In our paper, Manager-Shareholder Alignment, Shareholder Dividend Tax Policy, and Corporate Tax Avoidance, which was recently made publicly available on SSRN, we move away from equity compensation as a measure of manager-shareholder alignment and exploit a unique setting exogenous to the firm to assess the effect of manager-shareholder alignment on corporate tax avoidance. Our setting capitalizes on variation in the value to shareholders from corporate tax avoidance, which is driven by a country’s shareholder dividend tax policy. Firms in the United States, such as the ones examined in the prior literature, are subject to a classical tax system. Corporate earnings are taxed at the firm level and then again at the shareholder level when they are distributed as a dividend (i.e., double taxation). Therefore, corporate tax avoidance increases after-tax cash flows creating either more private benefits for managers or higher after-tax cash flows to shareholders. Other countries around the world employ an imputation tax system. In contrast to a classical system, an imputation system imposes taxes on corporate earnings at the firm level, but these corporate taxes paid are credited against the shareholders’ taxes when earnings are distributed as dividends. This credit causes the total tax paid on earnings to be equal to the shareholders’ tax (i.e., single taxation), so corporate tax avoidance increases after-tax cash flows available for managers’ private benefits but does not increase the after-tax cash flows to shareholders. Because corporate tax avoidance is costly, it actually reduces the after-tax cash flows to shareholders under an imputation system and makes them worse off.

…continue reading: Manager-Shareholder Alignment, Shareholder Dividend Tax Policy, and Corporate Tax Avoidance

The graduated corporate rate structure was publicly promoted as a tax on “bigness” when President Franklin D. Roosevelt first introduced it in 1935. In proposing the graduated rates, Roosevelt explained “[t]he advantages and the protections conferred upon corporations by Government increase in value as the size of the corporation increases . . . it seems only equitable, therefore, to adjust our tax system in accordance with economic capacity, advantage and fact. The smaller corporations should not carry burdens beyond their powers; the vast concentrations of capital should be ready to carry burdens commensurate with their powers and their advantages.” Given the relatively modest graduation in the original rates, however, this move is often portrayed as largely a political ploy rather than a serious tax measure. Paul Conkin noted that the 1935 tax bill in which the graduated rates were imposed “neither soaked the rich, penalized bigness, nor significantly helped balance the budget.” Even at the time its opponents called it a “legislative absurdity” enacted on the “whim” of the President. The conventional wisdom is that the graduated corporate income tax structure was designed to appeal to populist voters as part of the “rhetoric and psychological warfare” of New Deal-era politics, but was not designed to actually change the economics of operating businesses through large corporations. At best, it has been characterized as “an aid to small business.”

…continue reading: Taxing Bigness

I. Introduction

In the current environment and in the wake of Dodd-Frank (and, before that, TARP) mandated rules requiring shareholder advisory votes on executive compensation, shareholder-plaintiffs have more aggressively challenged executive compensation decisions. In recent months, an active plaintiffs’ bar has filed a series of cases, which generally fall into three broad categories:

• “say-on-pay” litigation;
• litigation relating to annual proxy disclosure, particularly with respect to equity compensation plans and say-on-pay proposals; and
• litigation relating to Section 162(m) of the Internal Revenue Code.

While most of these challenges have failed on substantive or procedural grounds or both, some have been more successful, and the plaintiffs’ strategies continue to evolve. Notably, even unsuccessful claims can result in costly disruptions and/or reputational harm, especially where injunctions against annual shareholder meetings are threatened.

In this memorandum, we:

…continue reading: Recent Developments in Executive Compensation Litigation

On December 21, 2012, the Italian Parliament approved the budget law for 2013 (the “Budget Law”) contemplating, among other things, the introduction of a new tax applicable to certain financial transactions (the “Financial Transaction Tax” or “FTT”).

While the Budget Law includes an articulate regime of the FTT, ”some of its features will be set with a Ministerial Decree to be issued by the Ministry of Economy and Finance (the “Ministerial Decree”) within 30 days from the entry in force of the Budget Law (which is subject to its publication in the Official Gazette, expected to occur in the coming days).

…continue reading: Italy Introduces a Financial Transaction Tax as of 2013

Amid the current debate over tax policy in Washington, there is a bipartisan consensus on one issue: the corporate tax rate, which is currently 35 percent, should be reduced to roughly 25 percent. At the same time, budgetary pressures preclude any significant increase in the deficit to accomplish corporate tax reform.

In light of these competing demands, most corporate tax reformers advocate broadening the corporate tax base to pay for any rate reduction. Unfortunately, few politicians have put forth base-broadening measures that would generate revenue sufficient to significantly lower the corporate tax rate on a revenue-neutral basis.

In fact, revenue-neutral corporate income tax reform is likely to be very difficult, because corporate tax expenditures represent a relatively small portion of total corporate tax revenues. A preliminary analysis by the Joint Committee on Taxation suggested that the elimination of all corporate tax expenditures—except for the deferral of tax on foreign source profits, a provision whose repeal would be politically and economically infeasible—would allow for the corporate tax rate to be reduced to only 28 percent.

Therefore, if policymakers want to reduce the corporate tax rate on a revenue-neutral basis, they will likely have to adopt other types of reforms to broaden the corporate tax base. Ideally, those reforms should offer the potential for significant revenue gains and reduce economic distortions.

…continue reading: Corporate Tax Reform

Early corporate law scholarship argued both that anti-takeover devices are inefficient (they reduce the value of the firm) and that firms adopt efficient governance terms before they make their initial public offering. Some of this scholarship asserted that firms go public without anti-takeover devices and adopt them later when agency costs are higher. However, subsequent research revealed that most firms adopt anti-takeover devices before completing their initial public offerings. For example, over eighty-six percent of firms that have gone public in 2012 have a staggered board of directors, and both Google and Facebook chose dual-class capital structures that allow the founders to retain voting control disproportionate to their economic stake.

The literature offers a number of explanations for this apparent puzzle. Capital market imperfections may prevent initial public offering prices from reflecting differences in corporate governance terms. Firms may choose inefficient terms due to bad legal advice or because of frictions in the market for financing prior to the initial public offering. Anti-takeover protections could be efficient after all, at least for some firms, because they correct for myopic investors or some other problem. Finally, managers may choose anti-takeover provisions to signal something about their firms. In an essay forthcoming in the Journal of Corporation Law I offer a very different explanation, one based on the tax code.

My argument begins with a variant of one of the existing explanations for anti-takeover protections. The heart of the argument is that managers are not driven solely by a desire for material gain but derive some happiness or utility from the control they exercise over their firm. To the extent that managers derive happiness from control, they may not choose governance terms that maximize the dollar value of the firm. However, unless there is some contracting failure, they will still choose efficient terms — terms that maximize the total value of the firm (the dollar value plus the control value).

…continue reading: Taxing Control

My recent article, Mutual Fund Sales Notice Fees: Are a Handful of States Unconstitutionally Exacting $200 Million Each Year?, forthcoming in the Hastings Constitutional Law Quarterly, describes the political compromise struck in 1996 between Congress and state securities regulators. That year, Congress enacted the National Securities Markets Improvement Act of 1996 (NSMIA), which effected multiple changes to the federal securities laws to promote efficiency and capital formation by eliminating overlapping federal and state securities regulations.

With respect to mutual funds, NSMIA resolved the problem of overlapping regulation by preempting state substantive regulation and registration requirements of mutual funds, thereby providing for exclusive federal jurisdiction over the contents of a mutual fund’s prospectus and operation of each fund. NSMIA was welcomed by the mutual fund industry because it eliminated the “crazy quilt” of regulation that had made registration of mutual fund shares unnecessarily cumbersome—in some cases leading mutual funds to restrict their fund offerings to residents of certain states.

However, in order to secure the acquiescence of the states and secure NSMIA’s enactment, NSMIA preserved state authority to require mutual funds to file sales reports and to pay state filing fees based on those sales in connection with the sales reports. A handful of states have taken unfair advantage of this fee loophole.

…continue reading: Mutual Fund Sales Notice Fees

It is hard to imagine a financial crisis that is not ultimately caused by creditors who had taken on too much debt. Debt is the root cause of most corporate financial failures and, if a snowball effect sets in, the root cause of financial system failure. Of course, debt also has advantages. Without debt, many privately and socially valuable projects could never be undertaken. Still, it is our current tax system that has pushed our economy to be too levered. Now is the time to address the problem—before it will again be too late.

From a creditor’s perspective, the two key advantages of debt are the tax deductibility of interest payments and the ability of lenders to foreclose on non-performing borrowers (which makes it in their interest to extend credit to begin with). Although both factors contribute greatly to the incentives of the borrower to take on debt, there is one important difference between them: the tax deductibility of debt is not socially valuable.

To explain this issue, let’s abstract away from the beneficial real effects of debt and consider only the tax component. In an ideal world, taxes should not change the decisions of borrowers and lenders. They would take exactly the same projects and the same financing that they would take on in the absence of taxes. At first glance, one might argue that the tax distortions of leverage are not so bad, because the interest deductibility of the borrower is offset by the interest taxation of the lender. But this “wash argument” is wrong. It ignores the fact that capitalist markets are really good at allocating goods to their best use. In this case, it means that the economy will develop in ways that many lenders end up being in low tax brackets (such as pension funds or foreign holders) ,while many borrowers end up being in high tax brackets (such as high-income households or corporations). The end result will be not only that the aggregate tax income is negative, but that debt is taken on by borrowed primarily to reduce income taxes and not because debt has a socially productive value.

…continue reading: A Simple Tax Proposal to Improve Financial Stability

I. Highlights

On September 13, 2012, the U.S. Treasury Department and the Internal Revenue Service (the “IRS”) published final regulations that will affect the U.S. federal income tax treatment of debt restructurings, amend-and-extend agreements, debt exchange offers, further issuances of outstanding debt, and other liability management transactions.

• These “publicly traded” regulations will increase the tax cost to some U.S. issuers of restructuring or amending the terms of distressed debt, particularly syndicated loans, and may increase the tax cost of such transactions for U.S. investors in illiquid distressed debt, particularly middle-market loans, whole loans, credit card and other receivables and ABS, MBS and CDO tranches with outstanding amounts of $100 million or less.
• For issuers of bonds, however, the regulations provide increased flexibility for further issuances – in tax parlance, “reopenings” – of outstanding debt, particularly debt trading below par.
• The new rules apply to both U.S. and foreign issuers and to U.S. investors, including U.S. investors in funds that invest in debt instruments such as hedge funds.

These rules will have different effects in different markets, in part because of the different economic characteristics of those markets and in part because of historic tax positions taken in different markets. We summarize those effects below, and then discuss the effect of the regulations on loans, structured finance and whole loan transactions, and bonds in more detail.

…continue reading: IRS Regulations Affecting Liability Management Transactions

On August 1, 2012, the Internal Revenue Service (the “IRS”) published final regulations concerning the tax deductibility of corporate expenses associated with the personal use by employees of corporate aircraft. [1] As noted below, these rules may have implications for those involved with public-company executive compensation disclosure, as well as of course for tax practitioners who must apply the rules to prepare federal income tax returns. [2] Generally, the principal takeaways are as follows:

…continue reading: New Personal Use of Corporate Aircraft Tax Rules