Month: May 2014

May 27, 2014 08:17 AM | Permalink |

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A few days after Americans filed their tax returns last month, the Internal Revenue Service released data on the offshore subsidiaries of U.S. corporations. The data demonstrate, in an indirect way, that these companies are not playing by the same rules as the rest of us.

The figures show how much profit American corporations tell the IRS that their subsidiaries have earned in each foreign country. Amazingly, American corporations reported to the IRS that the profits their subsidiaries earned in 2010 in Bermuda, the Cayman Islands, the British Virgin Islands, the Bahamas and Luxembourg were greater than the entire gross domestic product (GDP) of those nations in that year.

It is obviously impossible for American corporations to actually earn profits in a given country that exceed that country’s total output of goods and services. Clearly, American corporations are using various tax gimmicks to shift profits actually earned in the U.S. and other countries where they actually do business into their subsidiaries in these tiny countries. This is not surprising, given that these countries impose little or no tax on corporate profits.

Besides the five countries just mentioned, the data also indicate that other countries also serve as tax havens for American multinational corporations. For example, American corporations report to the IRS that the profits their subsidiaries earned in Switzerland were equal to 9 percent of Switzerland’s GDP. This is a much higher share of GDP than the profits reported in more significant European countries: about half a percent of GDP in Germany and France, and 3 percent in the United Kingdom. This suggests that American corporations are exaggerating how much of their profits are earned in Switzerland, which is not surprising given that some corporations are able to obtain very low tax rates in that country.

The dozen countries with the highest reported American offshore corporate profits as a percentage of their GDP in 2010 had only four percent of the total GDP for all the foreign countries included in the IRS figures. But American corporations report to the IRS that 54 percent of their offshore subsidiary profits were earned in these tax-haven countries. This is obviously impossible. The only plausible conclusion is that American corporations are engaging in various accounting gimmicks to make large amounts of their profits appear, for tax purposes, to be earned in these dozen tax-haven countries. 

These 12 countries have either zero tax rates or provide loopholes that allow corporate profits to go largely untaxed in many circumstances. The two columns on the right side of the table on page one show the amount of corporate income taxes paid on the subsidiary profits to the country where they were supposedly earned or any other foreign country. This is shown first as a dollar figure and then as a percentage of the profits supposedly earned in that country.

There are apparently foreign income taxes paid on some profits even in countries known to have a zero corporate tax rate like Bermuda or the Cayman Islands. This may often occur because the profits are shifted from a subsidiary in another foreign country that imposes some tax on profits when they are shifted to a tax haven country. Overall, however, these subsidiary corporations are able to avoid paying almost any taxes. The effective rate of foreign taxes paid on subsidiary profits in the dozen countries was only 7 percent.[1]

The U.S. allows its corporations to defer paying U.S. corporate income taxes on profits of their offshore subsidiaries until those profits are officially “repatriated” (officially brought to the U.S.). This creates an incentive for American corporations to engage in accounting gimmicks to make their U.S. profits appear to be earned in countries where they will not be taxed. These data demonstrate that this is happening on a large scale. In fact, American corporations reported that more than half a trillion dollars of their profits were earned, for tax purposes, in the 12 tax haven countries shown in the table.

Amazingly, some lawmakers are calling for even greater tax breaks for the offshore profits of American corporations. Some proposals would largely exempt previously accumulated offshore profits from U.S. taxes on an (allegedly) one-time basis (often called a “repatriation holiday”). Others would provide a permanent exemption (often called a “territorial tax system”). Perhaps these lawmakers do not realize that over half of the profits that American corporations claim their subsidiaries earn offshore — over half of the profits that could benefit from such new tax breaks — are reported by the companies to have been earned in 12 obvious tax havens.

Corporate profits that are genuinely earned through real business activities abroad are typically subject to taxes in the countries where they are earned, and if they are repatriated, the U.S. tax that is due is reduced by whatever amount of tax was paid to foreign governments. For this reason, the only offshore profits that are potentially subject to nearly the full 35 percent U.S. tax rate upon repatriation are those artificially shifted to tax havens. Companies engaging in these tax-avoidance games would therefore be the main beneficiaries of a repatriation holiday or territorial system.

Congress could end this corporate tax avoidance in a straightforward way by ending the rule allowing American corporations to defer paying U.S. taxes on their offshore subsidiary profits. They would still be allowed to reduce their U.S. income tax bill by whatever amount of tax was paid to foreign governments, in order to avoid double-taxation. But there would no longer be any reason to artificially shift profits into tax havens because all profits of American corporations, whether earned in the U.S. or in any other country, would be taxed at least at the U.S. corporate tax rate in the year they are earned.   

[1] The Tax Foundation recently issued a report stating that the “effective tax rate on foreign income was 27.2 percent in 2010, prior to paying additional taxes to the United States,” but that report only examines those offshore subsidiary profits actually repatriated to the U.S. Of course, the offshore profits most likely to be repatriated are those that were taxed at relatively high rates by foreign countries, because these profits generate the largest foreign tax credits that reduce the U.S. tax that would be due upon repatriation. For the same reason, tax haven profits, which generate little or no foreign tax credits, are not as likely to be repatriated. In other words, the Tax Foundation report simply excludes tax haven profits from its analysis of foreign taxes paid on subsidiary profits. See Kyle Pomerleau, “How Much Do U.S. Multinational Corporations Pay in Foreign Income Taxes?,” Tax Foundation, May 19, 2014.

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May 19, 2014 01:04 PM | Permalink |

Hundreds More Likely Do the Same, Avoiding $550 Billion in U.S. Taxes

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American Fortune 500 corporations are likely saving about $550 billion by holding nearly $2 trillion of “permanently reinvested” profits offshore. Twenty-eight of these corporations reveal that they have paid an income tax rate of 10 percent or less to the governments of the countries where these profits are officially held, indicating that most of these profits are likely in offshore tax havens.

While congressional hearings over the past few years have focused attention on the tax avoidance strategies of technology corporations like Apple and Microsoft, this report shows that a diverse array of companies are using offshore tax havens, including U.S. Steel, the pharmaceutical giant Eli Lilly, the apparel manufacturer Nike, the supermarket chain Safeway, the financial firm American Express, and banking giants Bank of America and Wells Fargo.

How We Know When Multinationals’ Offshore Cash is Largely in Tax Havens

Some American multinational corporations complain to members of Congress that their offshore profits would be taxed at the U.S. corporate income tax rate of 35 percent if those profits were subject to U.S. taxes. However, this can only be true if those profits are mostly held in tax havens — countries in which they are subject to little or no corporate tax.

The general rule is that offshore profits that an American corporation “repatriates” (officially brings back to the United States) are subject to the U.S. tax rate of 35 percent minus a tax credit equal to whatever taxes were paid to foreign governments. Thus, if an American corporation says it would pay a U.S. tax rate of 25 percent or more on its offshore profits, that means it has paid foreign governments a tax rate of 10 percent or less.

Twenty-eight American corporations have acknowledged paying less than a 10 percent foreign tax rate on the $409 billion they collectively hold offshore. The table on the following page shows the disclosures made by these 28 corporations in their most recent annual financial reports.

It is almost always the case that profits reported by corporations to the IRS as earned in tax havens were actually earned in the United States or another country with a tax system similar to ours.  Most economically developed countries (most of the countries where there are real business opportunities for American corporations) have a corporate income tax rate of at least 20 percent and rates are typically higher than that. The countries that have no corporate income tax or a very low corporate tax — countries like Bermuda, the Cayman Islands, and the Bahamas — provide very little in the way of real business opportunities for American corporations like U.S. Steel, Safeway, and Microsoft. But large Americans corporations use accounting gimmicks (most of which are, unfortunately, allowed under current law) to make profits appear to be earned in tax haven countries.

Hundreds of Other Fortune 500 Corporations Don’t Disclose This Information

These 28 companies are not alone in shifting their profits to low-tax havens—they’re only alone in disclosing it. A total of 301 Fortune 500 corporations have disclosed, in their most recent financial reports, holding some of their income as “permanently reinvested” offshore profits. At the end of 2013, these permanently reinvested earnings totaled a whopping $1.95 trillion. (A full list of these 301 corporations is published as an appendix to this paper.) Yet the vast majority of these companies — 243 out of 301 —decline to disclose the U.S. tax rate they would pay if these offshore profits were repatriated. (58 corporations, including the 28 companies shown on this page, disclose this information. A full list of the 58 companies is published as an appendix to this paper.) The non-disclosing companies collectively hold $1.4 trillion in unrepatriated offshore profits at the end of 2013.

Accounting standards require publicly held companies to disclose the U.S. tax they would pay upon repatriation of their offshore profits — but these standards also provide a loophole allowing companies to assert that calculating this tax liability is “not practicable.”  Almost all of the 243 non-disclosing companies use this loophole to avoid disclosing their likely tax rates upon repatriation — even though these companies almost certainly have the capacity to estimate these liabilities.

20 of the Biggest “Non-Disclosing” Companies Hold $801 Billion Offshore

While hundreds of companies refuse to disclose the tax they likely owe on their offshore cash, just a handful of these companies account for the lion’s share of the permanently reinvested foreign profits in the Fortune 500. The nearby table shows the 20 non-disclosing companies with the biggest offshore stash at the end of the most recent fiscal year. These 20 companies held $801 billion in unrepatriated offshore income — more than half of the total income held by the 243 “non-disclosing” companies. Most of these companies also disclose, elsewhere in their financial reports, owning subsidiaries in known tax havens. For example:

■ General Electric disclosed holding $110 billion offshore at the end of 2013. GE has subsidiaries in the Bahamas, Bermuda, Ireland and Singapore, but won’t disclose how much of its offshore cash is in these low-tax destinations. [Some of it is clearly there; see text box below.]

■ Pfizer has subsidiaries in Bermuda, the Cayman Islands, Ireland, the Isle of Jersey, Luxembourg and Singapore, but does not disclose how much of its $69 billion in offshore profits are stashed in these tax havens.

■ Merck has12 subsidiaries in Bermuda alone. It’s unclear how much of its $57 billion in offshore profits are being stored (for tax purposes) in this tiny island.

Even “Non-Disclosers” Slip Up SometimesAs noted above, General Electric does not disclose the U.S. tax it would owe if its $110 billion offshore stash was repatriated. But in its 2009 annual report, GE noted that it had reclassified $2 billion of previously earned foreign profits as “permanently reinvested” offshore, and said that this change resulted “in an income tax benefit of $700 million.” Since $700 million is 35 percent of $2 billion, this is an admission that the expected foreign tax rate on this $2 billion of offshore cash was exactly zero, which in turn strongly suggests that GE’s “permanent reinvestment” plan for this $2 billion involved assigning it to one of its tax haven subsidiaries.

Even “Non-Disclosers” Slip Up Sometimes

As noted above, General Electric does not disclose the U.S. tax it would owe if its $110 billion offshore stash was repatriated. But in its 2009 annual report, GE noted that it had reclassified $2 billion of previously earned foreign profits as “permanently reinvested” offshore, and said that this change resulted “in an income tax benefit of $700 million.” Since $700 million is 35 percent of $2 billion, this is an admission that the expected foreign tax rate on this $2 billion of offshore cash was exactly zero, which in turn strongly suggests that GE’s “permanent reinvestment” plan for this $2 billion involved assigning it to one of its tax haven subsidiaries.

Time is of the Essence

While the $2 trillion in offshore profits detailed in the appendix has grown gradually over the past decade, there are two reasons why it is vital that Congress act promptly to deal with this problem. First, a large number of the biggest corporations appear to be increasing their offshore cash significantly. 105 of the companies surveyed in this report increased their declared offshore cash by at least $500 million each in the last year alone. Eight particularly aggressive companies each increased their permanently reinvested foreign earnings by more than $5 billion in the past year. These include Apple, Microsoft, IBM, Google, and Cisco.

A second reason for concern is that there is some evidence companies are aggressively seeking to permanently shelter their offshore cash from U.S. taxation by engaging in corporate inversions, through which companies acquire smaller foreign companies and reincorporate in foreign countries, thus avoiding most or all U.S. tax on their profits. Drug giant Pfizer is currently attempting this move.

Hundreds of Billions in Tax Revenue at Stake

It’s impossible to know precisely how much income tax would be paid, under current tax rates, upon repatriation by the 243 Fortune 500 companies that have disclosed holding profits overseas but have failed to disclose how much U.S. tax would be due if the profits were repatriated. But if these companies paid the same 28 percent average tax rate as the 58 disclosing companies, the resulting one-time tax would total $403 billion for these 243 companies. Added to the $148 billion tax bill estimated by the 58 companies who did disclose, this means that taxing all “permanently reinvested” foreign income of the 301 companies at the current federal tax rate could result in more than $550 billion in added corporate tax revenue.

What Should Be Done?

Many large multinationals that fail to disclose whether their offshore profits are officially in tax havens are the same companies that have lobbied heavily for tax breaks on their offshore cash. These companies propose either to enact a temporary “tax holiday” for repatriation, under which companies officially bringing offshore profits back to the U.S. would pay a very low tax rate on the repatriated income, or a permanent exemption for offshore income in the form of a “territorial” tax system. Either of these proposals would actually increase the incentive for multinationals to shift their U.S. profits, on paper, into tax havens.

A far more sensible solution would be to simply end “deferral,” that is, repealing the rule that indefinitely exempts offshore profits from U.S. income tax until these profits are repatriated. Ending deferral would mean that all profits of U.S. corporations, whether they are generated in the U.S. or abroad, would be taxed by the United States in the year they are earned. Of course, American corporations would continue to receive a “foreign tax credit” against any taxes they pay to foreign governments, to ensure profits are not double-taxed. 

Conclusion

The limited disclosures made by Apple and a handful of other Fortune 500 corporations show that they have moved profits into tax havens — and that some have managed to avoid virtually all taxes on these profits. But the scope of this tax avoidance is likely much larger, since the vast majority of Fortune 500 companies with offshore cash refuse to disclose how much tax they would pay on repatriating their offshore profits.

Lawmakers should resist calls for tax changes, such as repatriation holidays or a territorial tax system, that would reward U.S. companies for shifting their profits to tax havens. If the Securities and Exchange Commission required more complete disclosure about multinationals’ offshore profits, it would become obvious that Congress should end deferral, thereby eliminating the incentive for multinationals to shift their profits offshore once and for all. 

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