It’s rare that decisions regarding transfer pricing make big news. But this one is different. An IRS victory in the Ninth Circuit against chip company Xilinx Inc. earlier this week may change the way that companies allocate their costs for purposes of transfer pricing. The decision already has international tax practitioners abuzz.
The facts of the case aren’t terribly good, causing some practitioners to wonder if it’s a case of “bad facts making bad law.” But here goes: Xilinx allocated part of its R&D costs to a subsidiary in Ireland, where corporate rates are much lower than those in the US. So far, so good. Lots of companies do this sort of thing.
Here’s where it turned ugly: for purposes of stock options, Xilinx kept the entire value of tax deductions related to the options inside the US. In other words, none of the deductions were allocated to the Irish company. This, of course, made the IRS go “Hmmm.”
Xilinx argued that these unrelated companies wouldn’t have shared the costs of the stock options. The IRS said differently. A lower court sided with Xilinx but an appellate court overturned that ruling by a vote of 2-1. Not an overwhelming victory for IRS but still a victory.
What gives tax practitioners pause is that the ruling could be considered to give IRS broad powers to adjust corporate tax returns. In an environment that is increasingly hostile for US corporations with foreign subsidiaries in countries with lower tax rates, it could be unsettling that discretion to allocate costs may now be called into question. My guess is that little will happen immediately, pending Xilinx’ decision as to an appeal. The company hasn’t yet indicated that it will appeal but I think we’d all be surprised if it didn’t.
Republicans in the Senate have made it clear that they are not fans of President Obama’s proposals to close international tax “loopholes.” Specifically, Senate Minority Leader Mitch McConnell (R-KY) decried the proposal, claiming that, “Amount to a tax increase during a recession, which would likely drive jobs overseas.”
Of course, the Obama administration is painting the proposal in the exact opposite light. The administration claims that if the cost of doing business abroad was made tax neutral, more companies would do more of their business in the US. Obama says that the current structure “[i]s a loophole that lets subsidiaries of some of our largest companies tell the IRS that they´re paying taxes abroad, while telling foreign governments that they´re paying taxes elsewhere, and then they avoid paying taxes anywhere.”
And how much money are we talking? In 2004, US multinational companies reportedly earned about $700 billion (with a b). They paid tax of $16 billion on those earnings. That works out to a 2.29% tax rate. Compare that to the lowest corporate tax rate of 15% for US companies earning income inside the company (and going up to 38%).
Interesting, no?
But, of course, these are multinational companies who are thriving and not relying on US taxpayers, right? Capitalism at work, right?
Nope. You know who is relying on those tax loopholes? The very companies that you and I are bailing out. Banks like Bank of America and Citicorp have each created more than 100 non-US tax-paying, off-shore subsidiaries (Citicorp has more than 400). That’s right. They’re using US tax dollars to pay bills, when they’re maybe not even paying their fair share.
I say maybe because “fair” is what’s really at issue here. Is the plan fair? Tech companies say no – they’ve been some of the loudest critics of the plan. In fact, the Silicon Valley Leadership Group has gone on record as saying that its members found it “surprising to be construed in the same way as tax cheats.” These tech companies claim that these new regulations will force them to rethink the way that they do business – and no wonder. On a recent list of 50 companies who pay the least in US corporate taxes, tech companies like Apple and Yahoo constituted almost half – 22 – of the list. This, of course, make sense, as it’s easy to move those businesses offshore.
Numbers aside, the Silicon Valley Leadership Group does have a point. Stashing billions of dollars offshore and not reporting it to the IRS is illegal. Using existing tax laws to your advantage is not. It’s very, very legal. It’s one of the things that we tax professionals do: advise how to use the law to your advantage.
So tossing multinational companies into the same pile as tax cheats isn’t fair. We might not like it. But it’s not fair.
On the other hand, perhaps paying 2% in earnings isn’t fair either.
Like Sen. McConnell, I have no real answers. I like the direction we’re moving, to try and level the playing field to bring US jobs back home. As someone who saw her dad’s job more or less be moved to Mexico (thanks, DuPont), I understand that we need to do something to keep US jobs in the US. I just don’t know that this is the way to do it. Your thoughts?
The Obama administration is planning to announce a steps towards his promised “massive overhaul” of international financial regulations this morning. Administration officials do not expect the announcement to be popular.
So, the good news first. Obama will announce plans to make permanent a research tax credit that was to expire at the end of the year. A whopping 75% of those credits went towards paying for employees; the continued perk should help buoy the employment sector a bit.
And now the bad news (well, that kind of depends on who you are).
First off, it’s not unexpected that Obama wants to target US taxpayers who are stashing funds in offshore tax havens in order to evade taxes. This is a no-brainer for raising revenue without raising taxes – or even changing much of existing law. Domestic taxpayers are not likely to squeal and it makes the administration look tough on tax evaders. The IRS is expected to hire up to 800 new employees to take on the task of reducing offshore tax evasion.
Changes to corporate tax law pose a greater obstacle to the administration. Currently, companies which keep profits offshore can defer taxation on those profits until the funds are repatriated. Obama wants to change that.
Obama’s proposal calls for an elimination of deductions as domestic expenses for generating profits abroad. In other words, expenses related to promoting profits for a branch in Munich would not be deductible for its US counterpart.
Obama also wants to close a Clinton-era tax provision which allows US companies to simply “check the box” in order to treat international subsidiaries as branch offices. In that way, those offices would not be subject to US tax. While proponents of the provision claim that it’s administratively effectives, critics claim that it was simply a way to avoid paying billions of dollars in taxes on international operations.
The idea, as the Obama administration paints it, is to keep jobs in the US by closing tax loopholes that the administration believes encourages companies to send US jobs overseas.
Or is it? Critics of the plan are characterizing it as just another means of raising revenue – i.e. raising taxes. The plan is expected to raise more than $200 billion in revenue over the next decade.
How unpopular is the move? Even before the plan has been announced, more than 200 letters of opposition have been sent to Congress. You can count on a big fight for this one.
