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Multinational Corporations: The Power of Earnings Stripping

March 31, 2008

capital1.jpgThe debate about cutting taxes for corporations and the wealthy is largely a pretense. The issue is not whether multinational corporations, bankers and the very rich benefit from tax cuts. The majority of multinational firms walk away from all taxes. A General Accounting Office report revealed that between 1996 and 2000, 61 percent of all U.S. companies paid no federal taxes.

Saving money and avoiding taxation pitfalls is a major concern of corporations, especially in the United States where taxes are professed to be higher than in most other nations. A corporation owned and organized in the United States pays federal taxes on corporate global income. A foreign corporation pays federal taxes and state taxes only on U.S. income generated. As a result, a technique known as corporate inversion is commonly employed to lower U.S. tax impact. Without a corporate inversion, all sources of income are subject to taxation in the United States.

multinational3deloitteinet1.jpgA United States corporation that undergoes a corporate inversion becomes a subsidiary of a foreign corporation or parent corporation organized in a tax haven country. This tax haven country imposes little or no tax on corporations. The new parent corporation receives income globally and pays U.S. taxes only on the United States income generated by its new U.S. subsidiary, the former United States “parent” corporation. The corporation no longer pays federal income taxes on foreign income.

Another bonus of corporate inversion is that tax-deductible payments transferred from a U.S. corporation to its foreign parent corporation create a tax-free transfer of income to the foreign parent. This legal transfer is known as “earnings stripping”. U.S. tax law attempts to limit earnings stripping, but techniques have been developed to maximize tax-free transfers. U.S. subsidiary corporations commonly pads loan funds transferred to the foreign parent company. Earnings stripping can apply to all types of transfer payments from the U.S. subsidiary to the foreign parent corporation. This includes research and development, labor expenses, licensing, and royalties along with overhead and administrative expenses. The transfers are often very complex with the sole intent to avoid taxation of any kind. In theory, U.S. tax law attempts to reign in the most abusive transfer payments. Corporate transactions provide plenty of opportunity to shift income away from the U.S. subsidiary corporation to the foreign parent corporation.

A corporate inversion is not a tax-free sale or reorganization. Taxes are based on any appreciation of assets held. Inversions are often performed during downturns in the market when corporate assets have taken a hit in value. The United States is going through a downturn now and is legislatively up-in-arms to prevent a rash of inversions.

hillbushaidny.jpgCongress has been concerned about the number of U.S. corporations engaging in corporate conversions and has been considering legislation to trim the practice for the last eight years. Corporate lobbyists have fought hard to keep Congress from changing inversion legislation by effectively bribing lawmakers through the use of influence, favors and contributions. International bankers run many affairs for corporations and have grown quite anxious when they heard that Congress was once again working to make sweeping tax changes.

U.S banks are caught in the middle, being required to abide to the extent that they can, by IRS rules and U.S. laws. When laws are in flux, bankers are worried about the expense of implementing the changes and required supervision to maintain compliance. International bankers are concerned mostly with protecting the money of corporate clients and the protection of their own bottom-line.

Changes to tax code were being proposed behind the scenes and the international bankers were upset because they were unaware of the details. Senators under guidance of Hillary Clinton have been workinclintonwomanincharge.jpgIn a panic, international bankers met with the U.S. Treasury Department on January 28.g to disqualify corporation interest expenses. The Institute of International Bankers met with senior staff from the offices of Senators Schumer and Clinton, who are heading up the measure in the Senate.

The stand of international banking is that since 1991, the Internal Revenue Service has offered “no interpretation or clear guidance” on corporate inversions, even though this has not stopped corporations and bankers from using the ploy to their advantage. According to a letter to Edward Carroll with the IRS, regulations “issued in 1991 have never been finalized, nor have they been updated to reflect legal and business developments. In the absence of clear guidance, it will be difficult for taxpayers to complete the Form, and the utility of the data provided will be compromised since the responses may not be based on comparable factual premises.” The panicky international bankers have requested that they receive advance review privileges to evaluate a draft of changes being proposed before the law is finalized.

Are bankers and corporations worthy of this preferred treatment? The system is based on offshore tax havens, where secret shell companies and bank accounts are used to carry out transactions that create paper profits and losses away from the influence of tax authorities and law enforcement. Estimates are that three million shell companies or offshore centers hold 31 percent of the assets and 26 percent of the stocks of American multinationals. Most of the offshore centers are under the control of international bankers for subsidiaries of multinational corporations. International Banking Corporations like Citibank, Bank of New York, Credit Suisse, Barclays and Deutsche Bank run the game for multinational corporations.

international-trade.jpgSince more than half of world trade is within corporations, half of the world’s trade goes through offshore centers, as corporations shift profits to avoid taxes. These offshore international banking subsidiaries perform functions that allow the corporations to cut their taxes. Offshore offices handle imports and exports, buying a U.S. export from a company at a sharply reduced paper cost and selling it abroad for market value at no profit. In the reverse, a company buys goods at a prearranged price and sells to the corporation at a grossly inflated one. In this way, the U.S. firm has a huge cost to deduct when it uses the item in manufacture or resells it at a loss.

export1.jpgThese are the kind of upstanding citizens that exist in the world of multinational corporate and international banking. This kind of activity has been in vogue since the Clinton Administration. These shady offshore arrangements depend entirely on United States tax code, free trade agreements and legal provisions put in place by lawmakers, allowing corporate bankers and firms to steal from the economy of the United States. Lawmakers have refused to close the gap in law until now. For years, lawmakers have ramped up their efforts to eliminate this offshore profiting, only to drop the matter after spending considerable time and tax dollars on the effort. Whether proposed tax provisions actually make it into tax law in this election year remains to be seen. Perhaps you would like to write to your lawmaker and let them know what you think.

~ E. Manning

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4 Comments leave one →
  1. April 15, 2009 6:26 am

    I read your posts for quite a long time and must tell that your articles must be valuable to readers.

  2. Richard Umbreon permalink
    April 5, 2009 10:09 pm

    Wow, I was reading your article and thinking ok, it has at least some merit given the topic, until I got to the last 3 paragraphs where I then found a ton (and I mean the proverbial ton!) of garbage (aka unsubstantiated gobblegook meant to pass as factual information) on how offshore tax havens are the root of all evil and destroying America. Hogwash, pure and simple.

    As we know, the root cause of all of our economic problems can be found right here in the United States of America, along with most of the other OECD leaders (maybe Canada is an exception at least in some respects) but we have no one but ourselves to blame for our economic duress, and earnings stripping is not even a minute factor in the largesse that has occurred.

    Furthermore, in your 2nd last paragraph, you were in fact describing transfer pricing, but you were t0o ignorant to even understand what you were describing, I found that pretty funny.

    I found the last paragraph the funniest, simply as the leading tax abuser internationally is …… you guessed it, the United States! We are in fact the biggest tax haven.

    BTW, I also got a good laugh out of the 2nd comment from Panama Offshore Services – be advised everyone that there is no such thing as an “offshore corporation” “non-resident company” or “international business company” in Panama. Panama has absolutely no discriminatory company legislation differentiating between companies for doing business domestically, and companies doing business abroad. The only reason Panama typically makes the radar in the offshore world is that Panama taxes all corporations territorially, which means they are taxed on domestic income, but not foreign income. For this Panama is often branded as an “offshore tax haven” despite the fact this has been their tax code since 1910 (long before this was ever a concern). About 1/3 of the countries have similar tax regimes, but of course the high tax OECD countries don’t, thus spank spank for having the gall to be different!

    I found this article while researching another topic and decided to check it out, but based on the blatant misinformation contained within, I am not at all incented to check out any other aspects of your blog, at least not until you skip the rhetoric and actually stick to the facts.

  3. January 17, 2009 6:29 am

    Hi,

    Panama offshore corporations are companies that don’t do significant business in Panama. These Offshore Panama corporations may also be known as offshore companies, International Business Companies, or non-resident companies. They are a great way of maintaining privacy and creating a tax shelter. Thanks for sharing.

    Thanks
    Sofia.

  4. March 31, 2008 4:13 pm

    I came across your blog on Technorati. Nice site layout. I will stop by and read more soon.

    Mike Harmon

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