Tax Base Erosion: Reformation of Section 482's Arm's Length Standard

Abstract

There is an important debate about fundamental tax reform looming, and the problem of homeless income (HI)—commonly referred to in the current round of debate as “base erosion and profit shifting” (BEPS)—is at the center of the storm. The media has incited the general public through llegations that multinational enterprises (MNEs), including many prominent MNEs, have misreported their income, and that tax havens are a public menace. Not surprisingly, a wide range of policy formulations have been, and will be, put forward to address the HI/BEPS problem. During the course of this debate, MNEs will argue that the current corporate taxation scheme of the U. S. is anti-competitive because it imposes the highest effective tax rate globally and imposes extraterritorial tax costs on U.S.-owned MNEs (U.S. MNEs) that are not imposed on their foreign-based competitors (non-U.S. MNEs). As the parent company elects the residency of the MNEs, many countries have decided to forgo taxing extraterritorial income entirely, hoping to attract the corporate headquarters, research and development, and other highly remunerated jobs of the MNEs to their country. Observing this trend, some countries have used the competitiveness argument to claim that the U.S. should avoid taxing international income entirely. Although this conclusion may carry these implications too far, important scholarship does make the case that excessive residency-based taxation of U.S. MNEs risks contributing to the trend of acquisition of U.S. MNEs by non-U.S. MNEs or U.S. MNEs expatriating, actually or constructively, because of the tax advantages afforded to foreign ownership. In response to this argument, at least six European nations have adopted so-called “patent box” regimes that provide concessionary tax rates to IP related income in an effort to attract high paying research and development jobs to their country.