Tax Avoidance: Intellectual Property Edition

The tech industry is innovative in more ways than one, and has found quite a tax dodge (excerpt):

Microsoft and HP rapped by US Senate over tax havens

The US Senate has criticised Microsoft and Hewlett-Packard for their use of tax avoidance schemes, which it says is rampant in the tech sector.

The Senate's Permanent Subcommittee on Investigations said the companies used places such as the Cayman Islands so they did not have to pay US taxes…

…Microsoft and HP denied any wrongdoing…

…Five of the top 10 companies with the biggest offshore cash balances are in the technology sector.

The committee said that between 2009 and 2011, Microsoft moved $21bn (£13bn) offshore, almost half its US retail sales revenue.

The panel said the moved saved it up to $4.5bn in taxes on goods sold within the US.

It also said the company moves royalty revenue to divisions in lower-tax nations, including Singapore and the Republic of Ireland…

…The panel said Hewlett-Packard funded US operations with inter-company loans, using an exception in the law for short-term loans, to avoid billions of dollars in taxes…

…The top Republican on the panel, Senator Tom Coburn, signed off the new report, but blamed Congress for the tax system that made such activities possible: "Tax avoidance is not illegal. Congress has created this situation."…

This all of a piece with trade and transfer mispricing – the motivation’s the same even if the methodology differs. More importantly, this article establishes one salient point: if there is a gain to be made, any profit maximising company – especially one with shareholder value in mind – will put in the effort up to the marginal cost of doing so.

In cases like these, where the costs involved are fairly minimal (a shell company and some lawyers fees), the game is worth the candle. Why pay 35% tax on billions of USD in income if, for a few thousand dollars you can cut the rate to 16% or below? That’s a no-brainer, especially since its also perfectly legal, if not always ethical.

To a lesser extent, the same incentives apply to transfer and trade pricing – why pay more tax, if you can legally get away with less? But since the likely gains from this route are smaller, the effort put in will also be commensurate – trade mispricing will continue as long as the reduced tax liability is greater than the cost and effort required.

This suggests that, unlike IP revenue, trade and transfer pricing abuses should be easier (though not necessarily easy) to stop, since the gains have to squeezed out of existing trade patterns rather than arbitrarily based in low-tax jurisdictions.

Of course, as always, this is easier said than done.