May 6 Letter to Senate Finance Committee

Posted on May 4, 2013 by Roger Royse

May 6, 2013

The Honorable Max Baucus, Chairman

The Honorable Orrin G. Hatch, Ranking Member

Committee on Finance
United States Senate
219 Dirksen Senate Office Building
Washington, D.C. 20510

Re: Tax Reform Options and Proposals to Raise Tax Revenues under the March 23, 2013 Budget Resolution

Dear Chairman Baucus, Ranking Member Hatch, and Members of the Finance Committee (the “Committee”):

This paper contains suggestions as the Committee reviews proposals to reform the Internal Revenue Code of 1986, as amended (the “Tax Code”).

The Concurrent Resolution of the Senate Budget Committee proposes a deficit reduction plan and instructs the Senate Finance Committee to report legislation that will reduce the deficit by $975 billion through changes to the Tax Code. In particular, the budget guidelines acknowledge the goals of fairness as well as boosting economic growth.

The United States remains the world’s most desirable location for new companies to develop innovative technologies, resulting in job creation and increased productivity, especially in technology hubs such as the Silicon Valley, Boston and New York.  However,  companies also find themselves paying the highest tax rates in the world. In addition, domestic companies are subjected to a worldwide, rather than territorial, tax basis, placing them at an additional competitive disadvantage.

As an attorney who has represented international startup and tech companies in Silicon Valley since 1991, I observe that even startup companies now find it worthwhile to structure their operations offshore and limit their involvement in the United States. This development is significant since much new technology is developed and exploited in a startup environment. When the startup community leaves the U.S., the future of technology development and innovation also leaves the U.S. Much of the industrialized world awaits this migration with incentives, accommodating immigration laws and, importantly, low tax rates.

No one disagrees that fundamental tax reform is needed or that companies operating in the U.S. must confront negative incentives artificially created by our tax system. This paper suggests approaching tax reform and rebuilding our economy on three basic principles:

  1. Lower corporate tax rates;
  2. Territorial taxation while limiting deferral of tax on excess foreign intangible income; and
  3. Restricting the states from undercutting federal tax incentives through inconsistent, excessive and unfair tax policies.

Increasing revenues solely through removing or restricting tax expenditures, especially small business incentives such as additional depreciation under section 179 of the Tax Code, would unfairly shift a large portion of the tax burden to small business. This paper proposes increasing the tax base, rather than increasing the tax on the existing base, as a means of resolving the tax/budget gap.

Corporate Tax Rates.  Schedule A compares the federal and state tax burdens on companies doing business in California and in the United States as compared to  companies located in other countries.

Faced with this dramatic tax rate difference, a company seeking a jurisdiction in which to establish a business presence must clear a high tax rate hurdle before it can consider the United States. Multinational companies must pay a blended federal and state U.S. rate that is much greater (up to 25%) than in other industrialized nations.  A glance at the numbers illustrates that reducing corporate rates may be the single most significant tax factor confronting inbound and international investors.

Territorial Taxation/Excess Foreign Intangible Income.  The Budget resolution notes the migration of intangibles from the U.S. to low- or no-tax jurisdictions and, in fact, almost every large multi-national company has a foreign IP holding company structure in place.  It is likely only because mobile or intangible income can be easily moved offshore (and reduce the effective worldwide tax rate) that U.S. companies have tolerated high corporate tax rates. As noted, a system that encourages foreign migration of intangibles is costly in the long run, as jobs, business and economic activity shift to foreign jurisdictions. Thus, any proposal to reduce corporate tax rates should also encourage the repatriation of foreign earnings back to the U.S., both through territorial taxation and cessation of tax deferrals on foreign mobile (or intangible) income.

Limits on State Taxation. One of the factors contributing to the decline of American competitiveness has been the increasing tax bite of states seeking new forms of revenue.  For example, as illustrated in Schedule A, the state of California takes almost 9% in additional taxes.  In states such as California, even a lowered 25% federal corporate tax rate will result in an excessive combined federal and state rate. Thus, a tax reform proposal that seeks to increase the taxable base through lower corporate rates and territoriality must also address the effect of state taxes on those goals. In particular, the following general tax initiatives would be most consistent with the federal tax reforms:

  1. Extend Public Law 86-272 to apply to all income;
  2. Mandatory Tax Code conformity with respect to certain federal tax incentives; and
  3. State compliance with international treaty obligations.

Each of these ideas is further developed below.

It is important to note that there is precedent for federal oversight when states have over-reached on tax issues. For example, Public Law 104-95 prohibits state taxation of certain pension income of nonresidents.  Public Law 86-272 (PL 86-272) prohibits the states from imposing net income based taxes on non–domiciliary sellers of tangible personal property. Both of these laws reflect the power of Congress to limit state taxation of interstate commerce.

Extend Public Law 86-272

No discussion of raising the tax base by lowering rates can ignore state income taxes. While it may seem that states should be free to compete with other states with respect to tax rates and other incentives, at the global level the competition is more properly framed as a comparison of combined U.S. federal and state tax rates vs. foreign country tax rates. Voters in California, for example, recently increased the top marginal individual income tax rate to 13.3%. The result of this increase will not merely force companies out of  California; because of California’s unique position as the nation’s technology and venture capital hub, the likely result will be to force companies out of the country. In that regard, confiscatory state income taxes frustrate federal tax policy and should be restrained so as to not burden interstate and international commerce.

PL86–272 prohibits a state from taxing a company’s income if it’s only activities are solicitation of orders for sales of tangible personal property which are sent outside the state for approval or rejection and are filled from outside the state. Since the enactment of PL 86-272, however, the global economy has evolved, and remote services and information technology are now significant businesses worldwide. The law, however, has not kept pace with these changes and the concepts that limit a state’s right to tax sales of tangible personal property have not been extended to other types of income.

In the new economy, companies from all over the world may do business in the U.S. with very little physical contact. Based on an ambiguity left open in Quill v. North Dakota, many states are now imposing income taxes based on “economic nexus” as opposed to physical presence. Economic nexus refers to nexus based on the amount of business done in a state. California nexus exists, for example, if a taxpayer’s sales in California exceed the lesser of $500,000 or 25% of the taxpayer’s total sales, a taxpayer’s real and tangible personal property in California exceeds the lesser of $50,000 or 25% of the taxpayer’s total of such property or if compensation paid by a taxpayer in state exceeds the lesser of $50,000 or 25% of the total compensation paid. R&T Sec. 23101.

Unfortunately, the result is a confusing and contradictory set of tax rules that complicate business decisions. A comparison of state nexus laws is compiled at http://www.cob.sjsu.edu/nellen_a/taxreform/economic_nexus.htm. Unfortunately, the trend is to tax companies that have no physical contact with a state, thus undermining Congressional initiatives designed to make the US more competitive in the global economy.

The Quill case has left the door open for Congress to define the extent of the states’ right to tax out of state businesses. Congress should act to impose a uniform nexus standard by extending PL 86–272 to income from services and intangibles.

Mandatory Tax Code conformity with respect to certain federal tax incentives

The Tax Code contains many provisions designed to encourage innovation of investment in various areas. For example, the research and development (R&D) credit encourages new R&D.  Recently, the tax exemption for gains from the sale of qualified small business stock (QSBS) was extended. Again, however, the economic activity encouraged by the Tax Code is frustrated by some states’ nonconformity with federal tax law.

The Franchise Tax Board in California, for example, has recently determined that the state QSBS tax exemption is unconstitutional because it required that economic activity occur in the state.  That reasoning could be extended to deny state R&D and Enterprise Zone credits as well.

The federal policy behind the enactment of the QSBS provisions (in this case, to encourage investment in startups) is frustrated by a contrary state tax treatment. At a 13.3% top marginal rate (when the federal savings was only 15% [20% in 2013]), it is easy to see that state tax treatment is almost as significant as federal tax treatment of this particular item.

The state codes are filled with provisions that contravene the policy behind the federal laws. Congress should designate certain incentives as mandatory for state tax purposes. QSBS is one example.

State compliance with international treaty obligations

One of the more significant impediments to the conduct of commerce between U.S. companies and companies in ther nations is the lack of treaty protection at the state level for foreign trading partners. U.S. income tax treaties exclude coverage of state income taxes, and no U.S. income tax treaty extends to state taxes. As a result, foreign companies regularly find themselves exempt from federal taxes but burdened by state taxes if they attempt to do business in this country.

For example, a foreign corporation might find that it is exempt from federal tax on its US business income because it lacks a US permanent establishment, yet find that it is subject to tax under a state’s economic nexus standard. Similarly, that corporation might claim an
exemption from withholding on dividends, interest or royalties under a tax treaty, yet find itself subject to state tax withholding on the same income.

When the federal government enters into an income tax treaty to avoid double taxation of income, state tax rules completely undercut that policy. The states should be required to conform to federal law in this important area.

The foregoing is a non-exclusive list of areas in which tax reform could serve to increase the table base and promote a consistent federal/state policy goal. As a tax and business law practitioner, my perspective is entirely anecdotal and economic analysis is appropriate to gauge the economic drain that results from state tax overreaching. I am available for meetings, testimony or further comments if requested.

Very truly yours,

Roger Royse, Founder

Royse Law Firm, PC

Schedule A

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Comments on Tax Reform Submitted to Small Business/Pass Throughs Working Group

Posted on April 14, 2013 by Roger Royse

April 14, 2013

Dear Representatives Buchanan and Schwartz:

The Small Business Draft provides for two options for reform of the rules relating to the taxation of pass-through entities. My comments address both options.

Option 1 contains changes to the S corporation rules that are long overdue in eliminating tax traps and “gotcha’s” that have deprived many taxpayers of the benefit of S corporations due solely to inadvertence. Other S corporation provisions remove some restrictions on qualifying for S corporation status. In particular, the restriction on the ability of a non-resident alien (“NRA”) to be a shareholder of an S corporation has been very problematic for many companies. Under current law, if an S corporation desires to acquire NRA equity and maintain pass-through tax treatment, the company must engage in complex restructuring through blockers and non-corporate entities. The proposal to allow non-resident aliens to hold stock through an electing small business trust (“ESBT”) is helpful but does not go far enough. The benefit of the proposal would only be available to taxpayers who can plan into NRA ownership and establish an ESBT. The proposal would not help companies that lose S status because of a change in status of a shareholder from a US person to an NRA or the transfer of an interest by a shareholder to an NRA. This is one of the few places in the tax law where one taxpayer’s (the S corporation shareholder) tax consequences may be determined by another person (the transferring shareholder). Not only should S corporations be allowed to have NRA stakeholders, the corporation should not be at risk of losing the S election due to the changing status or transfer by one of its shareholders.

The ESBT accomplishes the goal of retaining tax jurisdiction over the share of S corporation income of the NRA, but is itself subject to technical requirements that may not be widely understood or easy to meet. Given the policy concern of taxing NRAs on their share of the S corporation’s income, a narrower and more effective approach would borrow from the partnership withholding rules, and require the S corporation to withhold on the NRA’s share of effectively connected income and fixed or determinable or periodic income at a statutory or treaty rate. Thus, I suggest that the S corporation itself be subject to the same withholding rules that currently apply to partnerships with foreign partners.

Option 1 also repeals the rules relating to guaranteed payments, in effect allowing partners to be employees. Anecdotally, it is the commentator’s experience that the rules prohibiting partners from being employees is so counter intuitive and contrary to the way business is conducted that it is widely disregarded in practice. Large employee leasing companies have taken the position that partners can be employees under published IRS guidance. In addition, some states do not follow the federal rules on classification of partners and, in fact, require partners to be treated as employees even though they may not be treated as such for federal withholding purposes, creating complexity and confusion in withholding. The proposed change would eliminate a regime that has served little purpose and has burdened rather than benefitted withholding on compensation as an enforcement mechanism.

Option 2 proposes a unified system of taxation of pass-throughs that addresses the concern that different tax treatment may result from the same transaction due solely to choice of entity. The proposal prohibits special allocations, allows allocations only of net (and not gross) income and loss, requires entity level withholding, and requires gain on distributions of appreciated property. Option 2 would repeal well established partnership tax concepts and I oppose Option 2 for the following reasons and in the follow specific respects.

Fundamentally, I disagree with the proposition that a “one size fits all” structure is necessary or appropriate. For very good corporate and tax reasons, each of the S corporation, C corporation and partnership tax structures have qualities that fit certain businesses. At its core, some businesses are more properly conducted through an “entity” (the entity is a separate tax or reporting vehicle whose interests are separate from its owners) whereas others are more properly conducted as an “aggregate” (the entity is a relationship among its owners which pools or reflects the separate interests of its owners). See my article on this distinction at http://www.rogerroyse.com/PDF/MetaphoricalConstructsinLegalAnalysis042502.pdf. The partnership structure preserves the ability to operate as an aggregate of members while limiting those members’ personal liability. Removing this aggregate feature (which the proposal would do) will result in a loss of a basic method of structuring business ventures and will require the creation of complex multi entity structures to accomplish the same result.

The defining needs of the entity model are (i) differing risk levels, goals and levels of participation of the stakeholders, (ii) the ability to preserve continuity of interest or ownership in an acquisition, (iii) centralized management, and (iv) the ability to use equity as compensation. Prior to the “check the box” regulations (Treasury Regulations sections 301.7701-1 through 301.7701-3), the tax law recognized the characteristics of a corporation as (i) limited liability, (ii) centralized management, (iii) free transferability of interest, and (iv) continuity of life. While those distinctions may have been forgotten in a “check the box” age, they are useful in determining whether a business venture is more like an entity or more like an aggregate and how it should be taxed. The S corporation as an entity fits many operating businesses since it may have (i) numerous stakeholders, such as founders, investors, employees and creditors, (ii) a board of directors and selected officers, and (iii) the expectation of exiting via a stock for stock exchange or merger.

The partnership (or limited liability company [LLC] taxed as a partnership) structure, however, is better suited to combinations that are more properly viewed as aggregates of its members. Pooled real estate investment, in particular, is often considered an aggregate of the owners, which is why most real estate is held in LLC or limited partnership form. In fact, if not for the limited liability that LLCs provide, jointly owned real estate would almost always be held as tenants in common (“TIC”) interests.

Pooled securities investment vehicles, such as private equity and investment funds, are similarly well suited to aggregate models. In both those cases, the venturers seek to pool their resources for economies of scale or market reasons to acquire and hold for investment, as an aggregate of its owners, the acquired assets. In that regard, partnership structures look more like aggregates than entities, and the tax law has accommodated this market reality in Subchapter K of the Internal Revenue Code of 1986, as amended (the “Code”).

The analogy is not perfect, of course, and there are places where partnerships are treated as entities and not aggregates, and S corporations are treated as aggregates and not entities, but the basic distinction has evolved to reasonably fit business practice. Option 2 ignores the fundamental difference between entity and aggregate business combinations.

Specifically, Option 2 is problematic in two main areas. First, the concept of recognizing gain on distributions of appreciated property may fit the entity model, but runs contrary to the type of business that could just as easily be conducted as a TIC pursuant to a co-tenancy agreement. The ability to freely transfer property in and out of a partnership is the single most important distinction in making a choice of entity decision when the business is an appreciating asset such as land or securities. The entity model simply does not work for that kind of business, and those types of businesses will opt for inefficient TIC arrangements before accepting that model.

Secondly, Option 2 proposes to limit the ability to specially allocate gains and losses. Currently, the Code contains numerous restrictions on special allocations to ensure that such allocations must have “substantial economic effect.” In the aggregate model, differing stakeholders will regularly accept degrees of risk that may or may not match their percentage ownership in other partnership items. It is fair to allocate gross income and loss to the partners who actually benefit or lose economically. In fact, it would inappropriately shift loss or gain in some cases if such special allocations were not allowed.

In conclusion, I support the modernization of the S corporation rules to remove artificial impediments to doing business through the S corporation form. However, I oppose the unification of pass-through taxation as unworkable and inefficient.

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Comments on International Tax Reform Submitted to House Ways and Means Committee

Posted on April 14, 2013 by Roger Royse

Comments: International Tax Reform Working Group
Dear Representatives Nunes and Blumenaur,
The Silicon Valley of Northern California has become one of the most desirable locations in the world for new companies to develop innovative technologies, create jobs and contribute to the nation’s productivity. As business has become increasingly global and income has become more mobile, US businesses face increasing competition from companies based in other countries. However, companies in the US now find themselves paying the highest tax rates in the world. The US is not only unattractive in terms of tax rates, it is also unattractive in its method of taxing on a worldwide rather than territorial basis.
The last major tax reform in the United States was the Tax Reform Act of 1986 (“TRA ‘86”). Since that time, whole industries have emerged that did not exist before. Some of the largest companies in America could not have even been conceived of in 1986. Taxable income has become “mobile” and workers transient in ways that our tax laws are ill-equipped to deal with. More significantly, foreign businesses have become much more competitive and mobile.
While global tax rates have decreased and competition has increased, the US tax system has changed very little in some important ways. Practitioners struggle to apply decades old statutes and antiquated regulations to new transactions and business relationships. Having represented international startup and tech companies in Silicon Valley since 1991, I observe that even startup companies have now find it worthwhile to structure their operations offshore and limit the involvement in the United States. This development is significant, since much new technology is developed and exploited in a startup environment. When the startup community leaves the US, the future of technology development and innovation also leaves the US. Much of the industrialized world awaits this migration with incentives, funding and, importantly, low tax rates.
It is clear that fundamental reform is needed to remove the negative incentives artificially created by our tax system. The time has come to revamp both the tax rates and the tax system.
Given the existing tax environment, I applaud the efforts of the Committee and agree with the proposed approach that would:
1. Lower corporate tax rates to no more than 25%;
2. Tax US companies on a territorial basis by granting a participation exemption for dividends received from foreign subsidiaries; and
3. Limit deferral of tax on excess foreign intangible income.
I believe that the proposed changes, if enacted into law, would increase the US tax base by incentivizing global startups to locate in the US and encouraging multi-nationals to remain in the US.
While the proposals go a long way towards increasing America’s global competiveness, they do not address the problem of creeping state tax jurisdiction. In recent years, many states have steadily increased the tax burden on out of state and foreign companies operating within their borders. In some states, such as California, even a lowered 25% federal tax corporate rate will result in an excessive combined federal and state rate.
High state tax rates, when combined with the federal rates, discourage companies from locating in those states, even though the location of their markets, talent and financing may make those states logical places to establish themselves. Sometimes companies that are taxed out of a state will locate in another state; often, in my experience, they will simply leave the country, taking their talent, jobs and technology with them. Some
states have not only discouraged inbound investment through tax rates; many states have become notoriously more aggressive about finding sales and income tax nexus for imposing tax on international technology companies. While the states’ ability to impede interstate commerce is limited by the Commerce Clause of the US Constitution, no law exists that prevents excessive state tax rates or compels states to comply with tax treaties negotiated with foreign countries.
I will, within the next several days, submit comments proposing that Congress act to limit the ability of states to frustrate the efforts of Congress to encourage companies to do business in the US. In particular, I will propose the consideration of the following initiatives:
1. A federal limitation on the maximum rate of tax on income that states may levy;
2. The establishment of a uniform income tax nexus standard for information technology companies;
3. A Code-conformity requirement with respect to certain federal taxes designed to encourage innovation and investment; and
4. A requirement that the states comply with treaty obligations negotiated by the United States with foreign countries.
The idea of Congress regulating state taxes may at first seem unusual, but it is worth noting that there is precedent for federal oversight when states have over-reached on tax issues. For example, P.L. 104-95 prohibits state taxation of certain pension income of nonresidents. I am mindful of the significant constitutional issues involved in the regulation of state taxes, and am confident that, in view of the significant adverse effect state tax policies may have on international commerce, Congress can find constitutional authority in the Necessary and Proper Clause.
These ideas will be further developed in additional comments.
Roger Royse
Founder
Royse Law Firm, PC

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That Big Sucking Sound (or The Tax Rush of 2013)

Posted on January 20, 2013 by Roger Royse
Ross Perot coined the phrase “giant sucking sound” in 1992 to refer to the job loss that he thought would result under NAFTA. Twenty years later there is a different sucking sound – the sound of California’s eroding tax base under the Proposition 30, which was approved last fall. Proposition 30 increases the California sales tax rate and imposes higher taxes on taxable income over $250,000. Best of all, it applies retroactively to January 1, 2012, so you could end up paying more tax on income earned a year ago. Based on the new tax rates, California is actually expected to have a budget surplus this year.

Or will it?

With the increased federal taxes, California taxpayers would now pay a marginal rate of tax of up to 56.7%.  According to the Tax Foundation, a non partisan tax research group based in Washington D.C., California now has the highest statewide sales tax in the nation (7.25%), the second highest personal income tax in the nation ((10.3%) and the highest corporate tax rate in the West (8.84%).

Can you guess where I am going with this?

Several years ago, while I was on some (don’t laugh) business related junket to Las Vegas, I had the opportunity to hear state governmental and business leaders pitch their benefits to out of state companies. The basic theme was simple, not at all subtle, and very direct: “We Are Not California”. Yes we have drugs and gangs and OJ Simpson, but at least We Are Not California. The corollary was “So Move here Now.”  I was so impressed by the pitch that I ran right out and took the Nevada Bar exam (PS – I passed [yay!]). And then…. I waited…. And….Not much happened. I would have to admit that I did not get much benefit out of taking the bar exam, other than four days of testing in balmy Las Vegas in late July.  They held the exam in Vegas in July, by the way, because apparently the surface of the sun was all booked up.  Now it looks like I may be able to dust off my Nevada bar license and help some soon-to- be-former Cali’s move.

And I am not trying to pick on Nevada. Many other states have followed suit. Arizona and Oregon have regularly harvested companies from California with their more business friendly climates back when we had lower taxes. What do you suppose is going to happen now?

We call it erosion of the tax base, i.e., when you tax the rich with the expectation of getting more revenues, you end up losing a certain percentage of taxpayers. Because 14% of 0 is less than 10% of anything, you end up with less tax revenues from the taxpayers that leave, so the big question is “will enough people stay to make up for those who leave?” And will the extra 4% on the Richie Riches that stay be more than the 0% on those who leave.

Obviously, no data is yet available but we do have anecdotal evidence.  By anecdotal evidence, I mean that I have stories about what taxpayers look like after I advise them of what to expect if they stay in this state. The early anecdotal evidence suggests (are you ready for this?) that it is going to be ugly. Ten percent tax rates people could live with – 13 and 14 percent many will not. Prepare for a great outbound tax rush to rival the inbound gold rush of 49. In fact, I am going to call it the “Tax Rush of 2013” ™. If you are smart, you already own property in Incline Village. If you are like the rest of us, you are studying your options.

It’s not all bad, of course. There will be the poor saps who stay. In addition, did I mention that the tax is retroactive to January 1 2012? That means even the Cali expats will not be able to escape one year of 2102 tax increase (so it looks like that budget will be balanced after all, but look out for 2013).

I think that we must resign ourselves to losing a few rich folks. The bigger question is what will this do to business. After all, I am also a business attorney, so I should be concerned about what happens to business. Fortunately, not all business decisions are based solely on tax, believe it or not, and businesses sometimes locate in California for business reasons. Personally, I moved here to watch drug free professional cycling, and you know how well that turned out. However, sometimes companies set up shop in California for the talent and brains that reside here. Sometimes they come for access to customers and technology or maybe even for the $30 billion of venture capital that is looking for a home. We call those companies “startups” and they do Not Pay Tax. Hardly ever. If they do, we revoke their office ping pong tables and make all their employees wear adult clothes, and call them “middle market.” Middle market sounds like middle age and it is just about as sexy (not) to the technoistas that hang out in my neighborhood.  Therefore, to avoid becoming middle anything, the founders exit before getting profitable and start all over with a new non taxpaying company. We call them “serial entrepreneurs” (or Peter Pan Syndrome Sufferers).

Besides, for someone who survived the dot bomb crash of the last decade, I can tell you that tax is not a bad problem for a company to have. It means they have income, just long enough to exit and start the next non-taxpayer. And that brings me to the subtle point that needs to be made. (whew! Finally).

The fiscal cliff deal gave startups and VCs a huge bennie when it brought back the 100% exclusion from gain for qualified small business stock. You can read all about it here, but in a nutshell, a founder or investor could escape ALL federal income tax on up to $10 million of gains from the sale of certain small business stock. IF that founder is smart enough to move to a tax haven state, like Nevada or South Dakota (the little known weaker sister of its much more prominent neighbor, North Dakota), they could avoid paying US income tax at all on sales gains. Think about that for a minute. Zero rate of tax. Nevada would be like the Cayman Islands, without the scuba diving.

Would California business owners actually do that? Would they dare to leave and “stiff” California out of its share of taxes? Would they actually buy a house in one of those states (in most states you can get a mansion for the cost of a windowsill in California) and maybe end up living next to a neighbor with a monster truck and a girlfriend named Porsche?

You bet your ass they would. It happens all the time. Even now.

Ross Perot was talking about something different when he came up with “giant sucking sound” but I think the name is still good, almost as good as “The Tax Rush of 2013” ™ which I invented. It sort of sounds like an IRS frat party thing, but I still like it.

Of course this is all speculation on my part. The California magic of innovation, film, finance and technology may offset the increased costs. As I said, no hard data is yet available. Unfortunately, by the time it is ready, it will likely be too late.

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New Year’s Resolutions, The Fiscal Hill and International Competitiveness

Posted on January 2, 2013 by Roger Royse

Saying so may be cliché, but I am a big believer in looking back on the past year, seeing what went right (and what went wrong) and making New Year’s resolutions. And so, here we go, at 10 pm on January 1, 2013, my top ten New Year’s resolutions:

Resolution #1: I am going to do More of Everything. More exercise, more work, more sleep, more time with friends and family, more deals, simply more of everything. Instead of my usual ten resolutions to do more of this and more of that I decided that, fundamentally, what I really mean is that I am going to do More of Everything. Period. Except of course the things that I am going to do less of, which leads me to….

Resolution #2: I am going to do Less of Everything Else. This would include less red meat, less processed sugar, less overpriced Scotch, less speeding (and less speeding tickets). In a nutshell, Less of Everything Else.

Resolution #3: I am going to buy a television. I swear, this is the year I break down and do it. Growing up on the Northern Plains, we had only one television station when I was young. Thus, we all watched the same lame programs until a second channel came to our town. At that point, a great philosophical divide emerged which threatened our peaceful co-existence – StarTrek or Gilligan’s Island. We could curse the evil network demons for putting the two best shows up against each other in the same time slots, but we still had to choose. There was no middle ground, no TiVO. I was in the Gilligan’s Island camp, by the way (StarTrek didn’t have a “Ginger”), and fought many battles arguing the merits of my position.  While I was convinced of the nobility of my cause (Gilligan’s Island offered practical advice, after all. What if you Did get stranded on a deserted island?), the whole experience left me with a bad taste in my mouth for television, so I don’t have one. Not one that works, anyway. I think I’m better now. I think I can handle it. Thus, 2013 = New TV.

Resolution #4: The budget deal sucks (the Biden/McConnell deal). OK, maybe that’s not a resolution, but it just does. It does nothing to address spending and still leaves the US as one of the most highly taxed jurisdictions in the world, right up there with Japan. If you live in California, it is even worse with the recent tax increase called for by Prop 30. Plan on up to 10% state income taxes as opposed to Zero in Nevada, Washington and other states that are now filling up with former Californians. I may not be great at math, but the difference between 10% and 0 is 10%! That means that marginal federal and state rates in California will exceed 50%. That’s a high hurdle for Californians to clear.

Early today (January 1), the Senate passed the American Taxpayer Relief Act. Late tonight, the House passed the ACT and the President is expected to sign it as soon as possible before anyone realizes how bad it really is. The Act will prevent many of the tax increases that were scheduled to go into effect today. The Act will also increase income taxes for individuals with taxable income over $400,000 ($450,000 for married taxpayers, $425,000 for heads of household) to a 39.6% rate.

There is some good news in the Act. A temporary exclusion from gain from certain qualified small business stock is back (for a little while anyway). It would patch the alternative minimum tax (AMT) by raising exemption amounts. The AMT was enacted many years ago to ensure that rich folks who avoid income taxes through fancy tax shelters pay their fair share. Had it not been patched, it would have caught a large percentage of all filers, according to the IRS. Congress really had no choice but to patch this and hopefully they will someday repeal it. The tax rate on capital gains and dividends will go from 15% to 20% for taxpayers who would be subject to the new 39.6% bracket. The rest of the income tax changes are more annoying than significant. The personal exemption and itemized
deductions would phase out for high income individuals. Estate, gift and generation-skipping transfer (GST) tax will not increase, thus mooting a lot of what most of us have been stressing about this past month. Specifically, the exemption level will remain at $5,000,000 (as indexed for inflation) and the top estate, gift and GST rate will rise from 35% to 40%. Bonus depreciation is extended, so if you loaded up your credit card at Fry’s before year end to get the tax bennies, the joke is on you. The temporary payroll tax cut actually was temporary, and is now history. The Act doesn’t deal with the spending side of the equation, but that day will soon come.

So why don’t I like this deal? Because the bill does not touch corporate tax rates, and the rates are still too damn high. All of the recent chatter about the fiscal cliff has sounded like the US tax system is the only system in the world. I’ve got news for you – just like California industry will move to Nevada to avoid state taxes, US intellectual capital will move to more tax friendly jurisdictions to avoid federal tax and, believe me, those foreign
jurisdictions are lobbying for the business. Much like Nevada’s value proposition is “We are Not California” you can expect the rest of the world to continue to sound the theme that they Are Not The US when it comes to taxes.

This is hardly news. Even the Obama Administration recognizes the damage of the flight of technology from the US. Recall that the Administration has proposed taxing US companies on certain income from technology transferred offshore, reflecting its stance of punishing the removal rather than rewarding the return. See The Territorial Tax, or Why Does Congress Hate Technology? The damaging effect of our immigration policy (which mandates the removal from this country of US educated brains and the companies they spawn) has also been beaten to death by almost everyone, including me.

So, as much fun as it was to watch the President make speeches and listen to commentators comment and pundits pund, or whatever it is that they do, we are going to continue to be engaged in a  tax rate debate for the rest of the year; indeed, for the rest of this Administration. While that happens, the base will erode and foreign trade offices will continue to set up shop in our backyards. We may not be going over a cliff, but we are rolling down a hill. It’s time for Congress to address these problems before the descent picks up too much momentum to stop.

I had 6 more Resolutions to go, but they just don’t seem so important anymore. Not until we nail this issue of taxes, international competiveness, and the migration of talent and technology from the US to foreign shores.

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Manifesto

Posted on November 17, 2012 by Roger Royse

The Santa Cruz beach boardwalk was quiet at 10 am on a weekday morning in late October. The arcade was empty and only a few surfers could be seen out on the waves that pound the northern California coast that time of year. The amusement park next door to the Coconut Grove was still silent, and at first I assumed that my GPS had yet again taken me to the wrong place, but I entered the arcade anyway. At least I could get a good view of some beach volleyball players from there.

It turns out that my GPS got it right – the venue for “Branding the Monterey Bay Region to the Global Marketplace – Annual luncheon with Congressman Farr” was indeed located  next to a Ferris wheel.  The event, hosted by the Monterey Bay International Trade Association (MBITA) was designed to highlight the benefits of commerce in the region, especially international export commerce. Congressman Sam Farr, who was running for re-election, was there to keynote and most of his speech was quite predictable (this is a great place, we have farms, we have wine, we have tourism etc., etc…) BUT finally someone asked the question that was on everyone’s mind – “what will happen on January 1? Will we fall off the cliff?” Congressman Farr didn’t think so. He concluded that (regardless of who wins the presidential election) we would likely have last minute extensions. This is hardly news, but it is nevertheless annoying that nobody expects that our government can solve this most basic of issues.

But this blog post is not about the fiscal cliff. Everybody has already blogged about that and unless you are living on the beach, you know about the stakes, the tensions, the political posturing and the brinksmanship that is delaying the onset of fiscal responsibility. This post is not even about taxes (my favorite subject) and the fact that almost everyone in politics (including the President – better late than never) has finally figured out that having that highest tax rates in the world is not helpful when you are trying to keep business and jobs in the US (See http://rogerroyse.com/blog/2012/01/25/the-warren-buffett-tax/). This post is about the inaction that is dragging the US and, especially, the California economy down while the fiscal cliff sideshow diverts our attention.

I have blogged before about what other countries are doing to encourage innovation (See http://rogerroyse.com/blog/2012/02/16/startup-nation/). The US will clearly never go to a direct subsidy and I am not asking it to. I am simply pointing out what the competitive environment looks like. Against that back drop, companies establishing a presence in the US must face a restrictive immigration policy, high tax rates, inconsistent tax treatment, and a hostile legal environment. My hope is that the new Congress will address the following big hurdles that stifle innovation and inhibit economic growth. Here is my list,
my manifesto:

Immigration Reform.

The President mentioned immigration in his acceptance speech, which is good because our immigration policy is outdated and counter-productive. In the agricultural industry – the largest industry in the state of California – the existing H-2A temporary agricultural worker program has not met the needs of employers and workers.  A farm group has proposed a practical visa program that would reflect business realities. See http://www.agalert.com/story/?id=4820. In the tech world, the Startup Act 2.0 enjoys bipartisan support and is designed to create incentives for entrepreneurs to start new business.  See Congress Should Pass The Startup Act 2.0 for an excellent discussion of the Startup Act.

Our outdated business immigration policies have been a drag on the US economy and the first order of business should be to implement the entrepreneur visa program, allow green cards for foreign students with technical degrees, and raise the arbitrary caps on visas for highly skilled immigrants.

International Tax Reform.

I have harped on this issue before (see http://rogerroyse.com/blog/2011/11/26/the-territorial-tax-or-why-does-congress-hate-technology/) and I will do so again. The current administration’s approach has been to create US jobs by making it painful for companies to leave rather than making it beneficial for them to stay. If you want to see how well that strategy has worked, ask me how many of my clients now have Cayman Islands PO box addresses (Hint: A Lot). One of the best things that the Romney/Ryan campaign did was force the administration to loosen up a bit on this issue and propose lowering the corporate tax rate to 28%. It’s not great, but is better than where we are now. That was campaign rhetoric and the cynical might say that there is now no political reason that it will happen, but I would like to believe that Washington knows that we cannot remain competitive when we are lumped in with countries such as Japan when it comes to tax rates.

The answer is to drop the top corporate rate to 25%. At that point, we won’t have to worry about taxing the foreign expatriation of technology. It will stay here. ‘nuff said.

State Tax Fairness.

A more subtle issue is the increasingly frustrating practice of individual states stretching the rules to grab a bigger share of interstate revenues. Enterprises will spend $112 billion over the next six years on cloud related technologies according to Gartner’s Cloud Outlook. That’s a lot of potential for tax revenue. No one doubts that the states are hurting (save for
my home state of North Dakota, which is awash in oil money (See http://money.cnn.com/pf/america-boomtown/), but the result has been a crazy quilt of state and local sales tax and income tax nexus rules that make it almost impossible for a multi- national to know when they are subject to tax. Some jurisdictions have even taken the position that out of state concerns are taxable in in cases that the constitution clearly prohibits (yes Fort Collins I mean you). The worst part is the conflicting interpretations that states have taken with regard to “taxation in the cloud.” It should be called taxation in the “fog” instead, because the policies of some states demonstrate a basic misunderstanding of the industry.

Cloud services typically come in one of three flavors: Software as a Service, Platform as a Service, or Infrastructure as a Service. As a tax matter, those transaction scan be viewed as a provision of services, license of software, or rental of tangible property, each with different tax consequences. Sometimes that characterization by a state will result in a sales tax being due to a state. Sometimes that characterization will also result in a company having tax nexus (or presence in a state) justifying the imposition of sales tax collection or income tax payment in a state.  One fundamental problem is that the states have not been uniform in how they view these transactions, meaning that every multi state company must conduct a state by state analysis to determine what their tax exposure is. Because it can be so counter intuitive to someone who knows the difference between SaaS, Iaas and PaaS, they almost always get this wrong, and it shows up in due diligence when they get financed or sold.  This result is an unnecessary inefficiency and cost of doing business that could be addressed with uniform standards, but it is doubtful that 50 states will come to the same conclusions given how quickly the tech sector moves. It is time for a uniform multi-state compact, even if it has to be federally legislated. See our State Tax
Blog Post for an example.

Securities Regulation.

My favorite philosopher, Frederic Nietzsche, derided mass movements as “herd” mentality. According to Nietzsche, there was a hierarchy of supermen at one end of the
philosophical spectrum, and the “herd” or the crowd at the other end. Superman=good. Crowd=bad. Like Nietzsche was the anti-Christ, the JOBS Act is the anti-Nietzsche (at least on this one point). To the 2012 Congress, the herd or the crowd is a good thing, wise beyond all measure and capable of ferretting out the really juicy deals.

Or so it seemed when the whole idea of crowd sourcing first came up.

The 2012 JOBS Act authorizes and directs the SEC to promulgate regulations implementing equity crowdsourcing, or crowdfunding. Two provisions of the JOBS
Act are noted here: crowdfunding and the rules allowing public solicitation of accredited only investments.  So much has been written about the crowdfunding portion of this law that it is not even worth hyperlinking to (but I will anyway, see Is the JOBS Act evil? Or just misunderstood?). The “evil” in that piece refers to the paranoid suggestion (from bone headed regulators mostly) that legions of hucksters are lying in wait to use the JOBS Act to defraud gullible widows of their hard-inherited money, among others. The counter argument is that, because of the limits on the size of investments, an investor’s exposure would be sufficiently limited so that no one could really lose that much unless they were either (i) very unlucky or (ii) me (have you met my broker?). In actuality, the real evil is that the JOBS Act as enacted has strayed too far from its fundamental premise, i.e. that the wisdom of the crowd should decide.  So far, it is not looking like the crowd is going to have much to say about it, since advertising and solicitation for crowdfunded securities will likely remain limited. But enough about that. With a $1 million cap and the expansive audit and reporting obligations imposed on issuers and platforms, most of us are skeptical that this will go anywhere anytime soon. Now, if Congress were willing to increase the caps (the amount that any one individual can invest and the total amount of the offering) and allow public solicitation, then the intervention of the “crowd” might actually be useful in this process. I find it ironic that just as Nietzsche eventually drove himself nuts philosophizing about the herd, Congress is driving the rest of us nuts philosophizing about the crowd.

The changes to Rule 506, however, are much more promising. See SEC finally gets around to JOBS Act solicitation rules. Those changes will allow issuers to advertise and solicit IF all of the investors in the offering are accredited investors. Proposed regulations set forth some guidance on what will be required to satisfy the issuer’s obligation to verify that purchasers of the securities are accredited investors. Platforms are already tee’ d up to launch their companies into the spotlight as soon as the SEC finalizes regulations and says “go.” This is a giant step in the right direction but, again, it is not quite far enough. Companies have been soliciting accredited investors for years. If you don’t believe me, just go to one of the zillion pitch events that occur in my neighborhood each week. The real power in this is allowing professionals to go out and market private securities. The only thing they cannot do (unless they are registered broker dealers) is take success based fees.

And that brings me to the point of this section: the law should allow “finders” to take success based fees. The SEC has long viewed finders (i.e. those who “find” investors but do not broker the deals) as unregistered broker-dealers if they were paid based on funds raised. Case law has been more thoughtful, but with aggressive SEC enforcement (e.g. jail time) in recent years, the finder industry has basically been shut down. Big win for regulators – big loss for everyone else. The result of placing this artificial barrier between companies and investors is the new 506 exemption described above. While I think the new rules are just fine, sort of, and even kind of cute in a way, the law needs to go that one  extra step and let finders find and be paid for finding, even if it’s a success based fee.

A Million Other Things.

The List goes on. We have a long history in tax policy knowing what works and what does not. We have learned to see the value in technology and the danger in a government that wants to pick the winners and pardon the losers. We have data on what works in promoting international trade and what does not. Those topics are fodder for a future late night at the office and a later post. Stay tuned. UPKME3FP74ZA

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StartUp Nation

Posted on February 16, 2012 by Roger Royse

Talk about putting things off. I have been meaning to blog about my recent (well, last October) trip to Munich to drink beer and judge a startup competition, but could not quite get around to it. We were a panel of three: me, a VC, and a business consultant. We heard pitches by ten companies and the winner, the most likely company to be funded, was to win a trip to Sand Hill Road. The trip was called “Bavaria meets Silicon valley” and was sponsored by Garching Technology and Entrepreneur Center. See the program at http://www.gategarching.de/termine/wissenstransfer
The ten companies that we judged were quite impressive. Cloud solutions and enterprise software and hardware and mobile etc…. In fact, they were very impressive, and I see a ton of startups. I was attributing the high quality of the startups to German engineering and weinerschnitzel when I noticed that all of the companies had seed funding. And they all had about the same amount – roughly 100,000 Euros. It struck me as a bit odd since companies even of this caliber might have a hard time getting that first $200,000 in the door in the US. Then it was explained to me that the German government has numerous programs that cater to their startup community. These companies were funded, but with governmental support. Is that bad?
As a historical note, this trip came not that long after the disaster that we now know as Solyndra. I would like to back link to an objective article about Solyndra, but they are all pretty heated. The discussions bear titles such as “Obama’s Solar Scandal” and “The Dirty Truth About Clean Energy.” So rather than try to sort out here what might have happened, any Cyborgs from the future that come back to 2012 to read my blog will just have to Google it themselves. The problem, however, seems to be much bigger than just Solyndra. Solar loan guarantees will likely cost the government billions. http://www.siliconvalley.com/sv2020/ci_19939473?source=rss
So against that historical backdrop, I could not help wonder what to make of a bunch of startups that were in front of me only by the grace of government grants. And, by the way, there are about a million of them. See High-Tech Gründerfond (High Tech Founders Fund – HTG) at http://www.en.high-tech-gruenderfonds.de and KFW, a government-sponsored investment fund, at http://www.kfw.de/kfw/en/index.jsp
But anyway, the nagging thought in my mind was “are these really startups?” Real Silicon Valley style diet coke and M&Ms Top Ramen work for equity at nights and weekends startups? Or are they just disguised government research projects? And in the wake of the bad money in solar, is this really a good idea?
I am not trying to to pick on solar, by the way. I love solar. Some of my best friends do solar. But they just happened to have been beaten up by the Chinese a bit more than other industries and the losses show it.
But back to my main point – what about the German system? Despite my libertarian leanings, I would have to say that I like it. I like it because I believe in what works, I don’t care if it is tax breaks, subsidies, credits or grants. And the idea of easy access to seed funding works. Achtung Baby. It works. The companies that I saw in Munich likely would not have gotten off the ground here in the Valley. They are just too risky. But they were great companies and I have no doubt that a very high percentage will be successful. “But what about Solyndra?” You might ask. And that is where the new system of startup support parts ways with the older politically motivated systems. A $100,000 grant to a company is a lot different than a billion dollar loan guarantee. And a lot of small grants will do a lot more good than a large loan guarantee. Maybe not today. Maybe not tomorrow, but soon and for the rest of your life. (Rick, in Casablanca, 1942).
But don’t take my word for it – smaller DoE grants and guarantees are already in place in the US and have been for a very long time. And, most recently, the Obama Administration has gotten behind supporting the start-up community with its Startup America initiative. See http://www.whitehouse.gov/economy/business/startup-america
If you have been following my previous posts (and I know that you have) you know that I have been a little bit hard on Obama for his tax proposals. Startup America, however, is (according to their website) “a White House initiative that was launched to celebrate, inspire, and accelerate high-growth entrepreneurship throughout the nation.” It calls on “both the federal government and the private sector to dramatically increase the prevalence and success of entrepreneurs across the country“ and that’s just great. What it needs to do, however, is put seed funding into deserving companies. It needs to place some bets – lots of them. I haven’t really seen that happen yet, at least not in my neighborhood, and it needs to catch up.
In my upcoming book, “Dead on Arrival: Avoiding the Legal Mistakes that Could Kill Your Start-Up” I write about the “success triangle” of people, technology and money. The first two of those prongs tend to fall into place easily – it’s that last that needs help. And this is where Startup America can make a big difference.
So, for a change, I applaud the efforts of this Administration for “Unlocking access to capital to fuel startup growth” and I look forward to seeing that happen.
And if it doesn’t, I will blog about it. UPKME3FP74ZA

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The Warren Buffett Tax

Posted on January 25, 2012 by Roger Royse

If you listened to the State of the Union Address tonight, you would have heard the President announce his tax plan in dramatic fashion by declaring that a secretary should not pay more taxes than a billionaire. He was actually talking about tax rates rather than taxes, and in particular about the lower rates on capital gains (15%). It may be a coincidence that this comes during a time when Mitt Romney is being criticized in the press for having lots of low taxed capital gains, but the result is a proposal that anyone making more than $1 million annually should pay an effective rate of at least 30%. The proposal seeks simplicity (one simple rate), followed immediately by complexity in stating that the rule would be “implemented in a way that is equitable, including not disadvantaging individuals who make large charitable contributions.” That, of course, begs the question of who else would not be disadvantaged. How about those who have lots of loss carryovers, or pay lots of foreign taxes, or invest in start-ups? The confusion results because the solution is aimed at a problem that does not exist. The perceived evil is not millionaires paying too little tax, it is the capital gains rate itself. It is not as great a sound bite, but what the President should have said is that a person earning compensation income should not pay tax at a higher rate than a person recognizing gain from the sale of capital assets. And that is an argument that is as old as the tax code itself.
I don’t have an answer to this question, but at least I can see the humor in it. Currently, gains from the sale of qualified small business stock (QSBS) are taxed at low rates. Just last year those gains could have been exempt from tax altogether. And now they should be taxed at 30%? I don’t think it is the identity of the seller that is at issue since, frankly, a million dollars doesn’t buy what it used to anymore, and if you eliminate the QSBS incentive for millionaires, you have simply eliminated the incentive.
Well, that might be just a case where the rule must be “implemented in a way that is equitable, including not disadvantaging individuals who”… invest in start-up companies. So perhaps there will be an exception for qualified small business stock.

But don’t forget about real estate. Real estate is an entire industry built on the existence of a low capital gains rate. If capital gains goes away, you will be able to watch the needle on lease costs rise by the time your morning coffee cools. Trust me on this one. Thus, we may have to implement the rule in a way that is equitable, including not disadvantaging individuals who invest in real estate. In fact, I think we could take the statement: “implemented in a way that is equitable, including not disadvantaging individuals who make large charitable contributions” and just leave the last part blank. Try it yourself. It’s fun:

“We should work to work to ensure that this rule is implemented in a way that is equitable, including not disadvantaging individuals who [fill in the blank with whatever type of income you have]. “

And then we are back to complexity and unfairness.
Don’t get me wrong, I applaud the President’s efforts to find a solution to a perceived inequity. I also am glad to see that he obviously reads my blog post and is now (after my last post) proposing to lower corporate tax rates for international competiveness. However, I think the direct approach is the best approach here. If the offense is a low capital gains rate, the discussion should be about capital gains rates, not who earns the capital gains. Any other approach would not be implemented in a way that is equitable, including not disadvantaging individuals who…..

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The Territorial Tax, or Why Does Congress Hate Technology?

Posted on November 26, 2011 by Roger Royse

This week, on Thanksgiving Day, I left my office before noon to take my Thanksgiving Rueben sandwich at Printers, Inc. (the only place in Palo Alto that I could find that that was open). Yeah, I know, call me traditional. At the table next to me were two young guys speaking Russian. Despite my unopened Rosetta Stone DVDs, I could gather that they were software guys, talking about software, and possibly wondering why only a few Russians and one lawyer were working today, here in the center of the technology universe. The scene made me reflect in why they were here in the first place, and ponder what it will take to keep smart young guys like that here in the future. And, of course, my thoughts turned to taxes.
It may come as a surprise in the “Occupy” age to hear Congressmen talking about an exemption from corporate tax on foreign income and a move to a territorial tax. The reference to “territorial tax” means that the US would exempt part or all of a company’s foreign earnings from US tax. In other words, a US company would pay no or a reduced rate of tax on the receipt of dividends of foreign earnings from its foreign subsidiaries.
Because a “territorial tax system” is, in essence, a tax break for multinationals, it may come as even more of a surprise to learn that the idea of a territorial tax has bi-partisan support. In other words, both Republicans and Democrats are claiming credit for the idea. How can that be?
For sure, a territorial system has much to commend itself. First of all, most of the industrialized world taxes on a territorial basis. The US has always been somewhat unique in its aggressive approach to taxing the worldwide income of its residents and sometimes their foreign subsidiaries. Thus, the first word you will hear when the territorial system is mentioned is “competiveness.”
Second, there is a belief that exempting foreign dividends will encourage companies to pay their foreign earnings back to the US instead of keeping those earnings offshore, where they might be (gasp!) reinvested in foreign infrastructure and jobs.
Finally, an effective lower corporate tax rate would encourage companies to locate right here in the good ole’ US of A, instead of more exotic locations, like Cayman, or maybe Nevada.
I agree with all of that. How could you not? The beauty of the proposals, and the reasons that both Republicans and Democrats can get behind them, is because they are so vague. There are, of course, a million details that armies of tax lawyers will have to figure out, so if you thought that such a small change (exempting foreign dividends from tax) would not require a lot of planning, I say to you au contrare. I will let the other tax geeks write about the tax planning problems and opportunities this system would cause and create. My mission today is to focus on one issue in particular, and that is the effect on technology development and innovation.
I blogged earlier about a particularly silly idea that the Obama administration periodically advances – a tax on excess income from foreign intangibles. My concern then, and now, is that the Obama proposal, while having the perfectly laudable goal of taxing US companies on their fair share of income from technology, would in fact encourage the further migration of business offshore. I am sure smart people and economists agree with me, although I have not yet found any of them. I have the same problem with a territorial tax system – it would encourage the movement of technology development, and the businesses that are built around technology, offshore.
Let me be more specific. Companies that keep and develop intellectual property (IP) in the US will be taxed at US rates on that IP. Under worldwide system, the IP can be moved offshore but, at best, the US company will only defer tax on income from technology until the income is repatriated to the US, at which time it will be fully taxed (subject to foreign tax credits, for what that is worth). What do you expect companies to do if we change the rules so that income from the foreign exploitation of IP is never subject to US tax; indeed, maybe never subject to any country’s tax?
Granted, current (and proposed) rules will tax passive income from the foreign exploitation of IP, so dropping legal ownership into a mailbox tax haven company will not avoid tax. That only makes the problem worse, because companies will have an incentive to go offshore not only with the IP but also the business activities that result in an active foreign trade or business. Those activities require investment and employ people. Do we really want to encourage the migration of those activities?
In a way, asking the Congress to describe the problem of US competiveness is like asking a turkey to describe a turkey sandwich. Like the turkey is the sandwich, Congress is the problem (and seems to have gotten no help from the executive branch). The thing I love about tax tinkering to encourage political objectives is that it assumes that taxpayers have the chess-player-like strategic planning to respond to small economic carrots at the end of long legal poles, but are too dumb to notice that rates are too high.
There. I said it. Rates are too high.
Tax rates matter in a world where countries compete for intellectual capital. Tax rates matter in a world where I can work anywhere. Consider the flight of businesses from high taxed California across the border into low taxed Nevada. It isn’t for the black jack, it’s to avoid taxes. The same thing can easily happen internationally. (To be fair, the latest Republican proposal also includes a reduction in tax rates from 35% to 25%).
Of course, there is more to life than taxes (so I am told). And it is not only tax rates that cause companies to stay in the US. There are other factors, such as political stability, advanced infrastructure and the Dallas cheerleader, to name a few. But it is time to consider that, all other things being equal, tax rates matter, and all other things in this modern world are moving towards equal. When our tax and immigration policies repel rather than attract the world’s crème de la crème – the creators of intellectual capital and keepers of the future – it is just a matter of time before we find them all gone. I hope we figure this out before it is too late.

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The Emperor’s New Lawyer

Posted on May 14, 2011 by Roger Royse

Yet again, some smart entrepreneurs are trying to marry the profession of law with the business of law. The traditional law firm model has not kept pace with modern business practice, so the theory goes, and it is time for a modern, more efficient model. To be more to the point, the legal industry is “broken” according to one entrant into the market, (see ABA Law Journal May 9, 2011, link citation below). The new model anticipates a newer technology platform and a better business management company to serve up traditional legal services. The technology platforms might be different, and the business models may even be novel, but the idea of a low overhead virtual law firm is not new. Law firms have been quietly evolving for a long time now, and the internet has made it possible for small boutiques to offer sophisticated big firm solutions at lower, small firm rates. Indeed, there as been a revolution going on in the legal industry. Ten years ago, the Big 4 accounting firms threatened to take over the legal industry with three little letters – MDP (Multi-Disciplinary Practice) and would have done so if not for the practical and regulatory restrictions that followed in the wake of the Enron and Worldcom debacles. Most recently, we have seen legal outsourcing to India, interactive web-based document systems, artificial legal intelligence or “expert systems,” virtual law systems and, of course, Legal Zoom. They all rely on one theme – that the practice of law is inefficient, and the business of law need not be.
Now, I will be the first to admit that lawyers are lousy businessmen. We are trained in law, not business. That fact makes it relatively easy to compete in my industry, but also seduces the non-lawyer community to take a run at the $300 billion worldwide legal market from time to time. No one has yet pulled it off. No one has fundamentally changed the model, flawed as it is. Why is that?
The problem with all the new models is that they just don’t get the underlying basis of the attorney client relationship. For sure, there is a commodity level legal market. There are form-based projects and incorporations and powers of attorney and deeds and such. You can have it. It is not particularly interesting and to the extent that the machines can take that burden off us, I say “go for it.” But, someone has to decide which form to use, which button to push, and which issues are more important to the particular client that others. A machine will never do that. Never. Moreover, a virtual lawyer will never be as effective at doing that because that model lacks the in-person dynamic that informs our judgment. There is (as of yet) not a questionnaire or on line form finder or technology in the world that will probe, evaluate and counsel a client to not only answer their questions, but to make sure they are asking the right questions. That requires face to face meetings. It requires reading a client‘s wants and needs, whether expressed or understood. It requires experience in knowing how certain matters usually turn out when certain decisions are made and what the market would typically do and how it is likely to react. It requires knowing what we don’t know and being able to connect our clients with those we do know – whether it be other service professionals, VCs, angels or other providers. This is not a chess game – it is far more complicated than something a Turing system can decipher. Until the businessmen understand the professional side of the business, they will not revolutionize the business.
In the meantime, however, I believe there is a place for new models and new technologies. The pundits are correct that legal services are too expensive in an age in which the free flow of information has driven down prices. My own firm is working on expert systems to modernize and facilitate the decision making process. We will, however, always involve a face to face meeting with a lawyer. We are also working on technologies that streamline more routine tasks. I might even outsource a piece of a project from time to time. But we will always do it in a way that is just and fair and driven by professionalism rather than by markets. Business models will evolve and technology will drag us into modernity, but certain aspects of the practice will remain as immutable and timeless as the speeches of Demosthenes.

http://www.abajournal.com/news/article/legal_entrepreneur_forms_dc_law_firm_that_shuns_office_face_time_and_lawyer

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