Thanks, Usha, for the introduction. Let Us rule!
I am delighted to join The Conglomerate for a brief stint. I am an enthusiastic follower of the blog and an occasional commenter, so I am thrilled to have the microphone for the next two weeks.
I have some specific topics I plan to post about but I would like to start off the discussion with a meta question. I have been writing about securities law and going to conferences for a few years, inlcuding those of the law & economics variety. At these events, I often cross paths with tax professors, and I have noticed one curious difference between tax and corporate & securities folk: tax professors like tax collectors. Overwhelmingly so. They recognize that the IRS is not perfect, but when in doubt, they generally side with the IRS, not taxpayers.
Not so for corporate and securities professors. At every milestone anniversary of the creation of the SEC someone proposes that the Commission be abolished. So I am wondering why? It could be that my samples are biased. Or it could be that both sets of people like regulators, but corporate & securities people are just grumpier and less likely to express nice things about securities regulators. Or perhaps the difference is real.
Whatever the reason, I am going to reveal my personal bias here: I like securities regulators. That does not imply that I love every idea that comes out of the SEC. But as between the regulated entities and the SEC, my default is to side with the securities regulator. What is yours?
The late Larry Ribstein coined the phrase "the Apple Rule" when Apple seemed to be the only corporation engaged in options back-dating that got a pass from regulators and prosecutors. Now, it seems that the Apple Rule applies to corporate income taxes as well.
Here is Glommer Emeritus Vic Fleischer's very funny take on Apple's hearing in front of the U.S. Senate two days ago (or "the ghost of Steve Jobs Goes to Washington").
Here is Vic's more detailed explication of Apple's global tax maneuvers.
There are several ways that a company can lower its global tax bill by separating an otherwise integrated business model into components located in various subsidiaries in various taxing jurisdictions. To oversimplify things, a global operation can attempt to have subsidiaries in high tax jurisdiction bear costs (whether from paying high interest rates on intercompany loans or bearing the brunt of mark-ups for various inputs or fees for use of intellectual property) and have subs in low or zero tax jurisdictions recognize profits. This is easier for companies with very important intellectual property, but has been used by bricks-and-mortar companies like Starbucks (all green coffee is sold through a Swiss Starbucks and roasted by a Netherlands company and the markup paid to those entities; royalties for the "Starbucks experience" are paid to the Netherlands entity as well).
Apple's CEO assures us that Apple does not use "tax gimmicks." Instead, it has two subsidiaries that are incorporated in Ireland but managed from the U.S., which means that they are considered under Irish taxing authority by the U.S. and considered under the U.S. taxing authority by the Irish. They pay zero taxes. Apple also has two Irish subsidiaries that do pay taxes to Ireland, but they are very, very low taxes. And, a lot of profits are recognized by these four subs.
Apple's CEO also reminds us that Apple pays a lot of taxes to the U.S., about $6 billion in 2012, $3.4 billion in 2011, so we should feel pretty lucky. (See above for Vic's response.)
This is not the place to go for careful consideration of tax policy, but we do know something here about business regulation more generally, so an observation and a reference with regard to the IRS investigation of tea party groups and their 501(c)(4) status:
- I assume that the decision to investigate the tea party applicants by the agency was an exercise of enforcement discretion; as such, it should be unreviewable by the courts under the principle that agencies cannot be reviewed for their decision to bring enforcement actions on one set of guys as opposed to another set of guys (the idea is that reviewing those sorts of decisions would enmesh the courts too much in the work of the agency). The denial of an application for 501(c)(4) status, oddly enough, would be plainly reviewable as a matter of administrative law. But doesn't appear to be what happened here. Of course, the mere fact that you can't go to court doesn't make it right, and what is happening here is supervision (pretty angry supervision, too) by the other branches of government, rather than by the judiciary. Moreover, this is tax, and tax is different; there may be special review provisions at stake in the tax code I'm not aware of.
- Kristin Hickman is your source for the administrative procedures adopted by the IRS, and one of the themes of her work, fwiw, is that the IRS rarely complies with some of the basic principles of administrative law. See, e.g., here and here and here.
I hate to admit this, but my highly time-leveraged life seems to only work because of Amazon Prime. If someone needs a book, a math compass, a birthday present, even diapers, it has sometimes made sense for me to merely order the merchandise from Amazon, get free shipping and no tax. Yes, sometimes that's easier than driving the 20 minutes to Target. If I'm willing to pay $3.99, then I get it the next day. For a $20 item, it's seems like a wash. This may change.
On Monday, the Senate will vote (and probably pass) The Marketplace Fairness Act of 2013. (It has its own website, here.) This bill would require online retailers to collect and remit sales taxes based on the delivery location of goods purchased. If there is no delivery location, for example in the case of a download, then the tax will be based on the billing address. For those of us living in Illinois, this difference between ordering on Amazon now and in the future could be almost 10%. (Chicago's general merchandise tax is a total of 9.25%, down from 9.5% last year.) For those of you who live in the five states without a sales tax, keep on living in tax-free bliss.
The winners here are the bricks-and-mortar stores who have to charge tax. Apparently, "showrooming" is a thing -- customers shop in stores where they can see and try on merchandise, then order online and skip the tax. Ouch. This Act should take that incentive away. Even big stores like Gap and Best Buy charge tax online because they have a physical presence in most/all states. Of course, online retailers have had a good run, and that run may have been enough to kill many many competitors, including big ones like Borders.
Interestingly, Amazon, which has been the obvious beneficiary of tax-free online retailing, is supportive of the legislation. After years of fighting states that have tried to force Amazon to pay sales tax, (blog post here), the online giant is a cheerleader for the Act. Perhaps this is because Amazon has recently entered into voluntary arrangements with nine states, including large markets such as California, New York and Texas. Building warehouses in these states where it is already taxed has allowed Amazon to ship merchandise cheaper and even faster. And, Amazon may have established such a loyal fanbase of customers addicted to its convenience and fast shipping that it doesn’t fear losing customers over price.
What about downloads, you ask? Most states don't include digital downloads in definitions of taxable goods. In the states that do, you are probably already paying tax on downloads from Apple (which has physical stores), but not Amazon. Now, you will. And, the Marketplace Fairness Act may enbolden states to redefine general merchandise tax rates or use tax rates to include digital downloads.
So, who is against Internet sales tax equity? Online-only retailers that aren’t nearly as big as Amazon and the portal that serves them: eBay. Though the act exempts small businesses with no more than $1 million in revenue, that threshold leaves medium businesses with a price disadvantage and new compliance costs. Therefore, some groups argue that the $1 million threshold could be raised to $10 million without states losing much revenue, while giving needed relief to small-to-medium enterprises. And, of course, the Heritage Foundation and anti-tax watchdogs oppose the Act as just another tax increase that will hurt consumers.
Is it a new tax? Not really. It's the same old state sales tax, just with more enforcement. Though sales taxes are an obligation imposed on the consumer, retailers are supposed to collect and remit the tax. However, retailers with no physical presence in a state can’t be compelled to collect these taxes. Funnily enough, we were all supposed to be sending in the tax we aren't charged on our Amazon purchases. Who knew? Well, I hope I get some sort of Internet shopping amnesty.
To catch-up: In 2001 and 2003, Congress instituted a number of tax rate reductions that were set to expire at various times in the last decade. Extended before, these reductions are again set to expire on December 31. The media has focused on the impact on individual tax rates, which will increase. More markedly, however, the rates for both capital gains and dividends will rise dramatically. Specifically, dividend income would automatically be taxed as ordinary income, at the possibly new maximum income tax rate of 39.6%, instead of the rate for the past decade of 15%. Plus, the ACA surtax on high earners will kick in for many investors, bringing the maximum dividend rate to 43.4%, almost three times as much as the rate now.
So, how will this change corporate behavior in the coming months? Any estate tax planner will tell you (if they have time to talk at all) that for the next 2.5 months all they are doing is revising estate plans to address a possible change from the $5 million/person exemption to $1 million. But are corporations scrambling as well?
This article seems to suggest no. Corporations are not changing scheduled January dividends to December dividends, even though it would save their investors millions of dollars. Even though corporations did make switches in the shadow of previous 2010 deadline. So, do corporations know something we don't? Do these big corporations, like Wal-Mart, have eyes and ears (and dollars) in Washington that tell them not to worry about the tax cliff? Could Congress be ready to extend the rates after the election or even retroactively after the deadline? Corporations don't have a deduction for paying out dividends, so corporations should be neutral, unless the higher rates increase their cost of capital.
Scholars could have years of projects out of observing behavior prior to these rate cut expirations. Should investors change their behavior? Perhaps investors should sell shares on December 31 in anticipation of a January dividend, hoping that the share price would reflect the high probability of the dividend. Then, investors would pay the lower 15% on any capital gain, a rate that may also automatically increase to 28% on January 1.
OK, so first of all I have to apologize to my son, who asked me if there was prize money in the Olympics. I pooh-poohed the thought of tainting the Olympics with prize money. But, apparently there is -- $25,000 for a gold medal; $15,000 for silver; $10,000 for bronze. Sorry. I was wrongish.
OK, so second, there is a firestorm in the blogosphere right now about the absolute unfairness of taxing Olympians -- yes, Olympians! -- on their winnings. So, of course the numbers going around are that the tax on a gold medal is $8,750 and that Missy Franklin (as of yesterday) would owe $14,000 for one gold and one silver. (She now has two golds and a silver as of Wednesday night, but let's stick with the $14k number.)
Now, obviously the Weekly Standard and all those who would lower taxes chose Missy as their poster child because she is young, freshfaced and adored by all (including me, who can't stop watching that Call Me Maybe video). But, I think the numbers are wrong, which are based on a 35% effective tax rate. Missy may not be in the 35% tax bracket. Before her race last night, I'm going to guess that her income for this year (2012) was whatever she got at the Olympics and nothing else. She is an amateur and wants to have no endorsements so she can swim for her high school, Regis Jesuit. (See why we love her!?!). So, as of yesterday at lunch, I'm guessing her total earnings were $40k. Because she earned under $53,500, her tax would be $3,315 plus 28% of $17,900, for a total of $8,327. Not $14k. And, if she took the standard deduction and the personal exemption, her taxes could be $5,597. And, Missy might decide to itemize to deduct a lot of things related to training and travel, reducing her bill even more, but I leave that to the individual tax specialists. (For amateur athletes, I'm guessing the Olympics is an "activity not engaged in for profit," but maybe not for professional athletes, but that's beyond the purpose of this blog post.) So, I would think the maximum she would pay would be closer to $5k than $14k for two medals. (Now she has earnings of $65k, so the bill will be higher.)
Leaving tax accuracy aside, the bigger philosophical question is whether those who bring home the gold should face a tax bill. There aren't a lot of great reasons to exempt the honoraria from tax besides symbolism. Yes, Olympians work extremely hard and most live with very little income while training. Yes, some have lucrative endorsements, like Phelps and Lochte, but most have zilch. But, lots of people work very, very hard, and they pay tax on their income. If I took the next four years off to write a book or invent something or go to medical school, I would have to pay taxes should the book or investion sell or I became a surgeon. The drive and determination of Olympians is very inspiring, but a lot of folks who pay taxes have impressive drive and determination also.
However, Senator Rubio has proposed legislation to exempt the winnings from taxation because taxing Olympic prizes "punishes success" and "punishes excellence." This reporter thinks Olympians shouldn't be taxed, just like military personnel who are deployed in a combat zone. Wow. Are the Olympics really akin to a combat zone? Are U.S. Olympians more like U.S. soldiers in a combat zone than U.S. soldiers who aren't in a combat zone and still pay taxes? Astronauts pay taxes. Listen, nobody loves the Olympics more than me or cries more when they play the National Anthem, but I'm not buying it.
As an analogy, Nobel Prize winners are taxed on their very large ($1.5M) prize. And, many Nobel Prize winners are plain old professors and researchers who have toiled away for years waiting for recognition. And, Nobel Prize winners make great, lasting contributions to society. But, since 1986, we've taxed them.
Yesterday I told my Corporate Tax class that we could teach a whole course on the tax implications of the Facebook IPO. I wasn't kidding. Here are a few of the interesting issues that highlight current debates in the taxation of corporations and their shareholders. (Gregg Polsky has also covered some of these on The Faculty Lounge.)
Mark Zuckerberg's stock: CEO Zuckerberg holds almost 414 million shares of stock. At the time of the IPO, he owes no taxes on that stock until a recognition event, such as sale. When and how did he acquire this stock? Most likely, much of it is "founder's stock." This is friend of the Glom Vic Fleischer's territory (See Taxing Founder's Stock). Zuckerberg probably contributed the algorithms and code for Facebook in return for stock as a nontaxable event either as a contribution to a corporation by a control group or (as Vic explains), making an election to have the stock distribution a taxable event, with the valuation of the stock as equal to the contribution. Even though the stock is more accurately described as consideration for Zuckerberg's labor, it will be taxed at some point as capital gains, which is now 15% and considerably less than the ordinary income rate. Gregg argues that this isn't that bad because the corporation doesn't get a deduction for it, so no deduction plus 15% is better than 35% deduction and 35% taxation, if you look at it from the point of view of the public fisc. I think Vic is looking at it from the point of view of regular folks who contribute labor for stock versus founders. Interesting debate.
Zuckerberg's and others stock options: From reports in the media, it seems that the stock options that Zuckerberg holds (and probably others) are nonqualifying stock options. The S-1 describes a 2005 stock option plan that issued incentive stock options, but stock options issued before then or under a different plan don't seem to be qualifying options. Should holders of nonqualifying stock options exercise those options at or after the IPO, they will encounter a taxable event regardless of whether they sell the stock. Zuckerberg has over 120 million stock options giving as compensation, which he plans to exercise. His exercise price is 6 cents. So, at something like $30/share,that's about $3.6 billion (say it like Mike Myers) of taxable ordinary income (the spread between exercise price and price at conversion). Zuckerberg's tax bill (federal and California) may well be one of the biggest tax bills ever. Apparently, he plans to sell enough shares to pay his taxes, which may reach $2 billion. Other holders will also face the same dilemma of having a tax bill even if they don't have any additional cash on hand. Those who exercise qualifying ISOs will not have a current tax liability if they do not sell. (I have now wandered away from things I know about, so I will stop.)
But, for each option that is exercised that is taxable as compensation, Facebook gets a deduction, even though no cash is (or has ever) gone out of the company for that expense. So, Facebook calculates that it will have tax refunds for awhile given the billions of dollars in compensation expense it will enjoy.
Restricted Stock Units: Starting in 2008, Facebook began granting service providers RSUs instead ot stock options, probably to avoid the 500 shareholder threshold for registration under 12(g) of the Securities Exchange Act. These RSUs are scheduled to vest six months after the IPO. The recipients will be taxed at ordinary rates for the difference between the FMV of the stock at the time and the price paid for the grant (if any). (Though, recipients could make an 83(b) election at the time of the grant when valuation is both less and less clear, but this may be a risky move.) Finally, Facebook has to withhold cash for that. Facebook has listed this as a risk factor in its S-1:
We anticipate that we will expend substantial funds in connection with the tax liabilities that arise upon the initial settlement of RSUs following our initial public offering and the manner in which we fund that expenditure may have an adverse effect.
Whew. That's enough.
While charitable contributions and taxes are sometimes portrayed as substitutes, we think of charitable giving as "generous" and we think of paying taxes as a necessary cost of living in a civil society. Thus, Learned Hand aptly described our attitude toward the payment of taxes: "any one may so arrange his affairs that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury; there is not even a patriotic duty to increase one's taxes." Helvering v. Gregory, 69 F.2d 809, 810-11 (2d Cir. 1934).
Despite this widespread view toward the payment of taxes, Romney is still criticized for not paying (or wanting to pay) more taxes. In a WaPo piece from earlier today, for example, Rabbi Sharon Brous of Los Angeles observes, "On one hand, I really admire his sense of obligation to his immediate community, but I would offer that perhaps he might adopt a more expansive notion of what community is." This, despite the fact that Romney was not using the most tax-advantageous method of making his charitable contributions. (Thanks, Miranda.)
Rather than blaming Romney for paying too little in taxes, perhaps we should encourage more charitable giving. Again from the WaPo story:
Overall, Americans give between 2 and 3 percent of their income to charity, according to the Philanthropy Roundtable, but in the first few years of the recession, that number dropped, too. Newt Gingrich gave just $81,000 — 2.58 percent of his $3.1 million income and a fraction of his 2005-06 tab at Tiffany’s — to charity in 2010....
The more individuals and corporations give, the less the government has to. Giving, and giving until it hurts, forces you to recognize that, like a parent, you’re responsible for other people — whether in your own community or around the world. When you lay down your money, you say, “This (church sanctuary, child, environmental hazard) is my problem.” Providing a sense of interconnected obligation is traditionally what religious communities have done best, and it is no surprise that the religious groups that are growing fastest in America — Mormons, Pentecostals, certain sects of Jews — are those that make demands on their members' time and money.
Because I'm teaching Corporate Tax this semester, I'm probably poring over the "How Much Tax Does Romney Pay?" discussions. Yesterday, my friend and former colleague Miranda Fleischer was quoted in an article not about the passive income rates that drive down Mitt Romney's (and others) effective tax rate, but about his charitable deductions. Miranda has written extensively about the whys and wherefores of the charitable tax deduction. Her latest is Equality of Opportunity and the Charitable Tax Subsidies, 91 B.U. L. Rev. 601 (2011).
The candidates' tax returns have revived discussion about carried interest and the 15% tax rate of dividends and capital gains (see the other Professor Fleischer), but at least Romney's tax profile reminds me of some of the foundational questions of why we have the charitable tax deduction. Romney and his wife are very generous with their charitable contributions (they gave 16.4% of gross income, more than other filers with similar income). Newt Gingrich, on the other hand, donated less money as a percentage of income than even the average taxpayer, even though his AGI was over $3 million.
One of the questions surrounding the charitable tax deduction is why should the government subsidize charitable giving. If we believe that the deduction prompts taxpayers to give 30% more or something like that than they would otherwise give, the government is generally giving a partial match to taxpayers's pet charities. Miranda has in a series of articles fleshed out the philosophical reasons why government subsidization is probably a good idea. But I wonder whether it's necessary. Without the deduction, would taxpayers generally be less generous by 30% or so? Would we still donate to our religious institutions, alma maters, food banks, women's shelters and legal aid clinics without it?
I think the answer for the Romneys is yes. They probably donate to their church out of a mixture of duty and love for their church, and a deduction wouldn't change that. According to Miranda, the Romneys also aren't giving charitable donations in the most tax-advantaged way, so lowering their tax bill does not seem to be a goal of their generosity. Of course, you can say that with the Romneys' wealth, the marginal utility of the deduction may not be the same as for the rest of us. So, what about the middle class (or the other 99%, depending on your choice of rhetoric). Do we give or give more generously because of the tax deduction?
I think business law can provide insight here. Look at Kiva. If you make a "loan" to an entrepreneur through Kiva (which it makes through its foreign partners), you do not receive interest, but even that foregone interest is not tax-deductible. Neither is the principal amount, even if you do not cash out after being repaid but re-loan instead. (See Sarah Lawsky's Money for Nothing: Charitable Deductions for Microfinance Lenders, 61 SMU L. Rev. 1525 (2008). But, Kiva was pretty successful in attracting what were essentialy non-deductible charitable donations. Now, Kiva invites patrons to make either loans or tax-deductible donations for administrative expenses of Kiva. An interesting question is whether the addition of the tax-deductible option lessened the amount received as loans and what the resulting ratio between them is. Kickstarter, a crowdsourcing site for artists to fund new projects, raises money without the promise of a tax deduction (though some of its artists do have 501(c)(3) organizations). Do the tax-deductible projects get funded quicker and more fully? Are there other perks that donors prefer? Production credit? Special access or invitations?
Mitt Romney disclosed today that his his effective tax rate is "probably closer to the 15% rate than anything."
Are you surprised? I'm not, for two reasons.
First, most of his income comes from investments, the gains from which are taxed at the capital gains rate of 15% ... or less.
Second, he has substantial deductions, including (I assume) charitable deductions in excess of 10% of his income. After all, Mormons tithe. And we typically make contributions to the poor and to other causes on top of that 10% contribution. If you would like to lower your taxes in this way, start here.
Both the capital gains rate and the possibility of a cap on charitable deductions have been on the table in recent efforts at tax reform, and I suspect Romney's tax return will light a fire under both issues during the election.
UPDATE: The Obamas paid taxes at a rate of 25.3%, and 13.6% of their 2010 income went toward charitable contributions. See here. More on tax rates from that story:
Roughly half of households—mostly lower-income—pay no income tax, although many still pay payroll taxes. The average income-tax rate for the middle slice of households—those making between $34,300 and $50,000—was 3.3% for 2007, according to Congressional Budget Office data based in part on actual returns. That estimate includes the effects of various breaks, such as the per-child credit and the mortgage-interest deduction. Average income-tax rates rose to 14.4% for the top fifth, and to 19% for the top 1%, before dropping slightly for the very highest earners, who tend to have a larger percentage of their income from investments.
Although I teach, write and practiced predominantly in corporate and commercial law, I also have an LL.M. in Tax. Granted, my LL.M. coursework largely focused on business taxation, and therefore falls squarely within my interests. Nonetheless, given that tax and corporate/commercial law are treated as separate legal disciplines, I see tremendous opportunities for comparative and interdisciplinary analysis among tax, corporate and commercial law.
For instance, I find it intriguing that courts employ highly divergent decision-making approaches in these realms. In the tax realm, courts tend to focus on the actual economic arrangement of the parties, in an effort to identify economic substance rather than mere contractual form. Courts presiding over tax cases tend to utilize more expansive and contextual interpretive methodologies, and routinely scrutinize objective and subjective intent and other "facts and circumstances." These approaches stand in contrast to the dominant, textualist interpretive paradigm in corporate and commercial law, which relies almost exclusively upon strict interpretive norms (such as rules of contract interpretation) to construe written agreements.
To be sure, these divergent methodologies reflect the differing goals of tax, corporate and commercial law. While jurisprudence across all three disciplines emphasizes the need for certainty, uniformity and predictability in the law, tax law remains manifestly skeptical of the party autonomy that corporate and commercial law strive to protect. Courts presiding over tax cases are often called upon to examine possible crimes against the public fisc; in contrast, courts presiding over corporate and commercial law cases are generally called upon to manage disputes among sophisticated parties to voluntary, utility-maximizing arrangements.
Yet despite these distinctions, courts are increasingly importing tax doctrine into the corporate and commercial law context. A classic example is the "debt recharacterization doctrine." In the federal income tax realm, considerably high stakes turn on the proper classification as debt or equity of a person's interest in a corporation. Generally speaking, the characterization of the investment as a loan means that payments of interest will be includible in gross income. In contrast, to the extent the investment is deemed to be an equity capital contribution, then the principal amount of the investment must be capitalized into the investor's basis in the corporation's stock. The tax treatment of any repayment will be determined pursuant to rules governing corporate distributions, with any amounts deemed to be a dividend includible in gross income. In light of these differing tax consequences, courts have developed multi-factor, highly facts-intensive and contextual analyses to recharacterize a purported debt instrument into an equity investment, and to reassign tax consequences accordingly.
The debt recharacterization doctrine was subsequently imported into the bankruptcy realm. In that context, if a court determines that an investment is equity rather than debt, then the claim will be treated as an equity ownership interest in respect of which no distribution of corporate assets can be made unless creditor claims are satisfied. Even within the less formalistic realm of bankruptcy, the importation of the debt recharacterization doctrine is a major departure from dominant jurisprudential norms. As a general matter, bankruptcy courts look to state contract law when matters arise under private agreements and there is no statutory law on point. For this reason, although bankruptcy courts have wide latitude to exercise legal and equitable powers, most matters that arise in respect of contracts are construed in accordance with state contract law, including rules of contract interpretation.
Of course, the bankruptcy context, much like the tax realm, may provide inherent justifications for the application of more expansive judicial methodologies. In particular, courts applying the debt recharacterization doctrine in bankruptcy matters are frequently responding to the plight of third party creditors who may recover less due to the crafty maneuvers of shareholders.
More recent cases demonstrate a willingness to import tax doctrine into corporate and commercial law even where the justifications for doing so are less obvious. For instance, in Coughlan v NXP BV, C.A. No. 5110-VCG (Del. Ch. Nov. 4, 2011), the Delaware Court of Chancery applied tax law's "step transaction doctrine" to an action brought by a stockholder representative seeking to construe terms of a merger agreement. In tax law, the step transaction doctrine is applied where parties engage in multiple transfers to circumvent rules that would apply to a more direct transfer. In Coughlan, the merger agreement provided that, in the event of a change in control of NXP or of pertinent corporate assets, the person acquiring NXP or the assets would be required to accelerate certain contingent payments or assume the obligations. The stockholder representative argued that NXP's two-step transfer of assets to a joint venture amounted to a change in control. NXP argued that it engaged in two transfers that were each permitted under the merger agreement. The court applied the step transaction doctrine, finding that the two transfers should be analyzed as a single transaction that ultimately effectuated a change in control.
The court explained that the step transaction doctrine has been imported into the Delaware corporate and transactional context as well as the bankruptcy realm. It cited a 2007 case construing provisions in a partnership agreement, whereby the Court of Chancery defended application of the doctrine: "I see no reason as a matter of law or equity why the step transaction principle should not be applied here. Indeed, partnership agreements in Delaware are treated exactly as they are treated in tax law, as contracts between the parties." Twin Bridges Ltd. P’ship v. Draper, 2007 WL 2744609, at *10 (Del. Ch. Sept. 14, 2007).
To be sure, such a rationale denies fundamental differences in tax, corporate and commercial law. However, in terms of judicial decision-making methodologies, the increased application of tax doctrine to cases in the corporate and commercial law realm may signal a movement away from formalism, and a rising interest in identifying the actual economic arrangement of parties as opposed to merely construing contractual form. Indeed, the Court of Chancery articulates this point in Coughlan, issuing words of caution to parties who rely on the written word in their business planning and legal advocacy: "transactional formalities will not blind the court to what truly occurred." Coughlan, C.A. No. 5110-VCG at 23.
The local paper here last week mentioned in a fairly small article that Amazon had terminated its relationship with Illinois vendors who previously had earned commissions by referring internet customers to Amazon. (Some bloggers earn commissions from Amazon by referring purchasing customers through their websites; the Glom does not.) Why the big "You're Fired"? Well, last week the governor of Illinois, Pat Quinn, signed into law a new tax law that would require Amazon to pay local sales tax on that purchase. Amazon apparently did not think that was a good deal. The state of Illinois has promised to find these abandoned Illinois vendors new commission-earning relationships with other Amazon-like retailers, presumably ones that have physical locations and already collect tax like Sears, Wal-Mart and Best Buy. Some Illinois ex-affiliates are opting instead to take up business in another state, rather than wait for that help to come.
But, apparently, Illinois is not the only state looking for revenue cash left on the table (or under the sofa cushions) by passing an "Amazon tax." (NYT article today here.) And, apparently, Amazon is not that happy at being the biggest undertaxed cash cow in sight. Amazon takes the position that it is required only to collect tax on sales to states where it has a presence, not mere internet affiliates or even warehouses (as in Texas). Though the states are arguing that Amazon should be treated just like any other retailer that has to collect sales tax on its products, Amazon argues that it should be treated just like any other retailer without a brick and mortar presence in that state. Here is a recent SSRN paper by Edward Zelinsky on why Amazon taxes violate federal law, citing a Colorado controversy.
Given the financial straits of many states, I bet this isn't the last we hear of this topic.
What do our blogger emeritus Victor Fleischer, Kim Kardashian and the Gosselins have in common? They are tabloid attractions! Vic is featured today on the front page of the New York Post. It's not every day that a law professor and a working paper are featured in the Post, but of course it is Vic, whose creative and aggressive scholarship on carried interest was picked up by the mainstream media before. Vic's new target is the tax treatment of founder's stock, whereby entrepreneur's human capital becomes invested in stock, not salary, and therefore gets attractive tax treatment relative to the income of wage slaves like the rest of us. His paper, Taxing Founder's Stock, and his power point slides are available on his website.
I read every word that Vic writes and can't wait until his articles are cited in People magazine.
Is Delaware a corporate tax haven?
One of the most prevalent corporate state tax planning strategies involves subsidiaries organized in the state of Delaware. This method, using a subsidiary commonly referred to as a Passive Investment Company (PIC) or Delaware Trademark Holding Company, exploits the fact that Delaware does not tax income generated by intangible assets, such as a trademark, when held by the Delaware-based subsidiaries of a Delaware holding company. To reduce taxation in a state that has high tax rates, the high-tax rate parent company or high-tax subsidiary pays the low-tax Delaware subsidiary a fee for the use of the trademark or other intangible asset. The fee is deductible against income earned in the high-tax state company, and is not taxable in the state of Delaware. Thus, by engaging in a PIC strategy, the firm does not pay taxes to any state on the income shifted to the Delaware subsidiary and benefits from a deduction taken in a high-tax state for use of the intangible asset.
The idea that Delaware is a tax haven is not new, exactly, but this is a fascinating paper. Of course, the strategy described above would result in other states are losing tax revenue to Delaware. Thus, according to one of the commentators in this session, 22 states now have taken steps to counter this strategy. Could the door for PICs be closing? I don't know the answer to this, but the authors claim based on interviews of accountants that the strategy is alive and well.
We often get asked, here at the Conglomerate, why we don't monetize the blog - throw up advertising, talk to prospective suitors about the revenue stream, do a deal, and then outsource the business of writing posts offshore, while we live of the profits of our stock in Proctor and Gamble, or AIG, or whoever buys us.
One reason, sadly, is tax avoidance. I'm a bit late to this, but the city of Philadelphia, if you haven't seen it, is charging blog owners who take ads for a business license. Is that constitutional? We're going to let Concurring Opinions bring the test case.