Corporate taxation and international charter competition

Michigan Law Review

Volumn 106, Issue 7, 2008, Pages 1229-1284

  Kane, Mitchell A ^a   Rock, Edward B ^b,c  

^a UNIVERSITY OF VIRGINIA SCHOOL OF LAW   (United States)

^b Department of Business Law ^*

^c UNIVERSITY OF PENNSYLVANIA LAW SCHOOL   (United States)

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[No Author keywords available]

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EID: 44949231227     PISSN: 00262234     EISSN: None     Source Type: Journal    
DOI: None     Document Type: Review

References (137)

1. Case C-167/01, Kamer van Koophandel en Fabrieken voor Amsterdam v. Inspire Art Ltd., 2003 E.C.R. I-10155; Case C-208/00, Überseering BV v. Nordic Constr. Co. Baumanagement GmbH (NCC), 2002 E.C.R. I-9919; Case C-212/97, Centros Ltd. v. Erhvervs-og Selskabsstyrelsen, 1999 E.C.R. I-1459.
2. See, e.g., William W. Bratton & Joseph A. McCahery, Tax coordination and tax competition in the European Union: Evaluating the code of conduct on business taxation, 38 Common Mkt. L. REV. 677 (2001);
3. Wolfgang Schön, Playing different games? Regulatory competition in tax and company law compared, 42 COMMON MKT. L. REV. 331, 359-60 (2005);
4. Joel P. Trachtman, International Regulatory Competition, Externalization, and Jurisdiction, 34 Harv. Int'l L.J. 47 (1993).
5. See, e.g., Jens Dammann, A New Approach to Corporate Choice of Law, 38 VAND. J. TRANSNAT'L L. 51, 77-79 (2005).
6. See Julie Roin, Competition and Evasion: Another Perspective on International Tax Competition, 89 GEO. L.J. 543, 554 (2001). Roin explains: One of the tenets of the tax harmonization argument is that competition will force all jurisdictions to lower their tax rates to the same low (or zero) levels, such that no country will offer investors a "better" tax deal relative to other countries. Thus, tax competition transfers wealth from national treasuries to taxpayers without having the beneficial effect of directing business . . . toward "better" locations. Id. (footnote call number omitted).
7. Id. at 546.
8. See Roberta Romano, Law as a Product: Some Pieces of the Incorporation Puzzle, 1 J.L. ECON. & ORG. 225, 280-81 (1985);
9. Ralph K. Winter, Jr., State Law, Shareholder Protection, and the Theory of the Corporation, 6 J. LEGAL STUD. 251 (1977).
10. But see Lucian Arye Bebchuk, Federalism and the Corporation: The Desirable Limits on State Competition in Corporate Law, 105 HARV. L. REV. 1435, 1441 (1992);
11. William L. Cary, Federalism and Corporate Law: Reflections Upon Delaware, 83 YALE L.J. 663 (1974).
12. At the most abstract level, corporate law and tax law look like the same type of market for law. That is, each can be seen as a package of governmental benefits (the product) associated with a certain government-imposed cost (the price). In spite of this similarity, one need not hold the same normative commitments regarding the merits of competition in the two markets. The most important distinguishing feature of the two markets for law is that tax law is an important tool in achieving broad society-wide redistributional goals. This makes competition less-obviously desirable than in the corporate law case.
13. The RS rule is thus, in fact, a family of different rules. Depending on the importance given to the place of incorporation, an RS rule can, in practice, approximate a POI rule. Nonetheless, POI and RS represent two different types of locating rules (formal v. factual) that are worth keeping separate.
14. The key statutory language in both the AG and GmbH statutes has been interpreted to require that the registered seat be in Germany. 3 BUSINESS TRANSACTIONS IN GERMANY (FRG) § 24.02[1] (Bernd Rüster ed., 1983); 2 BUSINESS TRANSACTIONS IN GERMANY (FRG) § 23.02[5] (Bernd Rüster ed., 1983). The GmbH statute, including its locational provision, is in the process of being reformed in order to stem the tide of incorporation of German private companies in the United Kingdom. Ulrich Seibert, Close Corporations - Reforming Private Company Law: European and International Perspectives, 8 EUR. BUS. ORG. L. REV. 83, 89-90 (2007).
15. To the extent that tax residence is conjoined with greater jurisdiction to tax, such a preference seems odd. Claiming dual corporate residence, however, can be beneficial where the relevant tax issue is the claiming of deductions, as distinguished from the reporting of net income. For a discussion of such "dual resident companies," see Mitchell A. Kane, Strategy and Cooperation in National Responses to International Tax Arbitrage, 53 EMORY L.J. 89 (2004).
16. For excellent treatments of traditional modes of corporate migration in the E.U. context, see R.R. Drury, Migrating Companies, 24 EUR. L. REV. 354 (1999)
17. and Karsten Engsig Sorensen & Mette Neville, Corporate Migration in the European Union: An Analysis of the Proposed 14th EC Company Law Directive on the Transfer of the Registered Office of a Company from One Member State to Another with a Change of Applicable Law, 6 COLUM. J. EUR. L. 181 (2000). As discussed below, recent developments in E.U. law have rendered these analyses somewhat out of date.
18. Douglas J. Cumming & Jeffrey G. MacIntosh, The Rationales Underlying Reincorporation and Implications for Canadian Corporations, 22 INT'L REV. L. & ECON. 277, 279 (2002).
19. In many jurisdictions, cross-border mergers are not provided for in the local corporate law. Joseph A. McCahery & Erik P.M. Vermeulen, Understanding Corporate Mobility in the EU: Towards the Foundations of a European 'Internal Affairs Doctrine' 9 (June 27, 2007), available at http://www.bdi-online. de/Dokumente/Recht-Wettbewerb-Versicherungen/ Panel_I_WorkingPaper_UnderstandingCorpMob.pdf.
20. Drury, supra note 11, at 358-59 (pointing to France, Greece, and Spain). But see infra note 81 for a discussion on the European Union's Societas Europaea (SE) structure and the way it permits corporations from RS jurisdictions to migrate.
21. There are debates in the corporate law literature over a variety of points relevant here, including whether states in fact compete for corporate charters, see Marcel Kahan & Ehud Kamar, The Myth of State Competition in Corporate Law, 55 STAN. L. REV. 679 (2002); whether any competition that does exist leads to law that is better or worse for shareholders, see Bebchuk, supra note 6; Romano, supra note 6; and, if competition leads to more valuable firms, what the amount of increased value is,
22. see Robert Daines, Does Delaware Law Improve Firm Value?, 62 J. FIN. ECON. 525 (2001).
23. But see Guhan Subramanian, The Disappearing Delaware Effect, 20 J.L. ECON. & ORG. 32 (2004). For the purposes of this Article, we assume that charter competition leads to more valuable firms.
24. For details, see Marcel Kahan & Ehud Kamar, Price Discrimination in the Market for Corporate Law, 86 CORNELL L. REV. 1205, 1218-32 (2001).
25. For example, Canada once imposed such a levy on large corporations, though the tax has been repealed. Income Tax Act, R.S.C., ch. 1, § 181.1(1)-(1.1) (1985) (repealed 1994) (Can.). Luxembourg currently levies a 0.5% net worth tax on the unitary value of Luxembourg companies. International Updates, INT'L TAX REV., May 2006, at 53.
26. Many real world levies, of course, have both a benefits character and a redistributive character. This does not undermine the basic distinction drawn in the text. Indeed, this basic distinction would seem to fuel much of the controversy over the normative appeal of tax competition more generally. To the extent that "tax competition" means competition over benefits taxes, which are really just prices, it should become less controversial that competition is beneficial. Conversely, to the extent that "tax competition" means competition over taxes that are redistributive, the competition may well become more problematic, depending on one's view about the merits of the underlying redistribution. Compare Roin, supra note 4, at 570 ("[P]roponents of tax harmonization have overstated the seriousness of their redistributive claims just as they have understated the benefits to be gained from tax competition."), with Reuven S. Avi-Yonah, Globalization, Tax Competition, and the Fiscal Crisis of the Welfare State, 113 HARV. L. REV. 1573, 1625 (2000) (arguing that tax competition can limit the ability to use taxes on capital for redistributive purposes).
27. An even more attractive outcome would be a partial migration for tax purposes, involving realizing the ten million dollar tax surplus in Beta without having to pay the exit tax to Alpha. That solution will generally not be available, because it would require inconsistent locational determinations under the tax law with respect to the past and future profits. It is difficult to see why any tax system would impose an exit tax and allow that possibility. Of course, a corporation could escape the exit tax by not moving corporate location and still try to gain the benefits of the low-tax jurisdiction by shifting profits to that jurisdiction. That result, however, would generally require the corporation to move assets and functions in addition to the mere shift of corporate location. We put aside the possibility of real asset shifts in this Article (other than those accompanying a shift in real seat) because we wish to focus on the narrow question of the intersection of tax and corporate locational decisions. Real assets shifts run orthogonally to that question because they may occur with, or without, accompanying locational shifts.
28. A full specification requires sixteen possibilities because the laws of Alpha and Beta are not interchangeable when analyzing migrations. That is, one could get different results depending on whether a certain substantive regime applied to the exit jurisdiction versus the target jurisdiction.
29. Limiting the analysis to the law of one jurisdiction is essential. We suspect that no reader would tolerate a systematic analysis of sixteen different combinations of various substantive tax and locational rules across jurisdictions. But the problem is actually much worse than that, for we have yet to introduce the complication of corporate locational rules. Recall that we make the initial assumption that corporate and tax locational rules can be the same or different. This means that for each jurisdiction there are four possible combinations of tax and corporate locational rules. If we couple this with two substantive tax regimes, this yields eight possible regimes for any given jurisdiction. Thus a full specification of all of the possibilities in a two-jurisdiction world would require analysis of sixty-four possible combinations of rules. The basic problem we address here is complicated, but it need not be that complicated. Thus we will focus on the law of one jurisdiction, taking up discussion of four possible scenarios here. In the next Part, we introduce corporate locational rules, again limiting the analysis by focusing on a single jurisdiction.
30. Aside from the simplicity gained from examining only one jurisdiction's law, there is a good substantive reason for this approach as well. Simultaneously examining the tax law of both jurisdictions produces the following result: locational distortions will be minimized where the tax law of the jurisdictions is the same, thus removing incentives to locate on tax grounds. That is a result that is obviously not on the table. The interesting question is how one can unilaterally minimize tax locational distortions in a world where we expect the tax laws of jurisdictions to differ.
31. We use the qualified phrase "may observe" because the final level of distortion depends on how tax and corporate law locational rules intersect. If these locational determinations were always 100% independent, we would not expect different incentives regarding tax location to have any feedback into the corporate locational decision. The task of the next Part, though, will be to show why determinations are likely not to be independent.
32. Because the whole point of this exercise is to capture the comparative import of POI and RS locational rules, our assumption here is that location in Beta means placing only the incorporation in Beta, while the real seat is located in Alpha.
33. We should stress that in keeping with our focus on one jurisdiction to keep the analysis tractable, the diagram in the text relates solely to taxation in Alpha. Still, it is worth noting those features of the Beta tax system that would be necessary to create a tax surplus in the first place. A tax savings would generally materialize from location in Beta only if Beta-source income (or income from a third jurisdiction) is taxed by the source jurisdiction at a lower rate than the Alpha rate. Otherwise, Alpha's foreign tax credit should fully remove any residual Alpha tax on this income in the first instance.
34. The qualification is necessary because real world territorial systems typically do not exempt all forms of foreign source income. Also, migration from a territorial system could allow for incremental earnings strippings. Thus, corporate location will remain relevant even in Box 2 situations.
35. In keeping with the general framework of our analysis in this Article, we are once again considering only tax effects from shifts in location, thereby ignoring shifts in real assets except where mandated by the applicable locational rule, as may be the case with the RS rule. Of course, where Alpha is a Box 1 jurisdiction there is nothing precluding the taxpayer from moving the RS factors to Beta to achieve a tax advantage, even if such shift of factors is not required by the POI locational rule. For the reason just noted we ignore this prospect in the text because the shift is not mandated by the locational rule. In practice, though, if there is a tax advantage from shifting the factors we would expect to observe this where Alpha is a Box 1 jurisdiction. This simply means that in practice the theoretical indeterminacy drops away and tax surplus in Box 1 should always be greater than in Box 4. We also ignore the other major means of moving income out of the corporate tax base, namely, creating deductible intra-company payments. Because the potential for deductible interest payments arises equally with respect to all four scenarios just canvassed, however, it should not change the relative ordering of potential tax surplus in the four scenarios.
36. By "exit taxes," we mean taxes due on exit from the jurisdiction, either explicitly or because exit triggers dissolution of the corporation and payment of tax on deferred profits. Provisions that provide the old jurisdiction with security that taxes owed will be paid at some later date bear some similarities to, but should be distinguished from, exit taxes. Such provisions will not discourage exit as directly as exit taxes but may nonetheless penalize exit. For example, a firm whose taxes owed are fixed and collateralized upon exit and then suffers losses will likely be worse off than a firm that did not exit.
37. For a discussion of the case with the European Union, see infra Section IV.C.
38. If exit taxes were the only tax at issue, then we would, of course, necessarily remove tax-induced distortions by getting rid of the exit taxes. What makes the problem so difficult here is the prospect of tax distortion arising from the differential tax systems of Alpha and Beta with respect to new profits. Thus to eliminate tax-induced distortions completely one would need to structure the exit tax so that it exactly offset any tax surplus in Beta arising from new profits. Then tax surplus would be at zero in each of Alpha and Beta, and we could be confident that firms would make locational decisions on corporate surplus grounds alone. But exit taxes could never perform this function of completely offsetting tax surplus from the differential treatment of new profits. To see the point most easily, consider the case of the newly incorporated firm, for which exit taxes are never an issue. For these purposes, relatively young firms approximate the position of the newly incorporated firm. The historic tax base would simply be too small for exit taxes to perform the required function.
39. See Mihir A. Desai & James R. Hines, Jr., Expectations and Expatriations: Tracing the Causes and Consequences of Corporate Inversions, 55 NAT'L TAX J. 409, 410 (2002).
40. For a recent discussion of the arguments favoring a shift towards a more territorial regime in the United States, see PRESIDENT'S ADVISORY PANEL ON FED. TAX REFORM, SIMPLE, FAIR, AND PRO-GROWTH: PROPOSALS TO FIX AMERICA'S TAX SYSTEM 102-05 (2005), available at http://www.taxreformpanel.gov/final-report (last visited Jan. 26, 2008). The standard reason for favoring RS locational rules in tax is that they better reflect economic substance.
41. This is not to say that a shift towards territorial taxation and RS should not be part of a broader solution to the problem. Indeed, we urge such an approach as part of our broader analysis below. See infra Section III.B.1.e.
42. We take it as a given that no jurisdiction is going to adopt different methods of double tax relief or a different locational rule for the different situations. The administrative complexities of this would be insurmountable.
43. A side effect of this solution is to remove any interference the corporate law market may have on the tax law market. Consistent with our agnosticism on tax competition, we count that effect as neither a benefit nor a detriment of our proposals. Note also that the types of distortion we describe in this paper are not necessarily unique to the interplay between corporate law and corporate tax law. To generalize, any time the factors relevant to locational determinations under tax law play a role in determining the substantive law applicable to the corporation, the type of distortions described in this Article may arise. We take no position in this paper on whether it may be desirable to drive a wedge between the tax law and other domains of law. Nor do we take a position on the degree of flexibility that should be accorded to corporations in opting into or out of such other domains of law.
44. See Hideki Kanda & Saul Levmore, Taxes, Agency Costs, and the Price of Incorporation, 77 VA. L. REV. 211 (1991);
45. Saul Levmore, The Positive Role of Tax Law in Corporate and Capital Markets, 12 J. CORP. L. 483 (1987);
46. Mihir A. Desai & Dhammika Dharmapala, Taxation and Corporate Governance: An Economic Approach (Dec. 4, 2007), available at http://ssrn.com/abstract=983563.
47. See Desai & Dharmapala, supra note 36.
48. See Mihir A. Desai et al., Theft and Taxes, 84 J. FIN. ECON. 591 (2007).
49. Note that tax cost identified in the text is somewhat different from the type of efficiency consequence we generally have in mind in this Article. That is, we are centrally concerned with corporate choice of location and the efficiency losses that one might suffer where tax steers corpora tions away from the best corporate law, resulting in a loss of what we call corporate surplus. Costs to the tax system that arise because of an increased need to combat aggressive planning do not similarly affect the tax surplus of a corporation. Though they might do so depending on how the jurisdiction passes the increased cost back to the private sector, the literature to date does not explore the ramifications of any such dynamic effect. Still, it is a social cost to the extent that the state must expend more funds to collect a given amount of revenue. See Yariv Brauner, An International Tax Regime in Crystallization, 56 TAX L. REV. 259, 298 (2003) (arguing that a partial and gradual harmonization of global tax rules will reduce the burden of both tax planning and enforcement costs). Accordingly, a complete analysis of the economic effects of separating the tax and corporate law markets would take account of the relation of this social cost to the type of cost we are generally concerned with in connection with loss of corporate surplus.
50. It is difficult to evaluate this narrow point in isolation from one's overall normative commitments about tax competition. While retaining our agnosticism on the normative question, we would note simply that this factor does seem to provide a novel reason to favor tax competition. Standard arguments for tax competition do not address governance implications but rather focus on factors such as how competitive pressures will restrain the size of the public sector and will enable heterogeneous corporations better to select into jurisdictions with the right blend of public-good provision. See Geoffrey Brennan & James M. Buchanan, Towards a Tax Constitution for Leviathan, 8 J. PUB. ECON. 255, 258-60 (1977), cited in Avi-Yonah, supra note 18, at 1614 & n.181.
51. But see Wallace E. Oates, Searching for Leviathan: An Empirical Study, 75 AM. ECON. REV. 748, 749-50 (1985), cited in Avi-Yonah, supra note 18, at 1614-15 & n.188.
52. Use of the term "friction" to describe a constraint on tax planning that derives from some domain outside the tax law originates with Professors Scholes and Wolfson. MYRON S. SCHOLES & MARK A. WOLFSON, TAXES AND BUSINESS STRATEGY: A PLANNING APPROACH 7 (1992).
53. The concept was then developed at length by Dean Schizer. David M. Schizer, Frictions as a Constraint on Tax Planning, 101 COLUM. L. REV. 1312 (2001).
54. Schizer, supra note 41, at 1333.
55. Id. at 1323.
56. See Louis Kaplow, Optimal Taxation with Costly Enforcement and Evasion, 43 J. PUB. ECON. 221, 233 (1990).
57. The difficulty is twofold. One is the standard problem, mentioned in the text, of determining whether any given package of tax-law-plus-corporate-law friction yields a social cost or a social benefit in the aggregate. The additional problem is that it is exceedingly difficult to determine ex ante what package one should consider. There is uncertainty here because the final package of tax and corporate law depends on the operation of markets, rather than a combination of legislative acts of a single sovereign. This last point does, however, point to one unambiguous cost of segregating the markets: sovereigns sacrifice the ability to leverage the tax and corporate law against one another. In other words, it may be possible to use frictions affirmatively to accomplish goals that one cannot accomplish as easily through direct drafting of tax legislation. Cf. Schizer, supra note 41 (contrasting the effectiveness of I.R.C. section 1260, where frictions are relatively strong, with the general ineffectiveness of I.R.C. section 1259, where frictions are relatively weak).
58. Note that this would call for a case-by-case analysis of the particular substantive interaction. If the interaction is value enhancing where the laws of a single jurisdiction apply, this does not counsel against severing the markets. This conclusion depends on a comparative analysis of how the interaction plays out where the markets are separate and the corporation is unhindered in its ability to pair tax law from one jurisdiction and corporate law from another jurisdiction. Conversely, if the substantive interaction is value reducing where the laws of a single jurisdiction apply, this does not necessarily provide an argument for severing the markets. Again, the answer depends on the comparative question regarding the consequences of the substantive interaction with segregated markets.
59. This is true, at least, in a static but not dynamic sense. That is, if tax surpluses typically trump corporate surpluses, then the overlap at time 1 will prevent any future competition for charters from emerging.
60. Supra Section I.A.
61. It is, however, relatively common for jurisdictions to attempt to impose specific requirements on "pseudo-foreign" corporations. See, e.g., CAL. CORP. CODE § 2115 (West 2008). The constitutionality of such provisions in a federal system is inevitably subject to controversy. For the United States, see VantagePoint Venture Partners 1996 v. Examen, Inc., 871 A.2d 1108 (2005). For the European Union, see the discussion below of Centros, and subsequent cases, infra Section IV.C.1.a.
62. Drury, supra note 11, at 357 & n.7.
63. Henry Hansmann & Reiner Kraakman, The Essential Role of Organizational Law, 110 YALE L.J. 387 (2000).
64. As we discuss below, part of our first-best solution involves coordination of locational rules across jurisdictions. If one could achieve coordination it might seem that the effect described in the text drops away. That is, if all jurisdictions applied an RS rule for corporate law purposes, then it would become impossible for one jurisdiction to claim a corporation on the basis of real seat while some other jurisdiction (applying a POI rule) claims the same corporation solely on the basis of local incorporation. The possibility of conflicting bodies of corporate law applying to the same firm would seem to dissipate. Matters are more complicated than this simple formulation, however. Precisely because the RS rule is factual rather than formal, one could observe conflicts even in a case where all jurisdictions applied an RS rule for corporate law purposes. That could be the case either if the jurisdictions looked to different factual elements under the RS test or if the jurisdictions just applied the same test differently to a given set of facts. To avoid this possibility, jurisdictions adopting an RS rule should continue to view firms with local headquarters but foreign incorporation as defectively incorporated entities. Box 2 thus remains unavailable as a solution.
65. We mean tax in our limited sense. "Taxes" such as the Delaware franchise tax would of course still be relevant.
66. See infra Section IV.C.2.
67. Havens may well use corporate locational rules as part of an overall strategy to maximize revenue. For example, a haven might apply a relatively favorable tax regime where a POI rule is satisfied, while maintaining a different and relatively onerous tax regime where a conjunctive POI and RS rule is satisfied. This strategy would preserve full tax collections for "real" domestic firms, while also capturing some incremental tax revenue from foreign firms. The Organization for Economic Co-operation and Development ("OECD") has strongly criticized such a strategy of "ring-fencing," which it views as a feature suggesting a harmful preferential tax regime. The foreign taxpayer enjoys the jurisdiction's infrastructure at a reduced cost, and by barring domestic taxpayers from the regime, the community is protected from the otherwise harmful effects of the ring-fenced tax regime. COMM. ON FISCAL AFFAIRS, ORGANISATION FOR ECON. CO-OPERATION & DEV. [OECD], HARMFUL TAX COMPETITION: AN EMERGING GLOBAL ISSUE paras. 59, 62 (1998), available at http://www.oecd.org/dataoecd/33/1/1904184.pdf.
68. There could be reasons to disfavor such an arrangement that have nothing to do with markets for corporate charters. If one is suspicious of centralized power, then one may well not want the main revenue collection system operated at the federal level. We express no opinion on this issue, though we would note that the key feature of our system is that the substantive tax law is uniform while the corporate law is not. There is a fair amount of leeway to address the centralized power concern even within our system by, for example, delegating spending decisions back to the subfederal units.
69. We take some time to analyze this possible departure from the ideal because this in fact describes the current situation in the United States.
70. Note that the point in the text is that a jurisdiction can affirmatively use tax law to protect corporate surplus in certain cases where it has departed from the ideal arrangement of locational rules. The flip side of this is that the jurisdiction may be tempted to use corporate law to meet its tax goals. In other words, the jurisdiction might like that bad corporate law in a low-tax jurisdiction operates as a disincentive for the corporation to shift location for tax purposes. That disincentive can only arise, though, if the corporate and tax locational rules are the same. This dynamic could put pressure on the jurisdiction to adopt the nonideal package of POI locational rules for both corporate and tax purposes. The United States is a case in point. For example, one might defend the U.S. package of rules by reference to the fact that it could put some brake on tax-motivated corporate-inversion activity. But this comes at the cost of distorting the charter market in ways that can lead to the sacrifice of corporate surplus. Thus if the jurisdiction is concerned about preserving tax base, we believe a better approach is to rely on exit taxes alone rather than falling back on the conjunction of nonideal locational rules and corporate incentives regarding the quality of corporate law. We discuss below other ways in which the motivation to preserve tax base can create political pressures to depart from the ideal arrangement of locational rules. See infra Section IV.C.2.
71. Our analysis in the text holds only where the conditions in the federal system are in fact sufficient to support robust charter competition within the federal system. In federal systems where charter competition is sparse or does not emerge at all, such as in Canada, one would need to pay additional attention to the sacrifice of potential corporate surplus that could be realized in jurisdictions outside the federal system.
72. Note that we do not take up here, as we did with POI migrations, the case in which the jurisdiction departs from the ideal package of locational rules and applies instead a POI rule for both corporate law and corporate tax law purposes. Obviously in that case the issue of RS migrations drops out of the picture altogether, as a migration of a real seat no longer has legal import under either domain of law.
73. As we will see below, however, the theory breaks down in the case of the European Union. See infra Section IV.C.
74. Del. Code. Ann. tit. 30, § 1902(a)-(b) (2003), cited and discussed in Dammann, supra note 3, at 71 & nn.90-91.
75. S. Cent. Bell Tel. v. Alabama, 526 U.S. 160, 170-71 (1999), cited in Dammann, supra note 3, at 71 n.92.
76. A majority of states that collect corporate income taxes have enacted portions of the Uniform Division of Income for Tax Purposes Act (UDITPA), and a number of others have adopted its business income/nonbusiness income distinction. JEROME R. HELLERSTEIN & WALTER HELLERSTEIN, STATE TAXATION I: C ONSTITUTIONAL LIMITATIONS AND CORPORATE INCOME AND FRANCHISE TAXES ¶ 8.03 (3d ed. 1998). Under UDITPA, "business income" is apportioned between the states in which the company operated. UNIF. DIV. OF INCOME FOR TAX PURPOSES ACT §§ 1(a), 2, 9, 7A U.L.A. 147 (2002). "Nonbusiness income" is allocated in several different ways. For nonbusiness rents, royalties, or capital gains, from real property and tangible personal property, the income is allocated to the state in which the property is located or utilized, respectively. Id. §§ 5(a)-(b), 6(a)-(c). Nonbusiness interest and dividends are allocated based on commercial domicile. Id. § 7. Nonbusiness patent and copyright royalties are allocated either by utilization or, if not taxed in the state utilized, in the state of the taxpayer's commercial domicile. Id. § 8(a). While the apportionment formulas and allocation rules do vary between states, a corporation's legal domicile is not a factor. Though states are not constitutionally precluded from using a "legal domicile" test for allocation of profits from nonbusiness intangibles, no state currently does so. HELLERSTEIN & HELLERSTEIN, supra, ¶ 9.03[2] n.41.
77. Our call for territorial taxation is based on our supposition that jurisdictions will do better to focus attention on new profits rather than old profits. Standing alone, the analysis in Part II would suggest that a jurisdiction should adopt territorial taxation coupled with a POI rule, because this is the set of rules that minimizes tax surplus in the foreign jurisdiction. Why, then, do we propose a locational rule of RS? The reason is that there is a tradeoff here. The RS rule is undesirable in the sense that it augments tax surplus because the company must locate real factors, to which taxable income must be allocated, outside the jurisdiction. On the other hand, the RS rule is desirable because it allows the corporation to locate in a low-tax jurisdiction without changing place of incorporation, with an accompanying shift in applicable corporate law under the described federal structure. We think the second factor is by far the most important here.
78. These tax savings can be very large. See, e.g., Ingersoll-Rand Co., Registration Statement under the Securities Act of 1944 (Form S-4), at 18 (October 30, 2001) ("As a result of the reorganization, we expect to realize annual, incremental net earnings of at least $40 million and expect to realize a one-time benefit to net earnings in the fourth quarter of 2001 of $50 million to $60 million, net of costs to effect the reorganization.").
79. See John D. McKinnon, Senators Plan to Curb Relocations to Bermuda, Other Tax Havens, WALL ST. J., March 22, 2002, at A4 (quoting Sen. Max Baucus as saying "When a criminal gets off because of a technicality in the law, people are outraged. . . . I am just as outraged when a corporation takes a technical, manipulative reading of the tax code and robs the rest of the taxpaying public"); David Rogers, Capital Climate Discomfits Multinationals - Business Frauds, Patriotic Fever Dominate Debates on Offshore Havens, Tax Breaks, WALL ST. J., July 25, 2002, at A4 (quoting Sen. Charles Grassley as saying "We have to send a clear signal that these corporations ought to get their hearts into America or their rear ends out").
80. See Michael S. Kirsch, The Congressional Response to Corporate Expatriations: The Tension Between Symbols and Substance in the Taxation of Multinational Corporations, 24 VA. TAX REV. 475, 553-57 (2005);
81. Orsolya Kun, Corporate Inversions: The Interplay of Tax, Corporate, and Economic Implications, 29 DEL. J. CORP. L. 313, 346-58 (2004);
82. James Mann, Note, Corporate Inversions: A Symptom of a Larger Problem, the Corporate Income Tax, 78 S. CAL. L. REV. 521, 534-37 (2005).
83. See supra note 66 regarding the size of tax savings.
84. See Kirsch, supra note 68, at 495 & n.66.
85. International Tax Issues Relating to Globalization: Hearing Before the S. Comm. on Finance, 106th Cong. 11 (1999) (statement of Robert H. Perlman, Vice President, Tax, Licensing and Customs, Intel Corporation).
86. Elizabeth Chorvat, You Can't Take It With You: Behavioral Finance and Corporate Expatriations, 37 U.C. DAVIS L. REV. 453, 456 n.6 (2003).
87. OFFICE OF TAX POLICY, U.S. DEP'T OF TREASURY, CORPORATE INVERSION TRANSACTIONS: TAX POLICY IMPLICATIONS 2 (2002) (emphasis added), available at http://www.treas.gov/press/releases/docs/inversion.pdf.
88. See, e.g., ROBERTA ROMANO, THE GENIUS OF AMERICAN CORPORATE LAW 118-28 (1993); Cumming & MacIntosh, supra note 12, at 277;
89. Ronald J. Daniels, Should Provinces Compete? The Case for a Competitive Corporate Law Market, 36 MCGILL L.J. 130 (1991).
90. We do not further analyze the actual rules on double-tax relief, which is the last aspect of our proposed ideal arrangement for this type of federal structure. This is for two reasons. First, many E.U. jurisdictions already apply territorial taxation. Second, as discussed above, the method of double-tax relief takes on relatively less importance where, as in the European Union, there is some tax competition within the federal system.
91. Case C-212/97, Centros Ltd. v. Erhvervs-og Selskabsstyrelsen, 1999 E.C.R. I-1459.
92. Case C-208/00, Überseering BV v. Nordic Constr. Co. Baumanagement GmbH (NCC), 2002 E.C.R. I-9919.
93. Case C-167/01, Kamer van Koophandel en Fabrieken voor Amsterdam v. Inspire Art Ltd., 2003 E.C.R. I-10155.
94. The qualification "inside the European Union" is essential. Contrary to the sloppy formulation of some, the Centros line of cases has not established the POI doctrine as the company law choice of law rule in the European Union. Thus, for example, there is no basis for thinking that a company formed in a non-E.U. POI state without a bilateral recognition treaty with Germany, but with its real seat in Germany, will be recognized as a properly constituted corporation with legal capacity to sue in Germany. This is the sense in which Professor Wymeersch is correct to insist that Centros, Inspire Art, and Überseering are freedom of establishment cases, not company law cases. Eddy Wymeersch, Centros: A Landmark Decision in European Company Law, in CORPORATIONS, CAPITAL MARKETS AND BUSINESS IN THE LAW 629, 631 (Theodor Baums et al. eds., 2000).
95. See John Armour, Who Should Make Corporate Law? EC Legislation Versus Regulatory Competition, 58 CURRENT LEGAL PROBS. 369, 386 (2005) (providing data on so-called "GmbH limited" companies - German businesses incorporated as English private-limited companies);
96. Luca Enriques & Martin Gelter, How the Old World Encountered the New One: Regulatory Competition and Cooperation in European Corporate and Bankruptcy Law, 81 TUL. L. REV. 577, 600-06 (2007);
97. Alexander Schall, The UK Limited Company Abroad - How Foreign Creditors are Protected after Inspire Art (Including a Comparison of UK and German Creditor Protection Rules), 2005 EUR. BUS. L. REV. 1534, 1535 (reporting estimates that there are more than 20,000 United Kingdom limited companies (Ltds.) with their real seats in Germany);
98. Marco Becht et al., Where Do Firms Incorporate? 3 (European Corporate Governance Inst., Law Working Paper No. 70/2006, 2006), available at http://ssrn.com/abstract=906066 (providing evidence on other Member States' businesses' incorporations in the United Kingdom).
99. The SE is a relatively new entity established by the European Company Statute in 2001. It can be created by merger, creation of a holding company, creation of a joint subsidiary, or conversion of an existing company set up under the laws of a Member State. It cannot be created from scratch, and it has a minimum capitalization requirement of 120,000 euros. While it must have its real seat in its place of registration, it allows an SE from an RS jurisdiction to migrate without dissolution and reincorporation. Council Regulation 2157/2001, On the Statute for a European Company (SE), tit. 1, art. 8, 2001 O.J. (L 294) 1; Eric Engle, The EU Means Business: A Survey of Legal Challenges and Opportunities in the New Europe, 4 DEPAUL BUS. & COM. L.J. 351, 398 (2006). For further description of the SE, see Europa - Glossary: European Company, http://europa.eu/scadplus/ glossary/eu_company_en.htm (last visited Jan. 26, 2008).
100. Luca Enriques, Silence is Golden: The European Company Statute as a Catalyst for Company Law Arbitrage 5 (European Corporate Governance Inst., Law Working Paper No. 07/2003, 2003), available at http://ssrn.com/ abstract=384801.
101. The defect, in terms of our recommendations in Section III.B., supra, is a failure to separate the corporate law and corporate tax markets through the locational rule. In effect, the European Company Statute layers an RS rule back into the corporate law.
102. Council Directive 2005/56/EC, On Cross-Border Mergers of Limited Liability Companies, 2005 O.J. (L 310) 1 [hereinafter Cross-Border Merger Directive].
103. Council Directive 90/434/EEC, On the Common System of Taxation Applicable to Mergers, Divisions, Transfers of Assets and Exchanges of Shares Concerning Companies of Different Member States, 1990 O.J. (L 225) 1 [hereinafter Merger Tax Directive], amended by Council Directive 2005/19/EC, 2005 O.J. (L 58) 19 [hereinafter Merger Tax Directive Amendment].
104. Case C-9/02, Hughes de Lasteyrie du Saillant v. Ministère de l'Économie, des Finances et de l'Industrie, 2004 E.C.R. I-2409.
105. Case C-411/03, SEVIC Sys. AG, 2005 E.C.R. I-10805.
106. Cross-Border Merger Directive, supra note 84, at 1.
107. Id. art. 4(1).
108. Id. art. 5.
109. Id. art. 6.
110. Id. art. 7.
111. Id. art. 8
112. Id. art. 9.
113. Id. art. 16.
114. Case C-411/03, SEVIC Sys. AG, 2005 E.C.R. I-10805, paras. 16-19.
115. McCahery & Vermeulen, supra note 13, at 9.
116. Merger Tax Directive, supra note 85, art. 4.
117. Id. art. 8.
118. The principal restriction of the deferral of tax, at least with regard to SEs and possibly more broadly, is when the registered office is transferred. So long as productive assets remain in place, however, a change of place of incorporation will not trigger any tax on those assets. Id. art. 10.
119. For a discussion of the scope of the Merger Tax Directive, see RUTH MASON, PRIMER ON DIRECT TAXATION IN THE EUROPEAN UNION 25-28 (2005).
120. Armour, supra note 80, at 382.
121. Case 81/87, The Queen v. H.M. Treasury & Comm'rs of Inland Revenue, ex parte Daily Mail & Gen. Trust plc, 1988 E.C.R. 5483.
122. Income and Corporations Taxes Act, 1970, c. 10, § 482(1)(a) (U.K.).
123. Daily Mail, 1988 E.C.R. 5483, para. 19.
124. Case C-208/00, Überseering BV v. Nordic Constr. Co. Baumanagement GmbH (NCC), 2002 E.C.R. I-9919, para. 62.
125. Case C-167/01, Kamer van Koophandel en Fabrieken voor Amsterdam v. Inspire Art Ltd., 2003 E.C.R. I-10155, para. 103.
126. Under the SE structure it could also trigger a tax because the appreciated shares may no longer be "effectively connected with a permanent establishment" of the SE in the United Kingdom. Merger Tax Directive Amendment, supra note 85, at 19.
127. This call for blanket rejection of exit taxes is consistent with our claim that exit taxes are sometimes beneficial. The benefit arises where one has failed to achieve complete separation of the markets through distinct locational rules. Our suggestion is that the European Union should strive to achieve that complete separation (and remove exit taxation on migrations within the European Union). Exit taxes on migrations outside of the European Union could, however, still be beneficial from the perspective of maximizing corporate surplus.
128. Egyptian Delta Land & Inv. Co. v. Todd, [1929] A.C. 1, 1 (H.L.) (appeal taken from Eng.) (U.K.) ("It is settled by authority that the residence of a company, whether British or foreign, for income tax purposes is preponderantly if not exclusively determined by the place where its real business is carried on.").
129. For a discussion of why either country would care to combat it, see Kane, supra note 10.
130. Finance Act, 1994, c. 9, § 249 (U.K.).
131. Although many types of transactions have been grouped under the rubric of "international tax arbitrage," it is only the single case of that phenomenon related to dual resident companies that is of interest to us. It is of doubtful continuing relevance given that the United States was the chief counterparty - given the size of the U.S. economy and the fact that the United States had a tax POI rule - and the United States has taken its own steps to eliminate the benefits from the tax arbitrage.
132. Finance Act, c. 39, § 66, sched. 7; John Dewhurst, General Consents, 6 BRIT. TAX REV. 215 (1988). This was prior to the change to the "POI + RS" rule discussed above.
133. STAFF OF J. COMM. ON TAXATION, 109TH CONG., OPTIONS TO IMPROVE TAX COMPLIANCE AND REFORM TAX EXPENDITURES 178-81 (Comm. Print 2005).
134. Id. at 179-80.
135. A shift towards a disjunctive rule in this context would be somewhat different than the type of shift we describe in the text because the baseline nondisjunctive rule is different - that is, POI rather than RS for tax. Still, the example serves to highlight how political forces may drive the legislature to contemplate tweaking the tax locational rule to forward substantive tax-policy goals without much, or any, awareness of the possible ramifications under corporate law.
136. For a fuller discussion of the Israeli case, see Edward B. Rock, Corporate Flight, 36 MISHPATIM 161 (2006) (in Hebrew).
137. A corporation is considered resident in Israel if it is: "(1) A corporate body registered in Israel whose main activity takes place in Israel; . . . (2) A corporate body the control of whose dealings and their management are performed in Israel." Income Tax Ordinance § 1, reprinted in David Gliksberg, The Effect of the Statist-Political Approach to International Jurisdiction of the Income Tax Regime- The Israeli Case, 15 MICH. J. INT'L L. 460, 478 (1994). See generally Gliksberg, supra, at 476-81.