This elaborate tax structure, which is entirely legal, even has a name: the Double Irish Dutch Sandwich. Apple Inc. was one of the pioneers of this system back in the 1980s, but hundreds of other multinationals have now caught on, says DLA Piper's Ryan, who was tax director at Apple in the 1980s and helped establish and defend the company's international tax structure. "A lot of countries now actively encourage companies to set up within their borders to take advantage of their low tax rates," he says. "Their governments even have offices in the U.S. to promote their tax benefits." (Fittingly, Ryan was in Amsterdam when he talked to Corporate Counsel .)
Other tech companies known to use the convoluted but highly effective tax savings scheme include Google Inc., Amazon.com Inc., Adobe Systems Inc., and Microsoft Corporation.
To be sure, multinational corporations have a big incentive to shift profits out of the U.S. The corporate tax rate here is 35 percentone of the highest in the world. If done right, a company's overseas tax rate can be significantly lower. Apple, Oracle, Microsoft, and IBM Corporation reported tax rates of 4.525.8 percent on their overseas earnings between 2007 and 2009. "Transfer pricing is a perfectly acceptable, common, appropriate, and legal way for a company to structure its business affairs," says Andy Gottlieb, former general counsel at Novellus Systems Inc., a semiconductor equipment maker that merged last year with Lam Research Corporation and engaged in transfer pricing. "Companies should be looking at ways to??enhance shareholder return. That's their job."
Setting up transfer pricing transactions is not easy. It is highly regulated, and over the years the U.S. Department of the Treasury has issued thousands of pages of rules governing such arrangements. The key concern for regulators is whether the transfer prices between a multinational's various companies are established on a market-value basis. They are supposed to be determined at "arm's length," meaning that prices should be the same as they would have been had the parties to the transaction not been related to each other. This requirement is imposed with the aim of preventing companies from systematically moving around their assets to low-tax jurisdictions.
But this is where disagreements between regulators and companies arise. "Pricing IP is not an exact science," says John Ryan, a partner at Bingham McCutchen in Palo Alto who specializes in tax planning and audit defense. "IP is unique and noncomparable, so even with the best of intentions, estimates of an 'arm's length' price can be far apart." Even when companies settle disputes with the IRS over taxes owed on transfer pricing transactions, the government is lucky to get 4 or 5 percent of the proposed amount, he says.
Also, most transfer pricing transactions between a parent company and its offshore subsidiary would never occur between unrelated parties, notes Kenneth Clark, a partner at Fenwick & West in Silicon Valley, where he chairs the firm's tax litigation group: "So there can be reasonable disagreements as to what constitutes an arm's length price."
But the IRS is cracking down nonetheless.
In late December the IRS filed a case against Amazon in U.S. Tax Court in Washington, D.C., saying that the online retailer owes $234 million in taxes for the 2005 and 2006 fiscal years. The case centers on a transfer pricing dispute. Amazon argues that the IRS is overestimating the value of its intangible property, which includes computer software, trademarks, and marking assets, according to the court filing.
Juniper Networks Inc. disclosed last year that the IRS is claiming that the company underpaid taxes related to transfer pricing transactions and owes almost $900 million in additional taxes for the 200406 fiscal years. The Silicon Valleybased company, which makes networking equipment, is fighting the IRS 's claims.
Eaton Corporation, which manufactures electrical components, is going to Tax Court to contest the IRS 's claim that it owes $75 million in taxes related to transfer pricing transactions. The Cleveland-based company announced in May that it will move its headquarters to Ireland, where the corporate tax rate is 12.5 percent.