A tax break is lost, another is found

Grand Cayman subsidiary

Among those seizing that opportunity was Medtronic. The corporation has grown from a medical repair shop founded by a Minneapolis engineer in his garage into the world’s biggest maker of heart-rhythm equipment. It makes an array of other devices, including spinal technologies and insulin-delivery systems.

Personal Post

Dozens of pharmaceutical and medical-device makers that flocked to Puerto Rico, attracted by the various tax benefits. Medtronic opened its first factory in 1974 and expanded twice after that.

In August 2001 — about four years before the tax credit would disappear for good — Medtronic established a subsidiary in Grand Cayman, listing an address at an office now used by Intertrust Group, a corporate-services provider that helps firms establish shell subsidiaries in tax havens.

On paper, Medtronic transferred ownership of its Puerto Rican assets to this new Cayman unit, called Medtronic Puerto Rico Operations. The Cayman subsidiary is owned by a Dutch arm, which is in turn owned by a Swiss subsidiary, court filings show. In 2006, Medtronic transferred some of the Dutch company’s assets to the unit in Zug, Switzerland, a popular destination for companies seeking Swiss tax holidays.

The Cayman entity also entered into an arrangement to pay royalties to the U.S. parent to use intellectual property and other rights covering devices it manufactures in Puerto Rico and then sells back into the United States. The IRS contends that Medtronic’s Cayman unit underpaid for those rights, court papers show, shifting offshore income from U.S. sales. Taxes on such offshore profits are typically deferred indefinitely until the companies bring the earnings back to the United States.

Medtronic’s tax rate has plummeted. In 1995, the year before congress abolished the Puerto Rico credit, the break cut 4.2 percentage points off the company’s effective tax rate, helping to lower it to 33.5 percent. By 2011, Medtronic’s tax rate was down to half that. Overall, the savings from the low-taxed overseas income boosted Medtronic’s net income in fiscal 2011 by 30 percent, to $3.1 billion, based on tax disclosures in the company’s most recent annual report.

The company has benefited from a “tax incentive grant” in Puerto Rico, according to the annual report, but does not disclose that rate. Owning its Puerto Rican assets through a Cayman shell company lets Medtronic move cash around the world without being subject to a Puerto Rican withholding tax, according to two people familiar with such structures.

As Shay put it, “The government underestimated how sophisticated and aggressive multinationals would be in shifting truckloads of profits out of the U.S.”