Incredible Intangibles

Like a lot of journalists, I was an English major in college. The joke about us is that we all end up as baristas or waiters, with no real marketable skills. But perhaps the background helps with a career in tax writing. Who else but someone with a degree in literature, armed with a full understanding of postmodernism and well-versed in the works of DeLillo, Pynchon and Vonnegut could tackle concepts like the inherent subjectivity of intangibles?

That’s something I thought about while reading “The Mirage of Mobile Capital,” a provocative new paper from Wei Cui, a law professor at the University of British Columbia. It argues that current narratives about mobile capital–that the rise of intangible assets as value drivers has led to especially movable capital and intense tax competition–is an “intellectual mirage.” In fact, capital isn’t that much more mobile now than in the past, Cui argues, and if anything tax avoidance enabled by intangibles makes it less mobile.

To some degree, what Cui is arguing relates to a central point I’ve often made–tax competition and tax avoidance aren’t the same, and often they’re actually opposites. But they’re conflated, by tax experts as well as in public debates.

However, there’s also a key concept that drives Cui’s thesis–intangibles aren’t necessarily inherently mobile themselves, it’s that tax law defines them that way.

“Intangibles may seem mobile only because the rights to tax returns to them are arbitrarily assigned, but that is a fact about tax law itself, not an independent fact that tax policy responds to,” he writes.

Of course, the English major in me wants to point out that capital is also a social construct, something that’s defined by laws. Money, corporations–they’re all things we invent in our heads. Hell, everything’s a social construct.

But intangibles in the tax realm kind of stand out in their ethereal nature. They’re such a central part of international taxes, we often don’t take a step back and consider how weird they are.

They're important because intangibles include things like patents, copyrights, other types of IP–stuff that can be very valuable in our knowledge economy. And by being especially mobile, they're relatively easy for corporations to move to favorable jurisdictions, and then assign profits to those jurisdictions. And they're exceedingly difficult to price using market rates or the arm's-length standard.

By definition they don’t exist, physically. But these intangibles really don’t exist. A patent only exists on paper, but it has a central function, to protect companies from duplication by competitors. That function is governed by a completely different legal regime than tax law–that’s why companies don’t lose U.S. legal protections for patents or copyrights when they move them offshore. (To get technical about it, often the tax intangibles aren’t even the whole IP–it’s normally a piece of it, a right to use it in certain jurisdictions.) What tax folks mean when they talk about an intangible is more like an approximation of the thing...that doesn’t exist. It’s a shadow of a shadow.

We think of these intangibles as being inherently valuable, but it’s all value we ascribe to them. (The English major in me, who also took a lot of econ, wants to point out that this is true for all value, really.) It’s value that the law defines as existing–specifically, because of the arm’s-length standard. The intangible asset is valuable because it approximates something that independent parties would trade for, and our laws and treaties mandate that the value be recognized by tax authorities.

That’s the theory. In practice, these intangibles are often so unlike the real thing–not “found in nature,” as tax practitioners often say–that calculating their value takes on a religious nature, like trying to measure the exact distance to heaven. How do you determine the value of invaluable assets? "Crown jewels" that companies would never part with, or they'd face an existential crisis? That’s one of the central challenges that global tax law has been trying to solve for decades.

These are all facts that are simple and obvious to an international tax practitioner. They’re maybe worth repeating sometimes, though. It’s easy to forget this, and to start to think of these things as if they existed in a world of physical laws. Sometimes I’ll hear people talk about foreign income like it’s literal cash or gold that’s been stocked away, out of reach from the Internal Revenue Service unless we decide to send in the Marines. But actually, it’s our very laws which define that income as existing offshore at all.

Noted academic and tax justice advocate Gabriel Zucman has a phrase he often repeats–"tax avoidance isn’t a law of nature, it’s a policy choice."

You can disagree or debate with the implications he’s drawing, but as a fundamental fact it’s true. I might just add that choices are never simple or easy.

The squishiness of intangibles is a big reason why international tax policy has moved away from them in recent years, and towards more formulaic rules about the profits that intangibles create. Back in 2015, there was in fact a serious effort to re-evaluate how tax law treats intangibles, as part of the Organization for Economic Cooperation and Development’s Base Erosion and Profit Shifting project. Those rules mostly relate to the nature of the entity that’s holding the intangible, or the rights to profit from it–to collect that revenue, it must show it has the capacity or ability to manage it, the OECD rules dictate. That at least deals with entities that are little more than a post office box but earn enormous profits.

Even though those rules are almost 10 years old, I’m not sure enough evidence is in to declare them a failure or a success. The project has since been overshadowed by subsequent efforts, especially the OECD’s new Two-Pillar Solution. Those rules rely on formulas, based mostly on factors like tangible assets and workforce–defining intangibles by what they aren’t. Now it’s an approximation of the approximation of the thing that doesn’t exist.

Starting with the U.S. in 2017 with the tax on global intangible low-taxed income, the world has been implementing formula-based anti-avoidance rules in earnest. There hasn’t been a ton of informed discussion about whether it’s the right policy or not–it just somehow became the standard.

I’m trying to make a point that’s larger and more philosophical, though, maybe something that would be cooked up in a liberal arts college dorm room. It’s helpful to take a step back now and then and reflect on this nature of our tax system. So much of it exists on paper, and could be easily changed if we had the political will to do so. However, that doesn't mean that we should tear it up and start from scratch, as tempting as that may be.

More than a century ago, countries came together and agreed to divide up taxes this way, and we’ve been doing it ever since. That may not make it real, but it sure is important.

DISCLAIMER: These views are the author's own, and do not reflect those of his current employer or any of its clients. Alex Parker is not an attorney or accountant, and none of this should be construed as tax advice.

LITTLE CAESARS: NEWS BITES FROM THE PAST WEEK

• During a very lengthy markup hearing–believe me, I watched it all–the House Ways and Means Committee passed a three-bill package of legislation extending several key provisions of the 2017 Tax Cuts and Jobs Act, as well as many other changes. The votes were entirely along partisan lines–all Republicans voted yes, all Democrats voted no. The legislation included a few items that could affect international taxes, such as the limitation of interest. Somewhat surprisingly, it did not include a Republican bill to retaliate against the OECD Pillar Two plan. (Although several Republican members mentioned it during the hearing.) One interesting section will allow companies to opt out of controversial new foreign tax credit regulations from the U.S. Treasury Department–but only in the Western hemisphere. (This likely has something to do with Brazil, which is currently undergoing an overhaul of its tax system to align with OECD standards, that's causing many complications for U.S. companies doing business there.)
• The OECD held the first meeting for what it's calling the Pillar Knowledge Sharing Network, a peer-to-peer meeting of tax administration officials and experts offering "high-level practical advice" on implementation of the Two-Pillar Solution, meant to aid developing countries. This will be one of several peer review systems to guide implementation of the project, which will take years if not decades. This meeting comes as the organization continues to take criticism that it's a club of rich, European countries, so it's worth paying attention to how many poorer nations participate in initiatives like this.
• This is actually from two weeks ago--my apologies for missing it. The African Tax Administration Forum released a policy brief on "Carbon Taxation in Africa," outlining some of the issues facing developing countries looking to implement climate mitigation taxes. As I've noted, carbon taxation could soon take center stage in global tax discussions, and how non-Western countries approach it could be key. So definitely worth a look.

PUBLIC DOMAIN SUPERHERO OF THE WEEK

The Duke of Darkness, who debuted in K.O. Comics #1 in 1945. A police officer killed in the line of duty, Paddy Sullivan continues to fight crime in ghostly (and muscle-clad) form. Like most ghosts he can pass through walls and fly, but he can also summon super-strength when he needs too. While not bound by this earthly plane he still sometimes allows himself to be "locked up" by his former police partners, just to keep up appearances I guess.

Contact the author at amparkerdc@gmail.com.