As the U.S. economy crumbled in early 2009, President Barack Obama
offered a plan that he said would save American jobs: a crackdown on
corporate tax loopholes that encourage companies to send profits abroad
to avoid paying billions of dollars in U.S. taxes each year.
Tax lobbyist Ken Kies was not worried. A decade earlier, he had led a
fight to preserve a key loophole - known in Treasury Department
shorthand as the "check the box" rule - when another Democratic
president, Bill Clinton, had tried to kill it.
"I told my clients, 'Don't sweat this. This is never going to
happen,'" recalled Kies, who has advised corporate giants Microsoft and
General Electric on the issue.
Kies was right.
Business groups rose up against Obama's plan, arguing that it could
damage U.S. businesses already threatened by the weak economy. Democrats
in Congress balked, Obama dropped the idea and the loophole survived.
The story of the "check the box" loophole, which allows U.S.
companies to choose for themselves how to classify their subsidiaries
for tax purposes, and a companion policy known as the "look-through"
rule, shows how Washington bureaucrats, lobbyists and politicians have
worked together - sometimes wittingly - to save money for American
corporations and deprive the federal government of billions in tax
revenue each year.
What began in 1996 as an effort by the Treasury Department to
simplify the U.S. tax code mistakenly ended up as a massive tax loophole
for corporate America, which seized upon it and has never let go.
Besides fueling an explosion in earnings that U.S. companies keep
abroad - now more than $1.8 trillion, the Commerce Department estimates,
double the amount from less than a decade ago - the loophole has become
a symbol of how difficult it can be to repeal a tax benefit once it
becomes entrenched.
At congressional hearings last week, several lawmakers blasted Apple
Inc. for using the "check the box" loophole and other international tax
strategies to avoid paying what they estimated as $9 billion in
potential U.S. taxes in 2012.
Two of Apple's most aggressive questioners, Democratic Senator Carl
Levin of Michigan and Republican Senator John McCain of Arizona, have
called for closing the "check the box" loophole. But even they have
voted to keep it alive several times in recent years when it has been
inserted into other legislation.
Levin's office did not respond to requests for a comment. McCain declined to comment for this story.
"Once a policy mistake is made that is favorable to taxpayers, and
particularly to big taxpayers, it is extremely difficult to reverse,"
said a former Treasury Department official who helped write the "check
the box" rule and was involved in Obama's effort to repeal it.
The former official spoke on condition of anonymity, citing the sensitive nature of the tax break.
The "check the box" loophole - which costs the United States about
$10 billion per year, according to the White House - also has been a
reflection of Washington's "revolving door" culture of policy-making and
lobbying. Some of the bureaucrats who helped to write the rule went on
to work for corporations that used it to lower their tax bills.
They include William Morris, who was Treasury's associate international tax counsel when the rule was imposed.
Morris, who did not respond to requests for comment on this story,
joined GE in 2000 and is now director of the company's global tax
policy. The company, like many other big multinationals, keeps its tax
burden well below the official U.S. corporate rate of 35 percent in part
by taking advantage of "check the box" and other international tax
strategies.
GE's annual reports indicate that the company does so largely because
many of its profits are directed to its vast network of foreign
subsidiaries. In a filing with the U.S. Securities and Exchange
Commission in February, GE said its overseas affiliates were holding
$108 billion in offshore profits, which is more than any other U.S.
company.
Morris's precise role in GE's tax strategy is unclear. The company declined to comment for this story.
Other former IRS and Treasury officials involved in shaping the tax
loophole now hold senior positions at law and accounting firms in
Washington and New York.
BIRTH OF A LOOPHOLE
Offshore tax shelters have bedeviled the U.S. government virtually since the inception of the tax code in 1913.
A 1962 compromise between President John Kennedy and Congress imposed
U.S. taxes on "passive" income such as royalties and interest earned
abroad, but not on "active" income from regular business operations.
That law, known as Subpart F, made the tax code increasingly complex
as businesses grew larger and more diverse. The law was revised 10 times
between 1969 and 1996 as the U.S. Internal Revenue Service tried to
figure out how to classify, and then tax, tens of thousands of corporate
units.
In 1996 the Treasury Department moved to simplify matters with a rule
that enabled companies to "check the box" on a tax form to describe a
given corporate entity - including whether it was, for tax purposes,
irrelevant, a so-called "disregarded entity."
For a company and its subsidiaries that all operate in the United
States, the rule streamlined tax filing by allowing the subsidiaries'
income to be reported on the same forms as the parent company's income.
When applied to U.S.-based multinational companies, however, the
"disregarded entities" status could be used to set up high-volume
subsidiaries in low-tax jurisdictions such as Luxembourg or Ireland. A
key part of Apple's tax strategy, for example, is having a subsidiary in
Ireland that takes in all of the income from Apple's retail stores in
Europe.
Treasury had given little thought to how the "check the box" rule
might affect U.S.-based multinational corporations, according to several
people involved in the effort.
Treasury officials realized they had created a massive loophole when
they noticed a spike in cross-border financing shortly after the rule
took effect.
"The mistake was extending it to foreign entities," Donald Lubick,
Treasury's top tax official at the time, told Reuters. "That was
apparent pretty quickly."
Clinton's Treasury Department moved to revoke the "check the box"
rule in early 1998. But multinational companies such as Hallmark,
Coca-Cola, IBM and Philip Morris launched a full-court press to convince
Congress to keep the rule in place.
Enter Kies, a former tax specialist for Congress' Joint Tax Committee
who was eager to put his expertise and contacts to work as a tax
lobbyist.
Kies's former Republican bosses - Representative Bill Archer of Texas
and Senator William Roth of Delaware - accused the IRS and Treasury of
overstepping their authority in trying to take away the loophole.
Kies, meanwhile, says he pursued a strategy that he figured would
resonate with businesses, lawmakers and regular citizens: He argued that
eliminating the "check the box" loophole would damage U.S.-based
multinational companies by forcing them to pay more taxes not only in
the United States, but also to high-tax nations such as France.
Roth's Senate Finance Committee passed a bill in April 1998 to
prevent Treasury from making any changes to "check the box." That
language was watered down to a non-binding resolution by the time the
measure passed the Senate the next month, but Congress' message was
clear: Don't mess with the loophole.
Treasury soon gave up its effort to revoke it.
"In light of that reception that this rule got on Capitol Hill, we
withdrew the notice," said Philip West, who was then the top
international tax official at Treasury and now advises clients on
international tax strategy for the law firm Steptoe & Johnson.
'CHECK THE BOX' GROWS UP
By 2004, thanks in part to the "check the box" rule, U.S.-based
multinational corporations paid an effective tax rate of about 2.3
percent on $700 billion in foreign earnings, according to the Obama
administration.
To make "check the box" tougher to revoke, Kies and other corporate lobbyists urged Congress to turn the rule into a law.
Congress did so in 2006 with legislation that became known as the
"look through" rule. It bolstered the "check the box" loophole by giving
corporations more latitude to move some types of income from one
foreign unit to another without paying a tax.
The "look through" rule became law with little debate, according to
congressional records. It was tucked into a broad extension of other tax
cuts.
The 2006 law wasn't permanent, but supporters have managed to extend
it repeatedly by embedding it in large and important but unrelated
pieces of legislation that were headed toward easy passage in Congress.
That is what happened in 2009, when Obama threatened to cut the loophole.
Congress has extended it temporarily twice since then as part of
larger pieces of legislation. Both Levin and McCain voted to extend it
in January as part of the legislation that kept the U.S. government from
going off the "fiscal cliff," a package of across-the-board tax hikes
and spending cuts that threatened to plunge the U.S. economy into
another recession.
Both also voted to extend it in 2010 as part of a broad tax bill.
Obama has not proposed a repeal of the loophole since 2009.
During the Senate hearing last week on Apple's tax strategy, Mark
Mazur, Treasury's assistant secretary for tax issues, said in written
testimony that the Obama administration remained "concerned about the
misuse of various income-shifting devices, including misuse of the
'check the box' rules."
Mazur noted that the White House has made proposals to discourage
profit-shifting offshore. But it's unclear whether Obama will try again
to have the "check the box" rule revoked.
For perspective, Obama could read the words of another president who
also fell short in his assault on tax shelters, this one failing to
raise taxes on overseas holding companies.
"We face a challenge to the power of government to collect uniformly
and fairly, and without discrimination, taxes based on statutes adopted
by Congress," that president wrote.
The letter was signed by Franklin Roosevelt and dated June 1, 1937.
© 2013 Thomson/Reuters. All rights reserved.
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