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Finance

Good old Yankee ingenuity

In 2008, representatives from the U.S. Government Accountability Office took a trip to the Cayman Islands – not to lie on the beach at our expense, but to visit a five-story office building that is the official address for over 18,000 registered companies. They found that about 9,000 of these companies had a billing address in the U.S. and were not actual occupants of the building.

In October 2008, three large hedge funds testified to the Senate that though they were in-corporated in the Cayman Islands, they had no office and no employees there. Their offices and management were located in the states. Under U.S. tax laws, U.S. corporations have to pay taxes on all of their worldwide income, while foreign corporations are generally exempt from paying U.S. taxes on their foreign income. By registering your corporation in the Cayman Islands, you can operate as a foreign corporation and pay no U.S. income taxes, while competing with U.S. companies that do pay taxes.

In 2011, two foreign corporations were established by Microsoft and paid their U.S. parent $4 billion to reproduce and distribute Microsoft products abroad. Microsoft Singapore paid $1.2 billion for rights in Asia, and Microsoft Ireland paid $2.8 billion for rights in Europe. In 2011, Microsoft Singapore reported revenue of $3 billion for relicensing those same rights in Asia, while Microsoft Ireland reported $9 billion in Europe. In sum, Microsoft USA “sold” the intellectual property rights for $4 billion and its offshore subsidiaries sold the exact same rights for $12 billion – effectively allowing Microsoft to shift $8 billion in taxable income offshore in one year. They avoided U.S. tax on that income, even though 85 percent of the research and development for the products was done in the U.S.

Microsoft also sold some intellectual property rights to a foreign corporation it controlled in Puerto Rico. It immediately bought back a license to those rights for use in the states. Under the license agreement, Microsoft USA paid Microsoft Puerto Rico a percentage of the sales revenue it received from selling its own products in the U.S. In 2011, this allowed Microsoft to shift 47 percent of its sales revenue to its Puerto Rico subsidiary, thus avoiding U.S. taxes on almost half its stateside sales.

Under current tax laws, a U.S. parent company must pay taxes on offshore funds sent by a foreign subsidiary. But short term loans from the subsidiary to the parent are excluded. According to the Senate, since 2008, Hewlett Packard subsidiaries in the Cayman Islands and Belgium have provided as much as $9 billion at a time to fund Hewlett Packard’s U.S. operations, including payroll and stock repurchases. Apparently, the loans provided essential cash without which Hewlett Packard would not have been able to operate. The U.S. parent company orchestrated serial loans on an alternating basis from its offshore subsidiaries, so that they would take place without interruption for 30 straight months. By this method they were able to repatriate billions of dollars of offshore profits without paying taxes.

A basic principle of U.S. tax law is that when a U.S. corporation makes money abroad and brings its profits back to the states, it is supposed to pay taxes on the repatriated funds. The way around this is to direct your foreign subsidiary to open an account at a Cayman Island bank and deposit your foreign earnings there – asking the bank to convert the earnings into U.S. dollars. The Cayman Island bank then opens an account at a U.S. bank with the funds. In that way, the funds have been repatriated and the U.S. corporation can even direct the Cayman Island bank how to invest the funds. A Senate survey of 27 multinational companies in 2010 found that they were holding over $500 billion in tax-deferred foreign earnings. Nine companies, including Apple, Cisco and Google held more than 75 percent of their tax-deferred foreign earnings
in U.S. assets.

Here is a tax deduction that is particularly neat at these times of high unemployment and budget deficits. A U.S. multinational company can take an immediate tax deduction for expenses associated with closing a U.S. manufacturing plant and opening a new plant abroad. That includes deducting the costs of boxing up equipment, breaking a lease, firing employees, and for shipping materials overseas. It can also deduct the costs of building the new foreign plant and interest expenses for any funds borrowed. Then, by using schemes such as those described above, the U.S. company can repatriate the foreign profits without paying U.S. taxes.

This is all legal and merely the result of lawyers and accountants using good old Yankee ingenuity, and lobbyists doing what they are legally paid to do. So why should we be upset?

We are still living with high unemployment and heading for a fiscal cliff. The recent election generated a lot of rhetoric about tax rates for high income individuals, but there was little said about closing tax loopholes for corporations. A recent survey showed that 30 corporations had paid no income tax in 2008, 2009 and 2010. During that time, they had combined profits of over $160 billion. They included such well known names as General Electric, PG&E, DuPont, Verizon, Boeing, Wells Fargo, and Honeywell. U.S. corporations ended 2011 sitting on $2 trillion of cash.

When the Congress is considering removing the mortgage-interest tax deduction for middle-income homeowners, is it unreasonable to suggest that they might also look at some of the corporate loopholes described above?

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