Did you see the whipping the European Union gave Apple and Amazon?—Apple was told to repay USD $13 billion in “illegal” tax benefits to the Republic of Ireland. Amazon was ordered to repay USD $300 million in back taxes to Luxembourg (https://www.wsj.com/articles/eu-orders-luxembourg-to-recoup-almost-300-million-from-amazon-1507109839). If you read my first two articles under the same title you will recall that Amazon (and other companies including Apple) has played an international shell game to reduce its taxes. The European Union and the IRS say Amazon has done so illegally. So what’s going on here and what does it have to do with the Trump Tax Plan? First a little refresher dialogue from the hit new soap opera “Rock Star International Tax Lawyers In Love”:
Secret Amazon Executive (“Number 1”): “Are you telling me we can reduce our global tax bill by billions of dollars in all of these “high tax” countries like the US, UK, Germany, France, etc. all by shifting our income out of there? We can do that??”
Rock Star International Tax Lawyer (“RSITL”): “Why yes sir. And a lot of the plan just calls for you signing a bunch of agreements to transfer intellectual property between your companies, it doesn’t really cost you a lot of money. Except for my fee, he, he, he.”
Number 1: “But where would we shift the income to and why would they tax us less than what we are already paying?”
RSITL: “Well we’ve already worked out a special sweetheart deal with Luxemburg where they promised they are only going to tax us at a rate of _____%.”
Number 1: “Luxemburg? Where is that?”
RSITL: “It’s in Europe sir. We can form a Luxemburg subsidiary, send a few hundred jobs there, send Amazon’s intellectual property there with the stroke of a pen, and call it our “European Headquarters.” A customer in the UK, or France, or Germany that buys something on Amazon.com, will actually be buying it from our Amazon Luxemburg company. And so, voilá, that customer’s purchase will be income to the Luxemburg company, and won’t be taxed in the UK, or France, or Germany or wherever that customer is located.”
Number 1: “Seriously? We can do that?”
RSITL: “Yes sir. And the best part is that it will also greatly reduce our US tax bill!”
Number 1: “Wait, where is Luxemburg again?”
Remember the reason Amazon (and other companies) can “get away” with this, is because of the fiction that Amazon’s Luxemburg subsidiary is a separate, independent entity than its parent corporation in Seattle, Washington. The second reason that companies like Amazon can do this is because they own a large amount of “intellectual property.” Think about it, you don’t hear about Wal-Mart or Citibank engaging in these types of global tax schemes…why? Because those companies don’t have a major asset base that consists of intellectual property that can be transferred with the stroke of a pen.
Amazon is valued at $480 billion because of the technology, or “intellectual property” it owns. The tax shell game works because Amazon can then transfer that intellectual property with the stroke of a pen to its fictionally separate subsidiary in Luxemburg and then siphon off all the profits that Amazon earns in Germany, the UK, France, etc., to Luxemburg.
We already saw in my first article that the United States Tax Court “blessed” the US part of Amazon’s scheme in March 2017. Now the European Union says Amazon (and Luxemburg) violated antitrust laws because Luxemburg gave Amazon a sweetheart tax rate that gave Amazon an unfair advantage over its competitors. Do you understand that? The EU busted Amazon and Apple for violating ANTITRUST laws, not for violating tax laws.
You guys understand the basic pattern here then, right? US multinational company with lots of Intellectual Property in the US transfers that intellectual property with a pen stroke to one of its tiny, shell subsidiaries in Europe (Ireland, Luxemburg, etc) where the company has worked out a sweetheart low tax rate. The tiny shell subsidiary that “owns” the intellectual property then charges its businesses in the UK, Germany, France, etc. a “royalty”, “license fee”, “trade mark fee” or whatever word you want to use. That fee is large enough so as to reduce the amount of profits available to be taxed in the UK, Germany, France, etc.
Good God man, get to the point, what does this have to do with the Trump Tax Plan????!! I’m getting to that. The reason that US companies have incurred the legal risk of engaging in these shell games is to reduce the amount of profits that are taxed in the United States where the corporate tax rate of 35% is amongst the highest tax rates in the world.
One of the reasons that these companies actually get away with such schemes is because of a complex feature of US tax law called Subpart F that allows US companies to park profits outside of the United States forever, without being taxed in the US. It is estimated that over USD $2 Trillion is sitting offshore in non-US subsidiaries of US companies thanks to Subpart F.
And now I’ll get to the point: the reason that the Trump Tax Plan is “bad for Europe” is because it removes the incentive that US companies have to engage in the tax schemes that Amazon, Apple and others have conducted in order to escape the US’ 35% income tax rate. President Trump and the US congress have recommended a 20% corporate income tax rate as well as a “repatriation tax” of 10% on any part of the more than $2 Trillion sitting offshore that is transferred back into the US.
Assuming the Trump Tax Plan becomes law, US companies would not have the incentive to engage in the same tax schemes that transferred intellectual property and thousands of jobs to Europe, not to mention Trillions of dollars in profits.
Think about it: US companies have wanted to transfer intellectual property, jobs and profits to Ireland where the corporate tax rate has been 12.5%, or to Luxemburg where the “sweetheart” tax rate is even less. I mean, why do you think IRELAND of all places has attracted over 700 of the largest US companies over the past decades?? You think Apple, Google, Pfizer, Microsoft go there for the weather or the fact that the Irish drive on the wrong side of the road? No, it’s the low tax rate!
If the US corporate tax rate becomes 20% instead of 35% and the complex Subpart F regime that incentivizes US companies to park profits overseas is changed, all of a sudden a “European Headquarters” subsidiary in Ireland or Luxemburg may not look as attractive.
Now layer on top of this discussion Europe’s own efforts to extract a pound of flesh from US companies and you may have a perfect storm of circumstances incentivizing US companies to repatriate profits and jobs back to the US from Europe. Or at the very least providing a disincentive for American companies to engage in the “Double Irish” and “Dutch Sandwich” global tax shell games that we have talked about in this series of articles.
In addition to the billions of Euros the European Union is ordering Apple and Amazon to repay, “high tax” countries in Europe are now clamoring to change the European tax rules that have allowed US technology companies to game the European tax system. In September the European Union’s executive arm, the European Commission, announced it was considering a special “equalization tax” on digital revenues as a short term solution.
European Union Finance Chief Pierre Moscovici expressed his frustration with these tax shell games: “It’s a question of fairness…Like all taxpayers, they [US technology companies] must pay their fair share of taxes.”
The point of all of this simply underscores the changing landscape in both the United States and Europe that is working towards dis-incentivizing United States companies from the tax schemes that result in transferring a significant amount of high paying jobs and profits to Europe. If the U.S. Congress successfully enacts a 20% corporate income tax rate and revamps the complex international tax rules of Subpart F that pushes US companies to squirrel away un-taxed profits in Luxemburg (or Ireland or Malta or the Caymans), the US will become a tax bargain—God forbid—an “offshore tax haven” not just for US companies, but for companies of many nationalities.
And I haven’t even talked about some of the other U.S. tax code changes being proposed that may make the U.S. even more attractive for companies and individuals that seek access to the lucrative NAFTA market. President Trump has proposed ending the infamous Estate & Gift tax, which itself has provided a powerful obstacle to non-U.S. wealthy individuals who may have otherwise sought US residency or nationality but for the prospect of the IRS taking 40% of their family’s assets upon death. If the Estate & Gift Tax is ended the United States will become a more attractive option for high net worth individuals who seek the security of US citizenship or residency.
Congress’ proposed repatriation tax of 10% is also important, if only because it forms part of a larger plan to revamp U.S. international tax rules. In 2004 President “W” Bush implemented a repatriation tax incentive of about 6% which resulted in US companies transferring back to the United States over USD $300 billion of offshore profits. The effect of such repatriation on the US economy is subject to debate, but this time the repatriation tax comes with a promise to rewrite the rules that allow companies to park profits offshore in the first place. That is important.
Equally important is the suggestion in the Trump Tax Plan that “flow through” entities should enjoy a preferential 25% tax rate! While the Plan calls for a minor decrease in individual income tax rates (from 39.6% to 35% at last count), individuals may enjoy a preferential 25% income tax rate on business income they receive from a “flow through” entity. Details are sparse and an explanation of “flow through” entities beyond the scope of this article (and very boring) but trust me when I say that Europeans, Latin Americans, Asians, etc. may all have a greater incentive to invest in US businesses or move their tax homes to the United States if they are able to be taxed at a low, 25% rate simply by doing business as a “flow through” entity.
Whether all of this is “bad for Europe” as my title implies may be a matter of opinion. But it is certain that President Trump intends to engineer the US Tax Code to create incentives for American companies to invest and keep capital and jobs in the United States. If it is successfully implemented, the Trump Tax Plan could also serve as a powerful incentive to attract non-US businesses and individuals to the United States as well.