At a recent roundtable discussion, Caplin & Drysdale's Peter A. Barnes talks about lessons the international tax community could learn from states in the U.S. However, it was noted, that U.S. state approaches might best be applied situationally versus being adopted wholesale. For the full story, please visit Worldwide Tax Daily's website (subscription required).
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For example, Peter Barnes of Caplin & Drysdale said he believes separate-entity accounting "is the only way to go" in international taxation. "We're going to go that way," he said. "The U.N. has looked at it, the OECD has looked at it, I think we're going to stick with separate-entity accounting."
However, formulary apportionment might be appropriate within transfer pricing's profit-split method, Barnes said. There are plenty of examples, he said, but the easiest to grasp are advance pricing agreements for global trading between the United States and the United Kingdom and Japan that are essentially a profit-split with a unitary formula.
Panelists contrasted the international tax concept of permanent establishment (PE) versus the evolution in the late 20th century in U.S. states to what business activities create nexus for state corporate income tax purposes. While international standards governing jurisdiction to tax remain rooted in physical presence, a foreign entity's purposeful availment of a U.S. state's market can create nexus for state corporate income tax purposes.
Then Barnes suggested that there are areas where it might be: For example, producer and market nations are engaging in exactly the same debate as producer and market states, he said. "The services PE is an effort to push the boundary and to say physical presence is not the only basis on which we're going to tax you," Barnes said.
Diann Smith of McDermott Will & Emery said that because the U.S. states and federal government don't have the same approach to jurisdiction to tax, it's possible for a foreign entity to not have PE for federal tax purposes but have nexus in an individual state for state corporate income tax purposes. However, Barnes said that while there might be "initial horror" among audience members unfamiliar with that scenario, multinational clients are not unmindful of the standards that states apply. It's not that big a deal or a treaty problem because it's so well understood that U.S. treaties do not cover the states, Barnes said, adding that what's important to the multinational is how much income is attributable to the state for tax purposes.
But before proceeding to formulary apportionment, audience members pressed for more information about court cases that have looked at whether U.S. treaty obligations extend to the states. Huddleston cited Barclays Bank PLC v. Franchise Tax Board of California.
Barnes said he cut his teeth as an international tax professional on the Barclays case. "Sure, I would love it if the states were bound by the treaties," he said. However, "there are plenty of other issues that irritate our trading partners in the tax arena a lot more than this one," Barnes said, adding, "This issue, in my mind, is settled."
When an audience member wondered whether formulary apportionment could take intangible property into account in a meaningful way, Smith said there are situations when it might be possible. A government might decide patents should be sourced where they're being used, Smith said, and a government could look to where trademarks are used, developed, or generating earnings.
Huddleston agreed that there are some details that will need to evolve as the world moves to a tax base that includes intangibles, "but that speaks to the fact that physical presence can no longer be a reasonable standard in the world that we live in," he said. Barnes, however, said from an international perspective there is a tendency to set out two paradigms: On one end is the separate-entity accounting, arm's-length standard, while on the other is global formulary apportionment.
"I think the real dialogue needs to be, within separate-entity accounting, are there places where formulary apportionment of some manner is appropriate and is helpful?" Barnes doesn't believe there will be global formulary apportionment because of the differences between nations, where profit levels are demonstrably different across the world.
A move toward formulary apportionment also could add tremendous administrative complexity, Barnes said. France might have combined reporting, Germany might combine different affiliates, Japan might combine yet a different set of affiliates, and then six more countries might have separate-entity accounting, Barnes said.