A US Senate panel at a hearing in Washington DC on Thursday slammed Microsoft's 'tax gimmickry' at its regional centres in Ireland, Singapore and Puerto Rico, where the software giant revealed aggressive tax measures to avoid or evade billions of dollars in taxes over the past three years. Hewlett-Packard (HP) was also in the hot seat because it used cash held overseas that was subject to deferred tax. HP may have more than skirted the law but broken it.
The US corporate tax rate of 35% is levied on worldwide income but can be permanently deferred by not repatriating profits generated overseas. Today, US multinationals have stockpiled $1.7tn in earnings offshore.
In fiscal year 2011 which ended on September 30 last, the US effective corporate tax rate on domestic profits fell to 12.1% - - the lowest since 1972 and well below the 25% companies paid on average from 1987 to 2008. The low rate reflected accelerated investment writoffs that were introduced during the recession.
US corporate taxes were above 6% of GDP in the early 1950s but since the early 1980s have averaged about 2%.
Companies are lobbying for a lower headline rate and a territorial system which is used in most countries.
Last February, President Obama proposed the first major reform of the US corporate tax system in a quarter century and outlined a plan to cut the headline corporate tax rate to 28% from the current level of 35% while eliminating several loopholes that cut tax bills.
The Administration proposed that income earned by subsidiaries of US corporations operating abroad must be subject to a minimum rate of tax. It says this would "stop our tax system from generously rewarding companies for moving profits offshore. Thus, foreign income deferred in a low-tax jurisdiction would be subject to immediate US taxation up to the minimum tax rate with a foreign tax credit allowed for income taxes on that income paid to the host country. This minimum tax would be designed to balance the need to stop rewarding tax havens and to prevent a race to the bottom with the goal of keeping US companies on a level playing field with competitors when engaged in activities which, by necessity, must occur in a foreign country."
No specific tax threshold has been proposed.
The US Permanent Subcommittee on Investigations received information from Microsoft which shows transactions with subsidiaries in Ireland, Singapore, Puerto Rico and Bermuda that enabled it save at least $6.5bn in taxes. The committee also revealed that Hewlett-Packard Co. (HP) has used a series of short-term inter-company loans that allowed the company to get access to its offshore cash for domestic operations without paying taxes.
In the 2011 fiscal year, Microsoft had global revenues of $69.9 bn and earnings before tax of $28 bn. Microsoft’s global book tax rate was 17.5%. Microsoft had approximately 90,000 Microsoft employees worldwide in 2011. Based on consolidating financials (without eliminations within those groups), in FY 2011 the Irish, Singapore and Puerto Rican companies earned approximately $15.4 bn in earnings before tax (EBT), or approximately 55% of global EBT. The average effective book foreign tax rate for the Irish, Singapore and Puerto Rican companies was approximately 4% - - 5.69% in Ireland; 2.78% in Singapore and 1.03% in Puerto Rico.
So Microsoft's 1,914 employees in Ireland, Singapore and Puerto Rico from Microsoft’s total head count of 90,000, were responsible for 55% of 2011 profit before tax.
The committee said that Microsoft pools its worldwide research and development expenses, which totaled $9.1bn in FY2011. The participating entities each pay a portion of the research and development cost based on the entity’s portion of global revenues. For instance, Microsoft’s Irish operating centers account for roughly 30% of the company’s global revenue, so the Irish entities contribute 30% of the cost of research and development to the global cost share pool.
However, Microsoft Ireland Research (MIR) in Dublin only accounts for less than 1% of the company’s total R&D.
MIR has about 390 employees and its chief function is to then license rights to a wholly owned subsidiary, MIOL (Microsoft Ireland Operations Limited), which has about 660 staff in Dublin. For this role, MIR reported $4.3 bn of profits in 2011, with an effective tax rate of 7.2%. This income equates to about $11m of profit per employee. MIOL, in turn, manufactured copies of the Microsoft products and sold them to 120 distribution entities in EMEA countries, after which final sales to consumers was made. In 2011, for its role, MIOL reported profits of $2.2 bn, or about $3.3m per employee, and an effective tax rate of 7.3%. No US Subpart F tax is paid on any of the $9 bn license payment from MIOL to MIR. No US taxes are paid because, under the check-the-box regulations, MIOL was designated as a disregarded entity of MIR, meaning that license payments made by MIOL to MIR are ignored -- for tax purposes they are not considered to be payments between separate entities.
William J. Sample, corporate vice president, Worldwide Tax, Microsoft Corporation, said in testimony: "Microsoft’s tax results follow from its business, which is fundamentally a global business that requires us to operate in foreign markets in order to compete and grow. In conducting our business at home and abroad, we abide by U.S. and foreign tax laws as written. That is not to say that the rules cannot be improved--to the contrary, we believe they can and should be.
The US now has the highest corporate tax rate among OECD countries and, unlike our major trading partners, taxes the worldwide income of its domestic corporations. The US also requires worldwide American businesses to pay residual US tax when foreign subsidiary earnings are repatriated back to the US, which creates a significant tax burden for US companies, a disincentive for US investment, and compares unfavorably with 26 of the 34 OECD member countries (including recent converts Japan and the UK) that offer a permanent tax exemption for the repatriation of foreign subsidiary profits. We believe the US should reform its tax rules to support the ability of worldwide American businesses to compete in global markets and invest in the US."
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