Reuven S. Avi-Yonah & Haiyan Xu
The Financial Crisis of 2008 and Great Recession that followed have exacerbated income inequality within and between countries. In the aftermath of the economic turbulence, politicians have turned their attention to the twin problems of individual tax evasion and corporate tax avoidance. U.S. legislators enacted the Foreign Account Tax Compliance Act (FACTA), leading to the United States signing a series of Intergovernmental Agreements (IGAs) for the exchange of tax information. The Organization for Economic Co-operation and Development (OECD) developed the Multilateral Agreement for Administrative Assistance in Tax Matters (MAATM) and initiated the Base Erosion and Profit Shifting (BEPS) project to reduce tax evasion and tax avoidance globally. Although these efforts were well-intended, this Article argues that the tax policy response to the Financial Crisis and Great Recession has ultimately been inadequate. The problem, which is discussed in-depth in the sections that follow, is the benefits principle.
Part I of this Article introduces the primary weakness of the benefits principle: the reliance on source-based taxation for active income and residence-based taxation for passive income requires cooperation by too many jurisdictions. This section provides three case studies of individual tax evasion and corporate tax avoidance to illustrate the principle’s shortcomings. Part II focuses on the individual tax evasion problem. This section analyzes the FATCA, IGA, and MAATM responses and explains why these measures are likely to fall short. Part III focuses on corporate tax avoidance. This section examines the BEPS response and its inadequacies. Part IV proposes an alternative to international tax policy based on the benefits principle. This section argues that reversing the benefits principle by taxing passive income primarily at source and active income primarily at residence will more effectively reduce individual tax evasion and corporate tax avoidance in the developed and developing world.
Taming the Dragon: Drawing Lines — A Case Study of Foreign Hedge Fund Lending to U.S. Borrowers and Transacting in U.S. Debt Securities
Julie A.D. Manasfi
Legislators, judges, and administrative agencies often have to distinguish between similar transactions for tax purposes. To help, Congress has drawn some lines via certain categories. These categories, or “cubbyholes,” raise “line drawing” issues of whether seemingly similar benefits qualify as taxable under specific categories. One line drawing area where the stakes are high is in the taxation of foreign persons lending money to U.S. borrowers and transacting in U.S. debt securities. The relevant category that determines federal income tax consequences to those transactions is whether persons are “engaged in a U.S. trade or business.” The stakes are high in these situations because of the legal uncertainty in these transactions, which may create interconnectedness and credit channels, increase systemic risk, and make our system more fragile.
This Article analyzes the engaged in a U.S. trade or business cubbyhole in the context of foreign hedge fund lending to provide guidance to legislators who are faced with line drawing or cubbyhole issues. Part I examines the uncertain- ties created by recent developments. Part II questions whether academics can help legislators draw lines in general and with respect the specific case of hedge fund lending. Part III asks what type of law should govern: a rule or a standard. This Article concludes by advocating for the implementation of a “white list” approach based on policy developed in the United Kingdom to ensure that tax policy related to the engaged in a U.S. trade or business cubbyhole keeps pace with financial innovation.
Jonathan C. Lipson
This Article studies the growing use of contract in bankruptcy. Sophisticated “distress” investors (for example, hedge funds and private equity funds) increasingly enter into contracts amongst themselves and corporate debtors during bankruptcy in order to evade “mandatory” rules on the priority of distribu- tions, thus preferring themselves at the expense of other stakeholders (for example, employees of the corporate debtor). Bankruptcy courts that supervise these cases struggle with these priority-shifting contracts. They are asked to approve them, but have little theoretical or doctrinal guidance on how to assess them.
This Article develops a “relational” framework to explore this shift toward contract in bankruptcy. Relationalism seeks to understand power dynamics, and preferences for formal and informal promissory mechanisms in private ordering. Distress investors, bankruptcy professionals (lawyers), and judges in large cases form a classic relationalist environment. They are a community of repeat players with their own norms and preferences for formal and informal promissory exchange. Their contracting practices can affect the hundreds (sometimes thousands) of stakeholders in a large corporate debtor.
At the same time, there are growing calls to amend the Bankruptcy Code. Congress, however, has botched recent efforts to do so. Contract may be a better vehicle for institutional adjustment than Congress—if it is perceived as legitimate. A relationalist framework would help sort legitimate from illegitimate contracts in bankruptcy, thus improving our understanding of the system and its operation.
Puffery on the Market: A Behavioral Economic Analysis of the Puffery Defense in the Securities Arena
Puffery statements in the securities arena are statements that are so optimistic, general, broad, or vague that they are considered immaterial as a matter of law and, thus, shielded from liability. The courts’ underlying assumption is that investors disregard puffery statements and do not rely on them when making investment decisions.
Following recent scholarly criticism of the puffery defense, this Article aims to test whether investors indeed disregard puffery statements when making investment decisions.
Part I of the Article analyzes 233 federal court decisions between 2009 and 2013. The analysis reveals that despite the rising popularity of the puffery defense, the courts’ decisions lack concrete reasoning In addition, the courts have not adequately justified their presumption that investors do not rely on puffery statements.
Part II describes the limited research about the effect of puffery statements on consumers and investors. In an attempt to fill the gap in the literature, I conducted an experiment that tests whether puffery statements affect investors’ decisions.
Parts III and IV describe and analyze the results of the experiment. The main finding is that the courts’ assumption that puffery statements do not affect investment decisions is correct in most instances. These results should soften the criticism that scholars have raised with respect to the courts’ assumption. At the same time, the results call for a cautious analysis of strong puffery statements, such as factual statements, as well as cautious implementation of policy based on behavioral economics.