FROM THE OFFICE OF PUBLIC AFFAIRS

It is a pleasure to be here today to discuss several topics of current interest in the international tax arena. Let me begin with corporate tax shelter developments, particularly focusing my remarks on the international front. Second, I will describe the approach we're taking, and give you a progress report on, Treasury's deferral study. Finally, I will briefly discuss the future of foreign sales corporations.

In 1986, the Congress cured with almost instant results the corrosive effect of tax shelter activities that were eating away the individual income tax base, swamping the IRS and the Tax Court with controversies, and causing a cynical attitude toward the tax law among many Americans.

Today we are faced with a similar problem affecting the integrity of the tax system -- the recent proliferation of corporate tax shelters -- that warrants great concern and merits concerted action, both legislative and administrative. When we started working on our study of corporate tax shelters late last year, our first goal was to raise awareness that there was a problem and to explore the nature of the problem. Now, it is clear that there is widespread agreement and concern among tax professionals that the corporate tax shelter problem is large and growing.

Earlier this year, the American Bar Association testified about its "growing alarm [at] the aggressive use by large corporate taxpayers of tax 'products' that have little or no purpose other than the reduction of Federal income taxes," and its concern at the "blatant, yet secretive marketing" of such products. The staff of the Joint Committee on Taxation, the New York State Bar Association, the Tax Executives Institute, and others have echoed these comments.

These corporate tax shelter transactions can be particularly pernicious in the international context. For example, yesterday you heard about cross-border arbitrage transactions. Cross-border arbitrage schemes compound the vices of other tax shelters, because they can threaten the revenue base not only in this country, but in other countries at the same time. In addition, they may be more difficult to audit because of their complexity and because their underlying documentation may be more difficult to obtain.

Our budget proposals last year recognized that, as transactions in general become more internationalized, corporate tax shelters are also becoming more internationalized. We included a number of targeted provisions, aimed at specific tax shelter transactions that take advantage of the opportunities for tax avoidance available in the international area.

Also, some of the most significant administrative and enforcement actions taken in the past year focussed on cross border deals. The Compaq decision, involving abusive foreign tax credit claims, bolstered positions we had taken previously in Notice 98-5. The UPS decision condemned abusive taxpayer practices involving cross-border "captive" insurance. And the recently issued check-the-box anti-abuse rule targets aggressive uses of the entity classification rules to achieve international tax results that may be different than those that could have been achieved without them.

We proposed these rules because we believe that check-the-box was not intended to facilitate tax avoidance by the simple expedient of filing a piece of paper. We agree with those practitioners who have told us that these transactions should not be allowed, and that other, more aggressive transactions should be targeted as well. Check-the-box offered, and continues to offer, many advantages to both taxpayers and the government in terms of simplicity and administrative ease. In the international context, however, we are going to continue to monitor check-the-box, and act when appropriate, through regulations, litigation or other means.

What we have found over time, however, is that addressing tax shelters transaction-by-transaction is like attempting to slay the mythological "Hydra". You kill off one over here and two or three more appear over there. Already, this year, we have shut down so-called "chutzpah trusts" which were similar to a structure shut down by Congress in 1997 and we are now hearing about "Son of LILO." The "BOSS" transaction that we curbed yesterday by notice is a derivation on the section 357(c) product. Promoters, like computer hackers, will continue to search for defects in the code to exploit, and taxpayers with an appetite for tax shelters will simply move from those transactions that are specifically prohibited by the new legislation to other transactions the treatment of which has not been definitively proscribed.

Our goal is to curtail the development, marketing, and purchase of corporate tax shelters, frequently sold as "products" off the rack to produce a substantial reduction in a corporation's tax liability. To do this, we have identified the common sources and characteristics of shelters, and incorporated these identified filters into our budget proposals, so that we may address these abusive, tax-engineered transactions in a more global manner, hopefully preventing most from occurring. We must change the tax shelter cost/benefit analysis in a manner sufficient to deter these artificial transactions. The Treasury Department believes this global solution should include four parts:

(1) increasing disclosure of corporate tax shelter activities,

(2) increasing and modifying the penalty relating to the substantial understatement of income tax,

(3) codifying the economic substance doctrine, and

(4) providing consequences to all the parties to the transaction (e.g., promoters, advisors, and tax-indifferent, accommodating parties).

These proposals are intended to change the dynamics on both the supply and demand side of this 'market' - making it a less attractive one for all participants -- 'merchants' of abusive tax shelters, their customers, and those who facilitate the transactions. All the participants to a structured transaction should have an incentive to assure that the transaction comports with established principles.

I would like to emphasize a few key points. First, there is widespread agreement that increased disclosure and changes to the penalty regime are necessary to uncover transactions and change the cost/benefit analysis of entering into corporate tax shelters. However, we do not believe that these procedural remedies alone are enough. We believe the economic substance doctrine must be codified, thus requiring taxpayers to perform a careful analysis of the pre-tax effects of a potential transaction before they enter into it.

The centerpiece of the substantive law proposal is not a new standard, but rather is intended as a coherent articulation of the economic substance doctrine first found in seminal case law such as Gregory v. Helvering and most recently utilized in ACM, Compaq, IES and Winn Dixie. The economic substance doctrine requires a comparison of the expected pre-tax profits and expected tax benefits. Codification of the doctrine would create a consistent standard so that taxpayers may not pick and choose between conflicting decisions to support their position. Codification also would isolate the doctrine from the facts of the cases so that taxpayers could not simply distinguish the cases based on the facts.

Second, the proposed legislation would be inadequate without effective enforcement. The Internal Revenue Service is undergoing a substantial restructuring. This restructuring will concentrate IRS resources relating to corporate tax shelters, enabling it to identify, focus on, and coordinate its efforts against corporate tax shelters in a more efficient manner, while instituting and maintaining appropriate taxpayer safeguards. The enactment of corporate tax shelter legislation, combined with the efforts of the restructured IRS, will deter abusive transactions before they occur and uncover and stop these transactions to the extent they continue to occur. We are working closely with Commissioner Rossotti, Larry Langdon, Stuart Brown, and others at the Service to develop the best overall approach to address corporate tax shelters in the restructured IRS.

Let me assure you, however, the Treasury Department does not intend to affect legitimate business transactions and looks forward to working with the tax-writing committees and the private sector in refining the corporate tax shelter proposals, particularly our articulation of the economic substance doctrine. Our white paper already made substantial revisions to our original Budget proposals in response to comments we received. Further, to prevent interference with legitimate business transactions, the IRS and we are considering whether to require examining agents to refer corporate tax shelter issues to a centralized office for consideration. Such a referral process might be similar to that used with respect to the partnership anti-abuse regulations. The IRS also is considering whether to establish a procedure whereby a taxpayer could obtain an expedited ruling from the IRS as to whether a contemplated transaction constitutes a corporate tax shelter.

The proliferation of corporate tax shelters presents an unacceptable and growing level of tax avoidance behavior by wasting economic resources, reducing tax receipts, and threatening the integrity of the tax system. Secretary Summers, the Commissioner, and the Office of Tax Policy are committed to a concerted approach for combating this problem. We will continue to seek appropriate changes to address this problem and take all appropriate actions to shut down abusive transactions as we become aware of them.

My next subject is our study of subpart F. For as those of you who are students of subpart F know, and as I am increasingly finding out as we plumb the depths of subpart F in connection with our subpart F study, the U.S. anti-deferral rules are largely about preventing double non-taxation. As pointed out yesterday, double non-taxation is just as far off the mark as double taxation. Put another way, the subpart F debate is about U.S. tax, and when we should allow lower U.S. tax on foreign income than domestic income.

When subpart F was enacted some 37 years ago, no other country had a regime like it. Most of them didn't need it, because exchange controls ensured that their residents didn't send all of their money abroad. Since then, however, virtually all of our major trading partners have adopted CFC rules, while U.S. companies have become ever stronger, and the U.S. economy has become the envy of the world.

Nevertheless, we think that these rules should be reexamined, and we are in the process of doing just that. At this meeting last year, then-Assistant Secretary Don Lubick announced that we would be undertaking a study of the subpart F regime. I am pleased to report that, as Don promised, we are nearing completion of a report that is extensive, objective, and responsive to the evidence, even when that evidence says our current rules may need reform. The study, we hope, will serve as a tool to promote discussion. Thus, upon completion of the study, we will be seeking your comments - to continue what I hope will be a productive process.

To determine what subpart F was intended to achieve, the study examines the events that led to the introduction of the statute and its legislative history. The study then asks what subpart F should achieve: how should we tax foreign income in order to maximize our economic welfare? It asks whether there is continuing validity to the economic views that helped to mold subpart F forty years ago. In studying this we have been particularly interested in trying to determine whether new economic research -- particularly that done in the last ten years -- has affected the validity of the standard analysis that the best policy is to tax domestic income at the same rates as foreign income.

The study then takes a hard look at the issue of competitiveness. I will confess that we are having great difficulty saying with any degree of confidence that U.S. competitiveness is adversely affected by subpart F. Moreover, we are struck by the fact that, in 1962, generally competitiveness advocates did not advocate salting away income in tax havens, whereas today, we hear arguments that competitiveness requires just that.

Our study also evaluates the extent to which subpart F is achieving what it should be achieving. In other words, even if the current rules are aimed in the right direction, are they being easily circumvented? Are they well-suited to the way business is done today? Are they well-suited to the way business will be done in the new millennium?

In particular, we are looking at the extent to which the rules may need to change in light of new technologies, including new communications technologies and electronic commerce. For example, with respect to services like Internet access, remote database access, remote order processing and video conferencing, new technologies may make it difficult to determine where the services are performed. So rules that depend on identifying the place of performance for services may not be well suited to the new millennium. Similarly, new technologies may make it difficult to determine the place of use, consumption or disposition with respect to electronically delivered digitizable products, such as images music and computer software. To the extent the Subpart F rules rely on place of use, those rules may become increasingly difficult to apply.

Moreover, new technologies increase the ease with which employees of a CFC can be located outside the CFC's jurisdiction of incorporation and increase the ability of CFCs to acquire products and services remotely. This increases the opportunities for CFCs to be incorporated in low- or no-tax jurisdictions while they provide services to others located elsewhere. Are our rules well-designed to ensure that the appropriate amount of subpart F income is imposed in these cases?

For example, "foreign base company services income" includes only income from services that are performed outside the country under the laws of which the CFC is organized. Assume a U.S. corporate vendor of goods over the Internet establishes a wholly-owned CFC to process customer orders and arrange for product delivery through the use of the CFC's offshore computer servers and other equipment located in the country in which the CFC is organized. Through such an arrangement, the U.S. vendor may be able to isolate offshore income associated with that processing and delivery function with no corresponding income inclusion under subpart F, unless it is determined that the services are performed outside the CFC's country of organization.

These issues may not be unique to CFCs engaged in electronic commerce. Some of the same issues arise, for example, with respect to financial services businesses as well as businesses involved in more traditional activities, such as the development and manufacturing of tangible goods. Electronic commerce and new technologies do, however, affect the ease with which innovative business structures can be used and the ease with which tax havens can be exploited.

The use of tax havens is an area of great concern to us at the Treasury. These jurisdictions, through strict bank secrecy and other means, facilitate tax avoidance and evasion, thereby shifting the burden of collecting necessary revenue to honest taxpayers and undermining the integrity and fairness of the U.S. tax system. The use of tax havens appears to be expanding and will require the United States to respond.

We will examine our own laws to determine what changes are required to prevent the exploitation of tax havens in ways that reduce US taxes inappropriately. And we will continue our work with the international community to develop collective responses to the problems raised by tax havens, including responses that encourage these jurisdictions to cooperate with us so that their financial systems no longer act as a barrier to the effective enforcement of our laws.

For example, in the area of bank secrecy, the United States has been actively promoting information exchange in the OECD and elsewhere to address the concerns raised by the strict bank secrecy laws and practices that exist in some countries. It should go without saying that these laws and practices present significant difficulties for the IRS, which is charged with administering the tax laws fairly for all taxpayers. But these secrecy laws should also concern the U.S. financial community, which has to compete with banks operating in these bank secrecy jurisdictions. In the modern global marketplace, where virtually any taxpayer with a computer can choose to bank anywhere around the world, U.S. businesses can no longer rely on geography to protect themselves from this type of unfair competition.

We believe that the growing problems presented by bank secrecy must be dealt with head on, and we have been working with the banking community to promote greater transparency in this area. We do not believe, however, that bank secrecy problems should be dealt with by imposing withholding tax at the source, and abandoning the system of taxation by the country of residence. For this reason, we do not support proposals like the European Union's proposed "coexistence model," which would allow member countries to choose between exchanging information with other countries or withholding tax on payments made to residents of other countries. In our view, this kind of system would be extremely difficult to administer fairly and effectively. Perhaps more importantly, adopting such a system would sanction withholding taxes as an adequate substitute for information exchange. We firmly believe that countries should exchange information to ensure adequate enforcement of the system of residence-based taxation, regardless of whether they choose to impose a withholding tax under their internal laws. We do not believe, however, that divisions over this issue should be allowed to scuttle the important work that has been done in the EU on tax competition.

International tax competition occurs when one country provides a tax inducement to attract capital from another country. When practiced unfairly, tax competition can severely erode the capital tax base of the losing country. What does this mean? It means that the losing country may have to make up the lost tax through higher taxes on the income it still can get a hold of, like income from labor -- income from working people like you and me. And although harmful tax competition is commonly practiced by large sophisticated countries, it is most aggressively practised by countries we commonly think of as tax havens.

Harmful tax competition distorts investment decisions, erodes tax revenues and undermines fiscal stability. Tackling these practices should help businesses to compete on a level playing field and encourage investment growth and jobs. It will play an important role in promoting the health of the global economy and the global financial system.

That is why the United States has taken a leadership role in the OECD's harmful tax competition work, and the U.S. attaches great importance to working within the OECD and the G7 to develop initiatives supporting fair and effective taxation which promote economic growth. This work can lead to innovations in tax policy, base broadening, and reductions in overall tax rates.

Before closing, I'd like to mention one issue that I know is important to many of you. On October 8, a WTO dispute settlement panel decided in favor of the European Commission's complaint against the United States on the tax exemption for Foreign Sales Corporations (FSCs). The dispute settlement panel found that the FSC tax exemption constitutes an export subsidy in violation of the WTO Subsidies Agreement and the WTO Agriculture Agreement. The decision says that it must be implemented by October 1, 2000.

The United States has appealed the panel's decision to the WTO Appellate Body. The EC just this week cross-appealed on the issues of administrative pricing and the domestic content requirement for export property, issues on which the panel did not make any ruling. We expect that the Appellate Body will deliver its decision in the first quarter of the year 2000, most likely in the late February - early March time frame.

As we have been doing from the outset, Treasury has been working hard to defend the FSC with the U.S. Trade Representative, who is handling the case for the United States. We've also been working closely with Congressional staff and the private sector to try to preserve these provisions that are so important to many of you. Deputy Secretary Eizenstat, Phil West and I have been meeting with outside groups to obtain this input. Our doors continue to be open, and we welcome your input as we continue our work in this area.