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Silicon Valley vs. Corporate Taxes

March 12, 2013

Other tech companies have disclosed transfer pricing disputes with the IRS, including AOL Inc., Adobe, Hewlett-Packard Company, Microsoft, and Yahoo Inc., to name a few. Press reports have indicated that Google is being audited on some of its transfer pricing transactions. The amount of money at stake in all these matters is quite large," Bingham's Ryan says.

Lawyers and economists say that the IRS's renewed aggressiveness is due largely to the arrival of Sam Maruca, who was hired in 2011 to fill the agency's newly created post of transfer pricing director. The experienced international tax specialist, who worked at Covington & Burling before joining the agency, is highly respected and knowledgeable, they say. "Maruca came in and hired a cadre of people from the private sector—people who knew where the vulnerabilities were," says Warner, who has known Maruca for many years. He brought in accountants, economists, and lawyers from Big Four audit firms such as KPMG and Ernst & Young, and from the economics and tax consulting firm Horst Frisch. He also hired experienced tax attorneys from private law firms.

Even before his arrival, the IRS had been trying to stop companies from manipulating the system. But the agency suffered harsh defeats in several transfer pricing cases brought against companies it claimed had undervalued assets and skirted around regulations to avoid paying taxes. In one, brought against Veritas Software Corporation, now part of Symantec Corporation, the IRS said the company owed about $545 million in contested back taxes, plus interest. But the court strongly disagreed. In his opinion, U.S. Tax Court Judge Maurice Foley rebuked the agency, calling its calculations "arbitrary, capricious, and unreasonable."

"That loss emboldened tax advisers who help companies set up transfer pricing arrangements," says Elizabeth King, an economist specializing in transfer pricing issues at Beecher Consulting in Boston. "It creates enforcement problems when the IRS loses a big case." King previously worked at Price Waterhouse and at the IRS.

But many think that under Maruca's leadership, IRS examiners and economists are getting the tools they need to not only avoid fiascos like Veritas, but also to find a test case that will have an impact and send a message. "People in the tax advising community believe that Sam will start bringing cases that ought to be brought—cases in which there is real evidence that a company has underpaid its taxes," says Warner.

While a test case may still be a few years off, some believe that Maruca is already making his mark. Fenwick's Clark, for example, says that he sees many more IRS attorneys in attendance at audit appeals conferences. And John Ryan says the agents are more ­organized and better prepared than in the past.

The renewed rigor by regulators has made tech companies in Silicon Valley nervous. They're discovering that they're more in need than ever before of tax planners and audit specialists. And law firms in the area are, not surprisingly, answering the call.

Bingham McCutchen, which didn't have a tax practice in Silicon Valley, hired John Ryan away from McDermott Will & Emery, and Robert Kirschenbaum from Miller & Chevalier, to set up a tax practice there. Last year Skadden, Arps, Slate, ­Meagher & Flom moved two tax partners from Washington, D.C., to Palo Alto, and also hired Matthew Kramer, a former IRS attorney, as counsel. And in December, Foley & Lardner announced that Frederic Adam, who was a KPMG tax partner specializing in international tax matters, had joined its tax practice.

And the work isn't just coming from the usual suspects. Silicon Valley–based attorneys say they are getting calls from start-ups that need tax planning guidance to set up transfer pricing arrangements as they expand globally. Many of Silicon Valley's startups are managed by former senior executives of big tech companies that successfully used transfer pricing to lower their effective U.S. tax rate, says DLA Piper's Ryan: "It's not a foreign concept for them."

While activity in Silicon ­Valley is heating up, lawmakers in Washington are also on the warpath. Levin, who chairs the powerful Senate permanent subcommittee on investigations, made his harsh statements during a hearing on offshore profit-shifting activities. The subcommittee has reportedly looked at the activities of Google, HP, Microsoft, Apple, and some biotech companies. Part of their focus has been on the companies' offshore profit-shifting practices and the impact they have on the budget deficit.

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