TRANSFER PRICING DEBATE Part 1

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Is transfer pricing broken? Does the IRS/Congress need to adopt a new model to tax U.S. Multinational Corporations’ income earned worldwide?

Through this Blog, I have previously written about how US Multinational Corporations (USMNCs) have routinely utilized “tricks of the trade” (Transfer Pricing, Inversions and Earnings Striping) to minimize their U.S. tax liabilities.  I have also suggested some changes to the existing system (i.e., expatriation tax etc.)

Perhaps change is on the horizon.  In one of the keynote addresses at the 16th Annual Global Transfer Pricing Forum held in New York (September 22-23, 2016), Professor Edward Kleinbard (USC Gould School of Law, and the former chief of staff of the Joint Committee on Taxation), advocates for “The End of Transfer Pricing”.  See the Presentation slides here.

Professor Kleinbard begins his presentation by discussing the Apple “facts” as examined by the EU Commission in the recent Irish state aid case.  He highlights the following facts:

  • APPLE had $115 billion of income over a 10 year period;
  • APPLE paid Ireland only .05% per year during the same period;
  • APPLE paid other EU countries roughly $385 million in taxes over the same period;
  • APPLE’s effective tax rate was 3.5% not the statutory rate of 35%.
  • APPLE had pre-tax profits of $91.5 billion. 

Professor Kleinbard concludes that the arm’s length standard is no longer viable if APPLE can receive such beneficial treatment through its subsidiaries in Ireland.

Professor Kleinbard then discusses how the world is aware of the abusive nature of transfer pricing and that progressing with the fiction of transfer pricing and the arm’s length model is untenable, specifically, he cites the following examples:

Because of this pushback, Professor Kleinbard advocates for a change to the existing system.

More specifically, he advocates for the following changes to the Corporate tax rate:

  1. Statutory Rate reduced to 25%;
  2. Repealing Section 199 (deduction for income attributable to domestic production activities;
  3. Repealing the Alternative Minimum Tax (AMT;
  4. Destination Based Cash Flow Tax

He states that by reducing the corporate rate to 25% will eliminate the need for transfer pricing games, because US tax rate will be in the middle of the pack, and playing games will be unnecessary. 

Note: Professor Kleinbard has stated, “Transfer pricing is dead” since 2008.  See this Tax Analyst Article about his debate with Willard B. Taylor of Sullivan & Cromwell LLP at the International Tax Institute.

To Clarify, Professor Kleinbard actually stated that Transfer Pricing enforcement has been dead since 2007.  See this article by Michigan Law Professor Reuven S. Avi-Yonah.  Professor Avi-Yonah proposes three different approaches for Congress to revitalize transfer pricing enforcement:

  • adopting a unitary taxation regime;
  • ending deferral; and
  • adopting anti base erosion measures.

Unitary Taxation Regime:  This proposal suggests that Congress can adopt a unitary tax system, namely, treating each USMNCs as a single unit and disregarding the “formal distinctions” among the subsidiary corporations.  The advantages are: 1) a better model for taxing USMNCs because of the way they currently operate; and 2) the unitary tax applies the same treatment to all USMNCs and does not depend on the location of the parent corporation.

Professor Avi-Yonah believes that this is the best solution, but pragmatically speaking will be difficult to achieve.

Abolishing Deferral:  This proposal proposes to prevent USMNC from parking profits offshore (something subpart F of the Internal Revenue Code was originally designed to accomplish, but has failed to do so).

Professor Avi-Yonah believes this is a good approach, but that it will require countries to adopt this goal, which may be difficult to achieve.

Adopting Anti-Base Erosion Measures:  This proposal suggests limiting deductible payments to related foreign parties, including cost of goods sold, interest and royalties.

Professor Avi-Yonah believes adopting this proposal in conjunction with abolishing deferrals will eliminate the impetus to undertake transfer pricing by USMNCs.

Finally Professor Avi-Yonah advocates for the adoption of a mixture of these measures, similar to Senator Baucus’ proposal with option Y.  See analysis of Senator Baucus’ proposals here. (NOTE: Senator Baucus is now the U.S. Ambassador to China).  Under Option Y, income from foreign sales would be taxed at 80% of the US rate with a credit for foreign taxes paid.  This would ensure tax would be geared toward the ultimate destination of the sale of the goods (i.e. taxing where the goods are ultimately sold, or similar to Kleinbard’s destination cash flow tax.)

It will be interesting to see if any of these proposals will gain traction with the pending presidential election and with one of the key backers now a U.S. ambassador to China. 

If you have specific and credible information of a company undertaking transfer pricing and want to report the company for shifting its profits offshore, CONTACT US, to discuss your tax whistleblower claim.  The IRS is paying an award (between 15-30% of the collected taxes, interest, penalties, and additional amounts) for information it utilizes in adjusting a corporation’s income tax due to information provided by a whistleblower.

Mylan CEO, Heather Bresh, called before House Oversight Committee

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EpiPen maker, Mylan, called before House Oversight Committee to explain 400% price increase.

In the news recently, Mylan CEO, Heather Bresh, was called before the House Oversight Committee to discuss Mylan’s increase in prices of the EpiPen.  In case you missed it, EpiPen prices have risen about 400% with a two pack of the lifesaving injection drug at a retail cost of $600.

According to CNN, Ms. Bresh’s testimony before the House Oversight Committee will state that Mylan only makes about $50 for each $300 pen.  Money magazine also details how Mylan is trying to get EpiPen on the Preventative Medicines list, which would allow patients to receive EpiPen will little or no out-of-pocket costs, and so that insurance would have to pick up the cost.

What gets lost in the outrage over a drug price increase, is why the huge increase?  EpiPen has been around a long time, and the process to create EpiPen hasn’t changed for some time, so why the huge increase, and why is Mylan only getting $50 profit from a $300 item. 

One theory is Mylan has been increasing the demand of EpiPen through effective marketing practices.  See this Bloomberg article.  Another often not discussed aspect is transfer pricing, inversions and booking profits offshore.  As stated in the 10-K for Mylan for tax year ended (tye) December 31, 2014, Mylan inverted from a Pennsylvania Company to a Netherlands company with its principal executive offices in Potters Bar, UK. 

As previously discussed in this Blog, one of the key tools U.S. Multinational Corporations (USMNCs) utilize to lower its tax rate is to invert the corporate headquarters to a lower tax jurisdiction. 

Also as previously discussed in this Blog, a second tool used by USMNCs is transfer pricing.  In this case, as stated in this Time article, it costs Mylan about $30 to make each dose of EpiPen.  Mylan likely has the drug filled in the Netherlands or another tax favorable jurisdiction, and then re-sells the drug at the $600 price for a EpiPen 2 pack back to U.S. distributors, thereby booking the costs in the tax favorable jurisdiction. See this primer on transfer pricing.

By using this method (transfer pricing) USMNCs can claim a lower tax rate than the applicable 35% tax rate.  While I am not saying that Mylan utilizes transfer pricing, one indicator that Mylan may be utilizing transfer pricing is in its 10K, Mylan states that for 2014, Mylan only pays an effective tax rate of 4.2%.  (FYI, the statutory rate is 35% for corporations in the United States.)  Mylan also lists on is 10K that it approximately $693 million permanently reinvested in its foreign subsidiaries, which is how companies disguise on their 10K amounts they are holding offshore to avoid taxation in the U.S.

So this begs the question, why can Congress call Ms. Bresh to appear before the House Oversight Committee to discuss pricing, but the IRS can’t call Mylan to conduct an analysis of its transfer pricing or its inversion practice?

If you know of a corporation undervaluing assets in its transfer pricing models, contact our firm to discuss filing a tax whistleblower claim.  IRS will pay an award between 15-30% of collected proceeds (tax, penalties, and interest) to whistleblowers who provide substantial and credible information used by the IRS in prosecuting the alleged tax violators.

Sports and Taxes Part 2: Update on Messi trial and Kevin Durant's decision to take less money by signing with the Warriors

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First:  as noted in a previous post, Lionel Messi, Argentinian soccer star, and his father ("Messis") were on trial for tax fraud.  Now, as reported in Sports Illustrated, the Messis have been sentenced to 21 months in prison for being found guilty of three counts of tax fraud.  However, because Spain suspends sentences for first time offenders if the sentence is less than two years, the Messis will not serve time in jail.  Instead Messi and his father will have to pay a fine in the amount of € 1.7 million and € 1.3 million, respectively.

The Court determined that the Messis evaded paying more than € 4 million in taxes on Lionel Messi's image rights between 2007-2009 by sending income through Uruguay, Switzerland and Belize to minimize taxes.

Kevin Durant

Second: as reported in this SI artcle, NBA superstar Kevin Durant chose the Golden State Warriors and decided to take less money than by staying with Oklahoma City Thunder, or any other suitor.  Why did Durant take less money? Simple answer, state income taxes.  Using the models in the SI article which makes certain assumptions, Durrant would pay $31 million in state income taxes (to California) compared with $0 state income taxes had he signed with the San Antonio Spurs (to Texas) or Miami Heat (to Florida), and compared with $14 million in state income taxes had he re-signed with the Oklahoma City Thunder (to Oklahoma). So why did Durrant choose to take less money? As stated in this SI article, he wanted a more free flowing (ball moving) offense and was frustrated with recurring issues with a now former teammate (Russell Westbrook).

Why are these cases important/interesting?  In the first case (Messis), tax avoidance is not tax evasion, if done properly.  In the second case (Durant), personal desire trumped tax consequences.

MESSI

In the first case, it is interesting that the Messis undertook what in the tax world is known as transfer pricing with the intangible (Messi's image and likeness) and tried, unsuccessfully, to transfer the intangible between Uruguay, Switzerland, and Belize.  This same concept has been utilized by very large US multinational corporations (i.e. Apple, Google, Microsoft, Caterpillar, Medtronic, and others) to transfer their intellectual property ("intangible") to low tax jurisdictions (Puerto Rico, Ireland, Netherlands, Switzerland, etc.) to lower their bills in the U.S.

The simple question is why did it work for Apple, etc. and not Messi? One answer may be that a person's image and likeness are not separable from an individual, whereas the intangibles related to non-living things (i.e. iphones, search data, source code, heavy equipment, medical devices, etc.) can be separated from the individual. Or another possibility is that the U.S. is not attacking transfer pricing with U.S. multinational corporations with as much zeal as Spain.

DURANT

The Durant case is interesting because Kevin Durant chose to pay more state taxes but would be in the type of offense he craved instead of staying in OKC or moving to a tax favorable jurisdiction.  So this raises the question of whether tax motivates people to make a decision or whether it is just an afterthought.  For more information about state taxes and athletes see this Forbes article.  See also this article through Fansided about state taxes and athletes.

If you have specific/credible information about individuals or corporations avoiding the payment of tax through transfer pricing or other methods, you can get involved in preventing/limiting the tax avoidance by filing an IRS tax whistleblower claim.  The IRS pays an award between 15% to 30% of the tax collected to a whistleblower that provides specific and credible information about the taxpayer’s avoidance of tax.   Contact our firm if you want to discuss filing a tax whistleblower claim.