Tax lawyers should take their rightful place among rock stars and astronauts. Google, Apple, Amazon, Pfizer are only some of the mega businesses who think international tax lawyers are more exciting than John Glenn, Beyoncé, Justin Bieber and Drake all in one. Oddly creative in giving their international tax schemes such names as “Double Irish” and “Dutch Sandwich” these unappreciated artists of the tax code help craft the destiny of world-class businesses. So, why all the fuss about this international tax “planning” and what does it have to do with Europe or the Trump tax plan?
Well as my mom used to tell me in High School, “I don’t know exactly what you’re up to, but I know it ain’t good.” Yes indeed. But whether tax planning is up to “good” or “bad” depends entirely on one’s perspective. Some European countries and American corporations realize the benefits of international tax planning. However, other countries – such as Germany, the USA, and the United Kingdom – see themselves as losers in the equation.
Enter the Trump Tax Plan which was just released at the writing of this post. The Trump Tax Plan, among other things, proposes a drastic reduction in US corporate tax rates—from the current 35% to 15%. If these reduced tax rates become law, the incentive that many US multinational companies have had to locate substantial operations in countries like the Netherlands, Ireland and Luxemburg may disappear. In subsequent posts we’ll talk about the proposed tax changes in the context of international tax planning, but to understand the effect of the proposed US tax changes its important to understand how these international tax structures save billions in taxes for multinational companies.
The next several posts will discuss a few of the winners and losers, and who may be affected by the significant tax changes promised by a certain orange-haired politician whose name starts with “T” and ends in “RUMP”. I promise that you won’t need an advanced degree in tax to understand the discussion. Read my lips…”no new taxes”…er, sorry wrong politician. So let’s start at the beginning.
You’ve often heard politicians and companies rant on about how the USA has one of the highest corporate tax rates in the world (35%). So, it makes sense if you are Apple, or Google, or Amazon, to shift every dollar of taxable income gained in the USA to another country where the tax rate is significantly lower. Your glowing annual report to your shareholders would extoll the incredible amount of revenue that your worldwide operations generated but were protected from USA tax gouges, because they were moved to the country that taxed them the least. What a deal!
But how is this possible? Aren’t Americans taught shortly after exiting the womb that the USA taxes the entire income of each citizen no matter where in the world they live? In other words, every dollar of my American income earned anywhere in the world is taxed annually by the USA Internal Revenue Service regardless of my official home address. And if you are well informed, you may righteously rant, “This is not the case in most other countries!”
I sympathize. Although that is indeed the reality for mere mortal USA citizens, multi national corporations have found a way to shift their enormous earnings to much more accommodating tax havens in countries such as Malta, Ireland, Luxemburg, the Caymans, Netherlands, Ireland, Luxemburg, Bermuda, the British Virgin Islands, and many others.
This shifting magic depends upon two generally recognized tax and legal fictions. The first is this:
Separate corporate entities should be treated as economically independent units,
EVEN IF THEY ARE ALL OWNED BY THE SAME ULTIMATE PARENT!
I don’t know why I emphasized that last part since many of you already know this, but my Mom does NOT! She was shocked when I told her and asked me, “Are you going to tell me that if the CEO of Amazon, Jeff Bezos, goes to Amazon’s corporate subsidiary in Luxemburg they aren’t going to think he is their boss, just because they are working in a subsidiary incorporated in another country?” Well, uh, no, that’s not what I’m saying. Remember, that’s why I called it a “fiction.” And that fiction is what is at the heart of the Amazon case and a lot of international tax planning.
Said another way, pretend you are the CEO of a multinational USA-based business, for instance, Apple. Your company probably has thousands of corporate subsidiaries incorporated around the world. But as CEO you possess powerful management control over every corporate subsidiary. Anywhere. An employee of Apple’s corporate subsidiary in Ireland, for example, would probably identify themselves as an “Apple” employee, and he or she would be appropriately in awe of you as CEO because they would know you have a great deal of control over their future with the company. The business direction and operations of every corporate subsidiary in the Apple group is set and implemented by you and your management team, even though you may not technically be a corporate officer or employee at the actual location of any particular Apple subsidiary.
Thus, although you, as CEO, control the world-wide Apple business, USA tax laws actually allow each of the Apple subsidiaries to sell each other goods and services only if the prices charged for those transactions represent what two unrelated businesses would have charged each other; this price is known as the “transfer price” and is, indeed, a “hypothetical” price.
This is where the second tax and legal fiction makes tax planning all the more interesting to everyone concerned, as well as all the more lucrative for lawyers, accountants, and other economists:
US tax law, as well as the tax laws of most countries, establishes that a “transfer price” will be upheld if the price is what two unrelated parties would have charged each other at “arms-length.”
In order to determine what a hypothetical “arms-length, transfer price“ would be, an unbiased entity must be called upon to judge the amount. Thus enter the lawyers, accountants, and economists who charge hundreds of millions of dollars a year to referee and determine what is fair.
So, do you see where I’m going here? As long as a company has smart lawyers, accountants and economists telling them what a hypothetically fair transfer price would be for certain goods and services, then these judgments become the pricing authority.
Keep in mind that this is a general idea, serving as the basis for a lot of the tax planning scenarios that we will be talking about. This is how large multinational corporations are able to shift taxable income away from “high tax” countries like Germany, the United States, and France, to lower tax countries.
In fact – lest you think I’m crazy, OXFAM.ORG, the global charity dedicated to fighting world poverty delivered a policy paper on December 12, 2016 wherein they list, rather ominously, “The World’s Worst Corporate Tax Havens,” which sounds kind of like: “Darth Vader’s Top Vacation Spots.” That is, unless you are Google, Amazon, Apple and others, in which case it sounds more like “The World’s Greatest Party Places.”
So what does all this tax planning mean in real terms? Remember when I wrote above that “politicians and companies rant on about how the United States has one of the highest corporate tax rates in the world (35%)”? The thing is, as you may already know, large multinational companies do not actually pay that rate of tax. Consider these facts: Google’s parent pays an effective tax rate of 19%; Microsoft paid 16.5% last year and Apple paid 25.8%. The reason why they do not pay the 35% official corporate tax rate? International, rock-star, creative tax planners.
Note that the tax planning that reduces Google’s tax bill in the USA also reduces its tax bill in many European countries. Which is why the “rich nations” of the Organization for Economic Cooperation and Development (“OECD”) have banded together to pursue the Base Erosion and Profit Shifting (“BEPS”) project. They aim to attack the tax planning that has shifted taxable income from high tax countries to low tax countries. Sort of like a bunch of five-year-olds chasing a soccer ball. The posts that follow will discuss BEPS as well.
It is fitting to start with a Tax Court case that handed Amazon a home run against the IRS on March 23, 2017. The case has everything: international intrigue, rock-star tax lawyers, and bespectacled computer programmers munching pizza in the middle of the night.
To be continued in the next post…