An overhaul of the individual tax code might be a pipe dream, but with all the attention corporate tax avoidance has received, 2013 might be the year of global corporate tax reform. With countries across the world struggling to raise revenue in the aftermath of a global recession, giant multinational companies are taking a beating for their tax avoidance schemes, which some estimates say leave between $20 – $30 trillion in untaxed corporate income globally. Below are the major recent events and developments surrounding the issue:
+ 2011 – 2012: To crackdown on international schemes that could cost the U.S. over $100 billion/year, the Internal Revenue Service created a new division – International Transfer Pricing Operations – which is currently investigating dozens of multinational companies to hunt for “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 IRS division has already proposed slapping the online retailer Amazon with $1.5 billion in back-taxes related to their EU operations beginning in 2005. Other tax authorities, including the UK and China, have suggested similar measures, making Amazon’s tax liability greater than any other tech company reporting issues.
+ December, 2012: Shortly after Facebook’s controversial initial price offering, reports revealed that the company paid less than 0.1% in taxes on foreign profit, or just $4. 3 million on over $1.5 billion of income. Like many multinational companies, facebook used a strategy known as the Double Irish to significantly lower its tax liability. By establishing a subsidiary in Ireland (Facebook Ireland) Facebook could transfer non U.S.payments there, where the corporate tax rate is just 12.5%. Facebook then added a second Irish subsidiary, and moved the first to the Cayman Islands – a true tax haven. The Cayman subsidiary then licensed products and technologies to the Irish subsidiary for steep royalties and fees that could be set as business expenses to lower the Irish firm’s tax liability. The bulk of Facebook’s foreign profit is now taxed in the Cayman Islands, where the tax rate is laughable. This structure is common for large multinationals, particularly in the .com and tech sectors, but Facebook’s popularity and already controversial year brought new scrutiny to the issue.
*Note: Facebook also uses excessive corporate stock options to lower their domestic tax liability, which some analysts say could keep their tax bill exceptionally low for generations. *
+ February 2013: The Economist Magazine released a 14-page cover story titled *The Missing $20 trillion: How to stop companies and people dodging tax, in Delaware as well as Grand Cayman.* The article popularized scrutiny on the issue of corporate tax evasion. The opening line reads, “Civilization works only if those who enjoy its benefits are prepared to pay their share of the costs. People and companies that avoid tax are therefore unpopular at the best of times, so it is not surprising that when governments and individuals everywhere are scrimping to pay their bills, attacks are mounting on tax havens and those that use them.
+ February, 2013: representatives from Amazon, Google and Starbucks were called to a hearing before the UK’s Public Accounts Committee. The tone of the committee was sharp and accusatory; UK media outlet The Guardian reported that “the man from Amazon was told he was a waste of space, had no information to bring, and that the committee would summon someone else who might know what they were talking about.” Google’s representative received a similar smacking after pleading his company whose slogan is “do no evil,” merely played by the rules set by politicians. “We’re not accusing you of being illegal, we’re accusing you of being immoral,” said Committee Chairwoman Margaret Hodge, “People want to know why companies which benefit from an infrastructure paid for by them… are not paying their fair share.” Following this hearing, it will be difficult for the British government to continue turning a blind eye to these sorts of operations. As The Guardian so eloquently put it: “These buffoonish executives might have cost their companies billions, something few of us can claim.”
+ May, 2013: Apple C.E.O. Tim Cook and other top executives were called were out to Capitol Hill to face the Senate Permanent Subcommittee on Investigations, who critically questioned the ways Apple has—legally—avoided paying billions of dollars in U.S. taxes through a complicated system of overseas subsidiaries. The hearing came after the U.S. Senate’s Permanent Subcommittee on Investigations released a 40-page bipartisan report unveiling that Apple has been using legal loopholes in the United States and Ireland to stash $44 billion in offshore, taxable income between 2009-2012.
“What we intend to do is to highlight that gimmick and other Apple offshore avoidance tactics so that American working families, who pay their share of taxes, understand how offshore tax loopholes raise their tax burden and how those loopholes add to the federal deficit,” said Sen. Carl Levin (D-Mich.), the chairman of the Permanent Subcommittee on Investigations. The panel initiated the probe with the backing of its top Republican, Sen. John McCain of Arizona.
Take a look at the infographic on the right to see some of the most staggering numbers from the report.
**What Lies Ahead**
Political attention and heightened media scrutiny do not always equate to legal consequences or legislative action. While some companies have been charged with illegal activity, the bulk are being accused of immoral activity.
The companies charged with tax evasion are generally right in saying that they play by the rules, so it is up to legislators to change them. Some argue that the U.S. corporate tax rate should be lowered to discourage using foreign loopholes. Tax experts might point out an easier fix though: Changing a key exemption exists in U.S. transfer pricing rules. Under the law, foreign subsidiaries are subject to a foreign base company sales income tax; however, if the product being sold is significantly changed in the foreign base, they are off the hook. Examples are turning wheat into cereal, or soda into bottled soda.
The law was created before the rise of multinational tech companies like the ones described in this post. These companies can take advantage of the exemption because of the fuzziness of laws surrounding intellectual property. Using different programming or coding in their products before re-selling them to a foreign subsidiary often satisfies the requirement for “significant change.” For example, if an Amazon subsidiary in Luxembourg wants to sell a U.S. patented technology such as Amazon’s one click checkout feature, they need only re-work the program’s coding, then re-sell it to another subsidiary in a higher taxed country to lower their overall tax bill.
In defense of these companies, their liability is two-fold: to its shareholder fists, and taxpayers second. Like any individual, companies strive to lower their tax liability to as little as possible within legal limits. Google, the world’s most popular search engine and third-largest U.S. tech company, cut its taxes by $3.1 billion over the last three years through a complex foreign tax structure that capitalizes on international loopholes. Had they not, their stock price could have dropped by over $100 per share.
Still, there is reason to believe the tides are turning on this issue. Microsoft co-founder Bill Gates recently told reporters he thinks “That’s a good debate that people should have.” Microsoft has also appeared before the Senate subcommittee regarding their tax structure.
In Australia, where Mr. Gates spoke, lawmakers are drafting legislation to limit the span of offshore holding opportunities companies can use to avoid taxes.
Even Google’s executive chairman said he supports legal changes: “Governments have a lot more power than we do. We have to follow the law. If the law changes, we will follow it.”
In the U.S., the Levin-McCain bill, despite bi-partisan support, is dead in the senate. Nevertheless, with the Apple investigation revealed and continued public and political pressure, reform seems more likely than ever.
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.