Rules and Standards in International Tax Enforcement

Steven Dean
Professor of Law, Brooklyn Law School

The international tax regime has struggled to make the leap to the era of big data.  The internet and other potent digital tools make it easy to accumulate and trade vast hoards of information.  Learning how to harness that data to improve fairness and efficiency by making it just as hard to evade taxes abroad as it is at home has proven more difficult.  Simply put, despite years of sustained effort, the algorithm that can do for international tax enforcement what Über has done for finding a ride remains out of reach.

In pursuit of that algorithm, the international tax regime has abandoned flexible standards in favor of precise rules.  Unfortunately, a rule capable of effortlessly bringing tax cheats to justice has so far proven elusive.  In Neither Rules Nor Standards, 87 Notre Dame L. Rev. 537 (2013), I described the appeal and the limits of the the hunt for algorithms (rules) to replace the standards that have long formed the core of the international tax regime.

Which is better for the international tax regime?  Rules seem to be the obvious answer.  And indeed, since the global financial crisis, nations have embraced rules calling for the supply of information according to precise specifications.  The U.S. FATCA regime calls for foreign banks to supply information about U.S. taxpayers to the I.R.S.  while the OECD’s Common Reporting Standard imposes comprehensive income reporting obligations on a broad network of states.  Each promises to provide tax authorities with extraterritorial tax information they need to crack down on tax cheats.

Although appealing, rules can be difficult to get just right.  The classic example contrasts a posted speed limit (a rule) against a standard (drive at reasonable speeds).  It isn’t hard to pick a number, but as roads and conditions change, the conventional 55 mph speed limit will almost always be either too high or too low.   Worse, when drivers routinely drive ten miles above the posted limit, it gets hard for even the most law-abiding citizens to take the rule seriously.  Drivers might meet a hypothetical standard calling for them to drive at reasonable speeds, but in a world of rules that doesn’t matter.

Likewise, when international agreements merely called for states to “exchange such information as is foreseeably relevant” states were overachievers.  As then-I.R.S. commissioner Mark Everson noted in 2006

“Since the mid-seventies, we have received documents from our tax treaty partners reporting payments of foreign source income to United States persons, including individuals and business entities such as corporations, trusts, governmental entities, partnerships, and pension plans. Treaty partners generally report passive income such as interest, dividends, rents, and royalties. In 1995, we began receiving these documents on magnetic media instead of paper. Since that time, many countries migrated from paper documents to magnetic media. However, we continue to occasionally receive a limited number of paper documents from our treaty partners. In 2005, we received about 2.8 million documents on magnetic media from 20 countries.”

Measured against the applicable standard, such a volume of information seems extraordinary.

Today, the bar is higher.  FATCA describes an elaborate mechanism of withholding designed to anchor its information reporting requirements.  Unfortunately, U.S. tax authorities found themselves in the same position as a new owner of a piece of IKEA furniture missing a crucial final bolt after hours of toil.  Sophisticated taxpayers quickly learned how the complex rules were vulnerable, easily gamed by employing “blocker” structures.   Unable to find that missing piece, U.S. authorities decided that they had done enough and left a blank spot where an anti-blocker “bolt” should have been.  Really, I’m not making this up (take a look at Treas. Reg. §1.1471-5(h)(2)). Uncharitable, but perhaps not unfair, comparisons could be drawn to Theranos, the discredited medical testing company infamous for failing to deliver on its promised breakthrough technology.

As much as international tax enforcement would benefit from its very own Über, they haven’t found it yet.  Post-FATCA information flows have grown from those Everson described in 2006, but they reflect incremental change rather than a digital revolution.  Partner states and private actors continue to supply U.S. tax authorities with extraterritorial tax information much as they did a decade ago, now enhanced by a new generation of intergovernmental agreements.  FATCA’s potential to capitalize on the tools of the digital era to feed information directly from banks across the globe to the I.R.S—thereby achieving parity between domestic information reporting and the flow of extraterritorial tax information—remains unfulfilled.

The OECD’s Common Reporting Standard highlights the same basic problem.  The Common Reporting Standard creates a clear set of reporting obligations with respect to extraterritorial tax information.  Dozens of states have committed to participate.  The United States has not.  Absent congressional action, U.S. tax authorities have argued that they simply lack the authority to do so.  Given the outburst of inward-looking populism that characterized 2016, U.S. legislation designed to help other countries enforce their taxes seems a remote possibility.

The result in this case is chair missing a leg, not merely a bolt.  With the United States on the sidelines, the Common Reporting Standard looks a lot like that forlorn chair.  If escaping its information dragnet is no more difficult than moving money onshore—into the United States—the Common Reporting Standard seems like a cruel joke.

What does all this mean for the international tax regime?  Whether the better analogy is an algorithm that leaves you stranded on the curb or a precarious piece of flat-packed furniture, the two major innovations in global tax enforcement over the past decade have not (yet?) delivered on their promises.