Global austerity and anemic economic growth in developed countries has turned the spotlight on taxes and spending like never before. Corporate taxes have come under the scrutiny of citizen and consumer groups who are facing reduced government spending on welfare. Big global corporations like Amazon (AMZN) , Google (GOOG) , Apple (AAPL), Microsoft (MSFT), Oracle (ORCL , Adobe Systems (ADBE), Yahoo (YHOO), pay very low taxes using subsidiaries in tax havens like Bermuda, Luxembourg, Cayman Islands and other places. These companies which generate billions of dollars in profits each year pay a low effective tax rate using a variety of accounting and legal machinations.

Rampant use of Tax Havens

A recent article in Economist highlights how Starbucks has been forced to pay up, as pressure mounted on it from consumer groups. MNCs using their scale and size are intimidating small governments into lowering taxes at the expense of the small man.

Although Starbucks denies using tax havens, it admits to having negotiated a secret low rate of tax with the Dutch taxman for its subsidiary in Amsterdam. Worldwide, it says it pays out over 30% of its profits in tax. Many other firms are making extensive use of havens. A study published last year by ActionAid, an activist charity, said 98 of the firms in the FTSE 100 index have at least one subsidiary in a haven. An increasingly popular strategy is to transfer ownership of the multinational’s main intellectual property to a subsidiary in a tax haven, then charge other subsidiaries in higher-tax countries for use of it. Data compiled by the OECD, a rich-country think-tank, highlight how many patents are owned by outfits in such unlikely innovation hubs as Barbados, the Cayman Islands and Bermuda.

How profits are shown as expenses

Taxation is a complicated issue and figuring out where profits are being generated has become a herculean task. Transfers between subsidiaries is not always done using the principles as company accountants stretch the legal limits in all jurisdictions to reduce the tax outflow.

1) Royalty payments – The global companies transfer the IP and trademarks to their subsidiaries in the tax havens and a large chunk of the profits generated in bigger countries like UK and USA are transferred to these tax havens as royalty payments. This shows up as expenses and the taxes that would have been paid on the profits are never paid.

2) Show Revenues being generated by other subsidiary – In case of companies like Google where services are online, revenues are being shown as generated by a foreign company. For example payments for Google ad services in India are made to the Irish subsidiary. This means that the revenues which are generated in India go to Ireland.

What is Double Irish and Dutch Sandwich

The Double Irish arrangement is a tax avoidance strategy that U.S.-based multinational corporations use to lower their corporate tax liability. The idea is to use payments between related entities in a corporate structure to shift income from a higher-tax country to a lower-tax country. It relies on the fact that Irish tax law does not include U.S. transfer pricing rules.

Source : Wikipedia

Major companies known to employ the Double Irish strategy are Apple and Google.

Dutch , Swiss and Luxembourg Sandwich

The addition of a Dutch Sandwich to the Double Irish scheme further reduces tax liabilities. Ireland does not levy withholding tax on certain receipts from European Union member states. Revenues from income of sales of the products shipped by the second Irish company are first booked by a shell company in the Netherlands, taking advantage of generous tax laws there. Funds needed for production costs incurred in Ireland are transferred there, the remaining profits are transferred to the first Irish company in the Cayman Islands or Bermuda. If the two Irish holding companies are thought of as “bread” and the Netherlands company as “cheese,” this scheme is referred to as the “Dutch Sandwich.”. The Irish authorities never see the full revenues and hence cannot tax them, even at the low Irish corporate tax rates. There are equivalent Luxembourgish and Swiss sandwiches.

Source : Wikipedia

Legal but Unethical Practice won’t continue for long

MNCs have escaped paying their due taxes for a long time using legal but unethical means. But when the global budges are stretched and each dollar matters, these companies will face a huge backlash if they don’t pay their share of taxes. The French government has already forced Google to give concessions on the taxes it should pay. Starbucks has paid 10 million pounds as consumer activists protested against its unethical tax treatment.

Google is not getting it

The companies are not understanding the depth of anger and frustration amongst citizens where they don’t have expensive accountants and lawyers to funnel away profits to Bermuda. Nobody in the right mind would believe that a Bermuda operation of a company can generate $10 billion in revenues. It is a legal shenanigan plain and simple unless companies start voluntarily mending their practices, they will be involuntarily be forced to do so.

Schmidt Living in an Insulated Bubble (like the rest of 1%)?

“We pay lots of taxes; we pay them in the legally prescribed ways,” he told Bloomberg. “I am very proud of the structure that we set up. We did it based on the incentives that the governments offered us to operate. It’s called capitalism,” he said. “We are proudly capitalistic. I’m not confused about this.”

Summary

While MNCs have been adept in playing one government against another through competition in lowering of corporate taxes, the game can’t be continued for much longer. While Schmidt and others may gloat about their tax avoidance as capitalism, they are failing to read the public anger. Capitalism is not about using your scale and size to gain an unjustified advantage. If that was the case, we would have monopolies and cartels ruling every facet of consumer life and Google would have long before its ascent been swallowed or beaten to pulp by Microsoft.