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  3. Senate Finance Committee Hears Testimony On International Tax Compliance

Senate Finance Committee Hears Testimony On International Tax Compliance

by Mike Godfrey, Tax-News.com, Washington

07 May 2007


Treasury Acting International Tax Counsel, John Harrington last Thursday spoke before the Senate Finance Committee with regard to international tax compliance.

He told the Committee members that:

"From the standpoint of tax administration, offshore tax evasion historically has been a very difficult area to address. Questionable use of low- or no-tax jurisdictions has been an issue for decades. Globalization, however, has made foreign investment and foreign activities common, with overseas markets becoming an increasingly important source of income for US individuals and businesses."

"Individuals invest in foreign entities for a variety of reasons. In most instances, these investments represent legitimate business transactions, using foreign entities in ways that are typical for international commerce. At times, however, foreign entities can be used for tax evasion. For example, some individuals invest through a jurisdiction with a reputation for secrecy and opaqueness, hoping to stymie the Internal Revenue Service (IRS) in its administration of the Internal Revenue Code. Others try to hide income from the IRS by setting up elaborate business structures and financial arrangements, some components of which are located offshore."

"These varied scenarios make it clear that a one-size-fits-all approach will not work to stop offshore tax abuse while continuing to permit legitimate cross-border transactions, which are vital to the United States' participation in the global economy. This is why the Treasury Department has undertaken a multi-faceted approach to deal with the problem of offshore tax evasion."

Mr Harrington then went on to describe the actions taken by the Treasury to combat tax evading activity by US taxpayers offshore.

He announced that:

"As part of our overall effort to improve compliance, the Treasury Department and the IRS have taken a number of important steps on the administrative front and are continuing to work on other avenues to address offshore tax abuses. Although determined tax evaders may flaunt the tax rules, some taxpayers opportunistically seek to take advantage of ambiguous or outdated tax rules. Accordingly, we modify or update US tax rules when we determine that they are being used to perpetrate such abuse. Recent published guidance projects that will improve compliance and that target potential areas of abuse include:

  • Foreign Tax Credit: We have taken strong steps to halt misuse of the foreign tax credit. In November 2006, we issued final regulations regarding the proper allocation of partnership expenditures for foreign taxes. In March 2007, we issued proposed regulations that would disallow foreign tax credits tied to participation in certain artificially engineered, highly structured transactions. In August 2006, we issued proposed regulations that would address the inappropriate separation of creditable foreign taxes from foreign source income. We intend to make appropriate modifications and finalize both sets of proposed regulations as soon as possible.
  • Transfer Pricing: We have produced, and continue to produce, significant guidance in the area of transfer pricing. In an increasingly globalized economy, cross-border transactions between controlled entities present significant compliance challenges, making guidance in the transfer pricing area an important part of our administrative efforts to address noncompliance. In August 2006, we issued temporary and final regulations addressing the treatment of cross-border services, and followed them up with additional guidance in December 2006. We issued proposed transfer-pricing regulations addressing cost-sharing in August 2005. We intend to finalize both sets of regulations, with appropriate modifications.
  • Other Abusive Transactions: We have also shut down arrangements that utilized foreign jurisdictions to perpetuate abuse of the Internal Revenue Code. For example, in October 2006, we published proposed regulations regarding the Federal tax treatment of annuity contracts. These proposed regulations address a type of widely marketed transaction in which taxpayers claimed to be able to defer or avoid gain on the exchange of highly appreciated property for the issuance of annuity contracts. Recent Congressional hearings have highlighted how taxpayers were applying prior law treatment of these contracts to facilitate abusive private annuity arrangements, often involving offshore issuers. The proposed regulations, when adopted as final, will shut down those arrangements.

The IRS has also undertaken several compliance initiatives, including the Offshore Voluntary Compliance Initiative, aimed at taxpayers who used offshore payment cards or other offshore financial arrangements to hide their income, and the Offshore Credit Card Program, designed to identify taxpayers who use offshore bank accounts to hide income and offshore credit cards issued by secrecy jurisdiction banks to repatriate the unreported income. The IRS is continually monitoring this area for opportunities to implement new programs that will stop abusive transactions and improve compliance."

Speaking with regard to the need for obtaining information from other countries, the Treasury official told the Committee that:

"In today's global economy, countries must be able to obtain and exchange the information needed to enforce their domestic tax laws. A key element of US tax treaties, therefore, is the provision for exchange of information between the tax authorities. Under tax treaties, the competent authority (i.e., the tax authorities designated under the tax treaty) of one country may request from the other competent authority such information as may be relevant for the proper enforcement of the first country's tax laws. The information provided by the other country is subject to the strict domestic confidentiality protections that generally apply to taxpayer information. Because access to information from other countries is critically important to the full and fair enforcement of the US tax laws, information exchange is a priority for the United States in its tax treaty program."

"A tax treaty is not feasible or appropriate in all cases, however. In some cases, there simply may not be the type of cross-border tax issues between the United States and the foreign country that are best resolved by treaty. For example, in the case of a country that does not impose significant income taxes, there may be little possibility of the double taxation of income that tax treaties are designed to address. In cases where a full tax treaty is not appropriate or feasible, the Treasury Department seeks to provide for the bilateral exchange of tax information by entering into a tax information exchange agreement ("TIEA") with the other country."

He continued:

"Compared to tax treaties, TIEAs are a more recent phenomenon. In 1983, as part of the Caribbean Basin Initiative, Congress granted the Treasury Department the authority to enter into bilateral or multilateral TIEAs with designated countries in the Caribbean and Central America. This authority was extended in 1986 to allow the Treasury Department to enter into bilateral TIEAs with other countries."

"There are several items that are essential to the United States when negotiating a TIEA. First, the TIEA must provide for the exchange of information on request for both criminal and civil tax matters. Many jurisdictions are more willing to exchange information with respect to criminal tax matters, but such a restriction would greatly limit the utility of a TIEA from a U.S. standpoint. Second, the TIEA must provide for the exchange of information even if such information relates to a person who is not a resident or national of the United States or the TIEA partner. We may be more interested in the beneficial owner of an entity formed under the jurisdiction of the TIEA partner than we are in the entity itself. Finally, the TIEA must provide for the disclosure of information regardless of local "confidentiality" laws that may prohibit such disclosure, including laws relating to bank secrecy or bearer shares. Indeed, such laws may be one of the principal attractions for offshore tax evaders."

"Many of our TIEA partners have small tax administrations, and the TIEAs acknowledge this reality. Accordingly, a TIEA often will specify the details that a request for information under the TIEA should contain and also require the IRS to explain why it is making the request. Although each TIEA partner is usually expected to bear the routine costs of fulfilling its obligations under the agreement, TIEAs often require the requesting party to bear "extraordinary costs." This type of feature is often necessary to induce a small jurisdiction to agree to a TIEA."

Pointing out that tax information exchange is not just a bilateral issue, Mr Harrington went on to reveal that:

"The IRS has been actively involved in the development of several multilateral information exchange programs. The Joint International Tax Shelter Information Centre (JITSIC) was formed by tax authorities in the United States, the United Kingdom, Canada, and Australia. The objectives of JITSIC are to deter promotion of and investment in abusive tax schemes, particularly through information exchange and knowledge sharing. IRS Commissioner Everson has described JITSIC as having sharply improved IRS knowledge and understanding in a number of important international tax areas."

"In addition to JITSIC, in January 2006 the IRS and the tax administrations of nine other countries agreed to the establishment of the so-called "Leeds Castle" Group. Under this arrangement, the commissioners of the revenue agencies of China, India, and South Korea agreed to meet regularly with their counterparts from the United States, the United Kingdom, Japan, Australia, Canada, France and Germany to consider and discuss issues of global and national tax administration in their respective countries. By providing additional opportunities to share information and experience, these organizations are a significant tool in combating offshore evasion."

He also stated that:

"It is also important to remember that information exchange is inherently voluntary. We cannot force any country to agree to exchange tax information. Sometimes negotiations on this issue are very difficult. The treaty or TIEA partner may be required to repeal or modify domestic law. In addition, signing a tax treaty or a TIEA is only the first step in the process. A healthy information exchange relationship requires us to maintain good relations with our treaty and TIEA partners. Even an ideally drafted agreement is of limited value if the tax authorities do not have a cooperative relationship. For example, if a treaty or TIEA partner believes that the information exchange relationship is not respected or appreciated by the United States, this may have a chilling effect on exchange of information on request or, particularly, on spontaneous exchange of information."

"We have more to do in this area. Nonetheless, we have made great strides in recent years. Several new TIEAs have entered into force with jurisdictions that have figured prominently in previously documented accounts of offshore tax evasion. Within the last two years alone, TIEAs have fully entered into force with the Cayman Islands, the British Virgin Islands, the Bahamas, the Netherlands Antilles, Jersey, Guernsey, and the Isle of Man. We also recently signed a TIEA with Brazil, and the newly signed tax treaty with Belgium provides greater information exchange than we have previously been able to achieve with that country."

Concluding, the Acting International Tax Counsel announced that:

"As both Secretary Paulson and Assistant Secretary Solomon stated in recent testimony before this Committee, the Treasury Department is committed to improving tax compliance without unduly burdening honest taxpayers who currently meet their tax obligations. Tax compliance with respect to offshore transactions is an important aspect of that endeavor. By focusing on information exchange, we seek to reduce offshore tax evasion while achieving these goals."


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