[House Hearing, 112 Congress]
[From the U.S. Government Publishing Office]

TAX REFORM AND FOREIGN INVESTMENT
IN THE UNITED STATES

=======================================================================

HEARING

before the

SUBCOMMITTEE ON SELECT REVENUE MEASURES

of the

COMMITTEE ON WAYS AND MEANS
U.S. HOUSE OF REPRESENTATIVES

ONE HUNDRED TWELFTH CONGRESS

FIRST SESSION

__________

JUNE 23, 2011

__________

Serial No. 112-SRM3

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Printed for the use of the Committee on Ways and Means

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COMMITTEE ON WAYS AND MEANS

SUBCOMMITTEE ON SELECT REVENUE MEASURES

PAT TIBERI, Ohio, Chairman

PETER ROSKAM, Illinois RICHARD E. NEAL, Massachusetts,
ERIK PAULSEN, Minnesota Ranking Member
RICK BERG, North Dakota MIKE THOMPSON, California
CHARLES BOUSTANY, Louisiana JOHN B. LARSON, Connecticut
KENNY MARCHANT, Texas SHELLEY BERKLEY, Nevada
JIM GERLACH, Pennsylvania

Jon Traub, Staff Director

Janice Mays, Minority Staff Director

C O N T E N T S

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Page

Advisory of June 23, 2011, announcing the hearing................ 2

WITNESSES

PANEL 1:

Nancy L. McLernon, President & Chief Executive Officer,
Organization for International Investment.................... 5
Alexander Spitzer, Senior Vice President--Taxes, Nestle
Holdings, Inc................................................ 14
Claude Draillard, Chief Financial Officer, Dassault Falcon Jet
Corporation.................................................. 22
Jeffrey DeBoer, President & Chief Executive Officer, The Real
Estate Roundtable............................................ 28

PANEL 2:

Gary Hufbauer, Reginald Jones Senior Fellow, Peterson Institute
for International Economics.................................. 61
Robert Stricof, Tax Partner, Deloitte Tax LLP.................. 67
Bret Wells, Assistant Professor of Law, University of Houston
Law Center................................................... 79

SUBMISSIONS FOR THE RECORD

The Honorable Ms. Berkley........................................ 100
Brian Dooley..................................................... 101
Mayer Brown LLP.................................................. 107
Overseas Shipholding Group....................................... 109

TAX REFORM AND FOREIGN INVESTMENT
IN THE UNITED STATES

----------

THURSDAY, JUNE 23, 2011

U.S. House of Representatives,
Committee on Ways and Means,
Subcommittee on Select Revenue Measures,
Washington, DC.

The subcommittee met, pursuant to notice, at 10:02 a.m., in
Room 1100, Longworth House Office Building, the Honorable
Patrick Tiberi [Chairman of the Subcommittee] presiding.
[The advisory of the hearing follows:]

HEARING ADVISORY

Chairman Tiberi Announces Hearing on Tax Reform and Foreign Investment
in the United States

Thursday, June 23, 2011

Congressman Pat Tiberi, (R-OH), Chairman of the Subcommittee on
Select Revenue Measures of the Committee on Ways and Means, today
announced that the Subcommittee will hold a hearing on the importance
of foreign direct investment (FDI) to the U.S. economy and how tax
reform might affect foreign-headquartered businesses that invest and
create jobs in the United States. The hearing will take place on
Thursday, June 23, 2011, in Room 1100 of the Longworth House Office
Building at 10:00 A.M.

In view of the limited time available to hear witnesses, oral
testimony at this hearing will be from invited witnesses only. However,
any individual or organization not scheduled for an oral appearance may
submit a written statement for consideration by the Committee and for
inclusion in the printed record of the hearing. A list of invited
witnesses will follow.

BACKGROUND:

Foreign direct investment plays an important role in the U.S.
economy. According to the Commerce Department, FDI increased to $194.5
billion in 2010 after plummeting to $134.7 billion in 2009 as a result
of the economic downturn. (In 2008, FDI reached an all-time high of
$328.3 billion.) U.S. subsidiaries of foreign-based companies employ
5.6 million American workers--roughly 5 percent of the U.S. private
sector workforce. Foreign-headquartered companies share many of the
same concerns about the U.S. tax system that purely domestic companies
raise, such as the relatively high U.S. corporate tax rate. Foreign-
based companies also face tax issues unique to their business
structure, and some commentators have suggested that there are tax
obstacles to additional FDI in the United States.

In 2007, the Treasury Department published a study on inbound
transactions that covered earnings stripping, transfer pricing, and
eligibility for tax treaty benefits. Among other findings, the study
determined that there was not conclusive evidence on whether U.S.
subsidiaries of foreign parents engage in earnings stripping. Treasury
recommended that policymakers continue examining the question as better
information becomes available.

In announcing the hearing, Chairman Tiberi said, ``Foreign direct
investment is critical to growing the economy and creating jobs. U.S.
affiliates of foreign-based companies often consider themselves
American businesses, and share the same concerns about U.S. tax policy
as other American businesses, such as the high corporate rate. At the
same time, some tax issues are unique to foreign investment, and as
part of fundamental tax reform the Subcommittee must examine those
issues as well.''

FOCUS OF THE HEARING:

The hearing will focus on the important role that FDI plays in
expanding the U.S. economy and creating jobs for American workers. The
hearing will explore the tax environment facing foreign investors and
foreign-headquartered businesses investing or operating in the United
States. It also will examine a number of tax provisions applicable to
inbound activity, including (but not limited to) the U.S. corporate tax
rate, foreign investment in real property, and the earnings stripping
rules of Code section 163(j).

DETAILS FOR SUBMISSION OF WRITTEN COMMENTS:

Please Note: Any person(s) and/or organization(s) wishing to submit
written comments for the hearing record must follow the appropriate
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waysandmeans.house.gov, select ``Hearings.'' Select the hearing for
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here to provide a submission for the record.'' Once you have followed
the online instructions, submit all requested information. ATTACH your
submission as a Word document, in compliance with the formatting
requirements listed below, by the close of business on Thursday, July
7, 2011. Finally, please note that due to the change in House mail
policy, the U.S. Capitol Police will refuse sealed-package deliveries
to all House Office Buildings. For questions, or if you encounter
technical problems, please call (202) 225-3625 or (202) 225-2610.

FORMATTING REQUIREMENTS:

The Committee relies on electronic submissions for printing the
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1. All submissions and supplementary materials must be provided in
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attachments. Witnesses and submitters are advised that the Committee
relies on electronic submissions for printing the official hearing
record.

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The Committee seeks to make its facilities accessible to persons
with disabilities. If you are in need of special accommodations, please
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Note: All Committee advisories and news releases are available on
the World Wide Web at http://www.waysandmeans.house.gov/.

Chairman TIBERI. The hearing will come to order. Good
morning, everybody, and thank you for joining us this morning
for another in a series of hearings on comprehensive tax
reform.
As I think everybody by now knows, under the leadership of
Chairman Camp the Ways and Means Committee has been working
through a full assessment of our Federal Tax Code. And, from
the assessment, it is clear the Tax Code stifles job creation
at a time when unemployment rates in Ohio and across the
country remain well above their historic averages. The goal is
tax reform is to reverse this trend. The time is long overdue
to write a Tax Code that better incentives job creation in the
United States of America.
Today's hearing highlights an important contributor to our
economy: foreign companies who directly invest in the United
States of America. Their investment is critical to growing the
economy and creating jobs. Over the past 10 years, affiliates
of foreign companies have employed between five and six million
workers in America.
This month the Administration released two reports
affirming the importance of foreign direct investment. I agree,
and look forward to working with the Administration to
eliminate the regulatory barriers standing in the way of
creating greater foreign investment.
Chairman Camp requested that the Select Revenue Measures
Subcommittee further examine inbound issues raised in prior tax
reform hearings. We have heard concerns from U.S. businesses
about the Tax Code. Many U.S. affiliates of foreign-based
companies view themselves as American businesses, rather than
foreign businesses. Today's hearing will provide them the
opportunity to share their concerns.
Today's hearing will also examine tax rules specific to
foreign investment, including earnings stripping and transfer
pricing. The effectiveness of those rules in preventing foreign
companies from using the Tax Code to create a competitive
advantage over domestic companies is the subject of great
debate.
Finally, I look forward to examining the impacts of the
Foreign Investment and Real Property Tax Act. With talk of a
double-dipper session increasing the availability of capital
from foreign investors is a common-sense step to strengthening
the U.S. commercial real estate market. Last year, Congressman
Crowley introduced legislation with me to address this issue. I
understand similar legislation is in the works this year, and I
applaud those bipartisan efforts.
I want to welcome all our witnesses to today's hearing, and
look forward to their testimony. With that, I yield to our
ranking member, my friend from Massachusetts, Mr. Neal.
Mr. NEAL. Thank you, Mr. Chairman. And I want to thank you
again for calling this important hearing today.
Our committee has been examining the impact of tax reform
on U.S. multinational companies. I am pleased to now shift
gears, and to focus on the equally important topic of the
taxation on foreign-owned companies operating in the United
States.
In order to remain competitive in a global economy, foreign
investment in the United States is critical. This is especially
true during these difficult economic times, when job creation
is more important than ever. And foreign-owned companies create
jobs here, in the United States. Today these companies employ,
as you have noted, over five million Americans, and support an
annual payroll of over $400 billion. In my home state of
Massachusetts, U.S. subsidiaries of foreign-owned companies
have created almost 190,000 jobs.
I was very pleased to hear the announcement by the White
House Council of Economic Advisors on Monday that in 2010
foreign direct investment in the United States had increased by
49 percent from the low it reached in 2009. I certainly look
forward to hearing today's witnesses discuss how we can
continue to encourage foreign investment in the U.S.
Today's hearing will also focus on whether our current tax
system favors foreign companies over domestic companies. One of
today's witnesses will testify that foreign-owned companies
have a significant competitive advantage in the U.S.
marketplace over U.S.-owned companies. In my opinion, we should
treat foreign and domestic companies equally. That is why I
have introduced legislation to close the loophole that allows
the use of excessive affiliate reinsurance by foreign insurance
groups to strip their U.S. income into tax havens, avoid tax,
and gain a competitive advantage over American companies.
But before concluding, I would like to thank the chairman
for the bipartisanship that he has developed in offering this
hearing. Henry Ford noted that coming together is a beginning,
keeping together is progress, and working together offers
success. I hope we will continue to work together on tax
reform, and we can use this hearing as a model to continue the
work that we have witnessed in both the Majority and Minority
status that I have had on this subcommittee. I believe that is
how we will best achieve success in reforming our tax system.
Thank you, Mr. Chairman.
Chairman TIBERI. Thank you, Mr. Neal. And I concur. I want
to thank you for your leadership on this specific issue, and
just thank the staff, as well. Both the Republican staff and
the Democrat staff worked together on this hearing, and I want
to applaud both sides, both staffs, for their hard and diligent
work.
I also want to, before we begin, recognize a new member of
our subcommittee, hails from the Commonwealth of Pennsylvania,
colleague and good friend, Mr. Gerlach. Thank you for joining
our subcommittee.
Before we introduce the witnesses for the panel, I ask
unanimous consent that all Members' written statements be
included in the record.
[No response.]
Chairman TIBERI. Without objection, so ordered. We will now
turn to our first panel of witnesses. I want to extend a
welcome to Nancy McLernon, president and CEO of the
Organization for International Investment; Mr. Alexander
Spitzer, senior vice president of taxes for Nestle Holdings;
Claude Draillard, Dassault Falcon Jet Corporation, Little
Ferry, New Jersey; and Jeffrey DeBoer, president and chief
executive officer of the Real Estate Roundtable, here in
Alexandria, Virginia.
With that, Nancy, you can begin your testimony. You have
five minutes.

STATEMENT OF NANCY L. MCLERNON, PRESIDENT & CHIEF EXECUTIVE
OFFICER, ORGANIZATION FOR INTERNATIONAL INVESTMENT, WASHINGTON,
D.C.

Ms. MCLERNON. Thank you. Good morning. Chairman Tiberi,
Ranking Member Neal, and distinguished Members of the
Subcommittee, I want to thank you for the opportunity to
testify this morning. I applaud your leadership in holding this
timely hearing on the importance of foreign direct investment
to the U.S. economy.
I am president and CEO of the Organization for
International Investment. OFII is a business association
exclusively comprised of the U.S. subsidiaries of global
companies. OFII refers to our members as insourcing companies,
due to the jobs these firms insource to the United States.
OFII advocates for fair and non-discriminatory treatment in
U.S. law and regulation for these companies and the millions of
Americans they employ. Our mission is to ensure that the United
States remains the most attractive location for foreign
investment and job creation for global companies looking to
expand around the world.
This hearing comes at a time when the United States faces
serious fiscal challenges at home, and an increasingly
competitive global landscape for attracting and retaining
investment. And while the United States remains the world's
largest recipient of foreign investment, its share of global
investment has declined dramatically, from garnering 40 percent
of the world's cross-border capital 10 years ago, to about 17
percent now.
The committee's work on fundamental tax reform is vital to
ensure that the United States remains the premiere location for
global companies to invest. Simply put, America cannot afford
to lose more ground in the race for the world's investment.
The U.S. subsidiaries of global companies already play a
significant role in America's economy. The chairman and Mr.
Neal already talked about the number of jobs. These companies
employ over five million American workers, which is about five
percent of the private sector workforce. They maintain an
annual payroll of over $400 billion, and account for 6 percent
of GDP. And while they make up less than one percent of all
U.S. businesses, these firms pay a full 17 percent of corporate
taxes. And these companies pile billions of dollars in earnings
each year back into their U.S. operations, reinvesting over $93
billion, according to the most recent annual data.
Foreign direct investment tends to disproportionately
create and sustain high-end jobs for Americans. U.S.
subsidiaries pay their employees over 30 percent more than the
average company, reflecting the high-scale nature of their
scientific, engineering, and manufacturing workforce. And in
the hard-hit manufacturing sector alone, U.S. subsidiaries
account for 13 percent of the labor force, which is about 2
million jobs.
Annually, foreign direct investment leads to over $40
billion in domestic research and development, accounting for
more than 14 percent of America's private sector R&D. And while
counterintuitive to some, many globally-based companies have
established their American operations as a platform from which
to manufacture goods to sell to the world. U.S. subsidiaries
produce more than 18 percent of total U.S. exports.
It is worth noting that the vast majority of inbound
investment to the United States come from firms headquartered
in other developed countries. In 2010, almost 90 percent of
inbound investment came from Canada, Europe, and Japan. It is
worth noting that for all the headlines it generates, Chinese
investment accounts for a minuscule portion of foreign
investment in the United States: less than one percent.
In the midst of recent economic challenges, foreign
investment has continued to be an engine for job creation and a
catalyst for growth throughout the country. For example, at a
time when the unemployment rate is a focus of national
attention, Netherlands-based Philips Electronics is working to
fill 1,500 job openings across the country. The company already
employs over 25,000 people in the United States, including over
1,000 at its manufacturing facility in Highland Heights, Ohio,
where they develop, produce, and export high-end medical
imaging technologies such as MRI and CT scanners for customers
around the world.
Philips also chose to place the global headquarters of its
health care division in Massachusetts, and does the vast
majority of its worldwide health care manufacturing work in the
United States.
However, the competition to attract and retain companies
like Philips has never been stronger. Companies today have an
unprecedented array of options when looking to expand their
business around the world.
OFII sees tax reform as an important opportunity to
encourage greater investment in the United States. As American
businesses, OFII members share many of the same concerns
regarding tax policy as other U.S. companies. Specifically, we
believe Congress should give due consideration to three
overriding factors.
First, OFII is united with the broader American business
community, and its support for reducing U.S. federal corporate
income tax. In fact, OFII's annual survey of chief financial
officers showed that the corporate tax rate ranked as the
policy change that would have the greatest impact on
incentivizing investment here.
Second, OFII encourages increasing the certainty,
transparency, and reliability of the U.S. tax system to allow
for long-term strategic planning.
And finally, most important to this unique slice of the
business community, OFII strongly cautions against any
proposals that would disadvantage U.S. subsidiaries in their
efforts to do business in our market on a level playing field.
Such policy would surely impact our ability to attract global
investment.
I am pleased to answer any questions you may have, and I
look forward to working with this committee and Congress in
considering tax reform that will increase investment in the
United States. Thank you.
[The prepared statement of Ms. McLernon follows:]

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Chairman TIBERI. Thank you, Ms. McLernon.
Mr. Spitzer, you are recognized for 5 minutes.

STATEMENT OF ALEXANDER SPITZER, SENIOR VICE PRESIDENT, TAXES,
NESTLE HOLDINGS, INC., NORWALK, CONNECTICUT

Mr. SPITZER. Yes, thank you. Good morning. My name is Alex
Spitzer. Mr. Chairman, Ranking Member, Members of the
Committee, I am grateful for the opportunity to share my
personal views on international tax policy, as it relates to
U.S. operations of multinational firms and, in particular, any
impediments that may serve as a barrier to attracting
international investment into the U.S. manufacturing base.
I am senior vice president of taxes for Nestle in the U.S.,
and have held the top job in the company for the last 26 years.
Nestle, a Swiss public company, is the world's largest food
company, with sales over 100 billion, and was established in
1866, 50 years-plus before the enactment of the U.S. federal
income tax.
For more than 110 years, Nestle has been insourcing into
the U.S. and investing in American factories, jobs, and
businesses. Our first factory in the U.S. was built around 1900
in Upstate New York to produce chocolate products. Nestle
manufactures, in the U.S., a large range of products, including
Stouffers, Lean Cuisine, Gerber, Jenny Craig, PowerBar, Hot
Pockets, Poland Spring, Deer Park, Edy's, Haagen-Dazs ice
cream, Nescafe Coffee, CoffeeMate, DiGiorno Pizza, and also in
the pet food area, Friskies, Alpo, Purina, and Beneful.
We have a total of 51,000 employees in the U.S., and 85
manufacturing facilities and 7 R&D centers. Nestle's U.S.-
manufactured product sales approximate 28 billion annually,
including 600 million in exports out of the U.S.
Nestle in the U.S. has been consistently ranked by Fortune
magazine as the number one consumer food products company in
the industry. Excluding acquisitions, we have invested
approximately 5.5 billion over the last 6 years in M&A and
factories in our U.S. businesses. And since I have been at the
company, we have reinvested just about all of our U.S. profits
back into our operations here to grow our U.S. businesses.
When Nestle acquires a business, we usually maintain
current management and increase investment and expansion,
rather than cut costs or dismantle the business. For example,
after we completed our Dreyer's acquisition, we invested over
100 million in expanding our Bakersfield, California plant,
making it the largest ice cream factory in the world.
Turning to tax policy, there has been much discussion of
the U.S. corporate tax rate and its impact on the country's
ability to compete for global investment. There is no doubt
that a lower tax rate and a more transparent Tax Code would
make the U.S. more competitive for investment from abroad. The
rest of the world is moving towards lower tax rates. Simply
put, the U.S. must do the same.
However, I also want to highlight a number of other areas
of particular interest to my business. The ability of the
inbound business community and Nestle itself to deduct ordinary
and necessary business expenses related to investments, such as
interest and royalty for both federal and state tax purposes is
of great concern, and weighs heavily on our investment
decisions.
Not only are inbound companies singled out with regard to
restrictions on the deductibility of debt service via section
163(j), recently there seems to be a coordinated IRS effort to
audit inbound companies with regard to debt equity type issues,
although there is no indication of any abuse. Despite the fact
that a 2007 treasury report found no evidence of widespread
abuse with regard to section 163(j), there is still much
uncertainty regarding further restrictive legislation in this
area. This uncertainty weighs heavily on investment decisions.
In addition, various legislative proposals concerning
corporate residency rules, treaty overrides, also contribute to
the climate of uncertainty. There is now growing uncertainty at
the state level. In many cases, states seem to be bent on
conducting their own individual foreign fiscal policy. Many
states have enacted legislation to deny deduction of interest
and royalties paid to foreign parent companies, even those
headquartered in treaty countries. These initiatives would
violate the federal and treaty rules concerning permanent
establishments. And, unlike most sub-national governments, the
states are not bound by the U.S. tax treaties.
While I understand this is not within the committee's
jurisdiction, it would be helpful if members would promote the
inclusion of the states in upcoming treaties. If this trend of
taxation continues, I am afraid not only will it discourage
investment into the U.S., but it will jeopardize our tax treaty
network and/or encourage reciprocal treatment by our treaty and
trading partners.
In this regard, a proposal to deal with the growing problem
has already been introduced. I ask that you review and support
the Business Activity Tax Simplification Act of 2011, which is
currently before the House Subcommittee on Courts, Commercial,
Administrative Law of the House Committee on the Judiciary.
As a U.S. citizen, I think it important for the United
States to create a competitive environment to attract and
maintain investment by a competitive tax regime, as well as
ensure fairness and certainty in our tax rules and
administration. We should put the welcome mat out for
investment in an affirmative, proactive manner.
As the committee moves forward in considering reforms to
the tax system, I urge that you do so in a non-discriminatory
way that maximizes job-creating investment in the United
States.
Thank you for thoughtfully framing this discussion. I am
happy to respond to any questions.
[The prepared statement of Mr. Spitzer follows:]

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Chairman TIBERI. Thank you, Mr. Spitzer.
Mr. DRAILLARD.

STATEMENT OF CLAUDE DRAILLARD, CHIEF FINANCIAL OFFICER,
DASSAULT FALCON JET CORPORATION, LITTLE FERRY, NEW JERSEY

Mr. DRAILLARD. Good morning. My name is Claude Draillard,
and I am the chief financial officer of Dassault Falcon Jet
Corporation. Thank you for inviting me to testify this morning.
Dassault Falcon Jet Corporation--DFJ, in short--is a fully-
owned U.S. subsidiary of Dassault Aviation, a French business
aircraft manufacturer which is a major player in the global
aviation industry.
Since 1972, DFJ's operations have grown from a small sales
office in New York City to a company with 7 locations
throughout the United States. DFJ and its subsidiaries
currently employ a staff of over 2,500 workers in the U.S., and
is a major provider of jobs, mostly in Arkansas, New Jersey,
and other states. DFJ also has offices in nine other states.
And as the business aircraft market is a global market, we also
operate a number of sales offices internationally.
DFJ and its subsidiaries in the United States are operating
in the following lines of business for Falcon aircraft: sale of
new and pre-owned for the United States, Canada, Mexico, South
America, Pacific Rim, and Asia; outfitting and customization of
the vast majority of Falcon aircraft, including engineering,
and this includes Falcon aircraft sold outside of DFJ's
territory; some research and development work for cabin and
cockpit options, either as in-production installation or as
after-market installation; and all after-market services, such
as sales and repair of spare parts.
DFJ provides quality, high-salaried jobs throughout the
United States. The nature of DFJ's business requires the
employment and training of highly-skilled professionals in all
locations: engineers, pilots, support engineers and
technicians, aviation mechanics, but also CPAs and other types
of professionals.
DFJ also provides indirect employment all across the United
States through a network of suppliers of all sizes, including
divisions of major equipment manufacturers, such as United
Technologies, as well as local vendors that help provide
flexibility to our production operations.
Because business aviation is a high-tech, highly regulated
industry with very demanding customers, continued investment in
technology and facilities is necessary to operate a long-
standing profitable company. DFJ has a history of reinvesting
the cash generated by its American operations back into the
United States in the form of new technologies and production
upgrades, rather than distributing dividends to its foreign
parent.
This trend has allowed DFJ to make additional investments
in the U.S. DFJ's average capital expenditure, excluding R&D,
in the last 10 years has been in the vicinity of 15 million per
year, enabling the company to expand its Little Rock, Arkansas,
operations, enhance its maintenance operations, and invest in
new IT tools and other product life cycle management tools.
With the globalization of the economy, the relative weight
of the United States market in new orders for new and pre-owned
aircraft has decreased. Even though it remains a significant
market in number of units, the U.S. is no longer a growing
market, but mostly a mature renewal market.
Like everyone else, DFJ is navigating the current economic
uncertainties and the dramatic changes in world economic
powers. In this fragile time of recovery and economic change,
an array of uncertainties in U.S. tax policies and regulations
add obstacles to growth and new investment. In addition to the
U.S. corporate rate already being the second highest in the
world, there is concern of a rising direct and indirect tax
burden for U.S. businesses.
At the same time, some emerging countries are experiencing
budget surpluses that increase their ability to provide ever
bigger tax incentives. In anticipation of this, businesses are
asking themselves, ``Should we keep investing in the U.S. when
the country's economy does not seem to be recovering quickly?
Should we look to move where countries are providing tax
incentives for investment?''
Will current provisions to encourage investment and job
creation be able to survive, such as R&D credit and domestic
manufacturer's deduction, to provide some measure of relief?
At the same time, U.S. tax regulations, along with IRS
announcements and private letter rulings, have reached a new
level of complexity. Interpretations are becoming ever more
difficult to understand and reconcile. Disagreement in the
reading of tax regulations and provisions has significantly
lowered the pace of transaction between parties.
Another layer of complexity is added when state tax
legislation comes into play. For structured transactions such
as international leases of business aircraft, a number of
elements need to be analyzed on top of federal tax issues,
states question the validity for them of tax treaties. State
sales tax, use tax, and income tax provisions make certain
types of transactions extremely costly.
The business aviation industry is geographically shifting.
While DFJ is committed to its United States investments, there
is increasing incentive to look elsewhere to deploy our
resources. Needless to say, predictable, pro-growth tax policy
and simplification of federal regulations would make it more
attractive to maintain our investment in the United States.
I will be happy to answer any of your questions.
[The prepared statement of Mr. Draillard follows:]

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Chairman TIBERI. Thank you, sir.
Mr. DeBoer, you are recognized for 5 minutes.

STATEMENT OF JEFFREY DEBOER, PRESIDENT & CHIEF EXECUTIVE
OFFICER, THE REAL ESTATE ROUNDTABLE, ALEXANDRIA, VIRGINIA

Mr. DEBOER. Thank you, and good morning. My name is Jeff
DeBoer, I am president and CEO of the Real Estate Roundtable.
President Obama had it correct earlier this week when he
said investments by foreign-domiciled companies and investors
create well-paid jobs, contribute to economic growth,
productivity, and support American communities. Unfortunately,
the reality is, in the case of foreign capital investment and
U.S. commercial real estate, our current laws significantly
discourage the type of job-creating economic growth that the
President was touting.
America needs to be able to compete globally for investment
capital for all types of positive economic activities. And
today that simply isn't the case when we compete globally for
capital for our real estate markets.
Our commercial real estate markets historically have been
very positive contributors to economic growth. Healthy
commercial real estate markets provide jobs in construction,
design, management, architecture, and many other areas. Strong
real estate values provide the resources through property tax
payments and transfer fees to fund local budgets and pay for
roads, police, and education needs that we all think are
essential to healthy communities.
But today, while some commercial real estate markets have
started to come back, most markets nationwide remain deeply
troubled. They are marked by very weak property values caused
by excessively high unemployment, the lack of business
expansion, and extremely low consumer confidence.
In addition, large amounts of commercial real estate debt
are maturing. But because of steep property declines and
restrictive credit availability, trillions of dollars of
commercial real estate debt nationwide will not be able to be
refinanced without large infusions of equity capital. The
resulting burden on our nation's banking system, particularly
community banks, is inhibiting small business lending and
holding back job creation.
Everyone in my industry asks, ``Where will the capital come
from that is needed to rebalance our loans?'' One source that
is ready and willing is foreign-based capital. However, while
ready and willing to invest, this capital is essentially not
able to invest, because the Foreign Investment in Real Property
Tax Act, FIRPTA, make it highly undesirable, economically and
administratively.
FIRPTA is a discriminatory tax. It only applies to foreign
investors in U.S. real property. The 35 percent FIRPTA tax,
combined with state and local taxes, and frequently with the
branch profits tax, results in a foreign investor paying a tax
as high as 54 percent on capital gain.
In addition, the administrative burdens and cost associated
with structuring investments in U.S. real estate is
significant. No other asset class faces this tax.
A report by University of California professor Ken Rosen
found that reforming FIRPTA would unlock billions of dollars in
investments into U.S. commercial real estate. This is capital
that is currently sitting on the sidelines or, more likely,
going to other countries that have more favorable tax rules.
The time has come and gone for FIRPTA. Frankly, it should
be repealed, and perhaps you can do that in tax reform. There
are meaningful, cost-efficient reforms that can and should be
made now, however. We are pleased that Congressman Brady and
Congressman Crowley and other Members of the Committee are
working on legislation to make two simple meaningful changes.
First, the existing small shareholder exemption for foreign
investments in publicly-traded REITs should be doubled from 5
to 10 percent.
Second, an IRS notice called 2007-55 should be withdrawn.
Action in this area would significantly help smaller markets,
where capital is most needed. This latter point on the IRS
notice does not require legislation; Treasury could do it now
with the stroke of a pen. In this regard, we strongly support
efforts that Mr. Crowley and Mr. Brady and others on the
committee are making to urge the Treasury to review this
notice, and hopefully withdraw it.
One other significant issue concerns foreign investment in
U.S. debt. There are significant confusions regarding when a
foreign source capital can invest in debt in America and
restructure that debt. It would be very helpful to have these
guidelines straightened out and made more clear.
These simple reforms would spur billions of dollars in
foreign investment in U.S. real estate debt and equity. This
type of investment would significantly help stabilize troubled
lending markets. It would help create jobs. It would help move
our economy forward. Importantly, the end result would be to
make our nation globally competitive for capital looking to
invest in real estate.
Thank you for including our point of view in today's
hearing, and I look forward to responding to any questions you
have. Thank you.
[The prepared statement of Mr. DeBoer follows:]

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Chairman TIBERI. Thank you to the entire panel. Very good
testimony.
Question one is for the entire panel, and I will start with
Ms. McLernon. What advantages do you see, from where you sit,
do foreign entities have to invest in the United States? And
what are the disadvantages that the U.S. has for foreign
entities to provide capital and invest?
Ms. MCLERNON. Thank you, Mr. Chairman. What advantages do
foreign companies have? Let's go with that one first. I think
foreign companies----
Chairman TIBERI. Not advantages that they have. What
advantages are there for foreign entities to invest in the
United States----
Ms. MCLERNON. Okay.
Chairman TIBERI [continuing]. And what are the
disadvantages for a foreign entity to invest in the United
States?
Ms. MCLERNON. What I hear time and again from my member
companies, in terms of the reason to invest in the U.S.,
certainly the size of our economy is a main reason for
companies to invest. When choosing amongst a number of
different countries, it is the quality of our workforce that
comes up time and time again as the main reason for encouraging
investment here.
We have talked on the panel about some companies that have
global operations here in the U.S. So those are the operations
they can really place just about anywhere, and they are
choosing to place here. And again, it is the quality of the
workforce that I am hearing.
However, I am also hearing that there is a concern about
that quality going forward. Our investment in the ability to
maintain a skilled workforce in the years ahead, I think, has
been raised to the top level of concerns for our companies.
They manufacture here at the very high end. And so those are
the types of workers that they are going to look for here,
because that's where it makes sense, where the U.S. can have a
competitive advantage. So, I would say that that is one of the
reasons that these companies come here.
In terms of disadvantages, specifically for my unique slice
of the business community, certainly within the tax area, the
one issue that, in addition to FIRPTA that was mentioned
earlier, is the 163(j) provision in our Tax Code, which is
inherently discriminatory, only impacts practically the U.S.
subs of foreign companies. And it inhibits their ability to
expand and grow here by the way in which--that these companies
are restricted from borrowing from their parent company or
borrowing from a third party with a parent company guarantee.
So that is the provision in our Tax Code that does provide
some disincentives to these firms, in terms of being here.
Chairman TIBERI. Mr. Spitzer.
Mr. SPITZER. Sure. Nestle invests in the U.S. And we are a
food company, obviously, so, food costs, transportation costs
of moving food from Europe to the U.S. are very expensive. So
we go where the market is, where our consumers are, where
natural resources are, workforce, et cetera.
But I think some of the disadvantages--I have to echo
Nancy's comments about restrictions on the ability to deduct
interest and borrow. You know, we align our expenses with our
profits. So if we have expenses related to an investment in a
factory or a business here, the interest expense that goes with
that profit should be aligned. We align for basic economic
reasons, for exchange control reasons. In other countries, if
we are concerned about expropriation or political unrest, we
align profits and expenses. And interest is just a general
expense of doing business anywhere.
So, restricting an inbound investment artificially, as
compared to an investment by a U.S.-headquartered company, is a
disincentive. And further restrictions on interest deductions
would be even a greater disincentive to invest here.
Another disincentive is that most U.S. companies are on the
U.S. exchanges. Nestle is not. So, for us to use our stock in
an acquisition, it is almost impossible. So we have to do it
with cash, and we do all our acquisitions with cash. So, once
again, interest becomes a more important element of that
acquisition.
So, there are substantial disadvantages for a foreign
company trying to come in and invest in the U.S.
Chairman TIBERI. Thank you. Sir.
Mr. DRAILLARD. Well, for Dassault Falcon Jet, investing in
the United States was primarily being close to our customers.
The United States is still the number one market for business
aircraft, in number of units, by far. Other countries are
emerging, but the United States is still the primary source of
new orders for us and for all the major players in this
industry.
The other advantages, as Nancy was talking about earlier,
was certainly the skill of the workforce. But we see--and we
dramatically see it since, I would say, 2006--a decrease in the
level of the workforce. We are finding locally, especially in
areas like the center of the country and the southeast of the
country, we have more and more trouble finding local people
that have the skills we are looking for a high-end, high-
technology industry.
As far as we are talking about disadvantages, disadvantages
are mostly in our export efforts. The lack of tax treaties
between the United States and other countries sometimes hinder
us from basically growing our business and getting the fruits
from our efforts and exporting U.S.--well, mostly U.S.--
manufactured goods. Even though we are owned by a French
company, 60 percent of the airplanes we are selling has U.S.
content.
Mr. DEBOER. It is hard to imagine something more
disadvantageous than a 54 percent exit tax on an investment in
U.S. real estate. My statement has details on that.
But on top of that, I would say that the investments that
do come in create a tremendous misallocation of resources for
American investors seeking to partner with foreign capital
sources, because the structures that need to be assembled to
make these investments occur at any level require a tremendous
amount of tax planning and a tremendous amount of resource
allocation that should be going somewhere else, and could be
put to a more productive use.
I would like to also highlight, in addition to this FIRPTA
issue which, again, affects investment in U.S. real estate on
an equity basis--and we need equity to rebalance these loans--
but think about the debt situation.
We have a tremendous amount of commercial real estate debt
that is, essentially, under water and needs to be restructured.
This troubled debt, if it is acquired by a foreign capital
source, foreign capital sources have to worry about being
deemed to be in the trader business here in the United States.
And so they are very hesitant to make these investments,
because they don't know quite what the guidelines are from the
Treasury Department. This has been on their business plan since
2006. They have been petitioned by a wide array of actors in
this area to make guidelines and safe harbors more clear for
investors. And so I would urge that that also be looked at.
Chairman TIBERI. Last question for the entire panel, as
well, and we will start here on this side, with Mr. DeBoer.
In addition to your comments about FIRPTA, is there
anything specifically in the Tax Code, the current Tax Code,
that makes it less likely to see foreign capital, foreign
investment, foreign companies to come into the United States?
And if you could, elaborate in addition to what you have
already elaborated on FIRPTA.
Mr. DEBOER. Well, again, I think that, as has been stated,
we are in a global economy. And so it's not always just what is
in our tax law, but it is what is in other countries' tax laws.
And the way other nations treat real estate investment is much
different than the way that our nation treats real estate
investment. So, in addition to this barrier that we have, we
look at it as a barrier compared to what other nations have,
and we see it to be highly discriminatory here.
So, I guess I would leave it at that.
Mr. DRAILLARD. I would tend to agree with what has just
been said. On top of that, I would say that the earnings
stripping is probably one of the biggest problems that we see
not so much ourselves, but our customers.
Mr. SPITZER. Yes, I think 163(j) is the biggest impediment.
But also debt equity issues. I mentioned that the IRS, the
administration of the law by the IRS, concerning inbound
companies. And debt equity is another way of disallowing
interest deductions.
And I also think--Nestle is a very large company,
obviously. We are big boys, we can handle ourselves with the
regulations and the IRS. But if you want to attract medium and
smaller foreign businesses into the U.S., I think the general
complexity, uncertainty, and the administration of the law are
barriers to inviting mid-sized and smaller investments. And I
think that's a very important point to make.
I know in the transfer pricing area, for example, we have
been to court now three times on our royalties. Our business
model is, like many U.S.-headquartered companies, to maintain
our intellectual property in our home country Switzerland. It
is less expensive to do, because of the synergistic nature of
it. So trademarks, R&D, et cetera, and we charge out globally
for it, in the form of royalties for both trademarks and R&D,
although we conduct a lot of R&D here.
So dealing with the IRS on these issues, we have had
battles with them, we have gone to court three times, went to
trial once, summary judgment once, and then a settlement once.
And trial, summary judgment we won 100 percent, settlement we
won well over 90 percent. So, the bottom line is, even when you
are right, it is very expensive to deal with transfer pricing
issues.
The same thing on debt. We went to court on debt equity
issue in trial back in the 1990s. We won 100 percent. But for a
large company like Nestle, we can do it. We have the resources.
It is not pleasant. But for medium sized and small companies,
it is daunting. And once you have that reputation out there as
a difficult place to invest in, it is very hard to bring
investment in.
I know the states are out there, encouraging European
companies and Asian companies to come in. I don't think the
U.S. does anything like that. And maybe the U.S. should do
something like that.
Ms. MCLERNON. Mr. Chairman, I will just go ahead and make
it--get it out onto an even more basic level. I think the rate
is an impediment. And our companies, just as Nestle explained,
sometimes when the congress passes a provision that they expect
can be helpful, in terms of the rate, like an R&D tax credit,
which can be very helpful, the way that the IRS administers
that is not reliable.
And I have had one of my CEFOs from one of my companies
say, ``I cannot count on that. We have been litigating it for
10 years,'' even though they do a lot of R&D here. ``So, I
think of--when I am thinking of investing in the U.S., I think
of the rate, and I throw that up on the white board, and that
is what we look at.''
So, you know, boiling it down to its most simple level, I
would say that the rate itself was a big impediment.
Chairman TIBERI. Thank you. I will recognize the ranking
member, Mr. Neal.
Mr. NEAL. Thank you very much, Mr. Chairman. There is very
little that has been offered by our panel that I would find
myself in disagreement with. But I think that we use this
process to enlighten, as well.
Mr. Draillard noted that many companies--many countries
offer incentives to secure investment. But I think it bears
noting as well that we have got some pretty stubborn problems
ahead of us here in America, not the least of which is paying
for the war in Iraq, a VA system that is sure to be stretched
for the next 50 to 60 years for the 31,000 men and women who
have served us with great honor over these years, and, let us
be candid, not a bad deal for our European friends under the
umbrella of what we call NATO. They have spent about one
percent of their GDP since the end of World War II on national
defense, and the American taxpayer and the American soldier has
pretty much been in a position to foot the bill. That is part
of the consideration.
Now, I want to say to you that corporate tax reform needs
to be changed, and it certainly does. And the hearings that
Chairman Camp and others have offered are certainly
instructive, and hopefully will take us in a new direction. But
not to miss the point that there are some serious obligations
that America has, going forward.
And, as part of the process of the hearing, it strikes me
that we need to note those obligations and understand clearly
that, as I indicated a couple of moments ago, I think the
American taxpayer has been pretty generous with the defense
that they have provided to the rest of the world, and
frequently point out to critics of America that the reason that
many of our friends across the globe are not speaking a
different language, it is because of the American taxpayer and
the American soldier. We provide that umbrella of protection
for much of the rest of the world.
And Secretary Gates, to his credit, has put it forward once
again, as I did probably 20 years ago, in discussions that, at
the same time, we are looking at some structural deficits that
were significant.
Now, Ms. McLernon, you indicated--and I would like to hear
from the other panelists, as well--the R&D credit. That is a
big deal for Massachusetts. We are, despite the fact, a medium-
sized state--some might consider it a small state--we rely
heavily upon that R&D credit, largely because of the technology
and, let's be candid, because of the people that we attract in
Massachusetts to live on cutting edge opportunities.
So, how might you suggest that we do a better job, one,
with predictability, as it relates to the R&D credit, because I
think you are entirely correct, that you cannot, from year to
year, wonder if it is going to be around, or wonder what the
rate is going to be? And, at the same time, how would you
suggest that we do a better job of administering it beyond just
that issue of predictability?
And we can move to the other panelists, as well, after you.
Ms. MCLERNON. Okay, thank you. All the points that you just
stated, I absolutely agree with. And while the intent of
Congress is to put this in place to encourage more R&D in the
U.S., I think the IRS has sort of hijacked it. It has become an
issue that is always investigated very heavily at the IRS. And
companies--pharmaceutical companies, in particular, who--you
would think research means research means research; it doesn't
always turn out that way.
And by being able to convey more appropriately what the IRS
should be doing, and what Congress's intent--perhaps could be
helpful, because it is not getting, I think, what you want it
to be, because of the uncertainty that not only the non-
permanent nature of it, but how the IRS is looking at it.
Mr. NEAL. Thank you. Mr. Spitzer, you also owned that very
famous company in Massachusetts, Friendly's, for a period of
time.
Mr. SPITZER. Actually, I think that was Hershey.
Mr. NEAL. Oh, Hershey. I stand corrected.
[Laughter.]
Mr. NEAL. But you wanted to.
Mr. SPITZER. Yes. We have--I know in Massachusetts we have
a water company, and we just started a new business, Tribe
Hummus, which is manufactured up in Massachusetts.
Mr. NEAL. Right.
Mr. SPITZER. So--and my son was going to school up in
Boston. So I love Massachusetts.
But I have a little radical view on some of these things.
The U.S. Tax Code is so complex and so difficult. And I think
one of the reasons is we try to do so many things with it. It
is not just a revenue raiser. We try to do political things,
economic things, incentives. And if we could give incentives in
a different way that does not involve the Tax Code, then we
won't have the IRS auditing in such a way that it becomes so
difficult to achieve those incentives.
If we could give out grants of some sort--I know it is--
politically difficult, but it does create a real problem in
trying to actually take advantage of the things that the
government wants to give us to promote businesses.
But I just want to add----
Mr. NEAL. Please.
Mr. Spitzer [continuing]. Nestle's R&D exceeds every other
food company in the world. I think about 1.3 percent of our
sales is the amount we devote to R&D.
Mr. NEAL. Yes.
Mr. SPITZER. Which is huge.
Mr. DRAILLARD. As far as R&D tax credit is concerned, our
main concern is the definition of R&D. And here we need,
nonetheless, stability, but more visibility on this definition,
more clarity on this definition.
R&D means research and development. And development is not
fully defined in the U.S. Tax Code. And this hinders us from a
number of issues--if we could actually--we thought were
eligible for tax credit, like first of a kind installation.
When you install for the first time a brand new system on a new
airplane that hasn't been installed ever before, and it is
actually manufactured in the United States and installed for
the first time in the United States, this is not eligible. And
this is troublesome.
Mr. NEAL. Mr. DeBoer.
Mr. DEBOER. Mr. Neal, clearly we need to pay for our wars.
We support--I agree with everything that you said. In the case
of real estate investment, I guess I would say don't you find
it astounding that America, where everyone wants to live and
invest, has now slipped to third, globally, in terms of the
chase for global funds for real estate, behind the UK and
Germany? I find that astounding.
And, in terms of revenue--and I think that is where you are
going on this--who, really, is paying the FIRPTA tax? What kind
of foreign investor is actually paying a 54 percent exit tax
here? Not very many. And so, if you lower that--effectively--
tariff, you are going to bring in more capital, you are going
to create more jobs, you are going to stabilize communities and
ease up on some of the problems in our local community banks.
So that is sort of where we are coming from on this.
Mr. NEAL. In some of the hearings and discussions that we
have had, and I have had back home, I still have not been able
to get clarity from many corporate leaders on the issue of the
R&D, however. When I have asked them if they were to get a 28
percent or 27 percent corporate rate, would they be willing to
give up R&D, a great deal of uncertainty.
Thank you, Mr. Chairman.
Chairman TIBERI. Thank you. I recognize the gentleman from
Illinois, Mr. Roskam.
Mr. ROSKAM. Thank you, Mr. Chairman, and thank you for all
four panelists, for your testimony this morning. It has been
helpful and instructive.
You know there is people that are involved in the public
debate on this issue--I don't think anybody that is present
here today, in terms of members--but there is a sub-text, as it
relates to foreign investment, and that is this, that people
think--I would say uninformed people would think--that you are
going to invest in the U.S., no matter what, that there is the
imprimatur of the U.S., and sort of the worldwide reputation
and so forth, that no matter how bad things get here, you are
still going to come. I think that is actually a dangerous way
of thinking. I don't think it is true.
Can you walk us through--you each mentioned different
components in your testimony, you know. Ms. McLernon, you said
that the U.S. share has dramatically declined over the years.
Mr. Spitzer--and I am paraphrasing, just jotting down notes
from your testimony--you said the rest of the world is moving
to a lower tax rate, and the U.S. should, too. Mr. Draillard,
you said that the U.S. is no longer a growing market, and
investors are beginning to question whether this is really
where the action is--those are my words and not yours, but I
think that was your theme--and then, Mr. DeBoer, you were
basically making the argument, you know, essentially, why
should capital come here.
Can you give us the--a sense of what it is that companies
and foreign investors are looking out over the global
landscape? What is attractive? What are the things that you are
looking for? You mentioned predictability, and so forth, but
what are the things that you are looking for that the U.S. can
emulate? And who are we competing against? And what is the
nature of that competition right now? Let us start with you,
Ms. McLernon.
Ms. MCLERNON. Thank you very much, Congressman. You are
absolutely right, in terms of the U.S. has always thought that
global companies were going to come here because we were the
``it'' country, and this was the place to be. The numbers that
are now available don't support that, even though foreign
investment from 2009 to 2010 went up, because it was down so
low in 2009.
As I indicated, our share is really dropping,
precipitously. And that is for a variety of reasons, some of
which outside our country. Other countries are aggressively
marketing to get this investment. I think that is one of the
reasons that the Administration announced an effort last week
called Select USA, which is going to try to actively recruit,
among other things, foreign companies to the U.S. So, I think
that there definitely is some evidence that we are losing our
ability to do it.
From my membership perspective, tax policy certainly is a
factor in determining investment. But I would also add that a
skilled workforce, as I mentioned earlier, as well as
infrastructure investment, is quite important, as well. The
ability to move people, product, and information is critically
important, and especially when companies can really locate
their global operations anywhere to serve the world.
They are not only operating them out of their home country.
As I mentioned before, there are several U.S. or foreign-based
multinationals that have their global operations for certain
divisions here in the United States. But in order to attract
that, we need a smart, skilled workforce and a strong, sound,
state-of-the-art infrastructure system, as well as a
transparent, non-discriminatory Tax Code with a lower rate.
Those are the things that I have heard prioritized from my
membership.
Mr. SPITZER. Sure. I think we have a few employees in your
district in our candy factories there, well over 1,000.
Mr. ROSKAM. Don't you dare go to Ohio or Massachusetts and
shine any apples this morning.
[Laughter.]
Mr. SPITZER. Well, we have some things in Ohio, as well.
But if we are going to be in this country, producing
products, I think the competition, from our perspective, would
be Canada and Mexico, where we can easily put a plant up in
Canada, or put one in Mexico, and bring the products in.
And so, if we have more restrictive problems and ability to
deduct our business expenses, either at a federal level or a
state level--and let me just make a couple comments about the
states, which I already did--some of the provisions in the
states are so perverse, that they actually--if you make
investments here, then they try to bring in your foreign
affiliates into the country, which is just the opposite of what
you are trying to do. You want to encourage investment, not
discourage it specifically. So, whatever the committee can do
to encourage or discourage this kind of behavior will be
helpful.
But within Nestle, we have investments all around the world
in 140 or so countries. Nestle in the U.S. competes with these
other countries for the capital to make investments. So, if the
profits look better in some other country, a developing country
or wherever, we are going to put our capital where we think we
can make the most money. And so, the more restrictions on our
ability to earn money here will obviously sway the investment
decisions to other markets. And so we have to be very
thoughtful about this.
Mr. ROSKAM. Mr. Draillard.
Mr. DRAILLARD. Mr. Congressman, I think you got my theme
right. We are going where our customers are. And our customers,
even our U.S. customers, are going everywhere.
So, what is attractive was your first--the first part of
your question. What is attractive is where can we sell
airplanes. What is attractive is where can one find workforce
that we can bring in to any of our facilities, either in the
United States or in France.
What is attractive is also the protection of our
technology. We are--hopefully still--number one in the high end
of the business jet market. And the reason for that is our edge
in aviation, in aerostructures, basically. And we need skills
for that. And we need to protect that know-how. And stability
of the political structure is one of the biggest factors we
look at.
Tax, in that effect, we see tax as part of the stability of
political structures in the economic environment. And,
therefore, even though it may not be a deal-killer, the tax
rate is something we definitely look at.
Mr. DEBOER. Foreign investors are looking for the same
things in real estate that domestic investors are looking for.
They are looking for current income streams, and, more
importantly, they are looking for capital gain on the outside.
So the tax policy, particularly relating to the capital gain--
and that is where FIRPTA affects things--is very, very
important.
On top of that, I think what was previously mentioned about
transportation, infrastructure, the ease of these foreign
investors to come in, see their investments, visit the United
States, is very, very important. And those are other policies,
aside from tax policy, that are very important.
As far as competitors, I mentioned the UK and Germany. But
also, global capital flows are going tremendously into Brazil,
into China, into India. It is no surprise. And again, for those
investments, it is not for the steady income stream right now,
but it is for the value add and the capital gain that will come
later on.
Mr. ROSKAM. Thank you. Thanks, Mr. Chairman, I yield back.
Chairman TIBERI. The gentleman from Minnesota, Mr. Paulsen,
is recognized.
Mr. PAULSEN. Thank you, Mr. Chairman. And I just want to
follow up a little bit on the discussion about research and
development just for a second, because I think you identified
how your companies, your membership in your companies, as a
part of the testimony, it is such an important component of
jobs here, of economic development. And I just want to expand a
bit.
Can you just share some thoughts about why that is so
important? I do understand, working with the med tech industry,
in particular, that the incentives to attract research and
development are much stronger in other countries than they
actually are here, in the United States. What actually happens
when R&D is actually conducted here, in the United States?
What types of jobs are we talking about, whether it is in
the food industry, whether it is in med tech or other
membership companies? But can you maybe just elaborate a
little, Ms. McLernon?
Ms. MCLERNON. Yes, absolutely. Our companies produce about
14 percent of private sector R&D. So it is an important part of
what we do here, and we contribute a lot to the U.S. R&D base.
Much of the reason that our companies do R&D here--I think
we have talked on--is the quality of the workforce. It is also
access to universities. But these are high-end jobs. Because we
create 14 percent of research and development, it leads back to
the fact that our companies pay 30 percent higher than average
company. And this is because it conveys the higher-level, high-
skill nature job that these companies tend to support, in
scientists and engineers.
And so, I would say that research and development, when it
happens here, especially with using American scientists and
engineers, the U.S. economy benefits. I think many countries
around the world, including the U.S., are actively trying to
recruit that R&D. And the U.S. has done a pretty good job,
considering other countries are actively working in this area.
Mr. PAULSEN. Yes. So it is safe to say--Mr. Spitzer and Mr.
Draillard, please comment, too--but it is safe to say where the
innovation starts, where it occurs, is where you are going to
have sort of the supply chain, if you will, of other follow-
up----
Ms. MCLERNON. Yes, there is certainly----
Mr. PAULSEN [continuing]. progression of other jobs.
Ms. MCLERNON. There is certainly a multiplier effect, if
you will, of R&D investment.
Mr. PAULSEN. Right, right.
Ms. MCLERNON. Absolutely.
Mr. PAULSEN. Mr. DeBoer, I am going to just change themes
here real quick, before my time runs out. But Mr. DeBoer, you
talked about modifying FIRPTA as a part of your testimony, to
encourage greater foreign direct investment in U.S. commercial
real estate space here in the United States.
And I think when a lot of people think of commercial real
estate, they think of Washington, D.C., they think of New York,
they think of kind of the big, commercial real estate spaces.
But how would the modification of some of the proposals you are
offering or proposing--how would that help midwestern community
banks?
Because you sort of alluded that--I caught that in your
testimony, also. But how does that help Midwestern community
banks--and Minnesota is an example--give more--get more access
to credit for small businesses?
Mr. DEBOER. Thank you for the question, because I think a
lot of people are confused about how this would benefit markets
outside of New York or Washington or San Francisco, which are
actually doing reasonably well.
It goes to what I was talking about before. Investors want
capital gain. They want to invest in areas where they can see
those values come back. As you know, there has been some value
decline across the country. Certain markets are hit more hard
than other markets. These are areas that need tremendous
amounts of equity.
These owners have been essentially hanging on now since
2006/2007-time period, they have been funding the debt service
out of their own pockets, out of their own equity. The jobs
have not come back, the loans need to be balanced. There is a
tremendous amount of these loans that are held by community
banks.
Re-balancing these loans will help ease the pressure on the
community banks, point number one, which will allow the banks
to then be able to lend more of their capital, and devote more
of their attention to providing small business loans to
American small businesses to create jobs. So, helping ease that
side of the balance sheet for community banks would be very,
very helpful.
Then you look at the real estate, itself. A lot of these
assets have had deferred maintenance on them. In other words,
people--they are starting to run down. People are running out
of capital. They cannot, you know, tenant them up and put them
in the transaction stream and keep their values up. If they can
get capital put into them, construction workers will go back to
work and architectural firms will go back to work, and
transactions will occur so transfer taxes can occur and help
communities.
This--in particular, part two of what I talked about, the
notice, the IRS notice, this is a situation that would directly
help smaller communities, as opposed to larger cities, in
attracting investment. That is where foreign capital wants to
partner with local owners to recapitalize, reposition these
assets. That will be very, very helpful in smaller markets,
sir.
Mr. PAULSEN. Thank you, Mr. Chairman.
Chairman TIBERI. Thank you, sir. Before I recognize Dr.
Boustany, I want to just note, Mr. Spitzer, that Mr. Neal and I
both appreciate the presence that you have of Nestle jobs in
our states. And now that Mr. Roskam has left, we are willing to
work with you to divvy up those Illinois jobs to Ohio and
Massachusetts. So we can talk about that later.
[Laughter.]
Chairman TIBERI. Dr. Boustany is recognized for five
minutes.
Mr. BOUSTANY. Thank you, Mr. Chairman. Let me say Louisiana
is open for business, so we can talk about this.
You know, this is about economic growth and
competitiveness. And as policy makers, obviously we are very
concerned about economic growth as part--a major part of the
equation to deal with this high unemployment we have in this
country, you know, just the sluggishness, all the problems we
are seeing in the news, daily.
And as I reviewed some of the stats that we had in
testimony in the written binder here, you know, Louisiana, over
48,000 jobs from foreign subsidiaries, 5.7 million jobs in the
U.S., which is basically 5 percent of our U.S. private
workforce. Less than 1 percent of U.S. business, yet 17 percent
of corporate tax revenue, as Ms. McLernon pointed out. And yet,
I think all of you said that we are underperforming, as a
country, when it comes to foreign direct investment.
So, one question I have--and I think, Mr. Spitzer, you
alluded to this earlier--and that is the indirect jobs that
basically are created and sustained as a result of foreign
subsidiary activity, do we have actual numbers, or some sort of
a sense of the number of indirect jobs here created in the
U.S., as a result of direct job growth from foreign subs?
Ms. MCLERNON. As an organization we haven't done that
calculation, but absolutely indirect jobs need to be included.
I mean sometimes an investment can absolutely transform a
local economy. When Michelin invested in North Carolina, they
have transformed that area from a textile industry to one that
attracts global investment because of all the different
suppliers that came to help serve them. And so, you know,
absolutely. Indirect jobs should be part of this.
Mr. BOUSTANY. And given that many of your companies are
involved in U.S. exports to foreign countries, and the
President's goal is to increase U.S. exports, and linking our
small and mid-sized firms into this global market is critically
important in that respect--and so it seems to me that this
indirect job growth would be something that we would want, from
a policy standpoint, but it is also a way of linking our small
and mid-sized firms into the global supply chain. Is that a
fair statement?
Ms. MCLERNON. Yes. No, I would agree, Congressman. I think
that by interacting with globally-engaged companies, it can
encourage small and mid-sized companies to get globally
engaged.
In addition, sometimes when a company from abroad that has
suppliers in its area want to come and help serve that company
when it invests in the U.S., actually are incentivized to come
and set up shop, employ people here, do a Greenfield investment
in order to serve that global company here in the United
States.
So, there are a variety of indirect jobs that can come
about when a global company invests.
Mr. BOUSTANY. And, Mr. Spitzer, you raised the issue of
indirect jobs in the context of what your company does. Do you
have any numbers, estimates?
Mr. SPITZER. No, unfortunately, I don't. But, obviously, in
the food industry there is third-party packaging, third-party
transport, resources, et cetera. So it is--the numbers are huge
in our industry, but I don't have the numbers.
Mr. BOUSTANY. So, as a country, given that we are
underperforming in attracting foreign direct investment, we are
losing ground. It seems to me that, looking at those policies
that are having this detrimental impact, and making the kinds
of corrections that you have all suggested, would help us with
our unemployment problem, and help us get this country back on
a path of sustained and strong economic growth and job
creation.
Mr. SPITZER. Oh, absolutely. Yes, of course.
Mr. BOUSTANY. Thank you. All of you have mentioned the
complexity. Mr. Spitzer, you focused on this a good bit, and
talked about the coordinated effort by the IRS to audit under
section 163(j). And I, as the chairman of the Oversight
Subcommittee on this full committee, I would be interested in
learning more about the problems you have with all that.
Mr. SPITZER. Sure. Actually, it is not 163(j), it is
Section 385, which is--it is sort of a debt equity question----
Mr. BOUSTANY. Okay.
Mr. Spitzer [continuing]. Looking to see how much debt you
have versus the equity, and looking to see did you dot all the
I's, cross all the T's on borrowing from your foreign
affiliate, foreign parents.
And you know, as I indicated, there is no--as far as I
know, there is no sense that there is actual abuse out there,
or any documentation there is an abuse. But it is very
expensive to deal with these issues. And, as I said earlier, we
had to go to court many, many years ago on this particular
issue.
Since then, 163(j) came in, which is a further restriction
on the ability to deduct interest. So they still both exist,
simultaneously. And the IRS seems to be pushing now this
Section 385 debt equity issue.
I want to mention one example of the perverseness of
163(j). We, Nestle in the U.S., can borrow on its own. We
don't. Because if we were to borrow on our own, it would cost
us more interest.
Mr. BOUSTANY. Yes.
Mr. SPITZER. Which means that we are going to get less back
on our investment, which means our investments are going to be
smaller. And if we borrow on our own, and pay a higher interest
rate, we are going to pay less U.S. taxes.
So, it is very perverse, especially when you are borrowing
from third parties with a guarantee of your parent company. So,
if I borrow from a U.S. bank, Citibank, and I get a guarantee
from our U.S. parent so that we can get a lower rate, it does
not make any sense that this should be some sort of tainted
interest expense. This is all within the U.S. And we are
actually trying to make a larger investment, not a smaller one.
Mr. BOUSTANY. Thank you, sir. I see my time has expired.
But one last comment, Mr. Chairman. You know, we hear a
constant refrain about the IRS needing more resources to manage
its workload. But at the same time, we are hearing from these
folks that the code is so complex that it creates all this
additional need for resources, both at the IRS and on the part
of these companies, just for compliance. And so we have to
tackle this problem of complexity in the Tax Code, as we do
reform.
And I yield back.
Chairman TIBERI. Thank the gentleman. With that, I yield to
the gentleman from Texas, Mr. Marchant, for five minutes.
Mr. MARCHANT. Thank you, Mr. Chairman. What single piece of
legislation that is pending before this committee, this
subcommittee or committee, would you think that we should pass
that would have the most immediate positive effect on
investment, job creation by your clients or your industry or
your company?
Ms. MCLERNON. As of now, I don't--our organization is not
focused on a particular piece of legislation that you are
currently considering, other than--I don't know if the FIRPTA
legislation is part of what this subcommittee is focused on.
So, I would say, in terms of global investment, that would
certainly be a piece of legislation that we would support.
Generally, on tax reform, again, it is about the lower rate and
pushed in a transparent manner that is consistent and non-
discriminatory.
Mr. MARCHANT. Mr. Spitzer.
Mr. SPITZER. Sure. I was just down in Texas yesterday, in
Austin. So--a great state. We have some water businesses down
there. We own Ozarka Water, which is ours.
I don't know all the legislative proposals that are in
front of you. Obviously, a lower tax rate is very helpful. All
the OECD countries, except for Japan, have a much lower rate
than the U.S. does. And Japan is considering lowering its tax
rate, as well, below ours. So, we are not competitive on a tax-
rate-basis with other developed countries.
Obviously, I have talked about 163(j), and any further
restrictions in that area would be very difficult for a company
like ours to deal with. And I certainly think there should be
some liberalization there concerning third-party borrowings
that are simply guaranteed by our parent companies. It just
doesn't make sense to me.
A proposal that has been out there is this corporate
residency proposal. I think it was sort of directed at inverted
companies, which are pretty limited now, and maybe some hedge
funds. It's a baby and the bath water situation, in my mind. As
I understood the legislation, as proposed here, any decision-
making in the U.S., whether it is by corporate officers or not,
might bring a foreign company into the U.S. for federal tax
purposes.
So, for example--I don't want to pick on Sony, but Sony's
chairman, Howard Stringer, spends time in Tokyo, spends time in
London, spends time in New York--I think one-third, one-third.
If, all of a sudden, under these proposals under corporate
residency, Sony Japan woke up and found it was a U.S. company,
it would be devastating. All their affiliates around the world
would be CFCs. Dividends to the Japanese shareholders would be
subject to the U.S. withholding taxes.
And, unlike so many other countries--or few countries--that
have these sort of residency requirements, like the UK and
Holland, it is very formalistic. The proposals in the U.S.
would be very difficult for anybody to deal with. And I think
any advisor would have to recommend to their clients, ``Get
every decision-maker out of the U.S. pronto,'' because the
consequences could be so horrific.
Mr. MARCHANT. Thank you.
Mr. DRAILLARD. Number one would be absolutely the corporate
tax rate. Their--simplification is also a big item on our list,
just for the reason that it is a layer of fixed cost for most
companies. And the smaller the companies, the bigger that
burden is, and that hinders them from basically operating and
doing business, especially in a state like yours. We have a
number of local vendors in Texas that work for our Little Rock,
Arkansas, facility. And we see the burden of just administering
federal and state regulations, tax regulations, being so huge.
Just complying has become such a huge burden that it is a fixed
cost that they cannot basically overcome.
Mr. MARCHANT. Thank you.
Mr. DEBOER. We understand that Mr. Crowley and Mr. Brady
are readying legislation to be reintroduced on FIRPTA. We would
urge that that be immediately passed. It would have tremendous
salutary benefits.
The guts of this legislation is legislation that passed the
House in the last congress with 402 votes in support of it. It
died in the Senate, but perhaps we can move that--see that
action this year.
Incidentally, there is one thing that could be done
immediately that would have very, very direct and almost
immediate benefits, and that is this IRS notice dealing with
how liquidating distributions are treated from private domestic
REITs back to foreign investors. That could be done by the
stroke of a pen, administratively.
And, again, we understand that some members are looking at
urging the Treasury Department to look in this area, and we
would absolutely urge you to do that as quickly as possible,
and it would have immediate benefits. Thank you.
Mr. MARCHANT. Thank you.
Chairman TIBERI. The gentleman from North Dakota, Mr. Berg,
is recognized.
Mr. BERG. Thank you, Mr. Chairman. This is an important
hearing; I appreciate all your input.
Mr. Draillard, I--you have got a great plane. And I mean I
just think that is unique. If you think about a global
business, quite frankly, when you are making jets you can make
them pretty much anywhere. And they are going to sell where the
economies are the strongest.
And so, you know, I am very interested in kind of--I was
interested in your written testimony. And I just kind of want
to--I mean, clearly, the number one thing we need to do is have
a strong economy. That will help the aircraft industry.
I am a private pilot, so I will never fly a jet, but I am
always jealous of jet owners and flyers.
But what are the things that we could do to encourage more
jobs to come to America in the aircraft industry? I mean what
would be the one thing, from a policy tax standpoint, where,
you know, every manufacturer that is not in the United States
would say, ``Hey, we really need to look at the United States
as a manufacturing''--or ``a component for our production?''
Mr. DRAILLARD. There are many things we could do. And
actually, I am at a loss of where to start, but three main
things come to mind.
The first one is federal versus state taxes for structured
financing of aircraft. A lot of companies, even very large
companies, Fortune 500 companies, finance for different reasons
their acquisition of the airplane, probably up to 70 or 80
percent. The structure of the leases or of the asset-backed
mortgage that they take against the asset is very cumbersome,
from a tax standpoint. And, frankly, from an OEM perspective, I
think the only people making money out of it are the tax
lawyers.
The other thing we can definitely----
Mr. BERG. I am also a tax lawyer. Teasing, teasing.
Mr. DRAILLARD. Good for you, sir.
Mr. BERG. I am teasing.
[Laughter.]
Mr. DRAILLARD. But, you know, I am a simple equipment
manufacturer, so that is way over my head.
The second thing we can definitely do is encourage R&D.
Research and development is paramount to continue to modernize
our equipment. There is a fleet of airplanes, of corporate
airplanes, that are 30 years old in this country. Very soon
they are going to fall short of any regulation towards green
flying. They are going to come short of any regulation towards
the navigation equipment. So we need to encourage R&D and
retrofit of airplanes, because this is going to be the
structure of the next 30 years of flying in this country.
The third thing we can do is increase the number of tax
treaties with other countries, because aviation is big in this
country. This country is the birth of aviation, of corporate
aviation. However, other countries are developing. If we want
to keep our jobs--and I am not talking only of Dassault Falcon
Jet here, but there is a number of jobs in Wichita, Kansas, and
in Georgia that are related to business aviation--if we, as a
country, want to save those jobs and make sure that we expand
those industries and expand those areas of the country, we need
to have broader, more clear tax treaties with other countries,
so we can export airplanes from the United States, and not have
them built somewhere else.
Mr. BERG. Thank you. Very good. Mr. DeBoer, on the FIRPTA?
Mr. DEBOER. FIRPTA.
Mr. BERG. FIRPTA.
Mr. DEBOER. FIRPTA. Yes, I know, I----
Mr. BERG. There is a lot of acronyms out here, I am trying
to----
Mr. DEBOER. Let's just get rid of it, then we don't have to
worry about it.
[Laughter.]
Mr. BERG. That is pretty clear in your testimony.
I guess if you could, give just a brief background on why
it is law. What were the political dynamics that caused it to
become law? And I know you have some suggestions for changing
it, but maybe just address that briefly.
Mr. DEBOER. Sure. You know, I will. Can I just make one
comment prior to that?
I found very interesting what you said about attracting the
jet manufacturing industry and jobs here. Keep in mind we are
talking about real estate. Real estate is here. It is not going
anywhere. These are jobs that are in America, and we should be
trying to make those assets as healthy and transferable as
possible. And I just wanted to make that general point.
FIRPTA itself was put in law in 1980. And I should have
said to the chairman I appreciate very much being included in
this hearing today, because since that time there really hasn't
even been a hearing on FIRPTA. It was repealed, incidentally,
in the 1986 tax act by the Senate, but ultimately didn't
survive conference.
It was put in place at a time when the world was obviously
much, much different. People were a little bit concerned here
that foreign entities were coming up into the United States and
bidding up the value of farmland. In fact, the evidence showed
that foreign investment was less than two percent in farmland
at the time. The individual senator who promoted FIRPTA in 1980
was ultimately the individual who led the repeal charge in
1986, when he realized that this was not what was happening in
farmland in America.
So, not only was the underlying basis at the time somewhat
flawed, but you look ahead to today and you see what is going
on globally, as we talk about--and the basis of this hearing is
attracting global capital to the United States. Everybody is in
competition for capital. And so, the United States today, and
investors and real estate owners today, are much more global in
where they look for their capital sources to make their
properties valuable, and to make them productive parts of the
community.
So, a lot has changed. Some of the facts about how it was
originally put in place have changed. A number of the tax
policy issues that underlie somewhat some of this stuff have
changed a lot since then. And certainly the global competition
for capital has significantly changed.
Mr. BERG. Thank you. I will yield back.
Chairman TIBERI. Thank you. We are joined today by a
gentleman from the full committee who is not a member of this
subcommittee, but you are welcome to come any time, the
gentleman from New York, Mr. Crowley.
Mr. CROWLEY. Thank you, Mr. Chairman. Just on a lighter
note, Mr. Draillard, have you or your company ever hired a tax
lawyer?
Mr. DRAILLARD. [No response.]
Mr. CROWLEY. I rest my case, your honor. Just teasing.
Thank you, Mr. Chairman, and thank you, Mr. Neal, for
holding this important hearing today. The U.S. has the most
foreign direct investment of any nation in the world today, and
has been the beneficiary of a growing number of companies with
headquarters in other countries doing business here in the
U.S., as has already been mentioned.
President Obama stated earlier this week that ``at a time
where we need to use every tool in our toolbox to continue to
put Americans back to work and grow the economy here at home,
promoting foreign direct investment is an important opportunity
to accelerate our economic recovery.'' I agree.
And the White House issued a report earlier this week that
shows our nation's open economy and low barriers to foreign
investment have helped to make the U.S. an even more attractive
investment for abroad. Stating that, there are still some
barriers in the Tax Code that block the free flow of investment
here to the United States, and these include, as Mr. DeBoer has
mentioned, the FIRPTA tax laws.
I am pleased that the House, in a bipartisan way, passed
legislation last year to relax the FIRPTA laws to encourage
greater investment in the U.S. commercial real estate market.
The bill introduced by Representatives Tiberi, Brady, Berkley,
and myself passed the House last year on a vote--a very
lopsided vote--of 402 to 11. Unfortunately, though, the Senate
did not act upon that bill.
Representative Brady and I plan to reintroduce a similar
bill in the coming weeks. Additionally, to more immediately
break down other barriers to foreign investment in the U.S.
caused by the FIRPTA tax laws, Rep. Brady and I are sending a
letter to the Treasury and IRS, seeking an administrative
solution to a regulation that is choking investment in the real
estate sector at a time when we need more, not less, investment
here. And Mr. DeBoer has also expanded upon that.
That brings me to my question for Mr. DeBoer. Kevin Brady
and I, as I mentioned, are sending a letter to the Treasury
Department and IRS later this week, that we are hoping to get a
number of Members on the Ways and Means committee, our
colleagues, to sign on to. Our letter seeks the administrative
repeal of an IRS rule that adds a new layer of taxation on
foreign investors in commercial real estate.
Could you talk about this IRS regulation, and its impact on
the real estate market here in the U.S.?
Mr. DEBOER. Sure. The ruling in 2007 reversed the long-
standing policy in the tax law, and set, for the first time in
the tax law, that a liquidating distribution from a corporation
would not be treated as the sale of the stock of the
corporation. This is the only part of the tax law where this is
so. And, making it even worse, it creates a dichotomy, if you
will, in the way that domestic investors and foreign investors
are treated on liquidating distribution.
The example might be that you and I engage in a partnership
in a domestically controlled REIT, where you have 51 percent,
as the domestic owner, I have 49 percent. We own and operate
and put money into real estate and make them more productive,
and so on and so forth, and we ultimately sell them at a
capital gain. We dispose of our entire investment. The
liquidating distributions out to the foreign entity would be
taxed under FIRPTA. And, as I have described, could be taxed as
high as 54 percent.
This is somewhat comical, because, if I wanted to, as a
foreign investor, I would simply sell my shares if a market
existed to sell the shares, and I wouldn't pay any FIRPTA tax
on the sale of the shares. And so, reversing this 2007 notice
would immediately bring a substantial number of foreign
investors back into the marketplace on these types of
properties.
Mr. CROWLEY. I want to ask you my second question to expand
upon the benefits, not only to cities like New York, but
nationwide, in terms of making these changes. You have already
answered that question.
So--but I would make a comment about the issue of what
brought this about in 1980. I think there was also a bit of
xenophobia when Japan or some Japanese purchased Rockefeller
Center. I do note that Rockefeller Center--I checked, I was
there last week--it is still in New York City, it never moved
to Tokyo. And so I think that also--it is now owned by Tishman
Speyer, an American company, as well. So, I think that also
brought that about.
We saw the similar events take place during the CFIUS issue
when Dubai Ports was in negotiation to run a port here in the
States. And I think we brought about a rational solution to
that.
But, Ms. McLernon, could you take a moment to address the
concerns of some that increased foreign investment in U.S.
commercial and real estate could threaten the nation's security
and the safeguards in place to prevent that from occurring, in
light of what happened in CFIUS reform, and what could--as we
discuss FIRPTA, and what is in place to prevent any threat to
our national security.
Ms. MCLERNON. Congressman, it is an important question. I
should remind those that are in the room that the government
already has an interagency committee called the Committee on
Foreign Investment in the U.S., known as CFIUS, that reviews
all national security implications of foreign acquisitions of
U.S. companies. By and large, the vast majority of these M&A
deals do not involve national security. And, as I mentioned
earlier--and I think I have in my written testimony--98 percent
of foreign direct investment is from the private sector.
But the law that governs--the rules that govern CFIUS were
strengthened, as you mentioned, in 2007--now includes the
Department of Homeland Security, includes the national--the
director of national intelligence. And any transaction that
involves a foreign government now automatically--or foreign
government-owned company--automatically gets kicked into a
longer, more thorough, second-stage investigation.
And importantly, even after a deal is completed, if they
have not gone through the CFIUS process, the government can
actually pull a company back in for review and unwind the deal.
So we have very strong safeguards that are in place, thorough,
tough, that scrub these deals to ensure that there is no
implication for national security.
But again, the vast majority of any sort of M&A
transactions that happen in the U.S. cross border do not at all
involve national security issues.
Mr. CROWLEY. Thank you, Ms. McLernon, and thank you, Mr.
Chairman, for----
Chairman TIBERI. I thank the gentleman from New York. And
this concludes the first panel for today's hearing. Please be
advised that Members may submit written questions to the
witnesses. Those questions, and the witnesses' answers, will be
made part of the record.
I would like to thank the witnesses for their informative
testimony from the first panel, and for taking the time to
appear today. Your input has been very helpful to us, as we
continue down the road of moving forward on tax reform. Thank
you so much.
We will begin this second hearing and the second panel of
this hearing in a few minutes. Thanks for coming.
I would like to thank our second panel of witnesses, and I
would like to welcome our three witnesses on the second panel,
and I hope you are as good as the first panel. No pressure, by
the way.
[Laughter.]
Chairman TIBERI. I will introduce our second panel. Mr.
Gary Hufbauer, the Reginald Jones senior fellow at the Peterson
Institute for International Economics; Mr. Robert Stricof, tax
partner at Deloitte Tax LLP; and Professor Bret Wells,
assistant professor of law at the University of Houston.
Thank you all for joining us today. You will each have five
minutes to present your testimony. Your full written testimony
will be submitted for the record.
And with that, Mr. Hufbauer, you are recognized for 5
minutes.

STATEMENT OF GARY HUFBAUER, REGINALD JONES SENIOR FELLOW,
PETERSON INSTITUTE FOR INTERNATIONAL ECONOMICS, WASHINGTON,
D.C.

Mr. HUFBAUER. Thank you very much, Chairman Tiberi, and
Members of the Subcommittee. I wish you well on the endeavor to
reform the Tax Code.
Let me make five points. First of all, on tax rates. Among
advanced OECD countries, the United States has the second worst
corporate tax system, from the standpoint of encouraging
investment in plant equipment or R&D, or promoting production
at home for selling in export markets.
The U.S. corporate tax rate is second highest after Japan.
But also, the U.S. average effective corporate tax rate is
second highest, and the marginal effective corporate tax rate
may well be the highest. I define all these terms in the
testimony. But however you look at it, we are high on the tax
rate story.
Credible evidence leads me to believe that the output
produced by foreign firms operating in the United States would
increase by about two percent over a period of time if the
corporate tax rate was reduced by one percentage point. So, if
we could actually get the corporate tax rate down to 25
percent--a number which has been much discussed in recent
months--these foreign firms might enlarge their payrolls from
about 5 million--or, actually, 5.7 million--by another million
Americans.
I am often asked--and I want to turn now to revenue
collection--if U.S. corporate tax rates are so high, why is the
revenue collected by the corporate tax system such a modest
proportion of gross domestic product. It is about three percent
in a good year. I am taking the year 2007, and that compared
with the OECD average of nearly 4 percent in that year.
The main reason for the difference is that a very small
part of the U.S. tax base of the U.S. GDP belongs to the
corporate tax base. It is about 13 percent, compared to the
OECD average of about 22 percent. Now, why is the corporate tax
base so small? We have a dazzling array of pass-through
corporations--pass-through firms, I should say, which skip the
corporate tax system. And that doesn't help, clearly.
But also, large firms who have a choice--and that is all
large, multinational firms--when other things are equal, and
then the choice depends on the tax system, they would rather
invest--produce elsewhere, than in the United States. So our
tax system does a good job of encouraging the best and
brightest firms to invest abroad. But it also does an even
better job at discouraging tomorrow's global 1,000 corporations
from investing--from putting their headquarters here in the
United States.
Let me turn to an important point, and that is the
connection between tax rates, statutory tax rates, and revenue
collection. The important point is that there is no connection.
And I go into this in some detail in a policy brief. But
unfortunately, the way the CBO scores these matters, whenever
the corporate tax rate is cut, they say that revenue will be
lost. That is a complete fallacy. Unfortunately, it colors the
ability of the United States to get the corporate tax rate down
to a reasonable level.
Let me say just a few words on inward direct investment. My
view is that the United States should put more attention on
reducing its own rate and making the tax system here favorable
and inviting to foreign companies than putting additional
effort in cracking down on abuse. I am not saying there is no
abuse; I think the tools in the code are adequate, and that is
not where the congressional effort should be. Thank you very
much.
[The prepared statement of Mr. Hufbauer follows:]

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Chairman TIBERI. Thank you.
Mr. Stricof, you are recognized for five minutes.

STATEMENT OF ROBERT STRICOF, TAX PARTNER, DELOITTE TAX LLP, NEW
YORK, NEW YORK

Mr. STRICOF. Thank you. Thank you for the opportunity to
discuss my views on international tax reform as it relates to
the U.S. operations of foreign multinationals. I am a tax
partner with Deloitte Tax LLP with over 30 years of experience
as a tax accountant. I am the head of Deloitte's global U.S.
investment services group, which serves large foreign
multinationals making investments into the United States. My
practice is largely focused on serving industrial companies in
service businesses.
I am honored to have been invited to participate in this
hearing; my remarks will focus on certain impediments posed by
the U.S. income tax rules on foreign direct investment in the
United States, and technical comments regarding certain
legislative proposals that affect multinationals investing in
the United States. These impediments include: the earnings-
stripping provisions; potential U.S. tax law changes regarding
the determination of corporate residency; U.S. income tax
treaty override proposals; FIRPTA; and, to add another acronym,
FBAR reporting.
In respect of earnings stripping, as has been said in
earlier testimony, I would like to point out that there is no
clear-cut data that demonstrates that there is a systematic
problem with earnings stripping. The Treasury Department
conducted a study on this issue, and concluded that there
wasn't clear evidence of earnings stripping by foreign-based
multinational companies making direct investments into the
United States.
In order to further this study and gather more data, Form
8926 was issued. This form is defective in many ways. For
example, it is unclear whether a taxpayer should rely on the
proposed regulations issued in 1991 under section 163(j) when
answering the various questions on the form.
Additionally, there is no guidance as to whether the form
should be filed on an expanded affiliated group basis or on a
stand-alone affiliated group basis. As a result, similarly
situated taxpayers are likely filling out the form very
differently from one another. This means that the data that
Treasury gathers from form 8926 is likely unreliable, and it is
doubtful that an analysis of the information provided on the
form will accurately provide reasonable conclusions as to
whether earnings stripping is taking place.
Moving on to corporate residency, it is important to note
that determining where a corporation is a resident is essential
to identifying where that corporation will be taxed. The
proposed managed and controlled test would determine corporate
residency based on the jurisdiction where substantially all of
the executive officers and senior management of the corporation
who exercise day-to-day responsibility for making decisions
involving strategic financial and operational policies of the
corporation are based. This will raise uncertainty regarding
which operations of a multinational would be taxed in the
United States on such entities' global income.
Any uncertainty in this area may cause foreign
multinational companies to shift U.S.-based management teams
outside the U.S., which would cause the loss of high-paying
jobs in the United States. The management and control provision
will be extremely difficult to administer, and is likely to
lead to inconsistent administration that will clog the
competent authority process with our treaty partners. Given the
administrative, technical, and policy concerns surrounding the
management and control proposal, I would urge the retention of
the current law rules on determining corporate residency.
In respect to the income tax treaty override proposals, the
proposals, as drafted, would override almost all of our income
tax treaties, in that the active trader business test for
qualifying for treaty benefits that is included in almost all
of our treaties would be significantly reduced in scope. The
active trade or business test is perhaps the most fact-
intensive test for determining whether an entity qualifies for
treaty benefits.
The test typically requires an entity to show that the
business in the home country is substantial in relation to the
U.S. business, and the income receiving treaty benefits is
related to that business. Arguably, this is the most rigorous
test in the limitation on benefits section of our treaties, and
is not one that should be overwritten.
When legislation was originally proposed, the treaties with
Iceland, Poland, and Hungary were perceived to be abusive and
abused by non-treaty ultimate parents. Since that time a new
treaty with Iceland has entered into force, a new Hungarian
treaty has been signed, and the Treasury Department has
indicated that negotiations on a new treaty with Poland have
been concluded. Therefore, what may have been one of the main
reasons for the proposal is no longer an issue.
My paper also contains comments on FIRPTA and the so-called
FBAR provisions. In respect to FIRPTA, my main comments relate
to the administrative burden the current rule has, as any U.S.
corporation is presumed to be a U.S. real property holding
company. Taxpayers, particularly in controlled group
transactions, have often missed filings, as they are not
thinking about FIRPTA when they know that their subsidiary in
the United States has very few assets that are invested in U.S.
real property. Having this presumption has required many
taxpayers to request relief for missing filings related to
transactions that are not within the scope of the provisions. A
change to this presumption would ease this administrative
burden.
In the context of the FBAR provisions, there are unintended
consequences that may result from a foreign parent using a
foreign bank account where a U.S. person has signatory
authority to make expenditures on behalf of the corporation,
but has no personal financial interest in the account. These
persons are required to report their signature authority over a
corporate bank account in which they have no personal interest.
These filing requirements should be reviewed in order that they
would be more targeted at the persons that have a direct
financial interest in these accounts.
Thank you very much for the opportunity to share with you
my views on tax reform in the context of foreign direct
investment. I would be happy to answer any questions.
[The prepared statement of Mr. Stricof follows:]

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Chairman TIBERI. Thank you.
Mr. Wells, you are recognized for five minutes.

STATEMENT OF BRET WELLS, ASSISTANT PROFESSOR OF LAW, UNIVERSITY
OF HOUSTON LAW CENTER, HOUSTON, TEXAS

Mr. WELLS. Thank you, Chairman Tiberi, Ranking Member Neal,
and distinguished members. In this testimony I would like to
address the following items: first, the issue of tax
competitiveness; and second, the issue of tax base erosion.
Let me start by saying that I believe that tax
competitiveness is a serious issue. When the U.S. activities of
U.S. domestic companies are treated less favorably than the
U.S. activities of inbound competitors, a serious structural
problem is created that deserves careful attention by Congress.
Tax rules that treat U.S. activities of different economic
participants differently will cause the tax disfavored economic
participant to seek to become a foreign-owned company. Or else
they risk getting forcefully acquired.
The capital markets demand that this occur, and the recent
corporate inversion phenomenon is a wake-up call about the
serious implications of an unequal playing field. Foreign-owned
multinationals have a competitive advantage in the United
States exactly because they are foreign owned. Certain U.S.
multinationals with inbound investment activity share this
advantage. But the tax advantage afforded to inbound investors
arises because of their ability to erode the U.S. tax base
through base erosion payments.
Base erosion payments arise from related party transactions
such as intercompany charges for interest, as Mr. Spitzer so
eloquently talked about earlier, rents, royalties, as Mr.
Spitzer pointed out earlier, service fees, and from
intercompany purchase and sales of tangible goods between a
U.S. affiliate and a foreign affiliate. Through effective tax
planning, these base erosion payments can create homeless
income.
The income is homeless in the sense that it is not subject
to tax in the United States, where it originated, and where the
profits were derived, nor is it taxed in the offshore country
where it is received. The ability to create homeless income
affords inbound taxpayers a significant tax advantage and
unlevel playing field.
How did it come to be that base erosion payments could be
such a powerful tax planning advantage? To answer this
question, it is helpful to consider the historical context of
the United States when it formulated its international tax
policy.
In the early years, U.S. multinationals were the dominant
source of FDI around the world. And so, outbound investment far
exceeded U.S. inbound investment. In this setting, the United
States Government wanted the residual profits to escape source
country taxation so that these profits could be taxed by the
country that supplied FDI, meaning the United States in a
majority of cases. Residency taxation took preference over
source country rights to taxation.
And so, to further this policy, the U.S., through our
treaties, sought to require source countries to eliminate
withholding on interest, rents, royalties, in deference to the
home country's sole right to tax these profits. The United
States relinquished its own withholding rights as a reciprocal
measure. But again, the trade flows were tilted in favor of the
United States.
Today, the trade flows are reversed, with the United States
finding itself in the posture of a significant net capital
importer. Further, not surprisingly, taxpayers have reacted to
these generous inbound tax rules with full advantage. Today,
inbound investors can use offshore tax favored subsidiaries to
transact with their U.S. affiliate, move profits within their
affiliated companies without it leaving the economic group, and
earn thier income in a tax-favored way.
Homeless income is a mistake. U.S. international tax policy
was formed with the desire to prevent international double-
taxation. This, gentlemen, is a worthy goal. But the desire to
prevent double taxation was never intended to have the
consequence of creating homeless income out of U.S. business
profits.
Income earned in the United States economy should bear one
level of tax. And the assumption should now be that it won't be
taxed anywhere in the world, if not here. And not subjecting
profits of inbound taxpayers to at least one level of tax
creates an unlevel playing field with domestic companies.
Homeless income is a mistake that costs the United States
Treasury significant revenue. This mistake places inbound
participants in a better economic position versus U.S.
companies that do not have base erosion opportunities. If left
unfixed, this state of affairs will cause U.S. companies to
become prime takeover candidates, or encourage them to self-
help themselves into inverted companies.
Again, the corporate inversion phenomenon is merely telling
us what we already know. The basic issue is the following:
inbound companies can utilize multiple avenues to strip
earnings from the U.S. tax base with the benefit of creating
homeless income out of a significant portion of their U.S.
profits. We need a policy response that protects the U.S. tax
base against base erosion, not just because we need more
revenue, but because we need equal treatment between U.S.
domestic companies and cross-border inbound participants.
In my written testimony I provided a proposal that attempts
to prevent homeless income. But let me conclude by saying that
it is my belief that Congress cannot allow inbound taxpayers to
have significant opportunities that do not exist for U.S.
domestic corporations. Everyone should pay a similar level of
tax for similar economic activity in the United States. The
ability of inbound taxpayers to create homeless income out of
U.S. profits attacks the very core of the U.S. tax system, and
must be addressed.
Thank you so much for the opportunity to testify.
[The prepared statement of Mr. Wells follows:]

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Chairman TIBERI. Thank the three of you for your great
testimony. I have got a question for all three of you, and I
will start to my left here.
You have all talked about--in either your written testimony
or your verbal testimony--that we have the--we have a
comparatively high U.S. corporate tax rate, compared to our
competitors around the world. And there are incentives that
multinational companies doing business in the United States
have to transfer their income overseas.
What do you suggest we can do, through tax policy, to
change that incentive?
Mr. HUFBAUER. Thank you, Chairman Tiberi. Here I think
there is a sharp difference between Professor Wells and myself.
We used to have a worldwide tax system as our concept of the
norm--and I wrote about that in my testimony, I didn't have
time to discuss it. The worldwide tax system has long not been
the norm. It is now only followed by about six countries, none
of which have the high tax rates which the U.S. imposes.
We are out of step, it isn't that the world is out of step.
And we cannot go back to 1960, when the United States dominated
the world, not only militarily but economically. We are now in
a very competitive situation, as you well know.
So, my answer to your question is we have to get our rates
down to where other countries are, which is if we are going
just talk about the OECD countries we need to cut at least 10
percentage points, and I would say 15 percentage points, off
the statutory corporate rate. If we want to talk about China--
and many people do--it has to go further. We are way out of
step. That is the biggest single thing. And I think that is
where the attention should be focused, not on trying to, as I
put it in my testimony, build a moat around a U.S. tax system
which is out of step.
And it is not just out of step with China, it is out of
step with Canada. Canada has a far more competitive tax system
than we do.
I am just focusing on the rates, but I could extend that to
many other dimensions, particularly research and development, a
favorite subject of mine, or expensing of equipment, or
whatever. I mean we are just a country which does not use its
tax system to encourage investment, either in physical capital
or intellectual capital. Thank you.
Chairman TIBERI. Thank you.
Mr. STRICOF. It is very difficult for me to address policy
issues, as a tax technician. I am not a tax lawyer; I am just a
tax accountant. But let me give a little bit of my view on
this.
There is a big competition for capital in the world. People
have choices as to where to deploy their capital, where to earn
their profits. If you have a choice of employing your capital
in a place where you can pay a 20 percent tax rate, or a place
where the combined federal and state rate is easily 40 percent,
where would you want to earn your profits? It is a very simple,
methodical type of analysis, and a number of companies do that
type of analysis when deciding where they can put their
businesses.
Unlike Nestle, which has to put a lot of its business where
the consumers are, a lot of other types of activities can be
put anywhere in the world. The point made for Falcon Jets. They
could be manufactured anywhere, and they can fly here to be
purchased by U.S. consumers. So I think you have to look to see
what is going to encourage people to invest here.
I would also like to address a comment that was given to
the earlier panel, which was, ``If there was a choice between
lowering the corporate tax rate and getting rid of the R&D
credit, what would you do?'' Here, in this environment, I think
you have to look and see what other countries, for example the
UK, Netherlands, and many others have done. What they have done
is they have lowered their corporate tax rate, and also
provided incentives for R&D. They have their patent box regimes
and other regimes that encourage specific activities, as well
as general activities.
Chairman TIBERI. Thank you.
Mr. WELLS. It is a very important question, Chairman. Let
me say that my comment earlier was not to say that I pine for
the days when residency taxation were better. I just want us to
understand why we thought it was good to allow earnings
stripping in the past, when the U.S. was the dominant source of
capital, and would be the beneficiary.
What we find today is our tax rates are high. I agree with
Mr. Hufbauer on that point.
But focus on the testimony you heard earlier. Nestle had an
effective tax rate less than 10 percent worldwide in their
financial statements. How can it be that a consumer food
company in the domestic economies of the OECD can get less than
half the percent of the tax rate that this committee is
discussing?
It is because--they have told you already--their ability to
strip earnings out of the U.S. economy and other countries
allows them to achieve an effective tax rate that is
significantly below the rates we are talking about. I don't
disagree with Mr. Hufbauer saying that lower rates would be a
better system. But it is not going to be low enough to cause
anyone not to want to earnings strip.
Now, Mr. Hufbauer said China has a more favorable regime.
But let's remember they have withholding taxes on interest and
royalties, and have refused to give zero tax treatment to those
types of payments cross-border. So we can learn from China.
There is no question that when someone earns profits from the
U.S. activity, it should not escape total taxation.
And the other point I would make is this, that if we allow
inbound investors to have a significant competitive advantage
versus their U.S. competitors, the corporate inversion
phenomenon is telling us the result. We must treat U.S.
companies the same. And if they are going to pay a full U.S.
tax on U.S. business activity, then we must have a system that
causes inbound taxpayers not to pay more than their fair rate,
but at the same time to pay at least the same rate. If we
don't, we are rewarding winners and losers unfairly. And the
ability to have interest stripping and royalties stripping is a
benefit that an inbound company has, that Nestle has, that
others have, that U.S. companies that are U.S.-based do not
have.
Thank you for the opportunity.
Chairman TIBERI. Thank you. Mr. Wells, I want to follow up.
Thank you for your thoughts, too.
You wrote an article about a year ago in Tax Notes--and I
want to quote from it--regarding our corporate tax rate and our
worldwide system. ``Disadvantaged ownership of capital by U.S.-
based multinationals creates an incentive to shift that
ownership away from U.S.-based companies to foreign-owned
competitors, and the recent empirical studies suggest that this
possesses a significant threat to U.S. domestic job creation.''
And your article goes on to state that the U.S. should move
toward a territorial system that exempts active foreign income.
Do you still believe that, and can you expand on that?
Mr. WELLS. Yes. What I was saying in the article is that
the ability for U.S. companies, or the inability of U.S.
companies to be able to earn income in the same low-taxed
environment that foreign-owned companies have is a competitive
disadvantage. And we should expect that foreign-based companies
would have an opportunity to take those companies over to the
extent there are synergies for them to acquire them.
A territorial regime versus our existing regime is--there
are pros and cons to either approach, okay? And if you had a
territorial regime as the premise of what this committee wanted
to propose, it would be incumbent on this committee to make
sure that there were base-protecting measures that would
protect the U.S. tax base from being able to be eroded by all
taxpayers. In a territorial regime, the opportunities to erode
the U.S. tax base would exist for every participant. So, it
would be a challenge that this committee would be required to
take, because everyone would be in the same position.
But the point I think the committee should consider is
whether it's a territorial regime or a worldwide regime,
certainly how we tax inbound activity should try to achieve
comparable results for each economic participant, whether they
are a U.S. company or a foreign company. How you treat outbound
activities and the disparity between U.S. multinationals and
foreign multinationals in third countries is a harder question.
But certainly taxing the inbound activities, we should
attempt to have a horizontal equity between each of those two
companies.
Chairman TIBERI. Mr. Stricof, can you comment on that
issue?
Mr. STRICOF. Most certainly. Foreign-based companies, the
ones that invest in the United States, are largely in developed
countries. As was pointed out by Nancy McLernon in the earlier
panel, China represents less than one percent of all foreign
investment into the United States. So, where is this money
coming from?
The money is coming from Germany, from France, from the UK,
and others. And each of these countries has effectively decided
that their equivalent of subpart F--because most of them have
that--do not really need to cover the type of income that is
being talked about as being earnings-stripped. And, instead,
must view that money as being more important to come into their
local country however, and then be redeployed in their local
economies.
And what is that doing? I don't see where the UK is
suffering nearly as much as the U.S. or France or Germany or
any of a number of these other countries that have these
significant rules. I see the money coming back to those home
countries, and being redeployed in their businesses.
When it comes to base erosion, what was commented upon was
two or three different factors of base erosion. There are
management service charges, there are rent and royalties, and
then there is interest expense. When it comes to management
charges, I personally do not see management charges coming into
the U.S. to the same degree as I see management charges going
out from the U.S. by U.S.-based multinationals.
When it comes to rent and royalties, IP is usually
centrally located in a country where the company is based. It
is appropriate to charge a rent or royalty for the use of IP,
just like U.S. multinationals, if the IP is owned by the U.S.
company, charges out for the use of IP. While payments for IP
are base-eroding, I imagine in concept, they are really not
base-eroding with the same negative connotation that has been
given.
And, as I have already commented, in respect of interest
expense it is difficult to say whether U.S. companies are
eroding their tax base any more than anybody else. There is
just no empirical evidence of that. Thank you.
Chairman TIBERI. And finally, Mr. Hufbauer.
Mr. HUFBAUER. Thank you. I guess the first point that would
be made is when it comes to base erosion--and I have written
about this at length--my big concern is the erosion of the
personal income tax. And quite a bit of legislation has been
passed by Congress. Some of it maybe goes too far, but it is in
the right direction to not have U.S. citizens or residents
avoid the U.S. tax system by putting their assets abroad. That,
to me, is the big concern.
In terms of base erosion by corporations or business firms,
they--I think the only area of important concern is interest
payments, for the reasons that Mr. Stricof said. Royalty--I
mean our interest, our national interest in royalty, is exactly
to keep the rates very low, because our royalty income from
abroad of all kinds--trademark, copyright, intellectual
property patents, or whatever--is huge coming in, and rather
small going out. So, if you have a system where a goose--you
know, sauce for the goose is sauce for the gander--we want to
get those rates low.
In addition, I would commend to the congress to think about
the kind of patent box system that Netherlands and a few other
countries have introduced, not only to keep the rates low, but
to tax that kind of income at a very highly preferential rate
here in the United States to encourage R&D. That, to me, is a
meaningful R&D encouragement which we should have, and we don't
have.
But turning briefly to interest income, this is a very--you
might say it is homeless on a worldwide basis. The tax rates
are very low, and I have written about that extensively. They
are low here in the United States, they are low abroad. It is a
low-tax form of income. It has kind of distorted debt equity
ratios globally. It has contributed to our financial crisis. I
think it is a problem, and I think, if you are going to worry
about erosion, it really should focus on the interest side of
the whole picture.
Finally, let me say that I--Professor Wells and I are in
total agreement, I believe from the excerpt he read, on the
necessity of having a territorial system with a view to U.S.
outward investment. So we are in very close alignment there.
Our current system is quite discouraging to U.S. companies, by
comparison with companies based in almost any other country.
Chairman TIBERI. Thank you, all three of you. I will yield
to the ranking member, Mr. Neal.
Mr. NEAL. Thank you, Mr. Chairman. Let's go back over a
couple points that have been made here.
Professor Wells, you are pretty blunt in your testimony
that foreign owned multinationals have a competitive advantage
in the United States because they are foreign owned. You go on
to say that that tax advantage afforded to inbound investors
arises because of their ability to erode the U.S. tax base
through base erosion payments.
What about a specific example, and how prevalent is this?
Mr. WELLS. I can give you several specific examples. One
was when I was vice president, treasurer, and chief tax officer
of an S&P 500 company. I saw half of my peer group invert. And
I read the public statements. Why did they invert? Why did they
want to become foreign multinationals, when it was a paper
transaction? And what they said was is that they needed to get
at the same tax rate as their other competitors. That was the
reason they did it. That was their public statement.
So the first thing I would say, Mr. Neal, is that--the
inverted companies are telling us why they did it.
The second thing, in the article that the chairman referred
to I said, ``Well, let's test whether what they said was
right.'' So I took the five-year average tax rate for the
inverted companies in my peer group, and I compared it to
Schlumberger, the Behemoth in the oil field services sector.
And I said, ``What do their tax rates look like?'' And they
were within half a percent. Imagine that. They got to within a
half-a-percent. Now, their tax rate dropped from 37 percent,
the average of these companies pre-inversion, down to 20
percent post-inversion. But the 20 percent post-inversion rate
was on par with their other foreign competitors. So, I would
say that subsequent experience helps us understand.
But then there were other acquisitions that I talked about
in the article, namely Schneider's acquisition of Square D, or
the Nestle transaction that you just heard about, their
acquisition where they pushed debt into the U.S. target
company. The ability to lever their acquisition, and to strip
interest out of their U.S. affiliates by intercompany
transactions, allowed a significant portion of their U.S.
business profits to leave the U.S. and to go to a low-taxed
country.
And so, I think that we are getting enough anecdotal
evidence, both from the testimony you have heard today, the
subsequent history of what the inverted companies' tax rates
look like compared to their other competitors, and just knowing
that the tax planning tools between inverted companies and
foreign-owned companies are the same.
I think that the inverted companies have done this
committee a great service. They have given us a knowledge about
the cause-effect dynamics of why their tax rates went down, and
why it went down is because they are a foreign company with the
same tax planning tools as al other foreign companies.
Mr. NEAL. Mr. Stricof, you--and then Mr. Hufbauer, would
you like to offer your analysis?
Mr. STRICOF. Sure, thanks. I think there are some very
valid points that have been made. I think that when you look at
the competitive advantage a foreign company may have, a lot of
that has to do with capital flows, whether you talk about them
as base-eroding payments, or whatever. And one of the major
problems the U.S. entities have, as compared to their global
competitors, would be solved effectively by territorial
taxation.
What happens in, say, Nestle--and I am not trying to use
Nestle, other than everybody else has, so I mean no disparaging
remarks. What happens; Nestle decides to make an acquisition,
or any company decides to make an acquisition that is based in
any country in the world except the U.S. How are they going to
fund that acquisition?
They can take money from all the other countries they have
in the world, repatriate it to their home country at virtually
zero taxation; in most of the free world such a repatriation of
profits is either tax free or they have a 95 percent exemption
of that income coming back, which they can redeploy in the
acquisition.
What I find--and I do strategic acquisitions, I don't do
leveraged buy-outs or other things like that, I do a lot of
strategic work--I find that when you are doing acquisition
planning, who is going to win that acquisition? U.S. companies
go after the target; foreign companies go after that target.
Whoever has the best synergies from a true business perspective
is who actually wins the deal. It has very little to do with
the taxes.
If there are base-eroding type payments in the form of
interest expense that comes back to the parent country, it just
allows the foreign multinational to redeploy that cash. And
therefore, they have more cash available to do the acquisition.
I don't think it is really the fact that it is zero-taxed as
much as that they can get the money back to where they need it
to be.
Mr. NEAL. Mr. Hufbauer.
Mr. HUFBAUER. Thank you. About 40 years ago, when I was in
the Treasury, one of my early tax articles was on the
theoretical possibility of inversion. Well, it was theoretical
in the 1970s and, as Professor Wells and others have said, it
is something of a reality now.
But my recommendation, as I have said more than once, is to
improve our own tax system as the major answer, rather than
additional moats, as the major answer. I am not saying that we
shouldn't have some moats--and we have some which have been put
in by Congress--but the big issue is not the handful of
corporations which invert. Yes, that is an issue. But the big
issue are the global 1,000 corporations of 2020, and where they
will locate.
I believe there is a very strong synergy between corporate
headquarters and R&D and the rest of the economy. We want as
many of these corporations who are yet to grow and yet to come
on the scene to locate here, in the United States. And our tax
system is a disadvantage, for reasons that have been said in
more detail than I can say.
And we should think about that, and really concentrate, in
terms of inversion, on what I would call crystal clear abuses,
but not try to reinvent, in its erstwhile glory, the worldwide
tax system as it was conceived by Peggy Richmond, a very
distinguished scholar of an earlier era, back in the 1960s. We
are not going to go back to that world. Thank you very much.
Mr. NEAL. Mr. Wells, there are some who have suggested that
if we tighten the rules on earnings strippings, it is going to
discourage foreign investment. What is your take?
Mr. WELLS. Okay, I have several comments. The first is that
if an investor is told that they will pay the same taxes every
other American, whether they are foreign-owned or domestic-
owned, and that is a discouragement, well, then we have a
fundamental problem, Neal. Because if we will give someone a
tax preference in order to be here, then we should expect all
of the economic activity to be transformed. Mr. Stricof and
others in the accounting firms will do a fantastic job of
reshaping America into the most preferred investor into this
country.
So, we have to start with the premise, in my mind, that we
do not want to discriminate against foreign investment, but we
cannot allow economic participants to have an unequal playing
field.
Now, on the point earlier about residual profits and
royalties, I think that is an issue for this committee to think
through. We relinquished our source country taxation right to
tax residual profits because of what was said earlier, because
we expected more to come back to the U.S. Treasury, and we
expected the other home countries to tax those earnings.
But if your committee sees that the other country is not
taxing those residual profits, that they are escaping taxation
and result in no taxation, then the fundamental reason we
decided to not have source-based taxation--namely, to allow the
other country the primary right to tax these profits at their
normal rate--that assumption is off. It is wrong.
And so, if we are going to have comparable treatment in a
world where the other country doesn't want the deference, then
you have to think, well, what does today's world look like? In
the post-World War I era when we had these treaties coming
about, all of the World War I victors were wanting to fund
their war debt, and they would tax the residual profits. But as
Mr. Hufbauer has said, residency taxation is now leaving the
earth.
And so, why do we believe that other countries will tax
this offshore income? And if it is a competitive disadvantage,
then we must do something about it.
So, what I would urge you to think through is not just the
question of what we are going to discourage. We need to have
comparable treatment. And I don't think that comparable
treatment is going to cause anyone to not want to invest in the
United States.
Mr. NEAL. Thank you. Mr. Stricof or Mr. Hufbauer, would you
care to comment, as well?
Mr. STRICOF. One has to decide what is the goal. And if the
goal is to encourage foreign investment into the U.S., to
promote job creation, to promote capital investment, anything
that one does that restricts that will prevent that result from
occurring. That is what I think.
If you look at the companies that are making the most
investments in this country, you look again--just like I said
in my earlier response to a question, you look at Germany, you
look at the UK, you look at all these other countries. The
capital flows are going back to those countries in a tax-
efficient a manner. I guess the concept that is being expressed
by Mr. Wells is the U.S. should be the tax police of the world,
which we have heard about before. I don't know what makes the
U.S. the tax police of the world.
If the foreign jurisdictions that are earning the income
choose to tax that income or not, why are we trying to
interfere with that? I understand that in treaties, treaties
are bilateral, and that they are supposed to ensure that there
is no double-taxation in the world. The U.S. side of the
deductions are appropriate levels of deductions. That is what I
have testified to already, that is what Treasury effectively
had no qualms with in the case of historic investment into the
United States. If those other countries choose to allow their
own country--not to tax that income, why do we care?
Mr. NEAL. Mr. Hufbauer.
Mr. HUFBAUER. Thank you. Let me approach the question from
30,000 feet, starting at the Sierra Nevada between California
and Nevada.
I think it is a matter of sovereignty that Nevada has
decided not to have a corporate tax, and it is a matter of
sovereignty that California has, I believe, one of the highest
corporate taxes amongst the 50 states.
I don't regard a low level of corporate taxes as an unfair
advantage. It is a matter of what is within the competence of
state jurisdiction or national jurisdiction. So, in my view, if
Ireland has a 12\1/2\ percent rate, that is not Germany's
problem. And it is not the U.S. problem. That is Ireland's own
decision. And I do not think it is our job to try to recapture
the income which was somehow not taxed by Ireland.
Or, we can go to a more extreme case, the Caymans. They
have a zero corporate tax. I don't think it is our job to
somehow try to claw back or cajole the Cayman Islands into
coming up to the U.S. corporate tax rate.
I do feel it is appropriate for the United States to go
after money laundering, drug money and personal tax evasion.
But I am pretty strong that the choice of a corporate tax rate
between zero and whatever is a national sovereign decision, or
a state decision.
And then I back up from that, still staying at 30,000 feet,
to say that tax competition is healthy for the world, yes
healthy for the world. Tax competition at the corporate level,
I think, is good for us because it takes us off the notion
that, as Senator Long, whom I remember quite well, said,
``Don't tax you, don't tax me, tax the fellow behind the
tree.'' Well, tax competition takes us away from that notion
that there is somebody out there who is going to pay taxes, but
not us.
So, that is my 30,000 view. Thank you very much.
Mr. NEAL. Well, let me meet you at 30,000 feet. Would you--
and I am interested in your comment, obviously--would you argue
that a $27,000 post office box in the Cayman Islands or another
foreign jurisdiction is a legitimate corporate address?
Mr. HUFBAUER. It depends on the kind of activity that is
going on there. But according to data that I looked at, there
are far more post box corporations in Delaware than in Cayman.
And I believe that that is within the appropriate rules of a
country. I am not fronting for drug lords and money launderers.
But if it is open, transparent, yes. It is okay in Delaware, it
is okay in Cayman, by my view.
Mr. NEAL. So you would suggest that an American corporation
that decides to set up shop--use the example of Bermuda--with
simply a post office box and no employees is a legitimate
undertaking?
Mr. HUFBAUER. If that is what the Bermuda law permits, yes,
I will assume that it is. I am not certain on Bermuda law
there. But if that is a legitimate corporation under Bermuda
law, yes.
Mr. NEAL. And how am I to respond to those moms and dads
who have children in Afghanistan and Iraq, that those post
office boxes are used to evade American taxes?
Mr. HUFBAUER. Well, if you define it as evasion, which
takes me back to the money laundering or improper reporting,
absence of transparency, it is totally inappropriate.
But the threshold question: Is it evasion? And here we come
to a related question, the degree of transparency. And as I
understand it--I won't go to Bermuda, but for Cayman, as I
understand it, they have a very tight relationship with our
Justice Department, reporting all financial transactions in
which the Justice Department is interested, which probably
reflects what the Treasury Department is interested in, as
well.
And so, if we are not into that realm of transactions which
are what I would call evasion, yes. It is all right.
Mr. NEAL. Thank you, Mr. Chairman.
Chairman TIBERI. Gentleman from North Dakota, Mr. Berg, is
recognized.
Mr. BERG. Thank you, Mr. Chairman. I appreciate the
panelists. Thanks for being here.
I would like to crank it up to 50,000 feet, though. You
know, I have been watching tax policy for 30 years. I have just
been in congress a few short months but, I mean, I couldn't--I
just want to make the point I think there is always unintended
consequences. I don't care how much time and effort Congress
and staff and people can do to write tax law, you just can't
get it perfect. And whatever you do, you create opportunities--
call them loopholes or call them whatever--but the code is what
it is.
And again, as we are talking about, you know, interest
stripping, as we are talking about how, again, people are
following the law, but they are doing it because we have a law
that--saying we are not going to tax you if you do these
things, and you try and fix those, you create other problems.
And I guess I just wanted to make the point that I think,
you know, our chairman here and Chairman Camp, our objective is
to simplify the whole tax structure. If we, in fact, get back
to a real simple--again, 25 percent, rather than a 35 percent,
it makes us more competitive. And rather than having chapters
and chapters and reams and reams of exemptions, maybe we don't
have as many exemptions. Maybe it is pretty simple, it is
pretty black and white, working towards a territorial system.
And just again, simplifying the tax law--again, for those
people that make money in tax law and the changes in the
regulations, that may not be good, short term. But I just
believe that that would, again, help business focus on making
decisions that are good for business and good for customers and
good for profits, and not necessarily having to second guess
those business decisions, based on taxation.
So, having said all that, I would like to kind of step back
also. And I believe in best practices. And so we have talked a
lot about what we can do to change. But I would like to look at
the other developed countries around the globe, and say--and I
would like each of you to kind of respond to this. And I don't
want to look at today and I don't want to look at yesterday,
but I want to look to the future and say which countries have
the right tax environment that we are going to have to compete
with in the future, here in the United States?
And so, if we just could--again, if you could say, ``Here
is a country that I think is going to be where capital is going
to flock to, what could we''--just share that with this
committee, and so we can say, okay, here is something we ought
to look to.
Mr. HUFBAUER. Thank you. That is a good 50,000-foot
question.
I guess I would say the big missing part of the U.S.
system--and I understand the unpopularity of it--is a national
consumption tax coming under various names: a goods and
services tax, a value-added tax. And we are, again, way out of
step with the world. I think it is quite harmful to our
position as an exporter. Also it makes it very difficult to
collect the revenue which our country apparently needs to run
the projects that we want.
So, what I would look to would be a country such as Canada,
which has put in a GST. The rate isn't terribly high, but it is
a revenue raiser. Canada has reduced its corporate tax. And,
importantly, what Canada has done on the corporate tax--and
this comes from the Canadian constitutional system--is to let
about half be collected by the provinces. And I think that is
quite appropriate, because then provinces can decide, in my
model of tax competition, whether they want a high corporate
tax, which Ontario does, or a low one, which Alberta does. Let
them decide. Alberta relies more on oil royalties, obviously.
So, I would put Canada as a model in the business tax area.
I am not talking about the personal tax, and I will not get
into the personal tax. I would also name Australia as a model.
Australia has done a lot of reform over the years, rather
similar to Canada. I don't think the U.S. can emulate Ireland.
I think Ireland had a great model for a small country. I don't
think we can go down there probably in the near future.
I do want to emphasize--and this is possibly in response to
Congressman Neal's question to what Mr. Wells says, I don't
want to tolerate what used to be called personal foreign
holding companies way back in the 1930s, which become
incorporated pocketbooks for U.S. individuals to take their
money abroad. I really want to keep the personal tax system
here.
And I also am quite sympathetic to putting withholding
taxes on interest payments on a negotiated basis under
treaties. Thank you.
Mr. BERG. Thank you.
Mr. STRICOF. For somebody that could only fly at, what,
about 10,000 feet, you are doing pretty good at getting to
50,000 feet.
I have to repeat one statement before I continue, and that
is that I don't know anything about tax policy, I am not good
at tax policy, and I am not promoting any specific tax policy.
But I can tell you what I think is going on as a best practice
method in various countries.
And, again, I go back to the developed world and what are
they doing? They have all dropped their corporate tax rates,
universally. Even Japan is talking about, or has already,
dropped their corporate tax rate. Everybody with possibly the
exception of Japan--has instituted, as well, a major R&D
incentive.
I think that one of the things that made this country great
and allowed us to make so much external investment in the 1960s
is we owned the intellectual property of the world. We were the
most innovative, the most creative, best educated, you name it.
That was the United States. And, therefore, in the 1960s we
expanded dramatically around the world.
So, how do we make that happen? I can't tell you. That is a
policy issue. But I can tell you that whoever wins that, 20
years from now will be looking back and be the ones that are
saying, ``Yes, I did it right.''
Mr. WELLS. Representative Berg, I think dropping the rates
is probably a good suggestion. Whether territorial is the
answer with safeguards to the U.S. tax base or a worldwide
regime, that is something that--I think either regime could
work--but the committee needs to be very careful about.
I think that we don't want to be the tax police of the
world. But we are out of the 20th century, and the 20th century
thought was that we should allow base erosion payments because
the other country will tax the residual profits on a residency
basis, and we don't want double taxation. The world today is
double ``no taxation.'' And to the extent that double ``no
taxation'' is a loss of revenue, that is unfortunate for the
congress.
But what I am most concerned about, and what I hope you
leave the hearing with is, if one competitor has a no-tax
result, and it is a significant part of their U.S. business,
that is a competitiveness issue. And that is more than just
losing revenue that is desperately needed for our country. That
is a competitiveness issue.
So, as you think about designing a system, if we can have
everyone pay a single level of tax, and defer or allow profits
to be transferred or stripped to an offshore location only when
it is a real country that is really going to subject those
profits to a tax at the 20 to 30 percent rate that you have
been discussing, then that is fine.
But if someone is able to strip profits to create zero
taxed income, and they are the competitor that can do it and
the next competitor cannot, then I can tell you what the next
generation of businesses in America is going to look like. They
are going to look like the first person.
And that is what I would urge you to consider, that as we
think about what corporate reform looks like, that it should
attempt to get at an equalized tax rate among all economic
participants, or we would expect to be the one creating the
economic participants of the next generation.
Mr. BERG. Thank you. I have one other follow-up question.
And again, everyone is looking at risk versus return. We could
have high tax rates, but if every foreign investor was
guaranteed a super return, we would have all kinds of money.
And you know, having said that, we are assuming that things
are--the return is pretty much even among several countries.
How do we encourage--and other than the rates, regulation, I
think, has a place in this, as well.
And I just want to know if there is any--you know, over the
last--I guess the Obama Administration, if there is any
regulatory changes recently that you have seen that would
inhibit that investment from coming into the United States.
Again, if we could just--each of you respond, or any
comments on that.
Mr. HUFBAUER. You are right about the risk and return
issue. And this is one of the great strengths of the United
States. We have a very stable legal system. Property is highly
respected, compared to other countries. Certainly Switzerland
would be in the same category, but the legal regime of property
rights really cuts down the risk here, compared to a great many
countries in the world. So, that is one of our strengths.
Now, where do we have problems? I am not sure that the
Obama Administration has done anything out of line in this
respect. I think that our tort system, which is being
corrected, I believe, by the Supreme Court--and I applauded the
recent Wal-Mart decision--does create a certain amount of risk
for class action suits, and that sort of thing. I think that
risk is actually on the way down now. That is not because of
the Administration, it is really the courts.
I know there has been a lot of talk about the Dodd-Frank
bill, and has that made banks less willing to loan, and so
forth and so on. I regard that law as a work in progress, where
I am sure Congress will return to it if, in fact, it does
discourage lending to small and medium-sized companies. That I
have actually looked at. I think the lending situation today is
more because of the financial crisis than because of any new
legislation. But that may be an area in the future. Let me stop
there. Thank you.
Chairman TIBERI. The gentleman may answer the question.
Mr. STRICOF. Well, if I can't talk about policy, I
certainly can't talk about regulation.
[Laughter.]
Mr. STRICOF. But what I can do is applaud the effort
towards simplification. And I think anything that simplifies
our tax laws and the enforcement of our tax laws is certainly
going to be welcome by the business community, as a whole. It
has nothing to do with inbound versus outbound. It is just
effectively talking myself partially out of a job, but I think
anything that goes for simplification is very good.
But I would caution that the last time somebody decided to
have a tax bill that was labeled ``simplification'' in it, they
took the definition--I think it may have been--I can't remember
if it was gross income or taxable income from--it must have
been taxable income--from the definition of gross income minus
deductions equals taxable income to a three-page definition.
Mr. WELLS. I have three quick points. And, again, I am not
an economist like Mr. Hufbauer. He is probably the most
relevant person to ask. But as a citizen, to me, I think
broadening the tax base and making it simple is a wonderful
goal. Everyone should bear the same or as close to the same a
tax for similar activity.
Second, a sustainable fiscal budget. I think that one of
the biggest challenges for foreign investors today is knowing
the fiscal situation of the U.S. Government. And I think that
you are getting pulled 100 different directions as to what to
do. But I think that foreign investors would be overjoyed to
believe that the fiscal crisis that may be looming for the
country has been dealt with thoughtfully.
And I think the last point would be to know what tax reform
will be. And I think that is not to put pressure on this
committee. It needs to be thoughtful, and you need to take the
time to do it exactly right. But I think if companies and other
countries knew that our fiscal house was in order, and they
knew what our tax structure was going to be, and that the tax
base was as broad and as simple as possible, and we treated
everyone comparably, then I think that would achieve the best
result for the country.
Mr. BERG. Sounds simple.
Chairman TIBERI. Great way to end today's hearing. This
concludes today's hearing.
Please be advised that Members may submit written questions
to the witnesses. Those questions and the witnesses' answers
will be made part of the record.
Thank you. Thank you to the three of you for some really,
really good and educational testimony, a discussion, and I
believe it helps us, again, get more information as we want to
move forward on comprehensive tax reform. I appreciate your
time.
This concludes today's hearing.
[Whereupon, at 12:37 p.m., the subcommittee was adjourned.]
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