Corporate Taxes: Are US Multinational Corporations really paying their fair share?

There has been extensive coverage in this blog about how US Multinational Corporations are not paying their fair share by utilizing Transfer Pricing, Inversions and Earnings Stripping to reduce their effective tax rates below the statutory 35%.

Some examples are: Pfizer tried to invert a couple of times to avoid paying the US tax rate, Apple and its Irish transfer pricing, Google with its double Dutch Irish sandwich transfer pricing, Caterpillar with its Swiss structure, and on and on.

Some of these USMNCs have argued that despite utilizing these accounting maneuvers, they still pay their fair share of taxes (See Apple CEO Tim Cook's comments on 60 Minutes).  Others question whether the USMNCs are actually paying their fair share and whether they are contributing to the overall tax gap.

In contrast to USMNCs trying to shift profits offshore to avoid US Tax, there is one USMNC that is paying its fair share.  Disney, yes that Disney, and despite negative criticism (NY Times article re Disney outsourcing tech jobs to India, and Disney caught in the LuxLeaks scandal), it appears as if Disney is actually paying its true tax liability without utilizing the accounting tricks that other USMNCs utilize to reduce their effective tax rates.

According to this Investopedia article, Disney is paying at or near the US corporate tax rate (35%) of income taxes.  For example, the author states that for 2015, Disney had pre-tax income of $13.9 billion and paid corporate income taxes of $4.4 billion.  The author, David Cay Johnston, also states that Disney earned only 1% of its profits in the U.S. and paid about "1.3% if all the corporate income taxes".

Johnston also states that one reason Disney is paying a higher rate of taxes is that Disney is keeping its Intellectual Property in the U.S. and not transferring the IP to low tax haven subsidiaries.  Johnston also criticizes Disney for not spending its profits in reinvesting in U.S. businesses but in conducting stock buy-backs.

Johnston's main point is that Congress should close the transfer pricing incentive/loophole that has permitted companies (Apple, Google, Pfizer to name only a few) to utilize transfer pricing, earnings stripping and inversions to erode the US tax base and pay less taxes.  Johnston also challenges whether the corporate tax is achieving the goals it was designed to achieve.

Maybe Johnston is correct in having Congress re-visit the utility of the corporate tax structure (a similar criticism of Bob Iger's, the Chairman of Disney).  Or maybe the IRS should be doing a better job at enforcing transfer pricing, inversions, and/or earnings stripping to prevent the USMNCs from shifting taxable income it its foreign base subsidiaries, despite its recent loss in the Medtronic case.

If you have specific and credible information about a company utilizing transfer pricing, inversions and/or earnings stripping to minimize its US taxes, contact us about filing an IRS Whistleblower claim to assist the IRS in attacking the various abusive transfer pricing applications by USMNCs.

Inversions, Earnings Stripping and Transfer Pricing, the triumvirate of U.S. companies avoiding U.S. taxation.

As previously noted on this blog, the American public is now aware of U.S. companies inverting to a foreign jurisdiction to reduce or eliminate its U.S. income tax liabilities.  The publicity (see here for outrage over Pfizer’s inversion attempt in 2014 and response by the President and the Treasury’s new Regulations attempting to curtail inversions here) that inversions have received fail to paint a complete picture of the ability of U.S. corporations and former U.S. corporation from avoiding U.S. taxation.

As found here, Professor Steven Davidoff Solomon, outlines in his N.Y. Times article the next step to maximize the inversion by the former U.S. corporation is to strip the earnings from its now U.S. subsidiary.  As noted by Professor Solomon, the process starts by having the inverted offshore parent company make loans to its now U.S. subsidiary to pay for its operations in the U.S.  The loans would generate interest payments to the offshore parent company, which can be deducted by the U.S. subsidiary to offset the earnings (otherwise taxable) in the U.S. 

Professor Solomon also references the studies of inverted companies and their earnings stripping efforts in 2004 (See National Tax Journal 2004 Article, “Effective Tax Rate Changes and Earnings Stripping Following Corporate Inversion”) and the Treasury’s 2007 article regarding the same.  Professor Solomon also notes that while Treasury has attempted to minimize the inversions, there is little being done to stop earnings stripping.  Finally Professor Solomon suggests that the Treasury and Congress adopt a radical approach to prevent earnings stripping, namely Professor Stephen Shay’s article, which would convert the interest payments to the foreign parent to taxable dividends instead of interest income.

While these articles address the effect of inversions and continued expansion of the Tax Gap (See IRS’s website describing the Tax Gap at $2 trillion annually) the current focus on inversions and earnings stripping fail to address how U.S. companies are currently reducing their tax liabilities through transfer pricing.  For a brief description of transfer pricing, see Bloomberg articles here and here.

As documented by the Senate Permanent Subcommittee on Investigations (“PSI”) (See Part 1 (Microsoft and HP) of the PSI hearing on Offshore Profit Shifting and U.S. Code; or Part 2 (Apple), U.S. Multi-National Corporations (“MNC”) have aggressively taken advantage of Transfer Pricing (Section 482) and Subpart F to shift profits to its low tax offshore subsidiaries.  PSI recommends the following changes to address Transfer Pricing abuses including the following: 1. Revise Sections 482 and 956; 2. Revise APB 23 to minimize MNC’s ability to manipulate the earnings reports to enable transfer pricing; and 3. Have IRS utilize its anti-abuse powers to stop transfer pricing.  See PSI’s recommendations.

Despite these recommendations, Congress and the IRS have yet to successfully limit or prohibit U.S. MNC from stripping the earnings from U.S. companies by shifting the profits offshore through transfer pricing.  However, IRS has aggressively pursued MNC on transfer pricing issues regarding cost sharing arrangements between the parent and subsidiary corporations of the MNCs.  See International Tax Review’s summaries of IRS transfer pricing cases.  For example, see the following active IRS cases on transfer pricing issues:

1. Microsoft: IRS is challenging Microsoft’s cost sharing buy-in payment arrangement between Microsoft and its Bermudian Affiliate and its Puerto Rican Affiliate (see Microsoft Corporation vs. Internal Revenue Service, 15-cv-00850, U.S. District Court, Western District of Washington);
2. Amazon: IRS is challenging Amazon’s cost sharing agreement between Amazon and its Luxembourg subsidiary (see Amazon.com, Inc. v. Comm’r, T.C. Docket 31197-12);
3. Zimmer: IRS is making 482 adjustments between Zimmer and its Dutch subsidiary (see Zimmer Holdings, Inc. v. Comm’r, T.C. Docket 19073-14); and
4. Medtronic: IRS is challenging Medtronic’s value of intangibles transferred between Medtronic and its Puerto Rican subsidiary (See Medtronic v. Comm’r, T.C. Docket 6944-11)

If you feel strongly about the injustice of transfer pricing and have specific/credible information about corporations avoiding the payment of tax through transfer pricing, 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 with specific and credible information about a corporate taxpayer’s avoidance of tax (through transfer pricing, or other methods).   Contact us if you want to file a tax whistleblower claim.

Pfizer and the Inversion Debate.

As everyone is aware, America will lose another company in 2016 to Ireland with the closing of the Pfizer – Allergan inversion.  See Bloomberg article.  With the inversion (See this Fortune article for more information about inversions), Pfizer will relocate its corporate headquarters to Ireland and continue its long standing policy of transferring profits from the U.S. to a lower tax jurisdiction.  Pfizer’s move will continue a trend of U.S. companies playing the shell game with its U.S. sourced profits through transfer pricing.  See these Bloomberg articles regarding profit shifting to avoid taxes and  the U.S. corporate tax-dodge

The obvious question about such a move is: What happened to President Obama’s and Treasury Secretary’s, Jacob J. Lew, position that the US would try and prevent future inversions (See Forbes article for more information of the Treasury Regulations) in response to Pfizer’s first failed attempt to invert by purchasing Astra Zeneca?  (Note: see Bloomberg article about Pfizer’s attempt to acquire Astra Zeneca).  As stated by the Wall Street Journal, the Treasury’s efforts failed to prevent US inversions or foreign corporations from acquiring US corporations. 

So how does the U.S. solve the problem given the ineffectiveness of the changes to the Treasury Regulations?  Possible solutions could be: 1. To lower the corporate tax rate in the United States; or 2. A Tax Holiday.  See Congressional Research Service’s article: Corporate Expatriation, Inversion and Mergers: Tax Issues for a discussion of the solutions proposed to solve the inversion problem.

The first solution would be to de-incentivize corporations from changing their home jurisdiction by matching the corporate rates in other countries.  However, that might not stop the mass exodus of corporations or generate job in the U.S.  See Sam Becker’s article about Kansas’ attempt to lower tax rates for businesses and the negative impact on jobs in Kansas.

The second solution might be to declare a tax holiday and allow the companies to bring back money to the United States at a reduced rate or without paying tax.  As stated in Jaimie Woo’s Huffington Post article this might not be the best idea, because it is rewarding the companies that shifted its profits offshore through transfer pricing by allowing them to bring the profits home at a much lower rate.  Also, the tax holiday would not address the problem of inversions, because the reason the companies are inverting is to avoid all U.S. taxation, not just at a reduced rate.

Another possibility, but rarely discussed is an expatriation tax.  This solution wouldn’t solve the corporate inversion problem, but would provide a huge incentive to not invert. What is an expatriation tax?  If you are a U.S. Citizen and want to renounce your citizenship (or are ordered to renounce your U.S. citizenship), the IRS treats that situation as an expatriation and imposes a tax on all your assets.  See Internal Revenue Code Section 877A.  As stated by the IRS, the Expatriation Tax would treat the individual as having sold all of his/her assets the day before expatriating their citizenship, and would impose a tax on the sale of those assets (with a sizable exemption).

The Expatriation Tax Model could be implemented to include Corporations and not just U.S. individuals.  This would require the U.S. Corporations to pay the tax on the deferred earnings of their offshore subsidiaries, and all other assets prior to inverting to the foreign jurisdiction.  This would make sure the company pays its fair share of U.S. taxes before utilizing the foreign jurisdictions tax benefits.

Could this unique solution work?  It might not stop the inversions, but it would at least cause the corporations to pay their fair share of taxes for choosing to relocate (on paper) its corporate headquarters in another jurisdiction.  Unfortunately, as with the proposed legislation (changing the tax rate and a tax holiday) it is unlikely that Congress will implement this solution to prevent corporations from avoiding U.S. taxes.

If you feel strongly about inversions and have specific/credible information about corporations avoiding the payment of tax, something that you can do now to limit the tax avoidance is to utilize the IRS tax whistleblower program.  The IRS pays an award between 15% to 30% of the tax collected to a whistleblower with specific and credible information about a corporate taxpayer’s avoidance of tax (either through an inversion or other methods, such as transfer pricing, or sham transactions).   Contact us if you want to file a tax whistleblower claim.