Technology giants Microsoft Corp and Hewlett-Packard Co used offshore units to shield billions of dollars from U.S. taxes by taking advantage of loopholes and stretching the limits of the tax code, a Senate panel said on Thursday.
Calling tax avoidance rampant in the technology sector, the Senate’s Permanent Subcommittee on Investigations said tech companies used intellectual property, royalties and license fees in overseas tax havens to skirt U.S. taxes.
The panel subpoenaed internal documents from the companies and interviewed Microsoft and HP officials to compile its report, which uses the companies as case studies.
“The tax practices and gimmicks range from egregious to dubious validity,” Democratic Senator Carl Levin, chairman of the panel, said at a news conference.
Officials at HP and Microsoft strongly denied any wrongdoing and noted that tax officials had not objected to the structures.
Levin has been investigating offshore tax evasion for years and often issues reports calling attention to the issue.
Senator Tom Coburn, the top Republican on the panel, signed onto the new report, but he blamed Congress.
“Tax avoidance is not illegal. Congress has created this situation,” Coburn said, criticizing the complex tax code and the 35 percent corporate tax rate, among of the world’s highest, though few companies pay the statutory rate.
The subcommittee said that from 2009 to 2011, Microsoft shifted $21 billion offshore, almost half its U.S. retail sales revenue, saving up to $4.5 billion in taxes on goods sold in the United States.
This was accomplished, the panel report said, by aggressive transfer pricing, where companies put values on intra-company movement of assets. Corporate units are supposed to use a fair market price to value such transfers, but critics say they are manipulated to minimize tax.
The report also said the software giant shifts royalty revenue to units in low-tax nations, such as Singapore and Ireland, avoiding billions of dollars of U.S. tax.
In prepared testimony, Microsoft vice president for tax William Sample said all its units serve a purpose, though he acknowledged tax considerations come into play.
“While the primary objective of our regional structure is to improve our competitiveness and efficiency in each of the three regions, we evaluated available tax incentives.”
Sample also said several of its offshore units employed hundreds of workers, though Levin estimated it was a tiny fraction of its total workforce, compared with the amount of profits shifted to such jurisdiction.
Internal Revenue Service Chief Counsel William Wilkins said in prepared testimony that enforcing transfer pricing law “has been the IRS’s most significant international enforcement challenge.” Wilkins was set to testify later in the hearing.
U.S. companies have at least $1.5 trillion in profits sitting offshore. Most say they are keeping it there to avoid U.S. tax. Of the top 10 companies with the biggest offshore cash balances, five are in the technology sector.
“The high-tech industry is probably the No. 1 user of these offshore entities to transfer intellectual property,” Levin said.
The panel said Hewlett-Packard funded U.S. operations with a stream of intra-company loans, using an exception in the law for short-term loans, to avoid billions of dollars in taxes.
An HP spokesman said it complies fully with tax law and said the IRS has never raised any concerns about the programs cited.
“We are disappointed to see what appears to be a politically motivated attack on one of America’s largest employers,” HP spokesman Michael Thacker said.
Under tax law, foreign profits are subject to U.S. tax when they are “repatriated,” or brought into the United States, usually in the form of a dividend.
One internal document released by the panel suggested that HP routinely brought money into the U.S. without paying U.S. tax. An HP presentation noted that “without planning, repatriation of foreign earnings could lead to tax payments.”
Loans by the foreign units to a related U.S. entity are considered a dividend for tax purposes but there is an exception for loans that are repaid within 30 days, according to the committee’s tax experts.
HP set up a complicated series of short-term loans starting in 2008 to these businesses that were continuous without gaps, to get around that provision, the panel found.
Big companies have lobbied for a tax holiday to let them bring offshore profits into the United States at a reduced tax rate, arguing that the profits are trapped offshore. That effort has fallen flat amid reports suggesting such a program would cost significant government revenue and not produce U.S. jobs.
The report on transfer pricing “mocks the notion that profits of U.S. multinationals are ‘locked-up’ or ‘trapped’ offshore,” Levin said.
The subcommittee also criticized accounting giant Ernst & Young for blessing HP’s practices.
Ernst & Young partner Beth Carr said in testimony that the firm stands firmly behind its auditing for HP.