08 Feb

How the US Congress Hands US Corporate Taxes To Europe

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How the US Congress Hands US Corporate Taxes To Europe

  • Jeffrey SachsDirector, Earth Institute at Columbia University

  • The O’Leary: Incredible.

Hans Neleman via Getty Images

The American Congress is so incompetent that it is arbitrarily handing billions of dollars of U.S. tax revenues to Europe. The issue involves tax manipulation by America’s top IT and pharmaceutical companies, including Google, Apple, Amazon, Microsoft, Gilead and others. These companies should be paying U.S. taxes that instead are increasingly being collected by European countries thanks to Congressional (and IRS) gross negligence.

The issue is simple and yet hopelessly muddled in U.S. tax policy. Tech companies engage in R&D. When successful, they sell products at prices far above marginal cost. Indeed, sometimes the marginal cost of their products is zero. Their profits are a kind of rent or return on intellectual property (IP).

When Google or Apple or Amazon or Gilead earns international profits, the profits are the returns to prior R&D. That R&D was undertaken in the United States, or almost all of it was. The stream of earnings, therefore, is properly viewed to be the return to intellectual property that should reside in, and be taxed in, the United States.

“The American Congress is so incompetent that it is arbitrarily handing billions of dollars of U.S. tax revenues to Europe.”

Yet here is the absurdity of the present-day U.S. corporate tax system. The Congress and IRS have allowed the U.S. companies to relocate their intellectual property abroad through arcane and non-transparent accounting maneuvers, typically to some combination of Ireland, Caribbean tax havens such as Bermuda and the Cayman Islands, the Netherlands, Luxembourg, and other tax and secrecy havens. It is only by this absurd accounting fiction that Google’s IP (initially funded by the National Science Foundation, no less) is actually claimed by the company to reside in Bermuda, out of the reach of the IRS.

The deal works like this. With the IP artificially relocated to an offshore tax haven, for example Ireland, profits booked in a foreign country (say, Google sales in Sweden) are easily shifted back to Ireland, where they might face a sweetheart-deal secret tax rate as low as 1 percent or even zero. Indeed the Irish profits might be shifted further onward to Bermuda, for example, where tax rates are zero.

The way the shifting works is that the international branch of Google that books, say, $100 million in profits in Sweden pays an “IP royalty” back to an Irish-based subsidiary of Google. There are, then, no profits in Sweden (since the gross revenues in Sweden are offset by the royalty payments) and the $100 million in royalty payments are booked in Ireland. In some cases, the ultimate IP is located in Caribbean tax havens, so the Irish branch or subsidiary in turn pays a royalty to the Google subsidiary in Bermuda, or for other tech companies, in the Cayman Islands and other Caribbean tax havens.

If all of Google’s overseas subsidiaries and branches were consolidated into one corporate account, and all the company’s profits worldwide earned on U.S. intellectual property were consolidated into one bottom line for the purpose of calculating U.S. taxes, the shuffling of profits wouldn’t matter. Google’s $100 million in earnings in Sweden would hit the US bottom line anyway, where it belongs. But in fact, the opposite is the case: the un-repatriated “foreign earnings” of U.S. companies are tax deferred under the U.S. tax code, so the $100 million in profits is untaxed by the IRS as long as the profits are not returned to the U.S. American companies are reportedly sitting on more than $2 trillion of accumulated profits that they’ve booked abroad in this manner to avoid U.S. corporate taxes.

Of course, the so-called “foreign earnings” of Google or Gilead or other tech companies are not really foreign earnings at all in a true economic sense. They are the profits on U.S. exports of U.S.-developed intellectual property. To the extent that the profits result from factories and employees abroad, that would be another matter, but that accounts for little of the actual foreign sales.

“In their interest to garner favor with U.S. companies (mainly in search of campaign funds), the U.S. Congress has allowed these companies to escape U.S. corporate taxes…”

The present case of Gilead is even more absurd. The company owns the patent on blockbuster drug Sofosbuvir, the cure for Hepatitis C. The company bought the drug from the drug developer Pharmasett, which did all of its R&D in the United States. Yet the intellectual property on Sofosbuvir is claimed by Gilead to be in Ireland for tax purposes. When Gilead fleeces the U.S. government by charging $1,000 for a pill that costs $1 to manufacture, and the money is paid by the U.S. government to pay for treatment of a U.S. citizen in the U.S., Gilead has the chutzpah to book the U.S. profits in Ireland. And they get away with it.

You can’t make this stuff up.

But here’s the further twist. The European Governments are seeing how the U.S. companies are getting off without paying taxes. So now the European tax authorities are stepping forward to collect taxes on the profits earned by U.S. tech companies in Europe. And the companies are indeed settling with the European tax authorities for billions of dollars in tax payments — taxes that should be paid, not to Europe, but to the U.S. Treasury.

As I said, you can’t make this stuff up.

So the bottom line is as follows. In their interest to garner favor with U.S. companies (mainly in search of campaign funds), the U.S. Congress has allowed these companies to escape U.S. corporate taxes by magically declaring that their IP is located in some foreign tax haven. Yet instead of the money remaining with the U.S. companies, as Congress intended, it is increasingly going into the European tax coffers.

Before all is lost, the solution is to end the scam of allowing U.S. tech companies to arbitrarily put their IP wherever its suits their tax preferences. The IP belongs in the U.S., where it was developed. The taxes on the profits earned on foreign sales of the IP also belong in the U.S. The simple application of these principles would likely save the U.S. Treasury, and thereby the American people, tens of billions of dollars per year.

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