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By Ronald Fink
While the Obama administration's 2011 budget backs away from repealing the so-called "check the box system" for deferring tax on the earnings of U.S.-based multinationals' foreign subsidiaries through asset transfers, the plan could crack down on other means of transferring assets to low-tax jurisdictions.
Unlike the previous budget, the new one submitted by the president to Congress on Monday would continue to allow companies to transfer assets to foreign subsidiaries without paying tax on the gains so long as they designate the subsidiaries foreign "branches" of their U.S. operations.
But the administration also takes aim at transfers of intangible assets that result in what it calls "excessive" returns. While the budget itself doesn't define what constitutes such a return, senior administration officials said at a press conference on Monday that any transfer of intangibles to a jurisdiction where a company pays an effective tax rate of less than 10 percent and on which it earns a return of more than 30 percent would qualify, according to Remy Farag, a senior tax analyst in the tax and accounting business of Thomson Reuters.
In an interview with CFOZone, Farag noted that the administration's proposal seemed to be a response to a court decision against the Internal Revenue Service last December in a case dating back to 2000 involving Veritas, a software maker since acquired by Symantec.
In that year, Veritas transferred a piece of software to an Irish subsidiary in exchange for $166 million. The IRS claimed that the software was actually worth $2.5 billion, and Veritas owed U.S. tax on that amount instead, though the agency later reduced its estimate of the software's value to $1.7 billion. But the court ruled in favor of Veritas because it said the IRS vastly over-estimated the useful life of the asset. In an article Monday in a Thomson Reuters newsletter, Farag wrote that the court found the IRS estimate "arbitrary, capricious and unreasonable."
The administration's proposal does nothing to clarify how such assets should be valued, Farag said in the interview. In the Veritas case, he said, four different valuation methods were at issue.
But by proposing to tax companies on foreign earnings from transfers that produce excessive returns, the administration would encourage them to reduce their returns by valuing those assets more highly, he said. That, in turn, would increase their U.S. tax liabilities on such transfers.
"This might be their response" to the decision in the Veritas case, he said, adding that in his view the administration clearly is "looking for ways to get around it."
And while Farag said "it doesn't put all the issues to rest," he noted that it would "help the IRS characterize" transfer pricing arrangements like the one involving Veritas as tax avoidance schemes.
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