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As someone who works in the world of corporate finance, let me give a brief "public service announcement" explaining the stunningly simple sham behind corporate taxation and tax evasion (sorry, "tax avoidance").

We continually hear that the U.S. has the highest corporate tax rate, and regularly entertain public proposals for "tax holidays" where corporations should be allowed to "repatriate" trillions of foreign profits at minimal tax rates like 5%. (BTW: I love the pseudo-patriotrism suggested by the word "repatriate.")

The thing is that we are largely taking about regular ole' U.S. profits, not "foreign profits."  Let me explain the sham simply.  

A fictional company - let's call it "Ah-pull" - sets up two wholly owned companies: Ah-pull (U.S.) and Ah-pull (Caymans).  Ah-pull (U.S.) does all the things we consumers ordinarily associate with Ah-pull: retail stores, sales and profits.  Ah-pull (Caymans), however, is a shell company set up in the low tax Cayman Islands that holds all the trademarks, etc. associated with the products sold by Ah-pull (U.S.). And at the end of the year, Ah-pull (Caymans) charges Ah-pull (U.S.) a "licensing fee" to use these trademarks which, coincidentally, amounts to close to all the profits made by Ah-pull (U.S.).   - - Get it?  This is virtually money-laundering.

After paying such licensing fees - to itself by the way; this is moving money from the left pocket to the right pocket - Ah-pull (U.S.) reports little to no (or whatever amount it decides) as income, and the rest of its profits flow to low tax Ah-pull (Caymans).  

This is a transparent sham. Explained another way:  I am a lawyer and make, let's say, a $100k this year.  But, per the above, what if I set up my own corporation in the Caymans, transferred my law license to my own Cayman corporation, and then charged myself $75k for the right to use my own law license.  Well, then, I only made $25k in the U.S. and $75k in the low-tax Caymans.  Or, maybe the next year I only want $10k in US income, so I increase the law license fee to $90k.  What a wonderful world. I can finely tune all my income and taxes.

The whole thing is an absurdly obvious tax fraud.  Yet that is what we have as a corporate tax scheme.  

Don't believe me?  

Apple, for instance, was among the first tech companies to designate overseas salespeople in high-tax countries in a manner that allowed them to sell on behalf of low-tax subsidiaries on other continents, sidestepping income taxes, according to former executives. Apple was a pioneer of an accounting technique known as the “Double Irish With a Dutch Sandwich,” which reduces taxes by routing profits through Irish subsidiaries and the Netherlands and then to the Caribbean. Today, that tactic is used by hundreds of other corporations — some of which directly imitated Apple’s methods, say accountants at those companies.  

Without such tactics, Apple’s federal tax bill in the United States most likely would have been $2.4 billion higher last year, according to a recent study by a former Treasury Department economist, Martin A. Sullivan.  http://www.nytimes.com/...

Does that sound complicated?  It isn't.  It is the simple sham of transferring intellectual property to off-shore, low-tax, shell companies, and then having those same off-shore companies "charge" the profitable, operating U.S. company with faux licensing "fees" to siphon/launder the money to these tax havens.  But all of these companies - their earnings, payments, licensing, foreign status , domestic status, whatever - are all owned and controlled by the same parent company.  Without exaggeration, it is a shell game on paper.

It is so simple and fraudulent, that it is brazen.

But here is the thing.  Currently, companies can't "square the circle."  For reasons I won't dwell on now, these companies also can't get any of this off-shore money back into the U.S. (through dividends, etc.) without hitting the U.S. corporate tax rate.  That is the "bottle neck" you frequently hear about leading to cries of "tax holidays" or "corporate tax reform."

Don't listen to these cries, or to seemingly calm apologists on the Sunday morning shows. All or most of the "off-shore money" is U.S. revenue artificially parked in a Caymans account - -  NY branch, by the way.  The money doesn't need to be "repatriated" to the U.S. because it was never made outside the U.S. in the first place.  To bring this money (held in NY, LA, Boston, Chicago, etc. bank accounts) "back into the U.S." under the guise of a "tax holiday," or some "smart, centrist policy," is no different than negotiating with Al Capone for a "tax holiday."

What I am saying is not sensational.  It is mundane.  All reasonably large corporations have been doing it for years.

But, again, here is the thing.  Under current law, they can't get the money "back into the U.S." without paying the taxes that they originally sought to evade.  It is the sole reason you hear about "tax holidays" or "repatriating foreign profits" -- even from Dems like NY Chuck Schumer. Understand that.  There are a couple of trillion dollars in untaxed U.S. profits that a lot of people are getting nervous about.  There is no reason to give them a "tax holiday" to let them pay themselves at a 5% tax.  It is a swindle.  And it is not even that complicated or creative of a swindle.    

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Comment Preferences

  •  Re your example: IIRC, royalties are subpart F ... (3+ / 0-)
    Recommended by:
    nextstep, VClib, thanatokephaloides

    Re your example: IIRC, royalties are subpart F income, and so the taxable income in your hypothetical CFC would be taxable in the US in the year earned.

    I do individual tax, and this stuff isn't something I do a lot, so please feel free to correct or clarify or whatever.

  •  Corporate taxation is broken (2+ / 0-)
    Recommended by:
    alypsee1, VClib

    It will only get more broken as time goes on.  International tax competition insures this.

    We need to move towards eventually abolishing the corporate tax (long-term) and immediately abolish the repatriation tax (short-term.)  If you think this is just me being "out there" Pikkety held an even darker view of the future of corporate tax in Capital in the 21st Century.

    The US is almost the only country in the world with a repatriation tax, and it encourages US-owned corporations to horde cash overseas, robbing the US of both capital and tax income.

    •  So we should just surrender and hand the keys... (2+ / 0-)
      Recommended by:
      terabytes, thanatokephaloides

      to the billionaire's lawyer over there. Last one to leave turn out the lights?

      'International tax competition' insures nothing of the kind. The only thing insuring that corporate taxation becomes ever more porous and broken is the worsening corruption of our elected officials.

      •  The US is the only country in the G8 who tries (4+ / 0-)

        to tax offshore earnings. Why should the US collect a tax if GM makes and sells a car in China and makes a profit?

        "let's talk about that" uid 92953

        by VClib on Tue Jul 22, 2014 at 05:56:36 PM PDT

        [ Parent ]

        •  Because GM uses roads, bridges, public education.. (3+ / 0-)

          ...and the protection of the U.S. military, all paid for by working class taxpayers, to develop its products.

          If companies like GM are taxed on domestic earnings but not on overseas earnings, what are we telling corporate America?

          That, if they're smart, they should move as much economic activity as they possibly can overseas to evade taxation.

          It's yet another way that America's working class taxpayers are being forced to subsidize the destruction of their own livelihoods, underwriting the export of their own jobs to China.

          •  The US is the only country that tries to tax those (2+ / 0-)
            Recommended by:
            johnny wurster, nextstep

            earnings. When BMW makes and sells a car in the US they pay no tax on that profit in Germany. BMW pays US federal income taxes on that profit, but then BMW can repatriate those profits to Germany and pay no additional tax. It's time for the US to enter the 21st century regarding corporate tax policy.

            GM is trying its best to sell as many cars in the US as possible, and to have their domestic car and truck business be very profitable. That's where the US federal income taxes should come from, not from sales of Buick's made and sold in China.

            "let's talk about that" uid 92953

            by VClib on Tue Jul 22, 2014 at 08:10:20 PM PDT

            [ Parent ]

  •  Your hypothetical example is fraud (2+ / 0-)
    Recommended by:
    johnny wurster, nextstep

    under the current code. The structure needs to be much more complex to escape the US tax man.

    The trillions held "off shore" will never be repatriated at 35%. Those funds can be invested anywhere in the world, except the US. How could projects in the US even compete?

    "let's talk about that" uid 92953

    by VClib on Tue Jul 22, 2014 at 05:50:12 PM PDT

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