Transfers of Intangible Property: Revise §§ 482 and 936(h) to Tax Transfers Ofbusiness Functions
| Publication year | 2016 |
Transfers of Intangible Property: Revise §§ 482 and 936(h) to Tax Transfers ofBusiness Functions
William McDonald
Georgia State University College of Law, willmcdon@gmail.com
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Home-grown establishments like Burger King, Inc. are moving operations overseas in large part because of the international corporate tax system in the United States.1 Like a conscientious objector fleeing across the border to our neighbors to the North, Burger King's merger with the Canadian-based Tim Horton's could mean that the company will move its headquarters from Florida to Canada to take advantage of lower corporate taxes.2 Companies like Burger King use transfer pricing to shift income from higher tax countries to lower tax countries and obtain huge tax savings from doing so.3 Even though a company like Google operates in mostly high-tax jurisdictions with corporate tax rates topping 20%, carefully planned transfer pricing strategies allow Google to enjoy an effective tax rate of merely 2.4%.4
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In addition to changing tax residency in the context of a corporate inversion, moving income-producing assets and intangible property from a high-tax jurisdiction to a low-tax jurisdiction has the added advantage of reducing taxes going forward.5 Section 482 of the U.S. IRS Tax Code (the Code) requires an arm's length consideration for transfers of tangible and intangible property between related parties.6 To the extent that the company does not transfer its income producing intangibles (like the trademark, brand name, etc . . . ) from the United States to Canada, moving the corporate headquarters taken by itself would, without additional steps, generally not reduce the corporation's United States tax bill.7
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Every company adjusts its operations based on market changes or market changes that it seeks to bring about.8 Companies make strategic decisions about the markets in which they will continue or establish a "presence."9 In doing so, multinational companies continually change their activities and operations, and these changes "take the form of the establishment, replenishment, transfer, reduction and closing of more or less substantial activities."10 Against this background, countries have enacted considerable legislation to appropriately tax transfers of intangible property and operations.11
In the United States, § 482 of the Code references § 936(h) to find a list of intangible property subject to taxation if transferred across international borders from one related enterprise to another.12 This Note refers to such transfers as intercompany "cross-border" transfers. Section 936(h)(3)(B) appears to define "intangible property" by including a laundry list of items that constitute intangibles, but the list leaves out other intangibles like goodwill and going-concern value.13 In spite of the statute's seemingly expansive wording, the Obama Administration proposes adding goodwill to clarify the definition of intangible property within the meaning of § 482.14 The Department of the Treasury has encountered definitional
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issues both in the context of tax controversies as well as in the context of assessing the value of transferring intangible property. The definitional debate sets the stage for considering the extent to which the Administration's proposed changes address the definitional omissions in the Code in light of alternative approaches in use in other countries facing similar challenges.15
The primary purpose of this Note is to examine the need to address definitional and methodological holes in the interpretation of intangible property under § 482.16 The second purpose of this Note is to propose actions that Congress should take.17 In addressing the need to change the definition or approach of identifying intangible property, this Note begins with an introduction to the arm's length standard under international standards and national law.18 This Note then considers the current state of the Code, as well as accompanying case law, and the definition of intangible property.19 This Note also explores German law on transfers of intangible property.20 Following a discussion of the relative merits of each system in accomplishing the goals of obtaining a more consistent application of tax law to business facts, this Note proposes changes to the Code that would
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incorporate elements from German law to achieve these tax goals.21 First, this Note argues for the necessity of an expansive definition of intangible property. Next, this Note suggests taxing outbound transfers of tax-income-producing assets to lower tax jurisdictions by adopting a rule that makes the elements of a transfer of functions satisfied where the current law may leave it out.22 In comparing the German example, this Note explains where the German definition substantively departs from the U.S. definition and seeks to reconcile the two with an aim toward strengthening the U.S. tax base.23
A. Transfer Pricing and the International Arm's Length Standard
Most governments use the arm's length standard as the guiding principle for determining a multi-national enterprise's true taxable income and transfer prices.24 The Organization for Economic Cooperation and Development (OECD) defines the arm's length standard as:
[When] conditions are made or imposed between the two [associated] enterprises in their commercial or financial relations which differ from those which would be made between independent enterprises, then any profits which would, but for those conditions, have accrued to one of the
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enterprises, but, by reason of those conditions, have not so accrued, may be included in the profits of that enterprise and taxed accordingly.25
In the context of transferring tangible or intangible property, the arm's length standard seeks to replicate the prices that would have been agreed upon between willing parties had the parties not had an incentive to artificially adjust pricing to save on taxes.26
B. U.S. Transfer Pricing Regulatory Regime
In the United States, § 482 of the Internal Revenue Code (the Code) grants the Commissioner of Internal Revenue (the Commissioner) authority to allocate income and deductions "between or among two or more organizations owned or controlled directly or indirectly by the same interests."27 For transfers or licenses of intangible property, "the income with respect to such transfer or license shall be commensurate with the income attributable to that intangible."28 Generally, § 482 is broad enough to allow the Commissioner substantial latitude in regulating and enforcing the text
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of the statute.29 Although extensive regulations interpret and enforce a taxpayer's ability to set its transfer prices, "[u]nder current U.S. tax law, U.S.-parented multinational corporations . . . have a lot of tax planning flexibility."30 For example, the taxpayer himself has the most information about the nature of his operations, and the regulations give the taxpayer leeway in determining how to apply the regulations to his operations.31 Accordingly, when intangibles are the subject of intercompany transfers, there are two main issues: (1) the Commissioner must overcome definitional hurdles to establish that an intangible was transferred and (2) the Commissioner must value that intangible.32 Because both the existence of an intangible and the value of an intangible is often difficult to ascertain, taxpayers may engage in aggressive tax planning.33 Under the U.S. transfer pricing statutes and regulations, Congress is primarily concerned with identifying valuable intangible property that may be transferred in the context of a business restructuring.34 The OECD's new Chapter 9 in
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the Transfer Pricing Guidelines "encourages the use of transfer pricing guidelines to analyze business restructurings . . . [with] [p]articular emphasis . . . placed on pre- and post-restructuring risk allocation, taking into consideration the arm's length principle."35
C. German Law on Transfers of Business Functions
In contrast to § 482's focus on taxing the transfer of intangibles, German law provides a much broader starting point, evaluating a business restructuring by taxing transfers of functions.36 The Foreign Transactions Tax Act, as amended in 2008, allowed for the first time the evaluation and taxation of a transfer of business functions.37 According to the administrative principles enforcing the provisions of the Foreign Tax Act, "a function is a business activity that consists of a combination of similar business tasks performed by a certain position or department."38 According to the German rules, "the transfer of functions and risks . . . is considered to have occurred only when the assets acquired for profit-making are shifted along with the risks and opportunities, and the transferring party experiences a contraction of its functional capabilities as a result of the shift."39 The
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threshold for taxing the transfer of business functions is lower than the threshold under § 482 because the focus on a company's operations allows a much broader starting point for tax authorities to tax a transaction.40
A transfer of functions can occur when a company moves the production of a product line from one country to another country if there is no corresponding drop in overall revenues.41 A transfer of functions may take place under the rules where the "transferor remains in a legal or economic position to continue the performance of the function, and it is irrelevant to consider whether the receiving entity performs the function in the same manner as the transferring company."42
Nevertheless, the German rules on transfers of functions seek to accomplish the same goals as § 482—taxing transfers...
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