50 years. the last 20 years, while I have been practicing with Califorhave been directly involved in the administration and impleation of this method. I have been involved in representation of pard before the U.S. Supreme Court. We have three cases curv pending, one of which is at the Supreme Court now on a peand two more which are likely to be there shortly involving orldwide unitary method. ave worked and studied transfer pricing, I have participated e Federal study of that method with Senator Conrad, with the ng group which was appointed by President Reagan. I have ved IRS training in international audits. I will probably be in e of our legal support to our own international audit efforts, ection 482 efforts. ave co-authored or co-drafted legislation which California ed to go to the waters edge. I have co-drafted the regulations à implemented that. I have also drafted the regulations which sed to implement worldwide combined reporting when foreign es are involved. ere are two specific areas I would like to touch on. First, the that we are litigation with Barclays, the case now pending e the U.S. Supreme Court, there are a couple of things that d be mentioned about that case. e concerns or the reservations of the litigation which is ind involves the question as to whether California can constituly apply this method, and constitutionally in terms of its upon foreign affairs and whether, under the Commerce e, there is permission to do it. There is not an issue in that that the tax which California has assessed is a fair tax or that an inaccurate tax. The question is whether we can use this forry apportionment method. e formula used is the standard three-factor formula. Senator asked earlier as to whether there was litigation with respect e applicability of that formula. Yes, there is. The Container oration case in 1983 sustained that three-factor formula as the mark by which all these questions should be measured. w, when you look at the unitary method, we basically only seven numbers to determine the level of taxation, the amount come which a corporation or a business should assign to Calia. First, we need to know what is overall income. If the corpon has no income everywhere, then it doesn't have to pay us a f it has income, then they are going to pay a tax on an appord share of that income. So there is taxpayer equity involved, t is income determined by true third-party transactions, be ently verified and sustainable. Thereafter, once we have those seven numbe matter of mathematical calculation to determine should be assigned to a particular jurisdiction a would be. It is a very simple process. Now, in the Barclays case, one of the question one of the arguments that is often made with res apportionment is that it is that the cost involved it is excessive, but we believe that is a smoke and an illusion. As my example, I will use Barclays. Barclays offered testimony in our trial court, t ed by a partner in a major accounting firm, that to set up a system to comply with California wo lions of dollars. Now, they talked about settir system. They talked about having to make accou without determining whether there was a differer eign accounting treatment and the tax accounting talked about having to convert all these items in than do it in the foreign currency. In doing all this, they ignored the regulations w ten. Those regulations provide that we start with counting data, the consolidated financial accour business. We deal with it in the currency in whi report. We only require accounting adjustments to be are material. And in the Barclays case, we actu filing document, which, again, a major accounti pared, which indicated there were only five dif United Kingdom generally accepted accountin United States generally accepted accounting prind Only one of those had a tax consequence and w one item, which is an item where the United Ki to revalue your assets to reflect inflation, on the b ration, there is a reserve set up which reflects amount. So in order to make an adjustment to re an original cost basis, you have the item in the which you can go to and make that adjustment, s exists. It ignored the provisions of our regulation, w calculations are to be made in the foreign currer when you come to a bottom line number, the am signed to California, that you have to make th dollar item. In fact, the testimony that was offer wow, it is true, it will de pointed out, tnat wiɩn respect to inose urns, the Franchise Tax Board did not accept those returns. ere was a very good reason we did not accept those. Those acnted for the results of a single corporation and all of its particusubsidiaries, but those were the results of Barclays internationpanking operations. They involved over 30 subsidiaries, and they olved activities in over 70 countries. The change we required to to was to pick up the parent bank, the United Kingdom bank I the banking subsidiaries and other subsidiaries in the United gdom. But the point to be made with respect to that data is the data ich they prepared that return on came from the financial ords of Barclays' bank group. All we were asking them to do s to take a step up in those records, go to the records for the ole overall group, not just the activities which were present in ifornia. So the information to prepare the return was there, was ilable. It did not require additional cost to bring it together or pare or collect it. We have a similar experience in another foreign parent case we litigation, the Alcan case. Again, an estimate to prepare a Calinia worldwide combined report of over $10 million. Actual facts: s corporation prepared worldwide combined reports with Cali nia which were accepted. For 2 years, they estimated the costs ess than 25,000. For another 3 years, they estimated the costs to less than $75,000. Where is the $10 million figure? here is a third case and this one not as directly involved, but it olves the State of New York and its attempt to tax the Reuters ws Agency. Here again, we have 3 years involved. For the firs r, Reuters filed on a method New York requires, which included worldwide activities of that corporation. For the second and rd year, they attempted to file just on their activities in the te of New York. New York said no, that's not our system, you re to reflect your worldwide activities. They made estimate ed upon the financial records of Reuters and it issues assess nts accordingly. Reuters protested. They came into the New York tax agency and y claimed it would cost them a million dollars to prepare th essary returns. The courts in New York found those figures t grossly exaggerated on the reliance of two items. One, they ha d the return for one of the years that New York required, an y did not think they had spent a million dollars to prepare tha urn, and Reuters offered no evidence as to what it in fact cos 'hen, second, with respect to the other two years, once it becam ar that New York was not going to change its position, it too W test returns. hose acparticuernation and they quired to om bank e United the data financial em to do s for the resent in mere, was gether or t case we re a Caliual facts: with Calithe costs Le costs to ed, but it e Reuters the first ■ included cond and es in the stem, you estimates es assess gency and epare the figures to they had iired, and >pare that fact cost. it became ›n, it took siding, held studies on the question of how mu avoided by foreign based multinationals. One of t in that Committee hearing was a staff report wh Federal tax returns over a 10-year period for a r corporations and found that those corporations h erage of about $22.5 million of Federal tax o income per return of approximately $45 million. Now, we are not sure those numbers are comple cause, unfortunately, the testimony or the study to the Committee does not indicate what the ef losses might have been on that overall number. N that as a baseline number, during the course of of the Representatives set forth a list of compan obtained not from the IRS, but from other source which he believed were involved in those studies corporations, basically, all names which would be We were curious to see what the results of t would be in California, so we went back and look turns which they had filed with us and those whic and adjusted, and we have since updated that i this hearing. What we found was that those corporations ha worldwide combined reporting an average of $25 assigned to California. That is a smaller number number, but, remember, what we are talking a amount of income they assigned to California, and suming California is only a portion of the Unite start making upward adjustments of that number. If you assume California represents half the U double the number and all of a sudden we have $ income, an amount 11 percent higher than what the Federal Government. If you go to other assumptions, for example, sents one-eighth of the United States, a number for revenue estimating purposes, that number b lion per return. Now, we think that eight time high an increase here, because these are Japanes in all likelihood, they have a greater presence i they do other States within the United States. notion of the magnitude of what might be involved Now, let me point out, I am not suggesting amount of money which could be recovered under counting. What I am saying is this is the amoun ore new alternatives. But we would like to point out that what eing proposed with respect to the arm's length method is ely band-aids on a system. This system is hemorrhaging. Bandare not the proper medical treatment, when you have hemoring occurring. nank you very much. -nator DORGAN. Mr. Miller, thank you very much. ext, we will hear from Louis Kauder, an International Tax Atey here in Washington, D.C. r. Kauder. TESTIMONY OF LOUIS M. KAUDER,1 INTERNATIONAL TAX r. KAUDER. Thank you, Senator. have submitted my written statement for the record and I will summarize it. Quickly, my three points are that the present em is defective. I agree with the other witnesses. It does not x. It cannot be made to work. I think it also should be replaced. most cases nator DORGAN. Mr. Kauder, just for purposes of this hearing, d you give me just as bit of your background? r. KAUDER. Yes, it is in my written statement. I was a tax er for the U.S. Government in both the Justice Department the Treasury Department in the 1960's and early 1970's. For years, in particular, I was with the Office of International Tax sel at Treasury and my duties there especially were focused ransfer pricing. I was involved in tax treaty negotiations and particular duties with respect to the related party article, that e transfer pricing article, in the treaties. drafted and conducted and executed Treasury's first survey of inistration of the transfer pricing regulations that at that time new, and I drafted the first Treasury report published in Janof 1973 on transfer pricing. ortly after that I prepared a paper for the United Nations, at request, on the problems of administration and compliance in ection with related party transfer pricing issues. I have been ax practice in Washington ever since. I published a paper rely that recommended that Treasury adopt formulary appor nent. he current system relies just about entirely on comparable es, and everyone who addresses the issue agrees that it is very e prepared statement of Mr. Kauder appears on page 102. |