The Komisar Scoop

Corporate Profits Take an Offshore Vacation

By Lucy Komisar
Inter Press Service (IPS), Feb 23, 2007

Last week, Merck, the pharmaceutical multinational, announced that it will pay 2.3 billion dollars in back taxes, interest and penalties in one of the largest settlements for tax evasion the U.S. Internal Revenue Service (IRS) has ever imposed.

Merck had cooked its tax books by moving ownership of its drug patents to its own Bermuda shell company — an entity that has no real employees and does no real work — and then deducting from U.S. taxes the huge royalties it paid itself. While setting up a shell company is not inherently illegal, it is if tax authorities determine that its only purpose is to evade taxes. Bermuda is a tax haven that has no levy on royalties.

Merck also faces legal action in Canada for 1.8 billion dollars in back taxes and interest.

What Merck did isn’t unusual but in fact is becoming common for multinationals in the era of globalisation. It’s one of the ploys in a corporate bag of tricks called profit laundering. A company figures out how to move its book profits offshore so it can evade millions and even billions in taxes to the country where it really operates. In an era where much of a company’s assets may be intangible intellectual property — patents, logos, manufacturing processes — this strategy can make reported profits and taxes disappear.

People understand that nations’ economies are hurt when jobs move overseas. But what happens when intellectual capital, on which the increasingly knowledge-based economy depends, is also moved out?

IRS Commissioner Mark Everson said last June, “Tax issues associated with the transfer of intangibles outside the United States have been a high risk compliance concern for us and have seen a significant increase in recent years. Taxpayers, especially in the high technology and pharmaceutical industries, are shifting profits offshore.”

The cost of manufacturing drugs or computer technology is minimal compared to the cost of research and development. So, beginning in the early 1990s, several dozen pharmaceutical and computer companies established subsidiaries in Bermuda and other tax havens to game the system.

They set up shell companies and transferred patents or logos or other intangible property there. Then, when profits rolled in, the company paid big license fees or royalties to its own shell — at the price it decided — and deducted that from home taxes. Revenues were sucked out of the U.S. or other countries even though the patents were created and were still used for work within home borders.

Although almost 60 percent of U.S. pharmaceutical companies’ sales take place in the U.S., where the government’s refusal to control drug prices makes profits higher than elsewhere, the companies report to the IRS that their profits come largely from international sales. The world’s biggest drug firm, Pfizer, with most of its sales in the U.S., said that in 2004 it had 4.4 billion dollars in pretax profits in the United States and 9.6 billion dollars internationally.

Last year, Martin Sullivan, a former U.S. Treasury Department economist, noted in the journal Tax Notes that pharmaceuticals had accelerated their movement of profits to low-tax jurisdictions. He wrote that “In 1999, foreign profits accounted for 39.2 percent of worldwide profits of large U.S. drug companies. By 2005 that percentage had jumped to 69.9 percent.”

He figured that the companies’ foreign assets were 41 percent and their sales 43 percent of the world total, so that foreign profits should be 43 percent. But the companies reported them as 66 percent, cheating the U.S. of 23 percent of profits. That amounted to nearly three billion dollars a year from nine drug companies, including Merck, which cut 1.5 billion dollars from its taxes over a decade.

Prime technology companies playing the offshore game are Microsoft and Google. Microsoft gets about 75 percent of its 40 billion dollars in revenue from licensing fees. A few years ago, it set up an Irish subsidiary called Round Island One Ltd. to own its 16 billion dollars worth of copyrights on software developed in the U.S.

In 2004, it shifted nine billion dollars in profits to Ireland and thereby avoided paying some 500 million dollars in U.S. taxes. Using the Irish company, Microsoft also avoids taxes elsewhere in Europe, the Middle East and Africa. The maneuver helped Microsoft drop its worldwide tax rate from 33 percent to 26 percent.

Google similarly set up an Irish subsidiary, Google Ireland Holdings Ltd, which in 2004, its first year, helped the company avoid paying about 131 million dollars in U.S. taxes. Google noted in its annual report that year that it expected its effective tax rate to drop even more significantly. It explained, “This is primarily because proportionately more of earnings in 2005 compared to 2004 are expected to be recognised by our Irish subsidiary, and such earnings are taxed at a lower statutory tax rate (12.5 percent) than in the U.S. (35 percent).”

Both companies may have some minimal operations in Ireland, but the issue is how much value they allot to that jurisdiction for tax purposes.

IBM didn’t use an offshore shell but shifted royalties to another operating location. According to The (London) Observer, whistleblower Gerard Churchhouse, a former IBM marketing manager, revealed that in the early 1990s, IBM U.S. was losing money, so IBM UK transferred artificially high royalties to the U.S. company. He said it thereby evaded as much as 1.4 billion dollars in British taxes. Churchhouse said he was fired for raising the issue with his bosses. IBM refused to confirm or deny his story, but in 2001 it paid the British Inland Revenue about 1.4 billion dollars to settle claims of tax evasion.

The situation is getting worse. According to Sullivan, U.S. Commerce Department data show that U.S. companies increased the profits assigned to 18 tax havens by 68 percent, from 88 billion dollars in 1999 to 149 billion dollars in 2002. He said the increase in offshore profits was not related to increased economic activity and that, “subsidiaries of U.S. corporations now generate profits mainly in tax havens rather than in locations in which they conduct most of their business.”

The result of this and other sorts of tax trickery is that nearly two-thirds of the companies operating in the United States reported owing no taxes from 1996 through 2000, according to a 2004 report by the investigative arm of Congress, the Government Accountability Office.

Jack Blum, an expert on tax evasion and former counsel for the Senate Foreign Relations Committee, said, “Since the 1960s the percentage of tax revenue at the federal level that comes from corporations has declined from around 30 percent to around 8 percent. A substantial portion of this decline is the consequence of the ability of companies with global operations to shift income to jurisdictions where tax collectors cannot find it.”

The U.S. Treasury and IRS say they are reviewing accounting rules on transactions involving intellectual property, but the U.S. government has failed to adopt tough measures to end royalty-shifting.

Most of the 2.3 billion dollars Merck has to pay is back taxes and interest; only 100 million dollars is penalty. No Merck official has been charged with a crime. That signals that companies have little to lose by continuing their tax scams.

The Financial Times reported in 2004 that Merck “would have failed to meet consensus earnings forecasts without the improved [tax] rates.” Merck may think it took a profitable risk.

Photo of Mark Everson by Lucy Komisar.

Story on IPS site

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5 Responses to “Corporate Profits Take an Offshore Vacation”

1. Nick Says:
   September 2nd, 2007 at 5:33 pm

   Google and Microsoft “may have some minimal operations in Ireland”? What on earth are you talking about? Dublin hosts Microsoft’s second largest base outside Seattle, which deals with all sales from the EMEA region and virtually all localisation for the company. Shortly it will be hosting its entire on-line services there, from one of the largest data centres in Europe. The story is much the same for Google, which has massive server farms, and a very large number of staff based in the country.

   Your comment is grossly misleading.

   Editor: That makes the point. Why Ireland?
   Microsoft has a base in Ireland so that it can adjust its books to ascribe a large percentage of profits to this tax haven (12% vs US 35% corporate tax).
   Second, Microsoft has transferred ownership of intellectual property, developed in Seattle, to Ireland, where it cheats America of taxes on its prime source of income: royalties.
   Same for Google. Do you believe that if Ireland had a 35% tax that those companies would be shifting their profits out of the US?

2. Geoff Says:
   September 29th, 2007 at 10:53 pm

   Nick, it’s fairly widely known that they established there for tax reasons. Even the WSJ did an article about it a couple of years ago http://www.law.wayne.edu/mcintyre/text/in_the_news/WSJ.com%20-%20Irish%20Subsidiary%20Lets%20Microsoft%20Slash%20Taxes%20in%20U.S.pdf

   In this era of increasing globalisation, lowering business tax is one of the main ways that countries attract foreign investment.

3. Richard Gordon CP Says:
   October 5th, 2007 at 6:24 am

   Dear Ms Komisar: This morning I awoke to the CNBC cable show Squawk Box and they are aghast that a US prosecutor’s probe has been initiated into the recent Bear Stearn’s Hedge Fund collapse. Clearly they are unaware that the Funds tried to fall under Cayman Island Law but formally the US Bankruptcy judge denied this claim; and the federal courts now have jurisdiction into ALL investigations of offshore Hedge Funds and other ( ? ) offshore tax havens that might become under the jurisdiction of US courts. This disclosure might have an impact on investigations that you have interest in. Respectfully, Richard Gordon CP

4. Tony Johnson Says:
   December 16th, 2007 at 1:18 am

   Re: Offshore tax scams–a travesty and blow to American taxpayers!!!!

   The Congress and other Federal law enforcement officials will need to increase their manpower due to many outrageous tax scams played by big corporations– leaving the average and some middle class fox the entire tax burden of the nation!

   While the big corporations would insist in their federal pleadings that they are also “persons” under the laws–as any American Citizen individual–with “equal protections under laws”, they are showing serious signs of moral failures when they “take a hike” (to offshore-of course!) from the federal tax responsibilities and leave behind the average American taxpayer to shoulder their tax burdens!

   It is unprecedented (and shocking to conscience!) in American business history what is happening inside the minds of the CEOs who manage the big (tax offending) corporations mentioned by ex-Treasury Secretary, Mr. Sullivan! To be sure, there is absolutely NO EXCUSE under American Legislative (tax) history for any “person” of the “corporate” type to stealthily set (shop)(office and) IBC, Trust, Bank Accounts, in the offshore (low–or tax free) jurisdictions!

   I hope that that they will pay attention from now on…seeing that a Texas tycoon 83 years of age has been successfully sent to the Federal prison, much the same as the “Hotels Queen” of New York Helen Helmsley (and her husband) has been some years ago!

   Stealthy corporations caught setting shop outside the United States ought to be punished more seriously, as provided by Federal criminal laws, including their CEO and other related co-conspirators! It is a devastating shame and disgrace what these (mentioned) corporations are doing to our gracious country and its nice (tax-paying) people!

   Congress should therefore increase the manpower and resources to the respective law enforcement departments to detect and prosecute many more corporations and co-conspirators (there are a lot, are there not?) which set shop in (low-or tax free) jurisdictions…leaving the national tax burden upon the average hard working American! This is unfair, unlawful, inequitable and a travesty, under Constitution and laws!

5. Richard Gordon CP Says:
   December 22nd, 2007 at 8:58 am

   Dear Ms Komisar: Greetings! I thoroughly enjoy your website and inclusive articles. Two trillion dollars worth of central bank liquidity ( and potentially just as smidgeon of the yet to be determined total ) has flooded banks worldwide just to insure that the cash reserves ( 8% of total loans ) are met ( the 1987 Black Tuesday Wall Street crash and losses were valued @ $500,000,000,000.00 ); and thus the offshore accounts of the numerous CEOs and other investors by this action must certainly be intact throughout the numerous offshore banking centers. The permanent US government is once again in an election cycle. The participants ( less Mr. Kucinich and Mr. Paul ) are well aware that the majority of all US currency is now offshore ( better than 55% ). So who really controls the election process?? Congress is once more a non-participant in uncovering the corruption that so evidently is exposed in the many Bushgates that begin and abruptly end without resolution ( notice that Mr. Paulson’s Super SIV once established as a 100 Billion dollar fund is now a mere 20 billion!!!!. Chartered Banks are more interested in accumulating cash reserves than pushing those off books SIVs from the darkness to the light ( on books ) as the year comes to a close ) regardless of the many writedowns and sell offs by investment banks. Your attendance at the CFR lectures and public gatherings is most commmendable. The numbers of dollars involved in your exposees are so vast that it boggles the mind that today there are 800-900 US billionaires and in Mainland China there are now 100-200 billionaires. And the derivative numbers exceed 1200-1500 trillion WOW!!! What a roving crapgame that must be!!!( During the 1930s the # of millionaires was 46!!! ) Doesn’t it ever amaze you that so few Rothschilds and Rockefellers make the Forbes wealthiest annual list?? Again you are to be commended for your strength of purpose and conviction. I wonder what it will take for the majority of americans to realize the global fraud that has been perpetrated in their name under color of law?? I am beginning to see the development of an alternative financial architecture to replace the now almost certain bankrupt Anglo-American/Dutch version that we are all so used to participating in. The emergance of the Bank of the South; as well as the alliances of Russia, Iran ( and possibly that of China and Japan )and the numerous Sovereign Wealth Funds who most certainly are hedging their continued investment in dollars by buying up huge chunks of US and other corporate stock; and possibly responsible for the rise in oil, commodity and gold prices. Too few americans know the history of the corporation as a "person" and the rights they ( the corporation ) have usurped over more than 120 years. Welcome to the real world. as always, Richard D. Gordon CP

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