Transfer Pricing

As discussed in my prior blog, Inversions are one method that corporations (formerly located in the United States) can shift their income offshore and not be taxed in the United States.  While this is one method to increase profits and earnings outside the United States and away from taxation, another method would be to utilize transfer pricing.  See Bloomberg articles (http://www.bloomberg.com/news/articles/2010-05-13/american-companies-dodge-60-billion-in-taxes-even-tea-party-would-condemn or http://www.bloomberg.com/news/articles/2010-05-13/exporting-profits-imports-u-s-tax-reductions-for-pfizer-lilly-oracle) for a brief background about transfer pricing.

As everyone is aware, Tim Cook, Apple’s CEO was recently featured on 60 Minutes defending Apple’s Transfer Pricing operations.  In the interview, Tim Cook claims that he is not bringing back the money to the United States because 40% would be stripped away for taxes.  Mr. Cook’s comments are interesting because by characterizing taxes paid to the US as striping away value implies that the profits were not subject to tax in the first place.  Mr. Cook’s comments ignore the fact that in the United States, corporations are taxed on worldwide income and that the tax on the profits that Mr. Cook alleges are being stripped of their value by 40% were to have been paid to the U.S. government prior to shifting the profits offshore through transfer pricing.  

For a re-cap of Apple’s Transfer Pricing efforts, see Exhibit 1 of the Congressional Permanent Subcommittee on Investigation’s (“PSI”) report on Apple’s Transfer Pricing efforts.

But Apple is not the only company taking advantage of transfer pricing to shift its profits offshore and to avoid taxation in the United States.  See Reuter’s article re-capping the Citizens for Tax Justice’s and the U.S. Public Interest Research Group Education Fund’s report on the top US companies holding over 2.1 trillion dollars offshore or Rolling Stones article about companies avoiding U.S. taxes.

For more information on the other companies taking advantage of transfer pricing see the Congressional PSI hearings on Microsoft and Hewlett Packard. Also see Bloomberg’s article on Google’s use of transfer pricing to lower its tax rate to 2.4% or Bloomberg’s article about pharmaceutical companies using transfer pricing.

The problem people have with the large multi-nationals isn’t that they are using transfer pricing, but that they are using transfer pricing to avoid paying tax on profits, and then flaunting the use of the untaxed funds.  See Apple’s use of debt instruments to utilize its offshore cash horde to avoid paying taxes.  See also Congressional PSI’s report on the use of the alleged undistributed accumulated foreign earnings utilized in US assets (in US bank accounts or in US treasuries or US corporations.

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 our firm if you want to file a tax whistleblower claim.

IRS Identifies Problems with the Whistleblower Program

Internal Revenue Service

The Tax Whistleblower Law Firm fully supports the recommendations stated in 2016 report by the IRS National Taxpayer Advocate with respect to improving the IRS Whistleblower Program.  Although much more can be done administratively as well as legislatively to improve the whistleblower program, this is the first real effort by the IRS to identify the problems of the program.

It appears that “lack of communication” by the IRS is the most serious problem.  However just as important is the length of time from the submission of a Whistleblower Claim to the time in which an Award is paid (currently running 6-8 years).  Although much can be done to speed up the process, the Taxpayer Advocate failed to address this very important issue.

The National Taxpayer Advocate recommends that the IRS:

1. Revise the regulations under IRC § 7623 to provide that a whistleblower “administrative proceeding” within the meaning of IRC § 6103(h)(4) commences with the whistleblower’s submission of Form 211.  (Currently the Regulations provide that an administrative proceeding begins when a preliminary award recommendation letter is sent….which in fact is the end of the administrative proceeding).
2. Revise the regulations under IRC § 6103 or IRC § 7623 to provide that the IRC §§ 7431, 7213 and 7213A penalties apply to re-disclosures of returns or return information by a whistleblower who has executed a confidentiality agreement as part of an IRC § 6103(h)(4) administrative proceeding, and that the IRC § 6103(p) safeguarding requirements also apply to such a whistleblower.  (Currently there are no stated penalties to a Whistleblower for the disclosure of taxpayer information, although penalties (i.e. forfeiture of the Award) could be stated within the Confidentiality Agreement).
3. Revise the regulations under IRC § 7623 to require the IRS, upon the whistleblower’s execution of a confidentiality agreement as part of an administrative proceeding under IRC § 6103(h)(4), to provide bi-annual status updates sufficient to allow a whistleblower to monitor the progress of the claim (e.g., whether the claim resulted in an audit, whether the audit has concluded, the existence of any collected proceeds, and whether the case has been suspended) according to procedures developed by the WO.  (Currently the IRS has a pilot program to simply inform the Whistleblower that the Claim remains open).

For unknown reasons, (budget, lack of IRS managerial support, etc.) the IRS is slow/reluctant to act in improving the whistleblower program.  Therefore, it is suggested that Congress look into the matter of enacting legislation to improving the program by changing the law and enacting these recommendations as well as many other recommendations that have been made. 

After all, even the IRS defined its Mission as -

“Provide America’s taxpayers top quality service by helping them understand and meet their tax responsibilities and enforce the law with integrity and fairness to all.”

— Internal Revenue Service

Therefore, a bipartisan Congress should support these changes in an effort to collect the billions of underreported and underpaid taxes.

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.