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Google's $3b tax haven loophole probed

By: 
Jesse Drucker - Sydney Morning Herald

 The US Internal Revenue Service is auditing how Google avoided federal income taxes by shifting profit into offshore subsidiaries, according to a person with knowledge of the matter.

The agency is bringing more than typical scrutiny to how the company valued software rights and other intellectual property it licensed abroad, said the person, who requested anonymity because the audit isn't public. The IRS has requested information from Google about its offshore deals after three acquisitions, including its $US1.65 billion purchase of YouTube, the person said. The transfer overseas of these kinds of rights rights has enabled Google to attribute earnings to foreign units that pay lower taxes, Bloomberg News reported a year ago.

Last year Bloomberg said Google had cut its taxes by $US3.1 billion ($3 billion) in the three years prior using a technique that moves most of its foreign profits through Ireland and the Netherlands to Bermuda.

While Google's potential liability isn't clear, similar deals between companies and offshore arms are often the subject of disputes over hundreds of millions of dollars in taxes, said Daniel Frisch, an economist at Horst Frisch, which advises businesses on transfer pricing - the allocation of income between units in different countries. In 2006, the IRS settled a case with drugmaker GlaxoSmithKline for $US3.4 billion.

“The very biggest transfer-pricing tax disputes are over transfers of intangibles to offshore subsidiaries,” said Frisch, whose firm is based in Washington.

Google, owner of the world's most popular search engine, has cut its worldwide tax bill by about $US1 billion a year using a pair of strategies called the “Double Irish” and “Dutch Sandwich”, which move profits through units in Ireland, the Netherlands and Bermuda. Google reported an effective tax rate of 18.8 per cent in the second quarter, less than half the average combined US and state statutory rate of 39.2 per cent.

Tax holiday

“This is a routine inquiry,” said Jim Prosser, a spokesman for Mountain View, California-based Google. He declined to comment further.

Dean Patterson, a spokesman for the IRS in Washington, said federal law prohibits the agency from discussing specific taxpayers.

US companies are sitting on at least $US1.375 trillion in earnings in their foreign subsidiaries on which they have paid no federal income taxes, according to a May report by JPMorgan Chase & Co. Companies including Google, Cisco, Pfizer, Apple and Microsoft are lobbying the US Congress for a tax holiday on bringing home those profits, which would otherwise be subject to US income tax at the 35 per cent corporate rate with a credit for foreign taxes already paid.

The Obama administration is opposed to that tax break and has been stepping up criticism of tax preferences for various industries and millionaires. Last week, Senate Democrats proposed a new surtax on people earning at least $US1 million a year, a move that would generate an estimated $US453 billion over the coming decade.

France probe

The French tax authority also began reviewing Google's income shifting in December, examining transactions between the company's French and Irish subsidiaries, according to two people with knowledge of the probe. The French inquiry was prompted by the October 2010 Bloomberg article on the company's tax-cutting strategy, the people said.

A spokesman for the French budget ministry, which oversees the tax authority, declined to comment, saying the agency cannot discuss individual cases.

Multinational companies cut their tax bills by shifting earnings into subsidiaries in offshore tax havens, a strategy that is drawing increased scrutiny from the IRS.

In May, the IRS appointed its first transfer-pricing director, Samuel Maruca. Last year, it announced the assignment of additional agents and attorneys to examine a few large companies as part of a pilot program. The IRS wouldn't discuss whether Google is one of those companies.

Valuable patents

Moving profit abroad is particularly important for cutting the tax bills of technology and pharmaceutical companies because of their valuable and easily transportable collection of patents and copyrights. Google, Cisco, Facebook, Microsoft and Forest Laboratories, maker of the blockbuster antidepressant Lexapro, have used tax-cutting strategies that move profits into units - often with no employees or offices - in havens such as Bermuda, the Cayman Islands and Switzerland, Bloomberg has reported.

In recent years, the IRS has engaged in a number of high profile disagreements with multinational companies over their transfer pricing. In 2006, the agency announced it was settling its dispute with GlaxoSmithKline.

In 2009, the IRS lost a closely watched US Tax Court case with Veritas, now a part of computer-security software maker Symantec. In that dispute, over intellectual property rights moved to an offshore subsidiary, the IRS sought $US545 million.

Enforcement setback

The win for Veritas was a major setback for the IRS's ability to enforce transfer-pricing rules, according to H. David Rosenbloom, an attorney at Caplin & Drysdale in Washington, and director of the International Tax program at New York University School of Law.

Income shifting by multinational companies cost the US $US90 billion in federal tax revenue during 2008, according to a March article in the trade journal Tax Notes by Kimberly Clausing, an economics professor at Reed College in Portland, Oregon.

Google cuts its tax bill by about $US1 billion a year using a technique that allocates profits to a unit managed out of a law firm in Bermuda, where there is no corporate income tax. In 2009, the most recent year for which records are available, this subsidiary collected 4.34 billion euros (about $5.8 billion) in royalties from a Google unit in the Netherlands, according to a Dutch corporate filing.

As of June 30, Google held $US18.8 billion in cash in its foreign subsidiaries, almost half its total $US39.1 billion in cash and marketable securities.

'Buy in'

The IRS has already approved a major part of Google's strategy. In 2006, the agency signed off on a 2003 intracompany transaction that moved foreign rights to its search technology to an Irish subsidiary managed in Bermuda called Google Ireland Holdings. That deal - known as a “buy in” in tax parlance - meant subsequent profit overseas based on those copyrights has been attributed to foreign subsidiaries rather than to Google in the US where the technology was developed.

The IRS approval came in an accord known as an advance pricing agreement. Those arrangements are part of an agency program intended to forestall disputes with companies, including disagreements over the price paid by offshore units for patent and other intellectual property rights.

Google acquisitions

That deal between the IRS and Google only covered rights the company held as of the 2003 licensing deal with its Irish unit. It didn't cover copyrights subsequently acquired by the US parent and then moved abroad.

Following that 2003 transaction, Google made several acquisitions, spending $US1.65 billion for online-video site YouTube in 2006; $US625 million for email security service Postini in 2007; and $US3.2 billion for web-advertising company DoubleClick in 2008. The IRS now is examining the prices paid by the foreign subsidiaries for the rights to software and other intangibles moved offshore that formerly belonged to those three companies.

According to US Treasury Department rules, foreign units licensing rights from their US parents are supposed to pay an “arm's length” price, or the amount that would be paid by an unrelated company. If the offshore subsidiary pays too little, that has the effect of shifting income overseas, thus helping the parent avoid US income taxes.

SEC review

Google's taxes have also drawn government scrutiny from the Securities and Exchange Commission. Last December, the SEC asked the company for “greater detail” about the profit it said it had earned in countries with lower tax rates and the impact on its effective tax rate, according to correspondence released by the agency in March. The SEC said in a February letter that it had completed its review of Google's filings. It is unclear what action, if any, the agency took.

In August, Google announced it was spending $US12.5 billion to acquire Motorola, the Libertyville, Illinois telecom-equipment and mobile-phone maker. Google said it was doing the deal primarily for Motorola's collection of valuable patents. Prosser didn't respond to a question about whether Google would be moving any of those patent rights offshore.

 

Posted Date: 
18 October 2011