Amazon’s Epic Transfer Pricing Strategy

February 13, 2013 — 2 Comments

Amazon-LogoSince 2005 Amazon.com has avoided paying taxes on over $2 billion of income.  Like other multinational corporations, Amazon has taken full advantage of transfer pricing rules to legally exempt massive amounts of foreign profits from taxation.  Their winning strategy fulfills their obligation to their shareholders, but government authorities around the world, who had been complacent about the matter until recently, are cracking down on international tax avoidance schemes; Amazon, the global leader in e-commerce,  is at the front and center of the controversy.

The name of the game is transfer pricing, which is when a foreign subsidiary of a multinational company trades with either the parent or another foreign subsidiary.  Transfer pricing is exploited under certain conditions by charging artificially high payments for services between units of the same firm for rights or licenses to use a product or service.  These payments are set against losses to lower the one firm’s taxable income while the unit receiving the money typically has some sort of tax-advantage due to its structure and/or location, minimizing total tax liability. Due to differing national tax policies and inter-country money transferring rules, especially in Europe, some companies are able to re-arrange their foreign business structures to enjoy extraordinary tax benefits.  Companies like Amazon have made a fortune from it.

Governmental Backlash

closing in on

Taking advantage of transfer pricing isn’t illegal in theory, but doing so is highly controversial and teeters on the edge of national and international tax laws.  One small mistake can land a company in billions of dollars worth of lawsuits from multiple authorities.

For Amazon, that’s already happened.  The IRS has proposed slapping the company with $1.5 billion in back-taxes related to their EU operations beginning in 2005.  Other tax authorities have suggested similar measures, making their tax liability greater than any other Tech Company reporting issues.  Amazon’s accountants have estimated any legal consequences or back-taxes to be much less, and have set aside $229 million to settle any disputes.

The crackdown comes on the heels of the IRS’ newly created division —International Transfer Pricing Operations, which is currently investigating Amazon as well as other multinationals.  Their primary purpose is to audit “the reliability of assumptions used in setting the transfer price for an intangible asset,” [PWC Report] as well as intra-group services, business restructuring, cost-sharing arrangements and other activities that associate multinationals and transfer pricing [Ernst & Young].

The story isn’t much different for Amazon in Europe.  Recently, representatives from Amazon, Google and Starbucks (all of which have similar foreign tax structures) were called to a hearing with the UK’s Public Accounts Committee.   The UK media outlet The Guardian reported the hearing as being painfully sharp and accusatory: “The man from Amazon was told he was a waste of space, had no information to bring, and the committee would summon someone else who might know what they were talking about.”  Amazon’s representative also said that their Luxembourg operation made only $20 million in after-tax profit, far less than the $300 million that their financial records show.

Google’s rep didn’t fair any better during the hearing.  In response to the committee’s accusations of tax avoidance he said, “Google plays by the rules set by politicians… The only people who really have choices are politicians who set the tax rates.”  Committee chairwoman Margaret Hodge replied simply, “We’re not accusing you of being illegal; we are accusing you of being immoral.”  Later she added, “People want to know why companies which benefit from an infrastructure paid for by them and are paying people low wages who receive taxpayer-funded tax credits from the exchequer are not paying their fair share.”

The Guardian speculated it would be difficult for the government to continue turning a blind eye to these operation’s once the report from this hearing is produced: “These buffoonish executives might have cost their companies billions – something few of us can claim.”

Amazon’s Luxembourg Operation
Amazon's Luxembourg Headquarters

Amazon.com’s Luxembourg Headquarters

Amazon began abroad operations in 1998 (when they were still just a bookseller) by purchasing online retailers in the UK and Germany and re-branding them under the Amazon name; A French operation followed in 2000. At first, these units operated relatively independently; French consumers bought and paid the French website, German users bought and paid the German website, etc.   In late 1999 though, Amazon’s losses were toppling $1 billion, so the EU units were re-structured as service operations whose purpose was solely to provide customer service and distribute packages, while all other business activities were tied to a U.S. unit registered in Delaware.  In doing so, most of the European profits were transferred to the U.S. parent company and set against the U.S. losses.

This strategy was beneficial until 2003, when Amazon started turning a profit in the U.S., and the foreign revenue threatened to raise its tax bill.  So, Amazon turned to the tiny country of Luxembourg.

It can be assumed that Amazon chose Luxembourg because of its unique corporate tax benefits for tech companies.  Although the corporate tax rate is set at 29%, income from payments for intellectual property can be exempted by up to 80%, which can lower the effective rate to less than 6% [Reuters].

With a new office in Luxembourg, Amazon changed its terms with its EU unit so that third party retailers selling products through Amazon.eu would now be handled there, not in the U.S.  Foreign revenue was thus returned abroad, and to a very tax advantageous country.

A year later, another unit was established in Luxembourg – Amazon Europe Holding Technologies (to simplify things, we’ll call this Amazon 2) – whose purpose was to hold shares in Amazon group companies and “to acquire … any intellectual property rights, patents, and trademarks licenses and generally to hold, to license the right to use it solely to one of its direct or indirect wholly owned subsidiaries,” [Reuters] With no employees or premises, Amazon 2 filed as a tax-exempt company in Luxembourg.

One month later, Amazon created third Luxembourg subsidiary – Amazon EU SARL (Amazon 3), to be the supplier of all goods and services to EU customers.  This change made Amazon 3 the collector of most EU profits.  Alone, it would serve no purpose, but that’s where Amazon 2 comes into play.  Amazon 2 charged Amazon 3 fees for use of its intellectual property and other intangible goods – such as Amazon’s click-to-purchase technology.  In doing so, Amazon 3 could set those expenses against their earnings to lower their taxable income by over 95%.  The profits would then be transferred to the tax-exempt Amazon 2, saving them millions. At that point Amazon 2 didn’t own the rights of any technologies to sell though.  A secret inter-company transition satisfied this need, the details of which have never been made public; however, a transcript of CFO Tom Szkutak addressing analysts on a conference call a few weeks after this move reveals that Amazon 2 shifted “certain operating assets offshore,” to benefit their long-term global tax bill.

Keeping a Low Profile (Sort of)

Amazon 2 couldn’t get away with holding all EU profits tax-free – there would be too much legal risk; according to a Reuters investigation, since 2005 Amazon European Holding Companies made payments to Amazon Technologies Inc in Nevada of up to $300 million/year, while receiving over $700 million from EU sales.  Still, more than half of their revenue stayed in Luxembourg.

While the specifics haven’t been made public, it can be assumed that the arrangement had something to do with U.S. tax law. Under U.S. transfer pricing rules there is a key exemption: while most companies would be subject to a foreign base company sales income tax, if they manufacture or significantly change the product they sell, they are off the hook.  An example is turning wheat into cereal, or soda into bottled soda.  This exemption was created before certain intangible properties, such as software, existed. Technological products are easy to change or re-develop and are thus easier to satisfy legal requirements.

Despite all the steps outlined above, Amazon’s foreign structure existed more on paper than in reality, and would have attracted a red flag from tax authorities to a greater degree than it has if not for other actions.  One step was ensuring the Luxembourg units had a strong enough footing and staff to justify their tax benefit, as dictated under Luxembourg law.  To do this, all of Amazon’s EU operations were transferred to the Luxembourg unit in 2006; they hired more employees and locals to legitimize their operation, albeit only 300 total staff.

The price of the fees charged by Amazon 2 to Amazon 3 also needed to be set appropriately to avoid tax authorities.  While charging fees between firms of the same company is perfectly legal, their price needs to be justified, typically by market price.   Whether or not Amazon made those fees artificially high is a major accusation they will have to answer in future legal proceedings.

Amazon has made few statements on the issue of transfer pricing.  In an interview with bbc.co.uk, an Amazon spokesperson had only this to say about their European operations: “Amazon EU serves tens of millions of customers and sellers throughout Europe… We have a single European headquarters in Luxembourg… to manage this complex operation.”

The entire Luxembourg operation has allowed Amazon to accumulate over $2 billion in untaxed cash by paying an average rate of 12% tax on foreign profits, half the rate for most EU countries and a third of the U.S [The Guardian].

Due to .com and software companies like Amazon’s ability to use concepts of intangible property and intellectual rights, they are in a unique position to take advantage of transfer pricing laws.   Google, Yahoo, Adobe, AOL, Facebook, and Microsoft are all in the game too.  These companies serve their shareholders first, and international tax loopholes have undeniably led to increased performance.  If Amazon paid top corporate tax rates on all of its income, its stock price would fall hundreds of dollars.  The flip side? One study estimates that collectively, corporate foreign tax avoidance schemes result in $60 billion of lost Government revenue.


JDKatz: Attorney's At Law
JDKatz, P.C. is a full-service law firm focused on tax law and estate planning. We are dedicated to minimizing your existing liability and risks while providing valuable tax planning to streamline your tax issues in the future. Please call us at 301-913-2948 to schedule an appointment to meet with one of our trusted attorneys.

Trackbacks and Pingbacks:

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