Bloomberg reports today that the IRS is auditing Google's offshoring of profits. See Drucker, IRS Auditing How Google Shifted Profits Offshore to Avoid Taxes, Bloomberg.com (Oct. 13, 2011).
"The agency is bringing more than typical scrutiny to how the company valued software rights and other intellectual property it licensed abroad, said the person, who requested anonymity because the audit isn’t public. The IRS has requested information from Google about its offshore deals after three acquisitions, including its $1.65 billion purchase of YouTube, the person said. The transfer overseas of these kinds of rights rights has enabled Google to attribute earnings to foreign units that pay lower taxes .
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Google, owner of the world’s most popular search engine, has cut its worldwide tax bill by about $1 billion a year using a pair of strategies called the “Double Irish” and “Dutch Sandwich,” which move profits through units in Ireland, the Netherlands and Bermuda. Google reported an effective tax rate of 18.8 percent in the second quarter, less than half the average combined U.S. and state statutory rate of 39.2 percent. " Id.
After being alerted to Google's use of income shifting through media attention to the issue, France is also reviewing Google's income shifting between its French and Irish subsidiaries, according to the Bloomberg article.
This audit, however, takes place against the backdrop of a 2003 "advance pricing agreement"--essentially, a contract between a taxpayer and the IRS that "settles" the tax treatment of a transaction that the taxpayer expects to undertake.
The IRS has already approved a major part of Google’s strategy. In 2006, the agency signed off on a 2003 intracompany transaction that moved foreign rights to its search technology to an Irish subsidiary managed in Bermuda called Google Ireland Holdings. That deal -- known as a “buy in” in tax parlance -- meant subsequent profit overseas based on those copyrights has been attributed to foreign subsidiaries rather than to Google in the U.S. where the technology was developed. The IRS approval came in an accord known as an advance pricing agreement. Id.
In my view, advance pricing agreements --a recent introduction in the 'tax compliance' toolkit--are problematic in a democratic tax system. Only taxpayers with considerable dollars at stake can engage in the process, which allows them to "fix" in advance what their tax obligations are regarding particular business plans. The potential for agency capture, always present, is enhanced in this setting. Tax administrators are less adept at foreseeing likely ancillary consequences of a particular decision than the taxpayer itself and, worse, they may be "captured" by their proximity to the taxpayer and lack expertise or in-depth understanding of the issues sufficient to challenge the taxpayer's assumptions. The decision made ahead of time is likely based on sketchier information than an after-the-fact audit. Further, those negotiating such agreements may be less inclined to take an strong position vis a vis the taxpayer than those involved in enforcement and litigation decisions later in time would be. While changes in administration likely affect the government's commitment to, and interest in, both enforcement decisions and advanced pricing agreement decisions, one would expect that an administration that had made a point of being "business-friendly" would be more likely to enter into taxpayer-favorable advanced pricing agreements whereas one that had a more guarded view of business might be more interested in strong enforcement.
It's worth noting that the big IT and pharmaceutical companies that find it easiest to shift income offshore due to their intellectual property patents are also the ones pushing hardest for a so-called "repatriation tax holiday" on those offshore earnings. They've kept billions offshore and now want to be able to dole it out in executive bonuses and shareholder buybacks little tax. They often have the profits go to offshore tax haven countries, so this is income that has very little foreign tax paid on it either. As I've noted in earlier posts on repatriation (check the category index or just scroll back over the last few months), executives bonuses due to lower tax bills just adds to the outsize compensation those executives receive, while shareholder buybacks just diversifies their portfolios with little likelihood of expansionary impact on the US economy (especially if the diversification results in purchases of emerging market instruments instead of domestic ones).
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