A

The Retention by Individual States of Residual Powers Mandatorily to Impose Worldwide
Unitary Taxation on Taxpayers

We do not believe, as a matter of principle, that such powers are consistent with a true "water's edge" solution, nor with a framework of arrangements of which S.1974 forms part - In which such a key element is to give states access to taxpayer Information obtained under international tax treaties. Secretary Baker's 5 March 1986 letter to Senator Packwood refers to S.1974 as legislation which would

"...generally prohibit states from imposing corporate income tax on a worldwide
unitary basis..." (emphasis added)

This is the cornerstone of effective relief.

The objective must be to provide taxpayers with an unfettered right to be taxed in accordance with International principles already accepted and applied by the United States itself, and to be relieved clearly and unequivocally from all threat of mandatory worldwide unitary. Unfortunately, as drafted, S.1974 allows states to impose worldwide unitary against the wishes of taxpayers for failure by them or foreign governments to provide certain information and for other possible infringements of the legal or procedural requirements of states' tax laws.

It would be astonishing if, by including such powers in S.1974, mandatory worldwide unitary actually appeared to be sanctioned by federal legislation, contrary to the Administration's stated intent and public position on the matter. If enacted as it stands S.1974 would for the very first time enshrine federal acceptance of that system.

We urge that S.1974 be modified to delete all references to these powers and to make clear
that taxpayer default in relation to information or other matters will carry only the usual
sanctions in tax matters of monetary or, where appropriate, criminal penalties at federal
and state level.
We further suggest that in fairness taxpayers should not be penalised at
all for the failure of foreign governments to provide information or for their own
Inability under foreign national security law to do so.

B

The Conditionality of Taxpayer Relief from Worldwide Unitary Taxation

To provide a satisfactory solution to the worldwide unitary issue and to give practical effect to the President's expressed intent, protection from that system in the form of "water's edge" treatment should be available to taxpayers as an unfettered right.

S.1974 should unequivocally prevent local tax authorities from imposing their own Individual preconditions to the availability of "water's edge" treatment, whether those preconditions take the form of payment of an annual or entrance fee on top of ordinary business taxes, the surrender or waiver of legal rights or any other form and whether directly expressed in state unitary legislation or buried in the general corpus of state tax law.

с

The Mismatch between the "Water's Edge" Delimitation of Tax Jurisdiction in the Bill and
Existing International Taxation Principles

Worldwide unitary taxation does not separate non-US from US activities in line with US federal and Internationally accepted taxation principles. S.1974 attempts to do this by Imposing the "water's edge" limitation on the unitary method.

Unfortunately the draft definition of "water's edge" In S.1974 does not marry up with the permanent establishment concept of territoriality already established in International taxation and used in the United States' (and the United Kingdom's) own double taxation treaties and by the model treaties of the OECD and United Nations.

This would be sufficiently remedied by bringing into S.1974 the rules which the United
States already uses in federal taxation for identification of US operations for both tax
reporting and computational purposes. It would also allay a further fear that the proposed
information reporting rules in S.1974 could be interpreted as extending to foreign
companies in a foreign parented group which are not subsidiaries of US companies in a
"water's edge" group, and possibly even to the foreign parent itself, a result which would
vitiate S.1974.

Conclusion

British business believes that worldwide unitary taxation is wholly Inappropriate as a basis for the taxation of trade and commerce across national frontiers; that the recent Californian legislation, being seriously deficient in a number of respects, does not solve the problem; that worldwide unitary taxation raises problems of international dimension which only federal legislation is competent to remove effectively and that S.1974 modified on the lines outlined above would provide a satisfactory, universal and enduring solution to the current difficulties.

The CBI therefore commends S.1974 to the Committee.

APPENDIX

6

Explanation of the Objections to Worldwide Unitery Taxation

Worldwide Unitary Taxation is inconsistent with existing international taxation principles based on separate accounting on the arm's length principle.

Where a company operates across national boundaries rival claims of competing tax jurisdictions have to be resolved by some mechanism. "Arm's-length separate accounting" is long established and adopted as the appropriate mechanism by the federal government and other nations throughout the world, as well as by the OECD and UN model tax treatles. Each foreign company operating in a country or territorial sub-division is taxed there separately as an Independent enterprise. In its transactions with its parent company or other affiliates it is treated for tax purposes as if it were dealing at arm's length.

Unitary taxation, historically devised as a method of allocation of taxable capacity within the USA, and not worldwide, does not recognise the local profits actually earned by each company. It is not a uniform system since different states use a variety of formulations and many have never sought to apply it all beyond the United States, that is worldwide, which is where the international problems are created.

Separate accounting, the longstanding federal and international norm, and worldwide unitary taxation are incompatible. At the international level worldwide unitary is simply out of step with international standards.

il Worldwide unitary taxation is economically unfair, and creates double taxation and uncertainty for business

a

b

Unitary tax produces serious unfairness in the International sphere. The essential
underlying theory of unitary taxation, that a dollar of payroll, property and sales
produces roughly the same taxable return in different tax jurisdictions, is not valid
outside the USA where economic conditions, risks and costs vary enormously. It
over allocates profits earned in the whole world to those jurisdictions with higher values
of payroll, property and sales factors regardless of actual profitability commercially
measured.

By bringing in activities of foreign affiliates when determining Income attributable to a local company in a state, worldwide unitary can tax the company on more than its actual local income, can convert local losses into notional taxable profit, and can produce unrelievable double taxation. Unlike the separate accounting method, it is not coupled with relief for foreign taxes paid. It is, in effect, a tax charge on the affiliates even though they have no US presence. Multiple taxation of the same profits is inevitable if worldwide unitary is applied in some US states but the rest of the world, and the US federal authorities, apply the separate accounting system.

7

C

For business the separate accounting method by its recognition and acceptance throughout most of the world provides an element of predictibility and stability which is so important for business decision making and forward planning. In making Investments and planning decisions businesses need to have regard to local conditions. Worldwide unitary Introduces erextraneous elements Into the tax calculation which create uncertainty as to Investment returns, since the size of the tax bill is made to depend directly on circumstances extraneous to the state and totally unrelated to the In-state activity.

ill Worldwide unitary taxation creates disproportionate and impossible compliance burdens

Tax authorities using worldwide unitary demand information and records of foreign companies and thetr subsidiaries outside the USA not related to activities in the USA, both to decide whether to classify them as "unitary" and then to carry out a unitary assessment. Much of this data is neither required nor kept by foreign companies for commercial purposes or for federal, home nation or other international tax compliance purposes. Its production creates additional and often disproportionate compliance burdens, exacerbated by the costs of adjustment to the particular requirements of Individual states.

Where the information does not exist at all, or where it cannot be revealed for reasons of foreign national security, a company may be forced to submit to a unitary assessment regardless of its merit simply because the relevant data cannot be made available. The problem would be multiplied enormously if the unitary tax approach were to spread to more jurisdictions each of which imposed its own special information and compliance obligations.

iv Worldwide Unitary Taxation threatens the free and orderly development of world trade

Separate accounting with uniform rules and standards developed over many years, provides a consistent and coherent tax framework for the development of International trade and Investment. Worldwide unitary threatens that stability by introducing Incompatibility, unfairness and distortive double taxation.

Secretary Baker's 5 March 1986 letter, previously referred to, also records that fourteen of the United States' major trading partners confirm that worldwide unitary constitutes "...a serious obstacle to the development of our trade and investment relationships..."

V Worldwide unitary taxation creates a dangerous precedent

Worldwide unitary, if perceived as approved and endorsed by the United States or even a state with such enormous economic power as California, in the face of International opposition, could provoke emulation by other countries. Obviously they would be intent on maximising their revenues and could devise their own formulae and factors designed to bear most heavily on US and other foreign Investors. Any departure from separate accounting in the International tax field could prove the precursor to fiscal chaos.

Mr. Chairman and distinguished members of the Subcommittee, n behalf of Governor Deukmejian, I would like to thank you for providing he opportunity to express our opposition to S. 1974 and S. 1113.

When President Reagan was Governor of California, he wrote: One of the great strengths of our Federal-State system is the freedom of the States to act to meet their own particular problems in the ways chat seem best to them; interference by the federal government with the State's power to tax would be a major blow to such freedom."

I do not believe there is a person in this room, knowledgeable about the history of this country and the workings of our federal system, who could quarrel with the President's statement.

California has used the worldwide method of taxation for more than two decades. Other states have also adopted this method. Normally, choices made by California and other states with regard to the taxation of multinational business would be of no concern to the federal government. However, on rare occasions, state tax practices may impact or have resonances on areas which are of principal concern to the Federal government.

In recent years, our foreign trading partners have expressed concerns to the federal government about California's use of the worldwide unitary method. These expressions of concern led to the consideration of federal legislation and tax treaty treatment of the issue, all of which have been rejected.

In March of 1983 the Advisory Commission on Intergovernmental Relations, after an extensive study of state tax practices regarding multinational corporations, concluded that the federal government should only intervene in state tax matters upon a showing of "serious national harm."

In June of 1983 the United States Supreme Court in Container Corporation of America v. Franchise Tax Board (463 U.S. 159) held that California's use of the worldwide unitary method "while it had foreign resonances...did not implicate foreign affairs."