How Offshore Tax Havens Save Companies Billions Google, Forest Laboratories and other companies shave billions off their taxes by shifting their revenue through countries with lower income tax rates, Bloomberg News reporter Jesse Drucker says.

How Offshore Tax Havens Save Companies Billions

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This is FRESH AIR. I'm Dave Davies, in for Terry Gross.

Today is St. Patrick's Day, and our first guest is going to tell us about the double Irish. That's not a stout, but the name given to a clever financial maneuver that companies like Google, Forest Laboratories and others are using to legally avoid billions in U.S. corporate taxes. Ireland's corporate tax rate is about a third of the U.S.'s.

esse Drucker is a reporter for Bloomberg News who's written extensively about offshore tax havens over the past year. By one estimate, the U.S. Treasury is losing $60 billion a year to corporations who use paper transactions among their foreign subsidiaries, to reduce their tax bill. That's at a time when the federal deficit is ballooning, and government at every level is starved for revenue. I spoke to Jesse Drucker yesterday.

Well, Jesse Drucker, welcome to FRESH AIR. Let's talk about one of these techniques that you've written about for - which companies use to shelter their taxes overseas, which has the colorful name of the double Irish. Google uses it, others. How does it work?

Mr. JESSE DRUCKER (Reporter, Bloomberg News): Well, basically, Google -like a lot of other companies, it has very valuable intellectual property. In 2003, in a transaction that was signed off on by the IRS a few years later, shifted all of the rights, all the non-U.S. rights to its intellectual property to an Irish subsidiary.

In other words, all of the sales it does outside the U.S. that are based on its intellectual property would, at that point, get credited to its Irish subsidiary rather than to the U.S. parent. And that transaction meant that the Irish subsidiary had to pay the U.S. for those rights.

But ideally, if you're a company, you want to pay as little as possible because the more you pay, the more income there is coming into the U.S. You want to allocate as much income as possible into Ireland, where the corporate income tax rate is only 12 and a half percent - compared to the U.S., where it's 35 percent.

DAVIES: Right. And then this also connects to Bermuda, right?

Mr. DRUCKER: Yeah. Well, so what happens from there is that the Irish subsidiary that now controls Google's intellectual property rights outside the U.S. established an office in Bermuda.

It doesn't really have an office. It's actually - it's essentially an address at a law firm in Bermuda. But what happens is that Irish company, technically headquartered in Bermuda, then sublicenses those rights to an Irish operating company.

And so the result of that is that the Irish company, say, sells ads to, you know, anyone in Europe or Asia, and those revenues - and ultimately, those profits - come in to the Irish operating company. But it reduces those profits in Ireland by paying fees to the Irish company headquartered in Bermuda.

So it's essentially shifting income. You have Google shifting it from the U.S. into Ireland, and then from Ireland into Bermuda. This is what's called the double Irish. It's two Irish companies. One is Irish resident for tax purposes; the other is non-resident for tax purposes.

Now, there's an additional step here that makes it more complicated. The Irish company actually doesn't make those payments directly into Bermuda because if it did that, it would get stuck with an Irish withholding tax.

Instead, the payments make another step, to an additional Google subsidiary, this one in the Netherlands. And those payments go - so the payments go from Ireland to Holland to Bermuda. The kind of insertion of that Dutch subsidiary, which has no employees, is what's known as the Dutch sandwich.

(Soundbite of laughter)

Mr. DRUCKER: It's essentially a Dutch subsidiary sandwich by these two Irish companies. So you have, you know, an Irish operating company is out there selling ads. They actually have real employees in Dublin.

They make payments to a Dutch subsidiary with no employees, which in turn makes payments to a Bermuda-headquartered Irish company with no employees. And the result of all of this is that it's all helped to cut about $3 billion off of Google's income taxes over the last three years.

DAVIES: Wow. Let's just talk about the transaction between Google and its Irish subsidiary. Unless I'm missing something, Google runs - it's on both sides of the bargaining table, right? I mean, can this be regarded as a fair price?

Mr. DRUCKER: Well, you're asking a kind of very fundamental question about this. I mean, this is - you know, transfer pricing is the law of the land, not just here in the U.S. but in countries throughout the world.

It's the mechanism for allocating income between different subsidiaries around the world, and every major country in the world. And it essentially relies on the assumption that two subsidiaries of the same company can bargain with each other, and strike a price that's equivalent to an arm's-length transaction that goes on between two unrelated companies out in the real world. That is the term that you hear over and over again in transfer pricing: These are arm's-length transactions; it's the arm's-length method for allocating income.

And there are a number of people out there who think that fundamentally, that that makes this an unenforceable system, that you cannot have two subsidiaries of the same company dealing with each other at arm's length. In other words, there's no way that two subsidiaries could interact with each other the way two unrelated parties at arm's length would deal.

And perhaps even more fundamentally, the transactions that go on in transfer pricing world are transactions that in the real world - forget about the actual price for a minute - that the transactions themselves would never exist. You would never have a company like Google allocating all of its intellectual property rights to all of the world outside the U.S. to an unrelated subsidiary, that that would never happen. And therefore, kind of fundamentally, the system is unenforceable.

There's an attorney named Michael Durst, who was for years an adviser to companies on transfer pricing; worked for one of the big accounting firms and for several big, corporate law firms. And he's really emerged as one of the - as perhaps the leading critic of transfer pricing for precisely this reason. He said it's an unenforceable system.

DAVIES: And all this is perfectly legal?

Mr. DRUCKER: Yeah, all this is perfectly legal. I mean, it's a slightly complicated question because the system of transfer pricing is legal. I mean, it's more than legal. It's required. This is what companies are required to do. They are required to use arm's-length transactions -quote-unquote, arm's-length transactions.

The actual price that they pick is up to them. So it's always a little bit misleading to say the system is perfectly legal. It is perfectly legal, but there's an incredible amount of wiggle room as far as - kind of what price the companies pick.

And there's no one that forces a company to say OK, you are shifting income out of the U.S. into Ireland. Now go an additional step, and shift it into a mailbox in Bermuda.

Now, companies will make the argument these transactions are legal. And their competitors are doing it, and so they have an obligation to shareholders to do it as well.

DAVIES: Now, you've also written about how Forest Laboratories has used this even more effectively, right?

Mr. DRUCKER: Yeah, I mean, Forest has a nearly identical arrangement. They manufacture their drugs in Ireland. What makes Forest a little -what makes them a little bit different is that Forest, for its most valuable drug, an antidepressant called Lexipro - which is one of the bestselling antidepressants of all time - they're actually licensing those rights from an unrelated company.

They didn't come up with that drug, or they didn't largely come up with it. They contributed a little bit to it. But what's so interesting about Forest is that Forest kind of demonstrates how transfer pricing really just kind of removes real-world economics from the world of taxes for multinationals.

I mean, Forest is a company that does almost 100 percent of its sales here in the U.S. They have almost 100 percent of their employees in the U.S. They're headquartered in New York City, and yet the majority of their profits show up overseas, most of them attributed to a mailbox in Bermuda.

DAVIES: Does anybody know how much money the U.S. Treasury is missing because of companies that have taken advantage of these techniques?

Mr. DRUCKER: Well, that's a very good question. I mean, the most recent estimate is from an economist at Reed College, who estimated that the U.S. is losing about $60 billion a year in federal tax revenue. But she actually is in the process of increasing that estimate, and actually has now arrived at a figure of closer to $90 billion.

I mean, the reality is that there are many different ways - there are a lot of different variables that would, obviously, go into trying to measure something like that. I mean, there are essentially - sort of three scholars who have devoted a lot of time to doing that, all using totally different methodologie. And they all arrive at figures in the tens of billions of dollars.

I mean, Kim Clausing, an economist at Reed College, is the one who kind of has the most recent estimate, and she puts it at about $90 billion a year.

DAVIES: If companies are successful in moving enormous profits to subsidiaries offshore, like Ireland or Bermuda, doesn't that mean a lot of their money is going to get piled up in those countries and inaccessible to them unless they want to ship it back, in which they'd pay American corporate tax rates?

Mr. DRUCKER: Right. Well, the way the rules work is that, you know, technically, you're not permanently avoiding U.S. tax when you shift income into tax savings. You're merely deferring it. You're deferring it for as long as you essentially keep it outside the U.S. The term of art is these are indefinitely reinvested earnings. They're indefinitely reinvested in your non-U.S. operations.

And so when you bring it home, then you're supposed to pay U.S. tax. You're supposed to pay U.S. tax minus a credit for the income taxes you've already paid overseas.

Now, there's a couple things that go on there. One is that companies have a number of techniques for bringing back profits without paying the tax.

These often have kind of very colorful nicknames, like the Deadly D and the Killer B. They're kind of named after sections of the tax code. There's a columnist at a trade publication, Tax Notes, named Lee Sheppard, who has come up with some of these nicknames over the years. So she should get credit for that.

But you know, kind of what also goes on is a few years ago, in 2004, Congress passed the American Jobs Creation Act, which permitted companies to bring back profits from offshore one time, at a reduced tax rate - paying 5.25 percent instead of 35 percent.

And companies brought back about $312 billion that qualified for the break. And you know, there's a fair amount of academic literature that shows that very little job creation investment went on as a result of that. And in fact, most of that money was used to buy back stock.

And companies right now are lobbying for essentially, a repeat of that break. You know, John Chambers, the CEO of Cisco, has been kind of the most vocal person leading this charge. And so we may see a reprise of that.

DAVIES: We're speaking with Jesse Drucker. He's a reporter for Bloomberg News. We'll talk more after a short break. This is FRESH AIR.

(Soundbite of music)

DAVIES: If you're just joining us, our guest is Jesse Drucker. He's a reporter for Bloomberg News, and he's been writing recently about techniques that corporations use to transfer profits to offshore subsidiaries.

One of the arguments that corporations make for a tax holiday, for the government permitting corporations to bring back profits from offshore at a discounted rate, is that it would be in effect a free, non-government-sponsored stimulus plan. You know, you get - what - as much as a trillion dollars perhaps, that would come back to U.S. companies and that would be available to, you know, invest in new jobs and productivity. What about that argument?

Mr. DRUCKER: Well, it sounds reasonable. I mean, I think there are two important things to say about that. Number one is that companies - as we speak - according to the most recent data from the Federal Reserve, are sitting on a record pile of cash: $1.9 trillion. So to the degree the economy is challenged right now, it's not because of lack of cash at the disposal of companies.

I think the second thing is that in 2004 - I mean, actually, the money -the break was in '04, but the money came back in '05. There's a fair amount of academic research on what happened. And the result is that there was very little hiring, and very little investment, that went on as a result of the $300-some-odd billion that came back the last time. Most of that money seemed to go to buy back stock.

You know, kind of one the most interesting examples of this was Hewlett-Packard, which in 2005 under the tax holiday, brought back $14.5 billion - and that same year announced it was laying off over 14,000 people.

So you know, kind of both the evidence of the last time, and the reality of how much cash companies are sitting on right here in the U.S., would seem to raise serious questions about how stimulative that would be.

DAVIES: You know, it's interesting that - it's something that you observe in tax law generally - is that, you know, tax laws are enacted with presumably laudable public policy goals in mind: fairly taxing those for what they - people for what they should pay, and then also providing the right incentives that you want.

And then what always happens is that, you know, high-priced lawyers and accountants get busy, and they're smart and creative. And they think of avenues, ways, you know, loopholes to take advantage of them. And I'm sure other countries lose tax revenue to this particular activity, transfer pricing, just as the United States does. Have other countries figured out - anybody else figured out a way to get a handle on it? Do you know?

Mr. DRUCKER: Well, I mean, there's a kind of - it's a great question. It's ultimately, a very complicated question. I mean, you know, there are many different aspects to different countries' tax systems that are different from our own, that kind of make income-shifting more difficult in some other countries.

You know, I think a very easy thing to understand is that a lot of these other countries that have what are called territorial systems for tax and corporate income - the U.S. taxes corporate income on a worldwide basis. Pretty much every other country in the world taxes just what goes on within that country. It's not quite that simple. I mean, they all have some form of taxing income outside the country, but basically that's what they're doing.

A lot of those countries have much higher marginal income tax rates on individuals. I mean, you know, if you were a multimillionaire in, you know, France, Germany or the U.K., I mean, you're looking at marginal rates, you know, sometimes close to 50 percent. A lot of these countries also have valu-added taxes - basically, what's effectively a national sales tax.

So you know, a lot of these other countries kind of have other sources of tax revenue. You know, and the U.S. should probably explore some of these other avenues. I mean, at the very least, the U.S. should probably be exploring kind of some way to deal with the fact that we're losing $90 billion a year to this.

I mean, we're in a situation right now - you know, Camden, New Jersey, is in the process of laying off nearly half its police force. And we can see kind of what is going on with kind of called-for cuts to teachers' salaries, and laying off teachers around the country - when there are tens of billions of dollars in tax revenues being pushed into mailboxes offshore.

DAVIES: Well, you know, President Obama, I believe in his last State of the Union address, talked about simplifying the corporate tax code and lowering the rate. I mean, when you look at what he's doing, does - do his proposals get a handle on this?

Mr. DRUCKER: Well, they had - you know, it's funny. In the first - in the very first Obama budget proposal in early 2009 - they've had a number of proposals dealing with kind of various problems around transfer pricing, and around shifting profits into tax havens.

Probably the most significant one was something that would repeal something called check the box, which - kind of without getting into the details of that, would have made it much more difficult for a company like Google to shift income out of Ireland into Bermuda.

And after intensive lobbying both to Congress and the Treasury Department, they dropped that. The Obama administration dropped that proposal.

A lot of experts would say that would be a very effective - short of changing the entire system, that would have been a very effective tool for mitigating the loss of income, profits being shifted outside the U.S., that - they have other proposals out there to try to deal with this.

I mean, so far, none of them have really gone anywhere. That's not totally true. There was one around so-called foreign tax credits that did become law. But for the most part, they haven't really advanced.

DAVIES: And is that...

Mr. DRUCKER: And one of the problems, also, is that the president talked about lowering the tax rate, and closing some of the quote-unquote loopholes. Now, the problem with that is that there are so many special-interest provisions in the tax code that it's very difficult to get a united front even within the business community on kind of how to approach it because, you know, if you're going to get rid of something that benefits domestic manufacturers, well, they're not going to like that, even if you keep something that benefits, you know, intellectual property, heavy industries like pharmaceuticals.

So there are a lot of things that narrow the tax base, a lot of the special-interest provisions. But kind of getting unanimity on which ones you should keep and which ones you get rid of is, obviously, incredibly difficult.

DAVIES: You know, the other issue that comes up in these discussions is the notion that in an international economy, you have to be competitive. And you see this even among states and cities that will spend, you know, hundreds of millions in tax dollars to lure, you know, sports teams and convention centers - you know, essentially handing money to private interests because they fear that if they don't, the next city or the next state will get the business.

What about the argument that the United States needs to accommodate, you know, international corporations, and if they don't make it possible for them to hold on to their earnings, they'll lose them?

Mr. DRUCKER: Well, obvious - that's absolutely true that the U.S. and other countries need to create climates that are conducive to business. That's absolutely true.

And as long as this system exists where companies have the ability to shift profits, they're going to take advantage of that. I mean, I guess the question is: Do we want to have a system where your taxable income has so little relation to where the real-world economic activity takes place?

And kind of more broadly, I mean, the question it raises about the fairness of the tax system is kind of - the result of this is that it shifts the tax burden to the people that don't have the ability to do this - you know, i.e., the 99 percent of Americans that don't have access to sophisticated tax advisers, and also to the companies that aren't multinational. I mean, not every company which employs people and creates jobs is a multinational company with access to this sort of tax planning.

So you know, kind of especially in this time of - kind of - really severe fiscal straits, I think we want to ask the question of: Who is it that should bear the brunt of the problems here? And should it really only be the 90 percent or 99 percent of Americans who can't afford to send their kids to private schools, and can't afford private security, and can't afford, you know, cars and drivers, the people who rely on public schools and public transportation - should the debate only be about cutting their services? Because by and large, that is the only way the debate is framed.

And should the debate be enlargened to encompass - well, what about the profits that are being shifted into - mailbox overseas by companies that are located here in the U.S.

I mean, the situation with Google, also - obviously - is very interesting because, you know, Google, as we know, is a company that has its start because of U.S. taxpayer funding. I mean, both the original grant at Stanford University, and the scholarship that sent one of its founders, Sergey Brin, to Stanford - those were both funded by you and me, by the taxpayers.

And so the question is: Should we have a system where taxpayers essentially help to fund success and create profitable companies, but then don't fully share in the thing that they need to pay when they make profits, which are their taxes?

DAVIES: Well, Jesse Drucker, thanks so much.

Mr. DRUCKER: Thank you.

DAVIES: Jesse Drucker is a reporter for Bloomberg News. I'm Dave Davies, and this is FRESH AIR.

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