Facebook the Latest to Win Big on Foreign Tax Loophole

December 31, 2012 — 4 Comments

In an undeniably bad year for Facebook’s PR, recently revealed figures show that the company used tax avoidance strategies to pay less than 0.1% in taxes on foreign profit—$4.5 million on over $1.3 billion.

In the US, the corporate tax rate is 35% – the highest among developed economies.   Critics say this drives jobs overseas, but a bigger problem may be the lost tax revenue.  For years, multinational corporations (MNCs) have been using methods known as the Double Irish and the Dutch Sandwich to avoid paying millions and sometimes billions of taxes to the IRS; some can even reduce their foreign profit tax liability to near zero, as Facebook did.  An accounting executive from a fortune 500 company said these strategies were like using crack-cocaine, “once you start using it, it’s hard to stop.”  Below are some of the more prominent U.S. companies who are locked into this lucrative tax structure, but thousands more exist:

new-microsoft-logo-600google logofacebook_pic starbucks logo  Amazon-Logo

Two things you should know about the Double Irish and Dutch Sandwich strategies: 1) they are complicated tax avoidance procedures used by large MNCs and 2) they are both perfectly legal.

Facebook’s recent tax information unveiling provides an excellent case study of the Double Irish Dutch Sandwich   It began when Facebook developed a subsidiary in Ireland (Facebook Ireland) where the corporate tax rate is just 12.5%.  In doing so they were able to make all non-US companies who wanted to buy advertisements on their website pay Facebook Ireland – where the corporate tax rate is much lower, as opposed to the parent company in the US.  This would be a substantial savings in itself, but there is a second layer (hence double Irish).  The parent company, United States Facebook, then set-up a second Irish subsidary and moved the original Irish headquarters to the Caymen Islands – a true tax-haven.  The Caymen Islands company then licensed their products to the second Irish subsidary for royalties that  went effectively untaxed.  Meanwhile, Facebook Ireland deducted their royalty payments (about half a billion pounds in 2011) as a business expense/loss; it’s remaining profits were taxed at the 12.5%.

This type of money transferring to avoid taxes is legal because 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 the existence of certain intangible properties, such as software.  Therefore, with careful consideration to cost-sharing rules, the Cayman islands and US parent company can co-develop software so long as the rights belong to the subsidiary, which can then sell the product tax-exempt from the USA.  Confused?  Here’s the short version: a Double Irish is when an MNC creates 2 subsidiaries in Ireland and moves one to a tax-haven; the one that moved gets the product from the parent company, alters it in some way or develops it on its own, then sells it to the Irish company which is disregarded under US tax law.  The end result is impressively little tax liability.

A third layer is the Dutch Sandwich, which Facebook also used.  This is simply a Double Irish but with a third subsidiary added in the Netherlands.  The same principles as before apply, except now the Cayman Islands company licenses its products to the Dutch company, which can have little to no employees  and then pays almost all of what it collects to the Irish company for a small money transfer fee.  The end-result is an even smaller, often net-zero tax rate.

Lawmakers are aware of this issue, but it is unlikely to be tackled until we see corporate tax reform and of course, avert the fiscal cliff.

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.

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