On July 23, 2014, the Securities and Exchange Commission (the “SEC”) adopted significant amendments (the “amendments”) to rules under the Investment Company Act of 1940 (the “Investment Company Act”) and related requirements that govern money market funds (“MMFs”). The SEC’s adoption of the amendments is the latest action taken by U.S. regulators as part of the ongoing debate about systemic risks posed by MMFs and the extent to which previous reform efforts have addressed these concerns. Meanwhile, the U.S. Treasury Department (“Treasury”) and the Internal Revenue Service (the “IRS”) released guidance on the same day setting forth simplified rules to address tax compliance issues that the SEC’s MMF reforms would otherwise impose on MMFs and their investors.
Posts Tagged ‘Taxation’
Recently, there have been a growing number of large “inversion” transactions involving the migration of a U.S. corporation to a foreign jurisdiction through an M&A transaction. Inversion transactions come in several varieties, with the most common involving a U.S. company merging with a foreign target and redomiciling the combined company to the jurisdiction of the target.
While inversion transactions tend to have strong strategic rationales independent of tax considerations, the tax benefits can be significant. These benefits are varied but start with relatively high U.S. corporate tax rates and U.S. taxation of foreign earnings when repatriated to the U.S. Among other things, an inverted company may achieve a lower effective tax rate on future earnings, be able to access its non-U.S. cash reserves in a tax-efficient way, and have a more favorable profile for future acquisition activity.
With U.S. corporate tax rates among the highest in the world, U.S.-based companies with international operations regularly look for structuring opportunities to reduce the exposure of their overseas earnings to U.S. taxes. A recent trend driving deal activity is the prevalence of acquisition-related inversions whereby the acquiring company redomiciles to a lower-tax jurisdiction concurrently with completing the transaction. While not the exclusive driver, a significant benefit of these inversions is reducing the future tax exposure of the combined company. The tax rules applicable to these inversion transactions are inherently complex and situation-specific. Below, we outline some of the very general principles, as well as some of the opportunities and challenges presented by these transactions.
A tax on the balance sheets of big banks—first proposed by US President Barack Obama in 2010 but later shelved—is back on the political agenda. Last month Dave Camp, Republican chairman of the House of Representatives Ways and Means Committee, put forward a proposal for tax reform that included a 0.035 per cent levy on bank assets more than $500bn. This would hit large institutions such as Bank of America, Citigroup and Goldman Sachs.
The aim of the Republican plan is to find tax revenue that could be used to offset cuts in income taxes on individuals. Mr. Obama pitched his proposal as a way of raising money from US banks to help repay taxpayers who had to bail them out at the height of the crisis. Neither plan aims to make the financial system safer, and neither would. But with a few alterations, a balance-sheet tax could help strengthen the banks.
Over the past year, boards of directors continued to face increasing scrutiny from shareholders and regulators, and the consequences of failures became more serious in terms of regulatory enforcement, shareholder litigation and market reaction. We expect these trends to continue in 2014, and proactive board oversight and involvement will remain crucial in this challenging environment.
During 2013, activist investors publicly pressured all types of companies—large and small, high-flyers and laggards—to pursue strategies focused on short-term returns, even if inconsistent with directors’ preferred, sustainable long-term strategies. In addition, activists increasingly focused on governance issues, resulting in heightened shareholder scrutiny and attempts at participation in areas that historically have been management and board prerogatives. We expect increased activism in the coming year. We also expect boards to continue to have to grapple with oversight of complex issues related to executive compensation, shareholder litigation over significant transactions, risk management, tax strategies, proposed changes to audit rules, messaging to shareholders and the market, and board decision-making processes. And, as evidenced in recent headlines, in 2014 the issue of cybersecurity will demand the attention of many boards.
The tax status of so-called “carried interests,” held by private equity fund sponsors (and benefitting, in particular, the individual managers of those sponsors) is the subject of this post. A decision by the U.S. Court of Appeals for the First Circuit holding that a private equity fund was engaged in a trade or business for purposes of the withdrawal liability provisions of ERISA (Employee Retirement Income Security Act) has caused considerable comment on the issue of whether a private equity fund might also be held to be in a trade or business (and not just a passive investor) for purposes of capital gains tax treatment on the sale of its portfolio companies. Proposed federal income tax legislation, beginning in 2007 and continuing into 2013, also has raised concern as to the status of capital gains tax treatment for holders of carried interests. The following post addresses both of these developments.
Gender quotas for corporate boards of directors have attracted attention in Europe, where a number of countries have enacted mandatory or voluntary quotas. In the United States, some activists, scholars, and policy makers have advocated quotas as a way to shatter the glass ceiling for women in business and (possibly) to improve corporate decisionmaking.
The appeal of quotas is that they represent the kind of structural change that could alter business practices that exclude women from leadership roles. Social psychology has demonstrated that gender discrimination flourishes when institutions allow actors to give free reign to stereotypes and to unconscious biases. Effective anti-discrimination measures must inform actors about these biases and limit the effects of bias on hiring, promotion, and the distribution of rewards in the workplace and in society. Still, quotas may have a dark side: critics worry that quotas could damage women’s career prospects if new directors are seen as tokens. Critics also predict that quotas could harm corporate performance, if new female directors are untrained or inexperienced. Empirical claims on both sides await further study by scholars.
Multinational firms can avoid taxes through structured transactions among different jurisdictions (e.g., Rego 2003), such as reallocating taxable income from high-tax jurisdictions to low-tax ones (Collins et al. 1998). This type of income shifting significantly reduces tax revenues of governments in high-tax jurisdictions and potentially hinders domestic economic growth and other social benefits (e.g., GAO 2008; U.S. Senate 2006). Policy makers around the world, including the United States, European Union, and Canada, have either enacted or are considering regulations related to multinational firms’ cross-jurisdictional income shifting and tax avoidance behavior. However, relatively little is known about multinational corporate tax avoidance behavior (Hanlon and Heitzman 2010), though such knowledge provides a basis for making and enforcing related rules. Further, the relation between firms’ tax avoidance and financial disclosures is not well established. In our paper, Tax Avoidance and Geographic Earnings Disclosure, forthcoming in the Journal of Accounting and Economics, we investigate how geographic earnings disclosure in firms’ financial reports relates to multinational firms’ tax avoidance behavior.
In our paper, Innovation, Reallocation, and Growth, which was recently made publicly available on SSRN, we build a micro-founded model of firm innovation and growth, enabling us an examination of the forces jointly driving innovation, productivity growth and reallocation. In the second part of our paper, we estimate the parameters of the model using simulated method of moments on detailed U.S. Census Bureau micro data on employment, output, R&D, and patenting during the 1987-1997 period.
Our model builds on the endogenous technological change literature. Incumbents and entrants invest in R&D in order to improve over (one of) a continuum of products. Successful innovation adds to the number of product lines in which the firm has the best-practice technology (and “creatively” destroys the lead of another firm in this product line). Incumbents also increase their productivity for non-R&D related reasons (i.e., without investing in R&D). Because operating a product line entails a fixed cost, firms may also decide to exit some of the product lines in which they have the best-practice technology if this technology has sufficiently low productivity relative to the equilibrium wage. Finally, firms have heterogeneous (high and low) types affecting their innovative capacity—their productivity in innovation. This heterogeneity introduces a selection effect as the composition of firms is endogenous, which will be both important in our estimation and central for understanding the implications of different policies. We assume that firm type changes over time and that low-type is an absorbing state (i.e., high-type firms can transition to low-type but not vice versa), which is important for accommodating the possibility of firms that have grown large over time but are no longer innovative.
There has been a recent surge in research that seeks to understand the sources of variation in tax avoidance (e.g., Shevlin and Shackelford, 2001; Shevlin, 2007; Hanlon and Heitzman, 2010). The benefits of tax avoidance can be economically large (e.g., Scholes et al., 2009) and tax avoidance can be a relatively inexpensive source of financing (e.g., Armstrong et al., 2012). However, aggressive tax avoidance may be accompanied by substantial observable (e.g., fines and legal fees) and unobservable (e.g., excess risk and loss of corporate reputation) costs. Although understanding the factors that influence managers’ tax avoidance decisions is an important research question that has broad public policy implications, relatively little is known about why some firms appear to be more tax aggressive than others.
In our paper, Corporate Governance, Incentives, and Tax Avoidance, which was recently made publicly available on SSRN, we examine whether variation in firms’ corporate governance mechanisms explains differences in their level of tax avoidance. We view tax avoidance as one of many investment opportunities that is available to managers. Similar to other investment decisions, managers have personal incentives to engage in a certain amount of tax avoidance that may not be in the best interest of shareholders, thereby giving rise to an agency problem. From the perspective of the firm’s shareholders, unresolved agency problems with respect to tax avoidance can manifest as either “too little” or “too much” tax avoidance. As with other agency problems, certain corporate governance mechanisms can mitigate agency problems with respect to tax avoidance.