The IMF (International Monetary Fund) says that so many companies exploit complex avoidance schemes, and so many countries offer devices that make them possible, that examples are invidious. Nonetheless, the “Double Irish Dutch Sandwich,” an avoidance scheme popularly associated with Google, gives a useful flavour of the practical complexities.
- Here’s how it works (Figure 5.1 above): Multinational Firm X, headquartered in the United States, has an opportunity to make profit in (say) the United Kingdom from a product that it can for the most part deliver remotely. But the tax rate in the United Kingdom is fairly high. So . . .
- It sells the product directly from Ireland through Firm B, with a United Kingdom firm Y providing services to customers and being reimbursed on a cost basis by B. This leaves little taxable profit in the United Kingdom.
Now the multinational’s problem is to get taxable profit out of Ireland and into a still-lower-tax jurisdiction.
- For this, the first step is to transfer the patent from which the value of the service is derived to Firm H in (say) Bermuda, where the tax rate is zero. This transfer of intellectual property is made at an early stage in development, when its value is very low (so that no taxable gain arises in the United States).
- Two problems must be overcome in getting the money from B to H. First, the United States might use its CFC rules to bring H immediately into tax*.
- To avoid this, another company, A, is created in Ireland, managed by H, and headquarters “checks the box” on A and B for U.S. tax purposes. This means that, if properly arranged, the United States will treat A and B as a single Irish company, not subject to CFC (controlled foreign corporation)rules, while Ireland will treat A as resident in Bermuda, so that it will pay no corporation tax. The next problem is to get the money from B to H, while avoiding paying cross-border withholding taxes. This is fixed by setting up a conduit company S in the Netherlands: payments from B to S and from S to A benefit from the absence of withholding on nonportfolio payments between EU companies, and those from A to H benefit from the absence of withholding under domestic Dutch law.
This clever arrangement combines several of the tricks of the trade: direct sales, contract production, treaty shopping, hybrid mismatch, and transfer pricing rules.
*The United States will charge tax when the money is paid as dividends to the parent—but that can be delayed by simply not paying any such dividends. At present, one estimate (cited in Kleinbard, 2013) is that nearly US$2tn is left overseas by US companies.
The IMF says that assessing how much revenue is at stake is hard. For the United States (where the issue has been most closely studied), an upper estimate of the loss from tax planning by multinationals is about US$60 billion each year - - about one-quarter of all revenue from the corporate income tax (Gravelle, 2013). In some cases, the revenue at stake is very substantial: IMF technical assistance has come across cases in developing countries in which revenue lost through such devices is about 20% of all tax revenue.
Fiscal Monitor report, Oct 2013 [pdf]
Top 5 US tech firms held $515bn in cash at end June 2013 - - over $100bn of Apple's $147bn cash hoard is estimated to be 'overseas' (even though part of it is in banks in the US, according to the US Senate Permanent Subcommitte on Investigations last May)
US company profits per Irish employee at $970,000; Tax paid in Ireland at $25,000
Google's Irish-Dutch sandwich grew to €8.8bn in 2012
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