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Double Irish-Dutch Tax Sandwich (Part 2 of 2)

Jul.1,2012

Animated Example

Here is an example of how the Double Irish-Dutch Sandwich exploits these loopholes (note: enlarge illustration to click through slide show):

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A U.S. company licenses Ecommerce merchandise (downloadable books, music, apps)¹ to an Irish subsidiary (IP Holder) with its managers located in a tax haven, thus shifting IP Holder’s tax residence to the tax haven.
IP Holder then licenses the rights to sell the merchandise to a Dutch company (Dutch), wholly-owned by IP Holder.
Dutch then sub-licenses the rights to sell the merchandise to Irish another wholly-owned subsidiary of IP Holder (IP Seller) with a tax residence and employees located in Ireland.
IP Seller then sells the merchandise in every country except the U.S. IP.
Seller receives revenues nominally taxable in Ireland, but then pays almost all the revenue to Dutch as tax-deductible royalty payments. The small profit remaining is taxed by Ireland at 12.5%. Because the royalty payment was made to the Dutch subsidiary, located in the Netherlands and a country within the EEC, there is no withholding tax imposed by Ireland.
The Netherlands imposes a miniscule fee on the royalty income, and the income is then transferred to IP Holder in Bermuda (or other tax haven). Generally, the tax amount is negotiated with the Netherlands tax authorities.
The profits are received in Bermuda, a tax-haven that imposes no income tax. The funds can be reinvested and grow tax-free, and will not be taxed by the U.S. until the money is actually sent back to the U.S. parent company.
Often, the tax-haven company will have the legal status of an unlimited liability company, which means that the Irish companies are not required to disclose financial information, thereby shrouding their operations in secrecy, even though the company is incorporated in Ireland.
The U.S. parent corporation generally treats its Irish subsidiary as a “disregarded entity” for U.S. tax purposes, so the Double Irish-Dutch Tax Sandwich is not visible on the U.S. parent’s tax return. As a result of this technique, hoards of cash sit offshore to the dismay of shareholders who want the funds distributed as dividends.

Of course, the big loser is the U.S. Treasury, because this artificial set of transactions robs it of billions in tax revenues.

Conclusion

Multinational corporations are successfully diverting billions of dollars into off-shore tax havens through gambits like the Double-Dutch Irish Tax Sandwich, and by doing so, robbing the Treasury of much-needed tax revenues.

Now there is talk that the corporations may be willing to repatriate the funds, provided they receive a special tax rate of 5% (instead of the 35% corporate tax rate). Highway robbery? –you be the judge.

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1. This initial transfer is a taxable sale by the parent to the subsidiary under U.S. law, but the transfer invariably occurs before the parent becomes a public corporation, when its value is a fraction of the post-IPO valuation. Often, the parent capitalizes the subsidiary with the funds needed to pay back the parent.

There is usually a cost-sharing arrangement between the parent and subsidiary for future expenditures which effectively reduces the taxes paid by each party on income generated by the transfer of IP by 50% to 80%. Thus, for a minimal on-going cost, parent transfers the Ecommerce IP to its subsidiary, which then sells the IP worldwide and pays negligible taxes on its profits.

Double Irish-Dutch Tax Sandwich (Part 1 of 2)

Jun.1,2012

Introduction

May’s newsletter described how Apple, Inc. games the U.S. tax system by using a foreign tax strategy called a “sandwich.” The Double Irish-Dutch Tax Sandwich is an international tax-planning device used by many international companies to transfer taxable income outside the United States. It is prevalent in Ecommerce because sales derive from computer downloads and the physical location of the computer can be anywhere in the world. In general, the global system of taxation is based on the seller’s physical location, so by shifting the location to a low-tax country, the seller avoids taxes. Currently, the countries of choice are Ireland and the Netherlands for the reasons described below.

Ireland

Ireland enacted several quirky laws to attract foreign companies; however, these laws have been exploited, in unintended ways, by multi-national companies to avoid the U.S. and many European tax systems. The following Irish laws are used to design the Double Irish-Dutch Tax Sandwich:

Irish taxes corporate profits at 12.5%, less than half of the tax rate in the U.S. and many European economies.
Under international law, a corporation is a tax resident of the county where it incorporates; however, under Irish law, a corporation is a tax resident where its managers reside. Thus, a company can incorporate and operate in Ireland, but if its management is located in a tax haven, such as Bermuda, the company is considered a resident of Bermuda for Irish tax purposes.¹
Income earned in Ireland, but paid to a company in another country is subject to Irish withholding taxes of 20%, however this rule is inapplicable if the company receiving payment is a European Economic Community member..
An “unlimited liability company” does not have to disclose financial information such as balance sheets or income statements.

Netherlands

The Netherlands extracts a nominal tax on the royalty income, essentially a fee for using the Dutch tax system in this manner. In fact, the Rolling Stones and U2 have shifted their world-wide business operations to the Netherlands to exploit this loophole.

See my newsletter “Tax Haven for Rock Stars.”

End of Part 1

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¹ The U.S. tax system treats the company as Irish, because it was incorporated there. This disconnect between taxing systems is exploited by the multi-nationals to avoid taxes in both jurisdictions.

How Apple Games the Tax System

May.1,2012

Apple Inc. is aggressively manipulating the U.S. and California tax systems with questionable tax strategies and saving billions in the process. Ironically, large Silicon Valley companies pride themselves in gaming the tax system, even though government facilities and colleges their employees attend are crumbling from a lack of tax revenues.

Introduction

Apple Inc. is aggressively manipulating the U.S. and California tax systems with questionable tax strategies and saving billions in the process.

Ironically, large Silicon Valley companies pride themselves in gaming the tax system, even though government facilities and colleges their employees attend are crumbling from a lack of tax revenues.

Gaming the System

Because high tech companies deal with electronic assets that can be sold anywhere in the world, many form subsidiaries in tax havens (countries that have no income tax) to conduct their computer-generated sales.

Example: If Apple sells an ITune or IPad app in California, the sale produces federal and California gross revenue. If the same song or app is sold through an offshore tax haven country, no federal or California revenue is generated and Apple is not taxed on the income until it is transferred to the U.S.

Tax Strategy

Apple devised a complex tax strategy to place income offshore. Basically, it transfers electronic assets (IPad apps, or ITunes) to a subsidiary located in a tax haven. The subsidiary then sells the item to customers outside the U.S. and collects the revenue. As long as the revenue remains offshore, there is no U.S. or state tax due.

Note: Many other U.S.-based multinational corporations use these strategies to park billions, if not trillions of taxable income offshore.

Sandwich

The following is referred to as a “Irish-Dutch Sandwich” because it involves two countries:

1. IP is transferred from the U.S. parent to an Irish subsidiary, managed by individuals residing in a tax haven country (Cayman or British Virgin Islands). Sales occur in Ireland, but the proceeds are transferred tax-free to the tax haven. Due to a quirk in Irish law, company is not taxed because the manager reside in another country.
2. Usually, overseas profits are diverted to the Netherlands (the Dutch part of the sandwich) and then to the tax-haven.

Note: Many other U.S.-based multinational corporations use these strategies to park billions, if not trillions of taxable income offshore.

Avoiding State Taxes

Apple devised another scheme to avoid paying state taxes on U.S. investments: It simply sends profits to a subsidiary located in Nevada and the subsidiary invests the funds.

Example: Assume Apple earned $10 billion in the U.S. and paid $2.0 billion in taxes. The after-tax surplus is then moved to a Nevada subsidiary for investment. Assume $8.0 billion is invested in a publicly-traded company and two years later, the investment is sold for $10 billion.

Apple has a $2.0 billion gain for federal tax purposes. But it pays no state income tax because Nevada does not tax income. Had the funds been invested by the California company, Apple would owe approximately 9% in taxes or close to $180 million.

Conclusion

By forming shell subsidiaries that serve no real business or economic purpose, Apple avoids paying taxes on its overseas income, even though it is headquartered and has employees, plant and equipment, and conducts research and development in California.

Apple also avoids paying state taxes by investing its surplus through a Nevada subsidiary, since Nevada does not tax income or gains.