A U.S. Senate committee memo said Microsoft Corp. (MSFT:US) used aggressive international tax maneuvers to avoid billions of dollars in taxes over the past three years.
The committee memo, released for a hearing today in Washington, said Microsoft used transactions with subsidiaries in Puerto Rico, Ireland, Singapore and Bermuda to save at least $6.5 billion in taxes. The committee also revealed that Hewlett- Packard Co. (HP:US) has used a series of short-term internal loans that allowed the company to tap its offshore cash for domestic operations without paying taxes, according to the memo.
Senator Carl Levin, a Michigan Democrat and chairman of the Permanent Subcommittee on Investigations, didn’t accuse the companies of acting illegally, though he said he was “highly dubious” that HP was in compliance with the tax law.
Such financial maneuvers “may be in your temporary interest as a corporation,” Levin told Bill Sample, Microsoft’s corporate vice president for worldwide tax, at the hearing. “It increases your profits and reduces your taxes, but there’s a heavy cost to the United States,” Levin said.
Levin and the panel’s top Republican, Tom Coburn of Oklahoma, sent the memo to committee members.
Coburn described the moves as “properly legal tax avoidance” by companies taking advantage of a tax code that needs an overhaul.
“Our report is about the symptoms of the disease, not the real disease,” he said at the hearing.
The report describes the ways companies can move profits outside of the country and keep them there to avoid U.S. taxes.
“We comply with U.S. and foreign tax laws,” Sample said at the hearing. “That is not to say that the rules cannot be improved.”
U.S.-based companies owe U.S. taxes on profits they earn around the world. They receive credits against that liability for taxes paid to foreign governments, and they don’t have to pay U.S. taxes until they bring the money home.
The gap between the 35 percent U.S. corporate tax rate and lower tax rates in the rest of the world gives companies an incentive to book profits outside of the U.S. Levin said technology companies can easily move intangible assets such as patents outside of the U.S. with intra-company transactions at low prices.
Hard to Value
Those intangible assets are hard to value, and disputes about the correct price for such intra-company transactions are common. When foreign subsidiaries in low-tax countries pay too little, either up front or over time, they can get annual profits paid to them out of proportion to what they paid.
“The high-tech industry is probably the number-one user of these offshore entities to transfer intellectual property,” Levin said.
In questioning Sample, Levin outlined how Microsoft uses transactions within the company, all with its own money, to assign about 47 percent of its income from U.S. sales to a Puerto Rico subsidiary, and how it shifts some income from around the world to a Bermuda subsidiary that has no employees.
Levin’s investigators sent letters to companies and used subpoenas to get information that companies don’t typically disclose. He said they focused on Microsoft and HP to show patterns that are common across U.S. companies.
Levin attributed such tax avoidance in part to a lack of enforcement by the Internal Revenue Service, gaps in IRS regulations and “loopholes” created by Congress.
Levin emphasized HP’s use of loans to tap its offshore cash. The loans, the report said, are structured to comply with the letter of tax rules that allow short-term loans from subsidiaries in Belgium and the Cayman Islands to the parent company.
Although long-term loans would trigger tax consequences, the alternating-loan program provided a potential continuous stream of money for HP.
The memo, citing company documents, said as much as $5 billion was available to the parent company in 2008 and that the company borrowed from $6 billion to $9 billion in 2010. HP holds $29.1 billion in untaxed earnings outside the U.S., according to the company’s most recent annual filing (HPQ:US).
IRS rules allow companies to take loans from foreign subsidiaries without tax consequences within a given fiscal quarter. The Belgian and Cayman subsidiaries have different fiscal calendars.
The company developed a schedule that allowed loans from the Belgian subsidiary within its fiscal quarters, and then loans from the Cayman subsidiary with a calendar that covered the periods when the Belgian subsidiary was crossing from one quarter to the next.
Lester Ezrati, a senior vice president for tax at HP, said at the hearing that the company did have gaps in its borrowing from the foreign subsidiaries. He also said the IRS didn’t raise concerns when it examined the loans during a recent audit.
HP has fully complied with U.S. tax law, the company said in a statement.
“We are disappointed to see what appears to be a politically motivated attack on one of America’s largest employers,” it said.
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