trillion of knowledge-intensive 

services and $386 billion in high-technology manufactures, according to estimates by 

the U.S. National Science Foundation.41

The Future: Signs that America’s IP Strength Is Waning 

Despite America’s historic strength in creating IP and transforming IP innovations 

into new products, companies, industries, and jobs, concern is rising among leaders 

in both the private and public sectors that America’s IP strength is waning. 

Perhaps the most alarming case for America’s waning innovation strength has been 

made by the 2007 initial and 2010 follow-up Gathering Storm reports—alarming, 

not alarmist, because of the breadth of data brought to bear in this pair of studies 

for the National Academies of Sciences and Engineering by a distinguished committee comprised of leading academics, university presidents, CEOs of global firms, 

and Nobel laureates. 

It is widely agreed that addressing America’s competitiveness challenge is 

an undertaking that will require many years if not decades . . . a primary 

driver of the future economy and concomitant job creation will be innovation. . . . So where does America stand relative to its position of 5 years 

ago when the Gathering Storm report was prepared? The unanimous view 

of the committee members participating in the preparation of this report is 

that our nation’s outlook has worsened. . . . The only promising avenue, in 

the view of the Gathering Storm committee and many others, is through 

innovation. Fortunately, this nation has in the past demonstrated considerable prowess in this regard. Unfortunately, it has increasingly placed 

shackles on that prowess such that, if not relieved, the nation’s ability to 

provide financially and personally rewarding jobs for its own citizens can 

be expected to decline at an accelerating pace. . . . The Gathering Storm 

Committee’s overall conclusion is that . . . the outlook for America to compete for quality jobs has further deteriorated over the past 5 years. The 

Gathering Storm increasingly appears to be a Category 5.42

The sobering message of this gathering-storm metaphor has been widely repeated: 

‘‘America cannot rest on its laurels. Unfortunately, there are disturbing signs that 

America’s innovative performance slipped substantially during the past decade. 

Across a range of innovation metrics . . . our nation has fallen in global innovationranked competitiveness.’’ 43 Several studies using many indicators and methodologies continue to reach the same startling conclusion: America’s overall innovativeness, though still high, is falling—in many ways at a rapid rate.44

• The World Economic Forum’s 2014–2015 rankings have U.S. ‘‘Total Competitiveness’’ at #3, down from #1 two cycles ago, and down to #5 in the ‘‘Innovation’’ category. • For 2012, the World Intellectual Property Organization (in conjunction with the 

business school INSEAD) ranks the United States at #10 in its Global Innovation Index—down from #1 in 2009. 

103 

45These productivity-growth averages were calculated from annual data reported online by 

U.S. Bureau of Labor Statistics on 10/20/14 at www.bls.gov for data series #PRS85006092. The 

non-farm business sector is the most-commonly used measure of overall productivity growth for 

the U.S. economy, in part because of greater measurement challenges for both the public and 

agricultural sectors. Non-farm business accounted for about 74 percent of total U.S. gross domestic product in 2013. The unemployment rates are calculated for each period as the simple 

average of the constituent monthly unemployment rates, as reported online by U.S. Bureau of 

Labor Statistics on 10/20/14 at www.bls.gov. 

• In 2009, the Information Technology and Innovation Foundation ranked 44 

countries and regions on 16 core indicators of innovation capacity. The United 

States ranked #4. This was down from America’s #1 ranking based on 1999 

data. But when assessing the rates of change in innovation capacity during 

2000–2009 (that is, the rate of improvement on these 16 indicators), the United 

States ranked #43—ahead of only Italy. On this rate-of-improvement metric, 

China ranked #1. 

Consistent with these studies of weakening U.S. innovativeness are the data on 

America’s slowing productivity growth. Figure 3B documents this productivity slowdown. For each of four post-World War II periods, Figure 1.1 reports two items: the 

average annual rates of growth in productivity (output per worker hour) in the U.S. 

non-farm business sector, and the average U.S. unemployment rate during that period.45

The first period in Figure 3B, 1947 to 1973, was marked by a strong average annual 

rate of productivity growth of 2.81 percent. During this period American companies 

across many industries were dynamic world leaders, thanks in part to their emerging connections to the world economy rebuilding in the wake of World War II devastation. The 1973–1995 period, however, saw average productivity growth plummet 

to just 1.45 percent per year. The initial causes of this slowdown included two major 

oil-price shocks and high and volatile inflation. Its persistence came to concern 

scholars, policymakers, and business leaders alike. With productivity growth averaging 1.45 percent per year average standards of living need 48 years to double— 

far slower than the 25 years needed when productivity growth was averaging 2.81 

percent each year. Unemployment was painfully high in many years of this generation, averaging nearly 7 percent throughout. 

Then came a productivity renaissance. For the decade starting with 1995, U.S. productivity growth unexpectedly accelerated—to an average annual rate of 3.00 percent. This surge was widely visible in accelerated growth in U.S. GDP, jobs, and 

worker earnings. At one point in 2000, U.S. unemployment dipped to just 3.9 percent, and for several years during this period real earnings rose briskly for all U.S. 

workers—even less-skilled workers including high-school dropouts. These large ecoVerDate Mar 15 2010 17:20 Oct 17, 2016 Jkt 000000 PO 00000 Frm 00107 Fmt 6601 Sfmt 6621 R:\DOCS\22145.000 TIMD

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46Page 1 of Robert J. Gordon, 2012, ‘‘Is U.S. Economic Growth Over? Faltering Innovation 

Confronts the Six Headwinds,’’ National Bureau of Economic Research Working Paper No. 

18315. See also, for example, the following three careful recent studies and references therein. 

John Fernald, 2014, ‘‘Productivity and Potential Output Before, During, and After the Great Recession,’’ National Bureau of Economic Research Working Paper No. 20248. Robert J. Gordon, 

2014, ‘‘A New Method of Estimating Potential Real GDP Growth,’’ National Bureau of Economic 

Research Working Paper No. 20423. Robert E. Hall, 2014, ‘‘Quantifying the Lasting Harm to 

the U.S. Economy from the Financial Crisis,’’ National Bureau of Economic Research Working 

Paper No. 20183. The Economist 2012 special report from its October 13 issue, ‘‘For Richer, For 

Poorer,’’ also summarizes much of this recent and ongoing academic work. 47Table 2–2 and related discussion of An Update to the Budget and Economic Outlook: 2014 

to 2024, U.S. Congressional Budget Office, August 2014. Economic Projections of Federal Reserve 

Board Members and Federal Reserve Bank Presidents, September 2014, released September 17, 

2014. 48 In this paragraph, the first quote comes from p. xvi of National Research Council of the 

National Academies, 2012, Rising to the Challenge: U.S. Innovation Policy for the Global Economy, Washington, DC: The National Academies Press. The second quote comes from Wuchty, 

Jones, and Uzzil (2007), p. 1036, who report (p. 1036) that, ‘‘Research is increasingly done in 

teams across nearly all fields. Teams typically produce more frequently cited research than individuals do, and this advantage has been increasing over time. Teams now also produce the exceptionally high-impact research, even where that distinction was once the domain of solo authors. These results are detailed for sciences and engineering, social sciences, arts and humanities, and patents, suggesting that the process of knowledge creation has fundamentally 

changed.’’ Wuchty, Stefan, Benjamin F. Jones, and Brian Uzzil, 2007, ‘‘The Increasing Dominance of Teams in Production of Knowledge,’’ Science, May 18. 

nomic gains spread even to the U.S. government, for which unexpected surges in 

personal and business tax receipts led to federal-budget surpluses in the 4 years 

1998 through 2001. A large body of scholarship has analyzed this U.S. productivity 

acceleration and has found that much of it was related to one particular IPintensive industry: IT. 

But since 2005, U.S. productivity growth has slowed dramatically. It has averaged 

just 1.53 percent in the past several years, a rate back to nearly the levels of the 

‘‘lost generation’’ of 1973–1995. And even within this period productivity growth has 

been slowing even more: at annual rates of just 0.5 percent in 2011, 1.5 percent in 

2012, and 0.5 percent in 2013. Several leading scholars are now forecasting that 

U.S. innovativeness and productivity growth may be permanently lower. Indeed, one 

such scholar has recently forecast that, in contrast to the average growth in U.S. 

GDP per capita of the past 150 years of about 1.9 percent, ‘‘future growth in consumption per capita for the bottom 99 percent of the income distribution could fall 

below 0.5 percent per year for an extended period of decades.’’ 46

This productivity slump is feared to continue not just by leading scholars but, increasingly, by many important policy-making agencies as well. In its most recent 

update to its 2014–2024 economic outlook in August 2014, the U.S. Congressional 

Budget Office foresees average annual growth in potential U.S. labor productivity 

of just 1.5 percent. Because of a similarly guarded outlook on U.S. productivity, the 

most recent September 2014 forecasts of the members of the Federal Open Market 

Committee foresee beyond 2018 annual U.S. GDP growth of somewhere between 1.8 

percent and 2.5 percent.47

What explains America’s darkening IP and productivity outlook? Part of the cause 

is America’s waning investment in its innovation inputs—the people and resources 

dedicated to knowledge discovery and development. The pair of Gathering Storm reports cited above gather a wave of sobering evidence on America’s declining IP investments—both relative to America of the past and relative to more and more other 

countries of today. 

At one level, the growth in innovation investments around the world presents a tremendous opportunity for America—to, if supported by the right public policies, connect its innovation efforts with those of the world. Indeed, the surge in global innovation investments has transformed how new ideas are discovered and developed— 

now much more across borders rather than just within. ‘‘The innovation process can 

no longer be confined within geographic boundaries. Globalization has ushered in 

a swiftly evolving new paradigm of borderless collaboration among researchers, developers, institutions, and companies spanning the world.’’ This new global norm for 

discovering and developing IP is clearly evident in at the micro-level of patents, article writing, and other individual building blocks of IP. One prominent study examined nearly 20 million academic papers and over 2 million patents over 50 years 

and across all major disciplines ‘‘to demonstrate that teams increasingly dominate 

solo authors in the production of knowledge.’’ 48

105 

49 National Research Council of the National Academies (2012), p. 12, as cited in note 48. 50 In their survey of micro-level studies of productivity, Bartelsman and Doms (2002, p. 578) 

state that, ‘‘Of the basic findings related to productivity and productivity growth uncovered by 

recent research using micro data, perhaps most significant is the degree of heterogeneity across 

establishments and firms in productivity in nearly all industries examined.’’ This heterogeneity 

in productivity and other characteristics (e.g., size) appears in both developed countries (e.g., 

Olley and Pakes, 1996, and Syverson, 2004 for the United States) and developing countries (e.g., 

Cabral and Mata, 2003). Bartelsman, Eric J., and Mark Doms, 2002, ‘‘Understanding Productivity: Lessons from Longitudinal Microdata,’’ Journal of Economic Literature, 38. Olley, G. 

Steve, and Ariel Pakes, 1996, ‘‘The Dynamics of Productivity in the Telecommunications Equipment Industry,’’ Econometrica, 64(6). Syverson, Chad, 2004, ‘‘Market Structure and Productivity: 

A Concrete Example,’’ Journal of Political Economy, 112(6). Cabral, Luı ́s M. B., and Jose ́ Mata, 

2003, ‘‘On the Evolution of the Firm Size Distribution: Facts and Theory,’’ American Economic 

Review, 93(4). 51Superior productivity of U.S. exporters is usefully summarized in studies including Lewis 

and Richardson (2001) and Bernard, et al (2007), which states the following (pp. 110–111): 

‘‘Firms that export look very different from non-exporters along a number of dimensions . . . 

even in the same detailed industry. Exporters [in 2002 were] significantly larger than non-exporters, by approximately 97 percent for employment and 108 percent for shipments; they are 

more productive by roughly 11 percent for value-added per worker and 3 percent for TFP; they 

also pay higher wages by around 6 percent. Finally, exporters are relatively more capital- and 

skill-intensive than non-exporters by approximately 12 and 11 percent, respectively.’’ Lewis, 

Howard III and J. David Richardson, 2001, Why Global Commitment Really Matters! WashContinued 

At another level, however, whether America can benefit from the rising IP strength 

around the world will depend on whether America can continue to design and implement public policies that maintain America’s IP strengths in this rapidly changing 

innovation world. It is possible that America will succeed in this way, but success 

is by no means guaranteed. The assessment of many private and public leaders is 

that America’s position is precarious—in large part because U.S. policies across a 

wide range of areas, including tax policy, do not adequately reflect today’s globallycompetitive reality. A recent report by a distinguished panel of government, business, and academic leaders framed the innovation challenge thus. 

At the same time that the rest of the world is investing aggressively to advance its innovation capacity, the pillars of America’s innovation system are 

in peril. . . . It is not just policies directly addressing the development and 

deployment of new technologies but also policies concerning tax, trade, intellectual property, education and training, and immigration, among others 

that play a role in innovation. . . . In this dramatically more competitive 

world, the United States cannot return to a path of sustainably strong 

growth, much less maintain global leadership, by living off past investments and its capacity for innovation. . . . Nor can the U.S. compete on the 

basis of a policy approach that is the legacy of an era when American advantages were overwhelming and innovative activity tended to remain within our borders. . . . The U.S. has every opportunity to secure its economic 

leadership and national security well into the future. But it will require a 

fresh policy approach, one that ensures that the United States can compete, 

cooperate, and prosper in this new world of competitive innovation.49

Whether America can restore its innovation strength will depend largely on whether 

America can craft IP-supporting public policies that reflect the competitive global 

economy of today—not the world economy of much of the 20th century when America was largely unrivaled in IP. That time of American predominance has passed. 

Today calls for policies—including tax policies—that reflect the reality of how America’s IP-intensive companies and industries actually operate in the 21st century 

global economy. To this reality we now turn. 

America’s Most Innovative, IP-Intensive Companies Tend To Be Multinational 

Companies 

What do we know about the relationship between the IP, innovation, and productivity 

performance of companies and their global engagement? 

Start with the following first important fact: there is now a large body of evidence 

for many countries that plants and/or firms exhibit large and persistent differences 

in innovativeness and productivity.50 A second important fact that researchers have 

documented in recent years is a robust correlation between productivity and global 

engagement: plants and/or firms that export or, even more so, are part of a multinational enterprise tend to have higher productivity—and a bundle of other goodperformance characteristics, such as innovative intensity and wages—than their 

purely domestic counterparts.51

106 

ington, DC. Institute for International Economics. Bernard, Andrew B.; Jensen, J. Bradford; 

Redding, Stephen J.; and Peter K. Schott, 2007, ‘‘Firms in International Trade,’’ Journal of Economic Perspectives, 21(3). 52 Representative evidence of this performance advantage for U.S. multinationals appears in 

Doms and Jensen (1998), who documented how plants that are part of multinational companies—both U.S. parent companies of U.S.-based multinationals and U.S. affiliates of foreignbased multinationals—tend to exhibit higher TFP, labor productivity, and other performance 

characteristics such as capital intensity, skill intensity, and wages. This superior performance 

of multinationals has also been documented in many other countries: e.g., Criscuolo, Haskel, and 

Slaughter (2010) for the United Kingdom. Doms, Mark E., and J. Bradford Jensen. 1998. ‘‘Comparing Wages, Skills, and Productivity Between Domestically and Foreign-Owned Manufacturing Establishments in the United States.’’ In R. Baldwin, R. Lipsey, and J. D. Richardson 

(eds.), Geography and Ownership as Bases for Economic Accounting. Chicago: University of Chicago Press. Criscuolo, Chiara, Jonathan E. Haskel, and Matthew J. Slaughter. 2010. ‘‘Global Engagement and the Innovation Activities of Firms,’’ International Journal of Industrial Organization, 28(2). 53 In Figure 3C and the supporting text, BEA data on U.S. multinational companies have been 

matched as needed with private-sector economy-wide data from appropriate government sources. 

The BEA data are available online at www.bea.gov. Details on the source and definition of these 

non-multinationals data are as follows, where all data—in Figure 3C and all subsequent figures—were obtained online or from Barefoot (2012). Employment: Bureau of Labor Statistics, 

U.S. Department of Labor—U.S. private-sector nonfarm payroll employment. Output: BEA— 

Private-sector value-added output adjusted to exclude value added in depository institutions and 

private households, imputed rental income from owner-occupied housing, and business transfer 

payments. Investment: BEA National Income and Product Accounts—Table 5.2.5 (Gross and Net 

Domestic Investment by Major Type) Line 10 (Nonresidential gross private fixed investment). 

Research and Development: National Science Foundation—Total R&D performed by the industrial sector, current dollars. Exports and Imports of Goods—BEA National Income and Product 

Accounts, as reported in Barefoot and Mataloni (2011). Compensation Premium for U.S. Multinational Companies: The national measure of private-sector labor compensation comes from the 

BEA National Income and Product Accounts Table 6.2 (Compensation of Employees by Industry) 

Line 3 (Private Industries). Employee compensation as measured in the BEA data includes 

wages, salaries and benefits—mandated, contracted and voluntary. Finally, note that at the 

time of writing NSF R&D data for 2012 were not yet available, so in Figure 3C shares of U.S. 

private-sector R&D for 2011 are reported. 

Multinational companies are an important segment of globally engaged companies. 

Multinational companies tend to exhibit even higher productivity than just exporters 

or importers do, and thus tend to appear at the very top of the productivity distribution of firms. They also tend to be very trade-intensive, capital-intensive, innovationintensive, and high-wage not just relative to purely domestic companies but also just 

exporters and importers.52

The superior performance of U.S. parents of U.S.-headquartered multinational companies is shown in Figure 3C, which reports the share of important activities in the 

overall U.S. private sector accounted for by the U.S. parent operations of U.S.- 

headquartered multinationals in 2012, the most recent year of available data.53


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54 ‘‘Results from virtually every study across industries and countries confirm that high productivity precedes entry into export markets. These findings are suggestive of the presence of 

sunk entry costs into export markets that only the most productive firms find it profitable to 

incur’’ (Bernard, et al, 2007, p. 111). This fact of high-productivity companies selecting into global engagement has spurred a large and ongoing literature in international economics with a variety of new general-equilibrium models built on the foundation of this fact. For example, a now 

standard research framework of multinational firms assumes these firms obtain highproductivity knowledge assets that are transferred from home-country parents to host-country 

affiliates. 55Pages 166–167 of: Baily, Martin Neil, and Robert M. Solow, 2001, ‘‘International Productivity Comparisons Built from the Firm Level,’’ Journal of Economic Perspectives, 15(3). 

The parent operations of U.S.-headquartered global companies perform large shares 

of America’s productivity-enhancing activities—capital investment, international 

trade, and R&D—that create tens of millions of well-paying jobs for their American 

workers. 

• Output: Parent companies produced 26.8 percent of all private-sector output 

(measured in terms of GDP)—over $3.2 trillion. 

• Capital Investment: Parent companies purchased $584.4 billion in new property, 

plant and equipment—43.3 percent of all private-sector capital investment. 

• Exports: Parent companies exported $728.1 billion of goods to the rest of the 

world. This constituted 47.7 percent of the U.S. total. 

• R&D: To discover and develop new products and processes, parent companies 

performed $220.3 billion of R&D. This was a remarkable 74.9 percent of the 

total R&D performed by all U.S. companies. 

All these innovative activities contribute to millions of well-paying jobs in America. 

In 2012, U.S. parent companies employed more than 23.1 million U.S. workers, 20.0 

percent of total private-sector payroll employment. Total compensation at U.S. parents was $1.77 trillion—a per-worker average of $76,538, over a quarter above the 

average in the rest of the private sector. 

Moreover, the important contribution of U.S. parent operations to the overall U.S. 

economy has been quite stable for decades. In 1988, for example, U.S. parents’ R&D 

spending was 72.5 percent of the economy-wide private-sector totals—not much 

above the 2010 share of 68.8 percent. This stability over time demonstrates their 

ongoing contributions to the overall U.S. economy. 

The important fact that globally engaged companies—exporters, importers, and especially multinationals—exhibit higher innovativeness and productivity than do 

purely domestic companies begs the question about causation. Do high-productivity 

companies tend to become globally engaged? Or does global engagement trigger productivity gains? The answer is, ‘‘some of both.’’ 

First, there is clear evidence that high-innovation, high-productivity companies tend 

to select into being globally engaged—and, if particularly productive, being a multinational company.54 This resonates with much of the discussion above. More-innovative companies tend to be able to crack into foreign markets—and they also want 

to do so to boost returns on their IP investments. 

Second, there is also clear evidence that global engagement spurs the productivity 

performance of companies. Some of the most comprehensive research on this issue 

has been conducted by the McKinsey Global Institute, which over the past generation has examined thousands of firms and industries. A repeated finding is that exposure to ‘‘global best-practice firms’’ via trade and FDI stimulates firm productivity. A clear statement of this globalization-to-productivity link appears in the 

work of Nobel laureate Robert Solow. 

A main conclusion of the studies . . . has been that when an industry is 

exposed to the world’s best practice, it is forced to increase its own productivity. . . . The more a given industry is exposed to the world’s best practice high productivity industry, the higher is its relative productivity (the 

closer it is to the leader). Competition with the productivity leader encourages higher productivity.55

This integration into the world economy boosts productivity in companies through 

many channels. One is the competitive pressure to reduce costs via innovating processes, creating or shifting firm scope towards new products, and becoming more capital intensive. Another is the spread of knowledge by learning from customers, suppliers, and competitors. 

108 

56Page 333 of: Corrado, Carol, Paul Lengermann, and Larry Slifman, 2009, ‘‘The Contributions of Multinational Corporations to U.S. Productivity Growth, 1977–2000,’’ In Marshall B. 

Reinsdorf and Matthew J. Slaughter (eds.) International Flows of Invisibles: Trade in Services 

and Intangibles in the Era of Globalization, NBER and University of Chicago Press. 

It is also important to stress that global engagement boosts industry-level productivity by spurring the reallocation of workers, capital, and other resources from 

struggling companies to more-productive innovators—often exporters and multinationals. As discussed in Section II, countries boost average productivity by reallocating resources across industries. Recent research has documented a very important second dimension of resource-reallocation gains: within all industries—regardless of the pattern of exports and imports—across companies towards the higherproductivity, globally engaged firms. An important part of this industry-level resource allocation is the contraction of low-productivity firms, along with the faster 

expansion of firms already engaged in international trade and investment. This reallocation from low- to high-productivity firms as a result of trade liberalization 

raises average industry productivity, a process that has been documented for the 

United States and for many other countries as well. 

In addition to having very high productivity levels, for decades globally engaged U.S. 

companies have played an outsized role in driving aggregate U.S. productivity 

growth. This is the key finding of an important recent study that focused on productivity growth ‘‘because, even though studies of [multinational] performance based on 

microeconomic data have tended to identify effects on the level of productivity, if 

these underlying productivity-enhancing effects are spreading and/or filtering in 

over time, productivity aggregates will be affected in terms of growth rates (as well 

as levels).’’ Their results they rightly describe as ‘‘quite striking.’’ 

Although the MNC [multinational corporation] sector accounts for only 40 

percent of the output of nonfinancial corporations (NFCs) between 1977 and 

2000, MNCs appear to have accounted for more than three-fourths of the 

increase in NFC labor productivity over this period. Moreover, MNCs account for all of the NFC sector’s pickup in labor productivity in the late 

1990s; accordingly, they account for more than half of the much-studied acceleration in aggregate productivity. And, while MNCs involved in the production of IT contributed significantly toward this acceleration, MNCs in 

other manufacturing and nonmanufacturing industries contributed significantly as well.56

Foreign Activity by IP-Intensive Companies Complements, not Substitutes for, U.S. 

IP Investment 

How exactly are American IP-investment and employment affected by the global 

reach discussed above? It is important to understand that U.S. IP jobs and investments are created not only by exporting to foreign markets but also by producing 

and selling in them through FDI in foreign affiliates. Contrary to what is often presumed, expansion abroad by globally engaged U.S. companies tends to complement, 

not substitute for, their domestic activity. 

The link between exports and American jobs is clear. When companies in America 

gain new customers abroad for their goods and services, meeting this demand creates new American jobs in these companies. Because of the rich variety of goods and 

services America exports and the rich variety of production methods used by companies in America, the link from exports to jobs varies across companies, industries, 

and time. That said, research has documented the many ways in which exporting 

companies tend to be stronger than nonexporters. 

Less well understood is the link between jobs and IP investment in America and 

business growth abroad. Much of the public policy discussion surrounding U.S. multinationals assumes that engagement abroad necessarily substitutes for U.S. activity—in particular, for employment and R&D investment. This substitution concern 

misses the several channels through which the global engagement of U.S. multinationals tends to support, not reduce, their operations in America. As studies presented below have found, foreign-affiliate activity tends to complement, not substitute for, key parent activities in the United States. Three crucial features of how 

multinationals work that belie the substitution idea are complementarity, scale and 

scope. 

• For some given level of firm-wide output, when firms employ many kinds of 

workers and many non-labor factors of production, affiliate and parent labor can 

often be complements in which more hiring abroad also means more hiring in 

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57 In Figure 3D, data for the shares were obtained from the BEA multinationals data online 

at www.bea.gov. 

works, in which U.S. workers operate not in isolation but rather in close collaboration with colleagues around the world. 

• When affiliates are expanding abroad to boost their revenues, the resulting reduction in costs and boost in profits (thanks to greater scale and richer returns 

on IP) often spurs higher output in the company around the world, which can 

mean more U.S. hiring. 

• Affiliate expansion often not only boosts firm scale but also, as discussed previously, refines the mix of activities performed across parents and affiliates. 

U.S. parents’ employment can rise as they shift their scope into higher valueadded tasks—especially R&D and other IP investments. 

The concern that global expansion tends to hollow out U.S. operations is not supported by the facts of existing research—now presented below. Rather, the scale and 

scope of U.S. parent activities increasingly depends on their successful presence 

abroad. 

To see this, start with the often-heard claim that globally engaged U.S. companies 

have somehow hollowed out their U.S. operations, leaving only activity abroad. Is 

that true? What about the magnitude of U.S. parent activities relative to the scale 

of their foreign affiliates? Figure 3D reports the share of U.S. multinationals’ 2012 

worldwide employment, output, capital investment, and R&D that was accounted for 

by their U.S. parent operations.57

The key message of Figure 3D is that the worldwide operations of U.S. multinational companies are highly concentrated in America in their U.S. parents, not 

abroad in their foreign affiliates. 

• Employment: U.S. parents account for 65.6 percent of worldwide employment of 

U.S. multinationals—23.1 million parent workers versus 12.1 million at affiliates. This translates into a ratio of nearly two U.S. employees for every one affiliate employee. 

• Output: U.S. parents account for 69.6 percent of worldwide output (in terms of 

value added) of U.S. multinationals—over $3.2 trillion versus about $1.4 trillion. 

• Capital Investment: U.S. parents undertake 72.7 percent of worldwide capital 

investment by U.S. multinationals—$584.4 billion versus $219.8 billion. For 

every $1 in affiliate capital expenditures, parents invested $2.66 worth in the 

United States. 

• R&D: U.S. parents perform 83.2 percent of worldwide R&D by U.S. multinationals—$220.3 billion versus $44.6 billion, or $4.94 in parent innovation and 

knowledge discovery and development for every $1 by affiliates. 


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58Ottaviano, Gianmarco I.P., Giovanni Peri, and Greg C. Wright, 2010, ‘‘Immigration, 

Offshoring, and American Jobs,’’ National Bureau of Economic Research Working Paper No. 

16439. Studies that find a link from outward investment and U.S. exports are well summarized 

in: Moran, Theodore, 2009, American Multinationals and American Economic Interests: New Dimensions to an Old Debate, Washington, DC: Peterson Institute for International Economics. 59 United States International Trade Commission. 2011. U.S. Multinational Services Companies: Effects of Foreign Affiliate Activity on U.S. Employment. Washington, DC: Office of Industries. 60Page 195 and page 181 of: Desai, Mihir A.; Foley, C. Fritz; and James R. Hines, Jr. 2009. 

‘‘Domestic Effects of the Foreign Affiliates of U.S. Multinationals.’’ American Economic Journal: 

Economic Policy, 1(1). 

The United States, not abroad, is where U.S. multinationals perform the large majority of their operations. Indeed, this U.S. concentration is especially pronounced for 

R&D, which reflects America’s underlying strengths of skilled workers and legal protections such as IP rights that together are the foundation of America’s IP strengths, 

as discussed earlier. 

This much larger scale of U.S. parents than foreign affiliates has been present for 

decades. A generation ago, the share of U.S. parents in the worldwide activity of 

U.S. multinationals was slightly higher. In 1988, U.S. parents accounted for 78.8 

percent of U.S. multinationals’ worldwide employment and 79.2 percent of their 

worldwide capital investment. So over the past generation, the foreign-affiliate 

shares of employment and investment have risen by about 0.5 percentage points per 

year. As this report documented above, however, this rise has been driven mainly 

by ongoing expansion of parents that was outpaced by even faster expansion of affiliates, not by parent contraction. Faster affiliate expansion, in turn, has been driven mainly by faster economic growth abroad and thus faster growth in customers 

there. 

The bottom line is that the United States firmly remains where globally engaged 

U.S. companies locate the majority of their operations—especially their innovation 

activities—even as they have been growing more quickly abroad. 

What does the evidence show about the key question of complementarity: has that foreign expansion complemented or substituted for their U.S. activities? Aggregate, industry and company-level research to date shows that foreign-affiliate expansion 

tends to complement U.S. parent employment, investment, sales—and innovation efforts via R&D. 

One such recent study examined industry-level data for 58 U.S. manufacturing industries from 2000 through 2007. It found that the productivity gains and cost savings from expanding global production networks tended to boost overall U.S. employment in these industries—albeit with changes in the scope of U.S. activities 

being performed. Similar studies to this one have repeatedly found that when American manufacturing industries invest more abroad, this outward investment stimulates U.S. exports.58

Another study examined industry-level data for dozens of U.S.-based multinational 

companies in services over recent decades. It found that greater foreign-affiliate employment and sales correlated with greater U.S.-parent employment as well, consistent with the idea that affiliate and parent activity tend to, on net, complement 

each other.59

A third important study, conducted at the level of individual companies, carefully 

analyzed all U.S. multinationals in manufacturing from 1982 to 2004. It found that 

a 10 percent increase in foreign-affiliate capital investment causes a 2.6 percent increase, on average, in that affiliate’s U.S. parent capital investment. It similarly 

found that a 10 percent increase in foreign-affiliate employee compensation causes 

a 3.7 percent increase, on average, in that affiliate’s U.S. parent employee compensation. These links were clearest when analyzing the changes in affiliate jobs 

and investment driven by changes in affiliate sales. 

Their findings of complementarity were especially compelling for how U.S.-parent 

R&D is supported by foreign-affiliate sales. They found that 10 percent faster sales 

growth in foreign affiliates raises U.S.-parent R&D spending by somewhere between 

3.2 percent and 5.0 percent. The authors concluded, ‘‘Since foreign operations stand 

to benefit from intangible assets developed by R&D spending, it is not surprising 

that greater foreign investment might stimulate additional spending on R&D in the 

United States. . . . These results do not support the popular notion that expansions 

abroad reduce a [multinational] firm’s domestic activity, instead suggesting the opposite.’’ 60

111 

61Page 1 of: Abramovsky, Laura, Rachel Griffith, and Helen Miller, 2012, ‘‘Offshoring HighSkilled Jobs: EU Multinationals and Domestic Employment of Inventors,’’ Center for Economic 

Policy Research Discussion Paper No. 8837. 62The U.S. Manufacturing Base: Four Signs of Strength, by Theodore H. Moran and Lindsay 

Oldenski, Peterson Institute of Economics Policy Brief No. 14–18, June 2014. 

A fourth important study also examined individual companies, but this time European-based multinationals. It linked within these multinationals the employment 

and patenting activity of these companies’ inventors across both parent and affiliate 

countries, to enable them to ascertain the effect of companies’ expanding use of researchers abroad on their use of researchers at home. Contrary to the common presumption that foreign researchers will substitute for parent researchers, this study 

found the opposite: ‘‘Our main result suggests that a 10 percent increase in the 

number of inventors abroad results in a 1.9 percent increase in the number of inventors at home.’’ 61

One final important study also examined individual U.S. multinational companies— 

not just in manufacturing but also in services, and for the generation 1990 through 

2009. As with the above earlier study of U.S. multinationals, this very recent analysis also found consistent and strong evidence that expansion abroad by foreign affiliates tends to expand, not contract the activities of these affiliates’ U.S. parents. 

Figure 3E, taken from this study, summarizes its key findings.62

For U.S. parent companies in manufacturing as well as U.S. parent companies in 

services, expanded foreign-affiliate employment is associated with economically and 

statistically significant increases in parent employment, capital investment, output, 

exports, and—most of all—R&D expenditures. This latter correlation is especially 

notable here: expanding foreign affiliates trigger more, not less, parent efforts to discover IP and other such innovations. 

All of the strengths of the U.S.-headquartered multinational companies at the heart 

of America’s IP-intensive industries would be curtailed, not supported, by tax policy 

that discriminates against the IP income of the foreign affiliates of these companies. 

The clear conclusion from research to date is that, on average, foreign affiliates 

and U.S. parents expand together—driven by the dynamism of complementarity, 

scale and scope. In particular, foreign-affiliate growth tends to stimulate, not reduce, U.S.-parent IP investments. In the current environment of sharply slower 

productivity growth, America now more than ever needs policies that support, not 

constrain, the dynamic energies of its most innovative companies. Tax reform that 

penalizes IP income and activity is precisely the wrong policy direction for helping 

America reaccelerate economic growth through innovation and the resulting 

growth in U.S. jobs and incomes. 

Conclusions 

Intangible property has long played a central role in driving growth in U.S. output, 

jobs, and incomes. Discovering and developing ideas with value boosts output in existing companies and industries and creates entire new industries. This innovation 


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has long created new jobs and higher standards of living for all American workers 

and their families. 

Maintaining IP’s many contributions to the U.S. economy will require smarter public policy now and in the future, however, given the breadth of indicators that America’s innovation strength is waning. In particular, policymakers must understand 

the value of a tax system that does not discriminate against the IP performed by 

American companies. 

Such a tax system needs to recognize the global nature of America’s IP innovators. 

U.S.-headquartered multinational companies, which create the large majority of 

America’s IP, increasingly rely on their global operations to maximize the creativity 

and benefits of their U.S. inventions. These globally engaged U.S. companies have 

long performed the large majority of America’s IP discovery and development. Increasingly central to America’s IP success is the ability of its multinational companies to deploy that IP abroad. Connecting foreign customers with U.S. ideas tends 

to complement, not substitute for, American IP investments—both in terms of the 

quantity and the quality of U.S. innovation. 

The potential is great for American IP activity to connect with global markets. Tax 

policy should support, not inhibit, this potential. Unfortunately, the tax-reform proposals in the Discussion Draft would undermine this potential. The Discussion Draft 

would fundamentally shift the measurement and tax treatment of IP income earned 

by the foreign affiliates of U.S.-based multinational companies—and in so doing 

would discriminate against these affiliates’ IP income relative to their non-IP income. 

The U.S. tax burden on foreign-affiliate IP income under the Discussion Draft would 

be higher in three important comparisons: relative to current law, relative to other 

business activities under the Draft, and relative to foreign competitors under Draft. 

From all three of these perspectives, U.S.-headquartered multinational companies 

would be disadvantaged by the treatment of foreign-affiliate IP income—and thus 

would be discouraged from investing in IP. 

This legislation would incentivize U.S.-headquartered multinationals to invest less 

in new ideas and innovation, to invest more in non-IP assets, to make those nonIP investments outside America rather than inside, and to be acquired by a larger 

foreign company or to acquire a smaller foreign company and invert. It would advantage foreign-headquartered multinationals not subject to its worldwide taxation 

in bidding for IP assets around the world, and it would discourage the start-up of 

new IP-intensive companies in America. 

America stands much to gain from broad and fundamental policy reform to create 

an internationally competitive tax system. But that reform should not discriminate 

against IP and its increasingly important contributions to the U.S. economy of 

growth, good jobs, and opportunity. 

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