Cross-Atlantic Spat, Inversions and Google’s UK Deal

U.S. Treasury Secretary Jacob Lew has objected to the European Commission (EC) on the use of European Union (EU) state aid investigations as a way to retroactively tax earnings that rightfully belong to the United States.

Lew made the objections in a letter sent to EC President Jean-Claude Juncker.  Commission spokesman Ricardo Cardoso denied any bias against U.S. multinational enterprises (MNEs), saying that EU law applies to all companies doing business in the EU. The letter came after a Treasury aide met with EU officials about the U.S. concerns.

In January this year, four top Senate Finance Committee members wrote to Lew expressing “strong concerns” with how EU state aid cases “could pave the way for the EU to tax the historic earnings of many more U.S. companies.” They suggested that Lew consider the U.S. retaliatory authority, which permits the U.S. president to authorize the doubling of U.S. tax rates for citizens and corporations of a foreign country that subjects U.S. citizens and corporations to “discriminatory or extraterritorial taxes.”

Treasury Concerns

The Finance Committee held a hearing on “International Tax: OECD BEPS and EU State Aid” in December last year. At that hearing, Treasury Deputy Assistant Secretary of International Tax Affairs Robert Stack testified that the Treasury is concerned that the EC’s investigations and potential decisions:

1. Appear to disproportionately target U.S. companies,

2. Potentially undermine U.S. rights under its bilateral tax treaties with EU nations,

3. Are taking a novel approach in applying EU state aid rules and applying that approach retroactively rather than prospectively,

4. Could give rise to U.S. companies paying EU nations billions of dollars in tax assessments that may be creditable foreign taxes, resulting in U.S. taxpayers “footing the bill,” and

5. Substantively amount to EU taxation of historical earnings that, under internationally accepted standards, no EU member had the right to tax.

During the hearing, several members of the Senate Finance Committee expressed similar concerns.

Competition Minister Rejects Criticisms

Stack later met with EC officials to voice the U.S. concerns. Following that meeting, European Commissioner for Competition Margrethe Vestager, who didn’t attend the gathering, rejected U.S. criticism of the investigations. She said, “Just as it is an obvious right for U.S. tax authorities to tax revenues when they are repatriated, it is also for European tax authorities to tax money that is made” in the EU.

Johnson Controls Inc. and Tyco International PLC said they reached a definitive accord to combine the two companies by fiscal year end.

Following the proposed transaction, Ireland-based Tyco would be 56%-owned by shareholders of Johnson Controls, a car battery maker based in Wisconsin. Tyco, a global fire and security provider, would be renamed Johnson Controls PLC. The boards of directors of both companies have approved the terms of the agreement.

Note: While Ireland boasts a standard 12.5% tax rate for trading (that is, not passive) income, the United States continues discussions about international tax reform to potentially reduce the U.S. corporate tax rate to 25% or lower.

Urgent Action Needed

In a statement regarding this recent inversion, House Ways and Means Committee Ranking Member Sander Levin (D-Mich.) said:

“The Johnson Controls — Tyco deal shows the urgent need for Congress to get off the sidelines and pass legislation to end corporate tax inversions. While Speaker [Paul] Ryan has responded by saying that we need to do tax reform, we cannot continue to dawdle. Congress must close this loophole that is costing our country tens of billions of dollars in lost revenue. Legislation I introduced last year — which is retroactive to May 2014 — would stop these tax-motivated inversions once and for all.”

Separately, House Ways and Means Committee Chairman Kevin Brady (R-Tex.) said that the urgency of U.S. international tax reform is heightened by what has been happening in the rest of the world and what is on the horizon.

In a keynote address at the Tax Council Policy Institute’s 17th Annual Tax Policy & Practice Symposium, he said the recommendations from the Organisation for Economic Co-operation and Development’s (OECD’s) base erosion and profit shifting (BEPS) project “would disproportionately burden American global businesses,” as countries around the world, in following those recommendations, are “implementing aggressive new tax measures.”

Brady called recent European Union actions a “whole new arsenal of new revenue-grabbing tax measures.” He charged that EU state aid investigations “are threatening to impose retroactive taxes going back ten years on American businesses. . . . We cannot allow American taxpayers to foot the bill for increased tax collections in Europe and elsewhere.”

Principles of Reform

Chairman Brady noted that, in the two decades leading up to 2004, the United States averaged two inversions a year. That doubled to four a year in the decade through 2014 and increased to six in 2015. Many more U.S. multinational enterprises (MNEs) may “be forced to restructure their business operations and move U.S. activities, such as research and development, overseas,” due to concerns with higher taxes and compliance costs, double taxation, and other tax implications resulting from the OECD’s BEPS project recommendations, he said.

Chairman Brady outlined the following six core principles that would guide U.S. tax reform:

1. The tax code must be simpler, fairer and flatter, so that individuals, families and small businesses needn’t grapple with a tax code that is impossible to understand.

2. Tax reform must close loopholes, eliminate special rules, and limit the deductions, exclusions and credits that riddle the tax code today — so as to lower U.S. tax rates for everyone. Well-advised taxpayers today use an array of complex tax provisions to minimize their U.S. taxes under the law, but that complexity is a waste of resources that distorts investment decisions, leads to disputes with the IRS and takes critical time and capital away from running successful businesses.

3. Enterprises both large and small must have a competitive tax system, including a fair and competitive U.S. tax rate. Small businesses, which are typically operated as S corporations, limited liability companies (LLCs) or partnerships, deserve a tax system that encourages growth. Small businesses shouldn’t believe that their U.S. tax rate places them at a disadvantage to large C corporations.

4. The U.S. tax code must stop encouraging the shift of jobs overseas. Too many businesses are being acquired by foreign corporations or engaging in corporate inversions to avoid being a ripe target for foreign takeover. The U.S. tax code should encourage businesses to locate their operations in the U.S., create U.S. jobs and help grow the U.S. economy. The current U.S. worldwide tax system needs to be replaced with a permanent modern territorial-type system that helps U.S. companies compete and win overseas and easily bring earnings back home to invest in new jobs, research and growth.

5. A tax code must be built for U.S. economic growth, Brady said. Tax reform that merely aims to place America back in the middle of the pack “won’t cut it.” He added that the late Steve Jobs of Apple, when urging his team to develop innovative products, preached, “When you’re behind, leapfrog.”

6. A 21st Century tax system shouldn’t raise taxes to bail out Washington’s spending problem. To eliminate the U.S.’s enormous national debt requires more than entitlement reform and spending restraint. Strategies to constrain U.S. spending must be accompanied by U.S. growth. There is no better formula for growth than the right kind of U.S. tax reform.

Looking Forward

Chairman Brady said his committee will move forward immediately to draft international tax reform legislation. He said: “Our work here will be a down payment that clears the way to focus on the work on lowering rates and simplifying the code for all businesses and individuals, so that we are ready to enact comprehensive tax reform in 2017.”

Google executives recently defended the company’s tax settlement with the United Kingdom to a select committee of the British House of Commons.

The appearance before the panel followed news of a deal the company struck with the U.K. under which it will pay £130 million ($186 million) in back taxes. British tax authorities said the amount is over and above the tax that Google would have paid for past years (or would pay for the current period).

The tax rules require tax payment that is commensurate with the economic creation of value. Matthew Brittin, Google’s President of Europe, Middle East and Africa, noted that the company paid an average U.K. corporation tax rate of around 20% in the past few years.

How Value Creation Works

The Google executives explained that, under the concept of value creation, profits are attributed to the jurisdiction where value is created.

Brittin provided an example:

If your company is in the U.K. selling cosmetics, you might attend an event about services Google offers or even speak with a representative in Ireland about using those services. But the value is created when someone in Japan searches for cosmetics on their phone and connects with the U.K. company. Thus, most of the value is created by the product search, which is developed and built in the U.S. Some of the value is created by marketing and other services in the U.K. and Ireland.

To support his point, Brittin noted that there are 20,000-plus Google engineers in the U.S., where the majority of the value is created, compared with the 1,000-plus Google engineers in Britain. He said he would like to see the number of engineers in Britain increase — and, if it does, the proportion of taxes that Google pays in Britain would increase.

Looking Ahead

Asked if Google will be caught by the U.K. Diverted Profits Tax (DPT) going forward, Google’s Vice President of Finance Tom Hutchinson said that, because of the recent settlement, Google is paying the correct amount of U.K. taxes. “Going forward, if we are paying the right amount of tax according to the normal rules in the U.K., then DPT wouldn’t apply again,” he said.

Asked about similar discussions with tax authorities in Italy and France, Mr. Hutchinson indicated that he isn’t going to comment. “We are not confirming those rumors,” he said.