The Bush tax-cut debate may have captured the headlines leading up to the new year, but there are at least half a dozen lower-profile tax issues that CFOs should keep tabs on, with more to come as the year unfolds.
The most important is, no doubt, the corporate tax rate. Japan plans to cut its corporate rate by 5 percentage points in April, which will give the United States the dubious honor of having the highest corporate tax rate in the world. (The Organization for Economic Cooperation and Development calculates member country tax rates by looking at national levies, and then taking into consideration the deductibility of average state taxes.) As a result, the United States now tops the list with a 39.2% corporate tax rate, ahead of Japan's 35%.
American companies have long complained that the high tax rate is a competitive disadvantage. To cite but one example, other G7 countries exempt foreign business income — or at least 95% of the income — from the corporate tax base, says Andrew Lyon, a principal in the national economics and statistics group at PwC U.S.
Therefore, Lyon says, CFOs should keep an eye on the proposals from President Obama's deficit commission (officially, the National Commission on Fiscal Responsibility and Reform), which, among other options, has suggested taking the corporate rate down from its current 35% to between 23% and 29% (although the revenue would have to be made up somewhere else, which might include the elimination of tax credits). Lyon says the tax-rate drop would likely be accompanied by the introduction of an approach long sought by many companies — a territorial tax system (see below).
Marking Their Tax Territory
Congress is taking another look at reworking the tax system, only this time there may be more support for a change. In 2005, the Joint Committee on Taxation talked about revamping the U.S. tax system, moving it from a worldwide structure to a territorial system. So instead of taxing American companies on income generated in and outside the United States, the territorial system would tax income generated within its borders, with some exceptions, which is how many other developed countries run their systems.
A territorial tax system is up for discussion once again, says Stu Anolik, a managing director and tax expert with CBIZ-MHM, who points out that companies generally give a thumbs up to the reportedly "pro-free-market" system. Anolik says a territorial system eliminates the need for complex foreign tax credits, antideferral rules, and the bureaucracy that accompanies both.
Despite the fact that the U.S. tax system is intensely intertwined with the worldwide tax system, expect Congress to take a serious look at alternatives this year. "In light of [the President's]
deficit-commission report, looking at the tax system will be of more immediate concern," says Anolik. So will consideration of solid tax-deferral strategies, like the one Google employed this year to garner an effective worldwide tax rate of below 3%. How did Google do it? The Internet giant legally moved income generated by Irish subsidiaries to a Bermuda tax haven via Dutch subsidiaries.
The Internal Revenue Service reports that U.S.-based corporations more than tripled foreign profits, from $89 billion to $289 billion between 1994 and 2004, with 58% of the earnings recognized in low-tax or no-tax jurisdictions. More important, the globalization trend is not slowing. In fact, the IRS has stated publicly that it will ramp up enforcement efforts in several key areas, including transfer-pricing transactions.
The increased scrutiny of transfer pricing (the strategy by which multinational corporations move income among related subsidiaries in search of a low-tax jurisdiction within which to recognize revenue) has also elevated the issue from a back-office compliance exercise to an audit-committee priority requiring "active" management participation, says Steve Snyder, a director at Navigant Consulting. He cites temporary Treasury Department rules, an Obama Administration tax plan, and two recent court cases as other reasons why CFOs will feel transfer-pricing pressure in 2011.
Temporary rules issued by Treasury in 2009 are still in effect. They addressed how cost-sharing arrangements for intangible assets are valued when an owner-developer sells the rights to use the asset to an overseas subsidiary.
The rules are controversial because the guidance they provide regarding how companies should measure the level of risk held by the so-called controlling corporation often results in more taxable income shifting to the original developer. An Obama Administration tax proposal will, if accepted, broaden the definition of intangible property and tax "excessive returns" when intangibles are transferred from the United States to a related subsidiary in a low-tax jurisdiction.
There is a bright spot for corporations, says Snyder. Two recent tax-court decisions related to transfer-pricing issues went against the IRS and in favor of corporate taxpayers. In a case involving Veritas Software, the court took a "narrow" view of intangible property, and made a distinction between preexisting intangible property and intangibles developed under a cost-sharing agreement, handing a victory to the software maker. Similarly, the tax court sided with Xilinx Inc. when the engineering design firm took a deduction for employees' stock options related to the research-and-development staff working under a cost-sharing agreement.
New sales-tax laws, written to catch up to the realities of e-tail, could haunt online sellers in 2011. For the most part, online retailers aren't required to collect sales tax from buyers when the sellers don't have a physical presence (nexus) in the state where the buyers make purchases. But that competitive advantage for Internet retailers could disappear this year if more states follow New York's so-called Amazon law, says Tracey Sellers, a managing director at True Partners Consulting.
Passed in 2008, the legislation takes its nickname from Amazon.com, the most prominent of the 30 or so online marketplaces that the law targets. The law establishes nexus for online retailers in New York if they have what is known as a sales affiliate in the state that generates at least $10,000 in annual revenues for the retailer. These affiliate programs are a prominent feature of Amazon.com, eBay, and other online retailers, and describe an arrangement whereby the e-tailer acts as an Internet storefront for a business that may be located in New York State. If the affiliate is based there, any sales generated by a "click through" to Amazon is taxed by the state.
So far, New York's lower courts and its appellate division have found the law to be constitutional, but the appellate court is still seeking information on the Internet sales issue. As of December, Amazon.com and Overstock.com continued to appeal decisions that sided with the state. Meanwhile, the National Governors Association has launched the Streamlined Sales Tax Project, a multistate effort to simplify and align sales-tax policies as a way to ease the burden of tracking and collecting taxes in states where retailers don't have a physical presence. More to the point, the pressure to apply sales tax to goods and services sold via the Internet is certain to increase.
Shoring Up Your Position
The word transparency has been thrown around a lot since the Sarbanes-Oxley Act was passed in 2002. Now the IRS is using it as a rallying cry to demand more information about what is known as uncertain tax positions (UTPs).
UTPs are tax deductions for which companies set up a cash reserve because management suspects the position taken by the company may not stand up to an IRS audit. Currently, accounting rules require that companies report these "weak" or uncertain positions in the aggregate, as a total pot of cash that sits on the balance sheet. But Schedule UTP, which is filed along with annual corporate-tax returns, requires an itemized list of the positions, a brief explanation of each, and a dollar estimate of the potential losses, which, for practical purposes, becomes a bread-crumb trail for IRS auditors to follow.
At nearly $13 billion, the IRS budget for fiscal-year 2011 is 4% higher than its 2010 budget, and officials claim that the agency is "vigorously" pursuing its enforcement agenda. When it released its budget documents last year, the IRS also noted that it would "build and deploy" advanced information-technology systems, processes, and tools to improve its efficiency and productivity. Part of the efficiency effort is Schedule UTP, says Jeffrey LeSage, national managing partner for KPMG's U.S. tax practice. The itemized list allows IRS auditors to do less with more, since companies are being forced to raise their own red flags every time they suspect the IRS might balk at a deduction.
Abandoned, but Not Forgotten
After more than a decade, Delaware and Staples Inc. are still at odds over how much the office-supply giant owes the state in unclaimed property. Abandoned or unclaimed property is commonly payroll, refund, and dividend checks that under escheat laws are turned over to the state after a waiting period, if the company holding the property cannot locate the owner. Typically, owners claim only a fraction of what states hold in their treasuries, says Noel Hall, a principal and unclaimed-property expert with Ryan, a tax-services firm. What's more, states often borrow the unclaimed cash and use it to fund infrastructure and education projects.
In 2000, Staples voluntarily disclosed to Delaware that it owed about $137,000 for abandoned property it failed to report. However, Delaware launched an audit and alleged that the company owed nearly $4 million. Staples sued the state in 2010, but the case remains unsettled. It's the third unclaimed-property suit for Delaware in the past few years, with CA Inc. (formerly Computer Associates) and McKesson Corp. filing complaints there in 2008 and 2009, respectively. So far, Delaware has come out a big winner. CA eventually settled the case for $17.6 million, a far cry from its initial voluntarily disclosed amount of $2.3 million.
With states eager to fill coffers any way they can, unclaimed-property seizures will increase. The problem for corporations, says Hall, is that "most CFOs are sitting on a powder keg," especially if they have already written off the property but then either voluntarily move into compliance mode or are forced there by an audit, without quantifying the potential income-statement hit. States have been known to chase hundreds of millions of dollars in unclaimed property from a single company. And although settlements generally are for far less, the sting can cost some finance chiefs a bonus — and, in extreme cases, Hall says, their jobs.
Marie Leone is deputy editor for online initiatives at CFO.