Want to learn a magic trick? Take 47% of sales proceeds in the U.S., transfer them to your own subsidiary in Puerto Rico, and — poof — a $4.5 billion tax bill for goods sold in the U.S. disappears. That’s a sleight-of-hand maneuver Microsoft performed last year, and many other companies are getting away with too, according to a report from the Senate Permanent Subcommittee on Investigations.
At a hearing on Thursday, Democratic subcommittee chair Senator Carl Levin accused Microsoft and other U.S. multinational corporations of using just this kind of “tax alchemy” to stockpile $1.7 trillion in earnings offshore.
He said such “shenanigans” were rampant in the technology sector, where companies shunt intellectual property, royalties and fees to offshore tax havens.
The panel used Microsoft and Hewlett Packard as case studies in its investigation, issuing subpoenas for hundreds of thousands of internal documents from the two firms.
Levin confronted HP executives about the company’s system of constantly rotating short-term loans — a kind of shell game intended to outrun the taxman and sneak profits back into the U.S. Under current tax rules, if a company’s offshore subsidiary loans money to its parent company in the U.S., the loan is taxable — but not if the loans are repaid in less than 30 days.
Lester Ezrati, HP’s senior vice president of tax, defended the use of those loans and the company’s “indefinite investment” in foreign subsidiaries, saying that since 65% of HP’s revenue came from non-U.S. sources, moving cash overseas “was both logical and necessary.”
Senator Tom Coburn, ranking Republican subcommittee member, defended the practice, saying that “tax avoidance is not illegal.” Coburn shifted responsibility to Congress and called for tax reform. He said companies are driven to move funds overseas because of high U.S. tax rates and unnecessarily complicated codes.
Coburn said closing loopholes alone could backfire. “I don’t want to clean it up if [the companies’] decision is that they’re going to put all their invested capital overseas and they’re going to grow their business overseas and they’re going to move their jobs overseas.”
Bill Sample, Microsoft’s vice president for worldwide tax, underscored Coburn’s position and told the panel that U.S. tax rules are “outdated and are not competitive.”
But Harvard tax law professor Stephen E. Shay said that since a 1997 “check-the-box” rule went into effect, it had become far too easy for companies to defer taxes on their foreign subsidiaries by declaring them to be “disregarded entities” that are not subject to U.S. tax jurisdiction. “The result is that most of the offshore profits of multinationals are concentrated in a few low-tax jurisdictions,” he told the panel.
University of Michigan law professor Reuven S. Avi-Yonah testified that reforms could include abolishing deferrals or adopting a territorial tax system. Whatever solution Congress adopts, he said, the problem must be addressed: “Not doing so risks further eroding the U.S. tax base at a time when revenues are sorely needed.”