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How
Multinational Corporations Avoid Paying Their Taxes
By PETER ROST, MD
Drug companies and other multinational
companies based in the U.S. systematically avoid paying tax in
the U.S. on their profits. The companies elect to realize profits
in low-tax countries and because of this the rest of us have
to pay billions of unnecessary taxes to make up for the shortfall,
writes Peter Rost, an ex-pharmaceutical executive.
The biggest tax scam on earth has a very innocent sounding name.
It is called "transfer prices." That almost sounds
boring. It is, however, anything but boring. Abuse of transfer
prices is a key tool multinational corporations use to fool the
U.S. and other jurisdictions to think that they have virtually
no profit; hence, they shouldn't pay any taxes.
Corporations involved in this scam are "model corporate
citizens," or so they would like us to believe. The truth
is that they rob us all blind. The money we lose can be estimated
in the tens of billions, or possibly hundreds of billions of
dollars every year. We all end up paying higher taxes because
rich corporations make sure they don't.
But don't take my word for this.
A few weeks ago U.K.-based GlaxoSmithKline (GSK), one of the
largest pharmaceutical companies in the world, together with
the Internal Revenue Service (IRS) announced that GSK will pay
$3.4 billion to the IRS to settle a transfer pricing dispute
dating back 17 years. The IRS alleges that GSK improperly shifted
profits from their U.S. to the U.K. entity.
And U.K. pharmaceutical companies are not alone with these kinds
of problems. Merck, one of the largest U.S. drug companies, also
this month disclosed that they face four separate tax disputes
in the U.S. and Canada with potential liabilities of $5.6 billion.
Out of that amount, Merck disclosed that the Canada Revenue Agency
issued the company a notice for $1.8 billion in back taxes and
interest "related to certain inter-company pricing matters."
And according to the IRS, one of the schemes Merck used to cheat
American tax payers was by setting up a subsidiary in tax-friendly
Bermuda. Merck then quietly transferred patents for several blockbuster
drugs to the new subsidiary and then paid the subsidiary for
use of the patents. The arrangement in effect allowed some of
the profits to disappear into Merck's own "Bermuda triangle."
So what's going on here, how have multinational drug companies
been able to gouge us for years selling expensive drugs and then
avoid paying tax on their astronomical profits?
The answer is simple. For companies in certain businesses, such
as pharmaceuticals, it is very easy to simply "invent"
the price a company charges their U.S. business for buying the
company's product which they manufacture in another country.
And if they charge enough, poof; all the profit vanishes from
the US, or Canada, or any other regular jurisdiction and end
up in a corporate tax-haven. And that means American and Canadian
tax payers don't get their fair share.
Many multinational corporations essentially have two sets of
bookkeeping. One set, with artificially inflated transfer prices
is what they use to prepare local tax returns, and show auditors
in high-tax jurisdictions, and another set of books, in which
management can see the true profit and lost statement, based
on real cost of goods, are used for the executives to determine
the actual performance of their various operations.
Of course, not every multinational industry can do this as easily
as the drug industry. It would be difficult to motivate $6,000
toilet seats. But the drug industry, where real cost of goods
to manufacture drugs is usually around 5% of selling price, has
a lot of room to artificially increase that cost of goods to
50% or 75% of selling price. This money is then accumulated in
corporate tax-havens where the drugs are manufactured, such as
Puerto Rico and Ireland. Puerto Rico has for many years attracted
lots of pharmaceutical plants and Ireland is the new destination
for such facilities, not because of the skilled labor or the
beautiful scenery or the great beer-but because of the low taxes.
Ireland has, in fact, one of the world's lowest corporate tax
rates with a maximum rate of 12.5 percent.
In Puerto Rico, over a quarter of the country's gross domestic
product already comes from pharmaceutical manufacturing. That
shouldn't be surprising. According to the U.S. Federal Tax Reform
Act of 1976, manufacturers are permitted to repatriate profits
from Puerto Rico to the U.S. free of U.S. federal taxes. And
by the way, the Puerto Rico withholding tax is only 10%.
Of course, no company should have to pay more tax than they are
legally obligated to, and they are entitled to locate to any
low-tax jurisdiction. The problem starts when they use fraudulent
transfer pricing and other tricks to artificially shift their
income from the U.S. to a tax-haven. According to current OECD
guidelines transfer prices should be based upon the arm's length
principle that means the transfer price should be the same
as if the two companies involved were indeed two independents,
not part of the same corporate structure. Reality is that standard
operating procedure for multinationals is to consistently violate
this rule. And why shouldn't they? After all, it takes 17 years
for them to pay up, per the GSK example above, even when they
get caught.
Another industry which successfully exploits overseas tax strategies
to cheat us all is the hi-tech industry. In fact, Microsoft Corp.
recently shaved at least $500 million from its annual tax bill
using a similar strategy to the one the drug industry has used
for so many years. Microsoft has set up a subsidiary in Ireland,
called Round Island One Ltd. This company pays more than $300
million in taxes to this small island country with only 4 million
inhabitants, and most of this comes from licensing fees for copyrighted
software, originally developed in the U.S. Interesting thing
is, at the same time, Round Island paid a total of just under
$17 million in taxes to about 20 other countries, with
more than 300 million people. The result of this was that Microsoft's
world-wide tax rate plunged to 26 percent in 2004, from 33 percent
the year before. Almost half of the drop was due to "foreign
earnings taxed at lower rates," according to a Microsoft
financial filing. And this is how Microsoft has radically reduced
its corporate taxes in much of Europe and been able to shield
billions of dollars from U.S. taxation.
But remember, this is only one example. Most of the other tech
companies are doing the same thing. Google recently also set
up an Irish operation that the firm credited in a SEC filing
with reducing its tax rate.
Here's how this is done in the software industry and any other
industry with valuable intellectual property. A company takes
a great, patented, American product and then develops a new generation.
Then, of course, the old product disappears. Some, or all, of
the cost and development work for the new product takes place
in Ireland, or at least, so the company claims. The ownership
of the new generation product and all income from licensing can
then legally be shared between the U.S. parent company and the
offshore corporation or transferred outright to the tax-haven.
The deal, to pass IRS scrutiny, has to be made using the "arms-length
principle." Reality is that the IRS has no way of controlling
all these transactions.
Unfortunately those of us working and paying tax in the U.S.
can't relocate our jobs and our income to Ireland or another
tax haven. So we have to make up the income shortfall. In the
U.S. we have a highly educated society with a very qualified
workforce, partly supported by our tax payers. This helps us
generate breakthrough products. But once a company has a successful
product, they have every incentive to move the second generation
of a successful product overseas, to Ireland and a few other
corporate tax havens.
There is only one problem for U.S. companies with this strategy,
and that is that if they repatriate this money to the U.S. they
have to pay full corporate taxes. In fact, according to BusinessWeek,
U.S. multinational corporations have built up profits of as much
as $750 billion overseas, much of it in tax havens such as the
Ireland, Bahamas, and Singapore to avoid the stiff 35% levy they'd
face if they repatriated the funds back into the U.S.
But of course, Congress, which is basically paid for by our multinational
corporations, generously provided for a one-time provision in
the corporate tax code, so that they could repatriate profits
earned before 2003, and held in foreign subsidiaries, at an effective
5.25% tax rate.
And so the game goes on.
In the end, multinational corporations live in a global world
which allows them to pretty much send their money to corporate
tax havens at will, and then repatriate this money almost tax
free, with the help of the U.S. Congress.
CounterPunch
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