By Cathy Lockman
When Marilyn Gerdes accepted her appreciation gift at the conclusion of the Department of Accountancy’s recent Lyceum, she quipped, “Is this taxable?”
It was a fitting conclusion to an engaging presentation on tax controversies given by two University of Illinois graduates--Gerdes, former Senior Vice President of Tax for Sara Lee, and Patrick Roxworthy, Senior Vice President of Tax for Hyatt Hotels Corporation.
Gerdes drew on her experience in the manufacturing sector to explain to the standing-room-only audience the ramifications of international tax rates on corporations. It’s a topic she said is relevant not just for those who work with or for multinational companies, but also for those employed by domestic businesses. That’s because multinationals are able to engage in tax rate arbitrage, a competitive advantage that is unavailable to domestic corporations. Gerdes explained that arbitrage in this context is the opportunity to take advantage of lower tax rates by parking your cash in another country where you do business instead of paying the U.S. corporate tax rate of 35 percent if you bring that money home.
Only one country in the world, Japan, has a higher corporate tax rate than the United States, and most are far lower, so rate arbitrage can play a significant role in boosting a company’s bottom line. When you calculate both the potential tax savings and the cheaper labor costs in many of these countries, it becomes more obvious why manufacturers may have less of a presence in the United States. In fact, said Gerdes, companies that don’t take advantage of international corporate tax rate benefits may have to answer to shareholders who see tax rate arbitrage as just plain good business sense.
Manufacturers aren’t the only companies avoid paying unnecessary taxes by using tax rate arbitrage. Roxworthy explained that companies with intellectual property (IP) must be adept at the game as well. He cited the value of trademarks and other IP as a specific point of contention as regards taxability, with tax collection agencies such as the IRS typically putting a higher monetary value on the IP than the corporations. These concerns and others, he said, keep companies from quickly bringing their money back to the United States “where if it were taxed at a lower rate would create many economic benefits, including employing more people and growing the company. The current system creates an anti-competitive tax environment.”
With more than an estimated $1.8 trillion of corporate profits residing in countries outside the United States, it’s understandable why the IRS would frequently audit multinational corporations. But both speakers agreed that with the 35 percent tax rate waiting for those profits when they hit U.S. soil, it’s also obvious why corporations are investing their profits in overseas countries instead. An added reason is that corporations understand that the U.S. sporadically offers official tax holidays. When a tax holiday comes down the pike, they can bring their money back when it’s cheaper to do so, or, even better says Roxworthy, “real corporate tax reform, which is desperately needed but unlikely to be addressed until 2013, due to the upcoming elections.”
Even with extensive reform, however, Roxworthy predicts that in 20 years “we’ll likely be right back were we are now” because there is a reset cycle of creating tax credits and loopholes and then eliminating them over time only to return to the process years down the road.
But as much as tax policy may change, there’s one thing that large corporations can count on remaining the same, said Gerdes and Roxworthy. And that’s the likelihood that the IRS will audit them.
While sharing some of their personal stories of the challenges of being on the receiving end of an IRS audit, both speakers offered similar advice: be prepared for an IRS audit to take a lot of time and patience; always be professional; treat the IRS auditors with kindness, but don’t let yourself be pushed around; don’t take a position you can’t support, and keep a sense of humor. In the case of an audit by a foreign government, Roxworthy suggested using local accounting firms, not getting involved unless the issue is significant, and understanding the cultural issues that may come into play, such as the different negotiating styles that are acceptable in different countries.
However, at the end of the day, said Gerdes, it’s not audits or cultural issues or differing international corporate rates that makes our tax system, both for individuals and businesses, so complicated.
“The tax code is so complex because it is used has an instrument of public policy,” Gerdes explained. “A tuition or daycare tax credit or deductions for mortgage rate interest have a public policy purpose, to encourage people to buy homes, for instance. In the same way, public policy comes into play in the corporate tax world as well,” said Gerdes, with tax credits being provided for environmental stewardship, research and development, and other corporate initiatives.
It’s unlikely that the marriage of public policy and taxes will be dissolved anytime soon. However, both Gerdes and Roxworthy agreed that broad tax reform for individuals and corporations is on the political horizon, and that everyone, from taxpayers to policymakers, believes it’s needed.
“The question is how will we pay for it?” said Roxworthy.
And, to quote Gerdes, “Will it be taxed?”