353 46 354 41 355 4 355 417 I have had two articles published recently on various aspects of international transfer prici approaches to apportionment of international business income.' Both of these have been mad Committee Members and staff. I formerly served as an attorney on the Staff of the Joint C Taxation, where I worked on tax treaties and other international tax matters. I served later as Sp to the Senate Committee on Finance for the Tax Reform Act of 1969. I have practiced law in since 1956 with firms which have also had offices in Chicago, New York and other cities. I an my own firm of Wickham & Associates. This statement and my oral testimony are not submitted to you on behalf of any oth organization. They reflect my own views. They are based on my work in this area in public so practice and academia. I offer them to assist the Committee in arriving at decisions in furth public interest in this area. The views expressed here are substantial as those I presented last July in an appearance as an exper Possible new directions for dealing with problems concerning multinational appo international business income are the focus of this statement to the Committee. Enormous probi generated by the arm's-length transfer pricing approach which the U.S. Treasury and the IR regulations first proposed in 1966 and finally promulgated in 1968, which they since have a adoption by other countries, and which they still are urging Congress to retain. New direction I have some to suggest. The bill, H.R. 5270, on which these hearings-are-being-held, -has-seve which would set new directions in this on which I also will comment. 356 419 356 419 L 357 420 357 420 357 420 358 421 359 422 360 423 Background & Perspective. My interest in finding solutions to problems in the area really began in 1961 when I dis on the Joint Committee Staff that only two of the U.S. income tax treaties then in force had a c set of bilaterally agreed rules of source to govern which country had the right to tax internati income of non-resident firms or to govern when a country of residence of a firm would be oblig foreign tax credit to cede primary jurisdiction to the country taxing income on the basis of its sou the same time I discovered that some Treasury and IRS personnel were contending that such a issues should be left to them for disposition on a case-by-case basis under U.S. Internal Revenue 482, and that section should be left vague to operate "in terrorem". Shortly afterwards the conferees on the Revenue Act of 1962 agreed to drop from the bill to be sent to Preside provision in the House-passed version of the bill which would have provided a clearer and more of 3-factor apportionment among commonly controlled units of an international business' income of goods that would be used unless the taxpayer could demonstrate use of the comparable unco method of transfer pricing would be more accurate. That action was accompanied by an expre in the report of the conferees that Treasury would use the power it already had by regulation 482 to provide formulary apportionment in lieu of the arm's-length transfer pricing approach. T disappointed when Treasury and the IRS decided in the section 482 regulations proposed in provide any such formulary apportionment but to require use of the less specific transfer pric That allowed the IRS, after the filing of a tax return, to challenge any method used by a firm und rules which placed upon the taxpayer the extraordinarily heavy burden of proving not only that i *LL. B., Harvard Law School '53; A.B. Harvard College, The most recent of these, published yesterday in Tax Notes and entitled New Directions Needed For Solution of Transfer Pricing Tax Puzzle: Internationally Agreed Rules or Tax Warfare?", was co-authored by Charles J. Kerester of Mr. Kerester is a lawyer who is in practice as a member of the firm of Jones, Day, Reavis and Pogue and teaches law as faculty at the Case Western Reserve University School of Law. He also served as an attorney on the staff of the Joi taxation, where he worked on tax treaties and other subjects bearing on interjurisdictional apportionment of taxing auth • article, The New U.S. Transfer Pricing Tax Penalty: A Solution, or a Symptom of the Cause, of the International Puzzle?", was published in the Winter 1991 issue of The International Tax Journal. (at vol. 18, p. 1). While on the Joint I also authored two published reference works on tax treaties--(1) 'A Topical Comparison of U.S. Income Tax Convent and (2) a four-volume "Legislative History of U.S. Tax Conventions" (JCT, 1961)— and one unpublished analysis and polic income tax treaties. The provision was section 6 of II.R. 10650, 82nd Cong., 2d Sess. (1962). ** asked to make before the U.S. House Ways & Means Committee' on Oversight at a public hearing held on H.R. 5270 (102d Co July 21-22, 1992). be more to the point and more productive if it is founded on a sharper definition of the problems presented. Congress, and Committed in particular, have had enormous portions of their available time and resources consumed in recent years by attention to Treasury and IRS recommended alternatives for strengthening the IRS' hand in enforcement of the arm's- length transfer pricing approach. Yet the appropriations requested by the IRS for enforcement in this area and the legislation requested to deal with new problems scem only to increase. I think that the interests of this Committee and of the public will be better served by this Committee's refusal to continue accepting such Treasury/IRS proposals as solutions to the enormous problems presented under the present system. More of the same clearly is not a solution. The newly proposed Treasury/IRS regulations under section 482 also are not a solution; they insist on the costly old transfer pricing approach applied on an after-the-fact, case-by-case basis. The new advance pricing agreement (APA) procedures also are not solutions; they too, insist on case-by-case application of the old transfer pricing approach. The APA procedures also threaten to aggravate the potential for disparate and anti-competitive tax treatment of American business competitors and for unequal treatment of domestic and foreign-controlled international businesses. My work has led me to the view that several distinct but related core problems are at the root of difficulties being experienced under the present system. These are the cause of numerous additional problems that can be remedied only if steps are taken to remedy the core problems. Here I will first identify the core problems I see, briefly note their causes, and then discuss some of the additional problems that derive from the core problems, again identifying their causes so that appropriate solutions can be identified. Solutions for some are not solutions for others. There is no single or simple solution. I note at the outset that all of the core problems under the present system are caused by failures of government, not by taxpayer abuse or "evasion" as is so commonly asserted or assumed in discussions of the subject. This means that remedy of these problems can be effected only through governmental actions in those areas. 1. The lack of rules -- clear rules readily reducible to numbers required on income tax returns. One central problem permeating the entire area is a lack of clear, definitive rules that are both informative about what is expected and reducible to numbers required on tax returns. This lack of rules for determining transfer prices, as I pointed out in an earlier article, "was accepted as fact and described at length" by Treasury and the Service in their 1988 White Paper. It is also noted by the Staff of the Joint Committee at pages 54 and 49 of its explanation of H.R. 5270. (c) The lack of clear rules which are informative about what is expected and reducible to the numbers required on tax returns defeats the U.S. system for voluntary self-assessment of tax in this area of the law. This necessitates a case-by-case, after-the-fact approach and brings other ill effects which pervade the system at all levels. (See pages 344 - 5 of our article in 56 Tax Notes.) 2. The requirement of Treasury regulations that hypothetical "arm's-length_prices" be constructed for non-arm's length, intercompany transfers for which there are not real prices set by market forces a second core problem that is needlessly generating major problems which are unilaterally remediable through amendment of the regulations. Superficially, this problem is different from the first core problem having to do with a lack of rules, since here at least there is an explicitly stated rule in the Treasury regulation. This superficial difference, however, often turns out not to be real in practice because of the pervasive lack of comparables (which is not soluble by any new rule requiring comparables), lack of rules for determining what is comparable, and the lack of rules for setting transfer price in the absence of comparables, as we discuss further below. Nevertheless, this core problem in fact is quite different from the general lack of rules. That is because here there is a quite explicit regulatory rule, heavily sanctioned by an array of penalties for its violation, which compels taxpayers, tax collectors, and the courts all to cope with the massive, costly, and often |