H. Jacob Lager

Archive for the ‘Business tax rates’ Category

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Google’s Irish Sandwich Explained

In Business tax rate, Business tax rates, Foreign taxes on January 3, 2013 at 2:16 pm

irish sandwich

In our last entry I promised to explain how Google’s infamous “Double Irish” sandwich creates some serious US tax savings for the giant search engine.  Now, it’s recipe time.

In the best plain English I can manage, here is how the epicurean structure works:

Step One (the ingredients):  A US firm with valuable intellectual property creates two Irish subsidiaries and one in the Netherlands.

The first subsidiary (“HoldCo”) will be formed in Ireland but actually controlled in a low-tax environment such as Bermuda.   While US tax law (which looks to the jurisdiction of incorporation) will consider HoldCo an Irish subsidiary of the parent, Ireland will consider it a Bermudian entity because that’s where HoldCo’s “effective centre of management” will be domiciled.

The second subsidiary (“DutchCo”) will be a wholly owned subsidiary of HoldCo, organized and controlled in the Netherlands, and will elect to be disregarded from HoldCo, its sole owner for US tax purposes.

The third and final subsidiary, the management company (“MCo”), will be a wholly-owned Irish subsidiary of DutchCo, and will also elect disregarded status.  For US tax purposes, all three subsidiaries will be treated as one Irish entity.  However, Ireland will view the structure as consisting of three distinct corporations, one subject to Irish corporate tax (MCo) and the others exempt from it (HoldCo and DutchCo).

Step Two (putting it all together):  The US parent sells its valuable IP to HoldCo.  HoldCo will then license the IP to MCo (through DutchCo).  MCo will exploit that IP throughout the world, collecting income.   In Google’s case, this income consists of advertising revenue from all its non-US sources.

MCo’s taxable revenues will be reduced by its deductible royalty payments made to DutchCo pursuant to the two subs’ license agreement.  Similarly, DutchCo will then pay out its revenues to the Bermuda-based HoldCo.  Here are how the taxes then get calculated:

  • Whatever MCo profits exist will be taxed at Ireland’s 12.5 percent corporate rate.  But because it will deduct any royalty payments made to HoldCo, this number will be relatively small.  (This, by the way, is the essential condiment of the Irish Sandwich:  the fact that it relies on Ireland’s history of relatively weak transfer pricing laws.  Transfer pricing rules typically ensure that charges between units of a multinational corporate family approach fair market arm’s-length value.  Otherwise, a US firm could easily drain its profits by making wildly expensive (and tax-deductible) payments to its own Bermuda subsidiary.  Google’s Double Irish is meant to create the maximum possible tax value for corporations within the relative liberality of Irish transfer pricing laws.  A successful sandwich relies on bending, but not breaking, these transfer pricing rules. )
  • The payments that go to HoldCo (through DutchCo) will avoid Ireland’s 20 percent withholding tax on royalties due to operation of certain EU tax treaties.
  • The majority of MCo revenues will sit in HoldCo in Bermuda, where the corporate tax rate is essentially zero.

The end result?  Only a small Irish tax is paid on the vast majority of Google’s non-US income.

It sounds great, but is it legal?  Well, Google reportedly only implemented the structure after obtaining an IRS advance ruling after three years of negotiations.  So, yes, as long as Google keeps to its agreement, it can continue to eat this sandwich just so long as the Irish, Dutch, and Bermuda ingredients don’t spoil.

Photo provided by Urban Sea Star.

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Close Offshore Loopholes to Ease Fiscal Cliff?

In Business tax rate, Business tax rates, U.S. Tax policies on December 14, 2012 at 9:08 am

Fiscal cliff

The best part of writing about taxes is that there is no shortage of current events to chew on.

So I completely missed writing about Romney’s offshore carried interests.  That election is so Fall, 2012.  Mitt who?  What people really want to know about is the Fiscal Cliff!  (Cue ominous musical score).

The “Fiscal Cliff” is a phrase that summarizes the sum total of tax increases and spending cuts that are scheduled to take place on January 1, 2013 if Congress and the President don’t act to change the existing laws by the end of 2012.  At the time of the “Debt Ceiling Crisis” of 2011, the Cliff seemed at once (a) a good way to reassure foreign lenders and (b) something we could surely avoid by acting within the next two years. 

Well, now that we are less than three weeks away from falling off the Cliff, what does any of this have to do with international taxes?

Nothing right now, actually.

But there are sure a lot of people who think that all our Cliff stress could be eased by closing all those foreign loopholes big nasty corporations use to avoid paying US taxes.  The latest to join this chorus is non-profit organization US Public Interest Group (USPIRG), which claims that offshore manipulation “costs the federal government an estimated $150 billion in tax revenue each year.”  According to USPIRG, all we need to do close all those loopholes and we’ll actually have more than enough to “cover the $109 billion in automatic spending cuts” that will happen if (when?) we fall off the Cliff.

Sounds great.  But what are the actual “loopholes” that USPIRG thinks we need to close?  Well, that’s where it the article is a little . . . er, scant?  USPIRG cites three maneuvers by three well-known multinationals that should be undone:

  • Google’s use of the so-called “double Irish” and the “Dutch sandwich” structures which reportedly reduced its tax bill by $3.1 billion between 2008 and 2010.
  • Wells Fargo’s payment of no federal income taxes between 2008-2011 “due to its use of 58 offshore tax haven subsidiaries.”
  • Microsoft’s avoiding $4.5 billion in taxes by “artificially shift[ing] its income to tax-friendly Puerto Rico.”

So is all this true?  Over the next three weeks, I’m going to explore each of the above maneuvers and we’ll see just how these work and (maybe) how they can work for your business.

In the meantime, I’ll keep on eye out for that Fiscal Cliff.

My one bold prediction?  Not a good time to rely on Congress to reinstate the “active financing” exception.

 

Photo by Jim Moran.

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International sales and state and local taxation: Closer than you may think

In Business tax rate, Business tax rates, Court decisions on August 3, 2012 at 6:38 am

Michigan allows domestic corporation to aggregate with foreign entity

The mainstream media (first time I’ve ever used that term this election cycle!) often portrays the use of foreign business entities as an arcane, indecipherable tax-dodging practice available only to huge corporations and the very wealthy.

The truth is far more mundane and, therefore, relevant to growing middle-market and closely-held businesses.

Take, for example, this past Tuesday’s re-issuance of a May 15, 2012 decision by the Michigan Court of Appeals.   In Wheeler v. MI Dept. of Treasury,  the court held that the shareholders of a domestic S-corporation were entitled to combine that corporation’s income with that of its subsidiary foreign partnerships when determining how to properly apportion state income tax liability.

So what does all that mean?

How Multi-State Allocation Works

Like many states, Michigan relies on statutory rules of allocation to determine which income from out-of-state activities are not subject to Michigan income taxes.  Some taxpayers can easily identify out-of-state activities and thereby allocate their income to specific geographic areas.  Others often encounter difficulties attempting to make such an allocation.  States are allowed to tax these multi-state operators on an apportionable share of their multistate business attributable to their jurisdiction.  This is known as the “Unitary Business Principle” (or “UBP”) and is often expressed within a state’s revenue statutes in the form of a formula that accounts for factors such as the taxpayer’s in-state property, payroll and sales.

In Wheeler, the taxpayers were the individual owners of a Michigan S Corporation with underlying foreign subsidiaries that were also transparent for tax purposes.  The owners treated their income from all their domestic and foreign pass-through entities as a unitary business and included in their UBP apportionment calculation the factors attributable to their foreign entities, resulting in a lower Michigan tax bill.  Michigan argued that UBP did not allow consideration of the foreign entities’ activities.

The Decision

In holding for the taxpayers, the court noted that “the plain language of the [statute] requires unitary, international businesses to apportion their income, and the plain language of the [statute] in effect during the years at issue required unitary, international businesses to include international apportionment factors in the calculation of property, payroll, and sales factors. . . . [T]herefore, we enforce the statute as written and follow the plain meaning of the statutory language.”

The Takeaway

When you or your clients plan for next year’s anticipated total tax obligations, don’t automatically assume that international operations are entirely separate from domestic.  You might be leaving money on the table if you don’t examine a full unitary approach for all your operations.

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Flowchart: All Your Business Entity Selection Questions Answered On One Page

In Business entities, Business entity, Business tax rate, Business tax rates on May 14, 2012 at 9:27 am

Business entity selection is an issue at comes up in every deal I encounter.  For tax purposes, the correct type of business entity for a given client cam be ascertained by how they answer the following questions:

Am I the sole owner?

Am I willing to pay a state/franchise tax for limited liability?

Am I taking on any debt?

Am I taking on any preferred investors?

Am I willing to deal with a second level of taxation?

Compare your answers to this flowchart to see where you end up.

Business entity selection, business entities

If you have even more questions regarding business entity selection, please contact me.  We can cover your specific needs and help start the best business entity for your situation.

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GE: Bringing good things to life or avoiding Uncle Sam?

In Business tax rate, Business tax rates, Foreign taxes on March 5, 2012 at 6:15 am

Is GE avoiding taxes

One of my favorite internet memes is the “99% vs. GE.” Depending on the author, GE is either an evil multinational corporation that enjoys massive US tax subsidies, or a concerned global citizen that welcomes year-round IRS examination with free office space and donuts.

In the latest salvo, Washington-based Citizens for Tax Justice (“CTJ”) has claimed that GE owed just 2.3 percent in federal taxes on $81.2 billion of pretax profits over the last ten years.  According to CTJ Director Robert McIntyre, GE achieves this result by taking advantage of the “active financing” exception to the Tax Code’s subpart F rules, which would otherwise cause GE to owe US tax on its foreign income.  McIntyre claims that GE uses this exception to treat offshore financial products as “nowhere income.”

What does all this mean?

Subpart F is an entire, well, subpart of the voluminous US Tax Code meant to impute the income of a foreign business to its US owners.  Subpart F’s underlying purpose is to essentially prevent US taxpayers from sheltering income in nominee shell corporations formed in low-tax jurisdictions.

How does this “active financing” exception allow GE out of this regime?

Subpart F income does not include “qualified banking or financing income” of an “eligible” foreign subsidiary.  Eligibility is triggered if the foreign sub is “predominantly” engaged in the active conduct of a banking, financing or “similar” business; and the sub is engaged in “substantial” activity with respect to those businesses. .  Finally, “substantially” all of the subsidiary’s activities are carried out in its home country or the home country of one of its branches and taxed in one of those countries. GE has presumably established qualifying foreign subsidiaries that meet these elements.

Put simply: if GE owns a bank in Country X, that makes loans to actual Country X residents, and pays rent on its actual Country X storefront, that bank is subject only to Country X taxation. Even if Country X’s tax rate is 5% or 0%.

But let’s look at those requirements again:  “substantially,” “predominantly,” “similar,” “substantial” (redux).  To a tax lawyer, these words are ripe as a Georgia peach for creative structuring (and billables).

GE isn’t exactly creating “nowhere income,” but the combination of low-tax jurisdictions and the active financing exception’s subjectivity is enough to rankle CTJ.

I’m not suggesting GE is over-aggressive in its Subpart F compliance.  In fact, even McIntyre doesn’t come out and point to any particularly questionable foreign finance vehicle.  But with that much subjectivity built into the active finance exception, and with banking becoming more mobile and nimble every day, it’s not hard to imagine some serious envelope-pushing.

This possibility for abuse  is probably why Congress has never made the active finance exception permanent.  Originally, the exception was set to expire in 2002 but was  extended to 2006, then to 2009.  It was then extended again and again, and is currently, technically, finally . . . . expired.  Despite presumed lobbying efforts to the contrary, conventional wisdom assumes that the exception will not be reinstated until after the November elections.