Individual Seeks Guidance to Place Pressure on Multinationals

May 11, 2021

Internal Revenue Service
Attn: CC:PA:LPD:PR (Notice 2021-28) Room 5203
P.O. Box 7604
Ben Franklin Station
Washington, D.C. 20044

Re: Notice 2021-28, 2021-2022 Priority Guidance Plan

Dear Sir or Madam:

I am a retired CPA who has worked both domestically and internationally for many years. In the two decades since I first retired, I have authored many articles¹ and have developed and taught several different international tax courses and seminars within the University of Washington Tax LLM program.

Based on my working experience with numerous clients that spanned over thirty years and my studies over the past two decade both as an academic and in connection with my published articles and governmental submissions, I have identified a number of projects that should be considered a high priority for the Treasury and the IRS. These projects, which are attached as appendices to this letter, cover a number of areas. Since I have not been a paid advisor for well over a decade, my recommendations are free of any influence from potentially affected taxpayers. My goal is a system that works better and fairer for both the government and taxpayers alike.

Notice 2021-28 lists factors that the Treasury and the IRS consider in selecting projects for inclusion in its 2021-2022 Priority Guidance Plan. They include, for example, whether a project (i) involves significant issues relevant to many taxpayers, (ii) will reduce controversy and lessen the burden on taxpayers or the IRS, and (iii) promotes sound tax administration. All of the suggestions for projects covered in this submission more than satisfy these factors.

Many of the recommendations are focused on the pervasive profit-shifting structures that have so eroded the U.S. tax base and which are at the center of the current on-going discussions of how U.S. international tax law might be changed. Although many of my recommendations are inspired by these profit-shifting structures, it seems unlikely that the relevant underlying law will be legislatively changed. Thus, for example, subject areas covered in the attached appendices include income sourcing, effectively connected income, entity classification, subpart F, and tax treaties. None of these areas are likely to be legislatively changed.

Many profit-shifting structures involve complicated and legalistic schemes. Generally, the multinational corporations (MNCs) that have implemented such schemes record much or most of their profits within zero- and low-taxed foreign group members. Further, many schemes were adopted without the MNC making any meaningful operational changes that moved actual profit-making activities outside the U.S. Rather, such activities remained within the U.S.²

Importantly, MNCs adopting these schemes include not only U.S.-based MNCs, but also the many inverted MNCs that structured their inversions to remain untouched by the §7874 anti-inversion rules. For these inverted and other foreign-based MNCs (e.g. private equity foreign acquisition vehicles that acquire U.S. MNCs), shifted profits will often avoid both subpart F and Global Intangible Low-Taxed Income (GILTI) income inclusions, thereby completely avoiding any U.S. corporate taxation on shifted profits.

The government expends significant efforts and resources attempting to attack a multitude of MNC profit shifting structures. These efforts are labor intensive, time consuming, and have uncertain outcomes for all parties. Such attacks have relied on either transfer pricing (e.g. Microsoft, Amazon, Facebook, etc.) or re-characterization adjustments (e.g. Caterpillar, etc.).

With respect to transfer pricing adjustments, the IRS has seemingly limited its application to the value of outbound IP transfers (e.g. Reg §1.482-7(g)) and the calculation of annual payments under cost sharing agreements. This limited application leaves in place, and effectively legitimizes, the structures through which MNCs shift profits each and every year out of the U.S. and into tax havens and other low-tax countries. Thus, even in the event that the government wins its transfer pricing adjustment on a particular taxpayer, additional millions and billions of profits continue to be shifted annually as long as the MNC's structure continues to exist.³

Some of my suggestions focus on the Code's sourcing and effectively connected income (ECI) rules as well as its entity classification rules and the subpart F branch rule. I believe that updated and modernized rules will not only provide clarity for both MNC taxpayers and the IRS alike, they will importantly give the Treasury and IRS effective tools that will be objective, fact-based, and easy to apply. They can be an important supplement, or an alternative to, the transfer pricing and re-characterization tools now commonly used.

These ECI, entity classification, and subpart F rules are not new. They apply not only to future years after some of the suggested regulation modernizations and other changes are made, but also to past years where the facts support it. Strong bases for application to past years will be common.⁴

In addition, clear guidance would assist outside audit firms in providing guidance to their audit clients to make more meaningful disclosures of potential tax liabilities in their financial statements or to accrue tax, interest, and penalties where some clients may have inappropriately pushed the envelope in their profit shifting structures. The IRS should also designate tax motivated structures having relevant factual, profit-shifting characteristics as a “listed transaction”.⁵

Either alone or with old colleagues, I have authored or co-authored nine articles covering subjects related to MNC profit-shifting structures and how they may be subject to U.S. taxation under the ECI rules.⁶ The third of these articles details how such structures often create an unanticipated and unintended partnership for U.S. tax purposes that includes two or more MNC group members as partners in a partnership that conducts the joint business of the group members. The existence of a partnership makes the practical application of ECI taxation an easier and more objective exercise. The sixth article covers how ECI taxation should be applied after the TCJA and notes how the manufacturing branch rule included in the Subpart F regulations may often apply to cause some gross income not caught by the ECI rules to be subpart F income.⁷ The seventh article is focused on the TCJA amendment of the §863(b) sourcing rule for inventory property that has been both produced and sold by the same taxpayer. Additional background and issues relevant to suggestions made within this letter and its appendices are covered in detail in those articles.

Many MNCs erode the U.S. tax base through deductible payments by U.S. group members to foreign group members, including disregarded entity subsidiaries. Often, these payments would be subject to the 30% U.S. withholding tax, but this tax is most typically reduced or eliminated by the claimed coverage of a tax treaty. Foreign taxpayers also seek treaty relief for claims that do not involve withholding tax, such as a claim by a foreign group member that it has no permanent establishment under an applicable tax treaty. Appendix H provides specific guidance for needed regulatory amendments that would prevent the inappropriate use of tax treaties to achieve double non-taxation.

The Treasury and IRS should make clear to all taxpayers its intention to pursue profit shifting structures through notices, revenue rulings, or regulations, as appropriate. Doing so would send a strong signal to the boards of directors and managements of MNCs as well as to their legal and tax advisors, thereby causing some MNCs to scale back or even unwind existing structures, and to stop initiating new ones. Note that clear indications of Treasury and IRS intentions would achieve one of the stated goals of the "Form 1120-F Non-Filer Campaign” released on January 31, 2017. That campaign states, in part:

* * * * *

I hope that the above information is useful to the Treasury and the IRS. I would be glad to speak by telephone with you or to respond to emailed questions if that would be helpful.

Very truly yours,

Jeffery M. Kadet
(206) 285-1324
jeffkadet@gmail.com
kadetj@uw.edu
Seattle, WA