WhenMarilyn Gerdes accepted her appreciation gift at the conclusion of theDepartment of Accountancy’s recent Lyceum, she quipped, “Is this taxable?”
Itwas a fitting conclusion to an engaging presentation on tax controversies givenby two University of Illinois graduates–Gerdes, former Senior Vice Presidentof Tax for Sara Lee, and Patrick Roxworthy, Senior Vice President of Tax forHyatt Hotels Corporation.
Gerdesdrew on her experience in the manufacturing sector to explain to thestanding-room-only audience the ramifications of international tax rates oncorporations. It’s a topic she said is relevant not just for those who workwith or for multinational companies, but also for those employed by domesticbusinesses. That’s because multinationals are able to engage in tax rate arbitrage,a competitive advantage that is unavailable to domestic corporations. Gerdesexplained that arbitrage in this context is the opportunity to take advantageof lower tax rates by parking your cash in another country where you dobusiness instead of paying the U.S. corporate tax rate of 35 percent if youbring that money home.
Onlyone country in the world, Japan, has a higher corporate tax rate than theUnited States, and most are far lower, so rate arbitrage can play a significantrole in boosting a company’s bottom line. When you calculate both the potentialtax savings and the cheaper labor costs in many of these countries, it becomesmore obvious why manufacturers may have less of a presence in the UnitedStates. In fact, said Gerdes, companies that don’t take advantage of internationalcorporate tax rate benefits may have to answer to shareholders who see tax ratearbitrage as just plain good business sense.
Manufacturersaren’t the only companies avoid paying unnecessary taxes by using tax ratearbitrage. Roxworthy explained that companies with intellectual property (IP) mustbe adept at the game as well. He cited the value of trademarks and other IP asa specific point of contention as regards taxability, with tax collectionagencies such as the IRS typically putting a higher monetary value on the IP thanthe corporations. These concerns and others, he said, keep companies from quicklybringing their money back to the United States “where if it were taxed at alower rate would create many economic benefits, including employing more peopleand growing the company. The current system creates an anti-competitive tax environment.”
Withmore than an estimated $1.8 trillion of corporate profits residing in countries outside the United States, it’sunderstandable why the IRS would frequently audit multinational corporations. Butboth speakers agreed that with the 35 percent tax rate waiting for thoseprofits when they hit U.S. soil, it’s also obvious why corporations areinvesting their profits in overseas countries instead. An added reason is that corporationsunderstand that the U.S. sporadically offers official tax holidays. When a tax holiday comes down the pike, theycan bring their money back when it’s cheaper to do so, or, even better saysRoxworthy, “real corporate tax reform, which is desperately needed but unlikelyto be addressed until 2013, due to the upcoming elections.”
Evenwith extensive reform, however, Roxworthy predicts that in 20 years “we’lllikely be right back were we are now” because there is a reset cycle ofcreating tax credits and loopholes and then eliminating them over time only toreturn to the process years down the road.
Butas much as tax policy may change, there’s one thing that large corporations cancount on remaining the same, said Gerdes and Roxworthy. And that’s thelikelihood that the IRS will audit them.
Whilesharing some of their personal stories of the challenges of being on thereceiving end of an IRS audit, both speakers offered similar advice: beprepared for an IRS audit to take a lot of time and patience; always beprofessional; treat the IRS auditors with kindness, but don’t let yourself bepushed around; don’t take a position you can’t support, and keep a sense ofhumor. In the case of an audit by a foreign government, Roxworthy suggestedusing local accounting firms, not getting involved unless the issue issignificant, and understanding the cultural issues that may come into play,such as the different negotiating styles that are acceptable in differentcountries.
However,at the end of the day, said Gerdes, it’s not audits or cultural issues ordiffering international corporate rates that makes our tax system, both forindividuals and businesses, so complicated.
“Thetax 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 mortgagerate 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 corporatetax world as well,” said Gerdes, with tax credits being provided for environmentalstewardship, research and development, and other corporate initiatives.
It’sunlikely that the marriage of public policy and taxes will be dissolved anytimesoon. However, both Gerdes and Roxworthy agreed that broad tax reform forindividuals and corporations is on the political horizon, and that everyone,from taxpayers to policymakers, believes it’s needed.
“Thequestion is how will we pay for it?” said Roxworthy.
And,to quote Gerdes, “Will it be taxed?”