A conversation with Professor William Byrnes from Texas A&M about cost sharing agreements following the Tax Cuts and Jobs Act and in the lead up to coronavirus.
Mimi Song: I think, you know, going back to now specifically to talk about the Tax Cuts and Jobs Act and all those different taxes. Let’s talk about GILTI and let’s break it down a little bit. What is the purpose of GILTI? For everybody who doesn’t know: Global Intangible Low-Taxed Income, or GILTI.
William Byrnes: First of all, you got to give a big credit for those taxdrafters… [laughs.] You know, GILTI’s an honest acronym! It goes after what you mentioned. It goes after all income of an American parent of an American headquartered company; all your potential income, except for that routine rate of return of 10 percent of depreciable assets.
And you might wonder, “Why 10 percent?” Because I did wonder and I researched it and there are a bunch of economists in that… and that 10 percent is actually a really good routine rate of return number. But regardless! Across the board for pharma and for manufacturer of light bulbs, and for this, and for that technology… “Why 10 percent rate of return?” That sounds very Brazilian to me, but regardless – that’s what we have on the table.
It’s hard to write tax law. It’s hard to make what’s good policy and how do we write a tax law around that good policy. But if I was writing it, GILTI’s probably not the way I would write it. Because, by making it a 10% rate of return on your depreciable tangibles, doesn’t that therefore increase your incentive to actually move your factories? To get that 10 percent rate of return, to move your tangibles; to move your factories; to move your equipment outside the U.S.; to reduce your GILTI income, and to reduce your sub-Part F. And you do this because the more operating income you have from actual factories – as opposed to the magic and tangible stuff that we still really don’t understand as economists – that’s not really what we want as tax policy.
We wanted people to bring their manufacturing back in and GILTI is the opposite. But that 10 percent routine rate of return comes back in dividend deduction. It comes back tax-free. The GILTI income, on the other hand, which is everything else. So if you were a member of Congress who wanted to tax everything else, you got your wish. That’s what GILTI does. And it brings it back, not with the dividend deduction. It brings it back at the regular tax rate.
Mimi Song: What about the BEAT tax?
William Byrnes: Well, for right now you get a tax break with GILTI. If you want to call it that. Because half your GILTI can be relieved, right? Half of it. But who knows what’s going to happen next year!
With BEAT, the foreign countries are going crazy. They say that BEAT’s just a secondary withholding tax. They say, “Hey, we have tax treaties with you, United States, that say you already have a 30 percent withholding. And you’ve reduced that 30 percent through the tax treaties. Now you’re telling us that payments to Germany, a high tax country, payments to Canada, payments to France – those high tax country payments.”
Because we think about low tax, but the foreign countries, they’re thinking about they’re very high tax systems. We now have a fairly low corporate tax rate relative to some of our trading partners – [say,] Brazil.
BEAT comes along and says, “All these related party payments, all this transfer pricing, all this Ronald Coase payments.” [Laughs.]
The famous economist, as a matter of fact. He said we’ve got to do these things. [But] the reason they occur, is because you saved money. And saving money‘s a good thing in business. All of these payments that occur naturally, we’re now going to impose the regular U.S. tax.
And not only not going to be deductible, but you’re going to have to actually recalculate basically a corporate alternative minimum tax. Yes, the Tax Cuts and Jobs Act took away the corporate alternative alternative minimum tax, but it put it right back in with BEAT. You have to recalculate and pay the corporate tax on it. And that rate is going up – five percent, 10 percent, 12 and a half percent.
Let me remind you of history one more time, because this is what scares me about GILTI and the BEAT.
When the companies went to those low tax jurisdictions in the fifties and sixties and seventies, who here at the table remembers what the corporate tax rate was? It was over 50 percent at the federal level. States had their own corporate tax. So if you took States like New York or California, you’re in the 55, 56 percent U.S. corporate tax rate. What was the individual tax rate? So now you’re a shareholder. What was your tax rate in the United States during those periods of time? Well, to start with when Puerto Rico got started, that first pharmaceutical company? It was 91 percent – income tax.
Now if I had described that situation as, “There’s a country out there that does a 91 percent personal income tax that has 56 percent effective corporate tax rate…” you would all immediately think Venezuela. You would! But that was the United States. When companies started to move operations outside the United States, it was for – and with the encouragement of Congress, for whatever internal reasons that we had such high tax rates. They also wanted American companies to go out and build the world.
“Globalize! Build the world! Spread American influence!” But also to survive. It’s just like [the question,] “Why do we have personal income tax?” Because it’s the easiest tax to collect. Because it’s actually where all the money is, right? So we charged tax on our salaries and so forth.
[With transfer pricing,] if we could magically just tax companies and not have to tax ourselves personally, we would vote for that. But we can’t, there’s not enough money in corporate income tax, no matter how high, if we took a hundred percent of your income to pay for what we need — roads, schools, healthcare, whatever – it’s just not enough money.
So with BEAT, the United States has put in a system that is an alternative minimum tax for corporations. And it is going against the grain of modern business theory, again as established by Ronald Coase back in 1934. For those of you who know his seminal book.
But telling businesses that they have to go third party isn’t necessarily what we as America, what we want our U.S. companies to be integrated horizontally and vertically. We want our U.S. companies to own the subsidiaries they’re dealing with, whether it’s for national security… Whether it’s because we want to protect the assets, intangible and hardware.
Now, I know somebody in the room deals with technology hardware.
We want American companies to be responsible and own that. BEAT encourages you to do exactly what Ronald Coase said you wouldn’t do: Go to the third-party marketplace to avoid the BEAT, even though the transaction costs are going to be higher.
I don’t think BEAT’s good economically. I don’t think it’s good in tax. I do think it will be effective in raising some revenue for the first five or 10 years until corporations sort out that there are ways around BEAT.
Now, one of the ways is – guess what? Today’s subject: Cost sharing! [Laughs.]
Because cost sharing allows companies like yours, to net their naturally occurring payments back and forward inside the United States and outside. So inbound and outbound. Now, the regulations – and again, I’m sure of it because at the American Bar Association debate in January that we had on this, everybody on the panel agreed that the cost sharing regs allow you to net the payments back and forth.
And more importantly: So the netting, everyone agrees with that. Yes, it allows you to net. However, it allows you to net for BEAT. ‘Cause that was a real concern.
Now, no, there’s no regulation that says that yet in the BEAT race, at least. There’s no PLR.
But at the American Bar Association meeting, that was what the common agreement was including from U.S. treasury that doesn’t hold them — they’re not bound to it, but it was in a public form. Cost sharing allows you to net. So you’re going to see more cost sharing, not less cost sharing going forward because of BEAT. You’re going to see, I think, more cost sharing going forward because risk in today’s world is more severe.
The Cold War, Red Scare… “Oh, it’s so risky.” “What will the world look like?” [Then] “We’ll be in bliss afterwards!” Right? And then afterwards we’re like, “Oh my God, I wish it was the Cold War days when it was just me and the other side.” Right? And so it’s like, the world is risky. You know what? We can guarantee history repeats itself.
Risk will always be there that’s business. It’s existential, just like how we will die! I don’t know if there’s a risk of dying and you’re going to die. There’s no written, that’s guaranteed. It’s just the timing of it. Right?
Mimi Song: Right. Death and taxes.
William Byrnes: The risk will occur. It’s just a timing of when the risk and how severe that risk is.
Now we have coronavirus! Who knew that we would declare a flu, an epidemic, you know, the plague because of the black plague of the 13th Century. And it would destroy your supply chains. Who knew?
So I think that, you know, as we’ve enacted the Tax Cuts and Jobs Act to simplify – was the statement, you know – made about it to simplify our tax system. It’s done the exact opposite.
Not only has it complicated it, but it’s gone in a reverse direction of where the United States economically speaking wants to be both from a true economics point of view of encouraging manufacturing in the United States, but also from just a phenomena of economics that companies’ integration within corporate structures is a good thing.
Mimi Song: So let’s just recap really quickly.
The TCJA effectively reduced corporate the corporate tax rate. It was sort of created a pseudo-territorial system. You’ve got the introduction of the GILTI, FDII, and the BEAT tax. Do you think that the TCJA was influenced at all by the outcomes on the Amazon and Altera cases, and things of that nature?
William Byrnes: Absolutely. Again, when Congress wants to act, Congress can act.
So after the fact, Congress — listening to the public and listening to Treasury — stated, “Perhaps intangibles does mean goodwill. Perhaps intangibles does mean stock-based compensation,” if you will. These cases went too far in Congress’s mind. Congress included the new, ‘what is intangibles’ or means statement in 370 and in 482. So now it’s been more clearly defined, and that is a result of these cases.
I wish that Congress had also included the arm’s length standard. My fear is that because they didn’t, in our new world order of Pillar One that the United States, now that it’s backed off of the arm’s length standard, now that intangibles has meanings that as business people we accept … There is “spirit of innovation” for Amazon.
There is obviously goodwill, and foreign goodwill versus domestic goodwill… There, your workforce in place from having a great workforce in quality control… All of these are great intangibles, and we do value them from both a financial accounting point of view and if you want to buy a company, of course, we value those things. That’s why we made bylaws making companies because integrated, it has value to us, of course.
Mimi Song: Brand new intangibles associated with a digital economy and business models, that’s right.
William Byrnes: Marketing intangibles. But, but in a tax world, we haven’t valued those for good reasons in the past. Now going forward with the Tax Cuts and Jobs Act, it is 99.99 percent that we’re going to have to value them.
I’m not afraid of valuing them! From a tax economics, pure academic point of view, I think that we really should have been valuing them the whole time. But okay, that’s the way the law was written. That’s why we have courts as the current commissioner of the IRS said, “Thank God, for the court system.” And he is a tax litigator.
However, what we do is good for us, what we do is also good for India, China, Venezuela, Argentina —you name the country. And personally, I don’t think it’s a good thing for the United States under a Pillar One type regime or whatever the OECD crops up next to apply a greater meaning to intangibles to U.S. companies, because what are you as companies at the end of the day? They’re all intangibles!
Our manufacturing base is overseas! Our services base, thank God, still some in the U.S. but it’s overseas are at business process outsourcing and so forth. We are the nation of innovation.
When the IRS, the treasury put forward in the Amazon case that, “We have a new argument! What Amazon actually transferred that has to be valued and they didn’t value, and it’s worth billions of dollars was the spirit of innovation of Amazon.” And when I read that term, it’s like innovation. I was like, “They got it right, but we’re a country of innovation.“ And when America bears the risk of that innovation, who pays for it? You and I do because every time out of 1,000 companies, one of them is an Amazon and 999 of them failed, 999 didn’t pay their creditors, 999 didn’t pay taxes, and so forth.
So that comes out of our pockets in essence, the fish, because we still want roads and schools and so forth. So we ended up paying for it. We paid for that as a country. So as a country, shouldn’t we be very skeptical? And when other countries tell us that our innovation really belongs to them as some kind of new concept of marketing intangible shouldn’t, we look at a very close eye and say, “But who bore the risk?” It was us, The U.S. taxpayer who bore that risk under the same terminology.
I’ll agree with U.S. Treasury, that some of that innovation risk was born by the U.S. and I think companies from that perspective, at least going forward should cough up some more post facto. But when you do your new cost sharing arrangements, cough up some more money to the U.S. But by the same token, what is U.S. Treasury going to do for you when it comes to the other countries, bringing these new concepts of intangibles, when they decide to act their own Tax Cuts and Jobs Act.
Mimi Song: It’s interesting, because I think when everyone’s doing well economically, no one’s going to be complaining and we can have actually dignified conversations about what the right answer is. But given the current, uh, economic environment and what we are going to see, I think it’s going to become more challenging in the future.
I would say one last question, given the current environment post TCJA and you know, coronavirus and impacts to the supply chain, what are some strategies that you think multinationals should consider if they have existing cost sharing arrangements, or even if they should even want to potentially consider one in the future?
William Byrnes: Well, as I mentioned, I think cost sharing going forward is actually going to expand. So if the objective of U.S. Treasury and Congress was to stifle cost sharing, it’s exact opposite. Because of BEAT, because of just the nature of risk and risk is increasing with coronavirus. And so now we’re actually realizing risks, that’s the point. So the timing is going to happen, the timing happened.
It’s now we’re going to see much more cost sharing the strategies. More than 10 years ago, I moved from teaching tax planning — because I’m an academic of a tax programs to teaching tax risk management CRM, because I already saw it on the wall. I saw that your job is certainly about how can we mitigate and reduce our taxation because it’s a business cost. And again as I always bring it back, it’s a cost of my retirement plan, but that’s your job. But going forward, your job is much more about how do I stop double taxation because that’s the new world order if you have overseas operations.
So I think cost sharing – when “appropriately” done, because that’s kind of the new word – when it’s appropriately done is going to help you to mitigate some of the double taxation. If the United States Treasury in APHS will agree to your cost sharing, and most importantly agree to represent that agreement.
You don’t want to be representing your company with India, you lose every time. You don’t want to be representing your country with China, you lose every time. You want to be having the U.S. Treasury represent your company with India and China. That’s the mutual agreement procedure. In fact, this Pillar One of the OECD calls for there to be some ‘new world order’ mutual agreement procedures that are always acting always in place, but who’s representing you? U.S. Treasury. So cost sharing agreements going forward: I think the U.S. treasury – I’ve suggested this already with Treasury and taxpayers in the room – there’s going to have to be an APA process where cost sharing agreements in particular are part of a fast forward APA process and Treasury, “Well, that’s what the regulations are for.”
Well they didn’t work out really well, did they? So there needs to be a relook with industry of how cost sharing could be fast forwarded through an APA process where in essence, what the company is doing is hiring U.S. Treasury as your litigation counsel. And so when I have U.S. treasury in the room and the taxpayers in the room, I said, “Why don’t y’all describe to me what this new world order looks like.
Last year, you, Treasury are telling Amazon that, ‘There are about 5 billion shorts and they need to bring, or Coca Cola, Microsoft…’ pick your favorite company right now! Next year, there’s 10 countries out there. They’re going to tell you, ‘U.S. treasury through the U.S. company that your company has $10 billion, short, five of them.’ That’s 50 billion. What’s that world going to look like to U.S. Treasury and taxpayers?”
So if we can have a cost sharing mechanism that allows U.S. Treasury – as I said, to hire U.S. Treasury to get U.S. Treasury behind what you’re doing upfront…. So I’m sure all you in the room know about this new diagnostic process that U.S. Treasury’s published. If you don’t, it’s a very good document to go look at. But U.S. Treasury said, “Before you do an advanced pricing agreement, you must fill out this diagnostic, dysfunctional, functional diagnostic, and then submit it.”
And my perspective is that that’s great. U.S. Treasury will say, “Well, we can’t guarantee anything.” I say, “As long as I say, as long as you can guarantee the company 12 months from now, you’re going to hammer out an agreement.”
And if it’s just a split, the baby, like the courts have been doing for years, then split the baby because it no longer is it going to be about tax strategy, tax planning, or “what I don’t pay the U.S. government?” It’s all going to be about tax risk management, which is “What can I get away with? Can I come out alive? Can I come out with my skin still when I go out into the global new world order of Pillar One?”
So Pillar Two, the alternative minimum tax is that all the other countries, this we have now empowered the rest of the world to do what U.S. treasury wishes it had been able to do the last 50 years and Congress is allowing them to do going forward. But it’s going to be really ugly when the other countries are doing it to us. And if we’re the country of innovation and we’re the country of earnings power, they’re not doing it to their own companies because there’s no money there for them to take, or they’re already taking it. Or Venezuela[‘s approach]: “I’ll just expropriate it all, right?”
Mimi Song: [Laughs.]
William Byrnes: That’s where cost sharing needs to actually have more regulation. It needs to be clearly defined timeline for an APA agreement that allows you certainty. I bet everybody in this room will give up some money for certainty. And everybody in this room will give up some money to know that Treasury has your back, like baseball arbitration.
I’m not talking about internationally. I’m talking with U.S. Treasury. Why doesn’t U.S. Treasury do for you internally what it purports it once externally with other countries. “We demand baseball arbitration.” They won’t give it to us, but if you don’t know baseball, arbitration each makes your best offer and the arbitrator picks one.
So each of you has, you know in Coase theorem and stuff… [laughs] but each of you has the incentive to get as close to the most reasonable offers possible because only one of the two offers is going to be chosen.
Wouldn’t it be great if that applied with treasury puts forward its best APA offer you put forward your best? One of them is going to be chosen. Twelve months after we’ve reached the deadline, whatever the offers on the table are that’s what the arbitrator is going to choose. Let the arbitrator be the taxpayer advocate’s office. You know? So we all trust you. I mean, it’s not there anymore, but impartial…
Mimi Song: Impartial, right.
William Byrnes: … avid, let them choose it. And then once it’s chosen, treasury has your back and they’re your counsel.
Let me say one more thing about, about CrossBorder Solutions. So we go back to Coase – his book, right, In 1934? The reason we have cost sharing is because it reduces transaction costs. If tax risk management is your new world order, that’s a really, really expensive new world order. You’re now going to be doing… this is guaranteed, you’re going to be litigating in 10… 20 countries. Pick how many countries do you do business in, that’s how many countries you’re going to be in controversy.
I don’t want to use the word litigation, but they’re going to be coming with some new, large assessments that wouldn’t have happened five years past. You need to have AI built into your tax function. And when I go to all the conferences, the academic conferences, and the ABA, or international fiscal association, and all the large corporate tax leaders are there from tech, from the industry, from whatever… They all have the same attitude: “I have to do much more with the same budget…” Right? And, “How do you do much more at the same budget?”
Well, thank God America is a country of innovation and that we can even innovate in our tax function!
Mimi Song: That’s right, that’s right.
William Byrnes: So I want to hear about what y’all do, but I think the AI and the ability to use our budget, leverage our budget to do twice as much work that we need to do going forward. It’s going to be a big help.
Mimi Song: That’s right. Well, this is fascinating! Thank you so much. I love the historical references that you’re able to bring, because I think it puts it all into perspective. I really appreciate you being here, Professor Byrnes, and I hope everyone enjoyed it as much as I have.
You know, my takeaway really is okay… Cost sharings are probably going to increase and they could be beneficial for multinationals in this post TCJA environment. We should all take a look at that and then see how it’s going to impact your organization, and whether or not there’s going to be benefits to that.
William Byrnes: I think a great poll we could do in the room, but y’all should do as a company…
Mimi Song: Sure.
William Byrnes: How many people believe five years from now the corporate tax rate will remain 21 percent? Raise your hand. If you actually think it’s going to stay at 21 percent, historically?
[Audience member raises their hand.]
Mimi Song: We got one, we got one!
William Byrnes: Historically, it’s been over 50 percent. Historically, the individual tax rates been as high as 91 percent. You heard that up until Ronald Reagan, it was still above 60. It was pushing 70.
So going forward, if you believe the tax rates are going to stay 21 percent and there’s going to be a 50 percent relief for GILTI, it’s all smooth sailing. It’s all going to be okay.
[Mimi reassures the poor audience member that they are going to be just fine.]
William Byrnes: But if, like me, you think there’s going to be a real risk, a real actual actualization of higher tax rates that maybe there’s going to be no GILTI relief and so forth, then you’re going to find cost sharing every company you’re doing cost sharing with yourself and it’s going to be in manufacturing operations.
It’s going to be because that’s the only way you’re going to be able to survive in the American economy where tax rates are a lot higher than they are today. And you still need to compete against other countries that subsidized their companies that have low tax rates… No, it’s not going to happen.