March 02, 1995
Remarks by Margaret Milner Richardson,
Commissioner of Internal Revenue, at the
International Fiscal Association,
U.S.A. Branch Annual Meeting
Thank you. I am delighted to be here with you this morning. It
is truly an honor to open your annual meeting this year. In looking over your agenda for
the next two days, I noticed that you have much ground to cover. In the area of
international taxation, there is always a great deal that is new and exciting to talk
about, as your program reflects.
Perhaps the explanation for the excitement your program promises is what is going on in
the world today. Almost unbelievably, many long-standing political barriers have
dramatically fallen within the last five years, and, as a result, brand new marketplaces
are being developed. New legislation, such as GATT and NAFTA, is encouraging and
facilitating that market development. Many businesses have begun to learn that not only
can it be profitable to operate on a multinational basis, but, in some cases, it is
absolutely essential to survival. At the same time, the transactional techniques used by
businesses to tap into international markets are becoming increasingly sophisticated.
If this new political climate is conducive to producing economic fruit, then the new
tools needed to harvest that fruit are provided by the technology we see developing every
day. This technology allows businesses to communicate and transact with lightning speed
and tremendous efficiency, and to work in the productive light of midday, literally around
Due to this new environment, sound tax administration now requires a new capability for
handling complex tax issues arising around the world. In a burgeoning global economy, tax
administration cannot simply stop at our national borders. The Internal Revenue Service
must continue to carry out its mission - which is to collect the proper amount of taxes at
the least cost -- not just here in the United States, but around the globe. We must ensure
that all businesses and individuals, including those engaged in transactions that cross
our national borders, pay their proper share of U.S. taxes -- no more, but no less.
To keep pace with sophisticated business practices and technological advances both
within the United States and elsewhere, the IRS has been working hard to bring about a
nationwide reorganization and a major modernization of our computer and information
systems. We have made much progress in this regard, but much more needs to be done.
Fundamental operational changes are absolutely essential if the Service is to be
positioned to handle the difficult tax administration challenges that will come in the
But beyond these operational changes, we must also have a plan for addressing the
complex policy, legal, and enforcement issues raised as a direct result of the growing
global economy. Some of you may recall that, in December 1993, the Service and Treasury's
Office of Tax Policy announced a Joint Policy Statement and Action Plan on international
compliance which we said we would use to guide our efforts in the global marketplace in
the years to come. We also released a "whitepaper" at that time describing the
This morning, I would like to share with you where we stand with respect to the issues
we identified in formulating our Action Plan. I want to highlight some of our most
significant advances in the 5 areas covered in the December 1993 white paper, and I will
indicate those areas where we think some additional work is necessary and imminent. The
Action Plan focuses not only on improving international enforcement, but also on enhancing
voluntary compliance by ensuring that taxpayers can understand and apply international tax
laws without excessive cost or burden. Our approach is to make our tax system more
understandable and to synchronize our international tax rules and procedures with the way
things are done in today's business environment.
Our Action Plan identified S substantive areas in which the IRS and Treasury believe
concentrated resources are needed to enhance international compliance. These areas are:
1. Transfer Pricing;
2. Bilateral Tax Treaties;
3. Foreign Tax Credits;
4. Financial Products; and
5. Individual Tax Compliance.
I would like to touch on each of these areas:
Our Action Plan first declared the Administration's
commitment to putting problems with transfer pricing compliance behind us. As you know,
transfer pricing has been the most significant international compliance issue faced by the
United States in recent years. The Administration is absolutely committed to ending abuses
in this area.
As you all are well aware, last year we issued proposed and temporary regulations
implementing the transfer pricing penalty of section 6662, and subsequently published
final regulations under section 482. These regulations, working together attempt to change
the basic dynamics of transfer pricing compliance through an application of the
self-assessment principle. In other words, these regulations are structured to encourage
taxpayers to take responsibility for complying with the arm's length standard as they
initiate their cross-border transactions. The intent is to avoid having to resolve
difficult, factually- pricing issues through the traditional appeals and litigation
processes. We strongly believe that giving taxpayers flexible pricing guidance, backed up
with a reasonable documentation requirement and appropriate penalty enforcement, is the
right approach to attaining section 482 compliance.
We have supported the penalty regulations by establishing a transfer pricing Penalty
Oversight Committee made up of National Office personnel from the offices of Examination,
Assistant Commissioner (International), Appeals, and Associate Chief Counsel
(International), as well as an international exam case manager and an international branch
chief from the field. We established this Committee in response to concerns about
consistency of application of the about pricing penalty. These concerns had been raised
both by taxpayers and by our examiners in the field. The Committee's goal is to ensure
uniform application of the documentation requirements and uniform interpretation of the
reasonableness standard, nationwide.
We are confident that our new transfer pricing regulatory regime, combined with the
coordination provided by the Penalty Oversight Committee, will be effective tools for
bringing about the transfer pricing compliance levels we desire.
The Administration strongly believes in a sound transfer pricing regime designed to
ensure that the arm's length standard is applied uniformly and cooperatively around the
world. It is clear that if one country employs methods to enforce transfer pricing that
are substantially different from methods used in other countries, its taxpayers inevitably
will be faced with substantial double taxation problems, burdening those taxpayers as well
as the government processes used to resolve double taxation issues.
For this reason, attaining international consensus on transfer pricing is absolutely
essential to appropriate compliance in the area. Therefore, we were very mindful of the
rules Ret forth in the OECD Discussion Draft on transfer pricing when we issued our final
regulations last year. We have been extremely encouraged to see the development of a solid
consensus on the arm's length standard, through the OECD, and we strongly support
finalizing the OECD report substantially in its current form.
While on the topic of transfer pricing, I would like to say a few things about one of
our best examples of a voluntary compliance initiative -- the Advance Pricing Agreement,
or "APA," program. The APA caseload continues to grow. The ongoing cases involve
business operations of many sizes, from many countries, and in a wide range of industries.
We are very pleased to have Michael Durst with us as the new Director of the program.
We are confident that Michael will see to it that APA's are a continuing success story.
Already, he has implemented a case planning process at the beginning of each negotiation
that should prove effective in helping to manage the increasing caseload in the program.
In addition, Michael and others are working to ensure that the APA process is not just a
National Office phenomenon, but is well coordinated with our field offices in a way that
is conducive to good long-term relationships between taxpayers and the Service.
The program is also already benefiting from the new APA Policy Board, which we first
announced when we issued the Action Plan in December 1993. The Policy Board has not only
provided high-level program oversight, it has also fostered multifunctional participation
in the actual APA negotiations. The goal is to avoid a lengthy, serial review process by
having representatives from Chief Counsel, Examination, Appeals, and often Competent
Authority in the room together as the cases are being worked. This cooperative effort
should lead to speedy, high-quality results.
Last April, we issued a notice discussing the methodologies used in a number of APA's
relating to global trading issues. because of privacy concerns, we cannot divulge
information about particular APA's we have completed, but issuing generic information
about the approach taken in particular industries is something we would like to do more
of. We are currently considering the issuance of additional guidance, similar to the
global trading notice, that would be available to companies within a specific industry to
guide them when they come in for their individual APA's. We believe this type of guidance
would lead to a more streamlined and efficient process.
Another element of the APA program that you should see developing soon will be
bilateral and multilateral negotiations. More and more, we have been moving towards
simultaneous negotiations with some of our treaty partners with APA programs of their own.
We are also seeing consideration given to the development of APA programs among countries
without them. For example, a U.R. official recently announced that Inland Revenue -is
considering formalizing an advanced ruling program that will facilitate APA's. To date,
the U.R. has conducted APA's only on an informal basis. Canada recently issued formal APA
guidelines, and last week representatives from our APA staff met with Mexican
representatives to discuss coordination of bilateral pricing negotiations. The growing
potential we are seeing for a multinational cooperative effort in this area is very
I also would like to say a few words about the issue of obtaining third-party
comparable;. The new transfer pricing regulations allow for flexibility in determining the
best pricing methodology for each taxpayer, so individual circumstances are given a great
deal of consideration -- and this is reflected in the cooperative negotiations of the APA
program. But the new transfer pricing regulations, and consequently the APA negotiations,
also emphasize comparability as an essential component of the method determination. The
entire arm's length pricing regime depends upon access to meaningful third-party
Late last year, we conducted surveys of our International Examiners, Appeals Officers,
and International Special Trial Attorneys to evaluate their experience in obtaining and
using third-party comparable information in transfer pricing cases. are currently
analyzing the results of the surveys, but preliminarily it appears that obtaining
third-party data sufficient to effectively pursue section 482 issues can be a problem in
certain cases. Our personnel primarily rely on public sources and voluntary sharing of
information by the taxpayer and by third parties, but based on the problems reflected in
the surveys, these sources have not been entirely adequate.
Recently, there has been discussion at conferences and in the tax press of the
availability of comparables and the IRS' authority to issue a third-party summons to
obtain this information. This discussion appears to be a result of some recent,
well-publicized efforts to pursue comparables from third parties on a voluntary basis. In
the past, the Service generally has not pursued third-party comparable information through
its summons authority under section 7602, not because we do not have authority to do so --
we think that is very clear -- but because we have had, and will continue to have, an
internal policy of seeking comparables from public sources and on a voluntary basis and of
exercising restraint in using our summons power.
Because the availability of third-party comparable information is crucial to ensuring
transfer pricing compliance, we intend to quickly complete our review of the adequacy of
our techniques for gathering this information. We will then make any modifications to our
current policies and practices that are necessary to ensure that we are getting the
information we need to effectively administer the transfer pricing regime.
We have also pledged to streamline the resolution of transfer pricing disputes by
emphasizing the use of other alternative dispute resolution mechanisms. You may have read
recently about the development of a non-binding mediation process to be carried out in
Appeals after the parties fail to come to an agreement through the normal negotiation
process. At the request of both parties, an impartial mediator would be appointed to work
through difficult factual issues -- like those associated with transfer pricing and
In December of last year, we issued a proposed revenue procedure announcing a one-year
test of the mediation process and last week we held a public hearing on the proposed
revenue procedure. The proposal has been extremely well-received so far and ultimately may
prove to be a very effective means for avoiding costly transfer pricing litigation.
Bilateral Tax Treaties
We also announced in the whitepaper last year our
commitment to preventing abuses of the United States' tax treaty network. To that end, we
made great strides in 1994 towards ensuring that only bona fide residents of countries
with which the U.S. has a treaty can take advantage of beneficial treaty provisions.
Signed and awaiting Senate advice and consent on ratification are five new treaties and
two protocols. Each of these new treaties, as well as the Canadian protocol, contains a
modern limitation on benefits article that will further our anti-treaty shopping efforts.
I know that you have a session scheduled for later this morning to cover current treaty
issues. I just want to emphasize the increasing importance of our tax treaty network in
the global economy -- not just from the perspective of the Service, but from the
perspective of private industry. Therefore, we hope the Congress will turn its attention
to the pending treaties as soon as practicable.
Foreign Tax Credits
Our Action Plan noted that the amount of revenue at stake
in the foreign tax credit area is enormous. For example, in 1990, U.S. taxpayers claimed
roughly $25 billion in foreign tax credits. With the stakes so high, it is imperative that
we cut through the complexity of subpart A.
One of our most important steps has been to obtain foreign tax credit software for our
International Examiners. Because of the complexity of this area, such software is
essential for IEs to conduct effective examinations of foreign tax credit positions. The
software is now out in field and in use. Training was provided to Examination and Appeals
personnel in all the regions.
On the regulatory front, as most of you know, in early January, we issued proposed
regulations relating to the computation of the "deemed paid" credit under
section 902. These regulations are a comprehensive set of rules incorporating the
substantial statutory changes made in the Tax Reform Act of 1986 and replacing some very
old regulations originally issued in 1957. Thus far, the regulations have not received
much comment - which we take to be a good sign -- but written comments are not due until
Receiving a little bit more attention are proposed regulations we issued last May under
section 904(i). As an anti-abuse provision, these regulations are naturally receiving some
criticism. We have held the public hearing and are considering the comments we received. I
believe you will see a project for finalizing these regulations on the list of guidance
priorities for 1995 we announced yesterday.
As many of you know from your daily experiences by now,
new financial products have thoroughly invaded the marketplace, both domestically and
around the globe. Some products are even becoming household words. I am sure even the
Queen of England now knows what a derivative is. When she turned from the morning paper on
Monday to ask Charles about Barings' dealings in derivatives, Charles may have said, wit's
some sort of calculus thing," but I am sure the Barings bankers explained it to her
when she showed up to make her mortgage payment on Windsor castle.
Of course, derivatives and other financial products, like various types of hybrid
instruments, raise significant tax issues. As described in the 1993 whitepaper, Treasury
and the IRS believe it is essential to adapt our international tax administration to keep
pace with the evolution of financial products and the rapid growth of global financial
When we issued our Action Plan, we described our efforts with financial products as
"embryonic." Within the last year, however, we have established a new national
financial products program to provide oversight, technical field assistance, and emerging
issue identification. The new program is being carried out by a new Office of Financial
Products and Transactions, the Director of which reports both to the Assistant
Commissioner (International) and the Assistant Commissioner (Examination).
By combining the expertise of our Industry Specialization Program and our International
Field Assistance Program, and by creating the position of Office Director, we have
established the stronger central management necessary to ensure that overall guidance and
support on financial products is provided to the field.
One of the early-identified issues in this area is the valuation of complex derivative
instruments. We have seen that some taxpayers, particularly dealers in financial products,
have software programs to make their valuation computations. On audit, our Examiners have
been forced to either rely on the taxpayers' computations or attempt to do manual
calculations using their own basic spreadsheet software.
Because of the importance of the valuation issue, we have entered into a contract with
the Los Alamos National Laboratory to research and develop models for valuing derivative
transactions. Once these models are developed, the plan is for Los Alamos to help the IRS
implement these models in a usable system, provide manuals and training for these systems,
and provide continuing research and development of valuation models for new products as
they become significant in the marketplace. Our goal is to be able to provide our
Examiners with an effective tool for valuing these products quickly and more accurately.
In addition to these plans for improving the handling of financial products in the
field, we also intend for our regulations and other guidance to be increasingly sensitive
to the impact of derivatives and other types of financial products.
The proposed conduit regulations we issued in October are a good example of this
sensitivity to the effect of financial products in the international arena. The
regulations minimize the importance of a cash flow analysis, relying instead on a
principal purpose test and a determination of conduit effect based on outstanding
principal amounts. One of the important reasons for this approach is our understanding of
the potential distortive effect that complex financial arrangements can have on cash
As we move forward on other guidance projects, I believe you will see the government
becoming more sensitive to the presence of derivatives in the marketplace, just as you
have had to become sensitive to that presence in your practices.
Individual Tax Compliance
The whitepaper also emphasized the importance in today's
global economy of ensuring tax compliance of individuals, whether domestic or foreign,
engaged in cross-border transactions. International tax compliance activities have
traditionally focused on major multinational corporations that have long been prominent
international players. However, as a global economy takes shape, the number of individual
taxpayers whose activities cross national borders is growing exponentially. We are
committed to ensuring that these individuals pay their fair shares of U.S. tax. There are
several projects underway in this area that are worthy of note.
First of all, we have begun to invest additional examination resources in the area of
withholding on foreign payments with respect to portfolio investments. We believe that
compliance in this area is dangerously below par. We will also be seeking to enhance and
coordinate our use of both information returns and forms filed with withholding agents
relating to foreign payments.
To develop and launch a compliance strategy in this area, we established a
multifunctional Nonresident Alien Withholding Task Force. Much of the work of the Task
Force is aimed at enhancing the use of the payor and payee information provided by Form
1042S filing data. We also established a new Office of Foreign Payments and appointed a
new Director for that office, Carol Dorcy, who some of you may know. The Office of Foreign
Payments will be responsible for formulation and oversight of our foreign payment
enforcement strategies, including strategies for utilizing 1042S data. The Form 1042
itself is being revised to provide useful information more effectively. Ultimately, a data
file of 1042S information will become part of our Information Reporting Program.
The enforcement strategies we are developing are dependent upon some fundamental
regulatory changes that are underway. It is well known by now that we are working on new
regulations under sections 1441, 1442, 1461 and other related sections. These regulations
will likely be issued in proposed form within the next few months. The regulations will
propose a certification system that will be based on documentation requirements. Our
intention is to modify or replace current rules governing payments of both interest and
Taxpayer identification issues are at the root of not only problems in the withholding
area, but also problems that arise in our treatment of claims for refund. The U.S. tax
system relies on information reporting and document matching to verify compliance, using a
taxpayer identification number -- typically the Social Security number -- to conduct
proper matching. In the case of nonresident aliens, who usually have no Social Security
number, our current information reporting system is of limited use.
Because of this situation, we are working on a system for verifying the identities of
nonresident aliens 80 that our withholding, information reporting, and refund processing
problems can be eliminated. Proposed regulations will be issued very shortly that will
require nonresident aliens currently unable to get Social Security numbers to provide
IRS-generated tax identification numbers when filing tax returns, like Form 1040NR,
including returns claiming refunds. Subsequent regulations would then be necessary to
identify other situations in which the new tax identification number would be required.
I also want to mention the subject of money laundering. Some of you may not know that
the Service has enforcement jurisdiction over currency information reporting requirements
of the Bank Secrecy Act and plays a major role in investigating money laundering
activities. Recognizing the advent of a global economy and the fact that crime has no
borders, our Criminal Investigation Division, or "CI" as we call it, has
developed an international strategy for enforcing tax and money laundering laws.
Our current criminal investigations often take us to major foreign financial centers
where massive money laundering often occurs. Under the new strategy, our CI agents will
increase their efforts to gather intelligence about foreign criminal activities to support
ongoing domestic investigations. For example, CI currently has a special agent in Bogota,
Columbia who is working closely with the DEA in analyzing intelligence and financial
information that is seized by Colombian law enforcement officials from the Cali Cartel. CI
also has a special agent in Mexico City who is supporting CI domestic investigations and
providing technical assistance and training to the Mexican government to strengthen their
own money laundering controls.
Finally, I wanted to say a few words about the legislative proposals involving
international taxation of individuals put forward in the President's budget for FY 1996.
As you may have seen last week on Prime Time Live or read about Forbes recently, some
wealthy U.S. citizens and long-term residents have abandoned their U.S. citizenship or
status as residents in order to avoid U.S. taxation. Current rules to prevent this type of
tax avoidance have not been effective because departing taxpayers have restructured their
activities to avoid those rules, and because compliance with the rules has been difficult
to monitor. The proposal would provide that gains generally accruing during the time a
taxpayer was a citizen or long-term resident of the United States will be subject to U.S.
tax at the time the taxpayer abandons citizenship or residency. We strongly believe that
the existing statutory provisions need to be enhanced by the proposed legislation to
ensure that departing taxpayers pay their fair share.
We also have concerns that individuals are avoiding U.S. tax on income from tens of
billions of dollars worth of assets hidden in foreign trusts. Our concerns are with both
inbound and outbound transfers to trusts. On the inbound side, wealthy foreign families
are establishing foreign trusts for the benefit of U.S. persons who live well in this
country without paying income taxes. Under current law, the United States treats the
assets held by these foreign trusts as owned by the foreign family, and any distributions
of trust income to the U.S. beneficiaries are treated as nontaxable gifts. Under the
proposal, foreign persons establishing this type of foreign trust would not be treated as
owning the assets and earning the trust income. As a result, distributions to the U.S.
beneficiaries of these trusts would be subject to tax like ordinary trust distributions.
On the outbound side, we are concerned that U.S. persons are -transferring assets to
foreign trusts to protect them from U.S. creditors and are failing to pay U.S. tax on the
trust income. The proposal would call for the appointment of a U.S. agent for these
foreign trusts and would impose new reporting requirements to allow us to monitor their
activity, supported by increased penalties for noncompliance. In addition, under current
law, U.S. persons creating foreign trusts for the benefit of other U.S. persons are
generally taxable on the trust income. The proposal would curtail certain loopholes that
have been used to avoid tax in these circumstances.
The proposal also would provide a clear definition of a "domestic trust," and
would provide that all other trusts are "foreign." Currently, the definition of
what qualifies as a foreign trust is based on common law factors that are very difficult
to work with. Thus, the foreign trust proposals are intended to provide definitional
clarity as well as certainty as to the appropriate tax treatment of foreign trusts. These
proposals are extremely important to our overall effort to ensure compliance of
individuals in the new global economy.
As you can see, the IRS and the Office of Tax Policy are
devoting a great deal of time and resources to the international arena. As I mentioned at
the beginning of my talk today, we Are committed to ensuring that all taxpayers, both U.S.
and foreign, pay their proper share of taxes and that our international laws and treaties
are not burdensome to U.S. businesses vis-a-vis their foreign competition. We believe this
approach will lead to the compliance levels that we all deserve.
We know we can accomplish only our goals if we have the benefit of the insight of the
taxpayers and practitioners who regularly work in the international area. We welcome your
comments on any of the issues addressed in this Conference, or any other matter you
believe we should address to take us successfully into the next century. Thank you.
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