Corporate income stows away abroad

WASHINGTON -- Nearly half of the estimated $233 billion US corporations earned abroad in 2001 is held in foreign tax havens, up from 38 percent in 1999 and 23 percent in 1988, according to an analysis of recent Commerce Department data.

The numbers come as the Internal Revenue Service and Treasury Department are intensifying efforts to reap more corporate taxes in the face of huge federal budget deficits. Corporate taxes last year accounted for only 7.4 percent of total federal tax receipts, the second-lowest level on record behind 1983.

"When it comes to corporate taxation, all you can hear is a giant sucking sound," said Keith Ashdown, vice president of policy and communications at Taxpayers for Common Sense, a nonpartisan budget watchdog. "This is legal money laundering and it's bleeding the federal Treasury white."

Treasury officials say globalization makes it increasingly difficult to track money American companies earn abroad. Fraudulent accounting has grown along with the global reach of US business, while tax lawyers are finding new ways to legally finesse obsolete and porous reporting laws to their advantage.

"Companies are increasingly international," said Pamela F. Olsen, treasury undersecretary for tax policy. "The IRS has dedicated staff watching this, but my concern is their resources may not be as sophisticated as those on the other side. We need statutory change."

New legislation has further hampered tax collectors by making it easier for US companies to claim foreign countries with low tax rates as their headquarters.

"Congress talks tough when companies move offshore to places like the Cayman Islands, but they don't get tough," said Sheldon Cohen, IRS commissioner under President Lyndon Johnson and now an attorney at the Washington law firm Morgan, Lewis & Bockius.

To arrest the decline in corporate tax receipts, the US government has over the last few months:

Sharpened its focus on US companies that manipulate prices in ways that artificially prop up profits in low-tax countries and lower them in the United States.

Issued new rules aimed at reconciling the profits corporations submit to the IRS with the ones they disclose to Wall Street. Firms are legally able to report lower profits to the government than they report to investors because of inconsistencies between tax-accounting and financial-statement rules.

Multiplied the number of audits by shortening the time it takes to inspect a company's books.

Commerce Department data from December illustrate the challenge facing tax officials. The figures show that corporate earnings held in offshore tax havens like Luxembourg or the Cayman Islands have doubled over the last 15 years. Those two countries have tax rates of 0.9 percent and 5.2 percent, respectively, compared with 28 to 35 percent in the United States.

Martin A. Sullivan, an economist and columnist for TaxNotes, a daily journal on tax law and legal issues, combed through Commerce Department data and concluded that the profits US corporations booked in the world's 11 largest tax havens were more than double what they should be considering the scope of their operations there.

US companies recorded 46 percent of their total overseas profits in these 11 tax havens in 2001, the latest year for which figures are available, according to Sullivan's analysis. But these countries accounted for only 19 percent of the overseas economic activity of these companies, as measured by the value of their assets, sales, costs of equipment, and number of employees.

The conclusion, economists say, is that US corporations are getting better at parking excessive amounts of profits in low-tax countries. "This is an inevitable byproduct of globalization," said Joel Friedman, an economist at the Center on Budget and Policy Priorities, a Washington think tank. "There is widespread agreement this is going on and revenue is lagging as a result."

Olsen said she has not seen Sullivan's analysis but acknowledges there is a problem. She said Treasury officials have been calling for years for stiffer transfer-pricing rules, which govern what divisions of a multinational can charge each other. She made a plea in congressional testimony 18 months ago.

"These regulations go back to 1968," she said, "which is why we're working on them now. We have put out a couple sets of changes over the last few months and we are likely to come out with new ones soon. This is a difficult area to administer even with the proper guidelines."

A favorite tactic for corporations angling to park income abroad is known as "cross-sharing," in which a parent firm licenses its trademark or copyright to an affiliate in a country with low taxes. That country effectively becomes the repository for the income earned from that license, which makes the firm's taxes lower than they would be if the trademark remained in the United States.

Companies will also sell their products at artificially low prices to subsidiaries based in a tax haven, keeping the corporation's US tax exposure to a minimum. The subsidiary then sells the goods locally at market rates at a large profit that is taxed at the foreign country's low rate. Such transactions, known as "transfer pricing," allow US companies to concentrate income into low-tax jurisdictions, then wire those profits home during a bad earnings year.

Conversely, a US company may buy a product from a foreign subsidiary at an artificially high price. When the US company then resells the product in the United States, the profit appears small. The result: lower US taxes.

Disputes between the IRS and firms over transfer pricing are rarely made public, but occasionally one surfaces in the courts. In January, the IRS charged UK drug giant GlaxoSmithKline PLC with underpaying taxes of $5.2 billion on US profits earned between 1989 and 1996.

The Glaxo suit, which evolved from a 1992 audit, revolves around the company's top-selling ulcer drug Zantac. The IRS says Glaxo's US subsidiary paid too much for the drug, which artificially reduced the taxable income it earned on Zantac's US sales. Glaxo counters that the price was justified by the high costs of researching and developing the drug, which was done in Britain.

The Treasury Department has also issued a more detailed tax-return form for corporations to get a clearer picture of their true net income. Since the mid-1990s, the IRS has identified a widening gap between the "book" income companies report to their shareholders and the income they disclose to the government for tax purposes. Though the divergence can result from legal accounting strategies, it creates a murky environment that is fertile for abuse.

In 1998 the National Bureau of Economic Research, a nonprofit research institute, found that some $154 billion -- equal to half the gap between "book" and "tax" income for that year -- could not be reconciled using traditional accounting methods and attributed at least part of the difference to deceptive practices.

IRS officials say more detailed tax returns -- the old form dates back to the 1960s -- will make it easier to establish whether the gap between book and tax income is due to illegal activity.

The Treasury Department also hopes cutting the time it takes to process an audit -- from 38 months to between 15 and 18 months -- will allow inspectors to examine more companies.

"Right now we have a huge percentage of resources on large companies and not the second, third, or fourth tier," said Olsen. "We have to find some way of speeding up the process."

Stephen J. Glain can be reached at glain@globe.com.