Paper for the 2015 Philosophy of Management Conference
David Silver
Chair in Business and Professional Ethics, and Director
W. Maurice Young Centre for Applied Ethics
The University of British Columbia
david.silver@ubc.ca
ethics.ubc.ca
Paper Title: Tax Ethics and Corporate Inversions
Track submission: Philosophy of Management, Ethics and Economics, or Divers
I. Introduction
The recent merger between the U.S. fast-food giant Burger King and the
Canadian coffee and donut chain Tim Horton’s renews questions concerning the ethics
surrounding the paying of taxes by corporations. By headquartering the merged
company in Canada, the company will save hundreds of millions of dollars in U.S. taxes.
From another point of view, the U.S. Treasury will be deprived of several hundred
million dollars due to a largely tax-motivated corporate merger.
This merger is both legal and highly profitable. In this paper I explore the idea
that this tax-motivated merger is nonetheless morally wrong. I begin noting that
governments are morally necessary, and that in order to properly function, they require
an effective scheme for taxation. All members of society thus have an obligation to
comply with a fair tax system.
This raises the question of what a “fair” tax system looks like, and what counts as
“compliance”. I maintain that what counts as a fair tax system is a matter about which
reasonable people may disagree, and that the resolution of this matter should be left to
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a democratic system in which the interests of all citizens are treated equitably. It is not
up to each corporation, or corporate managers to determine what is a fair system.
Second, I maintain that when possible compliance with a tax code requires that
taxpayers honor the spirit, and not just the letter of the code. It is not always possible,
however, to follow the spirit of the tax code. This is because tax codes are based on
presumptions about economic transactions that can cease to be true. For example, a
historic premise of taxation has been that economic activity is location-bound. The
emergence of intellectual property, however, has disrupted this assumption. By holding
intellectual property in a low-tax jurisdiction, and charging for the use of the intellectual
property, a company can transfer substantial profits away from high-tax jurisdictions.
There are certain policy responses that jurisdictions can make in response to the
upending of presumptions within their tax codes. They can lower their taxes to be
competitive with low-tax jurisdictions, or they can change the tax code to attempt to tax
a “fair share” of the economic activity.
Both responses are problematic. Lowering taxes is problematic because it
introduces a race to the bottom in terms of corporate taxation. Changing the tax code is
usually a good idea but will often be ineffective when there is a widespread business
culture that seeks all legal means to minimize paying taxes. This includes discovering
loopholes, and lobbying against more effective regulations.
I maintain that the inadequacy of these policy responses is rooted in the
mistaken idea that corporations have no social responsibilities with respect to taxation
other than compliance with the letter of the law. Instead, I argue that corporations have
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an obligation to not take advantage of failures of the tax code; and, they have a positive
obligation to work with tax authorities to fix these failures.
II. The Business Purpose Test
One response to the view I have just put forward is that businesses are morally
free—or even morally required—to perform a tax-saving corporate inversion provided
that there is some business purpose for doing so other than the avoidance of tax. This
response is due to a bedrock feature of American tax law called the business purpose
doctrine. It holds that a tax-sheltering transaction must have some legitimate business
purpose other than the avoidance of taxes; otherwise it is disallowed for tax purposes as
a ‘sham’ or ‘abusive’ transaction.
The business purpose doctrine traces its origins to the 1934 case Helvering v.
Gregory in which Judge Learned Hand ruled that tax-motivated transactions must be in
accord with both the letter and the spirit of the tax code.1 Ironically, a quote from
Hand’s opinion has become a bit of sacred text among promoters of various tax shelters
and can be found widely on websites of companies marketing them. It states that:
a transaction, otherwise within an exception of the tax law, does not lose its
immunity, because it is actuated by a desire to avoid, or, if one choose, to evade,
taxation. 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.
Although this quote is typically offered as a defense of attempts to get around the spirit
of the law this is exactly contrary to what Hand meant by writing it. All that the quote
1 69 F.2d 809 (2nd Cir. 1934)
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states is that if a transaction is motivated by a desire to avoid taxes this does not as such
make the transaction illegal, unpatriotic or immoral. It does not say that any transaction
which is so motivated is legal, patriotic or moral.2 His point was that it wasn’t wrong to
seek to lower one’s taxes so long as one was in conformance with the spirit of the law;
however in no way did he endorse trying to lower one’s taxes by violating the spirit of
the law. I will add that it comes as little surprise that those who have a disregard for the
spirit and fairness of the law are similarly inclined to take Hand’s words out of context
and use them in a way opposite to their intended meaning.
The development of the business purpose doctrine within American tax law
stands in contrast to a contemporaneous development in Britain. Shortly after the
United States Supreme Court affirmed the Helvering decision the British House of Lords
faced a similar set of facts in the Duke of Westminster Case.
In that case the Duke of Westminster devised a scheme in which he deducted
from his taxable income the wages he was paying to his servants. Normally, this would
not be allowed; however, British law did allow deductions for the payments of annuities.
Westminster’s scheme was to agree with his servants that he would pay them via an
annuity instead of a regular salary for a period of seven years; he thereby claimed the
annuity payments as a tax deduction. During that time the servants would be doing their
2 In a later case Judge Hand made the general case for a purposivist approach to the law:
Of course it is true that the words used, even in their literal sense, are the primary, and ordinarily
the most
reliable, source of interpreting the meaning of any writing: be it a statute, a contract, or anything
else. But it
is one of the surest indexes of a mature and developed jurisprudence not to make a fortress out of
the
dictionary; but to remember that statutes always have some purpose or object to accomplish,
whose
sympathetic and imaginative discovery is the surest guide to their meaning. [Cabell v. Markham, 148
F.2d
737, 739 (2d Cir.), aff'd, 326 U.S. 404 (1945)]
5
normal duties even though the agreement stipulated that the annuity payments were
technically not in exchange for them.3
The case was decided in favor of Westminster and it provided the key legal
precedent for a “narrow, literal, pro-taxpayer approach which had dominated British
and Commonwealth tax-avoidance law until the 1960s.”4 In the decision Lord Tomlin
opined that "Every man is entitled, if he can, to order his affairs so that the tax attaching
under the appropriate Acts is less than it otherwise would be". In doing so he echoed
Lord Clyde’s lines from an earlier case:
No man in this country is under the smallest obligation, moral or other, so to
arrange his legal relations to his business or to his property as to enable the
Inland Revenue to put the largest possible shovel into his stores. The Inland
Revenue is not slow - and quite rightly - to take every advantage which is open to
it under the taxing statutes for the purpose of depleting the taxpayer's pocket.
And the taxpayer is, in like manner, entitled to be astute to prevent, so far as he
honestly can, the depletion of his means by the Revenue.5
Unlike Hand’s statement these quotes really do support the idea that it is morally and
legally permissible to engage in tax avoision. [Leo Katz’ term for evading the spirit of the
law while adhering to its letter]. They portray tax payment and enforcement as an
adversarial if not outright antagonistic process between the taxpayer and the tax
collector.
Tomlin argued that the approach to the law which the American courts had
adopted which recognized the legal standing of the spirit of the law was wrong because
it substituted “‘the incertain and crooked cord of discretion’ for the ‘golden and straight
3 I follow the description of the case from Likhovski 15.
4 (Likhovski, 14 cite)
5Ayrshire Pullman Motor Services & Ritchie v CIR ((1929) 14 TC 754)
6
metwand of the law’”. In so doing he was invoking the words of a seventeenth-century
judicial opinion by Sir Edward Coke.
Tomlin’s idea is that a literal, non-contextual reading of the law is clearer and
fairer than a reading of the law which invites judges to use their discretion to discern a
purpose to the law. This however is a distortion of the original use of the Coke’s words
in favor of the “golden and straight metwand”. Coke was arguing that the law was to be
judged by professional jurists (i.e. the golden and straight metwand) rather than by the
legally untrained king (i.e. the incertain and crooked cord of discretion).6 He was thus
not arguing against judges using informed judgment about the spirit of the law; rather,
he was arguing against royal amateurs attempting to decide difficult matters of law, and
as such was an early and brave defender of an independent and professional judiciary.
Tomlin’s argument has another deep flaw aside from its misappropriation of
Coke’s words. An approach to the law which takes into account its purpose or spirit can
be “golden and straight” rather than “incertain and crooked” because it is often quite
clear to a competent judge what the spirit of a given law is.
These differing American and British legal decisions demonstrate the opposing
ways that judges can interpret the relationship between the letter and the spirit of the
tax code. This can be seen further in the ongoing development of the business purpose
doctrine within the United States.
While American courts have generally come to accept the business purpose
doctrine this has not always guaranteed a continual close connection between the letter
6 Prohibitions del Roy (1607) Michaelmas Term, 5 James I. In Conference Before the King. First
Published in the Reports, volume 12, page 63. [see p. 478-481 of text.]
7
and the spirit of the tax code. This is because there are many transactions which have a
non-tax related business purpose but which violate the spirit of the underlying tax code.
Indeed, it is often quite easy to come up with some non-tax-related business purpose
for a tax-motivated transaction.
Consider Accenture’s explanation for why it incorporated in the tax-haven
country of Bermuda.7 Its official story was that its European and Asian partners could
not stand its being headquartered in the United States, and its American partners did
not want to be headquartered in an Asian or European capital. So according to
Accenture lobbyist (and former Congressman) Robert Livingston “they picked a nice
island, Bermuda.”8 As he put it, tax avoidance was merely a “minor factor”.
While Livingston’s claims do not meet the laugh test this is beside the point here.
There was at least some business purpose to incorporating in Bermuda other than the
avoidance of tax and this is all that is required to formally satisfy the business purpose
doctrine.
Whether a court will accept a formal satisfaction of the business purpose test is a
matter of continuing development within American tax law. Some judges give wide
latitude as to what counts as a legitimate non-tax business purpose while others are
inclined to follow Hand’s lead in examining transactions according to whether they are
in accordance with the spirit of the tax code.
7 See this article in the American Prospect
8 Livingston was a former congressman from Louisiana who had nearly become Speaker of the
House.
Accenture had also hired “Bush family confidant Charlie Black. . .former senator Dennis DeConcini
(DAriz.)
and Reagan White House chief of staff Kenneth Duberstein” in their effort to turn back legislation
which penalized Accenture for incorporating in a tax-haven country. The Washington Post,
9/24/2002.
“Tax-Haven Firms Lobbying Hard Against Curbs” by Jonathan Weisman.
8
This highlights the fact that the relationship between the spirit of the law and
how the law is interpreted by judges is continually subject to change. This in turn helps
explain the push by the business community to get judges appointed who are likely to
interpret the tax code in a way which allows businesses to get around its spirit.
Regardless of the stance judges take towards the spirit of the tax code (and thus
regardless of the actual state of the law) textualism has become the dominant legal
philosophy of American tax practitioners. This is not only because it allows them to seek
ways to formally satisfy the business purpose doctrine while violating its spirit. Given a
textualist approach a lawyer can argue that the judicially-originated business purpose
doctrine itself is legally suspect. A textualist might thus argue that it and any other
judicially-originated doctrine meant to keep the letter of the law in accord with its spirit,
“are the product of judicial activism and either should no longer be followed, or at a
minimum should not be extended into new areas of the law.”9
This complaint of judicial activism is without merit. I have argued elsewhere that
it is wrong for judges to substitute their own judgments about constitutional principles
over the reasonably considered, but contrary judgments of elected legislatures. This is
wrong because it is anti-democratic. It is hardly anti-democratic, though, for a judge to
rule in a way that preserves the integrity of the democratically intended spirit of a law.
The implausibility of textualism as either a descriptive or normative theory of the
law raises issues of ethics on the part of accountants and lawyers who appeal to it and
the businesspeople who seek out their advice. While it is the role of lawyers to serve as
9 (p. 2-3 of online version) “Textualism and Tax Shelters” Noel B. Cunningham James R. Repetti
9
advocates for their clients they also have duties which constrain their advocacy. For
example, a lawyer may not advise a client to lie on the witness stand even if this would
be in the client’s best interest. Similarly, lawyers have an obligation to render opinions
on whether transactions will survive a legal challenge only if they have real grounds for
saying so. Since textualism is not generally accepted by tax judges it is wrong for lawyers
to opine as if this were the case.
Businesspeople have a correlative duty not to rely on the tax advice of morally
incompetent lawyers and accountants. It is thus not sufficient to hire a well-regarded
lawyer when his reputation is based on a willingness to serve the interests of clients at
the expense of his moral obligations. This means that corporate managers may not
simply shop within the reputable legal community until they find the legal opinion they
desire. Instead, they must evaluate the moral character of the lawyer—and by this I
refer to his character insofar as he respects the letter and the spirit of the law.
When businesspeople default on this obligation and simply find the lawyer or
accountant with the most permissive reading of the law they set up a powerful incentive
which can lead to the corruption of previously upright accounting and law firms.
Accountants and lawyers have strong standards of professional ethics but are also in
business. If the largest and most reputable corporations will only hire the most
permissive accountants and lawyers who happen to have a good reputation, then soon
more and more of those with a good reputation will deserve it less and less.
It is my fear that this process is already well underway. This is easier to see in the
case of accounting since just a few firms dominate the market for large corporate
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clients. Arthur Andersen’s facilitation of several of the Enron-era scandals and its
subsequent demise revealed a culture that had strayed far from the ideals of
accounting. This is not to say, of course, that all the employees and partners of
Andersen were morally corrupt. Indeed, it is quite a misfortune to be a morally upright
professional in an organization with a corrupted culture.
III. The Ethics of Corporate Inversions
This discussion of the business purpose test shows that a corporate inversion is
not morally acceptable simply because there is some business purpose for doing so
other than the avoidance of tax. Going further, I propose that a tax-motivated
transaction is wrong when its purpose is to remove business activity from the taxing
jurisdiction of the state in which the activity occurs.
Let me qualify this slightly. I am not saying here that it is wrong to move a
business out of a given jurisdiction for tax purposes. For example, it may be morally
permissible for a business to physically relocate to another state because of differential
tax regimes. What I am saying here is that it is wrong to set up legal and accounting
structures which remove a business activity from the taxing authority of the jurisdiction
in which it occurs.
The corporate inversion maneuver is a prime example. There is another tax
maneuver which it is combined with that is equally wrong. This involves the use of
intellectual property to transfer income from high-tax jurisdictions to low-tax ones. In
this maneuver a company sets up a subsidiary in a tax-haven country and transfers key
11
intellectual property, including the brand name, to it. (Whether it does so at an armslength
price is another matter). The subsidiary can then charge the parent company for
the use of the intellectual property.
This transfers income out of a high income country to the tax-haven. So for
example, a company can sell a computer worth several thousand dollars in the United
States; however, the U.S. company pays a royalty to its own subsidiary in the tax-haven
and thus be assured of making little or no profit. 10 Eventually, this expatriated income is
supposed to be returned and taxed in the US. The reality is that the income will only be
repatriated for a fraction of the statutory rate. This is due, among other things, to
patiently waiting for (and helping create) a once-in-a-generation “tax holiday” which
allows companies to repatriate income at minuscule rates.11
It is completely trivial to come up with a non-tax related business purpose for
setting up a subsidiary to hold and manage intellectual property.12 Nevertheless, I
submit that it is wrong to do so as a strategy for removing business activity from the
taxing authority of the jurisdiction in which it occurs.
It is also wrong for the tax-haven state to engage in “tax poaching” in which it
sets up a legal structure in which businesses can remove themselves from the taxing
authority of the state in which it conducts business activity. They can do this by allowing
companies to incorporate in the tax-haven, but pay vastly lower amounts of tax. It is
10 http://www.nytimes.com/2013/05/21/business/apple-avoided-billions-in-taxes-congressionalpanelsays.
html?pagewanted=2&hp
11 “As companies’ earnings have accumulated offshore, many executives have been pushing more
aggressively for a tax holiday that would allow them to bring back funds at lower tax rates.”
12 Apple executives disputed the characterization of Apple Operations International. “A.O.I.
performs
important business functions that facilitate and enhance Apple’s success in international markets,”
the
testimony states. “It is not a shell company.”
12
wrong for businesses to take advantage of tax-poaching opportunities both because it is
wrong to exempt themselves from legitimate taxing authority, and because it is wrong
to participate in the tax-haven’s poaching scheme.
Apple Computer has recently demonstrated a heightened form of these
maneuvers. Ireland has set up a tax-poaching scheme in which it permits companies to
pay as little as 2% in corporate tax. A quirk (feature?) of Irish tax law, however, allows
Apple to exempt some of its income from all taxation. While the US and other
jurisdictions base taxing residency on where a company is incorporated, Ireland bases it
on where they are managed and controlled. So, Apple’s intellectual property holding
company that is incorporated in Ireland, but managed in California is a tax resident of
nowhere. It produces what is dryly referred to as “ocean income”.
The net effects are dramatic for just this one company:
Apple Operations International has not filed a tax return in Ireland, the United
States or any other country over the last five years. It had income of $30 billion
between 2009 and 2012. By shuttling revenue between international
subsidiaries, Apple was able largely to sidestep paying taxes.
This situation is wrong for all the reasons I mention above; and it is additionally wrong
as it shifts the national tax burden from businesses to wage earners. While this is not
necessarily wrong in itself, it is wrong for companies to unilaterally make this policy
change.
IV. Business attitudes toward government and taxation
There are many lines of reply available here. But let me anticipate one: the
proper relationship between businesses and taxing authorities is adversarial—it is the
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job of a business to push the limits of what it can get away with, and the job of
governments to define and enforce limits.
I think this is a seriously wrong understanding of the appropriate relationship
between business and government. Businesses ought not to see themselves in an
antagonistic relationship with legitimate governments, such as liberal democracies;
rather, businesses should see the government as an important partner that creates the
social conditions for fair and effective markets. As Judge Hand realized, this partnership
does not require a company to pay any more than its moral minimum in taxes. But,
businesses should not try to minimize their taxes by removing business activity from the
taxing authority of the jurisdiction in which it takes place; and this is precisely what taxmotivated
corporate inversions do.
An adversarial view of taxation is not just unfair to those who must pay a higher
share of taxes, or receive less of the benefits of government spending. It rejects the
legitimacy of the state to tax business activity within its jurisdiction, at least with respect
to business income.
This may reflect a hostility to democracy itself. This is evident enough in the
Westminster case where a Duke is judged by the House of Lords. They displayed a class
solidarity against those who would dare threaten the privileges of the nobility. That
particular class system may be all but extinct; however, the adversarial attitude towards
taxation of the contemporary business community may reflect a class interest of a
modern-day elite. The business leaders—both entrepreneurs and managers—may see
themselves as the meritocratic lords of today. Their business success should be
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celebrated—and not punished through taxation. This is not an anti-tax or antigovernment
position. It is against governments that burden the people who deserve the
fruits of their success..
This is all highly speculative, of course; but regardless of the psychology
underlying business’ adversarial attitude towards governments and their taxing
authority, it is a morally illegitimate attitude to hold. Taxes are morally necessary, and
we all have an obligation to comply with a fair scheme of taxation. Businesses must not
seek ways of avoiding taxation altogether; rather, they can work with governments to
improve the efficiency and fairness of tax codes, while at the same time paying their fair
share of taxes.
Businesses can also show leadership by de-normalizing the adversarial stance to
government and taxation. Finally, businesses can turn their limited managerial attention
away from tax avoidance strategies, and towards creating value for all their
stakeholders.