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difficulties presented by the arm's-length pricing requirement of the Treasury regulations. to noting that some key evidence which was presented in the 1988 Treasury White Pap hearings held in 1990 by the Oversight Subcommittee is reviewed at pages 345 - 7 of ou

(c)

The complications of the approach requiring "pricing" of ir would be eliminated if such intercompany transactions were disregarded as they are for so ma

(d) The U.S. Treasury regulations' requirement for arm's intercompany transfers is not, as a matter of law, required by either the U.S. tax statute or a to which the U.S. is a party. The statutory provisions of section 482 do not require the required by the existing Treasury regulations. In addition, no provision of any tax trea is a party requires arm's-length "pricing". The United States had many treaties in place p 1966 of the proposed Treasury regulation in which arm's-length pricing was first required expressly required or requires an arm's-length "price." (See page 348 of our article in 5

(e) The U.S. Treasury Department's reiteration of the contentio pricing standard is the "international norm" erroneously implies that there are no other implementing an arm's-length standard and fails to recognize that the Treasury Department c role in formulating and working to secure international acceptance of arm's-length alternativ which obviously is not working. (See page 348 of our article in 56 Tax Notes.)

3. The differences and lack of coordination between the source rules used b of U.S. unincorporated branches of foreign businesses and allowance of the foreign tax cred foreign operations of U.S. businesses and the rules used under section 482 for taxation subsidiaries of international businesses are unjustified and undesirable but are remedial un core problem we see is the use by the U.S. of one set of rules for (a) determining the sou subject to its tax where international business is carried on directly or through an uninco (b) for its allowance of a credit for foreign operations of U.S. businesses and the unjustif different set of rules-- not meshed with geographic sourcing rules-- for making realloca under section 482 where the business is carried on through an incorporated subsidiary or affiliate. This is recognized in examples presented by the staff of the Joint Committee 34 and 35 of their explanation of H.R. 5270. The newly proposed regulations would not c

4. Lack of international agreement on substantive and procedural rule resolving conflicts among competing multinational tax claims to income from internation services. -- A fourth core problem in the area is the lack of international agreement or source for division of profit and loss for income tax purposes, on procedural rules for multinational interpretations of such rules as they relate both to exercise of a nation's source and its allowance of a foreign tax credit for another country's taxes on income fro foreign country, and on rules for coordinating or meshing application of source rules w of section 482-type powers.

Here I limit my comment to identifying this as a major problem and kinds of issues which must be addressed to arrive at workable source rules for geograp income tax base appear to be ones that can supply the more specific standards needed of the rules for the exercise of the section 482-type powers and to coordinate those wit

Wickham, Transfer Pricing, supra note 1, at 10-19; Langbein, "The Unitary Method and the Myth of Arm's (Feb. 17, 1986).

'Prior to their issuance in 1968, the predecessor regulations since 1934 did not require an arm's-length p arm's-length standard, but not an arm's-length price. Article 45-1 of Treas. Reg. § 86. An arm's-length "star arm's-length "price." The latter is the requirement imposed by the Service and Treasury, first in proposed reg in 1966 and then in final regulations adopted in 1968. The provisions of section 482 or provisions correspondin in place since at least the 1928 Act. The earliest version originated in the Treasury regulations in 1917. Treas 78. The regulations were codified by section 1331 of the Revenue Act of 1921.

a foreign equivalent) and (b) from discharging its statutory or treaty obligations under the foreign tax credit cede some of these revenues to foreign countries of source. The resulting inability of government to predict h reasonable accuracy the revenues it may expect to derive and keep from international business nsactions has multibillion dollar budgetary implications for the United States. Overestimation of revenues m international business transactions leads to overestimation of revenues needed from other sources. These dgetary implications will only grow larger as the level of international business activity increases or as the asure of vagueness of the rules increases.

3. There is the inability of the U.S. and other nations to know whether each is getting its "fair re" of tax revenues from international business transactions.--The issue of "fairness" of a country's share of h revenues has a potential for causing major difficulties in international relations. Such difficulties may take destructive form of multinational tax warfare in which one country's punitive or discriminatory taxation foreign-controlled businesses provokes the foreign country's retaliatory taxation of businesses controlled by idents of the first country. More than the absolute level of tax revenue is involved. Widely and deeply held ncepts of political and economic justice and equity and fair play are also involved. Americans may see the ue, for example, in terms of whether foreign-controlled businesses "exploiting" the U.S. market are paying es on the fruits of their endeavors which correspond to the tax burdens of Americans. Such views may nslate into political pressures on elective U.S. government officials to raise needed U.S. revenue from the litically "low-cost" source of foreigners who do not vote in U.S. elections. U.S. political leaders and would-be ders would be well advised, however, to remember that the fervor of Americans' reaction to "taxation hout representation" may be mirrored in the reactions of people of foreign countries in which U.S.atrolled firms do business. The same U.S. government officials who are pressed by their citizenry to tax -eigners may also find themselves pressed by their U.S.-controlled business firms to advocate the latter's erests in "fair" and non-discriminatory tax treatment by foreign governments'.

Answering the question whether a country is getting its "fair" share of revenues from income taxation international business transactions requires more than unilateral actions on the part of each country mpeting for a share of that revenue. Each competing country may unilaterally make and enforce its own es as to the amount of tax it may seek from an international business, on grounds either that the business locally domiciled or that the geographic source of the income is local. The tax declared due under those ilateral rules, however, is only a declaration of that country's position, which may or may not be considered foreign countries involved to be a "fair share". Fairness of national shares of revenue from multinational come taxation of business transactions can be settled only by reference to factors in rules which are either reed to by the several countries involved or are set by judicial or other arbitrators agreed to by those untries.

The fact is that such internationally agreed rules are generally lacking. U.S. tax rules for exercising power under section 482 to reallocate taxable income from foreign to domestic U.S. entities are not rules geographically sourcing such income among competing countries. Source rules used by the U.S. for that rpose are separate from, and not coordinated with, the U.S. rules for exercise of its powers under section 2, which generally are applied unilaterally and frequently without regard to positions on issues of geographic ocation taken even by the U.S. itself let alone by other countries. (See 56 Tax Notes 350.)

There is a need for all responsible agencies of government in the U.S. and abroad to work nstructively and cooperatively to supply the framework of internationally agreed rules needed for ultinational income taxation of international business transactions. That course offers a promise of ernational tax harmony rather than international tax warfare.

4. There is the potential for multiple over-taxation of international business transactions, with = consequent depressing effect that may have on the free flow of such transactions in reference to free market ces of supply and demand. (See 56 Tax Notes 351.)

'Responsive to such concerns, Congress long ago enacted provisions of U.S. income tax law which authorize the President to institute aliatory taxation of foreign nationals of countries found by the President to have imposed taxes which are "more burdensome" or scriminatory" against U.S. nationals. See I.R.C. §§ 896 and 891.

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8. There are momentous cosis and needless waste of scarce gov enforcement and administration of the present case-by-case approach. Neither the tota revenue benefits received by the U.S. government in connection with administration Treasury's current or proposed arm's-length pricing regime under section 482 have eve Service or Treasury, so far as I am aware. Fragmentary elements occasionally are r report is made of such costs and benefits on a system-wide basis covering all the costs o operations of all units of the U.S. government that are involved. Moreover, the questionably determined that the proposed regulations under section 482 are not "m cost/benefit Regulatory Impact Analysis is required under Executive Order 12291.*

I note that the President recently extended his 90-day freeze on most months, and ordered government agencies to start using new cost-to-benefit an legislation or proposed rules.' I suggest that those requirements be applied to the So that they determine and account publicly for the costs of adhering to the present casesection 482. More specifically, I suggest that the Service and Treasury be required to Management & Budget, the Congress, and to the public on the annual and cumula Government (including the Service, the Treasury and the Justice Department) enforcement of section 482. The system-wide costs thus determined for administrati the present case-by-case approach under section 482 should then be compared with expected under a new system of generally applicable rules reducible to numbers r Without having done all the work described to make an appropriate cost/benefit analysi already available strongly suggests that a comparative cost/benefit analysis would a present case-by-case approach with a new system which provided pre-published rules that are reducible to numbers needed on tax returns.

9.

There is the dependence of the system on disclosure by taxpayers other third parties, of confidential financial and sensitive business information that needle difficulties. These difficulties include (a) the high cost of litigation and other e information; (b) breach of the information suppliers' confidences; (c) the use of ev taxpayer's cross examination; and (d) the demand for information about competito affairs which if directly sought by conscientious taxpayers' executives through communic representatives would, we are advised by anti-trust counsel, risk criminal violation of s Antitrust Act.

10.

There is a very real potential for disparate and anti-competitive competitors implicit in any tax regime that is reliant not on published and prin applicability but on a case-by-case approach liable under which the tax exacted in eac officials without the guidance of such generally applicable rules. This potential is advance pricing agreement procedures as I note further below.

11.

The potential of the present system for fostering an atmospher growing discord between tax authorities and taxpayers and among nations is needless. Re potential of the present transfer pricing tax system for generating discord, both inter States and internationally. (See 56 Tax Notes 353.)

The potential of the present system for domestic partisan disco international tax warfare could hardly be more vividly indicated than by the Wall headline about a U.S. presidential candidate's prioritizing U.S. operations of fore

IRS/Treasury Notice of Proposed Rulemaking, 57 Fed. Reg. 3571 at 3578 (proposed Jan. 30, 1992).

'Wall St. J., April 30, 1992, at A-2. Also see 84 Daily Tax Report (BNA) G-13 (April 30, 1992).

་

er in this paper. They do not abandon the case-by-case aspect of the Service's approach; instead they on it. They fail to supply the pressing need for pre-published rules of general and equal application to xpayers. They thus deprive all people and countries subject to the present arm's-length transfer pricing egime of the enormous benefits to all that can flow from a system for voluntary taxpayer self-assessment x. The Service's publication of some generic guidelines with respect to the advance pricing procedures, e Commissioner and the 1992 Treasury Report promise, would be modest steps in the right direction. ever, guidelines are no substitute for clear, pre-published and generally applicable principles of law. The nce pricing process will still be a case-by-case approach, reminiscent of the experience under the 1968 elines under an earlier version of section 367, which requires an enormous expenditure of resources to w an errant policy.

The APA procedures also fail to designate acceptable methods, from among several available, ternatives to the costly arm's-length pricing method for assigning to countries and taxpayers the profits osses) realized by a controlled group in its arm's-length international transactions. They divert limited and energy of tax policymakers and enforcement personnel away from endeavors that promise far greater ic return on the investment. The international tax counsel of General Electric Co. was quoted recently ying that while advance pricing agreements will help some taxpayers reduce uncertainty, they are not tical for relatively large companies. He reportedly advised that G.E. alone, which has 13 affiliates dwide, "would keep the government busy for the rest of the century if we pursued APAs."

What are the additional problems generated by the new APA procedures? Because they apply by-case and are so time-consuming and costly for taxpayers and governments, they can only aggravate the arities and lack of even-handedness in treatment of taxpayers that is inherent in any case-by-case approach guided by rules of general application. Winners will be found only among the relatively small number of er business taxpayers who can afford the costs, while the losers will include the vastly larger number of ler business taxpayers who cannot afford the costs of this and are deprived of the benefits of pre-published of general application.

Even more seriously, however, the new APA procedures are secret, enhancing the potential lisparate treatment of competitors and for unequal application of our tax laws as between domestic and gn-controlled international businesses. Advance pricing agreements are the result of secret negotiations een taxpayers and tax collectors, and meetings between countries' taxing authorities from which interested ayer representatives are excluded, in proceedings that may involve sums that are large for all parties. e advance pricing agreements may provide a given taxpayer some measure of certainty for a limited period cars and for the transactions in products subject to that agreement, they provide no guidance to the rest he world as to the applicable principles of law. Such secret agreements, coupled with the absence of ished principles of law, result in ad hoc agreements that in turn create the potential for disparate ment of competitors. Would it be acceptable for the Service to enter into advance agreements about hods of pricing for income tax purposes one line of motor products sold by Chrysler Corporation while es not do so for competing lines of motor vehicle products sold by Ford Motor Company or by Toyota? ot, how under the present system would any independent authority be able to monitor such activity of the ice? We ought not repeat the course of action rejected by the Court of Claims in the IBM case,' where Service granted one company a favorable excise tax ruling that it denied a business competitor for peting products.

Adoption and advocacy of the new APA procedures amounts to a Service invitation to large national business taxpayers, "Let's make a deal, a secret deal, about the method to be used for rmining your income taxes." That undercuts the appearance of integrity and even-handedness that is so to public acceptance of, and voluntary compliance with, our tax laws.

This problem is especially aggravated when senior Treasury and Service tax officials publicly ment on the high tax penalties and other costs that may be suffered by taxpayers who fail to avail

Remarks of Mark Beam in New York City on April 27, 1992, as reported in 1 Tax Management Transfer Pricing Report 4, at 25 (May 2).

nternational Business Machines v. United States, 343 F.2d 914 (1965).

A. The present case-by-case approach of the U.S. is a problem to be solved, not neither it nor the many new measures adopted for its enforcement can be a substitute for published rules of general application that are reducible to numbers needed on tax returns. (See 56 Tax Notes 353.)

For such reasons, we submit that the U.S. Congress, U.S. citizens, and countries' government and citizenry should reject the U.S. Internal Revenue Service's quest fo continue its adherence to a case-by-case approach to the exaction of income taxes in this ar can't afford it. Procedures for advance pricing agreements, programs for stepped-up enforc in audit or in litigation, programs for intensified information reporting or exchange of info taxing authorities, cannot function as substitutes for the principled new rules of substance th needed in this area. I recommend that senior U.S. Treasury Department officials, the Preside Congress join in rejecting the Service's request for no legislative action to implement sorely n to the costly problems in this area. As grounds for not taking such action, the Service has urg allowed to field test the results of the new enforcement money and powers it has requested an to proceed on a case-by-case basis. I believe that such grounds should be rejected. We don' years of empirical field testing and millions if not billions of dollars to know that the Servic approach is a problem that the public interest requires to be solved, not embraced.

B.

Proposed new Treasury regulations under section 482, intensify rather than

In their presentations to the House Oversight Subcommittee at the hearings held in A and in their simultaneous report to the Congress on section 482, Treasury and Service policyma newly proposed substantive regulations as one of their administrative steps for enforcemen which would make "[a]dditional legislative changes . . . premature at this time." I disagr developed earlier, the proposed regulations do not even purport to solve the core problems tha of the major difficulties being experienced in the area. We suggest that statements or imp contrary should be dismissed by Congress. They instead should be viewed instead as a declarat and the Service of their intention to continue their costly insistence on permitting only the pricing standard to be used.

As we have noted earlier, some of the major problems under the present remedied by unilateral action. Thus, we have noted a number of administrative or legislative ac be taken unilaterally by the Untied Stated which could effect important reductions in th difficulties now being experienced. As we have also noted, however, some of the problems un system are soluble only by international agreement. This is particularly true with respect to is "fairness" of the share of revenues derived by cach of two or more countries competing for tax from the same international business transactions. Accordingly, international agreement an taxing jurisdictions is required to secure more than a partial solution to conflicts among count or procedural rules pertaining to allocation of the base for taxing income from international tra is true whether the rules involved relate explicitly to exercise of jurisdiction to tax income on t source, to a domiciliary country's obligation to cede primary jurisdiction to another count allowance of a credit against tax of the domiciliary country for tax of the source country, or on nevertheless actually to a domiciliary country's exercise of a section 482-type power to re income to business units that are taxable as domiciliaries in a manner which conflicts with int prescribing geographic source of that income.

To some this point is obvious; to others it is not. Perhaps that is because o United States for so many years of thinking only in terms of what the U.S. can do administratively to change its approach to international businesses subject to the U.S. tax. reason, the result is that proposals often are put forward as alternatives for solving proble

101992 Treasury Report, at "Executive Summary", item (c).