The U.S. has the world’s highest corporate tax rate. In theory, that means its companies hand over more than one-third of their profits to Uncle Sam to pay for things like national defense, patent protection and public education. In reality? They don’t. There are many tactics corporations use to lower their taxes, few more powerful than booking their income in other countries. Complicated cross-border transactions cost the U.S. government $30 billion to $90 billion a year.
Iconic U.S.-based companies — including Apple, Caterpillar and Starbucks — have come under attack from lawmakers in the U.S. and around the world for their profit-shifting strategies. Governments are scrambling to stop what they see as a race to the bottom. The U.S. tax code, in particular, encourages companies to report their profits in low-tax or no-tax foreign jurisdictions and leave them there. The U.S. has the rare combination of a high statutory tax rate and a rule that makes companies pay the full U.S. tax on foreign profits only when they bring the money home. Caterpillar, for example, saved $2.4 billion from 2000 to 2012 by changing the address of its global parts business to Switzerland from the U.S. Apple set up a subsidiary that exploited the gaps in Irish and U.S. laws so that it didn’t have a home anywhere for tax purposes. Starbucks houses some of its intellectual property, such as its brand, in the Netherlands, which lets the company concentrate its foreign profits there. Companies deploy a tax lawyer’s full toolbox to move as much of their income outside the U.S. as possible. The latest trend is the corporate inversion, in which American companies buy smaller foreign competitors and move the merged company’s tax home overseas.
How do companies move profits around the world? It’s easier than ever because the capital that generates corporate profits is no longer bolted to factory floors. It’s mobile, so patents for pharmaceuticals and search engines can be located in the most tax-advantageous place. Theoretically, the Internal Revenue Service has a way to police those moves. The IRS is supposed to treat intracompany transactions that move assets out of the country as arm’s-length deals and allocate the taxes accordingly. What’s the problem? There aren’t good comparable sales in the real world and companies can move promising intellectual property out of the country at a low price before it booms in value.
Companies and their shareholders benefit from profit shifting. Governments and their citizens don’t. That doesn’t mean the authorities can figure out how to stop it. In the U.S., Democrats want a global minimum corporate tax. Republicans emphasize lower rates and new rules that would make it harder for companies to move intellectual property overseas. Both approaches are susceptible to exploitation by creative tax lawyers skilled at finding new loopholes. Either way, the proposals are mired in Congress and nothing is likely to happen until next year at the earliest. The other strategy? International cooperation, so countries can use common rules to prevent companies from finding the gaps. After all, if a company does research in California, manufacturing in the U.K. and back-office management in Ireland to support sales in Germany and France, how are the countries supposed to divide up the income? The Organization for Economic Cooperation and Development is trying to build an international consensus on combating profit shifting. The goal: A set of agreed-upon rules each country can adopt on its own. That’s as hard to achieve as it sounds.
The Reference Shelf
- The Organization for Economic Cooperation and Development has proposals to discourage profit shifting.
- The Congressional Research Service has an analysis of U.S. companies engaged in profit shifting.
- A Republican proposal to revamp the tax code, from House Ways and Means Committee Chairman Dave Camp.
- President Barack Obama’s tax proposal.
- The Government Accountability Office’s assessment of federal contractors operating in tax havens.
- Bloomberg QuickTake on tax inversion.