washingtonpost.com
Google slashes overseas tax rate through 'Double Irish' and 'Dutch Sandwich' strategy

By Jesse Drucker
Saturday, October 30, 2010; 9:10 PM

NEW YORK - By employing strategies known to lawyers as the "Double Irish" and the "Dutch Sandwich," Google cut its taxes by $3.1 billion in the past three years - moving most of its foreign profit through Ireland and the Netherlands to Bermuda.

Google's income shifting helped reduce its overseas tax rate to 2.4 percent, the lowest of the top five U.S. technology companies by market capitalization, according to regulatory filings in six countries.

"It's remarkable that Google's effective rate is that low," said Martin Sullivan, a tax economist with Tax Analysts. "We know this company operates throughout the world mostly in high-tax countries where the average corporate rate is well over 20 percent."

The U.S. corporate income-tax rate is 35 percent. In Britain, Google's second-biggest market by revenue, it's 28 percent.

Google, the owner of the world's most popular search engine, uses a strategy that has gained favor among such companies as Facebook and Microsoft. The method takes advantage of Irish tax law to legally shuttle profit into and out of subsidiaries there, largely escaping the country's 12.5 percent income tax.

The earnings wind up in island havens that levy no corporate income taxes at all. Companies that use the Double Irish arrangement avoid taxes at home and abroad as the U.S. government struggles to close a projected $1.4 trillion budget gap and European Union countries face a collective projected deficit of 868 billion euros, or $1.2 trillion.

"Google paid more than $1.5 billion in U.S. income taxes in 2009, and we expect that number to be even higher in 2010," said Tom Hutchinson, director of global tax for Google, based in Mountain View, Calif. "We have an obligation to our shareholders to set up a tax efficient structure, and our present structure is compliant with the tax rules in all the countries where we operate."

Google, the third-largest U.S. technology company by market capitalization, hasn't been accused of breaking tax laws.

Facebook, the world's biggest social network, is preparing a structure similar to Google's that will send earnings from Ireland to the Cayman Islands, according to company filings. A company spokesman declined to comment.

The tactics of Google and Facebook depend on "transfer pricing," paper transactions among corporate subsidiaries that allow for allocating income to tax havens while attributing expenses to higher-tax countries. Such income shifting costs the government as much as $60 billion in annual revenue, according to Kimberly Clausing, an economics professor at Reed College.

Rep. Dave Camp (R-Mich.) the ranking Republican on the House Ways and Means Committee, and other politicians say the 35 percent U.S. statutory rate is too high relative to foreign countries. Income-shifting, which helped cut Google's overall effective tax rate to 22.2 percent last year, shows one way that loopholes undermine that top U.S. rate.

Two thousand U.S. companies paid a median effective cash rate of 28.3 percent in federal, state and foreign income taxes in a 2005 study by academics at the University of Michigan and the University of North Carolina. The combined national-local statutory rate is 34.4 percent in France, 30.2 percent in Germany and 39.5 percent in Japan, according to the Paris-based Organization for Economic Cooperation and Development.

Minimizing costs

As a strategy for limiting taxes, the Double Irish method is "very common at the moment, particularly with companies with intellectual property," said Richard Murphy, director of Britain-based Tax Research.

The corporate tax rate in the United States motivates companies to move activities and related income to lower-tax countries, said Irving Plotkin of PricewaterhouseCoopers. He delivered a presentation in Washington this year titled "Transfer Pricing is Not a Four Letter Word."

"A company's obligation to its shareholders is to try to minimize its taxes and all costs, but to do so legally," Plotkin said.

Google's transfer pricing contributed to international tax benefits that boosted its earnings by 26 percent last year, company filings show. Based on a rough analysis, if the company paid taxes at the 35 percent rate on all its earnings, its share price might be reduced by about $100, said Clayton Moran, an analyst at Benchmark in Boca Raton, Fla.

The company, which tells employees "don't be evil" in its code of conduct, has cut its effective tax rate abroad more than its peers in the technology sector: Apple, the maker of the iPhone; Microsoft, the largest software company; IBM, the biggest computer-services provider; and Oracle, the second-biggest software company. Those companies reported rates of 4.5 percent to 25.8 percent for 2007 through 2009.

Google is "flying a banner of doing no evil, and then they're perpetrating evil under our noses," said Abraham Briloff, a professor emeritus of accounting at Baruch College in New York who has examined Google's tax disclosures.

Google's annual reports from 2007 to 2009 ascribe a cumulative $3.1 billion tax savings to the "foreign rate differential." Such entries typically describe how much tax U.S. companies save from profit earned overseas.

In February, the Obama administration proposed measures to curb shifting profit offshore, part of a package intended to raise $12 billion a year over the coming decade. While the key proposals largely haven't advanced in Congress, the IRS said in April it would devote additional agents and lawyers to focus on five large transfer pricing arrangements.

Income shifting commonly begins when companies such as Google sell or license the foreign rights to intellectual property developed in the United States to a subsidiary in a low-tax country. That means foreign profits based on the technology get attributed to the offshore unit, not the parent. Under U.S. tax rules, subsidiaries must pay "arm's length" prices for the rights - or the amount an unrelated company would.

Because the payments contribute to taxable income, the parent company has an incentive to set them as low as possible. Cutting the foreign subsidiary's expenses effectively shifts profits overseas.

Consent from IRS

After three years of negotiations, Google received approval from the IRS in 2006 for its transfer pricing arrangement, according to filings with the Securities and Exchange Commission.

The IRS gave its consent in a secret pact known as an advanced pricing agreement. Google wouldn't discuss the price set under the arrangement, which licensed the rights to its search and advertising technology and other intangible property for Europe, the Middle East and Africa to a unit called Google Ireland Holdings, according to a source familiar with the matter.

That licensee in turn owns Google Ireland Ltd., which employs almost 2,000 people in a silvery glass office building in central Dublin, a block from the city's Grand Canal. The Dublin subsidiary sells advertising worldwide and was credited by Google with 88 percent of its $12.5 billion in non-U.S. sales in 2009.

Allocating the revenue to Ireland helps Google avoid income taxes in the United States, where most of its technology was developed. The arrangement also reduces the company's liabilities in relatively high-tax European countries where many of its customers are located.

The profits don't stay with the Dublin subsidiary, which reported pretax income of less than 1 percent of sales in 2008, according to Irish records. That's largely because it paid $5.4 billion in royalties to Google Ireland Holdings, which has its "effective centre of management" in Bermuda, according to company filings.

This Bermuda-managed entity is owned by a pair of Google subsidiaries that list as their directors two attorneys and a manager at Conyers Dill & Pearman, a Hamilton, Bermuda law firm.

A Double Irish

Tax planners call such an arrangement a Double Irish because it relies on two Irish companies. One pays royalties to use intellectual property, generating expenses that reduce Irish taxable income. The second collects the royalties in a tax haven such as Bermuda, avoiding Irish taxes.

To steer clear of an Irish withholding tax, payments from Google's Dublin unit don't go directly to Bermuda. A brief detour to the Netherlands avoids that liability, because Irish tax law exempts certain royalties to companies in other EU- member nations. The fees first go to a Dutch unit, Google Netherlands Holdings, which pays out about 99.8 percent of what it collects to the Bermuda entity, company filings show. The Amsterdam-based subsidiary lists no employees.

Inserting the Netherlands stopover between two other units gives rise to the "Dutch Sandwich" nickname.

Microsoft, based in Redmond, Wash., has also used a Double Irish structure, according to company filings overseas.

Since the 1960s, Ireland has pursued a strategy of offering tax incentives to attract multinationals. A lesser-appreciated aspect of Ireland's appeal is that it allows companies to shift income out of the country with minimal tax consequences, said Jim Stewart, a senior lecturer in finance at Trinity College in Dublin.

"You accumulate profits within Ireland, but then you get them out of the country relatively easily," Stewart said. "And you do it by using Bermuda."

Once Google's non-U.S. profits hit Bermuda, they become difficult to track. The subsidiary managed there changed its legal form of organization in 2006 to become an unlimited liability company. Under Irish rules, that means it's not required to disclose such financial information as income statements or balance sheets.

"Sticking an unlimited company in the group structure has become more common in Ireland, largely to prevent disclosure," Stewart said.

Taxes deferred

Technically, multinationals that shift profits overseas are deferring U.S. income taxes, not avoiding them permanently. The deferral lasts until companies decide to bring the earnings back to the United States. In practice, they rarely repatriate significant portions, thus avoiding the taxes indefinitely, said Michelle Hanlon, an accounting professor at MIT.

In 2009, Treasury proposed levying taxes on certain payments between U.S. companies' foreign subsidiaries.

Treasury officials, who estimated the policy change would raise $86.5 billion in new revenue over the next decade, dropped it after Congress and Treasury were lobbied by companies, including General Electric, Johnson & Johnson and Starbucks, according to federal disclosures compiled by the nonprofit Center for Responsive Politics.

Bloomberg News

Post a Comment


Comments that include profanity or personal attacks or other inappropriate comments or material will be removed from the site. Additionally, entries that are unsigned or contain "signatures" by someone other than the actual author will be removed. Finally, we will take steps to block users who violate any of our posting standards, terms of use or privacy policies or any other policies governing this site. Please review the full rules governing commentaries and discussions. You are fully responsible for the content that you post.

© 2010 The Washington Post Company