We have been hearing how the US giants have been avoiding taxes (all legal means) for a while now. I, for one being curious, thought of finding what it is that these companies do, or how they avoid paying taxes. I found out these companies (I would rather say the US tech giants) use mostly a combination of two methods: the “The Irish Double” and “The Dutch Sandwich” to dodge taxes. Now before explaining this topics and what it is it, I would like to explain some basics like what is a tax haven and a little bit of history of these tax havens before we come back to the main topic. For the newbie, who are reading this topic for the first time – don’t worry, it is wiki stuff. Pros can directly jump ahead.
A tax haven is a state, country or territory, where certain taxes are levied at a low rate or not at all. According to ‘The Economist’: “What … identifies an area as a tax haven is the existence of a composite tax structure established deliberately to take advantage of, and exploit, a worldwide demand for opportunities to engage in tax avoidance.” Tax Justice Network in 2012 in a report estimated that between USD $21 trillion and $32 trillion is sheltered from taxes in unreported tax havens worldwide. If such wealth earns 3% annually and such capital gains were taxed at 30%, it would generate between $190 billion and $280 billion in tax revenues.
A 2006 academic paper indicated that: “in 1999, 59% of U.S. firms with significant foreign operations had affiliates in tax haven countries”. A January 2009 U.S. Government Accountability Office (GAO) report said that the GAO had determined that 83 of the 100 largest U.S. publicly traded corporations and 63 of the 100 largest contractors for the U.S. federal government were maintaining subsidiaries in countries generally considered havens for avoiding taxes.
Most economists suggest that the first “true” tax haven was Switzerland, followed closely by Liechtenstein. Swiss banks had long been a capital haven for people fleeing social upheaval in Russia, Germany, South America and elsewhere. In the early part of the twentieth century, in the years immediately following World War I, many European governments raised taxes sharply to help pay for reconstruction efforts following the devastation of World War I. By and large, Switzerland, having remained neutral during the Great War, avoided these additional infrastructure costs and was consequently able to maintain a low level of taxes. As a result, there was a considerable influx of capital into the country for tax related reasons.
There are several reasons for a nation to become a tax haven. Some nations may find they do not need to charge as much as some industrialized countries in order for them to be earning sufficient income for their annual budgets. Some may offer a lower tax rate to larger corporations, in exchange for the companies locating a division of their parent company in the host country and employing some of the local population. Other domiciles find this is a way to encourage conglomerates from industrialized nations to transfer needed skills to the local population. Still yet, some countries simply find it costly to compete in many other sectors with industrialized nations and have found a low tax rate mixed with a little self-promotion can go a long way to attracting foreign companies.
Now focusing on the topic at hand, much of the economic activity in tax havens today consists of professional financial services such as mutual funds, banking, life insurance and pensions. Generally the funds are deposited with the intermediary in the low-tax jurisdiction, and the intermediary then on-lends or invests the money (often back into a high-tax jurisdiction). Although such systems do not normally avoid tax in the principal customer’s jurisdiction, it enables financial service providers to provide multi-jurisdictional products without adding an additional layer of taxation. This has proved particularly successful in the area of offshore funds.
This type of methodology has been used by Google and came to light in the year 2010 when it was reported that Google uses techniques called the “Double Irish” and “Dutch Sandwich” to reduce its corporate income tax to 2.4%, by funneling its corporate income through Ireland and from there to a shell in the Netherlands where it can be transferred to Bermuda, which has no corporate income tax. The search engine is using Ireland as a conduit for revenues that end up being cost to another country where its intellectual property (the brand and technology such as Google’s algorithms) is registered. In Google’s case this country is Bermuda. In the year 2009, the internet giant made a gross profit of €5.5bn, but reported an operating profit of €45m after “administrative expenses” of €5.467bn were stripped out. Administrative expenses largely refer to royalties (or a license fee) Google pays it Bermuda HQ for the right to operate. Google has uncovered a highly efficient tax structure across six territories that meant Google paid just 2.4% tax on operations outside the US. In December 2012, Google was found to have moved $10 billion from Ireland via the Netherlands to Bermuda—avoiding huge sums of taxes in Ireland, the Netherlands, and its real home country, the United States. At a November 2012 hearing, members of Parliament quizzed executives from Google and Starbucks Corp. about their use of Netherlands subsidiaries to cut taxes.
Now, what is this “Double Irish”?
Double Irish arrangement relies on the fact that Irish tax law does not include U.S. transfer pricing rules. Specifically, Ireland uses territorial taxation, and hence does not levy taxes on income booked at subsidiaries of Irish companies that are outside of Ireland proper, typically in current or former British Overseas Territories.
It is called “double Irish” because it requires two Irish companies to complete the structure. The first Irish company is the offshore company which owns the valuable non U.S. rights. This company is tax resident in a tax haven, such as the Cayman Islands or Bermuda. Irish tax law provides that a company is tax resident where its central management and control is located, not where it is incorporated, so that it is possible for the first Irish company not to be tax resident in Ireland. The first Irish company licenses the rights to a second Irish company, which is tax resident in Ireland, in return for substantial royalties or other fees. The second Irish company receives income from exploitation of the asset in countries outside the U.S., but it is taxable profits are low because the royalties or fees paid to the first Irish company are deductible expenses. The remaining profits are taxed at the Irish rate of 12.5%.
For companies whose ultimate ownership is located in the United States, the payments between the two related Irish companies might be non-tax-deferrable and subject to current taxation as Subpart F income under the Internal Revenue Service’s Controlled Foreign Corporation regulations if the structure is not set up properly. This is avoided by organizing the second Irish company as a fully owned subsidiary of the first Irish company resident in the tax haven, and then making an entity classification election for the second Irish company to be disregarded as a separate entity from its owner, the first Irish company. The payments between the two Irish companies are then ignored for U.S. tax purposes (Heavy Stuff!!!). To understand properly go to the end and you can read the pdf at the link given.
Major companies known to employ the double Irish strategy are:
Eli Lilly and Company
And, what is “The Dutch 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 Netherland’s 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.
Let’s take Google’s example. In Bermuda there’s no corporate income tax at all. Google’s profits travel to the island’s white sands via a convoluted route known to tax lawyers as the “Double Irish” and the “Dutch Sandwich.” It generally works like this: When a company in Europe, the Middle East or Africa purchases a search ad through Google, it sends the money to Google Ireland. The Irish government taxes corporate profits at 12.5 percent, but Google mostly escapes that tax because its earnings don’t stay in the Dublin office.
Irish law makes it difficult for Google to send the money directly to Bermuda without incurring a large tax hit, so the payment makes a brief detour through the Netherlands, since Ireland doesn’t tax certain payments to companies in other European Union states. Once the money is in the Netherlands, Google can take advantage of generous Dutch tax laws. Its subsidiary there, Google Netherlands Holdings, is just a shell (it has no employees) and passes on about 99.8 percent of what it collects to Bermuda. (The subsidiary managed in Bermuda is technically an Irish company, hence the “Double Irish” nickname.)
In recent years, governments have become increasingly aware of the fact that lots of major corporations—notably tech companies including Apple, Google, Yahoo, Dell, and many others—are using this shady, albeit legal, techniques to shift income in ways that drastically minimize a company’s tax burden. Attracted by the Netherlands’ lenient policies and extensive network of tax treaties, companies such as Yahoo, Google Inc. (GOOG), Merck & Co. and Dell Inc. have moved profits through the country. Using techniques with nicknames such as the “Dutch Sandwich,” multinational companies routed 10.2 trillion Euros in 2010 through 14,300 Dutch “special financial units,” according to the Dutch Central Bank. Such units often only exist on paper, as is allowed by law.
By routing profits through the Netherlands en route to island havens, companies receive an important benefit: They generally don’t have to pay taxes on payments leaving or entering the country. Technology and pharmaceutical companies often seek to reduce their tax bills by paying royalties to license patent rights from offshore subsidiaries. Such transactions could incur a cost: many developed nations impose a withholding tax — sometimes as high as 33 percent — on royalties leaving for zero-tax locales with which they don’t have tax treaties, such as Bermuda and the Cayman Islands. By contrast, the Netherlands doesn’t impose withholding taxes on royalties leaving the country, regardless of their destination. Countries often either eliminate or reduce those taxes when such payments head to a treaty partner. The extensive Dutch treaty network thus protects payments on the way into the country as well.
The Netherlands’ role in facilitating tax avoidance began in force in the late 1970s, when it started so-called advance- pricing agreements to attract multinational companies. Under such agreements, multinational companies agree to leave a tiny amount of income in the Netherlands to be taxed in exchange for being permitted to route profits through the country. This remainder left for the revenue authorities in the Netherlands is known to tax planners as “the Dutch Turn.”
Yahoo, for instance, has an agreement to pay taxes equal to about 1.35 percent of the unit’s total revenue. The benefit of the Netherlands is that the company knows all upfront. Records show that the Yahoo unit reported Dutch income taxes in 2009 of 1.28 million Euros — out of the 101.5 million Euros in royalties it funneled through the subsidiary that year. That’s a small price to pay. In return, Yahoo can move profits to virtually any destination without paying a withholding tax.
Tax avoidance has fostered a sizable industry in the Netherlands of so-called trust firms, generating about 1 billion Euros in annual tax revenues and about 3,500 jobs, according to a 2009 study by SEO Economic Research. Local companies such as Intertrust Group Holding SA and TMF Group set up high-priced mailboxes for multinational companies. The benefits to Holland are employment, high-level tax advisers. In December, Blackstone Group LP (BX), the New York-based private equity giant, announced it would buy one of the biggest such firms, Intert rust, for $833 million.
Merck, the maker of diabetes drug Januvia and asthma treatment Singulair, lists 54 subsidiaries in the Netherlands. From 2002 to 2010 the company routed more than 7 billion Euros in royalties, mostly from European sales, to Bermuda via an Amsterdam subsidiary called Crosswinds BV. The unit — which had no employees — was named Crosswinds to conjure the image of royalties crossing in and out “like wind blowing.” In late 2010, after Merck acquired Schering Plough Corp., it stopped using Crosswinds to route royalties. Merck cut $1.9 billion off its tax bill that year because of Schering Plough’s offshore arrangements, securities filings show.
Double Non-Taxation is to prevent companies from paying tax twice in two different countries on the same profit. Dell, however, uses the Netherlands to avoid paying income taxes in either place. The world’s third-largest personal- computer maker has avoided about $4 billion in income taxes since 2004, thanks partly to its use of a Dutch unit. The subsidiary, called Dell Global BV, paid income taxes at a rate of 1/10 of 1 percent on profits of about $2 billion in 2011, the most recent year for which records are available. That means the unit took credit for almost three quarters of Dell’s worldwide income. That subsidiary had no actual employees in the Netherlands as of 2009, filings show. The Dutch company conducts its business through a branch in Singapore (DELL), where it designs and sells laptops and other equipment for the U.S., European and Asian markets.
For tax purposes, Dell says the unit’s profit is generated in Singapore, where it obtained an income-tax holiday in 2004. Although the company pays almost no income taxes in Singapore, the Netherlands doesn’t impose any significant income taxes either because “avoidance of double taxation can be claimed with respect to the” profit earned in Singapore, according to the Dutch subsidiary’s 2011 annual report.
The U.S. Internal Revenue Service is seeking back taxes avoided through Dell’s intra-company arrangements, according to a company securities filing. Dell is contesting the IRS’s proposed assessment. While the company didn’t disclose the amount in dispute, it said an unfavorable outcome could have a “material impact” on its financial position.
Yahoo is taking advantage of the Swiss tax generosity: In late 2009, the company began shifting profits from its European sales into a small subsidiary in Rolle, Switzerland, a picturesque town 25 miles north of Geneva at the foot of the Alps. Through Yahoo! Netherlands BV, headquartered at Dooves’s suburban home, Yahoo has also routed European and Asian revenues from Web ads to a subsidiary incorporated in Ireland that claims its residency in the tax-friendly Cayman Islands, according to filings.
In 2009, for example, the Dutch unit collected 101.5 million Euros in royalties from around the world — and promptly paid out 98.7 percent of that to the Cayman subsidiary, records show. If those payments went directly from, say, Yahoo’s France sales arm to the Cayman unit, they could trigger a 33.3 percent withholding tax in France. In 2011, a Yahoo French sales subsidiary reported 66 million Euros of revenue, yet paid just 462,665 Euros in income taxes, records show.
Yahoo recently introduced another circuitous path through the Netherlands to cut the taxes on profits from its Asian sales: Royalties travel from Singapore, to another subsidiary in Mauritius, a tax-friendly island off the southeast coast of Africa. In 2011, the Dutch unit collected 110 million Euros from Asian sales, before paying royalties to the Mauritius subsidiary. On paper, the cash remains with the Dutch subsidiary, which uses it to finance operations throughout the world outside the U.S. In reality, much of it sits in a HSBC Holdings Plc bank account in London.
On January 20 2013, a Dutch parliamentary committee met to consider the fairness of its own tax system and re-evaluate its role as part of a legal financial chain that allows companies to reduce the amount of tax they pay. Last month, the European Commission recommended that EU members require in their treaties that income be subject to tax in one country before being exempt in another. That could prevent companies such as Dell from avoiding taxes in two countries simultaneously. Another EU proposal to combat tax-avoidance strategies has moved slowly through the bureaucracy since 2004. It would allocate multinational companies’ taxable profits into various countries based on factors such as actual sales or number of employees there.
Whether the EU can implement such a change, remains doubtful. Under its rules, the move requires unanimous approval from the 27 member states, including the Netherlands. Last year, representatives from the Netherlands fought at least two internal EU proposals to clamp down on tax avoidance techniques. Other European countries are competing to attract multinational companies with tax inducements. Luxembourg has imitated the Dutch system of conduit companies and advance tax rulings, and Switzerland offers long-term tax holidays and other incentives.
Sources: Wiki, Bloomberg.
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