Michigan's Levin says the next big thing for the government to focus on, now that the offshore accounting schemes of individual taxpayers have gotten its full attention, should be the corporate transfer pricing game.
What happens in transfer pricing? Corporations in the US, for example, may develop a new drug and take out a patent on that drug. If the patent is used in the US and the drug is manufactured here, the corporation will owe US income tax on its profits. That tax is at a 35% statutory rate, but corporations don't usually end up paying anything near the statutory rate on their economic profits--their effective rates are considerably lower, with many of the large US corporations paying no federal income tax whatsoever, from a combination of accelerated depreciation, loss deduction carryovers, and other "tax expenditures" that act to reduce their taxes (such as the many items in the Code that reduce taxes on Big Oil companies that extract natural resources--at great cost to our environment and coastal beauty, as it turns out).
One of the things multinational corporations do to lower their taxes even further is to shift income offshore. Perhaps they have a reinsurance subsidiary, so they pay reinsurance premiums to that subsidiary and shift their actual insurance offshore. Frequently, the companies that profits are shifted to have almost no employees. They mail be just a mailbox conduit in the Netherlands or the Cayman Islands, where thousands of corporations are "located" in a single four-story building. The tax code has a provision that is intended to empower the IRS to fight such manipulation of income. It's called the "transfer pricing" provision in section 482, which says that items of deduction, income, credit are supposed to "clearly reflect income"--meaning that taxable income should be related to economic income, except for provisions clearly intended to provide a special benefit (such as subsidies for corporations that Congress has built into the code, like accelerated depreciation and bonus depreciation).
But policing transfer pricing is not easy. It involves detailed facts and circumstances, takes inordinate time, and must ultimately be tried before courts that have been packed by GOP presidents with business-friendly judges, most of whom over the last thirty years have also enjoyed "educational" seminars in Chicago school-style economics funded by the Olin Foundation and sponsored by George Mason law school with the intent of influencing judges' decision-making in favor of the now-discredited "free market" thinking of Milton Friedman.
Accordingly, a number of tax and business experts have suggested that Congress should scrap the fact-intensive analysis required under current transfer pricing theory for a formulaic approach that would allot a percentage of a company's profits to the US based on the number of employees, facilities and revenues in the US compared to elsewhere. That sounds like a good idea to me--less audit time required, more objective, and less easily manipulated for the benefit of the corporate taxpayer. As those who've read much of my scholarly work will recognize, I have long argued that the ability of a taxpayer to manipulate the income reported to the IRS Is problematic, raising questions of fairness and efficiency and administrability, all of which are important for tax policy considerations.
Bloomberg.com has an article today on the transfer pricing issue, written by a former Wall Street Journal reporter who knows the beat well. I commend it to you for a view of the problem faced by the Congress and IRS as any attempt to crack down on transfer pricing scams gets underway. It describes the "double Irish". And I have to admit, this was a ruse known widely to Wall Street law firms when I was there in the late 1990s and early 2000s. Have a company in Ireland, have it paid by a company in the Netherlands (which is just a conduit--no real company) in order to get the inter -EU
protection from withholding, have that Netherlands company paid by a company in one of the Island tax havens (Caymans, Bermuda). Behold! Lots of income leaves the US tax rolls, and doesn't get taxed anywhere else. See Drucker, Companies Dodge $60 Billion in Taxes Even Tea Party Condemns, Bloomberg.com, May 13, 2010.