Technology October 21, 2010, 8:00AM EST

The Tax Haven That's Saving Google Billions

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The subsidiary is supposed to pay an "arm's length" price for the rights, or the same amount an unrelated company would. Yet because licensing fees from the Irish subsidiary generate income that is taxed at 35 percent, one of the highest corporate rates in the world, Google has an incentive to set the licensing price as low as possible. The effect is to shift some of its profits overseas in an arrangement known as "transfer pricing."

This, too, is legal. In 2006 the IRS approved Google's transfer pricing arrangements, which began in 2003, according to Google's SEC disclosures.

Transfer pricing arrangements are popular with technology and pharmaceutical companies in particular because they rely on intellectual property, which is easily transportable across borders. Facebook is preparing a structure similar to Google's that will send earnings from Ireland to the Cayman Islands, according to company filings and a person familiar with the arrangement. Microsoft and Forest Laboratories (FRX), maker of the blockbuster antidepressant Lexapro, have used a similar Irish-Bermuda transfer pricing arrangement. Facebook, Forest, and Microsoft declined to comment.

Ethical Questions

Even if the tax avoidance structures are legal, not everyone considers them ethical. Google is "flying a banner of doing no evil, and then they're perpetrating evil under our noses," says Abraham J. Briloff, a professor emeritus of accounting at Baruch College who has examined Google's tax disclosures. "Who is it that paid for the underlying concept on which they built these billions of dollars of revenues? It was paid for by the United States citizenry," Briloff says, referring to the fact that Google's initial technology was based in part on research done at Stanford University and funded by the National Science Foundation. Profit-shifting arrangements such as Google's cost the U.S. government as much as $60 billion in annual revenue, according to Kimberly A. Clausing, an economics professor at Reed College in Portland, Ore.

The government has made halting steps to change the rules that let multinationals shift income overseas. In 2009 the Treasury Dept. proposed levying taxes on certain payments between U.S. companies' foreign subsidiaries, potentially including Google's transfers from Ireland to Bermuda. The idea was dropped after Congress and Treasury officials were lobbied by companies including General Electric (GE), Hewlett-Packard (HPQ), and Starbucks (SBUX), according to federal disclosures compiled by the nonprofit Center for Responsive Politics. In February the Obama Administration proposed measures to curb companies' ability to shift profits offshore, but they've largely stalled.

"The system is broken, and I think it needs to be scrapped," says Reuven S. Avi-Yonah, director of the international tax program at the University of Michigan Law School. "Companies are getting away with murder."

The bottom line: Google has built a complicated international structure that sends most of its overseas profits to the tax haven of Bermuda.

Drucker is a reporter for Bloomberg News.

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